India's proposed direct tax code--Questions and Answers (Thomson Reuters)

The cabinet approved a new direct tax code on Thursday that will replace archaic income and wealth tax laws in the country, a key reform initiative that is aimed at widening the tax net and increasing federal revenues.

The direct tax code bill will now be placed before parliament for approval on Monday. The government aims to implement it from April 1, 2011.

Here are some questions regarding the tax reform.

WHAT IS THE DIRECT TAX CODE ALL ABOUT?

India wants to modernise its direct tax laws, mainly its income tax act which is now nearly 50 years old. The government, wants a modern tax code in step with the needs of an economy which is now the third largest in Asia.

The new tax code is expected to widen the tax base, end unnecessary exemptions, moderate tax rates and add to the government's coffers.

The federal budget has estimated about $92 billion in direct tax receipts for the year that ends in March 2011.

WHY IS IT IMPORTANT FOR INDIAN FIRMS AND FOREIGN INVESTORS?

One of the key aims of the new tax code is to provide a system which takes into account increased cross border mergers and acquisitions by Indian corporates over the last few years.

The new code is also expected to streamline tax rates and administration for foreign institutional investors, for whom India is a top destination.

Despite the crisis in the euro zone, capital flows have been robust this year with an inflow of $8.5 billion so far.

WILL IT PROVIDE GREATER STABILITY TO INVESTORS?

The code aims to provide greater tax clarity and stability to investors who want to invest in Indian projects and companies.

These officials have said the government would not like to tinker with tax rates every year to provide a greater degree of tax certainty to corporates, investors and individuals.

WHAT WILL BE THE IMPACT ON INDIAN AND FOREIGN CORPORATES?

On the face of it, the corporate tax rate has been reduced from a little over 33 percent to 30 percent. But tax experts say whether a company pays more tax or less will also depend on a key provision called the minimum alternate tax (MAT).

MAT is applicable to those companies who do not show book profits liable to tax, as they claim a plethora of exemptions on account of being in capital intensive industries. The MAT rate has now been increased from 18 to 20 percent in the new code.

Foreign corporates today pay a higher rate of tax. However, the new rate of taxation for foreign corporates is not yet known.

WILL IT BE REVENUE POSITIVE FOR THE GOVERNMENT?

The government has marginally lowered the tax burden for individuals and has effectively left corporates with largely similar tax rates as before, hoping that these changes will make the new code revenue positive.

Though the exact impact is not yet known, finance ministry officials have said the new code will help shore up the tax GDP ratio significantly from around the current 11 percent level.

WILL THE ANNUAL BUDGET BE LESS IMPORTANT?

An important part of the budget every year has been the detailing of the tax rates. However, with the introduction of the new direct tax code, the tax rates will not be part of the budget presented to Parliament every year.

(Reporting by Abhijit Neogy ; editing by Alistair Scrutton and Surojit Gupta)
http://in.reuters.com/article/idINIndia-51111220100827

CSAT to replace civil services prelims from 2011

NEW DELHI: The government will soon come out with a detailed syllabus of the Civil Services Aptitude Test (CSAT) -- a new scheme of examination, which is to replace the existing Civil Services (Preliminary) Examination from 2011.

The test is meant for shortlisting candidates for the CS (Main) Examination, being conducted every year to recruit officers in IAS, IFS, IPS and other elite central services.

The Centre had in March approved the proposal for introduction of CSAT in place of CS (Preliminary) from next year, and subsequently asked the Union Public Service Commission (UPSC) to work out its syllabus.

"The government will shortly notify the new scheme of examination giving details of the syllabus which is being worked out. CSAT is expected to come into force from the Civil Services Examination, 2011", said the minister of state for personnel Prithviraj Chavan.

In written response to a parliamentary question in Rajya Sabha on Thursday, Chavan said: "In CSAT, one of the optional subjects which a candidate could have chosen out of 23 optional has been replaced with a common paper on aptitude test".

Referring to the syllabus, which is yet to be finalised, sources in the ministry explained that the candidates may now have to appear in two objective type papers, having special emphasis on testing their "aptitude for civil services" as well as on "ethical and moral dimension of decision making".

