Tim Harford is a senior columnist for the Financial Times. His long-running column, “The Undercover Economist”, reveals the economic ideas behind everyday experiences. Tim’s first book, “The Undercover Economist” has sold one million copies worldwide in almost 30 languages. He is also the author of “The Logic of Life“, “Dear Undercover Economist”, “Adapt” and most recently “The Undercover Economist Strikes Back.” In this free-wheeling interview to Forbes India, Tim discusses the ideas he explores in his latest book The Undercover Economist Strikes Back, from why he feels that stimulus packages to revive the sagging economies in the Western world have been far too small to why money does buy happiness to why Henry Ford was the man who invented unemployment.
One of the most interesting parts of your book is where you talk about the baby sitting recession. What is that all about?
The babysitting recession was first discussed in an article published by Joan and Richard Sweeney in the 1970s, but it has been made famous by Paul Krugman. There was a babysitting co-op in Capitol Hill, Washington DC, that suffered a severe and lasting depression. Couples would keep track of who was babysitting for whom by exchanging babysitting tokens; however, there weren’t enough tokens in the economy. Almost everybody wanted to babysit for other people, accumulating a few more tokens, as a reserve, before they spent any tokens themselves. But of course the arithmetic does not work: somebody has to go out or this no economy at all.
So what drew you this example?
A number of things are interesting about this example – notably that a total economic breakdown could be fixed by a simple policy tweak: printing more tokens. (Paul Krugman has more recently tended not to mention the end of the story: the co-op printed too many tokens and ended up suffering from a serious inflation problem. But that is more of an interesting sting in the tale than a refutation of the entire example.) In The Undercover Economist Strikes Back I use the babysitting recession as a nice simple example of a Keynesian recession; in a Keynesian recession there is some dysfunction in the way the economy works, a dysfunction that can be fixed by governments printing money or perhaps borrowing and spending money. Some commentators believe Keynesian recessions are logically impossible; this is nonsense and it is nice to have a simple counter-example.
Another interesting part is about the prison camp recession. What is that all about?
The prison-camp I talk about was in Germany during the Second World War. The economic activity in the camp – a bit of production, but mostly trading items sent to prisoners by the Red Cross – was analysed in a quite brilliant article by one of the prisoners, Robert Radford, who published his findings a few months after the war ended.
And what did Radford find?
The prison camp is almost the perfect counter-weight to the baby-sitting co-op. Trade in the prison camp worked amazingly well. There were well-understood prices and middlemen ensuring that prices in different parts of the camp tended to converge to similar levels. At one stage, coffee was worth more outside the camp in the cafes of Munich than it was inside the camp, that meant gains from trade, and coffee began to go “over the wall” – the prison camp had an export trade! Despite various attempts from the senior officers to regulate trade and particularly to fix prices at levels they regarded as fair, prices were flexible and refused to respect any social or ethical conceptions of the “just price”. This was close to a perfect market. And yet… and yet the prisoners nearly starved to death.
Oh, why was that?
Why they starved is not hard to understand. The parcels from the Red Cross began to dry up as the war progressed. Food and cigarettes both became scarce. In the last, desperate days, there were few goods and prices fluctuated wildly. Finally the US Army arrived and liberated the prisoners.
But what does all this have to do with a modern economy?
The point is that there are two conceptions of what a recession really is. One conception is Keynesian, like the babysitting co-op: some internal malfunction that needs fixing. But another conception is Classical: that economies fluctuate not because of anything wrong within the economic system itself, but because of policy errors or external shocks. Of course the prison camp is an extreme example of a recession caused by an external shock, but modern economies are subject to technological changes, fluctuations in the price of basic commodities, and of course financial shocks from a banking crisis.
Where do the baby sitting recession and the prison camp recession meet? What are the policy lessons one can draw from them?
A Keynesian, baby-sitting co-op recession invites a role for government intervention – most famously through fiscal policy (cutting taxes or boosting spending) but also through monetary policy (cutting interest rates or even printing new money). A Classical, prison-camp recession invites a more fatalistic response: there’s nothing the government can do to make things better, and plenty of things it can do to make things worse. The huge argument that has raged in many economies about fiscal stimulus versus austerity is really a debate about whether recent recessions have been mostly Keynesian, or mostly Classical. If Classical, then austerity is the right response: we’re poorer and we need to get used to it. If Keynesian, then fiscal stimulus is the right response: we’re only poorer if the government gives up and allows us to be!
So are the recent recessions Keynesian or Classical?
In a book you can give black-and-white examples and in life, nothing is black and white. But in my view the recent recessions have been at least partially Keynesian and governments – especially in the UK and US, where they had a choice – should have postponed austerity measures.
The western world has been running stimulus programmes. Do they really work?
It’s interesting that this is your perception. I think most stimulus packages have been far too small – although the US has at least tried. The evidence on such things is always tricky because macroeconomists (unlike microeconomists) cannot run controlled trials. But we can try our best.
Can you elaborate on that?
The International Monetary Fund at first estimated a modest effect from fiscal stimulus – that is, government spending does make the economy larger in the short run, but only a bit. But the Fund later recanted and argued that in the recent recession, fiscal stimulus was far more effective than they’d believed at first.
Let’s assume this is correct (I think it is). How did the Fund make their original mistake? The problem was that they were looking at historical evidence on stimulus spending, and the historical evidence incorporated much milder recessions in which monetary policy was a good alternative to fiscal stimulus. Those mild recessions weren’t a good guide to recent experience, alas.
What is the best way to make a stimulus work?
As for how to make stimulus work, I argue in my book that the best bet is advanced planning: governments should have a list of well-planned infrastructure projects, and should accelerate those plans in case of a downturn. That way, we carry out the investment we were intending to anyway, but at a time when it will have nice macroeconomic side-effects.
Economists have been criticised for having too much faith in GDP growth. Even Simon Kuznets, the man who invented GDP never saw it as a measure of welfare. You write that “they rely on the popular misconception that much of what is wrong with the way the economy is organised is wrong because we collect GDP statistics, and that the way to fix our economic problems is to measure something else. I think that is a mistake”. Why is that a mistake?
Because it isn’t the measuring of GDP that has caused the problems. We had economic growth – and inequality, environmental degradation and other problems – long before we could measure it. Of course there are thoughtful critics of GDP who suggest additional things we could measure, or ways to make GDP a better measure of economic activity. But the more radical critics seem to assume that our economy is organised the way it is because some sinister force is trying maximise GDP. And that’s just crazy.
A lot of recent thinking talks about happy economics (or what you call happynomics). Does money buy happiness?
Money does buy happiness, it seems – or at least having more money, within a particular society, is correlated with being happier (or rather, with telling surveyors that you are more satisfied with your life). The big contested question in happynomics is whether that’s also true across countries: so, is a richer country such as the US happier than a poorer country such as India?
Is that the case?
Early research from Richard Easterlin suggested that richer countries aren’t happier – hence the phrase “the Easterlin Paradox”: if money buys happiness for individuals but not for countries which are collections of individuals, what’s going on? Two possible explanations: one is that what really counts is relative income. Indians compare themselves to other Indians; Americans compare themselves to other Americans. If Americans compared themselves to Indians they’d feel rich and would be happier. But they don’t, so they don’t. An alternative explanation – favoured by economists Justin Wolfers and Betsey Stevenson – is that Easterlin is just wrong: at the time of his research, the data were of poor quality. Now we have better quality data and we see that money is correlated with happiness both across and within countries. It will be interesting to see this debate play out.
