India has been a trading nation for centuries, as has China. China has, however, been much more successful since 1980 in exploiting the opportunities provided by a globalised world to enhance its own growth. Its trade, led by exports, has increased much more rapidly to seven times ours. Free, fair and open trade with any and every country in the World is in the interests of India. ICRIER studies have shown that in 2000 the potential for trade between India and China was about 2.5 times the actual trade. The India-China study group (of which I was a member) has identified constraints and barriers that impede the attainment of this objective and recommended solutions. If these are sincerely and speedily implemented, there will be a mutually beneficial increase in trade.
Should better trade relations be contingent on and hostage to building of trust? Do we need to trust the Chinese to trade with them? I don’t think so! The essence of modern markets is impersonality. The systems of laws and rules that constitute the market as an institution allow strangers to trade with each other. If we only traded with our friends and relatives, the modern industrial economy could not exist. Impersonal trade can however, lead to greater information flows and knowledge and therefore help remove misperceptions. If trade is good then is isn’t more trade, engineered through a Free trade agreement, even better? This is false logic: More trade based on removal of distortions (e.g. a general reduction of our very high tariffs) is good for the Indian public, more trade based on creation of new distortions (e.g. selective reduction in tariffs for China) is bad both for industry and the public.
International trade in services is much more important to India than it is for China. An FTA would benefit China more than India, but can’t we balance this by better access for our Service exporters? Possible, but unlikely during the next 3 years. Service trade is heavily dependent on domestic rules, regulations and procedures. Partly because of the language barrier and partly because China is still a Socialist nation run on the principle of the “Dictatorship of the proletariat” such rules and regulations can be extremely non-transparent to Indian exporters and subject to individualistic application and change. It would be serious mistake to assume that if we reduce our goods tariffs to zero (the essence of a Free Trade Agreement) China will allow India free access to its service exports and the associated movement of skilled personnel. This will require a clear understanding of our national interest, hard bargaining, clear and explicit agreements and forceful implementation. It cannot be based on trust. In the next five years China will open its economy to service exports in line with its accession agreement with WTO. This will open opportunities for Indian service exports and will also indicate how open China’s service market will truly be. During the same period, the gap between India’s and China’s general tariff rates will be narrowed perhaps even eliminated. The scope for a mutually beneficial bilateral agreement will be much greater and we can and should revisit the issue in about three years.
Trust is critically important in a broader ‘partnership’ in economic, technological or strategic areas. Larger trade volumes cannot act as a substitute for rebuilding trust where it has been destroyed. The basic source of mistrust is the undefined border and the supply of nuclear technology (e.g. atomic bomb designs, in violation of NPT) and material to countries/regimes hostile to us. Other issues impinging on ‘trust’ include, (a) Opposition to the entry of India into pan-Asian economic organisations such as East Asian economic organisation and ASEAN+3. (b) Implicit (through Pakistan) opposition to permanent membership of India in the UN Security Council. The fact that India supported replacement of Taiwan, China by China, PRC in the Security Council decades ago is merely proof of India’s soft and sentimental approach in contrast to China’s hard realistic approach. Trust can only be re-established by addressing these issues. The willingness, after a long time, of China’s leadership to realistically address the border issue gives hope. On the other hand, the supply of nuclear and strategic technology to hostile countries/regimes is not conducive to building trust. Trust cannot be compartmentalised. It can only be rebuilt by addressing the broad range of issues in a sustained way.
Notes and Comments on Indian economy, Global economic issues, India's International relations and National Security.
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Friday, April 29, 2005
A Tripolar Century: The USA, CHINA And INDIA
Introduction
The fast growth of Japan till the mid-eighties, gave birth to several books about the Pacific Century and the Asia-Pacific Century. This talk gradually disappeared after the bursting of the Japanese bubble. The talk revived with the phenomenal growth of the NIEs or Asian Tigers but was soon overcome by the Asian Crises. Virmani (1999) showed that India (the elephant) was among the ten fastest growing economies of the World since 1980 and projected that in the next decade its growth rate would accelerate above that of the Tigers and reach the top three. Though China’s past growth had been overestimated by about 2% it (the dragon) would remain the fastest growing economy in the World during the first decade of the 21st century.
Krauthammer had heralded the arrival of “The Unipolar Moment” and set of a debate on its many ramifications. The reality of the unipolar world returned to center stage after the Asian crisis even some have asserted that the unipolar moment had passed. Since 9/11 the USA has asserted its primacy and the Unipolar nature of the World has been re-asserted. There is, however, a variety of views on how long the unipolar world will last. The current paper argues that the global economy is evolving in a direction that will result in a tripolar World by the middle of the 21st century. Thus the 21st century will be a ‘Tripolar Century’ with two of the poles in Asia and one on the other side of the Pacific. So ironically it could end up as partly a Pacific, partly an Asia-Pacific and partly an Asian century.
Economic Basis of Global Power
The globalised world of the 21st century will be driven by economic growth. This is based largely on an economic view of power a la Paul Kennedy. The relative power of nation states will depend on the relative size of national economies. This in turn means that within the set of growing economies the rate of catch-up growth and relative population size, indicate the shape of the likely future.
Developed economies with relatively high per capita income are at the frontiers of technology (knowledge) and grow relatively slowly. Growth varies among them based largely on technological innovation. Low and middle income countries lie well within the technology frontier and their growth rate depends on the transfer of technology (knowledge) from the developed countries, and its adaptation, application and diffusion. Such knowledge flows take place through multiple channels, such as machinery import and investment, FDI, foreign trade, internet, media and travel. The globalisation of the World economy during the 20th century has removed many of the constraints on such movement and reduced the cost of such flows. The low and middle-income economies can in principle grow much faster than the advanced economies as long as their income is well below that of the advanced countries. The Asian tigers were the first to take full advantage of the benefits of globalisation. Other Asian countries have followed in their footsteps. Between 1980 and 2003, 8 of the 10 fastest growing economies in the world in terms of average per capita GDP (the measure of catch-up growth) were in Asia.
If catch-up growth is sustained over several decades, as it has in Singapore, Hong Kong the economy will eventually reach the technology/income frontier . The growth rate of an economy is likely to slow as it comes closer to the frontier and the scope for catch-up growth is exhausted and more of the growth must come from its own technological innovation. With per capita incomes/GDP almost identical, the relative size of the population is the primary determinant of relative economic size. Therefore over the medium-long term relative population is an important determinant of size. The economic size and therefore the relative power of large relatively fast growing economies will therefore rise over time. The two most heavily populated countries in the World are China and India. They are among the 10 fastest growing economies in the world and are projected to remain among the 3 to 5 fastest growing economies. Their relative power will therefore inevitably rise. The question is only about the speed with which this will happen and the level that will be reached.
Index of Power Potential
We define an index of relative power potential that is parameterised by a technological weighting factor ‘a’ that can range upwards from 0. It can be shown that, (i) When the technology weight is zero the power potential is captured by the relative size of GDP measured at purchasing power parity. (ii) When the technology weight is 0.4 the power potential is approximately equal to the relative size of the economy at current market exchange rate. The power potential index for country i (PPIi) is calculated as:
PPIi = (GDPi/GDPu)*(PCgdpi/PCgdpu)a ,
Where GDPi and GDPu are GDP measured at purchasing power parity of country i and the USA respectively and PCgdpi and PCgdpu are the per capita GDP at purchasing power parity of country i and the USA respectively. The second term in PPI therefore represents a technology factor that is applied to economic size.
The technology weighting parameter a gives extra weight to a country’s inherent technological capability. The reasoning is as follows. As a result of globalisation knowledge/ technology, capital and human skills can flow freely across countries given appropriate policies. If all technological flows were unconstrained by national restrictions then a weight of 0 would best represent market conditions as all technology can be freely purchased. Each country’s command over resources including technology is given by its GDP at purchasing power parity.
The flow of Defence, Strategic and ‘Dual use technologies’ are however constrained by national polices and technology denial regimes and cannot be bought on the market. In this situation a nations inherent technological capability is still important for the development of such technologies. Such inherent technological capability is most simply and effectively captured by per capita GDP measured at purchasing power parity.
