Comment on "So-called export led growth", by Jie Yang, IMF WP/08/220

Yang has a different definition of “export led ” than one has always used (which one always thought was the standard one). Our definition is in terms of policy bias ( tax-subsidy, exchange rate) towards exports as against a tax-subsidy-exchange regime that is neutral between imports and exports.  The question is whether government deliberately attempts to promote exports (through fair and foul means) or has a neutral policy regime!   The second stage of this analysis is to see which of the export oriented regimes were successful in raising export growth and GDP growth.  Those that are successful would be termed as following an export led growth strategy, regardless of what happens to the exchange rate!  In fact a depreciation of the exchange rate may be a precursor to or part and parcel of a biased policy regime promoting exports.  In fact the time pattern would be important. For instance successful high growth countries may gradually move from export bias to a neutral policy regime, with depreciation in the former period and appreciation thereafter, where the latter is an outcome of the success of the earlier policy!

    
Productivity increases will result in the Balassa-Samuelson effect (tradable productivity growth higher -> appreciation) and inverse Balassa-Samuelson effect (non-tradable prdoctivity growth higher -> depreciation) depending on which sector has faster productivity change.  An interesting emperical observation in the paper is that about half the high growth economies (as per Yang's definition) had an appreciation while a smaller number had a depreciation.  This aspect needs to be investigated further however, by relating it to the policy regime they had (in terms of export bias) and the time pattern of exchange rate changes.

Fiscal Debt Sustainability

In my 25 years of interaction with multilateral financial institutions on fiscal issues, I have repeatedly made the following points (which remain valid till today): 1) That the simple rule that growth rate must be more than the real interest rate is a good guide to ensuring that debt GDP ratio declines over time. (2) Theory does not tell us what level of the debt-GDP ratio is optimal. A number of factors are important for judging whether this level is too high. Among these are, (a) The asset owned or the net debt-GDP ratio. In other words a country with a lower debt, net of assets, can sustain a higher gross debt-GDP ratio.  Given the financial innovation over the last 25 years, it is also necessary to emphasise that the liquidity, maturity structure and uncertainty/risk associated with the assets also matters! A further implication is that debt incurred for investment is more sustainable than if used for consumption and transfers. (b) The manner of financing of the debt, in particular the proportion financed by domestic as against foreign capita/savings.  Thus countries with higher private domestic saving rates can sustain a higher level of debt to GDP and vice versa! (c) The demand conditions in the economy relative to potential supply.  An economy sufferring from lack of effective demand (virtually all advanced economies today), need to balance policy measure to ensure medium-long run debt reduction, with investment in public and quasi public goods in the short run to ensure effective demand.  If this is not done, growth will suffer and debt-GDP ratios will end up higher than they could be!  However, in economies suffering from excess demand (several Emerging economies today) and inflation, immediate fiscal (expenditure) contraction can allow a more relaxed monetary policy that will sustain growth and accelerate debt reduction. 

Emerging Economies need Domestic Reforms

In June this year, I concluded that the USA and EU were heading towards a lost decade, because their political systems had kept them dealing fully with the financial crises (web site).  The social-political developments in Italy and the US since then have raised the risks of a double dip.  Given this background can the Emerging economies (China, India, Brazil, Russia et al) maintain the growth differential? My answer is, 'Yes, if they take urgent steps to remove domestic constraint to growth and to stimulate domestic drivers of growth.' For China this means re-orienting its economy towards lower party-State controlled profits, higher wages and private consumption, greater public expenditures on social services (as against manufacturing investment) and slower export growth-appreciated exchange rate.  For India it means a faster reduction of the fiscal deficit, and a step-up of the pace of policy-regulatory reforms. In particular four broad reform areas have the potential of both accelerating growth and reducing inequality: (1) Urban planning, land use and urban infrastructure(water, sewage, public transport, parking), (2) Food supply chain modernization (FDI in retail trade). (3) Oil-energy policy and regulation (price distorting to direct  subsidies, regulated benchmark competition in electricity). (4) Skill development founded on high quality basic education (3 R s).  Similarly, if  Brazil, Russia, Indonesia and other large EMs can put their domestic house in order, they can collectively survive the growth slowdown and heightened risk emanating from the USA and Europe    