Can economic growth carry on forever?
In principle, yes. Quite a few environmentalists and physicists have pointed out that the planet simply cannot support exponential growth – sooner or later (and, with exponential growth, sooner than we think) we will reach environmental limits.
You don’t buy that?
I regard myself as an environmentalist myself but I think this is just a simple conceptual error. Of course we cannot continue to use more resources or energy at an exponential rate. But economic growth is just growth in the market value of output. So it can continue forever – at least in principle. There are already signs that energy growth is being decoupled from economic growth: in countries such as the UK, the US, Germany and Japan, energy consumption per capita has been falling for a long time now. Population growth is also low or negative in many rich countries. I believe that we need to focus on practical environmental questions – for instance, how to reduce carbon dioxide emissions now – rather than these very abstract concerns about exponentiation.
One of things that you write about India is that “there simply isn’t enough money in India yet for it to be unequal”. What do you mean by that? Do you see it changing in the years to come?
The World Bank economist Branko Milanovic has this idea of the “inequality possibility frontier”. Imagine an extremely poor subsistence society. Then imagine some class of plutocrats, who somehow confiscate wealth and spend it themselves. How much can they take? The answer is: not much if the society is to survive, because the poor cannot dip below the average income because the average income is barely enough to keep you alive. Now imagine a much richer society. This, in principle, could be far more unequal because the poor could still survive on a tiny fraction of the average income. Milanovic and co-authors were interested not only in how unequal a society is, but how unequal it is relative to how unequal it could possibly be. My point was that despite important gains over the past twenty years, India is still a very poor society. There’s a limit to how unequal it can get until it gets richer – which should make us worry about the inequality we do see.
Why was Henry Ford the man who invented unemployment?
Ah yes, this is one of my claims – and I should say that it’s an exaggeration, of course. But here’s the puzzle: Henry Ford of the Ford Motor Company raised wages at his factory to such a level that men were queuing round the block for jobs, being hosed down by police in a sub-zero Chicago January. Why have such high wages? Why not cut them and save money, given how much demand there was for jobs?
The idea here is “efficiency wages” – that it can be efficient for an employer to pay well above the market rate because it gives him the pick of applicants, and a fiercely loyal group of workers who will do almost anything to keep their jobs. And of course, that describes many – perhaps most – jobs in the formal sector today. That means, in turn, that we’ll always have unemployment, not because of some macroeconomic slump, but because individual profit-maximising companies prefer efficiency wages.
You quote a lot of John Maynard Keynes all through the book. One of the things you quote in the last chapter is “the master economist must posses a rare combination of gifts…He must be a mathematician, historian, statesmen – in some degree….” Do you see that in current day economists?
Not enough. But that challenge is what makes economics such a marvellous subject to study. Everything is there in the subject, waiting to challenge us. Despite all the difficulties, economic remains a wonderfully important and rich topic to explore – and it’s still a great time to be an economist.
The interview originally appeared in the Forbes India magazine dated December 13, 2013
Stefan H. Thomke, an authority on the management of innovation, is the William Barclay Harding Professor of Business Administration at Harvard Business School(HBS).He is chair of the Executive Education Program Leading Product Innovation, which helps business leaders in revamping their product development processes for greater competitive advantage, and is faculty chair of HBS executive education in India. He is also author of the books Experimentation Matters: Unlocking the Potential of New Technologies for Innovation and Managing Product and Service Development. In this interview he talks to Forbes on the various aspects of innovation.
Innovation is a very loosely defined term these days. How do you define innovation?
When I started looking at innovation more than 20 years back, it seemed to be a little crisper then, in terms of definition. Now its all over the place. Interestingly, Wall Street Journal did an analysis sometime back where it counted the number of times the word innovation appeared in the quarterly and annual reports in the United States in 2011. They counted more than 33,000 times. Its just a much overused word.
So what does the world really mean?
The word innovation itself really means two things. It means novelty and value. The value requirement is a really important point. And that makes it different from the word invention. Invention is a more legal term. It is about getting patents. If you have a name on your patent you know that value is not a requirement to get a patent. It just has to be new and non obvious to get a patent. There are companies that have lot of patents which have no value for anybody. So its an input to innovation.
Innovation at times can be a really simple idea as well?
I was working once with a company in the area of in vitro diagnostics. Basically they made equipment to do blood analysis. So when you go to a hospital they draw blood from you and put it into a machine. The machine analyses your blood and gives printouts. One of the biggest innovations for their customers was an algorithm, which was essentially a piece of software that ensured quality control. That was one of their main selling points and customers would basically buy their equipment because they highlighted that. They said that I have this insurance that when I run these tests that the equipment automatically checks for quality and is actually very reliable. And they marketed that. From an R&D perspective it was one of the easiest things that they have ever done. It was really just an algorithm that they figured out using data.
That’s really interesting…
Yes. So sometimes you know the most expensive things are not necessarily that provide the greatest value to the market and vice versa as well.
I came across a blog you had written on product innovation where you questioned putting more and more features into a product. Tell us something about that?
I wrote an article together with Donald Reinertsen and in this article we talk about myths. This was one of the myths. He is also an expert on product development. And we have been in many meetings where the entire meeting is dedicated to discussing more and more features. There seems to be an assumption that in a lot of teams that we are basically done when we can no longer squeeze more features into a product. Presumably assuming that more features that a product has, the customer actually sits there and counts the features, and that somehow drives our ability to price it.
And you don’t agree with this approach?
Sometimes you can actually add value to a customer experience by taking features out, by de-featuring. But that rarely happens. I have rarely been to meetings where the main purpose of the meeting was to remove features from a product with the intent to add value. Usually when we sit around and discuss to remove features, it is usually because it is too expensive, it is not manufacturable. Maybe what teams should do is think about when they can no longer take things out of a product rather than when they can no longer add things to it. It’s a very different way of thinking about it.
Making things simple is difficult…
We often talk about it as a quote attributed to Leonardo da Vinci that simplicity is the ultimate sophistication. To make things simpler is very hard because that requires you to have a very deep understanding of what the user really wants. And once you have that deep understanding you have the confidence. Mark Twain once said if I had more time I would write a short letter. In fact that should be true in your field as well?
Yes, longer pieces are easier to write.
Exactly. And the same is true about innovation. Creating something out of a lot of bells and whistles is a lot easier to do sometimes than actually creating something that has the essential features because that requires a lot more thought and a lot more research.
Can you give us an example on this, other than Apple?
A small example is the Danish company, Bang & Olufsen. They make very very high end speakers, stereo systems etc, which are beautifully designed. These speakers are one of the most expensive speakers that you can buy. But there are no buttons for adjusting the frequencies, you just have the volume button. That’s it. What they have done is that they have created products that are very expensive and they have taken away all the controls that normally you would like to have.
How did they get away that?
They set themselves a very interesting standard. They said, when you listen to something on our speakers it should sound like the real thing. And we believe that no user will be able to get close to that by tweaking a few buttons than the way we set up. So they set their standards to be very high and said we don’t want the users to fiddle with it because we are getting as close as we can. All we want you to do is turn the volume button up and down. It’s quite contradictory. You would imagine that if you are charging all that money you would want to give more control to the customers.
But a lot of people love fiddling with features…
Yeah. There is always a market for everything.
