The Costs of Hesitant and Reluctant Globalization: India
T. N. Srinivasan*
1. Introduction
I am honored to be invited to deliver the V. K. Ramaswami Memorial Lecture. Ramaswami,
Ramu to myself and many of his friends and admirers, was an exceptional civil servant who,
while holding several senior positions in the government, including that of Chief Economic
Adviser in the Ministry of Finance, nonetheless managed to find the time to pursue his academic
research in economics to the extent that he left a significant impact on the theory of international
trade. Paul Streeten, Ramu’s tutor at Oxford, wrote in his obituary, soon after Ramu’s premature
accidental death, that, “Ramaswami was one of the very few economists who combined first
class academic work with top economic advice to government. While the combination of these
qualities sometimes seems to derive from an ability to divide one’s mind into separate
compartments (for those who use straight economic theory to give advice give bad advice, while
those who give good advice do not normally produce good theory). . . Ramaswami was all of a
piece” (Streeten, 1970). Having been a friend, admirer and academic collaborator, and also
having been associated with all three institutions that sponsor the Ramaswami Memorial Lecture,
I particularly appreciate this opportunity to celebrate Ramu’s impact on International Trade and
Indian economic policy. For the sake of full disclosure, I must say up front that, while I spent a
year at the Institute of Economic Growth, and was on the faculty of the Indian Statistical Institute
*
Samuel C. Park, Jr. Professor of Economics, Yale University, New Haven, Connecticut, USA.
This is a revised and expanded version of the V. K. Ramaswami Memorial Lecture, delivered at the Delhi School of
Economics on 21 March 2003 and to appear in Indian Economic Review.
I thank Montek Ahluwalia, Jagdish Bhagwati, Arvind Panagariya and Suresh Tendulkar for their comments.
1
for a decade and a half, my association with the Delhi School was indirect: as an applicant for a
professorship who did not make the grade!
The topic I have chosen is about the costs of India’s hesitant and reluctant globalization.
Ramaswami, like most economists of the time, was pessimistic about export expansion and
believed in the primacy of industrialization for development of countries such as India with a
presumed, but ill-defined, labour surplus. He wrote, “The existence of a large surplus labour
force in agriculture is the main reason for industrialization in India . . . Industrialization is also
called for in India on balance of payments considerations. Exports cannot be a leading growth
sector. The rate of increase of population is such that agriculture cannot contribute large
surpluses for export even allowing for improved productivity per acre. The world demand for
the major export items--jute, textiles, cotton textiles, and tea--cannot be expected to increase
rapidly . . .” (Ramaswami 1972, p. 137). He did not, as many others did, equate industrialization
with import substitution in the industrial sector. He was also explicit that “when imports are
severely restricted, it is easy for high cost industrial capacity to be established” (ibid, p. 138) and
was aware of the value for foreign direct investment. However, it is fair to say that he did not
fully anticipate that India then, and in the subsequent decades, would pursue import substitution
across-the-board and be hostile to foreign investment. His expectation of high cost industrial
capacity to be established proved correct. In a paper published after his death, which drew on his
celebrated paper on domestic distortions with Jagdish Bhagwati, and its later extension to which
I was also a contributor, Ramaswami expressed a different view: “less developed countries
should apply domestic policy measures to handle various distortions, externalities and noneconomic economic objectives which are often held to justify protection. The main valid reasons
for intervention in trade are the need to collect revenue and the exercise of national monopoly
2
power . . .” (Ramaswami, 1972, p. 134). The two views of Ramaswami I have quoted are very
relevant to my theme today.
Ramu’s early belief in the primacy of industrialization, or more precisely the mindset that
motivated our industrialization and external sector policies until the Manmohan Singh reforms of
1991, have not entirely changed. This is one reason behind our hesitant and reluctant
globalization. His second view, and its analytical underpinning, namely the BhagwatiRamaswami theory of domestic distortions and its later extensions (see Srinivasan 1996a, for a
review) continue to be relevant in assessing contemporary critiques of globalization. In what
follows I propose to review these critiques (Section 2). I then move on to examine the
distinction between liberalization of trade flows and capital flows (Section 3). Many advocates
of liberalization of trade flows, such as Jagdish Bhagwati, have been against or lukewarm about
liberalization of capital flows. Needless to add that whether this distinction is analytical or one
of sequencing (i.e., whether liberalization of capital flows ought to follow with some time lag
after creation of an appropriate institutional environment, in the financial sector) of the two
liberalizations, is of policy relevance from India’s perspective. In Section 4, I document the
costs of our hesitant and reluctant globalization in terms of foregone growth, the avoidable delay
in the eradication of poverty and our falling behind our competitors such as China. After some
brief remarks on the impasse in the Doha Round of multilateral trade negotiations, and India’s
negotiating positions (Section 5), I conclude (Section 6) with an assessment of the prospects for
India achieving a sustained and rapid growth in light of the growth slow down since 1996-97 and
the depressed state of domestic investment climate.
Before turning to a review of the critiques of globalization, let me explain what I mean by
Indian globalization having been reluctant and hesitant. The macroeconomic and balance of
3
payments crisis of 1991 that triggered the reforms was not the first that led India to approach the
IMF and the World Bank, to devalue the rupee, and liberalize foreign trade. The 1966
macroeconomic crisis also had the same policy responses. Yet, for a number of reasons (see
Bhagwati and Srinivasan, 1975), among the most important of which was the reneging of its
commitment by the World Bank to deliver nearly a billion dollars of non-project assistance to
ease the costs of adjustment, liberalization was reversed within a year and not to be attempted
until the mid-eighties. The government of Prime Minister Rajiv Gandhi did liberalize and
rationalized some of the most irksome controls and reduced very modestly some trade barriers.
However, there were no systemic reforms. Joshi and Little (1996, p. 63) rightly concluded that
“In June 1991, India was the most autarkic non-communist country in the world. Despite a little
liberalization in 1980s, all imports were subject to licensing or were prohibited. Licenses were
in general granted only on proof that there was no indigenous supply . . . .” The results of the
autarkic insulation of the economy from the world markets was the steep decline in India’s share
in world exports from over 2.21% in 1948 to a low of 0.4% in the early 1980s and 0.5% in 1990
(Ministry of Finance, Economic Survey, 1990 and 2003, WTO, 2002a, Table II.2). Clearly,
whatever trade liberalization there was prior to 1991, was hesitant and extremely limited.
The reforms of 1991 and the years following were systemic. The rupee was devalued, and a
system of managed float for the determination of the exchange rate followed. Tariffs were
reduced significantly from an import weighted average of 73% in 1991-92 to 25% in 1996-97
only to rise later to 35% in 2001-02 (Reserve Bank of India, 2003, Table 7.2). Also, with India’s
signing the Uruguay Round agreement in 1994, quantitative restrictions on imports had to go and
indeed they did by 2001. Restrictions of foreign capital inflows and direct investment were
relaxed considerably. Nonetheless, I would characterize the liberalization as reluctant for two
4
main reasons. The first is geopolitical. The second has to do with domestic politics. I believe
that, first, the collapse of the Soviet empire and its system of central planning, which was India’s
economic model, demonstrated once and for all the bankruptcy and the failure of the system.
Second, and just as, or even more important, the spectacular economic success of Chinese
liberalization and integration with the world economy since 1978, generated the fear of being left
behind by China, with whom we fought and lost. This fear must have played a role. My second
reason is the still continuing domestic political ambivalence about trade liberalization and
reforms. These considerations have led Dr. Manmohan Singh, and even more so, former Prime
Minister Narasimha Rao, to play down and even disown some of the liberalization they had
initiated. Of course, parties of the left as well as nationalist right (such as Swadeshi Jagaran
Manch) were never convinced of the need for liberalization, and are campaigning for its reversal.
