august 9, 2008 EPW Economic & Political Weekly50A Gripping Account, But without LiteraturePartha SenIndia it seems is always the emerging, though never quite emerged, giant. That said, it is true that over the last two decades we have seen major changes in the Indian economy. Even if we ignore the more contentious issues – on which more anon – its opening up to international trade and capital flows, the dominance of services in the gross domestic product (GDP) calculations, the higher rate of growth ofGDP, etc, certainly represent a quantum leap and deserve careful analysis. Thus, when one of the world’s leading international trade economists and an Indian, Arvind Panagariya, writes a book on the subject, one waits with bated breath to find out “What’s in it?” Panagariya has also been an active participant in policy debates in India, having been a regular contributor to the Economic Times. Outside of academia, his appointments included a (brief) stint as the chief economist at the Asian Development Bank.Panagariya’s early work was on variable returns to scale in international trade theory. This idea was central in the so-called new trade theory1 – of which Pana-gariya was certainly a precursor (if one dates the beginning of this theory to the late 1980s) and the endogenous growth literature. The assumption of increasing returns to scale, often implicit, is also a key ingredient in the presumed failure of the market that led to central planning. The infant industry argument for tariff protection also rested on such a premise.The book covers a lot of ground. Indeed, it could be the definitive textbook in an Indian economics course. Every topic Panagariya takes up is treated in detail. He does not hide his preference for a reduced role for the state in economic activity – something that most professional econo-mists would have sympathy for in the Indian context. Although he is quite even-handed when discussing an issue, sometimes an early closure on a topic betrays an ideo-logical predilection. So while electricity privatisation in Delhi is deemed (by the author) a success and discussed in some detail, Orissa’s abysmal experience with privatisation is not given half as muchspace. Similarly, the Enron episode is mentioned only in passing. As a last example,thereisa curious championing of lower tariffs for imported second-hand cars because these cars would, inter alia, reduce urban pollu-tion – a very unlikely position for a trade theorist who believes distortions should be tackled at their source. The book has 20 chapters. The first five provide a quick overview of the facts since 1947. Chapter six is a comparison of India’s growth experience with that of South Korea – a salutary reminder, if one was needed, of what might have been. This is especially interesting because unlike the other Asian tigers, Korea did not grow by running large current account surpluses. In chap-ters 7 and 8, there is a long review of the debate on poverty reduction (or other-wise) in the 1990s. The last six are devoted to “The Government”, including transpor-tation, education and public health. The meat of the analysis – I think the author (alas) is a vegetarian – is in chapters 9 to 14.Having given a sketch of the layout and of my expectations, let me turn to the book itself. The opening was not auspicious – the book begins with a list of Indian prime ministers. I thought (correctly as it turns out)2 this was a harbinger of a “Bad King John, Good Queen Bess” approach to interpreting the recent economic history of India. On reflection, I gave the author the benefit of the doubt because not many of my students – supposedly the crème de la crème of India – would know the names of even five prime ministers. Reasonable Position The crucial chapters, i e, chapters 9 to 14, by and large, take a reasonable position that I have no problem agreeing with. Chapter 9 covers the government’s budget deficit and its debt problem in a very standard manner. In chapter 10 Panagariya reviews the macroeconomics of the external sector using the open economy saving- investment identity. The RBI’s intervention and accumulation of foreign exchange reserves in a bid to prevent an apprecia-tion of the rupee is discussed. He notes that this policy has its limits and discusses alternatives. One of them is to “absorb” the capital inflows – the problem with this line of analysis is that identities have their limitations and a model is required.3 He then goes on to discuss capital account convertibility and makes a rather muted case for it, recognising the possible pitfalls.In chapter 11 he reviews the perform-ance of the Indian financial system and notes that government being a debtor finds it hard to let go of the banks. He also reviews the branch expansion of banks and its relation to poverty alleviation. He con-cludes, and I agree with him, that the gov-ernment-owned banks should be privatised and a modern regulatory system be put in its place. I found it amusing that tobuttress his arguments Panagariya refers toa“lucid” paper written in 1966 – the analysis of fi-nancial markets and their regulation has benefited enormously from the literature on asymmetric information and the author does not even mention that literature.Chapter 12 is on international trade and here the analysis is excellent, this being the author’s area of expertise. What I found surprising is the fact that there is no attempt at connecting this chapter and chapter 10.4 Chapter 13, again unexcep-tionable, is about giving a boost to manu-facturing activity by removing restrictions on size and exit. If India’s manufacturing has to enter the modern age, it requires a modern legal infrastructure like bank-ruptcy laws, and not Board for Industrial and Financial Reconstruction. Chapter 14 book reviewIndia: The Emerging Giant by Arvind Panagariya; Oxford University Press, Delhi (Indian Edition), 2008; pp xxx + 514, Rs 695.
