Thursday, February 16, 2017

The Economic Vision for Precocious, Cleavaged India

India has more than 1.2 billion people, and it is has been growing rapidly and carrying out substantial policy changes, but it seems to get only a small fraction of the attention paid to China. For those looking to get up to speed on India's economy, a useful starting point is the Economic Survey 2016-2017, published in January 2017 by India's Ministry of Finance (where Arvind Subramanian is the Chief Economic Adviser). The page also has a drop-down menu with links to previous annual surveys.

The title of this post is taken from the title of Chapter 2 of the report. "Precocious" refers to the facgt that India has been a democracy for so long, and that it turned to democracy started when the country was at such low level of per capita GDP. The term "cleavaged" refers to separations in India. As the report notes: At the same time, India was also a highly cleavaged society. Historians have
remarked how it has many more axes of cleavage than other countries: language and scripts, religion, region, caste, gender, and class ..." Here are seven points from the report that stuck with me.

1) In recent years, India's rate of economic growth is faster than China, and India has not been taking on the extraordinary debt load of China. 

The left-hand panel shows GDP growth (blue line) and debt/GDP level (red line) for China. The right-hand panel shows the same patterns for India.
2) India has become quite open to foreign trade,but also to internal trade across regions of India. 

For example, here's a figure comparing China and India on trade as a share of GDP.
And here's a figure showing where the horizontal axis shows the size of a country's population (measured in logs) and the vertical axis shows trade/GDP. Countries with more people tend to have  relatively more internal trade, and thus their ratio of external trade/GDP is lower. China and India are both out at the far right as large-population countries. Both are above the best-fit line, which means that their level of external trade is higher than the usual pattern, given their population levels.

When it comes to India's internal market, and flows across state borders, the report notes:
India’s aggregate interstate trade (54 per cent of GDP) is not as high as that of the United States (78 per cent of GDP) or China (74 per cent of GDP) but substantially greater than provincial trade within Canada and greater than trade between Europe Union (EU) countries (which is governed by the “four freedoms”: allowing unfettered movement of goods, services, capital, and people). This is all the more striking given that the data here covers mainly manufactured goods, excludes agricultural products, and is therefore an underestimate of total internal trade in goods. A substantial portion (almost half) of trade across states in India occurs as stock transfers within firms. That is, intrafirm trade is high relative to arms-length trade ... 
3) India has become fairly open to inflows of foreign capital. 

The left-hand panel shows capital flows as a share of GDP over five years, in which India is pretty similar to Indonesia, Mexico, and China. The right-hand panel shows patterns just for India of inflow of foreign direct investment, which have been rising as a share of GDP.

4) In many Indians states, wages for semi-skilled workers are low by world standards. 

The report discusses the possibility that India could latch on to a substantial share of low-wage manufacturing in areas like apparel and shoes.

5) India has has more success than many low-income countries in participating in international trade in services, but with the tides seemingly running against globalization, there is some question about whether this will continue.
"If India grows rapidly on the back of dynamic services exports, the world’s service exports-GDP ratio will increase by 0.5 percentage points—which would be a considerable proportion of global exports. Put differently, India’s services exports growth will test the world’s globalisation carrying capacity in services. Responses could take not just the form of restrictions on labor mobility but also restrictions in advanced countries on outsourcing. 
"It is possible that the world’s carrying capacity will actually be much greater for India’s services than it was for China’s goods. After all, China’s export expansion over the past two decades was imbalanced in several ways: the country exported far more than it imported; it exported manufactured goods to advanced countries, displacing production there, but imported goods (raw materials) from developing countries; and when it did import from advanced economies, it often imported services rather than goods. As a result, China’s development created relatively few export-oriented jobs in advanced countries, insufficient to compensate for the jobs lost in manufacturing – and where it did create jobs, these were in advanced services (such as finance), which were not possible for displaced manufacturing workers to obtain.
"In contrast, India’s expansion may well prove much more balanced. India has tended to run a current account deficit, rather than a surplus; and while its service exports might also displace workers in advanced countries, their skill set will make relocation to other service activities easier; indeed, they may well simply move on to complementary tasks, such as more advanced computer programming in the IT sector itself. On the other hand, since skilled labour in advanced economies will be exposed to Indian competition, their ability to mobilize political opinion might also be greater."
6) India is experiencing a sharp divergence and widening gaps in income and consumption across the states of India. 

