Can India catch up? Can Australia do better?- - Giving freedom a chance

By Sanjeev Sabhlok, 15 November 2011

Copyright© Sanjeev Sabhlok

• Based on personal research and a talk I have given in March, August and November 2011•Related to my book, Breaking Free of Nehru, and draft manuscript, The Discovery of Freedom.•My research is ongoing so this presentation is a sketch.

Note: This talk simplifies complex ideas considerably and focuses on the big picture

Structure of the talk1. An explanatory framework

2. India is now the world’s largest free market laboratory• Can India catch up?

3. Impacts on the world: a tsunami of competition unleashed• But opportunities are increasing rapidly

4. How should Australia respond?• Can Australia do better?

1. An explanatory framework

The natural effort of every individual to better his own condition is so powerful, that it is alone, and without any assistance, not only capable of carrying on the society to wealth and prosperity, but of surmounting a hundred impertinent obstructions with which the folly of human laws too often encumbers its operations.

- Adam Smith anticipating the socialists and Keynesians even in 1776

Freedom leads to innovation which leads to growth

“Any restriction on liberty reduces the number of things tried and so reduces the rate of progress”

- H.B. Phillips (mathematician)

Key observationInnovation is not driven by central planners (bureaucrats) who “pick winners”. Such attempts:

• merely reduce the number of things that people can try; and

• destroy wealth by wasting tax revenues in “projects” that impose no personal consequences for ‘central planners’ (they don’t lose their house and shirt if a $2 trillion Keynesian “stimulus” fails)

1

2

3

n

Two obstacles to freedom

Opportunity(technical

frontier)

Governance must enable liberty

(social reform is not a government’s job)

Ideasdon’t

come fromgovernments

Simplified explanatory frameworkGrowth = f (freedom, opportunity)

Innovationpushesout the frontier 2) Social

• interfering religious beliefs• science and critical thinking insufficiently valued

People innovate better if the

government getsout of their way

1) GovernanceNanny, paternalistic state:• interfering policies and laws• “Food police”

Injustice• contracts not enforced

The rise and fall of freedom in the West1947 1991

High levels of freedom

Keynesiansocialism

Hayekian fight back

Keynesiansocialism

• By 1970s most major businesses in the world (including the West) had been nationalised (goal: to control society’s investment and reduce private savings)

• Hayekians fought back (his Road to Serfdom underpinned Margaret Thatcher’s work) and prevented the West from going bankrupt in the 1980s

Bigger government, “fine tuning”,

“Keynesian stimulus”, paternalistic

regulation = falling levels of liberty

= inability to compete (e.g. Detroit)

•The Keynesians and socialists are behind this decline•Massive welfare state has been operationalised•Currencies severely degraded

-The US dollar is worth less than 5 per cent of its value 100 years ago•Borrowings at untenable levels - without productive capacity to repay•Results flowing in : Ireland, Spain, Portugal, Greece, Italy, (USA?)

The take-over of academia•Few economists today know about Adam Smith’s system of natural liberty•Excessive use of the language of “equity” (Fabian socialist concept)•Positive liberty concepts: language of “promotion of health” (paternalism)

Post-1688

What’s been the trajectory of freedom in India?

Colonialism Keynesian socialism Some freedom

1947 1991

India’s story: increasing freedom

•Colonialism till 1947 – almost zero growth•Fabian socialism till early 1990s – poor growth

•Nehru was Fabian socialist. Keynesian ideas were commonly used.•“Commanding heights” of the economy • As is inevitable, India was duly bankrupted in 1991

-India borrowed $5 billion from IMF to prevent default

•India learnt its lesson and has liberalised (partially)

2. India is now the world’s largest free market laboratoryCan India catch up?

India: the world’s largest test case for liberty

Freedom has been increasing rapidly since 1990s in India•Most sectors have been liberalised•Some sectors are free simply because the government doesn’t deliver what it says it will•Overall, still low levels of freedom (on various international indices)

•significant opportunity to increase liberty

India’s output has responded rapidly to the limited increase in freedom

Historical contextIndia was the world’s largest economy for most of human history