The parameter a provides the extra weight on this (technology) variable. In our view a=0 captures the economic potential and a=0.4 the power potential of nations adequately and the latter will be the focus of our analysis. For those who think that military power and consequently strategic technological capability play a greater role than economic power, a would be set at 0.6 or 0.8. The main difference is that the USA’s predominance over other countries is heightened if the technology weight is increased. In addition the relative position of the poorer countries worsens much more than that of the richer ones. Currently China is a lower-middle income country while India is a low-income country and their ranking deteriorates if we use higher values of a. The position of Russia an upper-middle income country also worsens. However its power potential remains less than that of China, though it becomes higher than that of India.
Actual power can vary from the level indicated by the power potential index because of (a) Differing national objectives (the will to power). For instance the will to power of post-war Japan was very low, while that of the USSR was and of China since 1980 is, very high. (b) Different allocation of national revenues to military and strategic R&D and equipment relative to that on other public goods and services (e.g. environment). Thus Russia continues to benefit from the high investment of the USSR in strategic technology. (c) Alliances that transfer restricted technology and equipment and thus effectively supplement national technological resources. For instance in the past China used its alliance with the USSR to develop its strategic technology and also benefited from its informal partnership with the USA (President Clinton called China a strategic partner). Many countries including Israel have benefited in the past from their formal or informal alliance with the USA.
Sophisticated models of global power, such as those of Tellis et al (2000) have incorporated both economic and strategic technology dimensions of national power. The Index of Power Potential is designed to capture most of the economic factors analysed in such sophisticated models, in the simplest possible way (Principle of Ocam’s Razor).
Current Unipolarity
The USA is clearly the predominant power today. Japan the second ranked power has less than 30% of the power potential of the USA in 2002. China the third ranked power is just behind it with 1/4th the power potential of the USA. Germany with less than 1/5th of US power potential is next with France, UK and Italy occupying the next three positions with a power potential of little over 1/10th of the US. India according to this measure is next, followed by Canada and Spain. Neither Brazil nor Russia are in the top ten.
There are many foreign policy experts who question the importance of economic factors in national power by citing the cases of Japan and Germany. According to the Power Potential Index their relative power is less than 30% and 20% of the USA’s respectively. In 1975 the relative power of Japan was 31% in 1975. Germany was divided so its (W Germany’s) power was fragmented. This was not sufficient for either of them to have challenged US power even if they wanted to, given the fear and resentment that it would have aroused in their neighbours. It can also be argued that the victors of World War II the USA, France and UK ensured that the losers, Japan and Germany did not develop great power ambitions, by imposing a pacifist constitution and tying them into the EU/NATO and US-Japan alliances.
In complete contrast many observers continue to talk about Russia as a future great power as Russia’s actual power appears to be much greater than its power potential. Its power potential as per the Index is currently about 6% of that of the USA. It was however as high as 19% in 1981-1982 but has declined steadily since then. The economy of the Soviet empire (including former USSR and E European satellite States), which constituted a unified ‘virtual State’ ruled from the Kremlin/Moscow, was much larger than the Russia of 1982. Therefore the power potential of the USSR, whose data is not available, would have had a much higher PPI. This allowed the USSR to devote much more resources to the development of strategic technology and equipment, a legacy from which current day Russia benefits greatly.
A Tripolar Future
Based on our projection of growth of per capita income and the population projections of the United Nations, we conclude that the World will become tripolar by the middle of the 21st century. There is nothing sacrosanct about the precise numerical projections. What is important is the trends and the direction they are leading the world. During the first half of this century India’s population will increase from 3.6 times to 3.75 times that of the USA, while China’s population will decline from 4.5 to 3.4 times that of the USA. Population growth is not therefore the primary driver of the change from a unipolar to a tripolar world, even though it places these two countries in a much more favourable long term position relative to all other countries (e.g. Japan, Russia) and associations (EU, ASEAN). Over these 50 years China will become a high income country with its per capita GDP increasing from 11% of the USA’s to 57%. Similarly, India will become a higher middle-income country with its per capita GDP increasing from 7% to 36% of USA. The global economy will be transformed by this convergence of incomes, because for the first time in history it affects the two most populous countries in the World.
Figures 1 and 2 show the evolution of power potential of the most powerful countries when the technology parameter is set at 0 and 0.4 respectively. The latter can be taken as the mean scenario in terms of power potential and also captures the direct effect of the concerned economy on other countries and the World economy. Figure 2 shows that China’s power potential will equal that of USA by the end of the first quarter of the 21st century, while the power potential of India will equal that of the USA by the end of the 2nd quarter (1st half) of this century. Thus the World will become bi-polar within 25 years and tripolar within 50 years. By the middle of this century China could be the strongest pole of a tripolar world in which the combined power of the USA and India would be only a little greater than that of China. This has important implications for economic and technological co-operation between the USA and India.
Figure 2 also shows that Japan has passed the peak of its potential power and will be on a declining trend over this century. Its power potential has already fallen below that of China and will fall below that of India within the next 20 years. The gap between Japan and the European powers of the 20th century will close steadily over this century. It will however remain a significant power during the first quarter of this century, if it changes its pacifist approach and develops a more muscular foreign and national security policy. Recent statements of the Japanese Prime minister and joint statements with the USA in the context of the US-Japan security treaty give a hint of this change. If Japan indeed becomes a “normal nation” it can play a critical role in securing peace in Asia in co-operation with other democratic countries of Asia during the first quarter of this century. This process of change may however be too slow and incremental (given the strong resistance and the nature of consensual decision making) to significantly affect the balance of power in Asia.
According to our mean forecast the power potential of Russia will rise slowly to exceed that of Germany by the middle of the century. It will however remain less than that of Japan, reaching about 80% of that of Japan by mid-century. If these scenarios turn out to be correct, both Japan and Russia would be classed as regional powers at that point.
Will it matter if the best parameter for measuring power is 0.8 rather than 0.4? Not really, as the only affect would be to increase the time it would take for the world to become bipolar and tripolar! Even if the technological weight is increased to 0.8 China will clearly emerge as the second pole by the middle of the century as its power potential will be 65% of the USA by 2030 and equal it by 2040. In any case it is not necessary for a country’s power to exactly equal that of the strongest power to emerge as a second pole. A power potential of 50% to 66% (with a=0.8) would make a country an alternative pole. By the end of the first quarter of this century, China will therefore be in a position to challenge the US power in Asia. Whether and how it chooses to do so will depend on many factors including the Balance of Power in Asia and its level of Strategic technology.
Similarly in the case of India, even with a technology parameter of 0.8, India’s power potential will exceed that of Japan by 2030. By the middle of the century it will be about 60% of that of the USA. Thus it will emerge as a third pole in a tripolar world. By way of comparison, second ranked Japan’s power potential at the height of its potential power in the early 1980s was less than one third of the USA. It has declined to one fourth of the US by 2000. France, Russia and other countries had a fraction of this power potential and were therefore in no position to challenge the USA. In the case of the rich countries the power potential does not vary much with the technology parameter.
From our current vantage point it appears very likely that India will be the weakest pole in the tripolar world of the 21st century. As India and the USA share fundamental human, social, institutional and democratic values, it may be in the interest of the USA to ensure that the economic and technological gap between India and China is closed as rapidly as possible so that India can act as a stronger pole in Asia. This will also help expand the freedom of action of other countries in West Asia, Central Asia and of the members of ASEAN.
India the Third Pole!
Few observers have taken the possibility of India’s emergence as a global power seriously. As our projections for India and China differ significantly from those by earlier authors it is necessary to provide a rationale. In our mean forecast we expect China’s growth rate to fall gradually to more normal levels rather than collapsing abruptly as many earlier authors assume. The IMF has shown that China’s growth so far is on a trajectory similar that of Japan and the NIEs in a similar period of their development, though it is faster than that of the ASEAN-4. Many earlier forecasts (including those by the ADB, World Bank and IMF) that projected a sharp slow down of China’s economy in the near future have been proved wrong. This does not however mean that the possibility of sharp slow down can be ruled out, only that the timing is very difficult to predict. As long as China remains dependent on FDI-export led growth and subsidised supply of capital and intermediates to exporters (disguised as non-performing Assets of banks) the risk remains. The second factor is the overestimation of economic growth in the 1980s and 1990s by about 2% points. We expect this overestimation of 2% to be gradually eliminated from the published data and an allowance has accordingly been made for this in our forecast.