Although broad political support for going back to the pre-1991 trade regime fortunately does
not exist, and even if it did, India’s commitments at WTO would preclude from happening,
neither is indicative of an enthusiastic embrace for rapidly reducing our remaining external
sector barriers. In fact, India’s negotiating stance in the Doha Round, to which I return in
Section 5, convinces me that no such embrace is likely.
2. Critiques of Globalization
The process of globalization could be defined narrowly as the progressive integration of
national economies with the world economy, and more broadly as the integration of national
polities through the spread of participatory democracy, and of national civil societies through
non-governmental organizations that are international in scope and membership. For the
purposes of my talk, I will adopt the narrow definition. Clearly such a process would involve
5
reduction to barriers to international trade in goods and services, movement of capital and
technology and above all to movement of workers and people. It is obvious that being open to
trade and investment contributes to each of the three sources of growth of an economy. These
are growth in inputs of production, improvements in the efficiency of allocation of inputs across
economic activities, and innovation that creates new products, new uses for existing products,
and brings about increases in the efficiency of use of inputs. By enabling the economy to
specialize in those activities in which it has comparative advantage, openness to trade enhances
the efficiency of allocation of domestic resources. By being open to capital, labour and resource
flows, an economy is able to augment relatively scarce domestic resources and use part of its
abundant resources elsewhere where they earn a higher return. Clearly, efficiency of resource
use in each nation and across the world is enhanced by the freedom of movement of resources.
Finally, the fruits of innovation anywhere in the world become available everywhere in such an
open world. Although the case for openness, that is for the process of globalization, seems
obvious, still the camp of critics of globalization include some distinguished economists. Before
turning to their arguments, it is useful to look at globalization in a historical perspective.
In his illuminating lecture, entitled “Winners and Losers Over Two Centuries of
Globalization,” Jeffrey Williamson (2002) identifies two booms and one bust in globalization in
the 19th and 20th centuries. According to him, the first global century ended with World War I
and the second started at the end of World War II, while the years in between were ones of antiglobal backlash. Keynes (1919) waxed eloquent about the glories of the first globalization
boom, one that occurred in a world in which there were few barriers to movement of people,
such as passports and visa requirements, no barriers to movement of capital, and adherence to the
6
gold standard eliminated exchange risks1. According to some (Obstfeld and Taylor, 2002),
capital market integration had reached levels in 1913 that are only now being reached in the
second globalization boom after the collapse of capital flows during the inter-war globalization
backlash. Of course, during the period of backlash, immigration restrictions were imposed, tariff
barriers were increased, not to mention competitive devaluation of currencies after the collapse
of the gold standard.
India was integrated in large part with the world economy under a regime of free trade
imposed by the British, particularly after 1870. Deepak Lal (1988, 2003) has drawn attention to
more than a doubling of India’s industrial production between 1886 and 1914, and to the fact that
by 1914, India had the world’s fourth largest cotton textile industry, and the second largest jute
manufacturing industry. The overall rate of industrial growth, according to him, was higher in
India than in most tropical countries and higher than even in Germany between 1880 and 1914.
1
The following from Keynes (1919) as quoted by Sachs and Warner (1995) sums it up:
What an extraordinary episode in the economic progress of man that age was which came to an end in
August 1914! . . . The inhabitant of London could order by telephone, sipping his morning tea in bed, the
various products of the whole earth, in such quantity as he might see fit, and reasonably expect their early
delivery upon his doorstep; he could at the same moment and by the same means adventure his wealth in
the natural resources and new enterprises of any quarter of the world, and share, without exertion or even
trouble, in their prospective fruits and advantages; or he could decide to couple the security of his fortunes
with the good faith of the townspeople of any substantial municipality in any continent that fancy or
information might recommend. He could secure forthwith, if he wished it, cheap and comfortable means of
transit to any country or climate without passport or other formality, could dispatch his servant to the
neighbouring office of a bank for such supply of the precious metals as might seem convenient, and could
then proceed abroad to foreign quarters, without knowledge of their religion, language, or customs, bearing
coined with wealth upon his person, and would consider himself greatly aggrieved and much surprised at
the least interference. But, most important of all, he regarded this state of affairs as normal, certain, and
permanent, except in the direction of further improvement, and any deviation from it as aberrant,
scandalous, and avoidable.
Keynes (1933) changed his mind during the depression and sang an entirely different tune. Again, as quoted by
Sachs and Warner, he said:
I sympathise, therefore, with those who would minimize, rather than with those who would maximize,
economic entanglements between nations. Ideas, knowledge, art, hospitality, travel--these are the things
which should of their nature be international. But let goods be homespun whenever it is reasonably and
conveniently possible; and, above all, let finance be primarily national.
He changed his mind again after World War II when he was instrumental in the establishment of the World Bank
and the IMF. Obviously foolish consistency is the hobgoblin of small minds and not that of great minds, like
Keynes’!
7
Angus Maddison (2002),who is brave enough to estimate GDP per capita income in constant
1990 PPP corrected dollars from year 0 for many countries, reports that India’s per capita income
rose by about 25% between 1870 and 1913, Clearly, contrary to common perception, India did
gain in the period first globalization boom during the colonial era.
The contemporary critics of globalization constitute a motley crowd, ranging from anarchists
and other opportunists who exploit for their own ends the genuine concerns that social safety
nets to protect the losers (and, undoubtedly, there are some) from globalization in developing
countries (DCs) is either non-existent or full of holes, to protectionists (particularly labour unions
and their political patrons) in rich countries as well as some academics. I will confine myself to
academic critiques.
One strand among the critiques makes the case that, first, the record of growth and
development of DCs during the hey day of their development strategy of import substitution is
respectable and second, the more recent cross-country regression-based claims of growth
enhancing effects of openness are so seriously flawed methodologically that their findings are of
no value from a policy perspective. Rodrik in several of his recent writings (e.g., Rodrik, 1997
and Rodriguez and Rodrik, 2001) has put forward this strand of criticism. His analysis, based as
it is on the application of conventional tools of economic theory and econometrics, cannot be
dismissed out of hand as ideologically motivated. However, it would take me too long to state his
critique in detail and rebut it. Jagdish Bhagwati and I have discussed on them in some detail
elsewhere (Srinivasan and Bhagwati, 2001). Warner (2002) has also responded to Rodrik and
Rodriguez. Our main point was that the cross-country regression methodology is ill-suited for
either making a positive case in favour of globalization (e.g., by Sachs and Warner (1995),
Dollar and Kraay (2000))or for critiquing it (e.g., Rodriguez and Rodrik, 2001) for a number of
8
reasons including the inappropriateness of the use of a common repression for all countries and
periods as well as data inadequacies. We argued that a nuanced country specific analysis using a
common analytical framework for a cross-section of countries, as was used in the studies
sponsored by the O.E.C.D. (Little, Scitovsky and Scott, 1970), the National Bureau of Economic
Research (Bhagwati, 1978; Krueger, 1978) and the World Bank (Balassa, 1971) in the late
sixties and seventies, were more appropriate. These studies, which included one on India
(Bhagwati and Srinivasan, 1975) indeed showed convincingly that the then prevalent inwardoriented trade policy regime in many of the countries studied was costly in term of foregone
growth and welfare, and the few countries of East Asia that had an outward oriented regime did
better.
