Indian Economy, 5th edition (50 page)

The reduction in share of advanced economies, particularly from 2005, has been accentuated by the slowdown that followed the ‘sub-prime crisis’ in the United States, the eurozone crisis in 2010, and the near stagnation in Japan for nearly two decades on the one side and the significantly higher rate of growth in low and middle income countries, particularly the large countries like India and China, on the other.

From the perspective of whether there has been a ‘catch up’ (or convergence) in per capita incomes across a larger set of countries, it is seen that the standard deviation of per capita income (at PPP constant 2005 dollars) of 131 countries from 1980 to 2009 continued to increase for most of the period since the mid-1980s (indicating divergence rather than convergence), except in the last two-three years
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. This indicates that despite a reduction in the share of advanced countries, the inequity between the developed and developing countries might have increased for most of the time period. Whether the recent reduction in standard deviation is associated with the ‘catching up’ process of countries (including low income countries), or a slowing down of developed countries following the financial and economic crisis, and whether this is likely to be a temporary phase are issues that need further investigation.

The foregoing dimension of
inequality
does not capture interpersonal inequality. According to a study based on consumption data undertaken by Branco Milanovic of the World Bank, global inequality has been quite high, with the bottom 50 per cent of the people accounting for only 6.6 per cent of world income/consumption on PPP basis in 2005 while the top 1 per cent accounted for 13.4 per cent and top 10 per cent for as much as 55 per cent.

As far as
India
is concerned, it has achieved faster growth from the 1980s. Not only was this growth higher compared to its own past, it was also much faster than that achieved by a large number of countries. Between 1980 and 2010, India achieved a growth of 6.2 per cent, while the world as a whole registered a growth rate of 3.3 per cent. As a result, India’s share in global GDP, (measured in terms of constant 2005 PPP international dollars) more than doubled from 2.5 per cent in 1980 to
5.5
per cent in 2010. Consequently, India’s rank in per capita GDP showed an improvement from 117 in 1990 to 101 in 2000 and further to 94 in 2009, out of 131 countries. China improved its rank from 127 to 74 during the same period. Underlying the relative decrease in share of advanced economies in the global GDP, there has been a marked shift in the
location of manufacturing.
This process was on in the 1990s too but got accelerated in the current decade. Again, the rise in share of China is particularly significant while other emerging economies, namely Brazil, India, Indonesia have also moved up in terms of their share in world manufacturing value added. Even with the change in distribution of global GDP and manufacturing across countries, it needs to be noted that the advanced countries still account for a large share of industrial output apart from being the repositories of technology and value added in services.

World Trade

The changes in distribution of manufacturing, to some extent, get reflected in the relative shares in world
merchandise trade
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(which also includes non- manufactured products). Again, there is a perceptible decline in the share of developed countries and rise in the importance of emerging economies, most significantly China. The share of India in global merchandise exports increased from about 0.5 per cent in 1990 to
1.5
per cent in 2010. Yet India’s share remains miniscule and it ranks 19th in the global order of exporting countries.

Even in
service exports,
the high income countries have witnessed a declining share but they continue to account for an overwhelming
79
per cent of global service exports
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. While India, by virtue of its information technology (IT) industry, has seen its share of service exports rise to 3.3 per cent, China has moved in from behind and now accounts for 4.5 per cent.

Financial services
play a major role in some of the developed economies and, of the top 10 financial centres, most are located in advanced markets
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. This is reflected in exports as well as imports and India figures in the top ten both as an exporter of financial services with a share of 2.4 per cent and an importer with a share of 6.7 per cent.
In general, the foregoing distribution of economic activities and trade has a bearing on where nations stand in terms of their position on various issues that get discussed in major economies global forums.

Demographics

The role of demography in shaping the size of the labour force and economic productivity and its structure has a bearing on economic growth. As compared to the 1980s, it is clear that a number of advanced countries have ageing populations. At the same time, their share in the global GDP is reducing in relative terms. The changing
dimensions
of the world demographics and the critical role the
international migration
plays become visible via the UN Population Division
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which is as given below:

1.
Of the 6.9 billion global population in 2010, 214 million or
3.1
per cent were international migrants.

2.
South-South migration is also becoming important about which sufficient data is not available.

3.
Without international migration, the working-age population (persons in age group 20-64 years, as per UN classification) in the developed countries would decline by 77 million or about 11 per cent – which could increase the dependence of the developed countries on international migrants or on outsourcing of work.

4.
While demographic changes are incremental, the cumulative change in demographic structure has started to impinge on the
fiscal capacity
of many developed economies, particularly in Europe – an increase in share of
retirees,
existing social compacts in many developed countries have come under strain as their capacity to service
public debt
has diminished and private debt has also risen.

5.
The recourse to automatic stabilizers during the financial crisis has stretched their fiscal capacity as public debt in relation to GDP has reached close to or exceeded the benchmark of 100 per cent of GDP and, in case of Japan, touched a whopping
220
percent of GDP
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.

6.
An interesting point to note is that as compared to most of the major economies, expenditure of the general government in
India
is much lower as is the case in respect of revenue.

At this juncture, there is an underlying
resistance
on both counts in advanced economies that may well make the revival of growth more challenging. With regard to economies like India, the availability of a larger proportion of working-age population is likely to play a central role in driving economic growth. As the dependency falls, opportunities for economic growth tend to rise, creating what is termed as a
‘demographic dividend’.

