There's really no question about it: the world economy
is heading for a period of great economic uncertainty,
in which instability, trade and currency conflicts
and possibilities of economic stagnation all loom
large. This reflects the absence of a global economic
leader willing and able to fulfil the roles identified
by Charles Kindleberger: discounting in crisis; countercyclical
lending to countries affected by private investors'
decisions; and providing a market for net exports
of the rest of the world, especially those countries
requiring it to repay debt. For obvious reasons, the
US cannot currently do these, and there is no evident
alternative. That is why co-ordination is so critical
right now for international capitalism, and why its
absence will definitely be felt.
Governments
of both developed and developing countries seem to
be caught between the (often self-imposed) rock of
fiscal consolidation created by the hysteria of bond
market vigilantes and the financial media, and the
hard place created by the unwillingness to give up
what is clearly an outdated growth model. As a result,
we are faced with the worst of all economic outcomes
in terms of socially fraught stagnation in the North
and ecologically destructive and fragile expansion
in the South, with workers everywhere getting even
worse off than before.
There are three major imbalances that continue to
characterise the global economy: the imbalance between
finance and the real economy; the macroeconomic imbalances
between major economies; and the ecological imbalance
created by the pattern of economic growth. While these
are obviously unsustainable, the very process of their
correction will necessarily have adverse effects on
current growth trajectories.
As it happens, the US current account deficit is already
under correction: the current account deficit in 2009
was just above half its 2008 level, and the data for
this year suggest that it will stay at around that
level. For the rest of the world, it does not really
matter whether the reduction occurs through currency
movements or trade protectionism or domestic economic
contraction: the point is that some other engine of
growth has to be found.
Curiously, the governments of the major economies
in the global system, including G20, do not seem to
have grasped this. The rather obvious point that all
countries cannot use net export growth as the route
to expansion does not seem to have been understood;
so, all governments think they can export their way
out of trouble. This will have inevitable implications
for trade and currency wars, and the likelihood of
global economic stagnation.
So, how well is the Indian economy likely to cope
in the near future, and how will the population as
a whole fare in these uncertain times? There has been
much celebration in the financial media in India about
how well we have weathered the Great Recession, and
certainly the output indicators (Chart 1) are impressive
in the overall global context. Despite poor agricultural
performance, rates of growth of aggregate GDP have
remained high because of continued high growth in
services and significantly accelerated growth of industry
(dominantly manufacturing).
Chart
1 >> Click
to Enlarge
However, the recent pattern of growth has in general
been so heavily skewed towards certain services that
it has created an apparently unbalanced economy (Chart
2). Agriculture and other primary activities account
for less than 15 per cent of GDP, even though they
continue to employ well over half the workforce in
what is obviously mostly low-productivity activity.
Manufacturing has remained stable, and relatively
small in output and even smaller in employment. However,
the newer services that now dominate the GDP do not
employ too many people either, so that most other
workers are engaged in low remuneration services.
Meanwhile, the FIRE sector (finance, insurance, real
estate, and business services) has been growing rapidly
and now accounts for an even higher share of GDP than
manufacturing – a sure sign of a bubble economy.
Chart
2 >> Click
to Enlarge
So
this means that we are back to the same unsustainable
pattern of growth that generated the images of ''India
shining'': booms in retail credit sparked by financial
deregulation and enabled by capital inflows. These
have been combined, especially in the wake of the
global crisis, with fiscal concessions to spur consumption
among the richest sections of the population. This
has generated a substantial rise in profit shares
in the economy and the proliferation of financial
activities, and combined with rising asset values
to enable a continuation of the credit-financed consumption
splurge among the rich and the middle classes along
with debt-financed housing investment.
The problem is that this is associated with a balance
of payments trajectory that is fundamentally unsustainable.
As Chart 3 shows, it is only the invisibles account
(led by remittances from India workers abroad and
software and related exports) that has kept the balance
of payments from appearing to be even more stark.
The trade account shows ever growing deficits, which
are increasingly driven by non-oil imports. Meanwhile,
the large inflows of capital are really being stored
up in the form of foreign exchange reserves, for fear
of causing excessive exchange rate appreciation.
Chart
3 >> Click
to Enlarge
In fact, after a brief period
of reduction, India's place as a currently favoured
destination for internationally mobile capital was
reinforced in the past year. Chart 4 shows how different
elements of the captial account have behaved in recent
years. The most rapid post-crisis recovery has been
in portfolio capital, which fell during the crisis
year but surged back to high levels the subsequent
year. In fact, the most recent data (not covered in
this chart) indicates a troublesome surge in such
hot money inflows, of more than $70 billion in just
a few months – troublesome because it can lead to
an unwanted currency appreciation and because it can
just as easily flow out again.
This
is a problem plaguing several emerging economies,
and underlines the need for capital controls to prevent
unwanted inflows of speculative capital. So much so
that even the IMF has started advocating such controls
for developing countries that are being swamped by
the ''carry trade'' based on interest rate differentials
across economies.
Chart
4 >> Click
to Enlarge
Unfortunately, our own government seems much less
consious of the dangers such inflows pose, especially
for an economy that is clearly in the midst of another
bubble-driven expansion. Instead, Ministers are talking
about the economy being able to absorb at least another
$100 billion of capital inflows – unmindful of the
reality that the economy has not even absorbed the
smaller amounts that are currently pouring in, and
instead is simply accumulating reserves.
In
any case, such absorption has to be sustainable, which
is why much more attention is required to improving
the trade account. This is going to be much more difficult
in the current global economy, but clearly the need
is for both diversification of trade and more attention
to sustainable expansion of the domestic market.
The good news is that on the external trade front
there does seem to have been a significant process
of diversification in the past decade, as Charts 5
and 6 indicate. China is among our largest trading
partners now, though that dominantly consists of India
exporting raw materials and intermediates and importing
finished goods from China. The Middle East has also
emerged as a major market, and other areas are playing
increasing roles as well.
Chart
5 >> Click
to Enlarge
Chart
6 >> Click
to Enlarge
However, without sustained expansion
of the domestic market, the condition of the bulk
of the Indian population will not improve. This really
requires increasing the disposable incomes of wage
earners and the self-employed, not just a credit-based
expansion of demand that is bound to end in tears.
But for this, there has to be more official focus
on generating both employment and better remuneration.
This is actually quite doable, since it can be led
by increased public provision of essential goods and
services (all of which are employment generating and
have high multiplier effects). But for that, we need
genuine political will.
