Can India catch up? Can Australia do better?

1. Can India catch up? Can Australia do better? By Sanjeev Sabhlok, DRAFT, 1 June 2011

2. The centre of gravity of the world economy is changing IMF: The combined realoutput of China and India now equals US output Table: Share of world output measured in purchasing power parity • Source: IMF’s World Economic and Financial Surveys: World Economic Outlook Database, April 2011 India’s economy is now as big as Japan. By 2016 it will be six times that of Australia.

3. Visual depiction China India • 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

4. India as the world superpower till 1750 • India’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)

5. 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)

6. Removing obstacles to opportunity Growth = f (governance, opportunity) 1 Obstacles Opportunity (technical frontier) • Government • Bad policy • Bad regulation • Bad enforcement • Society • Some religious beliefs • Insufficient value placed on • critical thinking 2 Innovation pushes out the frontier Ideas don’t come from governments 3 Role of government - to reduce negative effects of excessive government n

7. The result: Modern economic growth >> The Western economies started growing: an unprecedented phenomenon! • Key characteristics • Relatively 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 Source: Madison

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

9. The great divergence • 1750 marked the end of the Mughals and conquest of (a portion of) India by England • India stagnated while the West grew rapidly • The British were caretakers, not interested in India’s growth • Post-independence socialist policies caused further divergence • Nehru was confused by the Fabian socialists including Keynes • By 1980, India’s share of world output was 2.5 per cent • (China’s share was even less, 2.2 per cent) • India’s share of world trade is less than 2 per cent today • Per capita income is $3000 (PPP), compared with America’s $50,000

10. 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.

11. And now, the great convergence? • China took off like a rocket in the 1980s • Now nearly thrice the size of India • In just 30 years, China’s economy almost the largest • Will overshadow the American economy soon • India has rapidly picked up pace after 1991 • The IMF “medicine” of 1991 has helped • But • People have not internalised the new rules of the game • Socialist political parties continue to misgovern

12. Comparative growth of India and China

13. India positives • Total factor productivity is rising • India is the world’s largest free market laboratory today • Where the government has privatised (or is absent) significant progress has occurred • 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

14. India negatives • Severe government failure • One of the world’s most corrupt • 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 to set up a business • Labour market inflexibility

15. Will India catch up? • India is handicapped by poor governance • India cannot catch up with the West without radically improving its governance. • On current indications India will end up as a middling power • Still a much larger economy than it is today • Of great interest to Australia • With reforms in policy and governance, however, nothing is impossible • Hint: Australia (Victoria) can assist India in reforming its governance (no one thinking on this line: a missed opportunity!)

16. Huge competitive pressure building on the West • Tsunami of competition from low-cost innovators • technical frontier now being pushed out by China and India • pressure on costs to expand the market in India creating huge pressure to innovate • also the wage differential creates huge competitive advantage Examples: medical equipment, drug production, medical tourism • Impending giant tide of brain drain reversal • Ongoing perception of racism likely to prompt giant reversal of (previous) brain drain from China and India • Indians not happy with second class treatment by the West • Already the best Indians have stopped leaving India • Many have already returned permanently • The best brains of the West moving to India and China

17. Threat or opportunity? • Over a third of the world’s production will occur in India and China in the next few decades • Only nations that innovate will lead • Very hard to increase productivity in a services economy • Australia’s productivity is languishing • Growth in the West must necessarily stagnate or decline • If the West doesn’t engage, its competitive advantage will be lost • If the West assists, it will make friends and be perceived to be a helper • Competition will become intense, but this is not a zero-sum game! • The West can encourage and promote freedom • Tip: Everyone can benefit

18. What can Australia do? • 1. Increase efficiency • Minimise unnecessary government intervention • Ensure infrastructure is based on CBA • Reduce welfare state and churn • Stop direct management of schools and hospitals • Increase flexibility of labour market • 2. Actively reshape the future  • Get on the front foot • Significant opportunity to set up university and TAFE branches in India • Australia doesn’t have the baggage of history • (But the current impression of racism is not good) • Build strong economic and cultural relations with India • Not foreign aid but equal partnership! • Strategic networking with India’s governance system to support its modernisation