If you look at mobile phone marketing, the selling point seems to be features…
Look at Japan for example. If you look at Japanese mobile phones they have more features than anything you can imagine. You can watch television on them. They have got everything on these phones. But when you ask Japanese consumers, one of their problems is that they are so complicated to use. Not surprisingly, the iPhone has one of the highest penetrations in the Japanese markets. So the question is how can that be? It is more expensive. It has less technology in it. It has fewer features in it and yet it has one of the highest penetrations in terms of growth.
That’s an interesting example…
The reason why I came up with this observation is because I bought this toaster, which came with a manual and had a little LCD display on it. And it set me thinking. I bought an iMac and it had no manual and I bought a toaster and it came with a manual that thick.
There is no manual with an iMac?
No. There is no manual with an iPhone. You just get a little leaflet in there in terms of what to do if something goes wrong. In fact when Steve Jobs came back to Apple one of the first things he did was he took manuals away from developers. The belief was that manuals are for developers who don’t know how to make it intuitive. So as a developer if we don’t know how to make it intuitive we think that’s there is always the manual where we can write down and explain how it works. The problem is that nobody ever reads a manual. So the perfect solution was lets just take away the manuals from the developers. If you cannot explain it, if you cannot make it intuitive, then don’t it.
Do organisations become less innovative as they become large?
I wish I could give you a yes or no response. There are actually certain advantages that come with size and there are some disadvantages that come with size. As you get bigger., you have a momentum. You have an established customer base. Sometimes you can take a long term view as well because you have got an ongoing business and you can afford to wait a little bit. But you have some disadvantages as well. You have got a customer base, that may hold you back and drive you in a different direction. As you get a bigger, you need to have processes and procedures for coordination that are often then viewed as bureaucratic.
Can you give us an example of a large company that is innovative?
Take a company like BMW. It is very innovative. Right now they are launching the i3 which is an extremely innovative car. Its a fully electric car. But that’s not the only innovation. They also figured out how to actually make the entire body shell out of carbon fibre. This is an example a great innovation in all dimensions. They had to come up with a process innovation. Carbon fibres are basically carbon bodies, very light structures that go into very high end automobiles. For example, Formula 1 cars are typically made from re-enforced carbon fibre bodies. You need to bake them. Its a very labour intensive process.
And BMW changed that?
They couldn’t follow a manual process for a car like this because they want to mass manufacture it. It would be way too expensive. So they had to actually innovate in manufacturing. They had to automate the production of carbon fibre. And it changes everything. Once you make the body of your car from carbon fibre, things like crash dynamics totally change. Then there was the electric side of it as well. So the i3 which is coming out this fall. The whole project was more expensive than any of the car platforms that they have developed recently. Estimates are of around $1-5-2 billion. Its a huge risk and they don’t know whether the car is going to sell in enough numbers. It is going to be priced pretty close to $35,000-40,000 in the United States and close to around 35,000 euros in Europe. This is a huge bet that they are placing.
And they are able to do it because they are big?
BMW is a very big company . A small company may not be able to take that bet because they don’t have the expertise. They may have the expertise in one area but they don’t have all the different knowledge bases that this will require to put something like this together. So BMW has the deep expertise. They are very profitable. So they can afford. Whether they can afford to let the i3 fail that remains to be seen. If it fails that will be a big dent. But they can afford to put $2 billion into something like this which could really change the future not just for BMW but for the car industry as well. So large companies can be innovative.
I was reading one your research papers in which you talk about the fact that you cannot treat R&D like manufacturing and unleash techniques like six sigma….
There is a real danger right. I was working in the quality field when six sigma first came out. Six sigma was essentially designed to address production variability in Motorola’s semiconductor factories. It was adopted by others. And at GE it became a big change management programme. But we should also fundamentally understand what Six Sigma is all about. Six Sigma is about reduction of variability. And that is very suitable for tasks that are very repetitive. Variability is actually a bad thing and you want to drive it out. If I am at a bank and I am processing transactions then I want to these transactions to go through with zero mistakes. Any kind of variability is bad. That’s true…
But if you take a concept like this to innovation where we talk about experimentation, creativity and all these sort of things, variability is something that is quite natural. You take a technique like this and you are trying to drive out variability you can kill the entire process. The more upstream you go the more dangerous it is. Something by the way 3M found out the hard way. Jim McNerney became CEO of 3M. Having come from GE he was a master of six sigma. He drove it in at 3M. It initially helped them because there was a lot of variability at 3M. Fifty five divisions there was not enough co-ordination. When six sigma was implemented in upstream R&D driving out variability, they killed a lot of good things that they were working on. This frustrated a lot of people and later on when the next CEO came he really had to correct that.
Ideas often come at the edges.
It is also sometimes not predictable. If I am a developer and I am developing something new I don’t know exactly what I am going to be doing three weeks down the road. I don’t know the tests I am going to run one month from now because that is the whole point of innovation. Its uncertain. If I had all these answers, I probably wouldn’t be innovating. There wouldn’t be novel because I already know everything about what is going to happen. So inherently there is uncertainty that is built in and we just have to be comfortable living with that uncertainty. That is why I talk about business experimentation.
Can you tell us something about?
One of things that executives need to understand is that most assumptions/hypothesis that they make about novelty turn out to be wrong. The real danger for an executive is that if they feel they have an assumption about novelty and they go out without running the experiment, it could be quite disastrous. I don’t know if you have been following the JC Penney story.
What’s happened there?
It’s a fascinating story. Ron Johnson was the person responsible for Apple stores. More than 1 million are walking through Apple Stores everyday now. He was hired by J C Penney as their CEO, with the mission to revolutionise retail for JC Penney. So that was his job. He was one of the most admired executives in the retailing space for having done what he had at Apple. He tried to innovate retail for JC Penney and it turned out to be a disaster. I think sales were down 25-30% or so. And he didn’t run the experiment.
He basically made an assumption of what the future of JC Penney retail should look like and he did away with discounts. He was very confident because he was right in the past. And turned out to be wrong. He should have taken some 20 stores and run randomised field trials. A lot of executives get hired for their expertise and they have a lot of confidence. If you were right ten times in the past. You believe that you will be right the 11th time as well. Sometimes its a curse if we are right all the time. Sometimes the kinds of things we learn in one context we may not be able to move it to another context, when the context changes.
No interview around innovation is complete without talking about Google. The company keeps doing many things, but other than there AdSense business nothing really has been a big money spinner.
That’s been making a lot of money.
Innovation should also lead to some profit. How do you explain the disconnect in case of Google?
I am no expert on Google. There are two ways to look at. One way to look at it is the way you describe it. They have got one business model essentially and they are trying all these things. None of it, at this point seems to be able to create another business model or another source of significant revenue for them. Another way of looking at it is that all the things they do drive more traffic towards them. I don’t know how much money they are spending on Google Glass. But that in itself is driving so much traffic to their site, which then increases the costs of the ads. They can probably pay for the whole project and more, just from the addition of the incremental traffic and the incremental ad revenue that one project created.
This makes tremendous sense…
When you use Gmail, you are actually giving them information. They can actually use it to place customised ads. Its the same thing with Android, which they give away for free. But by making Andorid available for free, its all on the mobile phones and gives them access to mobile phones, which then allows them to do ads on mobile phone. You can kind of see the whole logic. All these things ultimately lead back to their fundamental business model which is the ad model. I bet they are trying really hard to think of other ways at one level, but at another level they are probably thinking about an eco system that they are trying to create that ultimately drives people back into the ad space, and gets more information about them.
