Singapore: Prime Minister Narendra Modi has a very specific
development strategy, and it involves moving India away from its current
services-driven growth trajectory to an East Asian-style export-led
growth model, based on the mass deployment of labour and capital,
Sanjeev Sanyal, global strategist at Deutsche Bank AG, said in an
interview. The East Asian model is not just about manufacturing but
about creating a virtuous cycle of savings, investment, exports and
employment creation, and given India’s demographic stage, it is a good
time to attempt this strategic shift, he added. Edited excerpts: You
share the view that a clear and internally coherent economic model is
emerging from Prime Minister Modi’s speeches and policy actions, and you
also believe India, under the new government, is shifting from its
current services-driven growth trajectory to an East Asian growth model.
What has led to these conclusions? Listen to what PM Modi repeatedly
talks about—export-led manufacturing, infrastructure building,
urbanization, expanding the banking deposit base to mobilize savings,
mass employment generation and so on. Put them together and they spell
out a very specific development strategy—the East Asian model based on
the bulk deployment of labour and capital. Japan was the first country
to pioneer this growth model, but it has since been replicated by
Taiwan, South Korea, Singapore and, most recently, China. It is a well
trodden path even if each country modified the strategy to suit its own
requirements. Of course, this model, too, comes with risks, but every
strategy will come with risks. Only time will tell if Modi can
successfully anticipate these risks and navigate through them. For the
moment, it is important to recognize he is less India’s Thatcher, and
more of an East Asian modernizer like Lee Kuan Yew. What is the East
Asian manufacturing-led model? Is this model replicable in India? The
East Asian model is not just about manufacturing but about creating a
virtuous cycle of savings, investment, exports and employment creation.
Let’s say, an initial injection of foreign direct investment (FDI)
boosts infrastructure spending. This infrastructure makes the economy
more competitive and encourages manufacturing exports.
Sanjeev Sanyal says Prime Minister Narendra Modi’s
development strategy involves moving India away from its current
services-driven growth trajectory to an East Asian-style export-led
growth model.
In turn, jobs are created by both manufacturing and construction
which boosts savings. These savings are then deployed back into
investment by an expanding banking system. Obviously, this is a very
simplified version of the model; there are many more ingredients that
are needed to keep this cycle going. The central bank, for instance, has
to be willing to hold the exchange rate weak and accumulate reserves.
At some point, once inflation has been tamed, the cost of capital needs
to be lowered significantly. Given India’s demographic stage, this is a
good time to attempt this model. But there is no guarantee that it will
succeed. Indeed, countries like Thailand and Indonesia appeared to have
triggered the cycle in the 1990s, but they were unable to sustain it due
to the Asian Crisis of 1997-98. So a lot depends on how this process is
implemented and managed. Data indicate India must create 10 million
additional jobs per year till the next elections to keep up with
demographic expansion alone. Data further show unemployment among
graduates is as high as 32%. You are of the view that Modi’s mandate is
to clear up the pipeline that allows the increasingly educated children
of farmers to join the middle-class. Is manufacturing the only solution
to address this issue? India’s services-driven growth model managed to
generate periods of rapid growth over the last 20 years. However, it
disproportionately benefited the existing English-speaking middle class
and did not generate enough jobs for the wider population. Thus,
services now generate 60% of GDP (gross domestic product) but employ
only 26% of the workforce. In contrast, half of the workforce remains
trapped in agriculture that generates only 13% of GDP. Therefore, you
need to get another sector to generate the jobs required to meet the
aspirations of those who wish to shift from farming, as well as absorb
the additional 10 million young people who are being added to the
workforce by demographic expansion. Industrialization, which includes
manufacturing, utilities and construction, is required as an additional
engine of growth. The share of industry in GDP has remained stuck at 26%
since the late 1980s but its share in employment has steadily
increased. It is clearly needed for generating jobs for the semi-skilled
workers who aspire to enter the middle class. As an aside, agriculture
also cannot be totally written off. We need agricultural reforms to
allow the sector to mechanize and grow even as workers are pulled out of
it. What does the government need to do in order to get firms to invest
again? The immediate thing that needs attention is to revive the large
number of stalled infrastructure projects. I believe the government is
already working on this. Longer term, investment-led growth requires a
stable macroeconomic environment, a rational tax structure,
laws/regulations/procedures that are not unduly burdensome and, finally,
a judicial system that efficiently enforces contracts. Basic
infrastructure like power, ports, railways and highways are also
critical. Investing is inherently a risky activity, so investors want an
environment that minimizes uncertainty and friction… The time has come
to systematically implement the solutions. Who will finance this new
model? Are banks equipped or large enough to fund manufacturing led
growth? India needs to push its gross investment rate to 38-40% of GDP
in a 5-10 year horizon. FDI is one way to get the cycle moving. It
brings in capital but also technology, best practices, linkages and so
on. However, the East Asian model is ultimately about mobilizing and
deploying domestic savings. This means that the financial system,
especially banks, will have to be expanded by an order of magnitude.
