‘India’s medium-term prospects still look bright’

by Dave

The Hindu Business Line

Prof Arvind Subramanian, Senior Fellow, Peterson Institute for International Economics, Washington DC, has written extensively on growth, trade, development, institutions, aid, oil, India, Africa, the World Trade Organisation, and intellectual property. He also holds a joint appointment at the Centre for Global Development and is senior research professor at Johns Hopkins University. In Chennai recently to launch his book India’s Turn: Understanding the economic transformation, he spoke to Business Line on a range of issues concerning the Indian and global economy.

Excerpts from the interview:

Over the last one year, starting with the sub-prime crisis to the crude price going through the roof, and inflation shooting up, the mood over the global and Indian economy has darkened, the euphoria over the Indian growth story has been tempered. So going from here, what do you think are the near-term prospects for the Indian economy?

I would like to take a medium-term look at the economy. [India] grew at about 6 per cent from the late 1970s till about 2002. Then, over the last four-five years, we have gone from 6 per cent to close to 9 per cent growth.

Then, two external shocks — the sub-prime crisis and the rising global commodity prices — started kicking in. So, in the medium term, we are looking at an 8-plus per cent growth. Of course, in terms of the cycle, there is going to be some effect of what is happening in the US and world economy.

So, for the next one year or so, we could be looking at growth of around 7 per cent. This is partly because of external shocks and the policy response to those shocks, by way of monetary tightening and other measures. So some slowing down of growth is inevitable in the next year or so.

What’s your outlook on inflation? With crude prices falling, do you think inflation will come down in the next year or so?

With the slowing down of the US and European economies and Brazil and India, the dollar started appreciating and some commodity prices have softened; so the inflation outlook looks better now than it did a couple of months ago. But that does not mean that the inflation worries globally are by any means over. I think, fundamentally, we are looking at stresses on supply. Productivity growth is slowing down in the US and probably in Europe too.

Also, the policy stance in the US still remains expansionary. Monetary policy in the US remains relatively loose because of the financial crisis there. Regarding fiscal policy, many economists in the US are calling for a second fiscal stimulus package because they want to avert a growth slowdown at all costs. Plus, all those countries that have dollar pegs are **running US monetary policy. So, the inflation scare is by no means over, despite the supply-side easing to some extent.

The Doha Round has collapsed and it was not a surprise. Now, where does the WTO go from here?

If you step back and look at what has been happening around the world, you would see that there is a lot of unilateral liberalisation going on. Countries have either liberalised unilaterally or as a result of regional trade pacts. So, the attractiveness of the multilateral process to effect further liberalisation in the developing countries has reduced significantly. A corollary of that is private sector interest in the rich countries, which was the main protagonist in pushing multilateral trade agreement, was completely absent. So this was the biggest problem with the Doha Round.

If we look at the way the Doha Round was launched, we can see its aberration. Even the rounds before that — Seattle, Cancun, Geneva, Potsdam — were fractious where countries did not want to negotiate. So, given this, failure was always on the cards.

What compounded the problem was that between the launching of the Round and today, it is a completely different world.

When the Doha Round was launched, oil was selling at $20 a barrel; now, it is around $120 and the price of rice has shot up. China’s current account was very small; no one had heard of sovereign wealth funds then, so the world has completely changed since the launch of this Round.

So we need to step back and say that the collapse of the Round is not a serious issue. The Doha Round is dead, let us bury it and move on to more important issues. I am not saying there is no need for multilateral cooperation, in fact, there is a greater need for that today. But what we need to co-operate on is different from what the Doha round had been stressing.

The issues we need to cooperate on are: Agricultural prices and their link to bio-fuels; the cartelisation of oil markets (which is a big problem for oil importing countries); undervalued exchange rates (the Chinese exchange rates are a serious problem for India); and global warming.

Q: What about the issue of farm subsidies in the US and EU, isn’t that an intractable problem? Are they under less pressure to address that issue now that Doha round has collapsed?

A: The agriculture policies of the US and EU are outrageous. Over the last one year, because prices have gone up automatically, a lot of the protection has come down as it is price related. In the EU, there has been some liberalisation; it has reduced some tariffs. But a lot of it is because prices have gone up, there is less need for protection.

But if we look at the recent farm bill passed in the US, to me it is outrageous that so much subsidies for the farmers are still being given even when prices are going up. But I do not think that farm subsidies were the only reason for the collapse of Doha.

India’s stance at Doha was that it needs to protect its farmers and ensure food security. To me, there seems to be a bit of disjunction between what we are doing domestically in this crisis (that is slapping export curbs, liberalising imports, which are hurting farmers) and what we were saying in Doha about protecting farmers.