So basically they won’t allow any other search engine to come up…
They won’t want to do that. Of course not. They want traffic. The worse thing that can happen to them is traffic going somewhere else and the ad revenue falling .The whole business model will go away.
The interview originally appeared in the Forbes India magazine dated November 15, 2013 with a different headline
Gary Dugan is the CIO – Asia and Middle East, RBS Wealth Division. In this freewheeling interview with Vivek Kaul he talks about the recent currency crash in Asia, where the rupee is headed to in the days to come and why you would be lucky, if you are able to find a three BHK apartment, anywhere in one of the major cities of the world, for less than $100,000.
What are your views on the current currency crash that is on in Asia?
People are trying to characterise it as something like what has happened in the past. I think it is very different. It is different in the sense that we know that emerging markets in general have improved. Their financial systems are more stronger. The government policy has been more prudent and their exposure to overseas investors in general has been well controlled. I don’t think we are going to see a 12 month or a two year problem here. However, countries such as India and Indonesia have been caught out and the money flows have brought their currencies under pressure. So, it’s a problem but not a crisis.
One school of thought coming out seems to suggest that we are going to see some version of the Asian financial crisis that happened in 1998, over the next 18 to 20 months…
I totally disagree with that. The rating agencies have looked at the Indonesian banks and they have said that these banks are well-abled to weather the problems. If you look at India, the banking system is well-abled to weather the problems. It is not as if that there is a whole set of banks about to announce significant write down of assets or lending. The only thing could go wrong is what is happening in Syria. If the oil price goes to $150 per barrel then the whole world has got a problem. The emerging market countries would have an inflation problem and that would only create an exaggeration of what we are seeing at the moment.
Where do you see the rupee going in the days to come?
There is still going to be downward pressure. I said right at the beginning of the year, and I was a little bit tongue in cheek when I said that in theory the rupee could fall to 72. At 72 to a dollar, in theory, clears the current account deficit. I never expected it to get anywhere near that, certainly in a short period of time. But some good comes out of the very substantial adjustments, because pressure on the current account starts to disappear. Already the data is reflecting that. Where the rupee should be in the longer term is a very difficult question to answer.
Lets say by the end of year…
(Laughs) I challenged our foreign exchange market experts on this and asked them what is the fair value for the rupee? I ran some numbers on the hotel prices in Mumbai, relative to other big cities, and not just New York and London, but places like Istanbul as well. India, is the cheapest place among these cities. Like the Economist’s McDonald Index, I did a hotel index, and on that you could argue that the rupee should be 20-30% higher. But, if you look at the price that you have got to pay to sort out your economic problems, it is probably that the currency is going to be closer to 70 than 60 for the balance of this year.
One argument that is often made, at least by the government officials is that because the rupee is falling our exports will start to go up. But that doesn’t seem to have happened…
It takes a while. I was actually talking to a client in Hong Kong last week and he said that warehouses in India have been emptied of flat screen TVs, and they have all been sent to Dubai because they are 20% cheaper now. It is a simple story of how the market reacts to a falling currency.
But it’s not as simple as that…
Of course. A part of the problem that India has is that the economic model has more been based on the service sector rather than manufacturing. The amount of manufactured products that become cheaper immediately and everyone says that I need more Indian products rather than Chinese products or Vietnamese products, is probably insufficient in number to give a sharp rebound immediately. Where you may see a change, even though some of the call centre managers are a little sceptical about it, is that call centres which had lost their competitive edge because of very substantial wage growth in India, will immediately get a good kicker again. It would certainly be helpful, but I would say that it normally takes three to six months to see the maximum benefit of the currency adjustment.
What are the views on the stock market?
I am just a bit sceptical that you are going to see much performance before the elections. I always say it is a relative game rather than absolute one. If all markets are doing well, then India with its adjustment will do fine. Within the BRIC countries, India falls at the bottom of the pack, in terms of relative attractiveness, just because there is a more dynamic story for some of the other countries at the moment.
One of the major negatives for the stock market in India is the fact that the private companies in India have a huge amount of dollar debt…
It is definitely a reason to worry. It’s not something I have looked at in detail. But as you were asking the question, I was just thinking that people are dragging all sorts of bad stories out. When there were bad stories before, people were just finding their way through it. And India has a wonderful way of working its way through its problems and has been doing that for many many years. Remember that these problems come to the head only if the banks call them to account. I think there will be a re-negotiation. It is not as if a very substantial part of Indian history is about to go under because someone is going to pull the plug on them.
Most of the countries that have gone from being developing countries to becoming developed countries have gone through a manufacturing revolution, which is something that is something that has been missing in India…
It is. You look at the stories from the past five years, and the waning strength of the service sector in India, in th international markets, comes out. A good example is that of call centres that have gone back to the middle of the United States from India. A part of that came through currency adjustment. You can say that maybe the rupee was overvalued at the time when this crisis hit. But it is true, in a sense, that India has got to back-fill a stronger manufacturing industry and it has got to reinforce its competitive edge in the service sector.
What is holding back the Indian service sector?
A number of structural things. I talked to some service sector companies at the beginning of the year. And one of things I was told was that I have got all my workers sitting here in this call centre, but now they cannot afford to live within two hours of commuting distance. Why did that happen? That is not about service sector. It is about the broad infrastructure and putting people at home, close to where they work. There are lot of problems to be solved.
There has been talk about the Federal Reserve going slow on money printing(or tapering as it is called) in the days to come. How do you see that going?
Everyone has got to understand that the principle of quantitative easing is to generate growth. So, if there is enough growth around they will keep tapering, even if they get it wrong by starting to taper too early. They will stop tapering if growth is slow. Secondly, number of Federal Reserve governors are worried about imprudent actions of consumers and industrialists, in terms of taking cheap money and spending it on things that they typically do not need to spend on. A good example is speculation in the housing market, something which created the problem in the first place. So they want to choke such bad behaviours. They will probably start tapering in September in a small way. The only thing that may stop it from happening is if the middle Eastern situation blows up. The US didn’t think it was going to get involved a few weeks ago. Now it is.
Isn’t this kind of ironical, that the solution to the problem of propping up the property market again, is something that caused the problem in the first place…
That’s been very typical of the United States for the last 100 years. Evertime there is a problem you ask people to use their credit cards. Or use some form of credit. And when there is an economic slowdown because of the problems of non performing loans, then you get the credit card out again. So, yeah unfortunately that is the way it is.
Why is there this tendency to go back to the same thing that causes the problem, over and over again?
It is the quickest fix. And you hope that you are going to bring about structural changes during the course of a better economic cycle. So people don’t bring the heavyweight policies in place until they have got the economy going again and sadly the only way you can get the economy going again is to just to make credit cheap and encourage people to borrow.
Inflation targeting by central banks has come in for criticism lately. The point is that because a central bank works with a certain inflation target in mind, it ends up encouraging bubbles by keeping interest rates too low for too long. What is your view on that?
These concepts were brought in when central banks thought they could control inflation. If you look at one country that dominates the world at the moment in terms of product prices and in terms of the inflation rate, it is China. Your monetary policy isn’t going to change the behaviours of China. And some of the flairs up in inflation have been as a consequence of China and therefore monetary policies have no impact. Secondly, the idea of controlling inflation, the concept worked for the 20 years of the bull market. Then we got inflation which was too low. So we have changed it all around to actually try to create inflation rather than to dampen inflation. I don’t think they know what tools they should be using. The central banks are using the same tools they used to dampen inflation, in a reverse way, in order to create it.