The point about the respectable growth record of DCs in the import substitution era of the
first three decades or so after the end of World War II, has to be put in a proper perspective.
First, relatively rapid growth in the early years after the end of World War II can reasonably be
attributed to rehabilitation of capacity run down during the war. Of course this phenomenon was
most significant in Western European countries that had been ravaged by the war and recovered
rapidly with the assistance of Marshall Plan. Some spill over of their growth to other countries is
certainly plausible. Second, and more important, the volume of World exports grew by nearly
8% a year on an average between 1950-1973. Clearly trade barriers would have a less restrictive
effect on a country’s trade, the more buoyant the global trade is. Third, the deterioration in
governance and other deterrents of growth such as political unrest and ethnic conflicts, were less
frequent then. Fourth, import substitution in many DCs in the early years covered products in
which they had a reasonable expectation of being internationally competitive. Besides, given
that industrial production was likely to be small, and industrial imports likely to constitute a
9
larger share of imports at early stages of development, it is to be expected that rapid growth in
industrial production contributed to respectable growth in GDP. However, this impetus to
growth gets exhausted as domestic production meets domestic demand. Also, the distorted
(relative to world prices) of domestic market prices of import substitutes tends to overstate
growth. For all these reasons it is simplistic to interpret the respectable growth records of the
DCs until the mid seventies as implying that inward orientation had no impact or even
contributed to growth.
The most recent and celebrated critic of globalization is the Nobel Laureate Joseph Stiglitz.
In his view “In many countries, globalization has brought huge benefits to a few with few
benefits to the many. But in the case of a few countries, it has brought enormous benefits to the
many” (Stiglitz, 2002a, p 1). He attributes these alleged differences to globalization having
meant different things in different places. Unfortunately he does not name the many countries,
nor provides any evidence, that large benefits from globalization accrued to the few with few
benefits to the many. As such his statement has to be dismissed as mere assertion. He argues that
countries that have managed globalization on their own, and he names East Asian countries as
examples, have ensured that they reaped huge benefits and these benefits were equitable shared
and these countries “were able substantially to control the terms on which they engaged with the
global economy. By contrast the countries that have, by and large, had globalization managed for
them by the International Monetary Fund and other international economic institutions have not
done so well. The problem is thus not with globalization but with how it has been managed”
(ibid, p 1).
What exactly does Stiglitz mean by managing globalization on one’s own terms? He says
that “Each of the most successful globalizing countries determined its own pace of change; each
10
made sure as it grew, the benefits were shared equitably; each rejected the basic tenets of the
“Washington Consensus” which argued for a minimalist role for government and rapid
privatization and liberalization” (ibid p 2).
Stiglitz is among many who used the term “Washington Consensus” to mean whatever they
wish it to mean. A careful reading of the original paper of Williamson, who coined the term,
would show that much of what he included in the consensus is still valid (Williamson, 2000;
Srinivasan, 2000). Neither in the article from which I have quoted, nor in his book with the same
title, does Stiglitz (2002b) delve into the voluminous literature on East Asian performance. This
literature is still growing. Neither Stiglitz nor the World Bank’s (1993) earlier study, East Asian
Miracle ask, let alone empirically evaluate, whether the distributional outcome in East Asia was
the result of a deliberate distributional policy as Stiglitz asserts or of the particular development
strategy chosen, namely outward orientation that exploited the comparative advantage in labour
intensive manufacturers. There is no convincing evidence that the Park government in Korea or
the Taiwanese government engaged in redistribution of benefits of growth through specific
policies. As is well known, redistributive land reform had been carried out by outsiders
(mainland Chinese in Taiwan) or under outside pressure in Korea before they shifted away from
outward orientation. In China the revolution did away with private property rights. Korea and
Taiwan had attained fairly high educational achievements early on. Clearly given these initial
actions, a shift towards outward orientation not only could have contributed to faster growth but
also to its benefits being more equally distributed. Be that as it may, Quibria (2001) doubts both
whether benefits of growth were evenly shared, and even whether initial conditions such as land
reform and better human capital endowments had much to do with their growth.
11
I would add that in the case of China also that indicators of human capital had reached fairly
high levels by the sixties. But until the policy regime changed and the economy opened in 1978,
there was no total factor productivity growth. In fact, according to Maddison (2002), TFP
declined at 0.78% per year in the pre-1978 era. However the facts that in East Asia earlier
accumulation of human capital contributed to later growth when policies changed or that earlier
redistribution reform contributed to benefits of later growth being more equally distributed do
not establish that the East Asian countries chose their own pace of globalization, whatever that
means.
These facts do have an important implication. Outward orientation, globalization, trade
liberalization or whatever one wants to call these processes, have one thing in common: they are
all enabling processes, that is, they expand or open up new opportunities, for individuals,
households, enterprises, nations and sub-national units. It should cause no surprise to anyone that
not all these groups would be initially well placed to take advantage of the opportunities that
open up, and those that are, get ahead of those that are not. Thus, the real issue is not whether in
the immediate period after opportunities are opened, there is an increase in disparities across
nations, sub-national units, households and individuals etc. but whether there are processes and
policies in place that would ensure that initially disadvantaged regions and groups are enabled to
overcome them, so that the initial divergence among regions and groups is turned into later
convergence. Thoughtful critics of globalization are certainly right in asking whether such
processes exist and function effectively. Indeed in India and in China there is some evidence of
increasing regional disparities and conventional tests of convergence across states and regions
are ambiguous in their findings. (See Abler and Das (1998), Cashin and Sahay (1996, 1997),
Dayal-Gulati and Hussain (2000), Demurger, et al (2001), Rao and Sen (1997).) Leaving aside
12
the methodological problems and data deficiencies associated with these tests, at least in the case
of India it can be argued that the decade since the reforms were initiated is too short a period for
a definitive evaluation of its effect on regional disparities.
Stiglitz is certainly right in saying that East Asian economies were not laissez faire
economies and their governments intervened in the economy. He points to the alleged success of
Korea in creating an efficient steel industry. There are two related issues in evaluating this
assertion. The first is that the relevant question is not that East Asians were or were not laissez
faire economies – few, if any, in the world ever are – but whether their industrial and trade policy
interventions contributed to their superior performance. Second is the issue whether the policy of
heavy and chemical industries promotion (HCP) in Korea in the 1970s was worthwhile. Contrary
to the assertion of Stiglitz, the answer seems to be in the negative to both questions. The studies
commissioned by the NBER and the World Bank completed during 1970-1980 showed, unlike
trade policy interventions elsewhere in the developing world, both the export promotion and
import restriction policies in Korea did not create an uncertain and heavily distorted incentive
structure across economic activities. Noland and Pack (2003) carefully analyze the selective
industrial policy intervention in Japan, Korea and Taiwan. They come to the conclusion that such
interventions, did not all have a significant positive effect on productivity growth, and where
they did, their contribution was very modest. In particular, the HCP policy in Korea was not
worthwhile contrary to Stiglitz.
I do not wish to expand on other critiques of globalization except to say that almost all of
them are versions of the Bhagwati-Ramaswami proposition, namely, that reducing or removing a
trade distortion (i.e. engaging in globalization) when other distortion remain, need not be welfare
improving. But these critiques do not seem to have absorbed the fundamental Bhagwati-
13
Ramaswami message, namely, that creating or maintaining a trade distortion is not necessarily
the second best policy of addressing a domestic distortion and that policy attention is better
focused on removing or addressing domestic distortions optimally, rather than deviate from
optimal trade policy, which for small open economies, is free trade.
