The World Economy: From Uni-Polar to Tri-polar

Introduction
For over a century the USA has been the largest economy in the World. Major shifts have however been under way since then. During the last 30 years the weight of the world economy has shifted from the USA and the rich countries of Europe to China and India. These trends will continue in the 21st century, bringing about a historic transformation of the World Economy. The Global economy will change from a uni-polar to a bi-polar one with the emergence of China. This will be followed a decade and a half later by the emergence of India, converting the World economy into a tri-polar one.
The rich countries of Europe have seen the greatest decline in global GDP share by 4.9% points, followed by USA and Japan with a decline of about 1% points each. Within Asia the declining global share of Japan since 1990 has been more than made up by the rising share of China and India. During the seventies and eighties ASEAN countries and during the eighties S. Korea along with China & India contributed to the rising share of Asia in world GDP. Between 1975 and 2002 Japan’s share of world GDP fell by 1% point while that of S. Korea, ASEAN, India and China rose by 1%, 1.2%, 2.2% and 9.2% respectively. Thus India’s gains since 1980 have been much larger than ASEAN & S. Korea but much less than those of China(*).
3.5.2 Uni-polar Global Economy: 2002
At the start of the new millennium the ranking of the 10 largest economies in terms of size is shown in the table 3. USA the largest economy is almost 2 times the size of the next largest economy China and about three times the third largest economy Japan. Thus the size of the US economy is larger than the next two economies combined, revealing clearly the uni-polar nature of the Global economy. The fourth largest economy India is a little over one-quarter the size of the US economy. The next five positions are taken by the big four of Europe: Germany, UK, France and Italy. Brazil and Russia bring up the rear with their joint size less than that of India. In turn the size of these three economies together is less than that of China.
Bi-pole China
Within 10 years the global economy will be transformed from a uni-polar to a bi-polar one. China is projected by us to become the largest economy in the World within 15 years. Though India like the rest of the world has been falling behind China, its share of World GDP will continue to grow. Before the end of the current decade India’s economy will become larger than that of Japan, thus taking it to 3rd place behind USA and China.
We measure the incremental impact of an economy on the rest of the World through trade and financial flow, by change in GDP at current exchange rate. By the end of the decade, China will become a larger driver of global growth than the European Union’s six largest economies. Similarly India will be a larger growth driver than the United Kingdom, the most significant growth pole in the EU. At this time the combined impact of the three Asian giants (including Japan) will exceed that of the USA. The global impact of other emerging economies is relatively small. In 2015, Canada and Russia are ranked 11 and 12 in terms of impact, which is less than a third of that of India at that time. The S Korean economy in contrast comes in at 7th rank with an impact that is half that of India’s. Brazil’s impact is projected to be much lower than that of Mexico.
India: 3rd Pole & Growth Driver
As the share of the USA in World GDP falls (from 21% to 18%) and that of India rises (from 6% to 11% in 2025), the latter emerges as third pole in the Global economy. By 2025 the Indian economy is projected to be about 60% the size of the US economy. The transformation into tri-polar economy will be completed by 2035 with the Indian economy only a little smaller than the US economy but larger than that of W. Europe.
China’s economy is projected to become 50% larger than the US economy by 2025 and almost double that of the USA by 2035. At this point China’s share of the World economy will be equal to the share of the US and Indian economies taken together. All the other countries that are either currently members of the Security Council or aspire to become so will therefore have relatively small shares. Japan the largest among them will have a share of about 5% while the others (including Russia) will each have 2.5% (table 3).
This scenario assumes that China will be able to sustain the ‘FDI-Export’ cum ‘Zero capital cost’ model of fast growth. The ‘FDI-Export’ model transformed ASEAN countries into “Miracle” growth economies, but the Asian crises showed that it is heavily dependent on creating and sustaining optimistic expectations. China’s risk is heightened by it combining with ‘zero capital cost’ to producers of inputs (including infrastructure) that bury inefficiencies in the government banking system (implicit fiscal subsidies). It is however hard to predict what kind of exogenous shock will knock such an economy off the high growth knife-edge path to more normal sustainable growth rates.
By around 2025, China’s impact (in terms of GDP at prevailing exchange rates) on World growth is likely to be larger than that of the USA and India’s impact larger than that of Japan. By 2035 India is likely to be a larger growth driver than the 6 largest countries in EU, though its impact will be a little over half that of the USA. China’s impact will, however be about 40% more than that of the USA.
Conclusion
The projected changes in the relative size of economies will have profound implications for global governance, the global balance of power and the stability of Asia. This phenomenal change in relative power poses major challenge to the economies of Europe, N America, and Asia that very few seem to fully understand or appreciate.

