Examination of Witnesses (Questions 52
- 59)
WEDNESDAY 22 NOVEMBER 2006
LORD DESAI
AND MR
MARTIN WOLF
Q52 Chairman: Good afternoon. Gentlemen,
thank you for coming. We are, as you know, conducting an inquiry
on South Asia, and clearly both of you have a lot of knowledge
and expertise on one of the most important developments, which
is the rapid economic growth that India is experiencing at the
moment and the rise of India in that sense. Could you give us
a sense of how that has impacted on the global economy and the
implications of that for the United Kingdom?
Mr Wolf: I would argue—to
be provocative—that so far the impact of India's rise on
the global economy is fairly modest, but it is potentially very
large. I qualify that by saying that it is important to remember
some of the magnitudes involved. At current prices, which are
relevant for the actual market impact, the Indian economy is only
40% of the size of the British economy and it is about the same
relative to the Chinese economy—it is very considerably
smaller. Its exports are roughly equivalent to one sixth of those
of China. Although the openness of the Indian economy, measured
by trade ratios, has somewhat more than doubled over the last
10 to 12 years, it is still, relative to China, a closed economy.
Trade ratios are less than half the Chinese ratios, which are,
admittedly, exceptionally high, and the absolute level of exports
remains well below those of sizeable G7 countries such as ourselves
or France, let alone leaders such as Germany, the US or Japan.
India has been opening and its exports have
grown a great deal—they are growing faster than the economy—but
it is still a relatively closed economy. In other words, most
of the activity is domestically oriented, and its impact on the
world through trade in general has been relatively small. That
is strikingly true—you may want to come to this point later—of
manufactured exports. The same applies to inward foreign direct
investment. India remains a relatively small recipient of inward
FDI, again compared with China—the ratio is something like
10:1.
Now let me mention the areas in which India
clearly has had a significant effect already. The most important,
as we all know, is information technology services, which have
grown with astonishing speed. Again, however, it is important
not to exaggerate their scale. Interestingly, India's exports
of all commercial services are still smaller than China's, although
the ratio is much closer than it is for merchandised trade. Clearly,
the existence of Indian IT services has been a significant and,
I think, largely beneficial competitive force in the world. It
is the low-cost marginal producer of basic IT services, and that
sets the prices in quite a number of areas. That sector is growing
at phenomenal speed and can be expected to continue to do so.
The other interesting area, which has arisen
very recently, is outward investment by Indian companies. The
Indian corporate sector is relatively developed compared with
China's. After the adjustment to the opening, it seems to me that
it has developed quite interesting overseas investment strategies.
Of course, the case of Tata and Corus is in our minds, but there
has been a lot of investment in the region. So I would say that
India's impact is nascent but not yet really significant.
I did not mention—perhaps I should—that
it is one of the factors, although again not a decisive factor,
in the tightening of the world's oil markets. India's growth path
is nothing like as resource-intensive as China's—India's
consumption of oil is only about one quarter of that—but
the growth is very rapid.
As for the impact on the British economy, I
have discussed the obvious areas. As we have seen, there is an
interesting investment, although it is small in relation to other
sources of investment. It is already included in call centres,
so it is already significant in IT services and could become more
so. However, it is important not to exaggerate its present impact.
Lord Desai: Let me start by saying
that, although you say South Asia, you mean India. South Asia
is more than India. It covers Pakistan, Bangladesh, Nepal and
Sri Lanka. The rest of South Asia is much more under par than
it could be because of a lot of local political troubles. Sri
Lanka especially could be a very prosperous country, but it has
had civil law for 25 years. Bangladesh is a troubled democracy
for reasons that are entirely personal and familiar, but to some
extent the divisions in South Asia are holding it back from what
it could be because in terms of population, it is larger than
China. That is my first caveat.
Secondly, the lack of negatives is even more
important than the present and positive. Forty years ago, we were
worried whether India could feed itself. We were worried about
the fact that India loomed large at a cost to the global community
with its famines and deaths. India has come a long way from there,
especially during the past 15 years. We shall probably deal later
with the many problems that remain, but to me the interesting
part about India is that, given its access to the English language,
its similar property rights and its legal structure, it could
adapt, change and grow more rapidly because some of the transition
problems are less in India than in China.