Socio-political Warning

For those of us familiar with country ratings based on fiscal situation and fiscal politics of emerging and developing countries the downgrade of US rating by S&P was surprising only to the extent that a US rating agency dared to be even handed and dared to apply to the US, the same rules and procedures that they had always applied to emerging economies (EMs):  That political inaction or gridlock about fiscal reform  is not a valid argument against a rating downgrade.  Nevertheless this downgrade is warning not only to the political systems of the US and the Euro area/European Union, but also for the emerging economies and developing countries.  That is, to use the relative good economic situation that still prevails in these countries to reduce fiscal deficits and put sovereign debt: GDP ratios on a downward trend, before the heightened risk of a European crisis triggers a double dip in the US and affects the EMDCs.  Such a crisis, however low the probability, will leave little room for manouver for those EMs that do not take pre-emptive action to reduce deficits, remove domestic bottlenecks to growth and undertake reforms to activate growth drivers.  For instance, the Indian economic survey 2008-9 (DEA, MOF) give a menu of 6 boxes, including fiscal reforms, that should be carried out to ensure that the growth rate does not decline below the potential of 8.5 to 9%.  Unfortunately these warnings the pace of reforms has slowed below the average trend seen in the previous two decades.  If the pace of reforms is not restored back to its trend, the rate of growth is likely to decline gradually, given the dire global economic outlook and heightened global risks

Financial Crises Stage 2

The financial turmoil following S&Ps downgrade of US debt, publicly signals the onset of stage 2 of the US-European financial crisis. It is also a wake up call to these countries' socio-political system, which has failed to fully deal with the policy reform issues thrown up by the financial crisis. One has repeatedly pointed out over the past 18 months (within the international institution with which one is associated) some of the critical issues (e.g. US household mortgage debt problem or the solvency issue in 3-4 euro countries) that were not being addressed and others which were being wrongly addressed (the focus on sharp instant expenditure cuts vs. legally and institutionally sustainable reduction in expenditure). However, it is only over the last few months one had come to the conclusion that given the political gridlock in the USA and political constraints in the Euro area, these two regions are likely to see a lost decade analogous to Japan. In this context, I view the S&P down grade as a 'wake up call' to the political systems of these two economies to resolve the policy stasis if they want their economies to recover at a pace faster than the 7-10 years of previous financial crisis. This requires policy intervention to accelerate household mortgage debt de-leveraging and a solution to the solvency problem through contributions from the debtors and stronger Euro countries.

Eliminating Poverty in India

POVERTY CAN BE ELIMINATED

What is the cost of eliminating poverty and hunger in India? That of course depends on the extent of poverty, which has been mired in academic debates about the measurement of poverty. There is however universal agreement that in the years from 1993-94 to 1999-2000 the poverty rate (HCR) was between 25% and 35%. We can therefore skirt the esoteric debate about the precise change in poverty between 1993-4 and 1999-2000 and its level in either year by considering three numbers. For each of these years we order the households/person by consumption level and identify the ones which are 25%, 30% and 35% from the bottom. That is we identify in each year the consumption level of the person(s) who would be just at the poverty line if the poverty rate was 25%, 30% and 35% respectively. Then we calculate the income transfer needed for every body below that level to be brought up to the level. This data is summarised in the table below.
Table 1: Consumption Expenditures and Expenditure Gap