Table : World Share of GDP at Purchasing Power Parity

Current Projected (2002 prices)
2002: Uni polar 2015: Bipolar 2025 2035: Tripolar
Country (Int$bi) Share Rank Share Rank Share Rank Share Rank

China 5861 12.1% 2 19.5% 1 25.2% 1 30.0% 1
USA 10308 21.3% 1 19.5% 2 17.8% 2 16.0% 2
India 2800 5.8% 4 8.2% 3 11.2% 3 14.3% 3
Japan 3425 7.1% 3 6.2% 4 5.5% 4 4.8% 4
Germany 2236 4.6% 5 3.5% 5 3.0% 5 2.6% 5
France 1601 3.3% 6 2.7% 6 2.4% 7 2.1% 8
UK 1549 3.2% 7 2.7% 7 2.3% 8 2.0% 9
Russia 1186 2.4% 10 2.6% 8 2.6% 6 2.5% 6
Italy 1525 3.1% 8 2.5% 9 2.0% 9 1.6% 11
Brazil 1355 2.8% 9 2.2% 10 1.9% 12 1.6% 12
Source: * Virmani, Arvind, "Economic Performance, Power Potential and Global Governance: Towards a New International Order" ICRIER Working Paper No. 150, December 2005

The Role Of EGS In Employment Policy

A basic objective of economic & social policy is to ensure that all able bodied citizens are provided a job at the prevailing market wage for unskilled work. Faster economic growth and employment generation will in a decade or so eliminate underemployment and disguised unemployment. Labour market reforms are essential for generating higher productivity organised sector jobs at a faster rate. An Employment Guarantee Scheme can play an important role as part of an overall reform of labour policy and government expenditure on poverty alleviation & rural development.
Because of our rigid labour laws, the employment elasticity of registered manufacturing (8% of labour force) has declined. Many new industrial facilities are designed to minimise use of labour and exporters prefer to set up labour intensive export facilities in competitor countries. The ID&R Act and its procedures need to be reformed to make it possible to remove corrupt, disruptive or lazy employees (* for details). The scope and reach of the IDA, which was arbitrarily extended during the emergency should be restored to its pre-emergency state. Chapter IX A, intended to promote voluntary consultation when trade unions in their infancy has become a virtual veto should be deleted.
One of the keys to the generation of high quality internationally competitive jobs is specialisation (including in services). The Contract Labour Regulation and Abolition Act was intended to regulate contract labour. Section 10 that came to be interpreted by courts to mean mandatory abolition must be modified to allow outsourcing of all services so as to encourage firms to specialise in, train labour for and improve productivity in each activity.
A comprehensive system of private pension/provident fund, centred on the individual will improve labour mobility. The system must be portable with benefits moving with the individual as (s)he changes jobs or organisations. It would be fully funded, with any employer contribution deposited into the individual retirement account. It must have modern and flexible investment regulations, which allow the build-up of a broad portfolio including higher risk-return assets like equity and private debt. It must ensure application of efficient governance structures and management so that the worker has access to the same returns that are traditionally available only to the wealthy.
Health insurance should be opened to greater competition by allowing 100% FDI in this sub-sector, it should also be integrated into the system in such a way that employees who move to another job continue to enjoy benefits during the search period and can carry any unused benefits to the new job.
The poor cannot afford to be unemployed while the better of spend a lot of (out of work) time searching for jobs. A web-based national electronic labour market should be set up by modernising and upgrading the national unemployment register. The system should generate and display an inventory of skills, from both the demand and supply side. The National Renewal Fund should be strengthened to assist in re-training and relocation of employees to increase the mobility of labour.
A unified labour code would be useful for unorganised workers if it deals with work conditions such as age of entry, hours of work, health, safety & welfare at the work place (maternity benefits, compensation for injuries & health insurance). In contrast a law that controls hiring & firing or sets minimum wage above market rate would merely open further avenues for harassment & corruption. Employers of unorganised workers should get a tax deduction for pension & health insurance contribution for workers.
Over the last few decades there has been a proliferation of poverty alleviation and employment generation schemes. Each has its own administrative infrastructure and works relatively independently. These schemes are commonly believed to deliver only a fraction of total expenditure (15%?) as benefits to the intended beneficiaries. There are also numerous schemes for building local infrastructure. An Employment Guarantee scheme (EGS) would be ideal if all these other schemes are eliminated and the funds allocated to a National EGS. By integrating infrastructure building, including watershed development and water harvesting, at the Panchayat and block level, in the EGS, effectiveness could be greatly increased. The scheme must be counter-cyclical in terms of district/region wise seasonal demand for unskilled labour. Wages paid should be based on average off-season market wages, which would be designated as the minimum wage for that district/regions EGS. It should incorporate a transparency clause, which requires supply of information on people hired, time spent and wages paid.
Information access is critical to increasing the value that reaches the poor. The Official Secrets Act virtually prohibits civil servants from giving any information to the public, by providing a stringent penalty for ‘unauthorised’ disclosure. It should be replaced by a Right to Information Act that carefully delimits the areas (e.g. foreign affairs, defence plans, strategic R&D, personal files) to which secrecy needs to apply. It would be designed to give the public the right to information about decision & actions that affect their lives. This must include every item of expenditure (small or large) made in the name of the poor, the weaker sections, scheduled castes and tribes. It must also include the various permits, licenses and permissions given to the public at the municipal and block or district level, so that they are available for public inspection.
Stable, high productivity semi-skilled jobs can be generated at a much faster rate if labour laws & rules are made more flexible. Faster economic growth and employment generation will in a decade or so eliminate underemployment and disguised unemployment. In the meanwhile, we need a simple well-focused government program, which is financially sustainable. The employment guarantee scheme can play a critical role if it integrates and replaces the plethora of rural development and poverty alleviation schemes. Even the most extravagant EGS cannot, however, be a panacea for all the ills of the poor. If it is just another add-on to the numerous schemes introduced over the past 25 years, its success is unlikely to be significantly greater than that of previous schemes.