Stiglitz’s main argument seems to be that, “Globalization can yield immense benefits . . .
[but] it has not only failed to live up to its potential but frequently has had very adverse effects...
the most adverse effects have arisen from the liberalization of financial and capital markets-which has posed risks to developing countries without commensurate rewards” (2002a, p. 3).
Stiglitz’s view of financial liberalization is shared by Jagdish Bhagwati (1998). Since the
Bhagwati-Ramaswami argument that, in the presence of a pre-existing and unremoved domestic
distortions, liberalization could be welfare worsening applies to both trade and capital
liberalization, the relevant issue is whether in a distortion-free environment one could still argue
that capital liberalization could be welfare worsening while trade liberalization would always be
welfare improving. I take up this issue in the next section.
3. Liberalization of Trade Flows Versus Capital Flows
In his characteristic style, Jagdish Bhagwati described the benefits of trade liberalization as
follows: “If you exchanged some of your toothbrushes for some of another’s toothpaste and you
remembered to brush your teeth, you would both have white teeth. And the chance of your teeth
being knocked out in the process is negligible.” But then he added, “But the analogy with capital
flows is different. If Tarzan uses fire to roast his kill, he gets a better meal. But when he returns
to England as the Earl of Greystoke carelessness with fire can torch his ancestral home”
(Bhagwati, 2003, p.7). This certainly should elicit applause for its humour, but on second
14
thought, it is not exactly clear what is being compared with what. Is it that external terms of
exchange of toothbrush for toothpaste and the domestic transformation curve of one for the other
are both certain, while the technology of transforming raw kill into cooked meal can generate
negative externalities with positive (but less than certain) probability?2 If it is, what has this got
to do with capital flows? If it is not, what is the analogue of capital flows?
Perhaps Bhagwati had in mind a world in which trade liberalization by a small open
economy does not affect domestic production possibilities, but only its consumption possibilities,
while capital account liberalization affects both. If this is the case, is it possible to argue that free
trade is always beneficial while free capital flows need not be? It is illuminating to analyze this
issue with a simple model.
Consider a small open economy which has an endowment of a single good and consumes
another good in addition, which it has to acquire by trading part of its endowment with the rest of
the world. Let the utility function of the single representative consumer of this economy be
Cobb-Douglas in her consumption CP of toothpaste and CB of toothbrushes, with the share of
expenditure on toothpaste being s . The toothbrush endowment of the economy is B and the
2
Interestingly, Rodrik (1998) also stresses uncertainty in the context of capital flows using another metaphor:
Imagine landing on a planet that runs on widgets. You are told that international trade in widgets is highly
unpredictable and volatile on this planet, for reasons that are poorly understood. A small number of nations
have access to imported widgets, while many others are completely shut out even when they impose no
apparent obstacles to trade. With some regularity, those countries that have access to widgets get too much
of a good thing, and their markets are flooded with imported widgets. This allows them to go on a widget
binge, which makes everyone pretty happy for a while. However, such binges are often interrupted by a
sudden cutoff in supply, unrelated to any change in circumstances. The turnaround causes the affected
economies to experience painful economic adjustments. For reasons equally poorly understood, when one
country is hit by a supply cutback in this fashion, many other countries experience similar shocks in quick
succession. Some years thereafter, a widget boom starts anew.
Your host begs you for guidance: how should they deal with their widget problem? Ponder this question
for a while and then ponder under what circumstances your central recommendation would be that all
extant controls on international trade in widgets be eliminated.
Substitute “International capital flows” for “widgets” above and the description fits today’s world economy
quite well.
15
world (relative) price of a tube of toothpaste is P toothbrushes. Let me model trade restrictions
as an export tax of b ad valorem. Suppose neither brush nor paste is storable and there are no
investment opportunities. However P is uncertain, and is commonly believed by private
consumers and endowment owners to be distributed with some probability density f ( P ) over its
support ( 0, ∞ ) . Let consumption take place after P is realized. With no intertemporal choices
and given the realized P and the tax b (with tax revenues being returned to consumers in a lump
sum fashion), the per period welfare U ( P, b) of our consumer is easily shown to be:
⎡ s s (1 − s ) 1−s ⎤ (1 − b) B
U ( P, b ) = ⎢
⎥
1− s s
⎢⎣ (1 − b) P ⎥⎦ (1 − bs )
It is obvious that
(1)
∂U
< 0 . Thus given b ≥ 0 , the optimal or welfare maximizing value of b is
∂b
zero. Free trade is optimal regardless of the distribution of P . Thus, even if the social planner
and the private sector differ in their beliefs about f ( P) it does not matter for welfare
maximization. Incidentally the assumption that trading decisions are made after the resolution of
uncertainty about P is not essential to this conclusion. It holds even if the choice of the number
of toothbrushes is made prior to the realization of P by maximizing expected utility.
To bring in capital flows, consider a two-period version of the model in which there is an
opportunity to invest in the toothbrush industry in the first period that augments the endowment
of toothbrushes in the second period and also an opportunity to borrow to augment the
endowment of toothbrushes in the first period. The borrowed amount has to be repaid with
interest in the second period, but the rate of interest is uncertain, taking the value r with
probability z , and ( r + s ) with probability (1 − z ) . As earlier, the economy can buy toothpaste
from the rest of the world at a price of P toothbrushes per tube of toothpaste. However, unlike
16
earlier, P is assumed to be certain and there is no export tax. Let d denote the utility discount
rate. If we denote by Ei the consumption expenditures in period i (i = 1, 2) , then it is easily seen
that the intertemporal welfare of our consumer is now:
W = ⎡⎣ Ei + { Ez / (1 + d )}⎤⎦ / J
(2)
where J is the exact price index, which, as is clear from (1), is given by:
⎡
⎤
Ps
J =⎢ s
1− s ⎥
⎣ s (1 − s ) ⎦
(3)
Let the amount borrowed be D and amount invested be I . Let F ( I ) be the number of
toothbrushes added to the endowment B of brushes in period 2 with
F (0) = 0, F ′( I ) > 0, F ′′( I ) < 0. Let D be the exogenous upper limit of borrowing set by lenders.
The social planner’s problem in this economy is to maximize the expected value E (W ) of
W with respect to I and D where:
E1 = B + D − I and
(4)
E2 = B + F ( I ) − D(1 + r ) with probability z , and
E2 = B + F ( I ) − (1 + r + s ) D with probability (1 − z )
(5)
Since P is certain, by proper choice of unit of measurement of toothpaste one can
normalize the price index J to be unity, so that we can drop it from the maximization problem.
Substituting (4) and (5) in (2), and taking expectations one gets:
⎧ 1 ⎫
E (W ) = E1 + ⎨
⎬ { B + F ( I ) − D(1 + r ) − s (1 − z ) D}
⎩ (1 + d ) ⎭
17
(6)
Now
F ′( I )
∂E (W )
= −1 +
so that optimal I , denoted by I D , is given by
∂I
(1 + d )
F ′( I D ) = (1 + d )
(7)
∂E (W )
1
d − r − s(1 − z )
= 1−
{1 + r + s(1 − z )} =
∂D
(1 + d )
(1 + d )
(8)
Hence, optimal D denoted by D D is given by
D D = D if d > r + s (1 − z )
(9)
= any value in ⎡⎣ 0, D ⎤⎦ if d = r + s (1 − z )
(10)
= 0 if d < r + s (1 − z )
(11)
The private sector’s welfare maximization problem would be the same as the social
planner’s, as long as the private sector has the same information as the planner about the
distribution of the uncertain interest rate. In such a case there is no rationale for any intervention
in the private sector’s investment and borrowing decisions. Suppose now the private sector
believes that the interest rate is certain to be r . Clearly with this belief being different from the
true distribution of the interest rate, private optimum could differ from social optimum and a case
for intervention in private decisions could arise. To illustrate this, let us consider a tax t per unit
borrowed in the first period. With this the private sector’s expenditures, given its beliefs, would
be:
E1 = B + (1 − t ) D − I + T
(12)
E2 = B + F ( I ) − (1 + r ) D
(13)
where T is the tax revenue tD returned to consumers in a lump sum fashion. Being lump sum it
does not affect the private sector’s borrowing and investment decisions.