In 1993-94 the Central government expenditure in the budget category “subsidies” was Rs. 12,682 crore of which Rs. 10,099 crore were for food and fertiliser subsidies. The latter would have been enough to bring all the poor to the consumption level of the person/household at the 25% level. During the same year the Central and State governments together spent another Rs. 14,160 crore on the budget categories ‘Rural development,’ ‘Welfare of SC, ST & OBCs’ and ‘Social Security and Welfare.’ This expenditure would have been enough to bring all the poor to the consumption level of the person/household at the 30% level. These two sets of expenditures (Rs. 25850) would have been more than sufficient to eliminate poverty in 1993, if transferred directly to the poor and disadvantaged (SC, ST, handicapped, old, poor farmers).
In 1999-2000 the total subsidies provided by the Central government were Rs. 25,690 crore of which Rs. 22,680 crore were for food and fertiliser. During the same year the Central and State governments together spent another Rs. 28,080 crore on ‘Rural development (RD),’ ‘Welfare of SC, ST & OBCs and ‘Social Security and Welfare.’ Either of these was sufficient to bring all the poor to the consumption level of the person/household at the 30% level. Given that poverty was between 26.1% and 28.6% either of these if transferred directly to the poor and disadvantaged (SC, ST, handicapped, old, poor farmers) would have eliminated poverty. Together these subsidies and poverty alleviation expenditures (Rs. 53,770 crore) would have been sufficient to eliminate poverty in 1999-2000, even if administrative costs and leakages used up half the allocation (and the small fraction of RD expenditures on water supply were excluded).
It can be argued that the ideal (most efficient) social welfare policy is a direct transfer of income to the poor through a negative income tax. In a developed country this would be very easy. How can we transfer these amounts directly to the poor, the needy and the disadvantaged in a poor country? The answer, by setting up an Indian version using a modern smart card system that delivers cash and/or subsidies to the poor based on their entitlements as per specified parameters and norms. Such a smart card could be programmed with identity (photo & biometric fingerprint), and have information on social (SC/ST) and personal/household characteristics. Each person/ households’ entitlements could be in the form of specified subsidies (per unit subsidy of si for up to qi units for all i in C) for the purchase of a set of items C. The set of items C could include food/cereals, kerosene, midday meals, nutrition supplements, drinking water, toilet/ sanitation services, basic drugs, schooling (primary/secondary), internet access, electricity and a host of other items reflecting the dozens of subsidies and programs currently in existence. The entitlement could be varied with and dependent on various economic and social handicaps such as SC-ST, age (infant or aged), mental handicap, physical disability, female head of household, lactating mother, chronic illness. In this way all the current stakeholders, special interest groups and social policies could be accommodated within a single integrated system.
These subsidies would have to be collected by the provider of the specified service from the government through the smart card system just as is done currently in a credit card system. Alternatively all these entitlements could be calculated and consolidated into a single cash value to be delivered to the beneficiary every month at his residential address, through the smart card system. Though on theoretical economic grounds the latter may be the preferred option, the former would also yield substantial gains and perhaps be more feasible at this stage.
If poverty could be eliminated so easily why has this not been tried before? There are many reasons, but the most fundamental is illustrated by the following experience: In the formulation of the tenth Plan for food policy/ PDS system there was a proposal to gradually introduce a credit /debit /smart card system to replace the existing PDS system characterised by enormous leakages and high administrative costs (see Virmani and Rajeev (2001)). In this system the entitled person could obtain the specified subsidy from any participating supplier of food/cereals. The person would pay the supplier the difference between the market price and the unit subsidy, and the supplier would collect the subsidy from the government. The formal proposal was to carry out an experiment (as a first step) to determine its effectiveness and to learn about and iron out any problems that may arise. Consequently funds were allocated in the tenth plan for introducing it in a sample of urban areas along with the introduction of food stamp system in a sample of rural areas. Not a single State govt agreed to undertake this experiment, as it has the potential of dramatically reducing leakages and administrative costs.
Smart Card System
The smart card would also constitute a national identity card. For instance the card could contain information on citizenship and voting eligibility (constituency for voting) as provided and checked by the home ministry and the election commission respectively. Secrecy and confidentiality clauses would have to be built into the national smart card system by law. For instance, any person who does not want to avail of any subsidies / entitlements from the government need not provide the information needed for calculating & monitoring the subsidy/entitlement. They would for instance only provide the information necessary to obtain a passport and voter registration card. Many agencies of government (e.g. CBEC, CBDT, and Home) have proposed identification cards. There are significant economies of scale in having one smart card system for all citizens, with different agencies having their own special modules (password protected access to memory segments) within the card for their specialised needs.
The setting up of a smart card system is somewhat distinct from running it even though there may be economies of scope. The former is very similar to carrying out a (special) census in which the data gathered would be entered into a smart card. There is however an additional, technically challenging component, the simultaneous recording of a photo and a biometric fingerprint so as to minimise fraud. The experience with a similar system used in SEBI MAPIN project suggests that it would be best to sub-contract it to private parties in each State/region.
The running of smart card system is on the other hand very much like the running of a credit card system. All the credit card companies, as well as companies that provide back office services to credit card issuers or marketers, would be interested in competing to obtain the contract for the running of such a system. As a credit card company has to incur a fixed cost in setting up its own credit card system, these companies may be willing to charge below cost if they can share the fixed costs of the public system with their private card systems. This could make a significant difference in the cost of spreading the system to the rural areas. Cash delivery through smart card would be akin to a modern version of the Post & Telegraph department’s money order system, already operational with specialised companies that intermediate international/national remittances. The cost of setting up and running a nationwide cash delivery system for the poor would probably be significantly less than that of a commodity related system. The total steady state cost of running this system (including depreciation and return on capital) should be of the same order as the current credit card systems (< 10%).
The identity of the households below the poverty line is not fixed from year to year. The largest turnover occurs because of health shocks followed by natural disasters (droughts and floods) that knock people below the poverty line, while others who have recovered from the shock or have improved their position move above the line. As a matter of abundant caution we could target the bottom half of the population for issue of smart cards (with complete entitlement related information). Annual updating of entitlement related information could be done for those below the poverty line and those up to half this percentage above the line (i.e. if poverty rate, HCR, is 24%, cover poorest 36%).
An independent authority including government officials and non-government organisations could be set up to monitor the integrity of the Poverty Elimination System. This supervisory authority would ensure that private operators are running the smart card system in a manner needed to ensure that the subsidy reaches the poor.
Poverty, which rose during 1950-1 to 1979-80 (Indian socialism), has been on a clear down trend during the Market reform period (1980-1 to current). The level of poverty in 1999-2000 was estimated by poverty experts to be between 26.1% and 28.5% as per the Planning Commission methodology. This level of poverty is to be expected in a low income country like India. India’s poverty ratio is relatively high because we are a relatively poor/ low income i.e. with low average income. 90% of the countries in the world had in 1999-2000 a higher per capita (average) income than India. Our Global poverty ranking is in fact better than our ranking by per capita income. The absolute number of poor is very high because our population is very large, the second highest in the world. Contrary to popular wisdom, the large number of poor has little to do with income distribution. Our income distribution as measured by the Gini co-efficient is better than 3/4th the countries of the World. Further our rank with respect to income distribution is even better, with the poorest 10% of the population having a consumption share that is the 6th highest in the World.
Poverty can be eliminated within the next five years if we are willing to radically change the approach to “poverty alleviation” which was started in the early 1980s. Smart cards anyone?