In contrast to China we assume a steady rise in the rate of growth of the Indian economy. Our analysis suggests that the extensive reforms undertaken in India in the early 1990s have so far increased growth rate by only about half a percent point because the negative effects of lower protection appear immediately while the positive effects appear gradually. The former reduces capacity utilisation of outdated capital while new more productive capital is built up gradually through investment and diffusion of best practice takes time. The underlying GDP growth rate will therefore rise over the next five years to 6.5%.
It will rise further to 7% thereafter, with continuing reform and the following factors. Firstly the fast growing (25% per year) Information technology and IT enabled services export sector will start contributing significantly to GDP growth. Though this sector is already a major contributor to exports, its share in GDP was minuscule. It is now becoming large enough for its continuing rapid growth to have a measurable impact on total GDP growth rate. Second, the un-exploited potential of FDI is likely to be utilised more fully in the next few decades. In contrast to China and ASEAN, India’s growth has been driven by domestic entrepreneurship while FDI has played a negligible role. A likely increase in FDI levels from $3-4 bi. in the past to $8-$10 billion in future will give a substantial boost to productivity and growth. The proven capability of Indian middle skills along with the availability of low wage unskilled labour and a new Special Economic Zone (SEZ) law, will attract increased FDI. Finally India is in the midst of its demographic transition and poised to exploit the demographic dividend. It will have the youngest labour force in the world. It will therefore become the primary source for goods and services that depend on such labour. For instance in many disciplines (e.g. physics), the most innovative ideas are developed by experts under 30 or 35.
An important common factor underlying the projected increase in India’s growth is the fuller use of the large under-utilised pool (20mi to 100mi) of independent minded, democratically confident, high IQ population. Another factor is the high level of social capital accumulated over centuries and the relatively high quality of its institutions (despite some deterioration over the past thirty years). It has been estimated that India’s current economic growth rate is about 2% points lower than that predicted by the quality of its institutions. Growth will therefore gradually rise to the predicted level with the correction of wrong policies.
Russia’s growth is also assumed to be much higher than it has been in the past. Even though the oil price rise has led to an acceleration of growth this push will end after oil prices have stabilised. Russia has the advantage of a relatively educated/skilled work force and vast natural resources. How effectively it will be utilised is however still uncertain.
European Union: Another pole?
Whether or not the European Union can emerge as another pole in a multi-polar world depends on its evolution into a “virtual state,’ that is a super-national body with elements of a nation state, such as the power to tax and to use the tax revenues for security (defence and offence). Its global power can in principle lie anywhere between that of its strongest member and that of the aggregate of all members depending on how much of it they surrender. For instance surrender of half the power by each country could mean that the EU virtual state’s power is up to half the total aggregate power of members (who would be left with only half their original power). The economy of Europe and Central Asia (taken as approximating the future EU) is projected to decline from a little over 125% of the US economy to a little over 100% of the US economy. Half of this would mean about 50% of the USA’s power potential. According to current indications this amount of power accumulation by EU (surrender by member states) is unlikely. This is reflected in the increased resistance to surrender of financial power by joining the EMU, the strong push by Germany to become a permanent member of the security council and the move to include Asian Turkey into the European Union so as to strengthen multi-culturalism and diversity in the EU.
Though there have been periods in which the EU appeared to be moving in the direction of becoming a ‘virtual state’ its current direction appears to be towards an umbrella organisation with increasing soft power. The EU constitution, if passed will certainly make the EU administration another player on the global scene, though individual countries of the EU (Germany, UK, France, Italy) will continue to play an important role in the global economy. Even a surrender of a 1/4th of each members’ power to the EU will not, however, make the EU into the fourth pole of a multi-polar world. We are therefore sceptical at this time that the EU per se will aggregate enough power under it to become another pole in a multi-polar world.
Partnership For Peace
Within a decade China’s economy will become larger than the US economy and may be almost twice as large by the middle of the century (in terms of GDP at purchasing power parity). Its power potential will therefore equal that of the USA sometime during the second quarter of this century. The World will become bipolar much before that happens, probably towards the end of the first quarter. China will almost certainly challenge USA’s economic power in Asia and across the globe and likely be much more unabashed in asserting its economic claims in the South China Sea and its economic interests in Asia, Africa and Latin America.
In parallel, India’s economy will overtake Japan’s within five years to become the third largest in the world and likely equal the US economy in size by 2040. The world will therefore become tripolar by the middle of the century. The size and power of China relative to India is projected to peak within a decade (at 2.3 times and 3.1 times respectively). The absolute gap will however continue to grow till the middle of the century. India will consequently be the weakest pole in this tripolar world of the 21st century. As the USA and India share fundamental human and democratic values and have no conflicts of interest, it will be in their mutual interest to develop a strong partnership for economic and technological development. The USA as the predominant power today should strengthen India’s economic and technological capabilities so as to benefit in future from its young labour force and large potential supply of knowledge workers.
The partnership between the USA and India needs to be balanced by the development of co-operative and inclusive economic structures in Asia, based on the lessons of European history and the European Union. We must build an Asian Economic Community that includes all the major powers of Asia (China, India, Japan) as well as S. Korea and the ASEAN countries. The Indian Prime Minister, Mr Man Mohan Singh has endorsed this concept. By analogy with the European coal and steel community the Asian (petroleum) oil community proposed by India’s Petroleum Minister, Mr Mani Shankar Aiyer, could act as a precursor to the Asian Economic Community. The possible inclusion of West Asian and Central Asian countries can also be considered at some stage. The USA and the European Union should support this endeavour.
Figure 1: Projected Power Potential of the Major Powers
Figure 2: Projected Power Potential of The Major Powers
The fast growth of Japan till the mid-eighties, gave birth to several books about the Pacific Century and the Asia-Pacific Century. This talk gradually disappeared after the bursting of the Japanese bubble. The talk revived with the phenomenal growth of the NIEs or Asian Tigers but was soon overcome by the Asian Crises. Virmani (1999) showed that India (the elephant) was among the ten fastest growing economies of the World since 1980 and projected that in the next decade its growth rate would accelerate above that of the Tigers and reach the top three. Though China’s past growth had been overestimated by about 2% it (the dragon) would remain the fastest growing economy in the World during the first decade of the 21st century.
Krauthammer had heralded the arrival of “The Unipolar Moment” and set of a debate on its many ramifications. The reality of the unipolar world returned to center stage after the Asian crisis even some have asserted that the unipolar moment had passed. Since 9/11 the USA has asserted its primacy and the Unipolar nature of the World has been re-asserted. There is, however, a variety of views on how long the unipolar world will last. The current paper argues that the global economy is evolving in a direction that will result in a tripolar World by the middle of the 21st century. Thus the 21st century will be a ‘Tripolar Century’ with two of the poles in Asia and one on the other side of the Pacific. So ironically it could end up as partly a Pacific, partly an Asia-Pacific and partly an Asian century.
Economic Basis of Global Power
The globalised world of the 21st century will be driven by economic growth. This is based largely on an economic view of power a la Paul Kennedy. The relative power of nation states will depend on the relative size of national economies. This in turn means that within the set of growing economies the rate of catch-up growth and relative population size, indicate the shape of the likely future.
Developed economies with relatively high per capita income are at the frontiers of technology (knowledge) and grow relatively slowly. Growth varies among them based largely on technological innovation. Low and middle income countries lie well within the technology frontier and their growth rate depends on the transfer of technology (knowledge) from the developed countries, and its adaptation, application and diffusion. Such knowledge flows take place through multiple channels, such as machinery import and investment, FDI, foreign trade, internet, media and travel. The globalisation of the World economy during the 20th century has removed many of the constraints on such movement and reduced the cost of such flows. The low and middle-income economies can in principle grow much faster than the advanced economies as long as their income is well below that of the advanced countries. The Asian tigers were the first to take full advantage of the benefits of globalisation. Other Asian countries have followed in their footsteps. Between 1980 and 2003, 8 of the 10 fastest growing economies in the world in terms of average per capita GDP (the measure of catch-up growth) were in Asia.
If catch-up growth is sustained over several decades, as it has in Singapore, Hong Kong the economy will eventually reach the technology/income frontier . The growth rate of an economy is likely to slow as it comes closer to the frontier and the scope for catch-up growth is exhausted and more of the growth must come from its own technological innovation. With per capita incomes/GDP almost identical, the relative size of the population is the primary determinant of relative economic size. Therefore over the medium-long term relative population is an important determinant of size. The economic size and therefore the relative power of large relatively fast growing economies will therefore rise over time. The two most heavily populated countries in the World are China and India. They are among the 10 fastest growing economies in the world and are projected to remain among the 3 to 5 fastest growing economies. Their relative power will therefore inevitably rise. The question is only about the speed with which this will happen and the level that will be reached.