Till
conscious action is put in place (discussed in the chapter
‘Preparing for the Demographic Dividend’
), the ‘dividend’ will not start accruing automatically in India’s favour. The prospects can be increased by India’s timely and needful actions.

Current Account and Forex Reserves

In response to a series of financial crises, especially after the East Asian crisis of 1997, many emerging and developing economies adopted new strategies for managing their external economy. These involved greater reliance on exports (aimed at current account surpluses) and the accumulation of foreign exchange reserves, in part to check currency appreciation and also as self-insurance against capital flow outflows/reversals (of the FDI and the PIS in India’s case). These strategies led to a shift from being net importers of financial capital to net exporters. As reserves got invested in developed economies, it led to a
contradictory phenomenon
of capital flowing from emerging countries to capital-rich countries (especially the US). In an accounting sense, this was equated to high saving rates in the emerging market economies (EMEs), especially
China
which was sitting on a current account balance of over US $ 300 billion
(as per the latest data provided by the WEO)
and a Forex reserves above
US $ 2800 billion.

In this regard,
India,
is somewhat a different case. While holding substantial forex reserves (US $ 295.6 billion
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), it has essentially had a
structural current account deficit
and is therefore not a contributor to global imbalances in the foregoing sense. Regardless of the merits of holding forex reserves, it is by now agreed that the relatively stronger external financial position (forex reserves) of the EMEs made them less vulnerable to the capital outflows/reversals following the global financial crisis of 2008 and in that sense a
vindication
of the strategy of maintaining high reserves.

High buid-up of current account surpluses and forex reserves have been
a matter of global debate
among the financial experts, central banks and the policy-makers. The pros and cons of it may be seen in the following way, especially, in the light of the ongoing global financial crises:

(i)
While holding forex reserves has been acknowledged to be useful in dealing with the crisis, it has also been argued that excessive reserves involve (quasi-fiscal) costs apart from yielding low returns as countries invest abroad rather than in high-return domestic investments.

(ii)
Furthermore, large fluctuations in the exchange rate could result in significant losses in its value (for example, if the US dollar weakens, it could result in a loss in value of forex reserves denominated/maintained in the currency).

(iii)
Apart from the holding costs to the economy, high build-up of current account surpluses and reserves has been seen as a major indicator of global imbalances and potential source of instability in the international monetary system.

(iv)
In the global context, it has been argued that reserve accumulation was an outcome of resisting currency appreciation and an attempt to stimulate export-oriented production at the expense of domestic demand.

(v)
The reserve accumulation by key emerging current account surplus economies, mostly held as dollar assets, supported a strong US dollar in spite of a growing current account deficit in the US. By thwarting exchange rate adjustment, this practice has been contributing to global economic imbalances.

(vi)
On the other hand, it has also been argued that the build-up of reserves is a consequence of loose monetary policies followed by reserve currency-issuing countries.

There may be divergent opinions on the positives and negatives in this case, the fact remains that the issue of exchange rate management, build-up of current account surpluses and of reserves cannot be viewed in isolation and these issues are embedded in a wider ongoing debate on the deficiencies of the
international monetary
and
financial system.
This is why there has been a strong demand for reforms in the IMF (which looks after the International Monetary System), especially, from the emerging economies which now seems logical to the advanced economies, too. But for the time being, the global economy has to learn the ways and means to operate amidst the high buid-ups of the current account surpluses and forex reserves which are kept/maintained by the EMEs.

Savings and Investment

One of the features of the ‘new normal’ in the world economy is the way savings as well as investment rates are distributed between the advanced and emerging economies. As per the database of the WEO, the most advanced economies have gross saving rates
below 20 per cent
while the opposite is true of the EMEs; in case of China it is around 52 per cent, for example.
India’s
investment rates, for example, have risen some 12 percentage points of GDP from the mid-1990s to around 35.1 per cent in 2010-11
(Economic Survey 2011-12).
Investment trends drive growth and the divergence seen in savings is almost symmetrically reflected for the investment rates.

Implications of the Change

The changes in composition/dynamics of the global economy discussed thus far suggest a perceptible shift in the global balance of output of goods (especially manufacturing). While services (in particular financial services) continue to be largely concentrated in advanced economies, a larger share in world population, coupled with higher growth, implies that the EMEs and developing countries will increasingly account for incremental growth in the global market for goods, services, and commodities. A change in the global economic balance driven by supply and demand forces therefore appears to be the
‘new normal’
and is likely to accentuate in the years to come, as has been discussed by the experts in following paragraphs:

(a)
In the situations when small economic crises crop up repeatedly over a relatively short period of time, policymakers in each country may treat each such episode as an independent event requiring independent action but in reality such ‘cluster crises’ may be a sign of some fundamental shift taking place in the global economy. Hence, faced with cluster crises, it is important to occasionally step back and take a more holistic view of the situation. There has been some research trying to do precisely that.

(b)
It does not seems too difficult to see what is happening, at one level – with rapid globalisation since the end of World War II, goods and services and also capital have begun moving much more freely across nations. The advance of IT has meant that it is possible for people with a modicum of skills to sit in one country and do work for another country – this adds a new dimension to the situation. Briefly saying, one of the most precious resources for economic progress, namely
skilled labour,
which earlier sat walled in within the boundaries of their respective nations, has suddenly become available to needs arising in distant parts of the world.