Why India’s economy is underperforming ?

• Major emerging-market economies around the world are slowing, for reasons both shared and unique. Hardest to understand, though, is why India, where annual GDP growth has fallen by five percentage points since 2010, is underperforming so much relative to its potential.
•  Emerging markets around the world – Brazil, China, India, and Russia, to name the largest – are slowing. One reason is that they continue to be dependent, directly or indirectly, on exports to advanced industrial countries. Slow growth there, especially in Europe, is economically depressing.
• But a second reason is that they each have important weaknesses, which they have not overcome in good times. For China, it is excessive reliance on fixed-asset investment for growth. In Brazil, low savings and various institutional impediments keep interest rates high and investment low, while the educational system does not serve significant parts of the population well. And Russia, despite a very well educated population, continues to be reliant on commodity industries for economic growth.
• For a country as poor as India, growth should be what Americans call a “no-brainer.” It is largely a matter of providing public goods: basic infrastructure like roads, bridges, ports, and power, as well as access to education and basic health care. And, unlike many equally poor countries, India already has a very strong entrepreneurial class, a reasonably large and well-educated middle class, and a number of world-class corporations that can be enlisted in the effort to provide these public goods.
• Satisfying the demand for such goods is itself a source of growth. But, also, a reliable road creates tremendous additional activity, as trade increases between connected areas, and myriad businesses, restaurants, and hotels spring up along the way.
• As India did away with the stultifying License Raj in the 1990’s, successive governments understood the imperative of economic growth, so much so that the Bharatiya Janata Party (BJP) contested the 2004 election on a pro-development platform, encapsulated in the slogan, “India Shining.” But the BJP-led coalition lost that election. Whether the debacle reflected the BJP’s unfortunate choice of coalition partners or its emphasis on growth when too many Indians had not benefited from it, the lesson for politicians was that growth did not provide electoral rewards.
• In any event, that election suggested a need to spread the benefits of growth to rural areas and the poor. There are two ways of going about that. The first, which is harder and takes time, is to increase income-generating capabilities in rural areas, and among the poor, by improving access to education, health care, finance, water, and power. The second is to increase voters’ spending power through populist subsidies and transfers, which typically tend to be directed toward the politically influential rather than the truly needy.
• In the years after the BJP’s loss, with a few notable exceptions, India’s political class decided that traditional populism was a surer route to re-election. This perception also accorded well with the median (typically poor) voter’s low expectation of government in India – seeing it as a source of sporadic handouts rather than of reliable public services.
• For a few years, the momentum created by previous reforms, together with strong global growth, carried India forward. Politicians saw little need to vote for further reforms, especially those that would upset powerful vested interests. The lurch toward populism was strengthened when the Congress-led United Progressive Alliance concluded that a rural employment-guarantee scheme and a populist farm-loan waiver aided its victory in the 2009 election.
• But, while politicians spent the growth dividend on poorly targeted giveaways such as subsidized petrol and cooking gas, the need for further reform only increased. For example, industrialization requires a transparent system for acquiring land from farmers and tribal people, which in turn presupposes much better land-ownership records than India has.
• As demand for land and land prices increased, corruption became rampant, with some politicians, industrialists, and bureaucrats using the lack of transparency in land ownership and zoning to misappropriate assets. India’s corrupt elites had moved from controlling licenses to cornering newly valuable resources like land. The Resource Raj rose from the ashes of the License Raj.
• India’s citizenry eventually reacted. An eclectic mix of idealistic and opportunistic politicians and NGOs mobilized people against land acquisitions. With investigative journalists getting into the act, land acquisition became a political land mine.
• Moreover, key institutions, such as the Comptroller and Auditor General and the judiciary, staffed by an increasingly angry middle class, also launched investigations. As evidence emerged of widespread corruption in contracts and resource allocation, ministers, bureaucrats, and high-level corporate officers were arrested, and some have spent long periods in jail.
• The collateral effect, however, is that even honest officials are now too frightened to help corporations to navigate India’s maze of bureaucracy. As a result, industrial, mining, and infrastructure projects have ground to a halt.
• Populist government spending and the inability of the supply side of the economy to keep pace has, in turn, led to elevated inflation, while Indian households, worried that no asset looks safe, have taken to investing in gold. Because India does not produce much gold itself, these purchases have contributed to an abnormally wide current-account deficit. Not much more was required to dampen foreign investors’ enthusiasm for the India story, with the rupee falling significantly in recent weeks.
• As with the other major emerging markets, India’s fate is in its own hands. Hard times tend to concentrate minds. If its politicians can take a few steps to show that they can overcome narrow partisan interests to establish the more transparent and efficient government that a middle-income country needs, they could quickly re-energize India’s enormous engines of potential growth. Otherwise, India’s youth, their hopes and ambitions frustrated, could decide to take matters into their own hands.

The global financial system is in desperate need of reform.