Index of Power Potential
We define an index of relative power potential that is parameterised by a technological weighting factor ‘a’ that can range upwards from 0. It can be shown that, (i) When the technology weight is zero the power potential is captured by the relative size of GDP measured at purchasing power parity. (ii) When the technology weight is 0.4 the power potential is approximately equal to the relative size of the economy at current market exchange rate. The power potential index for country i (PPIi) is calculated as:
PPIi = (GDPi/GDPu)*(PCgdpi/PCgdpu)a ,
Where GDPi and GDPu are GDP measured at purchasing power parity of country i and the USA respectively and PCgdpi and PCgdpu are the per capita GDP at purchasing power parity of country i and the USA respectively. The second term in PPI therefore represents a technology factor that is applied to economic size.
The technology weighting parameter a gives extra weight to a country’s inherent technological capability. The reasoning is as follows. As a result of globalisation knowledge/ technology, capital and human skills can flow freely across countries given appropriate policies. If all technological flows were unconstrained by national restrictions then a weight of 0 would best represent market conditions as all technology can be freely purchased. Each country’s command over resources including technology is given by its GDP at purchasing power parity.
The flow of Defence, Strategic and ‘Dual use technologies’ are however constrained by national polices and technology denial regimes and cannot be bought on the market. In this situation a nations inherent technological capability is still important for the development of such technologies. Such inherent technological capability is most simply and effectively captured by per capita GDP measured at purchasing power parity.
The parameter a provides the extra weight on this (technology) variable. In our view a=0 captures the economic potential and a=0.4 the power potential of nations adequately and the latter will be the focus of our analysis. For those who think that military power and consequently strategic technological capability play a greater role than economic power, a would be set at 0.6 or 0.8. The main difference is that the USA’s predominance over other countries is heightened if the technology weight is increased. In addition the relative position of the poorer countries worsens much more than that of the richer ones. Currently China is a lower-middle income country while India is a low-income country and their ranking deteriorates if we use higher values of a. The position of Russia an upper-middle income country also worsens. However its power potential remains less than that of China, though it becomes higher than that of India.
Actual power can vary from the level indicated by the power potential index because of (a) Differing national objectives (the will to power). For instance the will to power of post-war Japan was very low, while that of the USSR was and of China since 1980 is, very high. (b) Different allocation of national revenues to military and strategic R&D and equipment relative to that on other public goods and services (e.g. environment). Thus Russia continues to benefit from the high investment of the USSR in strategic technology. (c) Alliances that transfer restricted technology and equipment and thus effectively supplement national technological resources. For instance in the past China used its alliance with the USSR to develop its strategic technology and also benefited from its informal partnership with the USA (President Clinton called China a strategic partner). Many countries including Israel have benefited in the past from their formal or informal alliance with the USA.
Sophisticated models of global power, such as those of Tellis et al (2000) have incorporated both economic and strategic technology dimensions of national power. The Index of Power Potential is designed to capture most of the economic factors analysed in such sophisticated models, in the simplest possible way (Principle of Ocam’s Razor).
Current Unipolarity
The USA is clearly the predominant power today. Japan the second ranked power has less than 30% of the power potential of the USA in 2002. China the third ranked power is just behind it with 1/4th the power potential of the USA. Germany with less than 1/5th of US power potential is next with France, UK and Italy occupying the next three positions with a power potential of little over 1/10th of the US. India according to this measure is next, followed by Canada and Spain. Neither Brazil nor Russia are in the top ten.
There are many foreign policy experts who question the importance of economic factors in national power by citing the cases of Japan and Germany. According to the Power Potential Index their relative power is less than 30% and 20% of the USA’s respectively. In 1975 the relative power of Japan was 31% in 1975. Germany was divided so its (W Germany’s) power was fragmented. This was not sufficient for either of them to have challenged US power even if they wanted to, given the fear and resentment that it would have aroused in their neighbours. It can also be argued that the victors of World War II the USA, France and UK ensured that the losers, Japan and Germany did not develop great power ambitions, by imposing a pacifist constitution and tying them into the EU/NATO and US-Japan alliances.
In complete contrast many observers continue to talk about Russia as a future great power as Russia’s actual power appears to be much greater than its power potential. Its power potential as per the Index is currently about 6% of that of the USA. It was however as high as 19% in 1981-1982 but has declined steadily since then. The economy of the Soviet empire (including former USSR and E European satellite States), which constituted a unified ‘virtual State’ ruled from the Kremlin/Moscow, was much larger than the Russia of 1982. Therefore the power potential of the USSR, whose data is not available, would have had a much higher PPI. This allowed the USSR to devote much more resources to the development of strategic technology and equipment, a legacy from which current day Russia benefits greatly.
A Tripolar Future
Based on our projection of growth of per capita income and the population projections of the United Nations, we conclude that the World will become tripolar by the middle of the 21st century. There is nothing sacrosanct about the precise numerical projections. What is important is the trends and the direction they are leading the world. During the first half of this century India’s population will increase from 3.6 times to 3.75 times that of the USA, while China’s population will decline from 4.5 to 3.4 times that of the USA. Population growth is not therefore the primary driver of the change from a unipolar to a tripolar world, even though it places these two countries in a much more favourable long term position relative to all other countries (e.g. Japan, Russia) and associations (EU, ASEAN). Over these 50 years China will become a high income country with its per capita GDP increasing from 11% of the USA’s to 57%. Similarly, India will become a higher middle-income country with its per capita GDP increasing from 7% to 36% of USA. The global economy will be transformed by this convergence of incomes, because for the first time in history it affects the two most populous countries in the World.
Figures 1 and 2 show the evolution of power potential of the most powerful countries when the technology parameter is set at 0 and 0.4 respectively. The latter can be taken as the mean scenario in terms of power potential and also captures the direct effect of the concerned economy on other countries and the World economy. Figure 2 shows that China’s power potential will equal that of USA by the end of the first quarter of the 21st century, while the power potential of India will equal that of the USA by the end of the 2nd quarter (1st half) of this century. Thus the World will become bi-polar within 25 years and tripolar within 50 years. By the middle of this century China could be the strongest pole of a tripolar world in which the combined power of the USA and India would be only a little greater than that of China. This has important implications for economic and technological co-operation between the USA and India.
Figure 2 also shows that Japan has passed the peak of its potential power and will be on a declining trend over this century. Its power potential has already fallen below that of China and will fall below that of India within the next 20 years. The gap between Japan and the European powers of the 20th century will close steadily over this century. It will however remain a significant power during the first quarter of this century, if it changes its pacifist approach and develops a more muscular foreign and national security policy. Recent statements of the Japanese Prime minister and joint statements with the USA in the context of the US-Japan security treaty give a hint of this change. If Japan indeed becomes a “normal nation” it can play a critical role in securing peace in Asia in co-operation with other democratic countries of Asia during the first quarter of this century. This process of change may however be too slow and incremental (given the strong resistance and the nature of consensual decision making) to significantly affect the balance of power in Asia.
According to our mean forecast the power potential of Russia will rise slowly to exceed that of Germany by the middle of the century. It will however remain less than that of Japan, reaching about 80% of that of Japan by mid-century. If these scenarios turn out to be correct, both Japan and Russia would be classed as regional powers at that point.
Will it matter if the best parameter for measuring power is 0.8 rather than 0.4? Not really, as the only affect would be to increase the time it would take for the world to become bipolar and tripolar! Even if the technological weight is increased to 0.8 China will clearly emerge as the second pole by the middle of the century as its power potential will be 65% of the USA by 2030 and equal it by 2040. In any case it is not necessary for a country’s power to exactly equal that of the strongest power to emerge as a second pole. A power potential of 50% to 66% (with a=0.8) would make a country an alternative pole. By the end of the first quarter of this century, China will therefore be in a position to challenge the US power in Asia. Whether and how it chooses to do so will depend on many factors including the Balance of Power in Asia and its level of Strategic technology.