•In 12 out of the last 20 centuries it was the largest•In 6 (of 20) it was the second largest (after China)•Its share of world GDP was between 30 to 33% (comparable with its share of world population)

Poor performance between 1750 and 1990 not due to any innate reason

•Key deficit: Lack of liberty relevant to modern productivity society

Liberty works – the cases of China and India

Source: IMF’s World Economic and Financial Surveys: World Economic Outlook Database, April 2011

Table: Share of world output measured in terms of PPP

Country 1980 1990 2000 2010 2016

China 2.2 3.9 7.1 13.6 18.0

United States 24.7 24.7 23.6 19.7 17.8

India 2.5 3.2 3.7 5.4 6.6

Japan 8.7 9.9 7.6 5.8 5.0

Germany 6.7 6.1 5.1 4.0 3.4

Russia 0.0 0.0 2.7 3.0 2.9

Brazil 3.9 3.3 2.9 2.9 2.9

United Kingdom

4.3 4.1 3.6 2.9 2.6

Australia 1.3 1.3 1.3 1.2 1.1 China will overtake US, even at current exchange rates, by 2020

But can India actually catch up? Positives• Westminster model of liberal democracy and laws• Indians take to science and maths as a duck takes to water• Rapid social change is under way, breaking previous barriers• Total factor productivity is rising rapidly• Urbanisation is increasing rapidly

Negatives• Significant misgovernance across the board, including education• High levels of corruption and “crony capitalism”• Massive red tape• Poor infrastructure and continuing poverty

Forecast - assuming unchanged governance

Assuming no change to governance• India is very likely to overtake USA by 2030 (10-year lag to China’s)• India will probably overtake China by 2050 (consistent with Citibank’s

forecast) and remain the world’s largest economy thereafter

Three reasons:• 1. Democracy

-India’s democracy makes it resilient– democracy as “shock absorber”

-China’s authoritarianism makes it brittle

• 2. Private sector driven-Led by Indian private companies

– Many are now multinational– Significant number of billionaires

Third reason: Young populationBy 2050, nearly 40 per cent of China’s population will be older than 65

But catch-up is not about GDP. It is about per capita GDP• Indian per capita income is 10 times less than the West’s• India may achieve 30-40 per cent of Western per capita

income by 2050• But with current governance it can’t catch up – ever

• Gets harder and harder to catch up• Radical change in governance (and society) needed• No current political party capable of delivering the

necessary governance

3. Impacts on the world: a tsunami of competition unleashedBut opportunities are increasing rapidly

Those who catch up can do better (than the leader)Catch-up hypothesis assumes that followers copy, hence don’t threaten the leader

•But that’s not true-it is a myth that the West is “safe” at the “high end” or “design” end-the “design” space being contested by India and China

Intense innovation now occurring in India (and China)•Cut-throat price competition in the huge Indian market

-goods now sometimes nearly 90% cheaper•Reversal of ‘brain drain’ occurring

-the best Indians aren’t leaving India today –plenty of opportunities at home-Indian migrants abroad are returning (not helped by perceptions of racial discrimination in the West)-many high quality Western managers now working as expats in India

•Many multinational companies now have R&D base in India•Many good Western universities have established Indian branches•Indian universities increasing their quality rapidly

Examples where India is already one of the leadersIT

•$50 billion worth of IT outsourcing to India•Microsoft’s major development centre in India•Hollywood has outsourced much animation to India

Mobile phones •600 million mobile phone subscribers•Lowest charges in the world

Drugs •Half the world’s vaccines produced in India, and significant share of generic drugs

Hospitals (of world-class standard) and medical equipment •Cost of heart surgery = $2000•Cost of delivering a baby = $40

Finance•Major Wall St companies now conduct back office operations from India

Steel•Indian firm now owns large share of world steel plants•Rapid growth of Indian multinational companies

Tens of examples documented

in many recent books

Bad news: Mammoth competitive pressure on the West

Creative destruction is underway on an unprecedented scale

1. Competition from India and China is just one of many pressures

2. Advanced technology is making thousands of jobs redundant • Customer as producer (supermarket checkouts, airport baggage check-in)• Robotics will at least partially replace teachers, personal assistants, surgeons,

and others

A business or society that does not anticipate and adapt will die – quickly! • e.g. Detroit lost 25% of its population in the last ten years

Good news: New opportunities•Economic growth is never a zero-sum game!