• The global financial system is in desperate need of reform. But in the absence of international consensus on some key points, any reforms will be greatly weakened, if not aborted. Is there a single, coherent approach to resolving the problem?
• Nowadays there is ample evidence that financial systems, whether in Asia in the 1990’s or a decade later in the United States and Europe, are vulnerable to breakdowns. The cost in interrupted growth and unemployment has been intolerably large.
• But, in the absence of international consensus on some key points, reform will be greatly weakened, if not aborted. The freedom of money, financial markets, and people to move – and thus to escape regulation and taxation – might be an acceptable, even constructive, brake on excessive official intervention, but not if a deregulatory race to the bottom prevents adoption of needed ethical and prudential standards.
• Perhaps most important is a coherent, consistent approach to dealing with the imminent failure of “systemically important” institutions. Taxpayers and governments alike are tired of bailing out creditors for fear of the destructive contagious effects of failure – even as bailouts encourage excessive risk taking.
• By law in the US, new approaches superseding established bankruptcy procedures dictate the demise rather than the rescue of failing firms, whether by sale, merger, or liquidation. But such efforts’ success will depend on complementary approaches elsewhere, most importantly in the United Kingdom and other key financial centres.
• Strict uniformity of regulatory practices may not be necessary. For example, the UK and the US may be adopting approaches that differ with respect to protecting commercial banks from more speculative, proprietary trading, but the policy concerns are broadly similar – and may not be so pressing elsewhere, where banking traditions are different and trading is more restrained. But other jurisdictions should not act to undercut the restrictions imposed by home authorities.
• Closely related to these reforms is reform of the international monetary system. Indeed, one might legitimately question whether we have a “system” at all, at least compared to the Bretton Woods arrangements and, before that, the seeming simplicity of the gold standard. No one today has been able to exert authority systematically and consistently, and there is no officially sanctified and controlled international currency.
• Arguably, the ideal of a well-defined and effective international monetary regime has become more difficult to realise as markets and capital flows have become vastly larger and more capricious. Indeed, the global economy, it is said, has grown – and emerging countries have flourished – without a more organized system.
• But what is too often overlooked is that international monetary disorder lay at the root of the successive financial crises of the 1990’s, and played an even more striking role in the crisis that erupted in 2008. The sustained and, in a sense, complementary imbalances in the US and Asia stand out.
• From 2000 to 2007, the US ran a cumulative current-account deficit of roughly $5.5 trillion, with nearly symmetrical offsetting increases in reserves in China and Japan. China found it useful to run a large trade surplus, using a very high rate of internal savings and inward foreign investment to support its industrialization and rapid growth.
• By contrast, the US, in the face of slow growth, was content to sustain exceptionally high levels of consumption at the expense of personal savings, inflating a massive housing bubble that burst with a very large and deeply disturbing bang.
• The practical and inescapable lesson is that when any country is left to its own policy devices, its preferences may lead to prolonged and ultimately unsustainable imbalances. Sooner or later, adjustment will be necessary – if not by considered domestic policy or a well-functioning international monetary system, then by financial crisis.
• Not so long ago, we were comforted by theorizing that floating exchange rates would mediate international adjustments in a timely and orderly way. But, in the real world, many countries, particularly but not limited to small, open economies, simply find it impractical or undesirable to permit their currency to float.
• We are left with the certainty, however awkward, that active participation in an open world economy requires some surrender of economic sovereignty. Or, to put the point more positively, it requires a willingness to coordinate policies more effectively. The possibilities include:    1. Stronger surveillance by the International Monetary Fund and a firmer commitment by countries to abide by “best practices” and agreed norms.     2.Direct and public recommendations by the IMF, the G-20, or others, following mandatory consultation.    3.  Qualification or disqualification with respect to the use of IMF or other credit facilities (for example, central banks’ swap lines).   4. Interest or other financial penalties or incentives along the lines under consideration in Europe.

• But, if approaches that build on past failure do not seem sufficiently effective, perhaps a new approach toward currency fluctuations would be more promising. That would require some agreement about appropriate “equilibrium” exchange rates, with a fairly wide band that would allow for uncertainty and permit the market to exert its own discipline. But individual countries would orient intervention and economic policies toward defending the equilibrium rate, or, more radically, an international authority might authorize aggressive intervention by trading partners to promote consistency.
• An appropriate reserve currency and adequate international liquidity represent another central concern. For years, the pragmatic answer has been the dollar, and to some extent other national currencies, giving rise to complaints of an “inordinate privilege” for the US. But it is not in America’s interest to accentuate and extend its payment deficits at the expense of an internationally competitive economy with strong industry and restrained consumption. And the rest of the world wants the flexibility afforded by the currency of the largest, strongest, and most stable economy.
• A useful reserve currency must be limited in supply, but have sufficient elasticity to satisfy the large, unpredictable needs that may arise in a turbulent financial world. Above all, confidence in its stability and availability must be maintained, which highlights the practicality of a national currency, or perhaps a variety of national currencies.