The 80/20 divide

There is a classic 80/20 divide with respect to India and it's economy.

As you might be familiar, life is best thought of in 80/20 terms e.g. 80 per cent of wealth is controlled by 20 per cent of people; or 80 per cent of world trade is accounted for by 20 per cent of the countries (actually with the large undervalued exchange rate of China, the 80/20 Pareto rule may need to be modified to 90/10); 80 percent of the poor live in a fifth of the countries; 80 per cent of land area is barren and only 20 per cent is inhabited.

Some aspects of life belong to the 70/30 regime  -- the top 30 per cent of batsmen account for 70 per cent of the runs.

The conventional (80 percent) view among serious economists is that there is more hype than substance regarding India's future.

This view has a blue-chip pedigree -- leading economists at the World Bank, IMF, U N and Indian think tanks are its subscribers. They have the reputation, and the force is ostensibly with them.

Thus, while everybody agrees that economic growth in 2003-04 will top 7 per cent, (primarily because of something as brutally exogenous as rainfall), the 80s' prognosis for the future is more of the past, i.e. GDP growth averaging the same as that experienced over the last 20 years, 5.5 to 6 per cent per annum.

These guys have a lot more than history on their side. The dismal fiscal condition is their first exhibit. Consolidated (centre + states) faltu or extraneous expenditure (popularly known as the fiscal deficit) is close to 10 per cent of GDP.

This level is more observed in crisis economies than those on the threshold of a breakout.

If this were not evidence enough that the 20 per cent are high and way over the top, the 80s' cite the poor state of infrastructure -- how can there be progress, let alone a breakthrough, when roads don't work, ports are clogged, water is scarce, and power is unavailable?

Further, more than a third of the country is absolutely dirt poor with consumption of less than $1 a day, just about 10 per cent less than the poor continent of sub-Saharan Africa.

Growth miracles need domestic purchasing power like China, where the number of poor are considerably less, only 15 per cent. These statistics are from no less an authority than the World Bank.

Thus, according to the 80s,  the best that India can hope for is to stumble along its destiny. Steady plodding 5.5 per cent growth -- and Indians should not dream beyond the realisable reality. 

But there is a minority view. According to the remaining 20 per cent dyed in the wool optimists, and therefore doomed to be wrong forecasters, the situation is manifestly different than that indicated by the half empty glasswallahs.

For starters, say the roaring 20s, the much talked about and worrisome double digit fiscal deficit is not exactly a new phenomenon.

Indeed, it is more than 20 years old -- yes, the consolidated fiscal deficit in India has been in the 7.5 to 9.5 per cent, for every consecutive three- year period since 1980! In other words, to claim that the level of the high fiscal deficit will constrain us to accelerate growth is just plain vanilla wrong logic.

The change in the growth rate is a function of the change in the fiscal deficit, and analysts should not confuse levels and changes, i.e. a high fiscal deficit affects the level of growth, the change in the deficit affects the acceleration.

Apart from this conceptual error, the 80s thinkers do not concentrate on the trend in the level of the fiscal deficit, which is down, ceteris paribus.

The second major development completely missed by the 80s is the change in real interest rates. Nominal interest rates are down by about 4 per cent and inflation is up a couple of percentage points.

That adds up to a hefty 600 basis point decline in the real cost of capital. If this is not structural change, then it is clear that the 80s are the ones who are smoking, and smoking a depressant.

That the 80s blue-chippers are not comfortable with the new globalisation economics is also indicated by the fact that they are relatively clueless as to how such a decline in interest  rates has occurred when the fiscal deficit has stayed at such a high level, and if anything has inched up!

The third development missed by the 80s is due to their own huge error of commission. They are lazy enough to blindly accept World Bank poverty statistics.

While such trusting nature is touching, the simple fact remains that even official Indian poverty figures (for the same poverty line) are about 10 percentage points below the World Bank 35 per cent figure.

And if the official figures are adjusted for known problems of measurement, then  poverty in India and China is about the same, i.e.  less than 10 per cent. So lack of future purchasing power is a past problem.

The new spring in the step of Indian industry is not due to them coming of age because they just have finally grown up. No, these guys entered old age still demanding high tariffs in the name of a level playing field.

But, finally, they were given monetary (but not momentary) Viagra that allowed them to be internationally competitive, especially with stealers of the show, China.

Even if interest rates were to suddenly spring back up by 300 basis points (an unlikely event), this gain in the cost of capital has real effects in the form of extra investment, and extra growth -- about 0.3 per cent extra GDP growth for each 100 basis points decline in the cost of capital.

While obtained via a black box, the effect of declining capital costs is real,  particularly when it comes to infrastructure investments, which are almost all capital and no labour!

So obviously the halving in the cost of capital will have a huge effect on the supply of infrastructure.

Additional confirmation of extra growth will come, has to come, via extra investments. Again, because the cost of capital has gone down, structurally and substantially.

Perhaps the biggest reason why the 80s will be wrong is because they are not reading the tea leaves, the psychic dimension, the animal spirits, right.

For various reasons, but primarily because of the positive effects of liberalisation and globalisation, India is catching-up with the frontier across several dimensions.

These effects are reinforcing -- the winning of the beauty queen contests means that the cosmetics industry gets a leg-up; the success of Infosys leads to a belief that we can rapidly approach the frontier, and others follow; the decline in interest rates means we can compete with China in manufacturing; the quadrilateral highway programme means that we need not suffer from infrastructure; privatisation of electricity means that soon every house won't have to separately invest in the supply of industry; all of which adds to the fact that beating  Australia  was entirely to be expected.

So get used to the prospect of India being No 1 in cricket.

The final indicator that the 20s will be right is the market. True, Nobel prize winner Paul Samuelson said (for another world) that the market has predicted ten of the last three recessions.

However, at least 80 per cent of market economists and/or practitioners think that India is on a structural break.

If ever there was a fair test between the market and economists it is on India's future -- if this is India's decade (within an Asian century) then the blue-chip economists will be shown to be horribly off the mark and good only to teach text books; if the market economists are wrong, they will have to dearly pay, albeit with other people's money.

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