•As the pie expands, new opportunities arise for everyone•New goods, better goods, cheaper goods

•Opportunities for Australia include:•significantly increased exports

-India is already Australia’s third largest export market ($19.8 billion worth of exports in 2009-10)

•cheaper imports (including outsourcing of high-end services)•huge investment opportunities in India (education, e.g. TAFEs)•increased tourism to Australia

4. How should Australia respond?

- and, can Australia do better?

Australia remains inside the technical frontierPositives•Relatively better managed than most others

•E.g. relatively deregulated and flexible financial system

But huge restrictions on freedom, and significant inefficiencies

•Heavily padded bureaucracy, and a big government that directly operates schools and hospitals (and buses!) - inefficiently

•Paternalistic policies and onerous regulation of most activities

•Redistributive welfare with significant churn, hence wastage

•Old, ailing infrastructure (e.g. Melbourne’s traffic congestion)

•Taxpayer funds dumped into Keynesian black holes (won’t name but obvious)

•Habit of “picking winners” and “fine tuning”, thus crowding out R&D and other investment – such efforts are always based on false assumptions

How could Australia do better?Blocking freedom was fine in a less competitive world. It won’t do now:

1. Increase freedom: Get out of the way• Padding and Keynesian fine-tuning and meddling should come to an end

-Many suggestions in Breaking Free of Nehru are also applicable to Australia• Step back from the abyss of the granny (super-nanny) state

2. Be strategic: Shape the future • Inform but don’t spoon-feed businesses

-business associations can do far better than DBI, for instance• Build policy partnerships with India

-be seen to be India’s friend, e.g. free trade agreement (already some movement on this front)-build strategic networks with India’s governance system to influence the right kind of change

– e.g. Victoria could develop an exchange program for policy staff and executives to work in the Indian government (for 12 months each) and vice versa

Note: Geo-strategic imperatives also support stronger ties with India.

The end!Should you wish to discuss, please write to me at sabhlok@yahoo.com

EXTRA SLIDES – IN NO PARTICULAR ORDER

More info about the framework used in these slides:•My book, Breaking Free of Nehru

•also freely available on the internet

•Draft manuscript, The Discovery of Freedom •available on the internet – comments appreciated

Quick historical overview

Hunter-gather: till appx.10,000 years ago• Secret of success: muscle power, local knowledge• Outcome: small groups, low per capita “income”, high mortality

(Malthusian laws applied)

Settled agriculture: circa 8000 BC-1750• Secret of success: animal power, local division of labour, some trade

-Caste system of India led to well-oiled agricultural machine, hence successful• Outcome: some agricultural surplus, small tows and civilisation, low per

capita income, high mortality (Malthusian laws applied)

Modern Economic Growth: Industrial: circa 1750+• Secret of success: brain power, global division of labour, global trade

-Different rules of the game to the agriculture epoch• Outcome: growth without end, Malthusian laws no longer apply

Hunter gathererSettled

agricultureIndustrial

The result: Modern economic growth

Key characteristicsRelatively slow till 1820 (10s of times the pre-1000 growh rate)Rapid increase after that (100s of times the pre-1000 growth rate)

•Effectively, the industrial revolution is less than 200 years old

1-1000 1000-1500 1500-1820 1820-70 1870-1913 1913-50 1950-73 1973-2003

France 0.02 0.28 0.37 1.43 1.63 1.15 5.05 2.20

UK 0.09 0.25 0.80 2.05 1.90 1.19 2.93 2.15

USA 0.06 0.09 0.86 4.20 3.94 2.84 3.93 2.94

Other westernoffshoots

0.03 0.07 0.34 5.39 3.81 2.76 4.75 3.03

Japan 0.10 0.18 0.31 0.41 2.44 2.21 9.29 2.62

China 0.00 0.17 0.41 -0.37 0.56 -0.02 4.92 7.34

India 0.00 0.12 0.19 0.38 0.97 0.23 3.54 5.20

World 0.01 0.15 0.32 0.94 2.12 1.82 4.90 3.17

Source: Madison

>> The Western economies started growing: an unprecedented phenomenon!