Black Money: Reduce Creation

There are three major sources of Black money creation. Government controls, government expenditures and taxes. The government control and licensing system was taken to its peak during the seventies and resulted in the infamous License-Permit-Quota Raj (LPQ Raj). A gradual process of de-control started in the eighties, with a major spurt taking place in the early nineties. Since then it has continued at a modest pace. Those who operate at a very general level believe that the LPG Raj has largely been dismantled and is no longer hindering growth. Detailed study and/or experience of any sub-sector, however, reveals that this process is far from complete. The control mentality has pervaded every sector of the economy and every control is viewed by the majority of enforcers either as an opportunity to generate funds for themselves or as an imposition on their normal relaxed schedule. As there is little incentive, the minority of honest bureaucrats have by and large given up the struggle. Worse every law gives rise to rules and procedures that are first exploited to make money rather than to fulfil the basic objective of the law. The bottom line is therefore that a considerable amount of black money continues to be generated despite liberalisation. A determined and systematic effort at weeding out controls is needed in every sector if the generation of black money is to be reduced drastically and we are to accelerate growth.
The second and perhaps most important source of black money generation is the government expenditure system. Two decades ago one used to hear about commissions of the order of 15% on such expenditure. These commissions have apparently increased over time to the 30% range (plus/minus 15% where the opportunity is more/less). Higher siphoning off is possible in remoter areas where the objective is intangible (eg employment generation) and does not specify a concrete output. It is somewhat more difficult in Urban areas where specific projects are being carried out (e.g construction of a hospital or college building) and where relatively alert citizens and media can expose gross non-performance. The right to Information Act can be an important tool in the hands of citizens for increasing the accountability of the public expenditure system and reducing. The act must focus sharply on complete and comprehensive information about expenditures carried out(justified) in the name of the people/poor instead of getting distracted by controversial issues of national security, defence, foreign affairs and personnel files.
The third source of black money generation is tax evasion and corruption in the tax bureaucracy. As somebody once said, “There are only two things that are certain in Life, Death and Taxes.” Taxes are going to be with us for ever and over time as incomes increase more and more people will have to directly pay taxes. Simplification and rate reduction with a view to increasing voluntary compliance, has been the mantra of Indian tax reform since 1991. Though anti-reform moves have sometimes been sought to be palmed of as reforms and will perhaps be done again, the basic philosophy and direction of tax reform is now widely accepted across the political spectrum. Revenue increases through base broadening is the preferred means of increasing tax revenue.
What role does a tax amnesty have in this context. In 1997 when we recommended a sharp reduction in the marginal income tax rate, we also reviewed the experience with amnesties. There was only one research paper on India, that had tried to directly estimate the effect of an amnesty on tax collection. This paper showed that though tax amnesties increased revenue in the amnesty year they had a negative effect on revenue collection overall (i.e in subsequent years). At that time a carefully formulated amnesty was nevertheless recommended on the argument that a drastic reduction in marginal rates would create a new situation, by permanently bringing people into the tax net through voluntary compliance. The amnesty would therefore provide these new entrants an opportunity to start on a clean slate. This argument would work in the opposite direction when average marginal rates have been creeping up because of the imposition of various surcharges. In our view therefore an amnesty would be an anti-reform measure rather than a reform one.
Despite reforms, black money generation has not necessarily declined because of the deterioration of governance (expenditure & taxes). This factor also needs to be addressed if we are to make a major dent in this problem.