BOOK REVIEWEconomic & Political Weekly EPW august 9, 200851on agriculture is the weakest of the six corechapters – it concentrates on elicit-ingsupply in the short run, disregarding land degradation issues, etc.Tedious DetailThe book covers a lot of ground and, of-ten, in tedious detail. I believe that there are at least two reasons why an attempt to be comprehensive in one’s coverage is nota good idea. First, the analysis be-comes dated very quickly – e g, the recent supply-side shocks have already rendered a lot of the macroeconomics discussion re-dundant. Second, however hard one tries, it is impossible to be comprehensive enough.While there is ample space de-voted to, e g, education (and its reform), transport, on how to reform the IAS(!), there is no discussion on either energy (except electricity) or the National Rural Employment Guarantee Act. Similarly en-vironmental issues and demographic trends are conspicuous by their absence. So there is something to be said for being selective. There are excellent shorter books on the Indian economy, e g, by Little and Joshi, and T N Srinivasan. These books are selective in their cover-age but pull no punches, when required. Or, in the language that the author will understand,even if one has an absolute advantage ina lot of activities, one should stick to activities where one has a comparative advantage.Analysis of External SectorA comparison of China’s recent export-led growth is inevitably made with India’s rel-atively modest performance on the trade front. In manufacturing exports China has moved ahead wearing seven-league boots leaving India to play the tortoise (though the movie may be different from the book). In the recent past, China has run large current account surpluses. In this it is fol-lowing what Japan, Taiwan and Singapore did in their drive to emerge as manufac-turing hubs.5 In sharp contrast to this “East Asian” model, India has been run-ning (modest) deficits – the large trade deficits are covered by remittances, etc. How does Panagariya analyse this? As mentioned above, he is schizophrenic about this. In his analysis, India’s exports have not grown because of supply constraints, e g, infrastructure, lack of skills and labour laws. That exchange rates policy could help in this is not given the space it deserves. In discussing the possible use of India’s moun-tain of foreign exchange reserves, he would have India increase its imports – something that I will return to below.6What is not discussed at all in this book is this: Before the 1990s in India there was a bias against international trade, notwithstanding export subsidies, etc. When India was integrated into the world economy this bias should have been corrected by the policymakers – indeed if there are sunk costs, etc, of entering a foreignmarket, there should have been an “overdepreciation” (in real terms). In the light of east (and south-east) Asian experience, export of labour-intensive manufactured goods is the only policy that is capable of pulling people out of ab-ject poverty rapidly (especially in an over-populated country such as ours). This ex-ternal “big push” is not costless – just im-agine the environmental consequences of industrialisation to employ 60 per cent of India’s labour force. In the event, what India did do was to open up its capital account at more or less the same time as its current account. It witnessed large inflows of capital – not only foreign direct investment (FDI), which helps the cause of tradables, but also portfolio investment. This caused some appreciation of the currency and would have caused havoc but for the RBI intervening to buy foreign exchange. That this “Dutch Disease” afflicts India should be obvious to anyone without ideological blinkers. Also, if figure 11.3 (p 243) is to be believed, the portfolio inflows and the consequent boom on the stock market is not correlated with initial public offers (IPOs) – so there is no Tobin’s ‘q’ at work here. As the RBI accumulated foreign exchange reserves, the self-congratulatory financial press said that the foreign exchange was a sure sign of a thumbs-up from the rest of the world, and therefore, surely we need to have full capital account convertibility. Unfortunately, the policymakers have pan-dered to this clamour for removal of controls by liberalising outflows (and debt inflows) over time.7 But most analysts do not know enough about national income identities to understand that given the history of