by Arvind Subramanian, Peterson Institute for International Economics
Op-ed in the Business Standard, New Delhi
August 14, 2007
© Business Standard
India finds comparative advantage not in jeans, geography, or geology but in skills and managerial capital.
Sixty years usually signals the onset of dotage in humans. But it is in fact a relatively young age for nations. So, what kind of infant is the Indian economy? A decade or two ago, against the background of unsuccessful performance, this question would probably have elicited the caustic comparison: “Indian industry and the Indian economy are like Peter Pan: They never grow up.” Today, however, the infant seems more precocious than immature. The Indian economy has been doing many things well ahead of what countries usually do at this stage of their development.
No account of Indian precociousness can begin, of course, without mentioning the mother of all precocious feats, namely, sustaining a democracy in the inhospitable terrain of low levels of income and literacy, and a highly fractured society. In the post-war period, only a few other developing countries, (for example, Mauritius, Botswana, and Cost Rica) have sustained uninterrupted democracies, but they have been much smaller than India. The more common chronology has been growth first and democracy (maybe) later as the experience of East Asia has shown.
Moving on to economics, start with the most-cited anomaly of India relying on services rather than manufacturing as the basis for its growth. A slightly different way of characterizing this is the following. Historically, no country has escaped from underdevelopment using relatively skill-intensive activities as the launching pad for sustained growth as India has done. The most common mode of escape has been jeans, geology, or geography.
East Asian countries relied on relatively low-skilled manufacturing, typically textiles and clothing. Countries in West Asia today, and Australia and Canada further back in time, exploited their natural resources. And some of the island successes (Barbados and Mauritius) have exploited their geography by developing tourism.
Put differently, India seems to have defied its “natural” comparative advantage, which probably lay in the jeans mode of escape because of its abundant unskilled and low-skilled labor. Instead, it found or created—thanks to historical policy choices and technological accidents—such advantage in relatively skilled activities. That the relevant distinction is skill-based rather than sectoral is reflected in the fact that even within manufacturing, India has an atypically high share of skilled-intensive sectors.
India’s anomalous pattern of development on another score is less well-known. Development involves countries diversifying their economic base and only later—after an income level of about $15,000 per capita—specializing in fewer activities. India has diversified to a greater extent and faster than usual for a country of its income level and has also started specializing much earlier than the typical country. This early and precocious diversification proved to be an asset because it equipped Indian industry to exploit some of the subsequent opportunities created by the IT and software revolution.
But in some ways, the most astonishing sign of precociousness has related to capital. Development theory’s version of gravitational pull asserts that capital should flow downhill: from rich countries (where the risk-adjusted returns to capital are much lower because of diminished returns to capital) to poorer ones (where these returns are greater). But capital flowing uphill has been one of the anomalies of recent times: Many East Asian countries, especially China, and more recently, the oil-rich countries of West Asia, have run current account surpluses, whose mirror image is the export of financial capital. India has only rarely exported financial capital.
But India is the one country that seems to be defying a stronger version of the gravitational law of development, which says that managerial and entrepreneurial capital—foreign direct investment (FDI)—will always flow downhill. Empirical validation for this “law” can be found in a paper that I coauthored with Eswar Prasad and Raghuram Rajan, Foreign Capital and Economic Growth [pdf]: Whereas overall capital had occasionally flowed uphill, FDI never did. In the post-war period, the average income of countries that have been net exporters of FDI has been about $45,000 per capita. If only exports of FDI going to the rich countries had been considered, the number would have been higher still.
In 2006-07, India’s net imports of FDI were 9 per cent of GDP. So, India is still not a net exporter (it could have been had some transactions been recorded differently) but the really striking fact is that India’s gross exports of FDI were a whopping 12 percent of GDP, and much of this was destined for the OECD countries. In other words, India has become a large exporter of FDI to rich countries at a per capita GDP of about $900 per capita, when the average country has done so closer to a per capita GDP in excess of $50,000. How precocious is that? As impressive is the range and sophistication of industries that Indian managers and entrepreneurs are moving into: oil, automotives, information technology, pharmaceuticals, steels, and even wind energy. In contrast, a lot of Chinese FDI is in Africa and is resource-related.
For a country that shunned global capitalism until very recently—IBM and Coca Cola were asked to leave in the late 1970s—and was seen as a paragon of inefficiency, it is a remarkable, ironic turnaround. Indians are engaged in global capitalism not just as workers but as “bosses,” taking over and efficiently managing global capital!
In some ways, all this precociousness should be no surprise at all. The fact is that there are many Indian economies within geographic India and some of them do resemble developed economies: in being endowed with educated and entrepreneurial people, in being well-connected with the outside world, and in having access to capital. They are probably also too well “connected” within India. It would be more anomalous if these Indias had not recorded some of these precocious achievements.
But there are enough other Indias that should temper any triumphalism that the achievements of the precocious Indias might tempt us into. For one, poor India rather than precocious India is still the rule. And the very fact of defying comparative advantage means that India’s abundant resource—its unskilled labor—has been afforded limited opportunities for economic and social advancement.
So, at sixty, let us savor the achievements by all means, but always remembering that precocious infants can be maladapted ones, and also that they do not always grow into successful, happy, or even, normal adults.
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