Foreign Exchange Reserves and Infrastructure

There are three different issues involved in this question which need to be addressed and answered separately before putting then together into a single package. The first issue is that of lending external reserves for domestic investment. By definition external reserves have to be kept in safe assets not affected by BOP shocks to the economy as they are held to reduce risks in such an eventuality. The Asian crises showed that external borrowing by domestic banks for the purpose of domestic lending increases systemic risk of crises. “Using” FE reserves for domestic purpose has a similar effect. If reserves are seen as ‘excessive,’ this indicates an implicit judgements that the risks are low and will remain so even with lower reserves. They are two sides of the same coin.
The accumulation of our reserves is the outcome of a BOP & foreign exchange management policy designed to meet external and domestic shocks and promote growth. If this results in “excessive” reserve accumulation the policy needs to be modified. Though the build up of reserves till September this year has roughly halved to what it was last year because of industrial recovery and higher oil and raw material policies there is scope for slowing it further. ICRIER studies have shown the positive effect of the tariff reductions since 1992, on intra-industry trade and specialization, productivity and exports. Reserve accumulation can be efficiently stopped or perhaps reversed by a sharp reduction in tariffs. A reduction in peak tariffs to 10% by 2006 and to 5% by 2008 budget and the lowering the excessively high agricultural tariffs will enhance productivity, increase exports and accelerate industrial growth.
The second issue is that of infrastructure investment and development. Experience with Telecom sector reform has shown that efficient and effective development of infrastructure requires a policy framework that promotes entry and supports competition (particularly with the government supplier). This requires isolation of natural monopoly elements through unbundling and a professional independent regulatory framework to regulate monopoly elements and ensure fair competition with the incumbent. In the case of electricity the so-called ‘Theft & Dacoity’ (T&D) losses would also have to be tackled head on if competitive pricing is to be fair and equitable to honest users. As roads are a classic ‘Public good’ policy reform is not enough and most of the burden has to be borne by the government, policy reform can be helpful high density National highways.
The third issue is that of public investment in infrastructure and its financing. In theory public investment in infrastructure, financed by money creation or by debt can be undertaken as long as the social benefit of the former (in terms of growth/productivity) is greater than the social cost in terms of inflation and/or crowding out. The former depends on the institutional structures for undertaking such expenditures, and institutional reform (of which the National Highway authority is the best example so far) is required to reduce leakage and enhance social productivity. The latter depends on unused capacity in the economy, which was very high from 1998 to 2002, but has tightened since mid-2003. External supply side (e.g. oil) inflationary pressures have also increased over the same period. Thus the conditions for both monetary and debt financing have worsened over the last 18 months. It may therefore not be wise to increase monetary expansion and thus add demand side pressure to supply based inflation nor to crowd out rising private investment with higher government borrowing. Nevertheless, if the social benefit is higher than the social cost, perhaps a financial package can be devised to get round the constraints imposed by the FRBM.
Though the package has been put together as one to “use FE reserves to finance public infrastructure,’ the following restatement/revision would appear to achieve the same objectives more efficiently: Increase government infrastructure investment in concert with, (1) A sharp reduction in tariff rates. Reserve accumulation would slow and perhaps reverse providing greater scope for non-inflationary monetization of the deficit needed to finance infrastructure. (2) A pro-competition infrastructure policy and a professional independent regulatory framework for electricity, railways, ports, airports and dams & canals, (3) Institutional reform of public infrastructure monopolies, like State electricity boards, irrigation departments public works departments (for State highways and village roads). The last two measures would enhance the benefit from increased public investment in infrastructure and thus make the costs of financing them worthwhile.