And that’s where the problem lies…
For nearly two to three hundred years, the world had no inflation, yet the world was kind of an alright place. We had an industrial revolution and we still had negative price increases, but that did not stop people from getting wealthy.
Many people have been shouting from the rooftops that because of all the money that has been printed and is being printed, the world is going to see a huge amount of inflation, so please go and buy gold. But that scenario hasn’t played out…
Chapter one of the economic text book is that if you create a lot of money, you have got a problem. Chapter two is that there is actually another dimension to this and that is the velocity of money. If you have lots of money and if it happens to go around the world very very slowly it doesn’t have any impact. And that has been the point. The amount of money has gone up considerably but the velocity of money has come down. To date, again in the western world, there is little sign of the velocity improving. We are seeing this in the lending numbers. Even if banks have the appetite for lending money, nobody wants to borrow. Someone’s aged 55, and the job prospects are no wage growth, and the pension is tiny, I am not sure that even if you have gave him ten credit cards, he’ll go and use any of one of them. And that is the kind of thing that is happening in Europe and to some extent in the United States.
Yes that’s true…
The only money going into housing at the moment is the money coming from the institutional market, as they speculate. If you look at students coming out of college in the United States, they have come out way down with debt. There is again no way that they are going to go and take more loans from the bank because they have already done that in order to fund their education. So I do not seeturnover of money in the Western world.
There may be no inflation in everyday life but if you look at asset inflation, it has been huge.. That’s right. People just find stores of value. Gold went up as much as it did, in its last wave. If you look at Sotheby’s and Christie’s, in the art market, they are doing extremely well. The same is true about the property market. Places which are in the middle of a jungle in Africa, there prices have gone up to $100,000 an acre. Why? There is no communication. No power lines. It is just because people have money and are seeking out assets to save that money. Also, there has been cash.If you go to Dubai, 80% of the house purchases there, are in cash. So you don’t need the banks.
Can you tell us a little more on the Africa point you just made?
I did laugh when Rwanda came to Singapore to raise money for its first ever bond issue and people were just discovering these new bond markets to invest purely because they did not know what to do with their money. So someone said that I am building, you know in a Rwanda or a Nigeria, and people just ran with their cash, buying properties and buying up land wherever the policies of the government allowed. Sri Lanka again just closed the door on foreign investors because you start to get social problems as the local community cannot afford properties to live in. It was amazing how commercial many of these property markets became, even though in the past they were totally undiscovered. And as we have seen with many of them, you take considerable risk with the legal system. The world has got repriced. I always say that if you can find a three bedroom house below a $100,000-$150,000 in a major city, you are doing well anywhere in the world today.
In Mumbai you won’t find it even for that price..
Yes, though five years ago it was true. It is impossible now.
(The interview appeared in the Forbes India magazine edition dated Oct 4, 2013)
Ruchir Sharma is the head of emerging market equities and global macro at Morgan Stanley Investment Management. He generally spends one week per month in a developing country somewhere in the world. In 2012, his book Breakout Nations – In Pursuit of the Next Economic Miraclebecame a best-seller. The paperback version of the book was recently published.
The book among other things pointed out that the most important factor behind decade long economic boom in the emerging markets, a worldwide flood of easy money, had been largely overlooked. That era of easy money is now coming to an end, believes Sharma. “My entire case which I have even made in the book was the fact that the entire boom of the last decade, where the growth accelerated from 5-6% to 8-9% was totally global in nature, and that had nothing to do with India specific factors. And that boom is now unwinding. Now can we undershoot 5-6% for a year or two? Yeah we can,” said Sharma. In this free-wheeling interview he speaks to Vivek Kaul.
Recently you wrote an article in the Foreign Policy magazine titled “The Rise of the Rest of India”, in which you talk about Indian states that have done well over the past few years. What are the factors that make for a breakout state among the Indian states?
A very simple definition is that the state has been able to consistently grow above the national average over a five to ten year period. Often you can associate that growth to some change in policy or leadership which has taken place. It is the same as the concept that I have used in my book Breakout Nations.
What is the concept of Breakout Nations?
It is about which are the countries that are likely to grow faster than the emerging market average and compared to other countries in the same income group, over a five year period. The same concept I have applied to the states in India. The question I have tried to answer is which are the states which have grown above the national average for a five to ten year period. Often this growth is associated with some leader who has to come power.
Which are the states right now you feel are the potential breakout states or have already broken out?
The states where the most impressive results have been seen are Gujarat, Bihar, Madhya Pradesh Odisha, Chhattisgarh, Delhi etc. These are the places where typically you have seen growth. The ones where the most impressive delta or change has taken place, have basically been Bihar, Odisha, Madhya Pradesh, Chhattisgarh etc. That area has done well.
What about Gujarat?
Gujarat has done well. But Gujarat was already doing well in the previous decade. Its impressive that it has done better from a higher base. Similarly for Maharashtra, growth rates have been okay, but in the last couple of years they have begun to fall. And Maharasthra is so dependent on the legacy industrial base or the whole golden triangle of Mumbai, Pune and Nashik, that I don’t know how to call it a breakout state necessarily.
Does the Indian constitution need to be re-jigged to give Indian state more economic power?
I’d say that maybe later but to me that is not the big thing. India has three lists, central, state and the concurrent list. And the big thing in India which has happened is that a lot of the issues which were in the state list and the concurrent list have been usurped by the the centre over time. And this has got to do with environment, mining, labour and even things like food. The whole culture needs to be a collaborative culture rather than the centre deciding or one leader deciding that okay these are the five things that India is going to do. We have had centralised leadership in the past. We have had the Indira Gandhi days. Now you can argue that is that what you want? Economic growth wasn’t great during that period. You can argue that it sowed the seeds of secessionist movements rather than bringing the country together. So I am not sure this heavy handed centralised leadership is what works for a country like India, where the polity is so diverse.
How can this be tackled?
The first thing you can start doing is by giving the power back to the states. India’s constitution envisaged a federal structure. It is just that over time particularly the 1970s and the 1980s, a lot of the state powers were usurped by the centre in the name of centralisation and in the name of the the secessionists taking over. Using that kind of cover, a lot of power was usurped. The whole point is that when you have national schemes, you have to give much more flexibility to the states. For example, the planning commission is now talking about 10% discretion to the states. That can be increased to 30% or 50%, rather than the criteria and the mandates being set by the centre.
In a recent column for the Financial Times you wrote “The irony is profound…Voters are wondering aloud how their “breakout nation” became a “breakdown nation”, seemingly overnight.”
Can states be breakout states when the country is in a breakdown mode?
Of course not. The national average is ultimately summation of the states. The only reason for optimism that I still find is that at the state level things are a bit better. State level leaders understand how to succeed in various parts of India rather than having a one size fits all national policy. Having said that, there are issues at the state level as well. Many states have their own crony capitalists. At times they are autocratic and anti democratic. But my entire point is that there is a ray of optimism.
Five years ago we were drawing straight lines stating that India’s GDP growth has been 8-9% and if it continues for 10 years where will we be. If it continues for 20 years where will we be and so on. Today it is hard to be optimistic on the country because there is so much negativity which is going around. To me the breakdown is a perception thing more than a reality.
Are there things that can be done to set it right?
One flaw to me is this culture of lack of accountability. If you look at India today the lack of accountability starts of from this whole separation of party and government. This has really been one of the fault lines of India which is that to run a country with a division between party and government is really very difficult. It fosters a culture of lack of accountability.