Similarly in the case of India, even with a technology parameter of 0.8, India’s power potential will exceed that of Japan by 2030. By the middle of the century it will be about 60% of that of the USA. Thus it will emerge as a third pole in a tripolar world. By way of comparison, second ranked Japan’s power potential at the height of its potential power in the early 1980s was less than one third of the USA. It has declined to one fourth of the US by 2000. France, Russia and other countries had a fraction of this power potential and were therefore in no position to challenge the USA. In the case of the rich countries the power potential does not vary much with the technology parameter.
From our current vantage point it appears very likely that India will be the weakest pole in the tripolar world of the 21st century. As India and the USA share fundamental human, social, institutional and democratic values, it may be in the interest of the USA to ensure that the economic and technological gap between India and China is closed as rapidly as possible so that India can act as a stronger pole in Asia. This will also help expand the freedom of action of other countries in West Asia, Central Asia and of the members of ASEAN.
India the Third Pole!
Few observers have taken the possibility of India’s emergence as a global power seriously. As our projections for India and China differ significantly from those by earlier authors it is necessary to provide a rationale. In our mean forecast we expect China’s growth rate to fall gradually to more normal levels rather than collapsing abruptly as many earlier authors assume. The IMF has shown that China’s growth so far is on a trajectory similar that of Japan and the NIEs in a similar period of their development, though it is faster than that of the ASEAN-4. Many earlier forecasts (including those by the ADB, World Bank and IMF) that projected a sharp slow down of China’s economy in the near future have been proved wrong. This does not however mean that the possibility of sharp slow down can be ruled out, only that the timing is very difficult to predict. As long as China remains dependent on FDI-export led growth and subsidised supply of capital and intermediates to exporters (disguised as non-performing Assets of banks) the risk remains. The second factor is the overestimation of economic growth in the 1980s and 1990s by about 2% points. We expect this overestimation of 2% to be gradually eliminated from the published data and an allowance has accordingly been made for this in our forecast.
In contrast to China we assume a steady rise in the rate of growth of the Indian economy. Our analysis suggests that the extensive reforms undertaken in India in the early 1990s have so far increased growth rate by only about half a percent point because the negative effects of lower protection appear immediately while the positive effects appear gradually. The former reduces capacity utilisation of outdated capital while new more productive capital is built up gradually through investment and diffusion of best practice takes time. The underlying GDP growth rate will therefore rise over the next five years to 6.5%.
It will rise further to 7% thereafter, with continuing reform and the following factors. Firstly the fast growing (25% per year) Information technology and IT enabled services export sector will start contributing significantly to GDP growth. Though this sector is already a major contributor to exports, its share in GDP was minuscule. It is now becoming large enough for its continuing rapid growth to have a measurable impact on total GDP growth rate. Second, the un-exploited potential of FDI is likely to be utilised more fully in the next few decades. In contrast to China and ASEAN, India’s growth has been driven by domestic entrepreneurship while FDI has played a negligible role. A likely increase in FDI levels from $3-4 bi. in the past to $8-$10 billion in future will give a substantial boost to productivity and growth. The proven capability of Indian middle skills along with the availability of low wage unskilled labour and a new Special Economic Zone (SEZ) law, will attract increased FDI. Finally India is in the midst of its demographic transition and poised to exploit the demographic dividend. It will have the youngest labour force in the world. It will therefore become the primary source for goods and services that depend on such labour. For instance in many disciplines (e.g. physics), the most innovative ideas are developed by experts under 30 or 35.
An important common factor underlying the projected increase in India’s growth is the fuller use of the large under-utilised pool (20mi to 100mi) of independent minded, democratically confident, high IQ population. Another factor is the high level of social capital accumulated over centuries and the relatively high quality of its institutions (despite some deterioration over the past thirty years). It has been estimated that India’s current economic growth rate is about 2% points lower than that predicted by the quality of its institutions. Growth will therefore gradually rise to the predicted level with the correction of wrong policies.
Russia’s growth is also assumed to be much higher than it has been in the past. Even though the oil price rise has led to an acceleration of growth this push will end after oil prices have stabilised. Russia has the advantage of a relatively educated/skilled work force and vast natural resources. How effectively it will be utilised is however still uncertain.
European Union: Another pole?
Whether or not the European Union can emerge as another pole in a multi-polar world depends on its evolution into a “virtual state,’ that is a super-national body with elements of a nation state, such as the power to tax and to use the tax revenues for security (defence and offence). Its global power can in principle lie anywhere between that of its strongest member and that of the aggregate of all members depending on how much of it they surrender. For instance surrender of half the power by each country could mean that the EU virtual state’s power is up to half the total aggregate power of members (who would be left with only half their original power). The economy of Europe and Central Asia (taken as approximating the future EU) is projected to decline from a little over 125% of the US economy to a little over 100% of the US economy. Half of this would mean about 50% of the USA’s power potential. According to current indications this amount of power accumulation by EU (surrender by member states) is unlikely. This is reflected in the increased resistance to surrender of financial power by joining the EMU, the strong push by Germany to become a permanent member of the security council and the move to include Asian Turkey into the European Union so as to strengthen multi-culturalism and diversity in the EU.
Though there have been periods in which the EU appeared to be moving in the direction of becoming a ‘virtual state’ its current direction appears to be towards an umbrella organisation with increasing soft power. The EU constitution, if passed will certainly make the EU administration another player on the global scene, though individual countries of the EU (Germany, UK, France, Italy) will continue to play an important role in the global economy. Even a surrender of a 1/4th of each members’ power to the EU will not, however, make the EU into the fourth pole of a multi-polar world. We are therefore sceptical at this time that the EU per se will aggregate enough power under it to become another pole in a multi-polar world.
Partnership For Peace
Within a decade China’s economy will become larger than the US economy and may be almost twice as large by the middle of the century (in terms of GDP at purchasing power parity). Its power potential will therefore equal that of the USA sometime during the second quarter of this century. The World will become bipolar much before that happens, probably towards the end of the first quarter. China will almost certainly challenge USA’s economic power in Asia and across the globe and likely be much more unabashed in asserting its economic claims in the South China Sea and its economic interests in Asia, Africa and Latin America.
In parallel, India’s economy will overtake Japan’s within five years to become the third largest in the world and likely equal the US economy in size by 2040. The world will therefore become tripolar by the middle of the century. The size and power of China relative to India is projected to peak within a decade (at 2.3 times and 3.1 times respectively). The absolute gap will however continue to grow till the middle of the century. India will consequently be the weakest pole in this tripolar world of the 21st century. As the USA and India share fundamental human and democratic values and have no conflicts of interest, it will be in their mutual interest to develop a strong partnership for economic and technological development. The USA as the predominant power today should strengthen India’s economic and technological capabilities so as to benefit in future from its young labour force and large potential supply of knowledge workers.
The partnership between the USA and India needs to be balanced by the development of co-operative and inclusive economic structures in Asia, based on the lessons of European history and the European Union. We must build an Asian Economic Community that includes all the major powers of Asia (China, India, Japan) as well as S. Korea and the ASEAN countries. The Indian Prime Minister, Mr Man Mohan Singh has endorsed this concept. By analogy with the European coal and steel community the Asian (petroleum) oil community proposed by India’s Petroleum Minister, Mr Mani Shankar Aiyer, could act as a precursor to the Asian Economic Community. The possible inclusion of West Asian and Central Asian countries can also be considered at some stage. The USA and the European Union should support this endeavour.
Figure 1: Projected Power Potential of the Major Powers
Figure 2: Projected Power Potential of The Major Powers
Sunday, April 24, 2005
The New Tripolar World
The Dragon has emerged from the dungeons of Maoist communism to grab the benefits of globalisation whether its foreign direct investment, exports, education or skills without singeing it with its fiery breath. It has successfully combined communist party ownership & control with elements of a globalized market economy. The vegetarian elephant has similarly emerged from the Indian version of Socialism to experiment with market reforms in its usual slow and steady but plodding democratic way. Though both started the transition in 1980 the dragon has attained a lead over the elephant that may take three quarters of a century to be completely eliminated.
A 1999 paper, “Potential Growth Stars of the 21st Century: India, China and The Asian Century,” (Occasional Paper, Chintan, October 1999, www.icrier.org/avpapers. html) forecast that India would be one of the three fastest growing economies in the World. So far the forecast has not come true. Un-deterred, a new paper, “A Tripolar Century: USA, China and India,” (Working Paper No. 160, ICRIER, March, 2005) forecasts that India will, by the middle of the century, become one of three global powers constituting the global trinity. What is the basis for this forecast of a Tripolar World?
