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You need capital control to control the volatility of prices

You need capital control to control the volatility of prices
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First Published: Sun, Feb 14 2010. 09 25 PM IST

Suggesting caution: Economist Andrew Michael Spence says moderately aggressive incremental reform will be beneficial, and will support growth and development as well as reduce poverty. Ashesh Shah / M
Suggesting caution: Economist Andrew Michael Spence says moderately aggressive incremental reform will be beneficial, and will support growth and development as well as reduce poverty. Ashesh Shah / M
Updated: Sun, Feb 14 2010. 09 25 PM IST
Mumbai: At an international research conference hosted by the Reserve Bank of India in Mumbai last week, economist Andrew Michael Spence, winner of the 2001 Nobel Prize in economics and chairman of the influential Commission on Growth and Development, questioned many elements of the Washington Consensus, a set of policies that had gained acceptance across the world since the early 1990s.
Suggesting caution: Economist Andrew Michael Spence says moderately aggressive incremental reform will be beneficial, and will support growth and development as well as reduce poverty. Ashesh Shah / Mint
Spence later met Mint for an hour-long interview, where he spoke on why India should maintain some capital controls, actively manage its exchange rate and ensure that the banking sector should be largely domestically owned, even as he said that India needs to move ahead with “moderately aggressive incremental reform”.
He also said that inclusive growth requires creation of productive employment opportunities for the poor rather than transfer payments and that India needs to worry about the state of its public finances. Edited excerpts:
The new report by the Growth Commission says that there are two policy issues that need to be rethought: financial reform and export-led growth. What are the implications for India, which has been cautious about financial reform and less dependent on exports?
Financial sector reform is important. India needs to expand the safe channels for credit, raising capital, bond markets etc. But it takes time. There is a certain amount of infrastructure that goes along with that.
On the real economy side, the focus should be on employment (generation).
There is now some talk about a Beijing consensus replacing the Washington consensus, and hopes here in India about a New Delhi consensus. Do you think there are significant new lessons to be learnt now after the crisis?
It depends on what significant means. Let me be direct on that. The fundamental elements of the policies required for sustained economic growth have not changed. But it’s a riskier place. The world could be more protectionist and the global economy less accessible. There is non-trivial continual risk on the financial side.
So I think there is a need for heightened sensitivity and priority attached to resilience, how to defend oneself. What that means is being conservative, and not all that differently from where you in India were before. That is the right strategy. I don’t believe in all this talk about a Growth Commission Consensus, a Washington consensus and so on. Once you get the basics, every country is different.
I certainly don’t think that in important respects anybody is going to replicate the Chinese approach. That doesn’t seem sensible. India’s education system is quite developed and the services sector is very well developed relative to China. Also, the financial sector in terms of the legal underpinnings and predictability is more developed.
The important difference is the timing and pace. I think there is a reasonable likelihood that there will be some convergence over time, but the unknown is on the government side, whether there will be any convergence or there will be different models (of development). In the case of China, if you have a big middle class, you probably won’t keep a relatively authoritarian single party model forever. You have to try to predict the evolution of the Chinese system, whether it will go smoothly or whether the Communist party will go down kicking and screaming. Who knows?
But I do think that democracy in India is a durable, permanent and huge intangible asset as a long-term basis for growth. It’s a multi-ethnic, multi-lingual, multi-belief society—and it works.
At one point of time, India was moving slowly to financial sector reform. Now perhaps the consensus is that it’s the right way to go.
Just because being conservative makes you look smart does not mean that you should stop the reform process. If you have massive urbanization with infrastructure needs, you have to get other avenues of financing.
You need to have capital controls and exchange rate management so that you have some control over the volatility of the prices that determine the way you interact with the rest of the world. You need a dominant domestic banking system—whether or not government owns it. This is all consistent with a fairly sceptical attitude towards the global economy, since this continues to be a fairly risky environment.
But moderately aggressive incremental reform will be beneficial, and will support growth and development as well as reduce poverty.
India has a twin deficit and a large public debt. Does this worry you?
You can mitigate the deficit by the growth. But high public debt is not a smart idea and if there is a way to get it down taking advantage of the growth that would be a good thing. The element of flexibility that you would like to have is the government having a capacity to fund more to the core, public sector side of investment. The good side is that India will probably do that a whole lot more efficiently than other people. China will probably wade over the top in terms of quality versus output.
In a “new normal” world, is there a scope of cooperation and how do you see India working with other Asian nations?
There is a very good likelihood that Asia will increasingly function and pick up itself as a unit, with China as a very dominant presence and perhaps India. India has to make a choice as to whether or not it would focus on a bit international economic relations with the rest of Asia.
We think of the east of South Asia as the high-growth area of the world and in the longer term, probably the biggest part of the global economy. I think, India can benefit from having good relations with whatever Asia evolves into East Asia.
But, both from a domestic and international point of view, it is complicated. China is quite nationalistic for historical reasons when it comes to territory, so it’s not an easy natural relationship.
Can developing countries really do a lot about the environment, especially when they are growing? Won’t that halt the development process?
The Growth Commission report talks more about local environment issues. It’s a smart policy to think about earlier rather than later. China is a classic example of a country that went for development first and thought it should deal with the environment later. It is costing them more now. If you ignore the environment now and subsidize energy prices then everything goes wrong. Cities are built the wrong way, buildings are built the wrong way, and you have a long line of capital goods that are very expensive to fix.
On climate change negotiations, I think the position of the developing countries is about right. It’s a very, very complex issue and getting a consensus is tough. So I would bet on countries making significant progress on this unilaterally at a domestic level.
Developing countries can pursue this subjectively, with each country taking their own steps, which is doing what they can do without crimping their growth and making growth as energy efficient as they can. That’s explicitly the Chinese policy and is now becoming Indian policy.
In India there is a lot of discussion about inclusive growth, but the inequality is growing and some kind of oligopoly capitalism could be emerging. How big a threat is this for the growth story?
If you don’t have very, very high and visible growth in employment, a lot of people will be left out and this will easily lead to a political backlash. What matters to people is that they think that their opportunities are expanding. But if they don’t see it, and there is just a lot of talk that the country’s growth is 9% a year, but nothing seems to be defining change, that is a big problem. People are not stupid. They understand that it is a long process.
niranjan.r@livemint.com
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First Published: Sun, Feb 14 2010. 09 25 PM IST
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