current account deficits, these foreign exchange reserves have liabilities against them.8 Use them for infrastructure, for buying apart-ments in Florida, etc, if you like, but if there is a reversal of these flows (as in the Asian crisis and in Latin America 10 years back), you will be caught with your pants down. Contrast this with the east Asian countries, whose foreign exchange reserves were “earned” through current account surplus-es and therefore not susceptible to “revers-als”. In more recent times with inflation coming to the fore as a policy problem, the authorities are resisting a depreciation and using appreciation and an anti-export bias as a policy to fight inflation.9Panagariya harps on supply considera-tions due to which export growth is ham-strung. There is no denying this. What is missing in his analysis is an integrated analysis of what is underdevelopment, and how an economy can grow out of it through a “big push”? Here some inputs from a person who is a leading interna-tional trade theorist and cut his teeth on increasing returns to scale would have been invaluable. In addition, the author would have done well to display some knowledge of what constitutes an under-developed financial market. What we get is a book with lots of data and details of speeches by the various important players but abjuring economic theory to the extent possible. A fine gripping novel by Jeffrey Archer, but without the literary quality that I was hoping for. A real pity that.Email: partha@econdse.orgNotes1 Most of new trade theory assumes that the in-creasing returns are internal to the firm. It is my belief that in developmental issues, most of the increasing returns are external to the firm.2 A lot of space is devoted to various budget speeches, etc (and that too of only the central budget) and not enough to other “shocks”.3 If we stuck to identities, no one in his/her right mind would recommend liberalisation of imports, because it reduces the GDP.4 This is discussed more fully below.5 As mentioned above, South Korea is an exception to this.6 He, of course, is strongly in favour of reducing tariffs and increasing imports, in general.7 One of the arguments for full convertibility that Panagariya advances is that India would then become a regional (and possibly international) financial centre. This ignores the fact that a lot of policy independence is lost to maintain that status – e g, Hong Kong’s currency board.8 Not that Indians are bothered about such trivial details!9 A case could be made for this policy if we were sure that the inflationary shocks are temporary.
august 9, 2008 EPW Economic & Political Weekly50A Gripping Account, But without LiteraturePartha SenIndia it seems is always the emerging, though never quite emerged, giant. That said, it is true that over the last two decades we have seen major changes in the Indian economy. Even if we ignore the more contentious issues – on which more anon – its opening up to international trade and capital flows, the dominance of services in the gross domestic product (GDP) calculations, the higher rate of growth ofGDP, etc, certainly represent a quantum leap and deserve careful analysis. Thus, when one of the world’s leading international trade economists and an Indian, Arvind Panagariya, writes a book on the subject, one waits with bated breath to find out “What’s in it?” Panagariya has also been an active participant in policy debates in India, having been a regular contributor to the Economic Times. Outside of academia, his appointments included a (brief) stint as the chief economist at the Asian Development Bank.Panagariya’s early work was on variable returns to scale in international trade theory. This idea was central in the so-called new trade theory1 – of which Pana-gariya was certainly a precursor (if one dates the beginning of this theory to the late 1980s) and the endogenous growth literature. The assumption of increasing returns to scale, often implicit, is also a key ingredient in the presumed failure of the market that led to central planning. The infant industry argument for tariff protection also rested on such a premise.The book covers a lot of ground. Indeed, it could be the definitive textbook in an Indian economics course. Every topic Panagariya takes up is treated in detail. He does not hide his preference for a reduced role for the state in economic activity – something that most professional econo-mists would have sympathy for in the Indian context. Although he is quite even-handed when discussing an issue, sometimes an early closure on a topic betrays an ideo-logical predilection. So while electricity privatisation in Delhi is deemed (by the author) a success and discussed in some detail, Orissa’s abysmal experience with privatisation is not given half as muchspace. Similarly, the Enron episode is mentioned only in passing. As a last example,thereisa curious championing of lower tariffs for imported second-hand cars because these cars would, inter alia, reduce urban pollu-tion – a very unlikely position for a trade theorist who believes distortions should be tackled at their source. The book has 20 chapters. The first five provide a quick overview of