If we compare the distribution of World GDP at Purchasing Power Parity (PPP) and the distribution of World population between the US, China and India, the results are striking. USA has only 5 per cent of the world's population but accounts for 21 per cent of the World GDP. China in contrast has 21 per cent of the world's citizens but thanks to its phenomenal economic growth rates since 1980 now has 12 per cent of the world's GDP share. India has 17 per cent of the world's population but because of slower growth rates its GDP share is only six per cent of the total. However, the discrepancy between these three countries is expected to be closed during the 21st century.
Why will a centuries old gap be closed in half a century? Because the past two decades has seen the two most populous countries change their economic policies and play catch-up in growth rates. Consequently, they were among the 10 fastest growing economies since 1980 and will remain among the 3-5 fastest growing in the next several decades. As a result the income gap between the two and the USA will close gradually. Given their much larger population, China's and India's GDP at PPP will equal that of the USA by around 2016 and 2039 respectively, though average income will be much lower (ICRIER WP 160). Within the next five years India's economy will overtake that of Japan to become the third largest in PPP terms. A few years later India will become a lower-middle income country (currently low-income). In a recent paper I have forecast that India will, by the middle of the century, become one of three global powers constituting the global trinity. It also presents an index of power potential that shows that, (a) China's potential power will exceed that of the USA by the second quarter of the century, and (b) India's power potential will exceed that of Japan by 2025. In 2035, India's power potential will be half that of the USA. Fourth ranked Japan's power potential will be 1/5th that of the USA and 50% that of India. India's power potential will be almost 80% of the USA by 2050. By way of comparison it should be noted that at its peak in the 1970-1980s (3rd ranked) Japan's power potential was only about 1/3rd that of the USA. The world will therefore become tripolar sometime during the second quarter of the 21st century.
India's GDP at PPP and its power potential will decline relative to that of China during the current decade, stabilise during the next and start to rise during the third. According to our forecast the gap between the two will be closed in the third quarter of the 21st century. History shows that the rise and fall of great powers leads to wars. The globalised world of the 21st century provides an opportunity to break the jinx of history, by building a system of co-operative relations between the three great powers of the 21st century. As India will be the weakest pole of this tripolar world, the USA must help close the technology gap between India and China, that was partly created by discriminatory Western sanctions against India. This requires a translation of recent announcements by Secretary of State Condoleezza Rice into concrete changes in laws, rules and procedures. India and USA must build a partnership for peace.
China and India must also improve their bilateral relations. As China is the larger power it must recognise and respect India's role in Asia and the World. This requires a fair an equitable settlement of the border issue and a decision by China not to proliferate nuclear technology to countries hostile to India. Barriers to trade must be removed so that the trade potential is fully exploited. Drawing on the lessons of European history, India must pursue the idea of an Asian oil community and an Asian economic community with India, China, Japan and ASEAN at its core.
A 1999 paper, “Potential Growth Stars of the 21st Century: India, China and The Asian Century,” (Occasional Paper, Chintan, October 1999, www.icrier.org/avpapers. html) forecast that India would be one of the three fastest growing economies in the World. So far the forecast has not come true. Un-deterred, a new paper, “A Tripolar Century: USA, China and India,” (Working Paper No. 160, ICRIER, March, 2005) forecasts that India will, by the middle of the century, become one of three global powers constituting the global trinity. What is the basis for this forecast of a Tripolar World?
If we compare the distribution of World GDP at Purchasing Power Parity (PPP) and the distribution of World population between the US, China and India, the results are striking. USA has only 5 per cent of the world's population but accounts for 21 per cent of the World GDP. China in contrast has 21 per cent of the world's citizens but thanks to its phenomenal economic growth rates since 1980 now has 12 per cent of the world's GDP share. India has 17 per cent of the world's population but because of slower growth rates its GDP share is only six per cent of the total. However, the discrepancy between these three countries is expected to be closed during the 21st century.
Why will a centuries old gap be closed in half a century? Because the past two decades has seen the two most populous countries change their economic policies and play catch-up in growth rates. Consequently, they were among the 10 fastest growing economies since 1980 and will remain among the 3-5 fastest growing in the next several decades. As a result the income gap between the two and the USA will close gradually. Given their much larger population, China's and India's GDP at PPP will equal that of the USA by around 2016 and 2039 respectively, though average income will be much lower (ICRIER WP 160). Within the next five years India's economy will overtake that of Japan to become the third largest in PPP terms. A few years later India will become a lower-middle income country (currently low-income). In a recent paper I have forecast that India will, by the middle of the century, become one of three global powers constituting the global trinity. It also presents an index of power potential that shows that, (a) China's potential power will exceed that of the USA by the second quarter of the century, and (b) India's power potential will exceed that of Japan by 2025. In 2035, India's power potential will be half that of the USA. Fourth ranked Japan's power potential will be 1/5th that of the USA and 50% that of India. India's power potential will be almost 80% of the USA by 2050. By way of comparison it should be noted that at its peak in the 1970-1980s (3rd ranked) Japan's power potential was only about 1/3rd that of the USA. The world will therefore become tripolar sometime during the second quarter of the 21st century.
India's GDP at PPP and its power potential will decline relative to that of China during the current decade, stabilise during the next and start to rise during the third. According to our forecast the gap between the two will be closed in the third quarter of the 21st century. History shows that the rise and fall of great powers leads to wars. The globalised world of the 21st century provides an opportunity to break the jinx of history, by building a system of co-operative relations between the three great powers of the 21st century. As India will be the weakest pole of this tripolar world, the USA must help close the technology gap between India and China, that was partly created by discriminatory Western sanctions against India. This requires a translation of recent announcements by Secretary of State Condoleezza Rice into concrete changes in laws, rules and procedures. India and USA must build a partnership for peace.
China and India must also improve their bilateral relations. As China is the larger power it must recognise and respect India's role in Asia and the World. This requires a fair an equitable settlement of the border issue and a decision by China not to proliferate nuclear technology to countries hostile to India. Barriers to trade must be removed so that the trade potential is fully exploited. Drawing on the lessons of European history, India must pursue the idea of an Asian oil community and an Asian economic community with India, China, Japan and ASEAN at its core.
Tuesday, April 12, 2005
China’s Socialist Market Economy and Hindi - Chini Bhai-Bhai!
The media the press, everybody is talking about an India-China Free Trade Agreement (FTA)! The discussion, however, reflects a confusion between the need for increasing India-China trade and improving economic relations and the usefulness of an FTA. In WTO parlance an FTA means zero duties on all goods (with few exceptions). Further an FTA does not include Services, FDI or the movement of persons, issues of vital interest to India that would normally be covered in a CECA.
An ICRIER working paper (No. 151) has shown that the highest un-exploited potential of India’s trade with any/all countries is with China. Her study shows that trade could be more than doubled. I am sure most scholars would agree with this assessment, even though precise estimates may differ. Normalisation of Trade between the two countries is highly desirable and perhaps even necessary.
To ensure that this potential is realised two countries must jointly identify the constraints and barriers to trade and take steps to remove them. These include rules and procedures and their application, transparency, information-language barrier. All other trade facilitation measures must be taken to make sure that the gap between potential and reality is closed. This does not require an FTA.
Prime facie the economic benefits of a bilateral FTA between India and any other country are not obvious. India till two years ago had the highest non-agricultural tariffs in the world. With the reduction of the peak rate to 15% we now have rates that may be in the top 1/5th or 1/4th . Tariffs on agricultural goods are much higher with few as high as 100%. Reduction of these rates to zero under an FTA could result in substantial Trade diversion and welfare loss. Thus as long as our tariff rates remain high the a priori presumption must be that an FTA with any country with lower tariffs is likely to result in economic losses not gains. Only hard evidence to the contrary should overcome this basic scepticism.
Building mutually beneficial economic relations between India and China requires a clear understanding of the Chinese economy. There is a tendency for people involved in China to find economic similarities even when they do not exist. Definitions are adapted to make it appear similar to a normal market economy. This is reflected for instance in the definition of “Private sector’ “non-state sector” State owned enterprises (SOE), Collective enterprises, Town & Village enterprises (TVE), listed companies, joint venture companies etc. The standard international definitions in which ownership (majority, minority, largest share etc), management control (e.g. power to appoint CEOs) are not used/ applied in defining the “private” and “public” sector. This obscures the true nature of the economy and of the development strategy.
