What’s Causing India’s Economic Growth?
When billionaire Warren Buffet throws his money around, people listen. Recently, Warren Buffet announced his decision to buy stocks and ownership of a variety of companies in India, a country only 25 years ago considered a third-world nation. This kind of announcement deserves some investigation.
Isn’t India the country with millions living on less than $1 a day? Doesn’t it have a pathetic economic climate for free market investors? What changed? In two words, capitalism happened.
To understand, it’s important to realize where India is coming from. Before World War II, other Asian countries were quickly modeling their economies, governments, and even their cultures after the United States, most notably Japan (Last Samurai, anyone?). That foundation served Japan well after World War II when, despite their war-torn nation, they soured to a GDP growth rate of 9.6% for the next 20 years. If it worked so well for Japan, why didn’t India wake up and smell the coffee?
After all, India’s rich natural resources and moderate climate served as a perfect foundation for a growing economy. Yet, the masses of India’s population were dressed shabbily, on the verge of starvation, and crammed into dirty huts. Here are two basic reasons for this ridiculous situation.
1. The Indian culture. India is a society is based on a caste system, where you’re born into your life status, and to try and change your lot in life is sacrilege. If you were in the ‘unskilled worker’ caste, you would remain so and hope for a better station in your next life. This kind of climate automatically serves as a disincentive for people to try to advance their economic position beyond a certain point.
2. The political climate. Capitalism was discouraged by the government. When Prime Minister Jawaharlal Nehru discussed Indian private industry in the early 1950’s, he was recorded as saying, “We will encourage them in every way by not touching them for at least ten years, maybe more. We do not know when we will nationalize them.” Businessmen were smarter than that. They knew that as soon as their ventures started yielding profitable returns, they government would nationalize them. So, what would be the point of growing a business outside of government subsidies?
India was experiencing economic stagnation because of a lack of incentives.
This model wasn’t sustainable in a growing world connected economy. Fiscal imbalances and the Gulf War caused government-owned imports to dry up and exports to rise. Investors retracted the little they had credited, and the deficit skyrocketed as India borrowed from foreign nations to keep their nationalized industries alive. Debt rose to 53% of the GDP (sound familiar?), and a combination of inflation/deflation stretches left little investor confidence.
India pulled itself up by its own bootstraps by doing two things.
1) Paying off all of it’s debt in one fell swoop. India literally airlifted 67 tons of gold to England and Switzerland in May, 1991. This jolted the consumer and investor confidence, and restored the velocity of circulation.
2) The government liberalized its economy. Finance Minister Manmohan Singh began opening the economy to international trade, and began instituting deregulation, privatization, tax reforms, and inflation-controls.
The results have been spectacular. The forex reserves picked up and peaked at $314.61 billion in 2008. Their services sector (Which is a whole other topic worth writing about. More on that later.), constituting over half of their economic revenue, remains unmatched in Southern Asia (Their offshore outsourcing alone has brought in a pretty $47 billion.). This isn’t to say that poverty is no longer an issue, but the improvement is stunning.
Most impressive of all, is their rebound after the 2008 crises. The Indian economy is one of the few that didn’t experience a GDP decline, but instead continued to grow at a slow but steady 1.55%. It is expected to return to 9% GDP growth within the next few years (According to the US Department of State).
The lessons that we can learn from this ‘rags to riches’ story are surprisingly basic.
1) Incentives matter. An economy isn’t going to grow quickly enough to survive if the government nationalizes any successful industry. Free markets work.
2) Debt matters. The United States must pay off its debt, or consumer confidence will continue to fall and the dollar will lose all value. Our $14 trillion federal debt is equivalent to 97% of our $14.66 trillion GDP. Something needs to change.
In the end, the lessons should be clear — we should pay off our debt and allow the free market to do its magic.