18
Maximizing W (since there is no uncertainty according to the beliefs of the private
sector) we set
∂W
F ′( I )
= −1 +
so that optimal I is given by F ′( I ) = (1 + d ) . This is the same
∂I
(1 + d )
as the social planner’s decision (7). Thus the investment decision of the private sector is the
same as the social planner’s.
Now
∂W
(1 + r ) (1 − t )(1 + d ) − (1 + r )
= (1 − t ) −
=
∂D
(1 + d )
(1 + d )
(14)
Suppose d < r + s (1 − z ) so that the socially optimal decision is not to borrow. In the absence of a
tax t > 0 , if d > r , the private sector would borrow a non-socially optimal amount D . However
⎛ 1+ r ⎞
⎛ d −r ⎞
by setting a tax t such that (1 − t ) < ⎜
⎟ or t > ⎜
⎟ the social planner can ensure that the
⎝1+ d ⎠
⎝ 1+ d ⎠
private sector borrows the optimum amount of zero.
Is this what Jagdish Bhagwati had in mind? Even if he did, this rationalization of his
view is not very satisfactory. The rationale for intervention in this model does not have much to
do with capital account liberalization per se, but only to the existence of a distortion in the form
of the private sector not having the right information. As such, the government could have
simply made available the information it has to the private sector without having to tax the
borrowing! Of course, technically this is also an intervention though not on borrowing decision
of the private sector.
The model ignores aspects of borrowing and investing, such as currency mismatch (i.e.,
borrowing in foreign currency and lending in home currency) and maturity mismatch (borrowing
19
short and investing long). However, capital controls are not the first best instruments for
addressing these problems. The first problem disappears if exchange rate risks are suitably
hedged. The second problem (assuming that the investment would yield adequate returns) is
common to financial intermediaries such as banks. In a closed economy, a lender of last resort,
such as the Central Bank ensures that, as long as banks lend prudentially, any run on one bank
does not lead to a financial crisis. Of course, in the absence of an international lender of last
resort, there would be a problem if foreign short-term lenders withdraw. Again, adequate foreign
currency reserves of the Central Bank could alleviate this problem.
Some of the criticism of liberalization of capital flows seem to have no economic logic
behind them. For example, Stiglitz argues that, “prudential behavior requires countries to set
aside reserves equal to the amount of short-term lending” (2002a, pp. 2-3). I presume he means
short-term borrowing. Since reserves are invested in government securities of US and other rich
countries, which earn at best 4% per year, and short-term borrowing costs 20% or more, this is a
money losing proposition and Stiglitz is right in saying that “can hardly help the growth of a
poor country.” But does it make sense to say that prudential behavior requires keeping 100%
reserves? Obviously not. After all, clearly no country will borrow if that was the case--they
could as well have used their reserves to do what they would have done at a lower cost as
compared to borrowed funds. Normally, prudence would require keeping only a fraction of
short-term borrowing as reserves and this fraction would depend on the probability that lenders
would ask for repayment at short notice and also on the opportunity cost of reserves. Without
information on these it is difficult to answer whether short-term borrowing is worthwhile, and if
it is, how much reserves should be kept prudentially.
20
The literature on financial crisis and contagion is vast. My understanding of it, starting
from Paul Krugman’s so-called first generation model to all the subsequent generations of
financial crisis models is that underlying each of them is a distortion. In Krugman’s (1979) case,
for example, a distortionary fiscal deficit that is financed by money creation leading to reserve
depletion, problem of coordination of expectations in one of Obstfeld’s (1996) models) and/or
difficulties in insuring or hedging relevant risks. Again, the Bhagwati-Ramaswami proposition
applies--liberalization of capital flows with underlying distortions unremoved can be welfare
worsening. These distortions could include perceived problems with international financial
architecture, such as the absence of a lender of last resort. Saying this is not to say that the
literature has not yielded policy relevant insights, but only to point out that in any policy change
that involves risks, the expected benefits have to be assessed relative to risks. Some of this
literature tends to focus exclusively on risks while ignoring the potential benefits of liberalization
of capital flows.
Even if controls on capital flows induces greater macroeconomic stability, one cannot
assume that it has a positive impact on the level and sustainability of growth. For example,
macroeconomic stability, a feature of East Asia until the financial crisis, provided the foundation
for a relatively distortion-free microeconomic policy environment, including trade policy, to
deliver well-distributed and rapid growth in East Asia. On the other hand, given India’s severe
microeconomic distortions, macroeconomic stability until the eighties delivered only an anemic
growth. By the same token, abandoning stability as India did in the eighties, and borrowing at
home and abroad, while doing little to remove micro distortions, certainly delivered more rapid
growth than earlier. But such a policy inevitably and predictably led to the macroeconomic crisis
of 1991.
21
4. Enthusiastic Versus Reluctant and Hesitant Liberalization: China Versus India
China and India pursued similar state-controlled industrialization strategies with emphasis on
heavy industry until their recent reforms. However in China, state control was direct and total,
agriculture was collectivized, almost all industry was state-owned and most services were
supplied by the state. India had a mixed economy with agriculture, all of small scale and a
significant part of large scale industries being in the private sector. Although China grew faster
than India also before reforms, most of the difference is attributed to China’s greater savings and
investment rates.
It is most likely that the differences in the reform and growth processes of the two countries
also contributed to the differences in growth rates and their impact on poverty outcomes.
Chinese growth was faster and more pro-poor. Not only China continued to save and invest a far
higher proportion of its GDP than India, its integration with the world economy became far
deeper. Its share of foreign trade goods in GDP, albeit an imperfect proxy for global integration,
rose from approximately 12% in 1980 to nearly 44% in 2000. In India, the share fluctuated
around an average of 12% until the opening of the 1990s and has since risen to 20%. Another
aspect of global integration, namely, inflows of foreign direct investment (FDI) also showed
similar differences: the ratio of FDI to GDP in China grew from virtually nothing, when the
reforms began in 1978, to 4.3% in 2000. In India, even after a decade of reforms the ratio is only
0.6% (World Bank 2002).
The sequencing of reforms was also somewhat different in the two countries. China
reformed its agriculture first by abolishing collectives, introducing the household responsibility
system, and reducing mandatory deliveries of output to the state by farmers and thereby enabling
22
farmers to produce for the market. India’s agriculture, while always in the private sector, was
insulated from world markets, riddled with government interventions in the domestic market for
inputs and outputs, whose net effect was to disprotect agriculture. Indian reform process is still
to be extended to agriculture. Clearly, the fact that China reformed agriculture first, and
achieved spectacular results for several years, not only provided credibility to its reform process
but also increased incomes of the poorer segments of the Chinese economy. In India agriculture
in particular, and rural economy in general, are yet to be reformed systemically. Until it happens
not much of acceleration in the rate reduction of rural poverty can be expected.
