Well, here I am, hard at it trying to write a review for this blog of the latest Economist Intelligence Unit country risk report on India (which, worry not, will follow in due course) and what I find myself doing is revving-up on all cylinders to come back and point out some of the facts of this life to all those people who spent their time during the second half of 2006 arguing that India was overheating when it was busily growing away at a mere 8%. In fact India’s growth has not only continued, it has even accelerated slightly since the debate got started, growing at an 8.9% year-on-year rate during the most recent quarter (following 9.1% and 9.3% in the first and second quarters of calendar 2007, respectively). And far from inflation shooting up and away through the roof it is currently not too far from the Reserve Bank of India’s 5% target. Perhaps it is towards China or Russia that people should be directing their attention, or towards Eastern Europe, or even – god forbid – the eurozone, but India it seems is one country where the “great overheating” argument is steadily running out of steam. Of course there is one country which everyone will readily admit is not overheating, and in comparison with the rate of negative price increases they have on their hands in Japan India’s inflation may seem serious, but I think we can safely leave that topic on one side for today.
At this point I just want to repost part of a reply I gave to the Economist when they had the kindness to try to answer some points I had raised about the general quality of their economic coverage, and in particular about what I take to be their obsession with ignoring the demographic component in economic growth. For the Economist, it seems, growth and development is a single issue item, and is all about insitutions, and institutional quality. Which makes it kind of funny that Argentina, which must be among the worst of the emerging economy pack in institutional quality is still powering away, despite more or less openly manipulating their inflation data.
Obviously institutions matter, but so does demography. This is not a one horse race, or if you prefer, this particular horse doesn’t only run on one leg.
The topic in question here is India’s potential growth rate. Recent GDP performance at just under 9% must have been astounding many of India’s critics, especially given the way inflation, despite all that growth, has been kept pretty much under control.
So to go to the start of our story, back in September 2006, I posted a piece here on this blog entitled “Uncharted Water” where I argued precisely the following:
What is clear is that the Indian economy is currently gathering steam, and this at a time when there is a general consensus that the political will for reform isn’t what it used to be. Strange isn’t it?
My meaning here isn’t that reforms aren’t necessary, but that there are other factors at work, and in particular demographic ones. The importance of these demographic factors generally can be seen from the fact that it is now the newly developing countries (China, India, Brazil, Chile, Thailand, Turkey) who are pulling the global economy (and in the process pushing up energy and commodity prices). The developed world – which makes up say 50% of global GDP is growing much more slowly than the developing world – and some of this for ageing related demographic reasons. Global GDP is forecast to grow at a 5% annual rate this year, yet the US is growing at around 3.5%, Japan 2.5% and the eurozone around 2%. So you tell me, who is pulling who here?
And this is why I say we are moving into uncharted territory. Economists used to have a little model which worked on the assumption of each economy having a certain growth capacity in any given moment. But could any one tell me, what *is* the growth capacity of China or India? I certainly have no idea, and I haven’t seen anyone else make a convincing case on this topic. The magnitude of the growth we are now seeing in the developing world is beyond all historical precedent.
Doesn’t look to bad at all, does it, in the light of what has been happening during the second half of this year. And remember this was written in the Autumn of 2006, not Autumn 2007 when just about everyone and their auntie is saying something like this. Of course this whole debate is ongoing. Nandan Desai had an excellent piece here earlier in the year which put things pretty much in perspective and in October 2006 I had another piece in the IEB, basically in response to the Sizzling India article in the Economist, where I said:
I am even brazen enough to believe that trend growth may well have moved up beyond 8.5% going forward, and that indeed within 5 years we may well see India overtaking China in terms of average quarterly growth rates (of course this may well vary from one quarter to another, a phenomenon known as volatility, and of course 5 years from now the Chinese economy may not still be sustaining the very high growth rates we see today).
Again, I am really comfortable standing by this, and even the point about China, since the inflation problem really does seem now to be getting a grip there, in a way which it isn’t doing in India (and remember they have had nearly 30 years now of the one child per family policy, and at some point soon their labour market is going to tighten and tighten, and for a glimpse of what may well happen next in China see my recent analysis of the growing problem we now see in Russia: “Russian Inflation, Too Much Money Chasing Too Few People” (not too much danger of this getting to be a problem in India in the near future, now is there?).
Since this time of course, the whole recoupling/decoupling issue has really taken off as a live debate. My latest thoughts on this can be found here, and Claus Vistesen’s post – The Global Economy, Compass and Charts Needed – follows up on and continues the “uncharted waters” theme.
Well, now for the Economist. What I said in my response to them was the following:
To The Economist
At the risk of having to assume some kind of modern “j’accuse” mantle (for which of course there are ample precedents in the early origins of your own magazine) I am going to put up yet another comment. Maybe this is because I would like to participate in that “severe contest between intelligence, which presses forward, and an unworthy, timid ignorance obstructing our progress” which your contents page so boldly announces.
Maybe it is also because I want to pin down quite clearly for future reference just what the issues are, and just why it isn’t “absurd” to suggest that the Economist currently systematically fails to factor-in the demographic components in economic growth (or the lack of it). Well, saving the best (or should that be the worst) to the last, I would like now to come to the case of your India correspondent. This gentleman (and I sincerely hope that despite his evident predilection for strong Vindaloo curry he is one of these) has been systematically re-adjusting upwards India’s potential trend growth rate in recent months. In fact his estimate seems to have shot up from 6.5% in November 2006 to 7% in February 2007, to 8% in June 2007. Now that’s an upward adjustment of around 25% in trend growth in roughly 8 months. Quite an achievement, especially since he offers absolutely no explanation whatever for these adjustments, but what he does not fail to tell us – oh, he never lets a moment rest without beating this drum – is that: “India’s economy, like Delhi this week (or Vindaloo curry perhaps, EH), remains far too hot.”
