Confusion amid a crisis

Even as bloggers are busy decoding depression, the real challenge now for India will be to maintain the national savings rate above 35% of GDP.
This is the high season for confusion about the state of the world economy. The pace at which world output is slowing has caught most economists—other than the most pessimistic members of the tribe—unawares.
Even the D-word is now getting an airing. Economics bloggers are busy trying to define what a depression really means. British Prime Minister Gordon Brown used the word to describe the state of the global economy in a speech last week; his media managers quickly moved into overdrive to dismiss his usage as a slip of the tongue. But then the chief of the International Monetary Fund announced on Monday that the rich nations are “already in depression”. This came just a few days after the multilateral lender said that the world economy was already at a standstill. Dominique Strauss-Kahn says that the IMF growth forecast could be cut once again: “The worst cannot be ruled out.”
The semantics and speeches aside, the big issue is whether the world economy is stumbling into a Japan-style decade of zero growth and deflation, and what this will mean for India.
The immediate pain is visible. The first official estimates of Indian economic growth have been pegged at a six-year low of 7.1%. That’s a far cry from the needless bravado earlier this fiscal year, when the then finance minister P. Chidambaram insisted that Indian growth would not be affected by the global crisis.
Most private sector economists expect the economy to perform worse than the government’s statistics office has initially estimated. The 21 professional forecasters polled by the Reserve Bank of India every quarter expect an average growth rate of 6.8% in the current fiscal year, against the 7.7% average estimate made in the previous survey.
The current slowdown—and the prospect that it will worsen—could reopen the old debate: At what rate can India sustainably grow in the medium term?
There have always been contentious debates on what drives economic growth in any country—use of more resources such as labour and capital, or a better use of resources through higher productivity? Barry Bosworth and Susan Collins, in a 2007 research paper on “growth accounting” for India and China, showed that of the output growth per worker in these two countries between 1978 and 2004, roughly half came from capital accumulation and the other half from higher productivity.
Ensuring that India maintains strong economic growth despite the obvious global problems will require coherent strategy from the Indian government—both this one and the next. The current focus seems to be throwing cash at every industry and major project that can make itself heard in the election season. Some of this may be inevitable in a boisterous democracy such as ours, but lobbying and rent seeking also play a part.
Analyses such as the one from Bosworth and Collins suggest that long-term policy should focus on two important issues: maintaining rates of savings and investment so that capital accumulation stays on track; and long-term reforms that will create incentives for Indians to take risks and work harder.
First, let’s consider savings and investments. The splendid boom that began five years ago and is now winding down was driven by both a benign global business climate as well as a huge increase in the national savings rate. The latter has shot up by around 12 percentage points since the beginning of this decade—and higher domestic savings have been able to support the higher investment rate that led to accelerating growth.
The real challenge now will be to maintain the national savings rate above 35% of gross domestic product (GDP). Most of the rise in the savings rate these past few years was because of healthier corporate balance sheets and lower government deficits. Both are likely to deteriorate in the current downturn. It is safe to guess that national savings have peaked for now and will decline as a proportion of national output. Irresponsible fiscal policy could pull it down to levels that make it difficult for India to grow above 6% a year. That is something the Indian government should avoid.
The second big challenge will be to boost productivity, through more open product markets, better infrastructure, a more educated and skilled workforce, and access to capital for both large and small businesses. The march out of poverty is essentially about raising output per worker—and productivity has a big role to play in this.
These are trying times for policymakers. And there is too much confusion right now for a coherent policy to emerge. But even as the government is busy fighting many small fires, it should not take its eyes off the larger issue—that the economy will keep growing rapidly only if investments stay on track and there are reforms to boost productivity per worker.
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