Although India and China reformed their external sector by reducing tariff and non-tariff
barriers, as noted earlier, China’s opening went much deeper. In part this was because, while
opening the special and coastal economic zones for foreign investment, China in effect allowed
foreign investors 100% ownership, freedom to hire and fire workers and provided them with an
excellent infrastructure. In all these respects India lagged behind. Further, India’s reservation
(until very recently) of labour-intensive products such as garments, leather products and others to
the small-scale industry prevented the full exploitation of opportunities from its opening. China
increased its share of world exports of labour-intensive products, while India struggled to
maintain its share and in fact lost in some products. I compared our export performance in
labour-intensive commodities to China’s in two major markets, namely, European Union and
North American (USA and Canada), during the decade of the 1990s. I considered eight labourintensive product categories in which China and India would be expected to have comparative
cost advantage. China’s share in North American imports rose from 12% in 1990 to a peak of
27% during 1997-1999 and averaged at 22% for the decade of 1990-2000. India’s share, on the
other hand, fluctuated around an average of 1% with no trend. China’s share, as well as ours, in
23
the imports of the European Economic Community fluctuated, around an average of 3% in the
case of China and 0.8% in our case. India failed to regain its lost share in world exports. Our
share was 2.2% in 1948, and insulation from the world economy during our relentless pursuit of
an inward-oriented development strategy led to a drastic drop in this share to a low of 0.5% on
the eve of reforms in 1991. It has since climbed slowly to 0.8% in 2002. By contrast, the
Chinese share, which was around 1% on the eve of China’s opening and reforms in 1978, more
than quadrupled to 5.1% in 2002 (WTO, 2002a, 2003). India’s shallower integration and failure
due to lack of domestic policy reform to avail of the opportunities in the world market limited
not only the growth enhancing impact of trade reform, but also more importantly, its poverty
reducing effect.
In at least two other respects, Chinese and Indian reforms differed significantly, the
differences favoring China both with respect to growth and with respect to poverty alleviation.
The first is in their approach to the reform of state-owned enterprises (SOEs). The share of
investment in SOEs continues to be high (about 30% in India and two-thirds in China in 2000) in
both economies and employment in SOEs has not fallen significantly in spite of the fall in their
share of total output. These similarities notwithstanding, there is no Indian counterpart to
China’s dynamic township and village enterprises, which by all accounts were labour-intensive
and provided employments opportunities to the poor. The second area in which India lagged and
continues to lag behind China is in the availability of reliable and affordable infrastructure,
particularly power. While China has succeeded in attracting foreign investment into this vital
sector, India has failed to do so. Clearly infrastructural restraints inhibit growth directly and the
growth effects on poverty indirectly.
24
5. The Doha Round of Multilateral Trade Negotiations
The fifth session of the ministerial conference of the World Trade Organization (WTO) is to
take place in Cancun, Mexico during September 10-14 this year. At its fourth session in Doha,
Qatar, in November 2001, the ministers set a work programme for the WTO, with deadlines to
be met along the way. They are to review and take further decisions at Cancun.
The crowning achievement at Doha beyond doubt is the decision to launch a new round of
multilateral negotiations. The importance of this decision cannot be overstated. The threats to a
liberal, rule-based, and multilateral trading system were gathering strength as the ministers met.
The anti-globalization forces, a motley combination of anarchists, protectionists and their
political (and even some academics) patrons, and those who mistakenly, but nonetheless
genuinely, believed that global integration was hurting the poor in DCs, have not disappeared.
They were only deterred by the events of September 11, 2001 from mounting a Seattle-style
attack in Doha. The world economy, which was already in a slow down for over a year, if not in
a major recession, faced great economic uncertainties after the terrorist attacks on the World
Trade Center in New York on September 11, 2001, and the hostilities in Afghanistan that they
spawned. Unlike past episodes, the present slow down, which in fact started in 2000, is affecting
all major economies of the world at the same time. It is well known that in periods of economic
weakness, protectionist forces gather strength everywhere. By launching a new round, and
thereby creating a reasonable presumption of further multilateral reductions in barriers to trade
and investment flows, the ministers have provided incentives for exporting interests everywhere
to counter protectionist threats. By affirming their commitment to negotiate further reductions in
trade barriers and thereby furthering the process of global integration, the ministers have spoken
clearly and loudly against the anti-globalization cabal.
25
By launching negotiations for non-discriminatory multilateral reductions of trade barriers, the
ministers hopefully also addressed the threat to the multilateral trading system arising from the
proliferation of preferential trading on a regional basis. The seriousness of this threat can be
seen from the following facts. As of mid-2000, there were 114 such agreements in effect and
notified to the WTO by one or more WTO members (WTO, 2001b, p. 37). Virtually all WTO
members, other than China (including Hong Kong and Macau), Japan and Mongolia, were
partners in at least one regional trade agreement (RTA). The EU is a partner in the largest
number of agreements encompassing Europe, Africa, Asia and, as of 2000, Latin America.
WTO (2001b, p. 39) recognizes that “the trend to the conclusion of RTAs, which took off in the
1990s, continued to be very strong in 2000; indeed, perhaps the term “regional” is increasingly
superfluous to describe the plethora of new agreements linking countries around the globe.” In
April of 2001, President George Bush and leaders of 33 other nations met in Quebec City,
Canada, at a summit. They instructed their ministers to conclude, no later than January 2005,
negotiations on a free trade area extending from high arctic in the North to Terra de Fuego in the
South. Finally formal invitations to ten Central and Eastern European countries to join the EU
was approved at a summit meeting of its existing members in Copenhagen during 12-13
December 12-13, 2002.
It has been claimed (World Bank, 2000) that contemporary regional trade agreements
(RTAs) involve benefits from “deeper” integration through harmonization of standards,
competition and investment rules and so on, and that there are political benefits such as greater
national security, greater bargaining power in global negotiations and the possibility of “lockingin” domestic reforms by invoking commitments undertaken in an RTA. However, no convincing
case or evidence have been offered as to why preferential trading is a prerequisite for reaping
26
these unconventional benefits. The argument that preferential trade liberalization on a
discriminatory regional basis, and on a multilateral, non-discriminatory basis are mutually
reinforcing is utterly convincing. “Open regionalism,” which claims that the two processes are
compatible, is a vacuous notion, if not an oxymoron. These arguments in support of preferential
trade liberalization are not persuasive. This being the case, the launching of the Doha Round of
multilateral liberalization is very important. Let me now turn to the contents of the Doha
declaration.
The developing countries (DCs) had earlier placed before the WTO General Council the
difficulties they encountered in implementing their Uruguay Round commitments. Before Doha,
the General Council had met in special sessions to deal with them. Countries led by India had
taken the position that the implementation issues had to be resolved before they would endorse a
new round. In their Doha declaration, the ministers attached “the utmost importance to the
implementation issues and concerns raised by members” and indicated their determination to
solve them by making them an integral part of the agreed work program” (WTO, 2001a,
paragraph 12). They also adopted some of the decisions of the General Council on these issues.
On agriculture, the ministers, “without prejudging the outcome of negotiations,” committed
themselves to “comprehensive negotiations aimed at: substantial improvements in market
access; reduction of, with a view to phasing out, all forms of export subsidies; and substantial
reductions in trade distorting domestic support . . . modalities for further commitments including
provisions for special and differential treatment, shall be established no later than March 31,
2003 (WTO, 2001a, paragraphs 13, 14, emphasis added3).