That said, India is admirable in terms of what
it has done for itself rather than the impact that it has had
on the global economy. Unlike China, India depends much more on
domestic demand than it does on exports for its growth, so it
is a domestic demand driven market. Also unlike China, as Martin
Wolf said, it is driven very much by its own resources with foreign
direct investment playing a very small part. Perhaps India is
an exporter of capital, but I look forward to when India is an
importer of capital. It is about the third largest investor in
the United Kingdom so, from that point of view, the way in which
the UK economy has to look at India in terms of size is so far
not very big, but let us look at all the synergies that are available.
For example, the India international film awards in Yorkshire
next year will be much more important. Those sorts of connections
with India will be much more important with us than anywhere else.
Q53 Chairman: Do you think that the
diaspora has played an important role in the transformation to
which you refer?
Lord Desai: Absolutely. In a sense,
I think that the India diaspora is both the diaspora that came
from India itself and the diaspora that came from east Africa.
By and large, the diasporas have done very well economically and
integrated very well into the structure. Those people maintain
the context, whether in respect of financial and cultural interests.
Even as I speak, a South Asia investment and
trade seminar is taking place in St. James. I spoke there this
morning. If a diaspora could get together here, it would be a
good way in which to tell the South Asian native Governments to
behave better than they are behaving towards each other, but that
is my dream. We could really have a great weapon in a diaspora.
Mr Wolf: I mentioned the
specific issue of IT services. It is quite clear that the growth
of the Indian IT services industry has been fuelled significantly,
though not solely, by the acquisition of knowledge and technology
by Indian nationals working abroad—particularly in the United
States. Very close connections have been created, particularly
between Indian businesses and what may broadly be defined as American
IT businesses. Those connections are, to a significant extent,
personal.
Lord Desai: I have one other observation.
In the 1950s, when I was a young student, our ambition was to
go into the Indian administrative services. The best that one
could do was to go into the civil service. Now, the best students
do not go for government jobs at all; they go abroad, or they
go into the financial services markets. One can see the presence
of the diaspora both in London and New York—very bright
young people abroad, who have had access to education and who
are doing fantastic jobs.
Q54 Mr Horam: Let me for the moment
leave aside Lord Desai's dream of the South Asian community getting
its act together, and concentrate solely on India. Current rates
of growth have been quite high—regularly 6, 7 or 8% a year.
Will that continue in the immediate future? Are there concerns
about the current account deficit and so forth?
Mr Wolf: India has a very modest
current account deficit in relation to GDP. I think it is a little
more than 2%. I have the figures here.
Q55 Mr Horam: 3.5% actually, I think.
Mr Wolf: I think it was £25
billion. I can get the exact numbers, but let us say it is 3%.
The economy is growing at anything between 6% and 8% a year, and
that may substantially increase with FDI, provided things do not
get messed up. There are very substantial reserves of well over
£100 billion, which is nothing like China's but is still
very substantial. Given those factors, I do not regard the current
account deficit as a significant threat. The internal debt of
the Government is a more interesting question and we could perhaps
discuss it, but I do not regard external debt as a problem. It
is not like the situation in 1991. As a share of GDP it is more
or less the same as ours, and our economy is growing at a quarter
of the rate. India could probably grow out of it fairly easily.
As a general proposition it is entirely appropriate
to say, and all theory should suggest, that fast-growing developing
countries should be expected to run current account deficits,
though that is not happening in east Asia, of course. It just
means that they are net importers of capital, and we should expect
that. China is a huge and fascinating anomaly—it has become
the world's largest net capital exporter despite being the world's
fastest growing economy—but that is completely unique in
history. That remark is a footnote, however. I do not regard
the current account deficit as a problem. I tend to be one of
those who are slightly more pessimistic in the sense that, as
you probably know, there is a vigorous debate at present among
economists in India—the people involved—on whether
the trend growth rate in India is 6% or 8%. I tend to the view
that the rate is more plausibly closer to 6% than to 8%, though
it has been 8% in recent years.
The main reason for that view is that, if the
rate were 8%, that would imply an extraordinary, though not completely
unique, efficiency in the use of capital. The investment rate
in India is not much more than half that of China, and although
I am prepared to accept that the investment return and the efficiency
with which capital is used are higher, it is difficult to believe
that it is going to be that much higher on a sustained basis.
The population is favourable and is not a constraint, but despite
what many people say the same will be true of China for the next
25 years, so that is not a big difference.
If India were to sustain 8% growth on
an investment rate of about 25% of GDP, that would be extraordinary,
and I tend to think that 6% is safer. That is the sort of number
that my friend Shankar Acharya—the longest-serving Government
of India chief economic adviser—has suggested is right.