Could you elaborate on that?
There is this perception that has been for years now that there are something things which when you ask the people in the party, that why they are not being done, they say its the government’s responsibility to do this. And you ask the government and they tell you we don’t have the political power to do it. That lack of accountability then just flows down, with everyone being busy protecting their own turf and not taking any collective responsibility for anything. So that fault line to me for one needs to end, which is that you can’t have the separation of the party and the government. Also the fact is that if you look at the world what you see is that technocrats have not been very good as heads of states.
What do you mean by that?
They have been very good as support staff. But as heads of states if you look at Latin America and Asia, in the past, there are more examples of mass based leaders being successful. This is because reforms are political in nature. You can’t have them being administered by technocrats. Technocrats neither have the political understanding nor the political capital to implement reforms. Reforms need to be sold to people. Hence they are political decisions. Given this, you need a mass based leader at the top.
So that brings me to the logical question. Is that leader Narendra Modi?
See I am not sure of that. I don’t want to get into this thing about who it should be or who it shouldn’t be. My entire point is the fact that you have mass based leaders at the state level. The states are not run by technocrats. The breakout states that I speak about are run by politically smart people, who understand what needs to be done for development, and who get that connection of what is good economics and what is good politics. They see the bridge between the two. To me its about mass based leaders. Whether India can have this at the national level, I am a bit more sort of doubtful about.
But do successful state level leaders transform into national leaders?
It has never happened. Never. That’s the staggering point. Many leaders have tried to go out. The list is a long one. From Sharad Pawar to Mulayam Singh Yadav and even someone like a Mayawati, they have all tried to build a national footprint but they have never been able to succeed. Often having strong regional roots is a liability at the centre because then they begin to associate you only with one particular state. Even in the Congress I find it fascinating that there is so much talk as to who could be the next candidate for Prime Minister. I would think that logically it should be a chief minister rather than any of the national leaders.
But no one comes to my mind when I think of the Congress chief ministers…
Exactly. Logically we should argue that by any chance if Sheila Dikshit wins the next election then she should be the automatic choice for being the next PM candidate assuming that Rahul doesn’t want the top job. Someone like her should be the top person for that job. You need someone with a mass base, who understands politics.
What has suddenly gone wrong with the rupee. Between January and May it yo yoyed between 53.5 to around 55.5 to a dollar. But after that it has fallen dramatically...
A lot of it has to do with this fault line across emerging markets which is the fact that all countries with a high current account deficit have really taken a big hit as far as their currencies are concerned. The whole game began to change, as is well documented by now, after the Federal Reserve decided that it wants to think about tapering off its quantitative easing. After that the the US interest rates have risen a lot. The 10 year interest rate has gone up by 100 basis points since May. This has obviously led to people evaluating how much money they want to put up internationally.
But is the rupee falling just because of the Federal Reserve thinking about going slow on money printing?
The fact is that we have our own domestic problems which are compounding the whole thing. There is a sense that no one’s in charge and that we have an election coming up. There is a sense that it will be very hard for the government to make tough decisions to remedy this situation. Also, some of the problems have not been fully appreciated or recognised. One thing that we are just about coming to realise is that corporate India has too much leverage. It is very concentrated leverage amongst a few companies.
Do you see the rupee falling more?
We are in the midst of a panic and magazine articles have their own time cycles. In panics I just can’t say where these things will stop.
Can we say that the rupee is falling because the rupee is falling?
It’s a global panic now. The train has left the station and you can’t now catch it. And where it stops I don’t know. That is the sense I get. This is not say that this is not our problem. If we did not have a large current account deficit we wouldn’t have this problem today. But the fact that we have a large current account deficit and are being punished globally for it, is just a reality.
Should the RBI try and stop the rupee’s fall or let it find its own level?
I don’t think that we have a local solution anymore. All that the RBI can do is to moderate the fall. But we have seen with other currency attacks that when currencies are under panic foreign exchange intervention can be very ineffective. The classic case was the British pound in 1992. What India can do is to figure out how to correct these things over a period of time, which is what we should think about. RBI or whoever it was in charge in Delhi was doing much worse before. They were following this bureaucratic impulse that you come up with this one decision all the time to show that you are doing something.
Is India anywhere close to Thai crisis of 1998, where the country more or less ran out of foreign exchange?
I don’t think that it is as extreme as that. What happened in Thailand was a very extreme situation. Their short term debts and current account deficit were larger than what we have. Having said that one thing that I have known about crises is that you only know about these things post facto which is that after every crisis you come up with new factors to add to the list of the things that you should watch out for. I think that is the whole point. If you look at the past crises this does not seem as dire as what we saw in East Asia in 1997-98 or in India in 1991. But my only caveat here is that you always come up with the real reasons post the crisis.
Economic theory has it that as the currency depreciates exports go up and imports fall. But in the last two years as the rupee has fallen, our trade deficit(the difference between imports and exports) has gone up dramatically. How do you explain that?
The recent fall of the rupee has been very sharp but before this the rupee was adjusting for the high inflation we have had for such a long period of time. Exports are dependent on multiple factors, exchange rate being only one of them. Global demand which is another major factor influencing exports, has been weak. If just changing the nominal exchange rate was the game, then it would be such an easy recipe for every country to follow. You could just devalue your way to prosperity. But in the real world you need other supporting factors to come through. You need a manufacturing sector which can respond to a cheap currency. Our manufacturing sector, as has been well documented, has been throttled by all sorts of local problems which exist.
What are the other impacts of a falling rupee?
One of the factors that has been under-appreciated in this drive to see the currency go lower is that there is a negative effect also on the huge foreign exchange loans taken by the corporates. So even though there is not much that can be done to stop the rupee’s fall you can’t at the same time wish that you can just devalue your way to prosperity because there is a negative feedback loop which takes place.
And a lot of exports are import dependent…
Yes. There is a negative feedback loop because the corporate sector is heavily indebted in foreign currency. So that is the problem.
So there is a corporate debt crisis brewing up. You have pointed out in the past one in four Indian companies does not have enough cash flow to repay its debt. How do you see that playing out?
Those companies are just going to be shunned for a long period of time. People are now just investing in the 15-20 big companies and keeping away from the rest. India has lost a major competitive advantage. India’s advantage that used to be quoted to foreign equity investors, particularly portfolio equity investors, was how we have a huge number of companies to invest in. That has shrunk incredibly now. Some of these companies are not going to be able to survive, that’s the harsh reality.
Oil prices are at an all time high in rupee terms. What sort of impact will that have on the fiscal deficit. The finance minister said today(on August 27, 2013, the day the interview was taken) that come what may the government will meet the fiscal deficit target of 4.8% of GDP. Can we buy that?
We achieved the target last year. But you have to understand how that was done. The government will have to really freeze spending, and that in turn will compress consumer demand. The issue is whether they have the political appetite to do that. Or the government will have to raise diesel prices. Currently, they are Rs 9-10 behind on the under-recoveries. They need to raise diesel prices by such a massive amount to stick to the fiscal deficit target. So can the government meet its fiscal deficit target? Of course they can. But the price unfortunately in this case will be economic growth.
If they don’t increase diesel prices they have a problem. If they do increase diesel prices they have a problem.
Exactly. That’s the negative feedback loop I talked about. The days when you could just move the exchange rate from x to y and hope that exports will pick up, is a very simplistic solution. It does not take into account the negative feedback loops that can arise in terms of corporate debt denominated in foreign currencies and also the fact that the oil import bill gets considerably worse.
