The Giant in the East – III

By Adnan Syed

This four part series examines the rise of India as an economic giant, the threats that India faces in this remarkable rise, and implications for Pakistan.

Originally planned as a three part series, I decided to split the series into four parts due to sheer volume of information that I came across while writing this series. (AZW)

Bottom line: It Mostly Comes Down to the Economy

Arguably, in recent memory, the United States came dangerously close to losing its mantle as a modern economic and military power on September 15, 2008. That was the day when famed Lehman Brothers filed for bankruptcy. As the financial markets opened the next day, the economic engine of the United States quickly started stalling. Banks balance sheets were severely compromised as their assets were falling precipitously in value by the minute. Liquidity in the financial system started drying up as institutions pulled back from trading with each other. Unsure of their own financial health, as well as health of their counterparts, banks simply stopped lending to businesses and individual customers. Over the ensuing months, thousands of small businesses crashed, firms laid off massive human capital to stay alive and some 8 million Americans lost their jobs. The jobless rate that was hovering at 5% shot up to almost 10%, and if it was not some frantic efforts by the Federal Reserve and the US Government, US economy may have fallen completely off the cliff.

It is the 14 trillion dollar economy that sustains the United States as the great modern superpower of the world. The taxes generated by the economy feed the massive military complex that ensures that the United States remain world’s foremost policeman. This economy pays for massive government projects that have allowed the US to be a pioneer in space and deep oceanic exploration. Since 1945, this economy enjoyed one of the longest stretches of sustained economic growth that remain unrivalled in its scope, size and continuity. This remarkable growth remained supported by a compounding technology and continuous innovation in finance and economics, as the United States continued to adapt and respond to many challenges that a maturing economy faces.

One of the most fundamental factors that determine the nation’s stature in the modern world is the state of its economy. For the first 40 years of its independence, India remained known as the world’s largest democracy, cradle of ancient civilizations but little else. It was more known for almost legendary poverty levels and its rickety infrastructure. Its democracy remained functioning, but remained fragile due to massively inefficient governments, endemic corruption and large scale poverty levels. Yet, the fact that a billion people strong country, with its massive religious and ethnic divide, persevered with democracy is a testament to the resilience of its total population. Unwittingly, for the first few decades India was suffering massively from extreme poverty, but it was also setting itself up for the great economic expansion once the right economic vision would cross path with the massive potential embedded in the nation.

This expansion is happening right now, and is gaining traction by the minute. India is however still passing through the initial expansion in its economy. India is still a maturing economy. This phase is characterized by the transformation of unused human capital into an economically productive capital. As long as the spare human capital continues to get deployed (and India has plenty of it), the economy will continue to grow at high rate. India does not yet face the challenges faced by matured economies like the United States or Europe. The challenge for matured economies is to keep their economies growing at a decent level, when the population growth rate stagnates and it is harder to squeeze out further productivity from the existing stock of capital.

 

Challenges for a Maturing India

As such, for the next 15-20 years, India’s sole focus is to remain growing at a healthy pace without either overheating its economy, or applying massive downside shock that would cause the economy to stall and undo all the good work done thus far. Both scenarios may cause a massive social unrest. In the first scenario, India faces runaway inflation and extremely high financial volatility that may do massive harm to the health of the financial system. The problem with sudden shock in a steadily performing economy is that it introduces one variable that no one wants to see: massive uncertainty. A simple, non-volatile 7%-10% growth rate for the next one or two decades will see India through to the prosperity that many are forecasting today.

India will face the dilemmas faced by the advanced nation after a few decades. But first, India needs to successfully transition to become a developed nation. This is easier said than done.

1) India runs the danger becoming simultaneously a very rich country/very poor country if the economic growth continues to grow only in certain states. The initial leg of a massive economic growth is seldom distributed evenly; however this phenomenon breeds massive social resentment if it is allowed to go for long. Eight Indian states, Bihar, Chhattisgarh, Jharkhand, Madhya Pradesh, Orissa, Rajasthan, UP and West Bengal show massive poverty levels. These states have yet to show any substantial participation in the economic progress showed by the rest of the country. Getting the poor states involved in the current economic expansion will be one of the biggest challenges for the policy makers in India.

2) A sustained economic expansion requires astute economic leadership. A too fast rate of growth overwhelms existing resources and causes massive spikes in inflation, thereby causing social upheaval. Social stability and better economic performance depend upon each other. This is the reason why China frantically tries to control its runaway growth rate by constantly tinkering with credit growth.