Key changes since 1400

1: The use of reason•Critical thinking

-Islam, through Cordoba, helped recover Greek thought•The questioning of authority

-Reformation•Induction and the scientific method – Francis Bacon

2: Constitutionalism and liberty•Origin of democracy

-Magna Carta -> Glorious Revolution•Theory of the modern state: Thomas Hobbes, John Locke

-Society was earlier the centre. Now the individual

3: The secret of wealth creation (free market)•Commercial institutions created

-Modern banks, corporations (e.g. Medici family of Florence)•Invisible hand (Adam Smith)

-(Refinements by F.A.Hayek)

Detailed discussion

in my draft manuscript,

The Discovery of Freedom

(available on the internet)

India was the world superpower till 1750India’s performance in recent centuries is atypical

It was the wealthiest region during the agricultural age• Largest arable area till the USA came to the scene• Remained the world’s wealthiest in 12 out of the last 20 centuries

-First century World GDP share = 33%-11th century World GDP share = 28.9%-1700 world GDP share = 24.4% (similar share of world trade)

Has India been a ‘victim’ of its long-standing success?• Caste system was well-suited to its agricultural society

-It is no longer suitable, but is now very difficult to change

Intellectual stagnation• Major philosophical schools and scientific advance (e.g. number system)• Charvaka’s and Buddha’s ideas transmitted to Greece –> Sophists –> Socrates• The breakthroughs of the modern world arose in Italy (Renaissance)

Why did India struggle even after the end of colonialism?•Cause 1: Socialist ideology

•By quirk of fate, Nehru the Fabian socialists set India’s policies-Rejected Milton Friedman’s specific advice-Rejected von Mises’s views on India’s productivity

•Cause 2: New rules of the game not widely understood•Indian education system flooded with socialists•Economics education extremely poor

•Cause 3: Arrogance about Indian history and culture•False pride that refuses to believe that the West could actually offer any learnings to India•Caste system not suited to dynamic societies.

Per capita income shot up in the West, then Japan, then…

Visual depictionThe rapidly changing world

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1980 1990 2000 2007

Year

Sh

are

of

wo

rld

GD

P (

PP

P)

UnitedStates

China

India

Japan

Germany

UnitedKingdom

Australia

China will become the world’s largest economy by 2016 (Maddison thought 2015, but IMF thinks 2016)

•Per capita in China will still (in 2016) be only a fourth of that of USA•Ultimately China could become four times the size of USA

China

India

Comparative growth of India and China

China, 2.2

China, 3.9

China, 7.1

China, 13.6

China, 18.0

India, 2.5India, 3.2

India, 3.7

India, 5.4

India, 6.6

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2

4

6

8

10

12

14

16

18

20

1980 1990 2000 2010 2016

China

India

China will overtake US in real exchange terms by 2020

Source: The Economist, 25 June 2011

India positives

Total factor productivity is rapidly rising

Wherever the government has privatised (or is absent) significant progress has been achieved• IT sector and private sector IT education• Mobile phone wireless network

Source of the graph: http://mpra.ub.uni-muenchen.de/10316/1/MPRA_paper_10316.pdf

India is already Australia’s third largest export market ($19.8 billion) in 2009-10

Source: Composition of Trade, DFAT.

Already fifth largest two-way trading partner

Will become second largest trade partner in the next decade

India key negatives•One of the world’s most corrupt governments Australia India China Transparency international 2010

8 87 78

•Low levels of freedom-Failing institutions e.g. judiciary, press

•Insufficient focus on infrastructure-However, it now has the largest private sector investment in infrastructure

•Difficult in setting up a business

•Labour market inflexibility

Australia India China Heritage Foundation (freedom)

3 124 135

Australia India China World Bank Doing Business (June 2010 report)

10 (with 2 for starting business)

134 79