A recent Working paper (No. 160, ICRIER, March 2005: www.icrier.org/wp160.pdf ) has given a stylised model of China’s economy. China’s basic Goal is National power through Growth maximisation. Employment generation, individual income growth and public welfare act as constraints (rather than secondary objectives) to the growth maximisation objective. The CPC network, a mix of centralised and decentralised systems, implements these objectives. Like most other developing countries, quality of governance in China is gradually deteriorating. This involuntary lack of control (e.g. on corruption) should not be confused with deliberate policy change by the State/CPC.
The strategy adopted to achieve the growth objectives has four important elements. The FDI-export policy is the most important and critical means for achieving this goal. China is now a part of the global supply chain for labour-intensive exports, and these are highly competitive. The reason is not however the productivity of Chinese labour in terms of output per man-hour. A critical subsidiary element of the FDI-export strategy was the abolition/suspension of minimum wage conditions, upper limits on working hours and rules against firing workers. Control of labour market (labour responsibility system) ensured the supply of workers who worked 100 hours a week, 52 weeks a year. Thus high productivity per person-year is due to more hours worked per week compared to normal market economies (35 to 48).
The second element is the social ownership of capital assets (100% till 1980) . The returns from these assets are used to raise national investment rates to very high levels, without creating disincentives and distortions through high tax rates. High infrastructure investment since 1997 is a manifestation of this. The third pillar is normal markets for most goods and services where the forces of demand and supply operate to set prices. This removes the worst feature of the Soviet system that played an important role in its collapse.
The fourth pillar is the control over banks and capital markets, which allows subsidisation of capital-intensive and skill intensive exports as well as FDI investment in hi-tech industry, indirectly through banks (govt department). The modus operandi is to give loans to State/CPC owned/controlled enterprises that supply inputs to the target companies. These loans are not expected to be repaid and therefore the use of the word NPA is a misnomer.
The result: Incredible rates of growth of 9.5% per annum for 25 years. Even if there is overestimation of 2% (scholars estimate 1% to 3%), 7.5% per annum is the highest in the world during this period (30% higher than India’s).
The Asian crises showed that some of the elements of this strategy are risky. The strategy is a bit like peddling furiously on a bicycle to keep from tipping over. Expectations of foreigners play a key role in FDI. Euphoria about China’s growth keeps FDI flowing. That in turn ensures very high growth of production. Given the low share of private income and consumption in GDP, excess capacity is created in many industries. This can only be utilised by pushing exports. Either unit values fall (e.g. textiles) or implicit subsidies have to be provided.
This picture of the Chinese economy suggests that the arguments for an FTA with China and the according of “Market economy” status to it are very weak. We should focus on normalisation of economic relations, settlement of the border issue and collaboration in areas where there are clear identity of interests (e.g. oil purchases) rather than jump from one extreme to the other. It is said that India-China Bhai-Bhai, became India-China Bye Bye, which in turn has become India-China Buy-Buy (over the last five years). Let us not restart the cycle by getting euphoric over words like “strategic partnership.” It is much better for both countries, as well as for the rest of Asia, if we jointly build a normal, realistic and well-rounded relationship that will last through the 21st century.
An ICRIER working paper (No. 151) has shown that the highest un-exploited potential of India’s trade with any/all countries is with China. Her study shows that trade could be more than doubled. I am sure most scholars would agree with this assessment, even though precise estimates may differ. Normalisation of Trade between the two countries is highly desirable and perhaps even necessary.
To ensure that this potential is realised two countries must jointly identify the constraints and barriers to trade and take steps to remove them. These include rules and procedures and their application, transparency, information-language barrier. All other trade facilitation measures must be taken to make sure that the gap between potential and reality is closed. This does not require an FTA.
Prime facie the economic benefits of a bilateral FTA between India and any other country are not obvious. India till two years ago had the highest non-agricultural tariffs in the world. With the reduction of the peak rate to 15% we now have rates that may be in the top 1/5th or 1/4th . Tariffs on agricultural goods are much higher with few as high as 100%. Reduction of these rates to zero under an FTA could result in substantial Trade diversion and welfare loss. Thus as long as our tariff rates remain high the a priori presumption must be that an FTA with any country with lower tariffs is likely to result in economic losses not gains. Only hard evidence to the contrary should overcome this basic scepticism.
Building mutually beneficial economic relations between India and China requires a clear understanding of the Chinese economy. There is a tendency for people involved in China to find economic similarities even when they do not exist. Definitions are adapted to make it appear similar to a normal market economy. This is reflected for instance in the definition of “Private sector’ “non-state sector” State owned enterprises (SOE), Collective enterprises, Town & Village enterprises (TVE), listed companies, joint venture companies etc. The standard international definitions in which ownership (majority, minority, largest share etc), management control (e.g. power to appoint CEOs) are not used/ applied in defining the “private” and “public” sector. This obscures the true nature of the economy and of the development strategy.
A recent Working paper (No. 160, ICRIER, March 2005: www.icrier.org/wp160.pdf ) has given a stylised model of China’s economy. China’s basic Goal is National power through Growth maximisation. Employment generation, individual income growth and public welfare act as constraints (rather than secondary objectives) to the growth maximisation objective. The CPC network, a mix of centralised and decentralised systems, implements these objectives. Like most other developing countries, quality of governance in China is gradually deteriorating. This involuntary lack of control (e.g. on corruption) should not be confused with deliberate policy change by the State/CPC.
The strategy adopted to achieve the growth objectives has four important elements. The FDI-export policy is the most important and critical means for achieving this goal. China is now a part of the global supply chain for labour-intensive exports, and these are highly competitive. The reason is not however the productivity of Chinese labour in terms of output per man-hour. A critical subsidiary element of the FDI-export strategy was the abolition/suspension of minimum wage conditions, upper limits on working hours and rules against firing workers. Control of labour market (labour responsibility system) ensured the supply of workers who worked 100 hours a week, 52 weeks a year. Thus high productivity per person-year is due to more hours worked per week compared to normal market economies (35 to 48).
The second element is the social ownership of capital assets (100% till 1980) . The returns from these assets are used to raise national investment rates to very high levels, without creating disincentives and distortions through high tax rates. High infrastructure investment since 1997 is a manifestation of this. The third pillar is normal markets for most goods and services where the forces of demand and supply operate to set prices. This removes the worst feature of the Soviet system that played an important role in its collapse.
The fourth pillar is the control over banks and capital markets, which allows subsidisation of capital-intensive and skill intensive exports as well as FDI investment in hi-tech industry, indirectly through banks (govt department). The modus operandi is to give loans to State/CPC owned/controlled enterprises that supply inputs to the target companies. These loans are not expected to be repaid and therefore the use of the word NPA is a misnomer.
The result: Incredible rates of growth of 9.5% per annum for 25 years. Even if there is overestimation of 2% (scholars estimate 1% to 3%), 7.5% per annum is the highest in the world during this period (30% higher than India’s).
The Asian crises showed that some of the elements of this strategy are risky. The strategy is a bit like peddling furiously on a bicycle to keep from tipping over. Expectations of foreigners play a key role in FDI. Euphoria about China’s growth keeps FDI flowing. That in turn ensures very high growth of production. Given the low share of private income and consumption in GDP, excess capacity is created in many industries. This can only be utilised by pushing exports. Either unit values fall (e.g. textiles) or implicit subsidies have to be provided.
This picture of the Chinese economy suggests that the arguments for an FTA with China and the according of “Market economy” status to it are very weak. We should focus on normalisation of economic relations, settlement of the border issue and collaboration in areas where there are clear identity of interests (e.g. oil purchases) rather than jump from one extreme to the other. It is said that India-China Bhai-Bhai, became India-China Bye Bye, which in turn has become India-China Buy-Buy (over the last five years). Let us not restart the cycle by getting euphoric over words like “strategic partnership.” It is much better for both countries, as well as for the rest of Asia, if we jointly build a normal, realistic and well-rounded relationship that will last through the 21st century.
Monday, April 4, 2005
Rule of Law or of Law Breakers?