The US and EU were unwilling to liberalise their agriculture but we were not willing to go too far either. We have liberalised agriculture as a result of food price hikes but we are not willing to commit that these policies would not be reversed in future. We still want huge margins of freedom to manoeuvre our policies. At the moment, our tariffs are pretty low but we want to regain the right to raise tariffs at some future date to protect farmers which is an issue.

I found China’s stance at Doha interesting. China did not want the Round because it wanted the right to protect its farmers. China’s stance was more credible than India’s because India still has a lot of margin to protect farmers as our bindings are much higher than actual tariffs. That is not the case with China. Under the WTO accession agreement, China’s bindings were much closer to the actual tariffs. So they do not have the freedom to raise tariffs to protect their farmers and that is what they were seeking.

But stepping back from who said what and when, the point is no one really wanted the Round. It was all drowned in the cacophony about who was not willing to liberalise when the fact was no one wanted to. So it was the agricultural exporters who got hurt.

But the really interesting political economy issue here is that countries like Brazil and Argentina, (which are big agricultural exporters that wanted  agricultural liberalisation), even they, at the end of the day, are saying that if prices remained high, they were happy. We can live without freer trade as long prices rule high. They are getting market access anyway.

Q: You have said recently that removing the curbs on global grain trade could bring down food prices. Do you see that happening?

A: In March-April, food prices we
re really surging, especially rice. So what became evident was, especially in the rice market, when countries imposed curbs on exports — India, Vietnam and the Philippines (Thailand was also contemplating) — the prices really spiked. And as these policies got reversed, you did see prices softening again. The funny thing about trade in agriculture is when we have a situation of surplus, we have protection, where countries subsidise agriculture, which leads to greater supply. But when we have pressures on the supply side, perversely we see the reverse happening, with countries curbing exports and removing import barriers. So this policy is making global grain prices move counter-cyclically. Prices go down in countries which have surplus due to subsidies and they go up in countries where there is scarcity.

The WTO is also ineffective here as it is unable to prevent protection in countries where there is excess supply and it is unable to prevent liberalisation and export controls in countries with scarcity. So what we need is more symmetry in the global trading system so that it could act as a price stabilizer.

You see when India imposed curbs on exports [ed - Argentina did as well leading to nationwide strikes] and liberalised imports, that seemed the logical thing to do to make more food available within the country. But when all countries adopt this policy, it does not help as it further drives prices up. So everybody ends up losing.

…I call this the ‘precocious India’ phenomenon. We do all the skill-intensive stuff and people get very excited, but there is a huge cost to be paid because we are developing against our comparative advantage. Our comparative advantage is the 600-million labour force.

Now, the question is, can this be reversed? Many economists have argued that labour laws need to be reformed to make hiring of unskilled labour more attractive and make India a labour-intensive manufacturing hub. I wish this could happen, as this is a very attractive policy prescription but I do not think it is likely to happen. This is because we are on a growth path which is skill-intensive and it is impossible to reverse that trend.

So, is the Indian growth process going to remain unequalising? The answer to that question is, yes, at least for some foreseeable future, it is going to be unequal, which is unfortunate.

So how does policy respond to this dilemma? Given the skill-intensive growth path of India, the only way to respond to this is to increase the supply of skilled labour to match the pace of its demand. Higher education, skill-based training are issues of high priority because that is what the economy is demanding.

This is not to say that we should not do anything to make unskilled labour more attractive, more employable but, unfortunately, I do not see that having much of an impact as the private sector does not seem too keen on hiring unskilled labour.

Our higher education policy is a bit of a disaster. I think it is the last bastion of the licence Raj which has not been liberalised.

Q: Do you think schemes like NREG can address the issue of inequality?

A: I view schemes such as NREG as targeted welfare. Whether rural assets are being created or not we cannot be sure. It is a way of providing transfers and it has the virtue of being self-targeting. Only people who are really poor with little options elsewhere are going to show up for this scheme. So in terms of welfare it is a good scheme.

The basic problem with our policy-making is we are unable to devise well-targeted poverty programmes. What [India] needs is a scheme where we can hand out direct cash subsidies to poor people. So schemes such as NREG are a step in that direction and, hence, desirable. Of course, there is the problem of leakages. I am sure the leakage to benefit ratio differs from State to State or even between districts in a State. But the NREG is a good step forward and we should look to expand it into a good targeted welfare programme.

We have schemes like this in Brazil and Mexico. The ‘Progressa’ scheme in Mexico provides direct cash transfers to poor households but makes it mandatory for these households to send their children to school. These cash transfers are conditional and the evidence suggests that these schemes are quite successful. So it should be our endeavour to expand NREG scheme and make it a well-targeted, effective welfare scheme.

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