India, China and the World Economy

Despite the financial crisis and the associated gloom, I firmly believe that the world economy is on the threshold of a new era. Many people realize this, of course, though from different perspectives: the software developer in the United States feels his job is threatened, the call center employee in India finds a new lifestyle, European and American business schools look to Singapore for greener educational pastures, and third world immigrants make up sizable fractions of the populations of many industrialized countries. Some have argued that globalization is nothing new – that we saw it all a hundred years ago – but today’s low costs of physical transport and (especially) of information transfer will have much deeper impacts than before. Another new development is the rise of China, which looms large on the world’s radar as a low cost producer of an enormous quantity and variety of manufactured goods. Japan’s rise through the 1980s created plenty of worry in the United States: China is ten times as big and still has a long way to go in its growth. Some researchers have drawn parallels between what is happening now – with China’s export-led growth, the dollar’s role as a reserve currency, and the US current account deficit – and the period of Europe’s spectacular post-war growth, when US external economic policies also supported that process. But that was a recovery – Europe had been economically advanced since the Renaissance. China’s rise will bring about a world economic order that has not been seen for 500 years or more. India has the potential to be yet another global growth pole. India and China both realize this of course, and the prospects of gains from trade and cooperation have spurred historic moves towards resolving the sources of past political and strategic tensions (and with the glimmer of a hope of extending this change to relations with Pakistan). ‘India’s software and China’s hardware’ is one popularly perceived complementarity. India’s management and China’s labor might be another one, at least in some contexts. With all their differences, one commonality between both countries has been their relative shift from state to market as driver of economic growth. The two countries also have similar concerns about growing economic inequality. In India, somewhat old-fashioned rhetoric about the links between globalization, the market and inequality still persists, driven by the ‘old left’. Responses based simply on extolling of the virtues of the market for economic growth do nothing to resolve these concerns. At a different level, Gurcharan Das goes back to Aristotle to stress the importance of the middle class, and praises the role of this brash new class in India, while writers such as Pavan Verma (The Great Indian Middle Class) and Pankaj Mishra (Butter Chicken in Ludhiana) are disturbed and even repelled by this class’s lack of social concern. Policy discussion in India often has this flavor of a college debate, with eloquence overriding analysis. In an important paper, published in 1998 in an obscure economic journal (Keio Economic Studies), Abhirup Sarkar provided an important component of the analytical underpinnings of the kinds of policy approach that India’s current Prime Minister and Finance Minister have articulated in recent years. The essence of the model is as follows. The middle class is distinguished from the rich and the poor not only by their income levels, but what kinds of goods they purchase. These middle class consumption patterns are important in affecting the extent of innovation, and the extent of innovation is what drives growth. Sarkar shows that simple redistribution policies will not break an equilibrium where the economy is stuck in stagnation. Instead, raising enough of the poor to the middle class by improving their productivity is what works. Thus, there is room for the perspective of Milton Friedman as well as Amartya Sen in such an analysis: the market does its work, provided the initial conditions are right. But the easiest or most obvious policies are not necessarily the ones that the government should follow. Putting the above in concrete terms, policies to improve the human capital of the poor, or, more broadly, their capabilities, are exactly the right ones, if the model is to be a guide. This is precisely where India lags seriously behind China, in areas such as health, nutrition, and education. The policy focus should be squarely on how the government can achieve this better than it has over the last 50 years. Getting the government out of the habit of meddling in all kinds of things where it has no business, or which are lower priorities, would certainly help. Reorganizing government to be more transparent and accountable cannot hurt either. This is not the end of the story, however. Public goods, such as infrastructure and law and order, matter for private productivity. This is another important role for government (which can easily be added to Sarkar’s model, complementing, not replacing, the market. The problem in India is again how to do this efficiently in practice. The middle class has been used to a low level of public goods, and has dealt with government inefficiency through de facto private provision, following the lead of the elite in essentially seceding from participation in the requisite collective action. This has to change in India, else it will end up more like Latin America than East Asia. Latin America has high inequality and a narrow middle class, and governments there have never achieved sustained, broadbased growth. India can do better, and it is up to the middle class to make it happen, because it wields disproportionate influence on government policy, and sets expectations for government performance. A few years ago, Karnataka’s chief minister claimed that, “Bangalore cannot become Singapore.” But I think it can, if the government does its job well. And India can be China, or rather, China plus political freedom. India’s middle class, as it swells in numbers through market-driven growth, has to shoulder the responsibility to make it happen. For India’s middle class, my slogan is: L’état, c’est vous.

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