What are the most important problems facing India and what are the most urgent reforms needed? The answer varies with the knowledge and interests of the person asked. The list includes, Infrastructure, Electricity, roads, railways, Agriculture, irrigation, Poverty, Inequality, Education, Health, Water shortage, Urban development /slums, high fiscal/revenue deficit, low tax-gdp ratio, low expenditures on social sectors/infrastructure, land policy/rules.
Perhaps one can focus the question a little: If you were made dictator of India with the authority to address a few issues what would they be? My answer: The most difficult thing for a democracy to reform. That which affects those who make the laws (members of parliament and state assemblies) and are supposed to be the guardians of these laws (judiciary, police). The greatest danger to the nation and the greatest long-term threat to India’s continuing development is the breaking of the law by the law makers. Like the proverbial rotting head of a fish it affects everything else.
The deterioration in governance, that has taken place over the decades is broad based & universal: Civic amenities, publicly provided utilities, public education and health law & order and justice have deteriorated, in some places beyond belief. What one had heard about law & order in Bihar for several decades and began hearing about UP during the last decade, can strike even in the capital and its suburbs. Kidnapping in Ghaziabad, police extortion in the heart of Delhi (a beat constable asking a small scale factory owner for ‘hafta,’ backed by the threat of overnight theft of materials lying in his premises). Some years ago, the secretary (food) of one State govt. admitted in a meeting with IAS peers that they were not competent to procure excess production or deliver food to the starving. Hearing this from an inheritor of the ‘steel frame of India,’ was a shock. Similarly, the chief minister of one notorious State confessed that the existing State machinery could not spend money productively and that it would be very happy if development activities could be carried out by anyone else, including the provider of the funds.
The lack of interest and motivation to fulfil the basic functions of government is the fundamental cause. The underlying problem is distorted incentives and the corruption of power. Power corrupts and absolute power corrupts absolutely. As the systems of governance deteriorate under rent seeking and rent creation, the power to do good falls relative to the power to harm. The result is that today, the latter is much greater than the former, so that the rare employee wanting to do good has the dice loaded against him/her. There is an urgent need to strengthen the checks and balances in the political system. Though the framers of our constitution paid a lot of attention to the potential for corruption in the bureaucracy, they made the fatal mistake of assuming that all future elected representatives would be incorruptible and selfless like those who fought for independence. They could not imagine that the judiciary could also be corrupted.
There is an urgent need for electoral reform to reduce the currently overwhelming incentive for political corruption. If the Neta-criminal nexus is not broken a time will come in the not too distant future when it will become virtually impossible to stop the criminalisation of the entire police force. Possible elements of a solution include, (a) State funding of elections through a matching funds approach. (b) Transparent accounting and mandatory auditing of the accounts of political parties that receive State or company funds. (c) Mandatory bar to running for (or holding) any political office by any one against whom criminal charges have been legally framed, (d) Special courts to try politicians/potential candidates against whom such charges have been framed so that those who are the object of motivated/false charges can be tried and cleared quickly. Penalties could also be prescribed against those who wilfully make false charges.
The police force has over time become an important instrument of political power and manipulation. The police are therefore no longer an independent instrument for enforcing and upholding the rule of law and for providing personal security to all its citizens. The misuse of police by the political masters for personal ends as well as the use by the police of state power vested in them, for their own personal ends, is not merely a theoretical possibility but a frightening reality. This enormous power of the police to do harm must be checked before it becomes uncontrollable.
A number of commissions from the Dharam Vira commission to the Law Commission have suggested the creation of a buffer between the political bosses and the day-to-day operation of the police. One approach is to set up an autonomous police commission in each state along with open and transparent process for appointing the senior officers of the commission. There is also need for an independent public prosecutor whose job is to take cognisance of, oversee investigation of and prosecute major crimes (e.g. murder, armed robbery/dacoity, kidnapping, rape, police crimes). To ensure accountability to the public, which has become the object of police harassment, each police commission & public prosecutor would be accountable to an oversight committee of representatives from all walks of life (including the administration & judiciary). This would ensure that the police themselves obey the law and the law-breakers among them are given exemplary punishment.
Reform of the judiciary could similarly involve a National Legal commission to provide oversight over the legal system and ensure the neutrality and probity of judges at different levels.
We cannot afford to keep waiting for a consensus among all political parties (including those with 20% criminals). Let not the best be the enemy of the good. The two national parties and their non-criminal allies should come to an agreement and start the process of reforms.
Perhaps one can focus the question a little: If you were made dictator of India with the authority to address a few issues what would they be? My answer: The most difficult thing for a democracy to reform. That which affects those who make the laws (members of parliament and state assemblies) and are supposed to be the guardians of these laws (judiciary, police). The greatest danger to the nation and the greatest long-term threat to India’s continuing development is the breaking of the law by the law makers. Like the proverbial rotting head of a fish it affects everything else.
The deterioration in governance, that has taken place over the decades is broad based & universal: Civic amenities, publicly provided utilities, public education and health law & order and justice have deteriorated, in some places beyond belief. What one had heard about law & order in Bihar for several decades and began hearing about UP during the last decade, can strike even in the capital and its suburbs. Kidnapping in Ghaziabad, police extortion in the heart of Delhi (a beat constable asking a small scale factory owner for ‘hafta,’ backed by the threat of overnight theft of materials lying in his premises). Some years ago, the secretary (food) of one State govt. admitted in a meeting with IAS peers that they were not competent to procure excess production or deliver food to the starving. Hearing this from an inheritor of the ‘steel frame of India,’ was a shock. Similarly, the chief minister of one notorious State confessed that the existing State machinery could not spend money productively and that it would be very happy if development activities could be carried out by anyone else, including the provider of the funds.
The lack of interest and motivation to fulfil the basic functions of government is the fundamental cause. The underlying problem is distorted incentives and the corruption of power. Power corrupts and absolute power corrupts absolutely. As the systems of governance deteriorate under rent seeking and rent creation, the power to do good falls relative to the power to harm. The result is that today, the latter is much greater than the former, so that the rare employee wanting to do good has the dice loaded against him/her. There is an urgent need to strengthen the checks and balances in the political system. Though the framers of our constitution paid a lot of attention to the potential for corruption in the bureaucracy, they made the fatal mistake of assuming that all future elected representatives would be incorruptible and selfless like those who fought for independence. They could not imagine that the judiciary could also be corrupted.
There is an urgent need for electoral reform to reduce the currently overwhelming incentive for political corruption. If the Neta-criminal nexus is not broken a time will come in the not too distant future when it will become virtually impossible to stop the criminalisation of the entire police force. Possible elements of a solution include, (a) State funding of elections through a matching funds approach. (b) Transparent accounting and mandatory auditing of the accounts of political parties that receive State or company funds. (c) Mandatory bar to running for (or holding) any political office by any one against whom criminal charges have been legally framed, (d) Special courts to try politicians/potential candidates against whom such charges have been framed so that those who are the object of motivated/false charges can be tried and cleared quickly. Penalties could also be prescribed against those who wilfully make false charges.
The police force has over time become an important instrument of political power and manipulation. The police are therefore no longer an independent instrument for enforcing and upholding the rule of law and for providing personal security to all its citizens. The misuse of police by the political masters for personal ends as well as the use by the police of state power vested in them, for their own personal ends, is not merely a theoretical possibility but a frightening reality. This enormous power of the police to do harm must be checked before it becomes uncontrollable.
A number of commissions from the Dharam Vira commission to the Law Commission have suggested the creation of a buffer between the political bosses and the day-to-day operation of the police. One approach is to set up an autonomous police commission in each state along with open and transparent process for appointing the senior officers of the commission. There is also need for an independent public prosecutor whose job is to take cognisance of, oversee investigation of and prosecute major crimes (e.g. murder, armed robbery/dacoity, kidnapping, rape, police crimes). To ensure accountability to the public, which has become the object of police harassment, each police commission & public prosecutor would be accountable to an oversight committee of representatives from all walks of life (including the administration & judiciary). This would ensure that the police themselves obey the law and the law-breakers among them are given exemplary punishment.
Reform of the judiciary could similarly involve a National Legal commission to provide oversight over the legal system and ensure the neutrality and probity of judges at different levels.
We cannot afford to keep waiting for a consensus among all political parties (including those with 20% criminals). Let not the best be the enemy of the good. The two national parties and their non-criminal allies should come to an agreement and start the process of reforms.