There is a small cottage industry that has sprung up in trying to explain why the current fall of the rupee is due to international factors. How much of the rupee’s fall is due to international factors and how much of it is due to local factors?
Probably we can divide it 50:50. As I said, the fact of the matter is that if we were not running a current account deficit today, we would not be having this panic. Sure there would be some sell off because all emerging markets are under pressure. Growth forecasts across emerging markets have been downgraded regardless of their current account deficit. Nevertheless, it is ironical that the Chinese currency is up for the year. The currencies of some of the countries like Mexico and Philippines have fallen very slightly because they don’t have current account deficits. It is a very current account deficit centric problem that we are currently seeing now.
But the current account deficit did not appear overnight.
This is the irony, that the crisis has been badly managed. These fault lines have existed for a while. The current account deficit has been going up continuously over the last two to three years above levels which most economists consider to be sustainable. And we ignored that. In our desire to keep growth artificially high in 2009 and 2010, we engaged in a lot of stimulus government spending. We let our fiscal deficit blow out. We violated the FRBM (Fiscal Responsibility and Budget Management Act) and have never ever gone back to that. The Prime Minister has ignored so many fault lines.
Could you elaborate on that?
He dismissed crony capitalism as being something which possibly is the right of passage that any country going through an early stage of development will have to go through. Every such country will have its own robber barons. So what is the big deal that India does? He dismissed the rise in inflation by saying that rise in food prices are a sign of prosperity. He kept on going on about how savings and investment ratios are so high that growth is unlikely to ever dip below 8-9%. And on each one of them any sort of serious economic analysis would suggest that these arguments were flawed.
And this had a huge impact?
We know that if you have crony capitalism it can lead to a backlash against wealth creation. Look at issues like the ban on iron ore exports, the mining of coal etc. Some of this is because we have had crony capitalism and that has led to a backlash against wealth creation and that has led to these bans to start with.
What about the inflation argument offered by Manmohan Singh?
The whole business about inflation rising because of a rise in prosperity is a real myth. Why has China not seen this massive inflation problem despite 30 years of great growth? Why did Korea and Taiwan did not see any sustained inflation pressure? Or even Japan during there very high growth phrases? Why? This is a total myth. India’s inflation rankings have deteriorated considerably. Our inflation used to be always below the emerging market average for the last 20-30 years. It’s only in the last three to four years that we have been way high than the emerging market average, not just bit higher, but way higher. Also, other countries with high savings and high investment have also seen a growth fall off. The Soviet Union’s investment to GDP ratio was 35% before the collapse. It was all bad investment. This is what happens when there is too much academic focus on things.
In a recent column in the the Financial Times you wrote “A not so funny thing happened while the world was watching for an emerging market crisis to erupt in China. The crisis erupted in India instead.” Could you elaborate on that?
For the first half of the year a lot of focus was on China. China has had a massive credit binge over the last five years. And in recent times we have seen in the US, Spain etc, typically countries which have had a massive credit binge are vulnerable because when you increase your debt over a short span of time of three to five years you accumulate a lot of bad assets. And that leads to trouble for the entire banking system. So people have been very worried about the high debt to GDP ratio in China. Even I have been concerned about it and written about it. There were people sending out alerts on a China crisis. I think very few people were sending out alerts about a India crisis.
Exactly. That’s the irony to me. Everyone was looking for a crisis in China and it ends up erupting in India, first.
The Indian economic growth has fallen to around 5%. Do you see us going back to the good old Hindu rate of growth of 3.5%?
No that’s not been my case. Hopefully things have changed there. There is a lot of natural buoyancy. What I do find more impressive compared to 30-40 years ago is the quality of state chief ministers. They have improved a lot in comparison to the 1970s and the 1980s. In fact even the 1990s. The moment we think of the third front we all get a bit scared because we think of the motley crew which ran the government in the mid 1990s. If you look at the state chief ministers today, they are generally better. My entire case which I have even made in the book was the fact that the entire boom of the last decade, where the growth accelerated from 5-6% to 8-9% was totally global in nature, and that had nothing to do with India specific factors. And that boom is now unwinding. Now can we undershoot 5-6% for a year or two? Yeah we can. We overshot for a while, we can undershoot for a while. That is still my base case scenario. I am not willing to give up on India and say that India is going to go down the route of 3% growth which existed till 1980. Also it is important to remember that the aspiration levels of the people here are too high now to tolerate that kind of an outcome. They will force something to happen to change that outcome.
Any view on the food security bill which was recently passed by the Lok Sabha?
I have no strong view on that. My concern is about the fact that you can’t keep writing cheques that which the country can’t cash. We need to understand that we can only spend that much. And if we have to spend extra then we have to show stuff that we can cut elsewhere. The big damage of the food security bill is not the bill itself but the fact that why was this not used at the very minimum by the Prime Minister as an excuse to say okay, if you want to pass this, you have to raise diesel prices by an ‘x’ amount, so that we offset some of the cost.
The interview originally appeared in the Forbes India magazine edition dated September 20, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)
Our politicians think our problems come from being connected with the world, but the reality is we are too little connected to the world, says Pankaj Ghemawat.
The United Progressive Alliance government is fond of telling us that India’s weakening macroeconomic indicators – a falling rupee, a declining stock market, rising bond yields – are the result of being tied to a weak global economy and factors external to India. But if you were to ask Pankaj Ghemawat, Anselmo Rubiralta Professor of Global Strategy at IESE Business School in Barcelona, Spain, India is not exactly as globally connected as we think it is.
Ghemawat has constructed a broad index of international integration, the DHL Global Connectedness Index, which was first released in November 2011. The 2012 version of this index was released last year and it shows India closer to the bottom. “This index extends beyond trade to incorporate capital, information and people flows as well, and covers 140 countries that account for 95% of the world’s population and 99% of its GDP,” says Ghemawat.
India ranks 119 out of 140 countries on the depth of its global connectedness. “When it comes to trade intensity, India still ranks in the bottom 25% in the sample. As far as capital connectedness is concerned, it is closer to the median,” says Ghemawat.
Capital connectedness is calculated from measures of foreign direct investment (FDI) and foreign portfolio equity investment into the stock market of the concerned country. India’s decent performance on capital connectedness is primarily on account of the huge money that has come into the Indian stock market from abroad in the last decade and big outward FDI flows in the form of overseas acquisitions by Indian corporates.
If one looks at just inward FDI, the performance is dismal. As Ghemawat puts it, “In terms of inward FDI stock (i.e. foreign companies having built or bought businesses in India) expressed as a percentage of GDP, India comes in the bottom 10%.”
FDI flows into India have also fallen in three out of the last four years. For 2012-13, FDI fell by 21% to $36.9 billion, government data show. The United Nations Conference on Trade and Development (UNCTAD), in a recent release, said that FDI inflows to India declined by 29% to $26 billion in 2012.
The government has, faced with an unsustainable current account deficit (CAD), has been trying to encourage FDI into the country to firm up the rupee against the dollar. Last year in September, the government opened up FDI in multi-brand retailing with the rider that each state can decide whether it wants companies like Wal-Mart to set up shop within its borders.
But since then not a single dollar has come into the sector. “One reason for foreign money not coming in is that investors are not sure whether the policy will continue as and when a new government comes in. Also, letting states set their own rules on such an international economic policy matter is basically unheard of elsewhere,” said Ghemawat. Towards the middle of July 2013, the government relaxed FDI norms in 12 sectors, including telecom, insurance, asset reconstruction, petroleum refining, stock exchanges and so on.
