Will the Indian economy overtake Germany by 2018

What India and China should leave behind : When growth addiction becomes a problem

Abhijit Banerjee is Professor of Economics at MIT. Esther Duflo is Professor of Poverty Reduction and Development Economics at MIT. Not only are they married to each other, but also joint founders and co-directors of the Abdul Latif Jameel Poverty Action Lab (J-PAL) at MIT and (together with Michael Kremer) winner of the 2019 Nobel Prize in Economics Jan Doolan. Copyright: www.project-syndicate.org

One of the most worrying news of 2019 didn't get the media coverage one might have expected in the US and Europe: The International Monetary Fund, Asian Development Bank and OECD have downgraded their 2019-20 growth forecasts for India to around six percent .

That would be the lowest value since the beginning of the decade. Others consider even these numbers to be too optimistic and assume very much gloomy narratives. For example, Arvind Subramanian, who until recently was the top economic advisor to the Indian government, argued on the basis of a comparison of data on various economic indicators that growth could drop to 3.5 percent.

In China, gross domestic product (GDP) growth is also slowing, from 14.2 percent in 2007 to 6.6 percent in 2018. The International Monetary Fund predicts that it could fall to 5.5 percent by 2024. Most likely, this economic downturn in China and the potentially significant growth slowdown in India will attract significantly more attention in 2020.

On Friday the Beijing statistical office announced that the largest economy by far only grew by 6.1 percent in the past year - after 6.6 percent in 2018. Against the background of the trade conflict with the USA and a generally weaker economy, China's economy is thus 2019 as slowly as it has not grown in almost 30 years.

Strong growth in China and India has lifted millions out of poverty, and the downturn is likely to slow progress in improving the lives of the poor. What should China and India do? Or rather, what should they leave behind?

Please don't be complacent

When we wrote our book "Good Economics for Hard Times" in 2018 - before the bad news about economic developments in India started to hit the tickers - we were already worried about a potential downturn in this country (the downturn in China was already known).

In anticipation of the slowdown in growth, we warned, “India should fear complacency.” The point we made is simple: In China, economic resources were very poorly used during communism and in India during the period of extreme dirigism. If these political systems change, the first progress will be visible very quickly - the available resources are now being used in the best possible way.

In the case of Indian industrial companies, for example, there was a significant acceleration in technological modernization at plant level after 2002 and a certain reorientation towards the best companies within each branch. This was apparently unrelated to changes in economic policy and has been described as "India's puzzling manufacturing miracle".

Declaration of generation change

But it wasn't a miracle, just a modest improvement on a rather pathetic starting point. There are several possible reasons why this came about. One explanation would be a generation change in which control passed from parents to children, often educated abroad, more ambitious and more knowledgeable about technology and world markets.

Or perhaps the accumulation of modest profits ultimately made it possible to pay for the move to bigger and better factories. Or maybe both causes - and others - played a role. More broadly, maybe the reason some countries, like China, can grow so fast for so long is that they start with a lot of underused manpower and resources that can be put to better use.

But when the economy has lost its worst factories and firms and resolved its worst allocation problems, the scope for further improvement naturally diminishes. Growth in India, like China, has had to slow down. And there is no guarantee that it will not slow down until India has reached the same level as China in per capita income. India could be caught in the same "middle income trap" as Malaysia, Thailand, Egypt, Mexico and Peru before.

Japan as a warning

The problem with this is that it is difficult for countries to wean themselves off their growth addiction. There is a risk that political decision-makers will become wildly active in an effort to restore growth. The recent history of Japan should serve as a useful warning.

Had the Japanese economy sustained the rate of growth that it achieved between 1963 and 73, Japan would have overtaken the US in 1985 in gross domestic product per capita and in 1998 in general gross domestic product. What happened instead is enough to make you superstitious: in 1980, the year Ezra Vogel of Harvard University published his book "Japan as Number One", growth plummeted, and it has not really stopped since then recovered. During the entire period from 1980 to 2018, Japan's real GDP grew by an average of just 0.5 percent annually.

There was a simple problem with this: the low birth rate and the almost complete absence of immigration meant that Japan was aging rapidly (and is still aging today). The labor force peaked in the late 1990s and has fallen 0.7 percent annually since then (and will continue to decline).

Good money, less good projects

In addition, Japan caught up economically after the disaster of the war in the Pacific during the 1950s, 1960s and 1970s as its well-educated population began to be deployed to the best of its ability.

That was over by the 1980s. In the euphoria of the 1970s and 1980s, many people (in Japan and elsewhere) persuaded themselves that technological developments would still allow Japan to maintain high growth, which probably explains why the high investment rate (over 30 percent of GDP) during the 1980s Continued for years.

Too much good money chased after a few good projects in the so-called bubble economy of the 1980s. As a result, the banks ended up sitting on a lot of bad loans, which led to the serious financial crisis of the 1990s. Growth stalled.

By the end of the “lost decade” of the 1990s, Japanese politicians might have slowly realized what was going on and what they had to lose. After all, Japan was already a relatively prosperous economy with much less inequality than most Western countries, a strong education system, and many important problems awaiting resolution, particularly how to maintain a decent quality of life for its rapidly aging population. But the authorities seemed unable to adjust: restoring growth was a matter of national pride.

Infrastructure with no apparent purpose

As a result, successive governments vied to devise a range of stimulus packages and spent trillions of dollars, mostly on roads, dams and bridges, infrastructure that served no apparent purpose.

As perhaps predictable, these impulses did nothing to increase economic growth, but led to a huge increase in national debt. In 2016 it was around 230 percent of gross domestic product - by far the highest value among the G20 countries and one of the possible harbingers of a massive debt crisis.

The lesson for politics in China and India is clear: they have to accept that growth will inevitably slow down. The Chinese leadership has recognized this and made a conscious effort to control public expectations accordingly. In 2014, President Xi Jinping spoke of a "new normal" of seven percent or more annual growth instead of the previous ten percent. But even this forecast could still be too high. In the meantime, China has embarked on huge global construction projects, which is not necessarily a good thing - they may be trying to copy the Japanese strategy after all.

Ultimately, the key is not to lose sight of the fact that GDP is a means, not an end. It is undoubtedly useful, especially if it creates jobs, leads to higher wages, or increases the government budget so that the government can redistribute more money.

Quality of life is more than just consumption

The goal, however, remains to improve the quality of life of the average citizen - and especially the poorest. And quality of life means more than just consumption. Feeling honorable and respected is important to most people, and they suffer when they feel like they are disappointing themselves and their families.

While a better life is in part about being able to consume more, even very poor people care about their parents' health, their children's education, public hearing, and the ability to pursue their own dreams.

Higher GDP is only one way to get there and should not be assumed to be the best way.

Many of the major development achievements over the past few decades have been the direct result of a political focus on this broader conception of wellbeing. This is true even for some countries that were and still are very poor. For example, even in some very poor, not particularly fast growing countries, there has been massive reductions in under-five mortality rates, in large part because policies were promoting neonatal care, vaccination and malaria prevention.

This brings us back to the downturn in India and China. There is still a lot that politics in both countries can do to improve the lot of their citizens and help us hold on to some hope for the future of our planet. A short-sighted focus on the pace of GDP growth could miss that opportunity.

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