3
The “modalities” are targets (including numerical targets) for achieving the objectives of negotiations, as well as
issues related to rules (www.wto.org/english/tratop_e/negoti_mod1stdraft_e.htm).
27
On non-agricultural products, the ministers also agreed to negotiations (albeit by modalities
to be agreed) “to reduce or as appropriate, eliminate tariffs, including the reduction or
elimination of tariff peaks, high tariffs, and tariff escalations, as well as non-tariff barriers, in
particular on products of export interest to developing countries. Product coverage shall be
comprehensive and without a priori exclusions” (WTO, 2001a, paragraph 16, emphasis in
original).
Trade Related Aspects of Intellectual Property Rights (TRIPS) figured both in the main
ministerial declaration and a separate one concerning TRIPS and public health. In the main
declaration, ministers agreed to negotiate the establishment of a multilateral system of
notification and registration of geographical indications for wines and spirits by the fifth session
in Cancun. More relevant for developing countries is the extension of protection of geographical
indications to other products (e.g., Basmati rice). This was left to be addressed by the Council
for TRIPS, which has also been instructed to examine the protection of traditional knowledge
and folklore.
Interestingly, while recognizing that WTO members with insufficient or no manufacturing
capacities in the pharmaceutical sector could face difficulties in making effective use of
compulsory licensing, the ministers left it to the Council on TRIPS to find an expeditious
solution to this problem. The least developed country members were given until January 2016 to
implement or apply Section 5 (on Patents) and Section 7 (on Undisclosed Information) of TRIPS
agreement without prejudice to their seeking other extensions.
On the vital issue of labour standards, the ministers simply reaffirmed their decision at the
Singapore ministerial to leave the issue to the International Labour Organization. The ministers
recognized “the case for a multilateral framework to secure transparent, stable and predictable
28
conditions for long-term cross border investment, particularly foreign direct investment” and
agreed that “negotiations will take place after the fifth session of the ministerial conference on
the basis of a decision to be taken, by explicit consensus, at that session on modalities of
negotiations”4 (WTO, 2001a, paragraph 20). Until that session, the Working Group on
Relationship Between Trade and Investment on a variety of issues was to continue its work.
On competition policy, transparency in government procurement and trade facilitation, the
ministers recognized the case for a multilateral framework to enhance the contribution of
competition policy to trade and development. On this and on the ministers agreed that
negotiations will take place at the same time and on the same terms as set forth for negotiations
on trade and investment (WTO, 2001a, paragraph 23.)
On trade and environment, the ministers agreed to negotiations, without prejudging their
outcome, on the relationship between existing WTO rules and specific trade obligations set out
in multilateral environmental agreements (MEAs), procedures of exchange between MEA
secretariats and the relevant WTO committees and on the reduction or as appropriate, elimination
of tariff and non-tariff barrier on environmental goods. The ministers instructed the Committee
on Trade and Environment to pursue work on all items on its agenda and its current terms of
reference, while giving particular attention to the effect of environmental measures on market
access, particularly of DCs and LDCs, relevant provisions of TRIPS and to eco-labeling (WTO,
2001a, paragraph 32).
It is clear that a lot of work was to have been completed by the end of 2002. Even if it had
been, the ministers, when they meet in Cancun in September 2003, were to be presented with
4
A literal reader of the declaration would conclude that the phrase “decisions to be taken, by explicit consensus”
applied only to the modalities of the negotiations, and not for undertaking the negotiations. On India’s insistence,
the chairman of the Doha ministerial clarified that it applied to both. The legal standing of this clarification is
unclear.
29
several reports by the General Council and by the Director-General and expected to undertake
stock-taking in some important areas. Unfortunately some crucial deadlines have not been met
that were to have been met by 31 March 2003. These relate to TRIPS and Public Health,
Agriculture and Special Differential Treatment. This failure has thrown into doubt whether the
deadlines remaining before the ministers meet would be met. Indeed, some fear the negotiations
are headed for a collapse. The serious differences between France and Germany on the one
hand, and the US on the other, with respect to the invasion of Iraq could spill over into trade
negotiations. Apparently negotiations have been at a standstill in Geneva since the Iraq war.
The Trade Negotiating Committee is scheduled to meet in May, June, July, and August and
WTO’s General Council is to meet in May and July. Unless in the next few months, the major
trading nations of the world, namely the US, EU and Japan, climb down from their hard
positions and make some compromises, the expectation that an agreed draft declaration will be
ready for the ministers to consider when they meet in Cancun in September is unlikely to be
fulfilled. In that case, it might be too late to salvage the Doha Round.
India has been trying to build a coalition amongst the DCs in order to achieve development
objectives in the Doha Round. India’s priorities in the pre-Cancun meetings have been Special
and Differential (S and D) Treatment for Developing Countries, Implementation Issues, TRIPS
and Public Health. India sees a difference between positions taken by trade ministers from
developed countries, who are viewed as sympathetic to DC concerns, and their trade negotiators
“who strive to get the best deal for themselves and avoid meeting developing country issues on
tenuous technical grounds or are willing to consider flexibilities in terms of longer transition
periods” (speech of India’s Minister of Commerce and Industry, Mr. Arun Jaitley, at an OECD
30
Ministerial Council Meeting in Paris, Press Release, Government of India, Press Information
Bureau, 2 May 2003).
India’s insistence on S and D is not in the best interest of India or other DCs. For example,
India’s proposals on Agriculture call for an exemption of a “Food Security Box” for DCs which
includes the following measures:
•
•
•
All measures taken by the developing countries for poverty alleviation, rural
development, rural employment and diversification of agriculture should be
exempted from any form of reduction commitments;
Appropriate level of tariff bindings to be allowed to be maintained by developing
countries as a special and differential measure, keeping in mind their
developmental needs and high distortions prevalent in the international markets
so as to protect the livelihood of their very large percentage of population
dependent on agriculture. The appropriate levels of tariff bindings will have to
necessarily relate to the trade distortions in the areas of market access, domestic
support and export competition being practiced by the developed countries;
Developing country members should be exempt from any obligation to provide
any minimum market access.
Clearly, if these are accepted, the DCs in effect can set tariffs at whatever levels they choose!
S and D treatment was formally incorporated through the so-called enabling clause of the
agreement concluding the Tokyo Round of Multilateral Trade Negotiations in 1969. By
definition, it is a derogation of the principle of nondiscrimination enshrined in Article I of
GATT. It also opened the door for bilateralism since preferences for each DC were negotiated
bilaterally by each country that granted such preferences. There is no more accurate way of
characterizing the so-called Generalized System of Preferences than calling it a system by which
the rich distributed crumbs from their table to the poor on terms they determined! S and D
treatment had hurt DCs in at least three ways. Once, through the direct costs of enabling them to
continue their import substitution strategies; a second time, by allowing the developed countries
to get away with their own GATT-inconsistent barriers (i.e., in textiles) again imports from
developing countries; and a third time, by allowing the industrialized countries to keep higher
31
than average tariffs on goods of export interest to developing countries. On the other hand, if
DCs agree to be bound by the same rules as others, but at a later time (while credibly committing
not to ask for an extension of the later time), it would benefit them. This will allow DCs
adequate time to bring about needed changes in their economies, while signaling producers,
consumers and investors in DCs that at the end of the specified period, they will be facing the
same rules as the rest of the membership. Again, given this certainty of change in rules that will
apply to them at the end of a known period, they can optimally adjust to the change.