Here's a figure showing per capita GDP, with each row showing a state of India. The red squares show the levels in 1984; the blue circles, in 1994; the green triangles, 2004; the yellow diamonds, 2014. The spread across regions is clearly widening. The figure reminds me of an old line about the economy of India, describing it as "part southern California, part sub-Saharan Africa."

There are several layers of puzzle here, as the report notes:
"Poorer countries are catching up with richer countries, the poorer Chinese provinces are catching up with the richer ones, but in India, the less developed states are not catching up; instead they are, on average, falling behind the richer states. ... This trend is particularly puzzling since that the forces of equalization—trade in goods and movement of people—are stronger within India than they are across countries, and they are getting stronger over time. This raises the possibility that governance traps are impeding equalization within India. ...
[O]ne possible hypothesis is that convergence fails to occur due to governance or institutional traps. If that is the case, capital will not flow to regions of high productivity because this high productivity may be more notional than real. Poor governance could make the risk-adjusted returns on capital low even in capital scarce states. Moreover, greater labor mobility or exodus from these areas,  especially of the higher skilled, could worsen governance.  A second hypothesis relates to India’s pattern of development. India, unlike most growth successes in Asia, has relied on growth of skill-intensive sectors rather than low-skill ones (reflected not just in the dominance of services over manufacturing but also in the patterns of specialization within manufacturing). Thus, if the binding constraint on growth is the availability of skills, there is no reason why labor productivity would necessarily be high in capital scarce states. Unless the less developed regions are able to generate skills, (in addition to providing good governance)
convergence may not occur. ... 
Both these hypotheses are ultimately not satisfying because they only raise an even deeper political economy puzzle. Given the dynamic of competition between states where successful states serve both as models (examples that become evident widely) and magnets (attracting capital, talent, and people), why isn’t there pressure on the less developed states to reform their governance in ways that would be competitively attractive? In other words, persistent divergence amongst the states runs up against the dynamic of competitive federalism ...
7) India's economy is mostly driven by the private sector, but surveys in India reveal a high level of ambivalence about the public sector.  

The green bars show production from state-owned enterprises in India--known there as "public sector undertakings" or PSUs--as measured by share of sales, profits, assets, and market value. The red bars show the same measures for China; yellow bars, Russia; dark blue bars, Brazil; gray bars, Indonesia; light blue bars, South Africa; purple bars, Malaysia. All of these countries show what would be a large level of state-owned enterprises by the standards of high-income countries, but India does not especially stand out. .

However, India does stand out in how its citizens feel about the private sector. This graph shows the results from a group of questions about the private sector on the World Values Survey. The level of pro-market sentiment in India is comparable to Argentina and Russia.

There is much more in the report. For example, a number of chapters are focused on specific policy changes and proposals. One chapter discusses the "demonetisation," in which India recently took its two largest-denomination notes out of circulation, abruptly and without warning, as a way of fighting corruption, crime, and the underground economy.  Another chapter discusses the possibility of a large public agency to take on the legacy of bad debt, and clear the balance sheets for large companies and banks, so that they can focus on looking ahead rather than on cleaning up past problems. Yet another chapter discusses the idea of a universal basic income in India. "The central government alone runs about 950 central sector and centrally sponsored sub-schemes which cost about 5 percent of GDP." But these programs impose considerable bureaucratic cost and fail to assist many of the actually poor.

Homage: I ran across a mention of this report in a post by Alex Tabarrok at the always-interesting Marginal Revolution website, which focuses on a chapter of the report discussing how a number of India's governmental redistribution programs are ineffective and even counterproductive.