3) As the Indian economy grows, international capital comes ashore, looking for better returns. This capital causes prices of assets to grow up unreasonably. The investors start getting caught up in the euphoric buying that drives the prices up. This activity has no economic benefit, only a result of too much capital chasing assets for no good reason.

This is exactly where an economy becomes exposed to speculative investors as its markets and financial institutions become dangerously exposed and their balance sheets collapse as markets eventually correct themselves later.

India can do well to avoid any excessive volatility in the coming years. However, the scope of policy mistake is huge. The world is an extremely interconnected place, a blessing as well as a curse for all of its member economies. Capital flows freely across borders, looking to find better returns. This capital was the lifeblood of the Indian expansion in the initial years. And too much of it may turn out to be a massive problem in the coming years.

4) Perhaps, most importantly, as nations become wealthier, their coffers start filling up with higher tax returns and trade duties. How the nations spend their coffers is how their economic performances are judged at the end.

India’s biggest capital is and will remain its human capital. Despite her geographical significance and substantial natural resources, it was not until the human capital came on board that the economic growth really kicked off.

This human capital is still only 70% literate. Just 15% of students reach high school and just 7% graduate. Indians do not have access to universal healthcare and are not adequately protected by the rule of law.

What India needs to do better is to let everyone feel prosperity. This is not done by the socialist model, but by providing its population with better education, better healthcare, better rule of law and better jobless benefits. Providing the human capital now with higher education and better quality of life is in India’s own interest. The country will soon need to find more skilled labour, as economy transitions from simple out-sourced and manufacturing jobs to more complex value-add ones. If the human capital is still struggling with just basic education inside a chaotic society, the economic growth rate will recede very sharply in coming years.

For India to remain a country of choice for the world, she needs to spend more on its rule of law institutions. Corruption drained India of almost $462 Billion from 1948-2008 (almost 40% of current economic size)[i]. If left unchecked, it will not only continue to impede economic performance, the fickle investors’ trust in India will start getting shaken very quickly.

In summary, while all ingredients are in place for India to continue its meteoric rise, any policy mistakes can derail this performance very quickly. There are some encouraging signs on for India. Several studies are showing that India is beginning to bridge its economic divide better than China[ii]. Chronic infrastructure problems are getting fixed at an increasingly higher rate. The democracy has never been stronger, and even the educational sector void is filled in by the private sector enterprise.

 

India, the Future Military Giant

Considering the geo-politicalvolatility of the region where India is located, it is likely that her economic strength will translate into further military strength. India has spent an average of 3% of its GDP on military expenditures over past two decades. If we assume that India will become the world’s biggest economy before 2050 (Goldman Sachs projections), and the percentage of military expenditures will remain constant, India will be spending almost $1.2 trillion/year in the year 2050 (in today’s dollars, not even including future inflation) on its military[iii]. To give some idea, India today spends almost $40 billion per year on its military, while the current military giant, the United States spends almost $675billion per year on its military today. 

In coming decades, India’s regional rival will be China, another behemoth that outran India in the economic race in the beginning, but has always suffered from an autocratic government that is paranoid about individual freedoms, and works day in and out to keep the communist-led capitalism experiment moving along. We can conjecture that this one-of-a-kind communist-led-capitalism experiment will face a day of reckoning some day. We will likely see Tiananmen Square styled massive protests a few years or a few decades into the future. If the Communist Party peacefully allows full democracy to come to China, the transition may be relatively smooth. Otherwise, the world will encounter unprecedented volatility as world’s second (or the biggest) economy finds itself in a political upheaval.

 China will continue to grow its military arsenal around its ideas to challenge the United States as the future superpower. China’s geographical presence from the South China Sea to Central Asia means that China will continue to grow its security strength. China is, and will be building up its military might on back of its economic muscle.

Considering the traditional uneasy relationship between these two giants, India simply cannot help but become another military giant of the future. Unfortunately, this development will not help relations with Pakistan; a paranoid neighbour that has built the bulk of her defence and foreign policy around the idea of a belligerent India.  

 Tuesday: The implications for Pakistan


[i] http://timesofindia.indiatimes.com/india/Black-money-trail-India-drained-of-Rs-20-lakh-crore-during-1948-2008/articleshow/6946266.cms

[ii] http://eaces.liuc.it/18242979200901/182429792009060105.pdf  (go to page 20 for summary of the article which does not have much technical jargon)

[iii] I assume that the US economy will grow by 2.75% from today to 2050 every year. Calculations do not include inflation.




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