Five Point Program For Pro-poor Growth

1 National Road Grid
Roads are both literally and figuratively the pathways to the growth of agriculture, services and industry. Connect every village (habitation), town and city with all-weather, paved/metaled roads of specified standard in five (10) years. Road connectivity is particularly important in the poorer States and regions, where growth has not picked up. The existence and quality of the roads should be monitorable by a web enabled information system.
Remove controls and restrictions on trade and transport at the State and local level. Plan for the provision of land on the sides of district roads and block road junctions so that economic activity, such as trade, hotels, restaurants and repair facilities can spring up. Plan National and State highways keeping in mind that underpasses and/or parallel local roads may have to be built in many places as economic activity spring up on the sides.

2 Let 1000s of Towns Bloom
For every existing town, plan and install a modern drainage, sewerage and water supply system with water works, sewage treatment plants and garbage disposal sites. The impact in terms of economic activity, health and nutrition can be enormous. Help develop consultancy firms that can Plan and organize such systems and organizations that can compete with each other to build these systems across the country. Once 100% coverage of towns is attained, extend the planning effort to semi-urban areas and villages in co-operation with Panchayti Raj institutions and NGOs.
Allow and encourage private entrepreneurs to build thousands of new towns/townships in semi-urban, semi-rural areas. Connect these to the nearest highway and water-supply mains. Scrap expropriatory sections of the Rent control act(s) and corresponding rules and procedures, so that the private sector can build and provide rental accommodation for the lower middle class and the poor.

3 Water Management
India is a relatively water-scarce country and Global environmental changes threaten to make this worse. Yet our limited water resources are either not fully utilized or are misused (depleting ground water).
There is an urgent need to improve the comprehensiveness and quality of water planning and management at every level (Center, State, district, town, panchayat, smallest farmer). Water harvesting, water shed development, recharge of water bodies and aquifers, must be planned and implemented in every nook and corner of the country. Education and demonstration of models with the active participation of NGOs can play an important role. Dams and canals have a place in cutting down the flow of water into the sea, recharging aquifers and supplying dry areas and parched towns. Tube wells in depleting aquifers must be discouraged through proper pricing of electricity and perhaps even water.
4 Universal Primary Education and Skill development
Universal Primary education is too readily identified with universal enrolment and low drop-out rates, rather than the ability to count, read, write and explain at the primary completion level. Before declaring victory and moving on to target universal secondary education we must ensure that every young person (25 or below say) meets the global standard of Primary education. Government must set up testing, standards and certification systems that can determine if these standards have been met.
The only way to ensure this is to empower every youth with a debit card, which allows him/her to purchase primary education from any school including any government school. The set of authorized uses of the debit card will be fully funded by the government. The funding of the government school and part of the administrators/teachers’ pay must be linked to the total debit card receipts (monthly fees paid through the debit card).
Every youth, rural or urban, after completing primary education must also have access to the six thousand or so globally identified skills. This requires a massive joint effort by government, NGOs and private skill providers. Government must provide funding for the poor while all possible private and foreign expertise and experience is attracted to India to provide training in all these skills in the next five years.

5 100% Telecom Connectivity
The USO fund must be used to ensure that the mobile footprint covers 99% of India in the next five years. Open access to physical infrastructure and land lines (including telegraph and electricity wires) and fibre optic networks must be ensured in rural areas for attaining universal access to internet in the next 10 years.