Ghemawat feels that there is a lot that India can learn from China on this front. China started opening up its retail sector to FDI in 1992, initially with various restrictions, but ultimately allowing 100% FDI in 2004. This benefited them with foreign players bringing in new management practices along with supporting technology and investment capital. And we shouldn’t forget the complementarity for foreign retailers between sourcing from China (contributing to China’s export boom) and selling there.
Ghemawat argues that much of the fear about FDI in retail is exaggerated, because even with full liberalisation, foreign retailers would hardly come to dominate the Indian market. “Retail is a very local business, where an intimate understanding of customers, real estate markets, and so on, is essential to success.” He cites a recent estimate that 40 foreign players account for only about 20% of organised retail in China, to suggest that foreign and domestic retail could thrive side-by-side in India.
“Foreign retailers don’t always win out against domestic rivals,” he adds. “Electronics retailers Best Buy from the US and Media Markt from Germany both shut down their stores in China in the last few years. They just couldn’t compete with local rivals Gome and Suning, which had greater domestic scale and business models more attuned to the Chinese market. Home Depot also exited China in 2012. But Chinese consumers gained anyway – competition against foreign retailers spurred locals to improve customer service, one of their weak points.”
Coming back to data from the Indian market, Ghemawat notes an interesting factoid from the 2013 Economist Corporate Network Asia. The nominal GDP of India grew by 12.6% in 2012. In comparison, the sales of MNCs (mainly Western) in India grew by only 6.3%, only half as fast as the GDP. “While this could be viewed as positive regarding Indian firms, a difference of such a big magnitude is probably reflective of a lack of openness,” said Ghemawat.
There are multiple reasons for India’s poor showing on these indicators India regularly figures in the bottom tier of countries in terms of the extent to which its policies promote trade. In the World Economic Forum’s 2012 Global Enabling Trade Index, India figures in the bottom tier. On the market access parameters, in particular, it figures third from last in a list of 132 countries. Ghemawat also cites the OECD’s FDI restrictiveness index which he has inverted into the FDI Friendliness Index. “India again figures in the bottom 10% of 50 countries in terms of the extent to which it encourages FDI.” No amount of ministerial cajoling of potential foreign investors is likely to outweigh the impact of such protectionist policies.
These indicators, of course, translate into low productivity and lack of infrastructure required to carry out a profitable business. “The Global Competitiveness Report tells us all we need to know about India’s poor infrastructure and low productivity,” says Ghemawat. “India currently ranks 59th on the list (out of 144 countries). It has fallen 10 places since peaking at the 49th spot in 2009. Once ahead of Brazil and South Korea it is now 10 places behind them. China is 30 places ahead of India,” he adds.
When it comes to the supply of transport, energy and ICT (information, communications technology) infrastructure, India is 84th on the list. This lack of infrastructure is the single biggest hindrance to doing business in India, feels Ghemawat. And this has kept foreign investors away from the country. Also given India’s weak health and basic education infrastructure (where it is 101st on the list), India remains low on productivity, which is an important factor for any foreign investor looking to make an investment. And as if all this was not enough it is worth remembering that it is not easy to start any business in India. Every year the World Bank puts out a ranking which measures the Ease of Doing Business across countries. In the 2013 ranking, India came in at rank 132 on the list – the same as in 2012. When it comes to starting a new business In
dia is 173rd on the list. Hence, foreign investors have an option of starting their business in a much easier way in many other countries. Given this, why should they be hurrying to India?
The spate of recent scams also has not helped the way India is viewed abroad. There is significant evidence to show that corruption hampers trade. Says Ghemawat: “According to one study, an increase in corruption levels from that of Singapore to that of Mexico has the same negative effect on inward foreign investment as raising the tax rate by over 50 percentage points.” India stood at 94th position in Transparency International’s 2012 Corruption Perception Index. “Given this, tackling corruption has to be a priority,” adds Ghemawat.
The moral of the story is that although India is much more open than it used to be 20 years ago, there is a lot that still needs to be done. And this is important because there is a clear connect between the global connectedness of a country and measures of prosperity. As Ghemawat puts it, “There is a strong positive correlation across countries between the depth of a country’s global connectedness and measures of its prosperity, such as its GDP per capita and its ranking on the UN’s Human Development Index. To be sure, correlation is not the same as causation, but statistical analysis indicates that after controlling for initial income levels, countries with deeper global connectedness have tended to grow faster than less-connected countries.”
The point is further buttressed by one look at the list of countries that are on the top of 2012 DHL Global Connectedness Index created by Ghemawat. These countries are the Netherlands, Singapore, Luxembourg, Ireland, Switzerland, the United Kingdom, Belgium, Sweden, Denmark, and Germany. In the recent past some of these countries have been caught up in the aftermath of the financial crisis, but it’s important not to let recent growth rates overshadow measures of current prosperity, on which all of these countries far surpass India.
Ghemawat gives the example of the Indian information technology sector. “Ask this simple question to yourself: Would Indian IT companies have been as globally competitive if we had protected them from international competition?” The answer of course is no. But that is the case with the business services sector. There is a huge protective moat around it. This, despite the fact that the sector has a huge potential to create jobs.”
And he backs his argument with numbers. “Although some services (like haircuts) will always be delivered locally, liberalizing trade in services alone could boost global GDP by at least 1.5%.” In India’s case, opening up business services is even more important given that we don’t trade much with our neighbours due to various reasons. “For example, Indian trade with Pakistan, according to one study, is only 2 to 4% of what it might be under friendlier circumstances. The rest of India’s neighbours are relatively small and poor, presenting limited opportunities compared with, for example, the benefits China realised by tying into Japanese and Korean production networks. It is neither exaggerated nor xenophobic to say that one of India’s key structural problems is that it is located in a difficult neighbourhood,” says Ghemawat.
Countries tend to trade the most with their neighbours. Ghemawat explains, “all else being equal, if you cut the distance between a pair of countries in half, their trade volume will go up almost 200%. Add a common border, and trade rises another 60%. That’s why more trade happens within world regions than across them, and the US’s top export destinations are Canada and Mexico.”
In India’s case, at least over the short-to-medium term, trading primarily with neighbours won’t be workable (though Ghemawat does urge India to take the lead on regional integration in South Asia). Hence, he feels that some business services can be outsourced over greater distances than many categories of merchandise are traded, since physical shipment of products is not required.
One exception he notes is how, recently, China became India’s biggest trading partner, overtaking the United States. But Ghemawat feels that caution is in order. “India runs a huge trade deficit with China and exports mainly primary products there: Cotton, copper and iron ore account for nearly one-half of the total. Given the limited progress the US has made in rebalancing its trade with China, it’s hard to see what India might accomplish within any reasonable timeframe,” he says. Trade deficit is the difference between imports and exports.
Ghemawat also feels that India has a lot to gain by encouraging trade within states. “I have been trying unsuccessfully for years to get hold of data on trade between Indian states,” he says. “India has a lot to gain by encouraging and increasing trade between states. As the former Chairman of Suzuki once put it to me, what India needs is not external trade liberalisation but internal trade liberalisation. And I heard Ratan Tata say something similar about the need for more integration and fewer barriers within India. For a large country, the potential gains from internal trade are typically much larger than those from international trade,” Ghemawat concludes.
The interview originally appeared in the Forbes India magazine in the edition dated Sep 20, 2013