Herein lies one of the biggest risks of the East Asian model. The Asian
crisis of 1997-98 was partly due to a failure to manage the financial
sector expansion. Even Japan and China have had problems managing this
sector. This is why the role of the Reserve Bank is critical—it needs to
make sure financing is available for investment-led model, and ensure
poor capital allocation does not break the system. But can manufacturing
take off without reforming India’s labour laws? Will the current
government have the courage to touch this politically sensitive issue?
Will state governments support the centre on this? Since this model is
based on the mass deployment of labour, it requires a rational set of
labour laws. It is not just about the content of Indian laws but the
bewildering number of labour-related rules and regulations that a
business needs to negotiate. The irony is that in the name of protecting
workers, the laws have left the bulk of the workforce languishing in
the unorganized sector. What India needs is a simple, clear set of rules
that are widely applied—especially those related to worker safety
(critical, since manufacturing and construction can expose workers to
numerous hazards). The good news is that for the first time we are
seeing state and central governments looking seriously at making
changes. We should watch this space closely. Assuming that these laws
are amended and the investment cycle revives, can India absorb millions
of workers into the urban landscape to make this model work? Until very
recently, policymakers saw urbanization as a bad thing that should be
discouraged. Lately, the realization has dawned that urbanization is the
inevitable spatial manifestation of development. If Modi succeeds in
triggering the East Asian model of growth, India will urbanize just like
China has done over the last two decades. Indeed, it will be an
urban-majority country within a generation. Nonetheless, the PM
recognizes Indian cities are not prepared for the deluge. This is the
reason he keeps emphasizing the need to build 100 smart cities. So far,
however, we do not have details of how he intends to build these cities.
Must the rupee be kept weak for this model to succeed? There are
several economists who feel the rupee is too weak and that it should be
much stronger. However, it is important for this model that the rupee is
stopped from appreciating too much from current levels even if there
are strong FDI inflows. First, a weak exchange rate will provide Indian
manufacturing exports with an initial competitiveness boost. Second, it
will allow for the accumulation of foreign exchange reserves. Some
economists think that large reserves are a waste, but I disagree. The
reserves are an important bulwark against external shocks which is
especially necessary when a rapidly expanding financial sector may be
vulnerable. Finally, an investment boom could initially feed the current
account deficit until such time the savings rate perks up. So, in any
case, the rupee may not quite be as undervalued as people think.
Manufacturing cannot succeed in isolation—the country needs reforms in
infrastructure—roads, railways, ports—in the power sector, financial
services as well as oil and gas, mining among others. Can all of it come
together for this model to succeed? As I said, the East Asian model is
not only about manufacturing but about a virtuous cycle. The building of
infrastructure is important as it boosts the supply-side but is
simultaneously a source of demand and a job creator. So it is very
important that infrastructure projects get implemented smoothly. The
mining sector, too, is critical—especially coal. Given that the new
growth trajectory will be more materials- and energy-intensive, it is
important that the government thinks through the environmental
trade-offs very carefully. We cannot be certain that PM Modi will
succeed. There are many roadblocks and risks along the way. However, it
is becoming clear there is a coherent plan. Only time will tell if it
will work. There is s genuine resolve but there are also genuine
roadblocks. Why has India’s total factor productivity (TFP) growth, that
has averaged around 2.5% in the past decade, declined almost each year
since 2007, and is presently running well below 2%, while countries such
as Indonesia, Philippines, and Thailand have seen TFP rise during the
same period. There are many signs that productivity has slowed since
2007 although I am not sure of the exact TFP numbers you have quoted.
There are several reasons for this slowdown. The economic reform process
has been stalled for many years, and the productivity gains of previous
rounds of reform have run their course. There are some sectors that
have seen no reforms at all—most notably agriculture. Furthermore,
numerous infrastructure and other projects lie stalled across the
country. This is resulting in inefficiencies and severe bottlenecks. In
order to revive productivity growth, the reform process needs to be
urgently revived. China and South-East Asia still provide better
infrastructure, flexible labour laws, stable policy and regulatory
environment, among other factors. Even if India were to undertake major
reforms, why should any of the existing manufacturing facilities shift
base to India? Make no mistake, China remains a formidable industrial
power. However, Chinese wages have been rising rapidly for years. Its
workforce has peaked and will now decline steadily from here. So the
country will have no choice but to move up the value chain and adapt.
For the same reasons that production moved to China from Japan and the
West, many industries will move to lower cost locations. Some of these
may be absorbed by South-East Asia, but there is no reason India cannot
compete with Thailand or the Philippines. They have their strengths, but
India has its strengths. For instance, India has a much larger internal
market that can be used to achieve scales that few other nations can
individually aspire to. As just demonstrated by its successful mission
to Mars, it also has technological capabilities that are on a different
level.
Source: LiveMint
