Fault Lines - II

Continuing from the last post, here I'll try to deal with the second set of fault lines which emanates from trade imbalances between countries and these in turn stem from prior patterns of growth. Countries like Japan, Germany and China are overly dependent on exports for their own growth on account of low domestic demand in their own countries. This excess supply slushes around in the world market, looking for countries that have the weakest policies and the least discipline and tempts them to spend until they simply cannot afford it and succumb to crisis. But why opt for a export-led growth strategy at all? Why not simply strengthen your domestic market which will consume this supply? Why in the first place would other countries spend so much on buying this excess supply when it knows that the end result is going to be doom? Neither are these easy questions to answer nor are the choices easy to make. I shall try to elaborate in the next few paras.

What are the factors that differentiate rich countries from the poor? Physical capital i.e infrastructure such as roads,airports,high-tech machinery,gadgets is the most obvious one. Next comes human capital i.e the level of education among the people which will enable them to derive the best benefit out of this physical capital. You can't hand over a tractor to a tribal and expect him to increase his productivity by giving up on slash-and-burn style of agriculture. But the most important differentiating factor is organizational capital i.e the capability to deploy the available physical and human capital in a complex environment with maximum productivity and efficiency. The countries that developed early i.e Australia, Canada and the United States developed organizational capital slowly over a long period of time. Industries typically began with a number of small firms of which only a few managed to survive over the years and become leaders. Governments simply didn't have the capacity(as in understanding of industry) to intervene and it didn't, except for lending a helping hand by way of trade barriers and tariffs to keep away competition from abroad. It was in short, the purest form of capitalism.

The late developers on the other hand,such as Japan,Germany,Korea,Taiwan and India, realised that in order to catch up with the advanced nations they needed a high annual growth rate on a consistent basis. They simply couldn't afford to spend a lot of time to allow organizational capital to develop all by itself. Competition from advanced economies to domestic producers made it all the more difficult. These countries therefore chose the path of managed capitalism which these days is a more benign term for "crony capitalism" (handing out of favours to a selected few). These countries had two options- they could either create government enterprises to undertake business activity or they could intervene in the functioning of the markets to create space for a few cherry-picked private firms which they felt were the most competitive and likely to do well. In either case,all the country's capital and resources were available to only a select few firms. Some countries chose the first path and some the second. India, as it should be obvious,chose the first. (Recall our Public Sector Undertakings or PSUs?)In either case, the governments ensured that these firms had access to loans at low interest-rates, and subsidised power,water and other natural resources which act as raw materials. Managed capitalism however, comes with its own set of problems.

First is nepotism. There is nothing to stop a government from distributing favours to family,friends and relatives who in turn being assured of official largesse tend to become lazy and inefficient,thus defeating the very purpose of protection. The second problem is that households get a raw deal so domestic consumption tends to be low. For starters, wages are low because supply of labour is abundant owing to the large number of people looking to move from low-productivity agriculture into factory jobs. Also,governments might intervene on behalf of manufacturers to keep wages low in order to keep them competitive and profitable. Since the firms are also paying less for energy and minerals,governments tend to boost revenue by taxing households even more. And all this while the firms are charging high prices for their goods in the domestic markets where they enjoy a monopoly.Since the loans made to businesses are at low interest-rates, banks keep deposit rates for households low as well,adding insult to injury.In short,producers are favoured at the expense of consumers and consumption is constrained. This prompts the government to encourage firms to export.Here,it should be noted however that as a end result we do get some strong domestic champions and domestic industry does become mature and competitive.

It is however,not always easy to encourage firms to export. For countries like Taiwan where the domestic market is small, an export orientation is unavoidable if firms are to grow. But the case of a country like India is different. As has been said earlier,India followed a path of developing a strong PSU sector serving the domestic market.Also,large business houses like Tatas,Birlas and others who were early players had been accorded special privileges, while preventing competition by way of the infamous "license-permit raj".India should have made the switch to exports in the 1960s.But because the protected Indian market was large,these firms were perfectly happy exploiting their home base despite government attempts to encourage exports.Government efforts themselves weren't very strenuous given that the protected firms were important financial sources for the ruling party to fight elections.In this case,democracy proved to be India's undoing as opposed to countries like Singapore and Korea whose leaders had no such irritations to bother about. As a result, India stayed closed,poor and uncompetitive for a long time until 1991 when it was left with no choice but to change or perish.

The excess supply generated by these now export-oriented economies looks for countries with weak policies that are disposed to spend but also have the credibility to borrow the finance to fund the spending. But there is a limit to which one can spend and take on debt.

This post has grown too long already so the effects of what happens when a country can no longer spend will be dealt with in the next post.Also,I shall attempt to summarize this discussion in a few sentences at the end.I'm aware that questions raised in the first para have still not been clearly answered.I hope however,that I have been successful to some extent till this point.

PS: Couldn't resist adding this in the end. The manner in which 2G spectrum was distributed, mining leases are being given out all over the country and land is being distributed to developers by politicians, have all led political commentators to observe in newspaper editorials that India is turning into a "crony capitalist" state.