the facts since 1947. Chapter six is a comparison of India’s growth experience with that of South Korea – a salutary reminder, if one was needed, of what might have been. This is especially interesting because unlike the other Asian tigers, Korea did not grow by running large current account surpluses. In chap-ters 7 and 8, there is a long review of the debate on poverty reduction (or other-wise) in the 1990s. The last six are devoted to “The Government”, including transpor-tation, education and public health. The meat of the analysis – I think the author (alas) is a vegetarian – is in chapters 9 to 14.Having given a sketch of the layout and of my expectations, let me turn to the book itself. The opening was not auspicious – the book begins with a list of Indian prime ministers. I thought (correctly as it turns out)2 this was a harbinger of a “Bad King John, Good Queen Bess” approach to interpreting the recent economic history of India. On reflection, I gave the author the benefit of the doubt because not many of my students – supposedly the crème de la crème of India – would know the names of even five prime ministers. Reasonable Position The crucial chapters, i e, chapters 9 to 14, by and large, take a reasonable position that I have no problem agreeing with. Chapter 9 covers the government’s budget deficit and its debt problem in a very standard manner. In chapter 10 Panagariya reviews the macroeconomics of the external sector using the open economy saving- investment identity. The RBI’s intervention and accumulation of foreign exchange reserves in a bid to prevent an apprecia-tion of the rupee is discussed. He notes that this policy has its limits and discusses alternatives. One of them is to “absorb” the capital inflows – the problem with this line of analysis is that identities have their limitations and a model is required.3 He then goes on to discuss capital account convertibility and makes a rather muted case for it, recognising the possible pitfalls.In chapter 11 he reviews the perform-ance of the Indian financial system and notes that government being a debtor finds it hard to let go of the banks. He also reviews the branch expansion of banks and its relation to poverty alleviation. He con-cludes, and I agree with him, that the gov-ernment-owned banks should be privatised and a modern regulatory system be put in its place. I found it amusing that tobuttress his arguments Panagariya refers toa“lucid” paper written in 1966 – the analysis of fi-nancial markets and their regulation has benefited enormously from the literature on asymmetric information and the author does not even mention that literature.Chapter 12 is on international trade and here the analysis is excellent, this being the author’s area of expertise. What I found surprising is the fact that there is no attempt at connecting this chapter and chapter 10.4 Chapter 13, again unexcep-tionable, is about giving a boost to manu-facturing activity by removing restrictions on size and exit. If India’s manufacturing has to enter the modern age, it requires a modern legal infrastructure like bank-ruptcy laws, and not Board for Industrial and Financial Reconstruction. Chapter 14 book reviewIndia: The Emerging Giant by Arvind Panagariya; Oxford University Press, Delhi (Indian Edition), 2008; pp xxx + 514, Rs 695.
BOOK REVIEWEconomic & Political Weekly EPW august 9, 200851on agriculture is the weakest of the six corechapters – it concentrates on elicit-ingsupply in the short run, disregarding land degradation issues, etc.Tedious DetailThe book covers a lot of ground and, of-ten, in tedious detail. I believe that there are at least two reasons why an attempt to be comprehensive in one’s coverage is nota good idea. First, the analysis be-comes dated very quickly – e g, the recent supply-side shocks have already rendered a lot of the macroeconomics discussion re-dundant. Second, however hard one tries, it is impossible to be comprehensive enough.While there is ample space de-voted to, e g, education (and its reform), transport, on how to reform the IAS(!), there is no discussion on either energy (except electricity) or the National Rural Employment Guarantee Act. Similarly en-vironmental issues and demographic trends are conspicuous by their absence. So there is something to be said for being selective. There are excellent shorter books on the Indian economy, e g, by Little and Joshi, and T N Srinivasan. These books are selective in their cover-age but pull no punches, when required. Or, in the language that the author will understand,even if one has an absolute advantage ina lot of activities, one should stick to activities where one has a comparative advantage.Analysis of External SectorA comparison of China’s recent export-led growth is inevitably made with India’s rel-atively modest performance on the trade front. In manufacturing exports China has moved ahead wearing seven-league boots leaving India to play the tortoise (though the movie may be different from the book). In the recent past, China has run large current account surpluses. In this it is fol-lowing what Japan, Taiwan and Singapore did in their drive to emerge as manufac-turing hubs.5 In sharp contrast