Planning in a Market Economy

Some people have asserted that the Planning Commission is redundant and should be abolished. To the extent that there is some logic to this assertion, the argument applies to virtually all ministries of the central government barring, defense, home, external affairs and finance. These ministries are not likely to be abolished during my lifetime. The proper question to ask therefore is, ‘What is the appropriate role of the Planning Commission in a market economy? In my view there are four areas that the Planning Commission is best positioned for, among all government institutions:
(1) The Planning Commission is the only institution that has the formal task of interacting with the States in virtually all areas of government functioning. Traditionally it has also had a measure of independence from the Central government and been viewed as an honest broker between the Center and the States. It is therefore uniquely positioned to deal with issues of co-ordination between the Center and the States.
(2) The Central government continues to invest in and spend money on a host of sectors and sub-sectors. The ideas of the fifties that this allocation would be based on comprehensive social benefit-cost calculations remained a gleam in the eye of theoretical economists. The Planning Commission is, however, the only body that can, in principle, objectively determine the optimal allocation of resources among competing uses. This is a difficult and highly challenging job, which would require enormous upgrading.
(3) Large lumpy infrastructure projects require co-ordination. Because different agencies are responsible for different areas (e.g. ports and railways) the Planning commission can ensure that the completion timings are coordinated to maximize the overall benefit-cost ratio.
(4) The Planning Commission can act as a think tank for policies and reforms, either by hiring and empowering internal experts or by sponsoring external research or both. There is great dearth of rigorous empirical research on the effect of different policies and of exogenous shock (e.g. oil prices). The PC can play an important role in promoting intellectual excellence and generating ideas for national development.

Prospects for India-Korea Economic Partnership

The process of liberalisation initiated in the new economic policy by India in 1991-92 and South Korea's attempt to look beyond its traditional sources of growth in the last decade gave momentum to the India-Korea economic relationship. Since then, considerable progress has been made in trade and investment between the two countries. The volume of trade expanded from less than $1 billion in 1991 to over $2 billion in 2002-03. Trade between India and Korea witnessed a quantum jump in 2002-2003 registering a growth of 34%. Growth in trade is also characterised by diversification of the trade basket. The export basket for India, though still dominated by low value-added products, has in recent years expanded to cover a wider range of industrial products like machinery and mechanical appliances, iron ore, electrical machinery and equipment and man-made staple fibres. Exports of software and electronics have increased manifold in the last few years. Imports from Korea, on the other hand, continue to be dominated by electronic goods, even though the share of transport equipment is increasing rapidly. Imports of machinery and equipment are set to grow further as several Korean companies are engaged in highways, power plants, chemicals, petrochemicals and metro rail projects in India.
The bilateral economic relationship has, however, not achieved its full potential. In 2002-03 India’s trade with South Korea accounted for less than 2% of its total trade while Korea’s trade with India was less than 1% of its total trade in the year 2002.
Given the economic size and dynamism of the two countries, their civilisational ties and the fact that they are both members of the Bangkok Agreement, the largest PTA in terms of market potential, trade between India and Korea can be expected to double in the next few years. Opportunities for trade expansion and diversification are evident from the as yet unexploited sectoral complementarities between India and Korea. Korea has expertise in manufacturing and financial and international marketing know-how, while India has abundant low-cost and technically-skilled manpower and established strength in science and technology. India and Korea can thus utilise their synergies to boost bilateral trade further.
Sectors like steel, chemicals, pharmaceuticals, automobiles and auto components, textiles, agro-products and gems and jewellery offer scope for expansion in trade. Knowledge-based industries like biotechnology and information technology are the gateways to future trade ties between India and Korea. Korea is fast progressing towards becoming an IT society. Korea’s ratio of internet penetration is the highest in the world and this is where India can make inroads. Korea has world class broadband IT infrastructure, ideal test bed for technology innovation and is a leader in mobile technology. India’s strength lies in its high quality and talented engineering pool, world-class software and services industry and is the world central point for IT outsourcing. Opportunities for joint cooperation and development as well as outsourcing projects for third countries are, therefore, substantial.