Now just in case what I am suggesting here is questioned I would like to quote chapter and verse, since the issue is an important one.
In November 2006 the Economist’s India correspondent estimated capacited growth for India at around 6.5%.
23 November 2006 Too Hot To Handle
INDIA’S curries can be even hotter than the fieriest of Chinese hotpots; likewise the temperature of the two economies. Despite widespread claims that China’s economy is overheating, actually India’s shows more signs of boiling over.
In the year to the second quarter, India’s GDP grew by an impressive 8.9%, while China’s more up-to-date figures show even more breathtaking growth of 10.4% in the year to the third quarter. But to judge whether an economy is too hot, one needs to compare this expansion in actual demand with potential supply, ie, the sustainable rate of growth. Despite India’s growth spurt in recent years, its sustainable pace is still much lower than China’s, which puts its economy more at risk of overheating and rising inflation.
India’s trend growth rate has almost certainly increased but it is still nowhere near as high as China’s. Mr Prior-Wandesforde estimates that it is now around 6.5%, up from 5% in the late 1980s. But India’s recent acceleration largely reflects a cyclical boom, thanks to loose monetary and fiscal policy. The Reserve Bank of India has raised one of its key interest rates by one and a half percentage points to 6% over the past two years, but inflation has risen by more, so real interest rates have fallen and are historically low. This makes the economy more vulnerable to a hard landing.
By February 2007 the estimate had risen to “not much above” 7%.
1st February 2007 India overheats
“But the problem is that this new speed limit is almost certainly lower than the government’s one. Historic data would suggest a figure not much above 7% – well below China’s 9-10%……If something is not done, then a hard landing will become inevitable.”
and by June 2007 it had been revised up nearer to 8%.
June 7th 2007 Waiting For The Monsoon
“This is not to deny that India’s economic speed limit has increased, to perhaps 7-8%, thanks to stronger investment and economic reforms. But growth has exceeded that limit. The economy still shows alarming symptoms of overheating”
And depispite all this, we are now in December 2007, the Indian economy has been growing at around 9% for the last three quarters, and inflation has been kept, as I say, remarkably under control.
So actually what we are all really waiting for here is not the arrival of the monsoon, but some explanation from the Economist’s India correspondent about how he is calibrating all these estimates. There is nothing particularly to be embarassed about in getting this one wrong, since it is pretty difficult to put a number on where Indian growth is going, but it does seem hard to maintain the credibility of your calls if you conveniently keep ignoring what you were saying only yesterday, and more importantly fail to diagnose exactly why it is that India has been able to grow so much faster than you expected. And of course one day India may overheat, and stopped clocks do give the right time twice a day, but this doesn’t make them especially useful measuring instruments.
Back in the autumn of 2006 I argued that we were now entering “uncharted waters” and that no-one really had any accurate idea of what India’s true mid-term trend growth rate actually was. I also asserted that it was in all probability way above the more conservative and conventional estimates. I was guessing really, but behind my guesswork was a long hard look at India’s underlying demography, and it is just this kind of approach that the Economist India correspondent discounts. Again, chapter and verse:
1st February 2007 India On Fire
Many Indian economic commentators say that further structural reforms, though desirable, are not essential to keep the economy growing at 8% or more because of the “demographic dividend”. A fast-growing working population and a falling dependency rate (thanks to a lower birth rate) will ensure more workers, more saving and hence more investment.” “India’s demographic structure is indeed starting to look more like that in East Asia when its growth took off. But this mechanistic view of growth assumes that demography is destiny and that economic policies do not matter. In fact, open markets, education and investment, especially in infrastructure, were the three chief ingredients of East Asia’s success. Population growth by itself does not add to prosperity, unless young people are educated and new jobs are created. India needs to reform its absurdly restrictive labour laws which hold back the expansion of manufacturing particularly.”
Basically I find myself in agreement with the Indian economists he doesn’t like. It isn’t that these reforms aren’t desireable, as he admits, we all agree on this. But the point is, even ex-reforms (and of course there have been reforms and global opening) demographic momentum would indicate that substantial growth is now going to occur. How substantial? Hard to say, but I think it is quite probable that 5 years from now India will be growing faster than China, and may even peak out at the highest annual growth rates yet seen for a significant economy over the 5 to 10 year window. I can justify why I think this with some sort of coherent argument, but I think the big danger for the sort of view they are advancing at the Economist is that they imagine virtually nothing is possible without institutional reform, and this is just as big a mistake as saying demography is everything. You need to systematically take the two components into account. If you don’t do this you risk getting into the ridiculous position the World Bank found itself in earlier in the year, when countries like Argentina and Thailand complained that since their countries were registered as going backwards on the global governance index, while both countries were growing quite nicely, then logically the methodology used to construct the index must be wrong. IMHO the World Bank has been totally mechanistic about institutions and thoroughly deserves all the problems it creates for itself on this count. OK, so that’s it. I finally rest my case. The dialogue will continue.
And it is, undaunted by the failure of all that vindaloo curry to overheat more than his own digestive tracts our dear correspondent is now worrying about, guess what, the rise of the rupee. More on this, and the real current state of the “overheating” situation in my next post tomorrow.