to this “East Asian” model, India has been run-ning (modest) deficits – the large trade deficits are covered by remittances, etc. How does Panagariya analyse this? As mentioned above, he is schizophrenic about this. In his analysis, India’s exports have not grown because of supply constraints, e g, infrastructure, lack of skills and labour laws. That exchange rates policy could help in this is not given the space it deserves. In discussing the possible use of India’s moun-tain of foreign exchange reserves, he would have India increase its imports – something that I will return to below.6What is not discussed at all in this book is this: Before the 1990s in India there was a bias against international trade, notwithstanding export subsidies, etc. When India was integrated into the world economy this bias should have been corrected by the policymakers – indeed if there are sunk costs, etc, of entering a foreignmarket, there should have been an “overdepreciation” (in real terms). In the light of east (and south-east) Asian experience, export of labour-intensive manufactured goods is the only policy that is capable of pulling people out of ab-ject poverty rapidly (especially in an over-populated country such as ours). This ex-ternal “big push” is not costless – just im-agine the environmental consequences of industrialisation to employ 60 per cent of India’s labour force. In the event, what India did do was to open up its capital account at more or less the same time as its current account. It witnessed large inflows of capital – not only foreign direct investment (FDI), which helps the cause of tradables, but also portfolio investment. This caused some appreciation of the currency and would have caused havoc but for the RBI intervening to buy foreign exchange. That this “Dutch Disease” afflicts India should be obvious to anyone without ideological blinkers. Also, if figure 11.3 (p 243) is to be believed, the portfolio inflows and the consequent boom on the stock market is not correlated with initial public offers (IPOs) – so there is no Tobin’s ‘q’ at work here. As the RBI accumulated foreign exchange reserves, the self-congratulatory financial press said that the foreign exchange was a sure sign of a thumbs-up from the rest of the world, and therefore, surely we need to have full capital account convertibility. Unfortunately, the policymakers have pan-dered to this clamour for removal of controls by liberalising outflows (and debt inflows) over time.7 But most analysts do not know enough about national income identities to understand that given the history of current account deficits, these foreign exchange reserves have liabilities against them.8 Use them for infrastructure, for buying apart-ments in Florida, etc, if you like, but if there is a reversal of these flows (as in the Asian crisis and in Latin America 10 years back), you will be caught with your pants down. Contrast this with the east Asian countries, whose foreign exchange reserves were “earned” through current account surplus-es and therefore not susceptible to “revers-als”. In more recent times with inflation coming to the fore as a policy problem, the authorities are resisting a depreciation and using appreciation and an anti-export bias as a policy to fight inflation.9Panagariya harps on supply considera-tions due to which export growth is ham-strung. There is no denying this. What is missing in his analysis is an integrated analysis of what is underdevelopment, and how an economy can grow out of it through a “big push”? Here some inputs from a person who is a leading interna-tional trade theorist and cut his teeth on increasing returns to scale would have been invaluable. In addition, the author would have done well to display some knowledge of what constitutes an under-developed financial market. What we get is a book with lots of data and details of speeches by the various important players but abjuring economic theory to the extent possible. A fine gripping novel by Jeffrey Archer, but without the literary quality that I was hoping for. A real pity that.Email: partha@econdse.orgNotes1 Most of new trade theory assumes that the in-creasing returns are internal to the firm. It is my belief that in developmental issues, most of the increasing returns are external to the firm.2 A lot of space is devoted to various budget speeches, etc (and that too of only the central budget) and not enough to other “shocks”.3 If we stuck to identities, no one in his/her right mind would recommend liberalisation of imports, because it reduces the GDP.4 This is discussed more fully below.5 As mentioned above, South Korea is an exception to this.6 He, of course, is strongly in favour of reducing tariffs and increasing imports, in general.7 One of the arguments for full convertibility that Panagariya advances is that India would then become a regional (and possibly international) financial centre. This ignores the fact that a lot of policy independence is lost to maintain that status – e g, Hong Kong’s currency board.8 Not that Indians are bothered about such trivial details!9 A case could be made for this policy if we were sure that the inflationary shocks are temporary.