India has also come up as an attractive investment destination for Korean companies. Korean motivation to invest in India is shaped by critical advantages in terms of labour costs and easy access to Chinese, S-E Asian and West Asian markets. South Korea ranks fifth in cumulative investment approved in India. Main sectors that have attracted Korean investment are transportation, largely in the automobiles sector, fuels, electrical equipment (such as computer software and electronics, mobile telephony and consumer goods), metallurgical industry and office and household equipment.
Today, South Korean business groups such as LG, Samsung and Hyundai have become household names in India and are diversifying their businesses into different sectors and also using India as a base for expansion of their global business.
Increased focus on cooperation between our small and medium enterprises is also on the agenda of India Korea bilateral economic relationship. Successful tie-ups in this category would have a beneficial impact on an otherwise technically lagging sector in India.
India and Korea have for long recognised the advantages of regional integration arrangements. India is a founder member of the Bangkok Agreement, signed in 1975 and recently rejuvenated by China's entry. This agreement is the only preferential trading arrangement that provides preferential access to three of the major markets of this region, i.e., India, Republic of Korea and China. This may be an initiative, therefore, where India and Korea can jointly work to broaden the scope of the agreement to deal with non-tariff barriers and trade in services as against its current coverage of tariff concessions on goods only. On the multilateral front also, it would be beneficial for both India and Korea to evolve a consensus on issues of common interest and jointly work for an early resolution of the Doha Development Agenda.
India-Korea economic relationship also offers scope for providing the foundation for a stronger Indian presence in the East-Asian economic zone. India has much to offer as a bridge between East Asia and Central and West Asia. Further, as Asean negotiates free trade agreements with China, Japan, South Korea and India individually, the vision of a larger framework that includes the Asean+3+1 or Asean + 4 is taking shape. The accumulated wealth of Japan and the Republic of Korea and the huge markets of China and India will create fresh opportunities for trade driven growth in the region.
An India-Korea equation with a strong underpinning of economic relations and supported by shared values, religion and culture can make a significant contribution towards the Asean + 4 economic integration process.
Co-authored with Amita Batra

Inflation and The Way Out

Global oil prices have risen above the OPEC price band over the last 12 months. Because of general elections, the global oil price increase was not passed through into the Indian oil prices. The dismantling of the APM remained purely on paper. The Yukos crises in Russia and the blowing up of Iraqi pipelines has led to a sharp rise in oil prices to $ 45 a barrel. Only a part of global price rise was passed into the Indian market by the new Government in June. As a result of the global rise in oil prices, Indian inflation has increased by about 0.5% point, and is likely to increase further in August. Pressure on this front therefore remains.
In addition to global oil prices, raw materials and minerals prices also increased last year. After a lag of 6 to 9 months, manufactured goods prices of items which have a large component of such minerals in their inputs have tended to increase (e.g. iron ore and iron & steel). These increases were largely due to a tremendous increase in demand from China and from global recovery. Both these sources of growth have abated somewhat and inflation arising from these two sources is likely to moderate. I expect WPI inflation to decline to around 6.5 per cent by December.
The following policy reforms could be helpful in containing inflation (in India): (a) Reduce tariffs on agricultural commodities in which prices are rising sharply; (b) Reintroduce the amendment to the Coal Nationalisation Act to allow private entry in the coal sector so that there is genuine competition for imported oil; (c) Amend the Electricity Act (2003) to make the regulator independent and professional and set up a good regulatory system; (d) Launch a crusade against theft of electricity (35% to 50% of total generation); and (e) Reduce the “peak rate” of tariffs from 20% to 15% (latest by the next budget).