Others believe it to be higher, but I strongly believe that 6%
is sustainable indefinitely. There is an enormous catch-up potential
in the country; its GDP per head of purchasing power is about
a tenth of that of the world's leaders and about half that of
China. There is a tremendous catch-up potential. They are not
really using many of their opportunities in manufacturing, most
notably their competitiveness—if they improve policy a little,
it is potentially very considerable in significant areas of economic
activity—and they have the domestic demand engine which
comes from their huge size.
They can achieve economies of scale internally,
so unless they mess up in a rather big way or there is some disaster
such as a war with Pakistan that turns nuclear—something
horrendous—I think that 6% is very plausible; and then we
can discuss how much further north of that it could go. I tend
to think that they need significant further reform to be confident
of hitting 8%, but I regard 6% as pretty solid by now; that is
more or less what they have been achieving for most of the last
20 years—and without much difficulty during the last
five.
Lord Desai: I am more optimistic
about that than Martin, but on the balance of trade deficit I
had a hard time explaining to Peter Shore why there was not a
sterling crisis when the trade deficit is so large nowadays. The
capital markets are compensating for trade deficits. I think trade
deficits loom less large nowadays. In terms of what Martin said,
in my view China savings rates are absurd; and given what Chinese
savings rates are plus the FDI flow, China's growth rate is not
good enough, because if you think of, say, 45%, that is about
2 or 3 percentage points—
Q56 Mr Horam: What is China's growth
at the moment?
Mr Wolf: About 10%.
Lord Desai: If you say about 45%
and if you get 2 or 3 percentage points as FDI, at 48% you are
only attaining a growth rate of 10% or 11%, whereas India has
29% saving, with Government mis-saving 2 to 3 percentage points
and hardly any FDI, so with 25% or 26% you are achieving a 6%
to 8% growth rate. So in terms of capital outward ratio, there
are two caveats. China has invested a lot in infrastructure. It
is very capital-intensive. When you go to Shanghai, you realise
it—all those roads and the maglev—
Q57 Chairman: Have you been on it?
Lord Desai: They have spent millions
of pounds preparing for the future. India has been reluctantly
pushed forward in its infrastructure development, and is not doing
too fast a job on it. That is one reason why the capital outward
ratio is lower in India than in China.
One more thing is calling for greater efficiency.
In the last six or seven years, the private sector has played
a much bigger role in India's economic growth than traditionally.
The private sector is realising its full competitive potential.
It tends to be much more efficient with capital than the public
sector. The shift from public to private sector increases capital
efficiency, and you have a reluctance to go too much into infrastructure.
But that is temporary; sooner or later India will have to come
clean about infrastructure. That is the only reason why I can
see the growth rate not increasing much faster. India has to make
more policy changes; India has the potential for much higher growth.
Q58 Mr Horam: You say that India
will eventually have to invest in more infrastructure, but what
sort do you mean? Will it be schools?
Lord Desai: Mending roads, ports
and airports, and communications.
Mr Wolf: I regard power as the
most important. There are chronic shortages; but, even worse,
probably the biggest single source of capital inefficiency in
the private sector is the need of virtually all companies of more
than a tiny size to have their own generators. Basically, it is
a self-generation system. That is a significant overhead cost
and a huge waste of capital. One could have said this at almost
any time during the last 25 years, but it has become a very big
problem. It is probably the sector that they will find most difficult
to reform, for reasons that we can discuss if you want.
Lord Desai: There is also the
question of power theft. In the best houses in Delhi, people divert
power and do not pay for it. So major reform of the power sector
is needed. Those are India's big infrastructure needs.
Q59 Mr Horam: Just looking at the
figures on the size of the service sector, I am astonished to
see that this year it makes up more than 50% of gross domestic
product—industry is 27% and agriculture, 22%. That is astonishing.
We have been talking recently about development models—that
is an unusual one.
Lord Desai: The reason is that
India chose a manufacturing strategy—a stagnating sector.
Indian manufacturing and the expanding public sector—it
is called the organised sector—is labour-intensive. Given
the labour laws, there has been very little extra employment in
that sector. Until the last five or six years, the private sector
was very much constrained. India's manufacturing sector is at
the high value added, capital-intensive end, rather than low and
medium-tech. In my view, India's biggest need is for much more
rapid manufacturing growth at the low and medium-tech end than
has been the case so far, for which I have been arguing in India.
India needs to change those proportions, not by neglecting services,
but by giving manufacturing a much larger proportion. It can do
that only by having something like a 15% growth in manufacturing
per annum, which is feasible.
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