India has proposed several measures aimed at limiting the application of anti-dumping
measures (ADMs). Still, in the second half of 2001, India had the dubious distinction of having
initiated the largest number (55 out of 210) ADM investigations. In the first (second) half of
2002, India also had the same dubious distinction, having initiated 25 (54) out of 104 (149)
investigations (WTO 2002b, 2003). Moreover, the attitude of the Designated Authority of the
Directorate General of Anti-Dumping and Allied Duties (DGADAD) regarding the issue of
taking into account consumer interests in taking ADMs is disturbing. “To begin with there was
no specific provision in the Act to take into account the interests of consumers. Secondly, there
were logistic problems in contacting the so-called representatives of consumer interest as the
sheer numbers could be staggering. While it was easy to consider consumer interest in the case
of an intermediate good or raw material, it could become unwieldy when the concept of
consumer good came up in a situation when the end users were not interested in anti dumping
and were only too happy with the cheaper product” (DGADAD, 2003, p. 92). Given that ADMs
are discriminatory, can be manipulated, and distort trade significantly, DCs such as India, which
are victims of ADMs imposed by developed countries, should resist imposing them themselves.
Although it is very unrealistic, still in the negotiation on clarifying Article VI of GATT/WTO
32
relating to anti-dumping, India should have proposed banning ADM altogether, rather than
merely restricting its use.
6. Conclusions
Let me conclude with an assessment of the current economic situation in India and what it
portends for the near to medium term future. The contemporary Indian macroeconomic scene is
a paradox. Consider the following facts: fiscal deficit of centre and states together in 2001-02 at
9.9% of GDP is higher than its level of 9.4% in the crisis year of 1990-91. If we add the deficit
of the non-financial public sector enterprises to the conventional fiscal deficit, the overall deficit
would be even higher now as a proportion of GDP than in 1990-91. The revised estimates for
2002-03 suggest a gross fiscal deficit of 5.9% for the central government. The budget estimate
for 2003-04 is only marginally lower at 5.4%. On the other hand, our current account has turned
into surplus, and foreign exchange reserves have crossed the $80 billion mark. Foodgrain stocks
with the government, at 48 million metric tons in early January 2003, are three to four times
what would be required for the operational and buffer stock needs. It appears that commercial
banks are holding more government securities than they are required to hold. Despite a serious
drought, inflation is not an issue, and interest rates are falling. Taken together, these facts are
paradoxical for a developing country such as India and suggest a rather unhealthy state of affairs.
I say so because, for a poor developing country, it would be normal for the current account to be
in deficit, being financed by a capital account surplus from sustainable foreign capital inflows.
And again, it would be normal for the capital inflows to support domestic investment in growth-
33
promoting capacity. Instead, we have a current account surplus, and capital inflows are reflected
in the accumulation of reserves5.
Ours is a regime of managed float in which the exchange rate of the rupee has been kept
within relatively narrow bounds. Given this fact, I do not wish to minimize the insurance role of
reserves in smoothing shocks to terms of trade and in responding to the volatility of short-term
capital flows. Still, our reserves are far higher than our short-term external debt. Although a part
of capital inflows reflect the fact that real interest rates in capital exporting rich countries are
currently lower than ours, such capital flows are sensitive to the differentials in real interest rates
and volatile. We could experience a fairly sudden outflow of such capital if real interest rates
rise elsewhere relative to ours. It is true that reserves (at least that part which is not gold and
foreign currency) do earn a positive return. However, unless I am very mistaken, the overall
marginal return from reserves, even taking into account the insurance aspect, would almost
certainly be much less than the return from growth-enhancing investments in the economy were
the situation to be normal. The Reserve Bank of India (RBI) has intervened to buy foreign
exchange so that the rupee does not appreciate too much and hurt our exports. Even so, my point
would be that had the situation been normal, appreciation would have been less likely, and RBI
would not have had to intervene.
Looking at the situation from a different perspective, our high fiscal deficit apparently
has not put pressure on the current account. It would have, if either an increase in the fiscal
deficit reflected higher public investment expenditure, such as on infrastructure, which in turn
crowded in private investment so that aggregate investment exceeded domestic savings to a
larger extent, or alternatively, private investment was rising regardless of the composition of
5
By accumulating reserves, China, India, Pakistan, and other poor Asian developing countries are in effect lending
to the rich US and financing its current account deficit!
34
public expenditures. The fact it has not could mean either the deficits crowded out private
investment so that an increase in the fiscal deficit was accommodated by a fall in private
investment, given total domestic savings, or private investment was down for other reasons, and
its fall enabled the government to run higher deficits. Had there been serious crowding out of
private investment, I think we would not have seen a downward movement in interest rates.
Also, the fact that banks are investing in government securities rather than commercial paper
suggests that all is not well with private investment, though I do not wish to downplay the
chilling effect on the investment decisions of public sector banks because of the prospect of the
management being pilloried by members of Parliament and criticized by the Comptroller and
Auditor General if investments do not pan out, regardless of whether it was because the
management made an honest but poor commercial judgment or it was due to malfeasance by the
management. Clearly any criminal conduct has to be investigated and punished. But applying
civil service rules to commercial actions by management and employees of public enterprises,
including banks, is inappropriate. It induces extreme risk aversion on their part in making
business judgments.
A careful empirical macroeconomic analysis that distinguishes exogenous shocks and
endogenous responses to those shocks and allows for leads and lags is necessary for us to arrive
at a sound explanation for our abnormal macroeconomic scene. Unfortunately, the abysmal state
of macroeconomic statistics relating to savings investment and GDP precludes such an analysis.
My look at the available data suggest that funds available for financing investment by the public
and private non-household sector from financial savings and capital inflows exceed the estimated
investment, the difference being attributed in official statistics to errors and omissions6. These
6
I discuss the problems with our macroeconomic and other data in Srinivasan (2003).
35
have been large in recent years. In any case, my bottom line is that our abnormal economic
scene is a reflection of our poor investment climate.
It seems to me that the current macroeconomic situation notwithstanding, a growth target
of 8% per year of the Tenth Plan is achievable. First of all, India’s average annual growth rate
was close to 6% since 1980, with a peak rate of 7.5% in 1996-97. An acceleration to 8% from
this base is not a substantial jump and can be sustained given appropriate policies, most
importantly with respect to openness. Second, our current macroeconomic scene of subdued
investment climate suggests that once the climate is changed for the better (or to use Keynes’
colorful phrase, “animal spirits” are revived) the comfortable stock of foreign exchange and food
reserves would enable higher investment rates to be sustained without fear of igniting inflation or
running into unsustainable current account deficits. Third, a better domestic investment climate
would also attract more foreign direct and portfolio investment. However, improving the
investment climate would require actions on the obvious and well-known constraints: high fiscal
deficits, poor infrastructure, dysfunctional labour and bankruptcy laws and reducing the
stranglehold of public sector banks in the financial sector. The needed political consensus for
taking these actions does not seem to exist. The most urgent task is to work towards building
such a consensus7. If we fail in this and the needed actions are delayed or not taken, India will
be condemned to a 21st century version of the “Hindu” rate of growth, namely 5%-5.5% per year,
a rate too slow for eradicating poverty in a reasonable time.
7
It is worth recalling (see Srinivasan (1996b) for details) that in the decade before independence, several plans for
national development were put together by groups across the political spectrum, including the Indian National
Congress’s National Planning Committee, a group of industrialists and businessmen, trade unions and Gandhians.
Interestingly, there was a common core in all these plans on the need for planning with the state playing a major role
in the economy, that could be deemed a political consensus. It is another matter that planning turned out to be a
failure and the state’s dominant role has been strangulating, rather than accelerating, growth.
36
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