Both these papers -- having equal weightage -- will be common to all candidates in place of one common paper (general awareness) and one optional paper (any particular subject of choice) under the existing system, which lays greater emphasis on subject knowledge.

As of now, the change will be effective only for the first of the three stages of the CSE from 2011 onwards. The second and third stages -- CS (Main) Examination and Interview, respectively -- will remain the same till a panel of experts goes into various aspects of the entire system and submits its report.

The proposal to this effect was sent to PMO last year by UPSC.

Officials, familiar with the proposal, explained that the changes had been suggested by various committees. Most of the panels had advocated for laying greater emphasis on "aptitude" of candidates than their subjects' knowledges, arguing that the specialists or experts of any particular subject may not necessarily be good civil servants unless they have actual inclination towards it.

An official said: "The new system (CSAT) will also provide a level-playing filed and equity since all candidates will have to attempt common papers unlike the current format which provides for only one common paper".

Though scaling system is currently used in Preliminary examination in order to ensure that no candidate who has opted for any particular optional paper gets any undue advantage because of varying degree of difficulty of any paper or inherent scorability, the government has received a number of complaints objecting to the method on one or the other ground.

Vishwa Mohan, TOI, Aug 27, 2010

Nuking own interests (Deccan Chronicle, 26 August,2010)

Recent developments on two fronts — one external and the other internal — underscore the need to think carefully about our relationship with the United States. On the external side, there has been a flurry of developments relating to Afghanistan. For a start, there is increased Pakistani activism to promote a settlement in Afghanistan by offering to act as an intermediary between Kabul and the insurgent groups. The Americans disavow any involvement in these efforts. Nevertheless they are taking a close interest in the “reconciliation” process. For it appears to offer the easiest way of reducing American military commitment to Afghanistan.

The fact that Pakistan could be nicely stringing them along is not lost on all American observers. But the Obama administration continues to delude itself about Pakistan. Seven months after the capture of Taliban leader Mullah Baradar, the Pakistanis are openly claiming that the arrest was aimed at preventing any talks between Kabul and the insurgent leadership that sought to leave Pakistan in the cold. Yet Washington tries to explain these away as “self-serving” claims by Islamabad. This is, of course, entirely in keeping with the Obama administration’s spin on the WikiLeaks revelations about Pakistan’s role in stoking the insurgency.

The American stance cuts against our interests in Afghanistan. Pakistan’s quest for “strategic depth” — a euphemism for a client state — in Afghanistan has destabilised the region for the last three decades. The United States’ unwillingness to treat Pakistan as part of the problem rather than the solution threatens to perpetuate this instability. What’s more, in deference to Pakistan’s wishes the US has connived at undermining our position in Afghanistan. The most recent instance is the American-driven agreement between Afghanistan and Pakistan which prohibits Indian exports to Afghanistan through Wagah.

Kabul, for its part, has been vocal in its criticism of Pakistan’s assistance to the insurgent groups. Afghan President Hamid Karzai’s effort to reach out to the political leadership in Pakistan has yielded little. In a strong opinion piece in Washington Post earlier this week, the Afghan national security adviser wrote that success in Afghanistan requires “confronting the state (Pakistan) that still sees terrorism as a strategic asset and foreign policy tool”. New Delhi too has belatedly decided to consider working with Iran and Russia in forestalling a Taliban resurgence. Efforts have also begun to persuade members of the anti-Taliban Northern Alliance to get their act together. But eventually New Delhi will have to go further in strengthening its strategic relationship with Kabul and in initiating steps that will not be welcomed by Washington.

However, developments on the domestic front suggest that the government remains chary of displeasing the US — even where our own interests are at stake. The ongoing tussle over the Nuclear Liability Bill is an excellent case in point. The central point of contention concerns the liability of the supplier — as opposed to that of the operator of a nuclear power plant — in the event of an accident. The original draft bill placed all the liability on the operator. But Clause 17 of the draft bill also allowed the operator a “right of recourse”, that is the right to recover from the supplier any compensation the operator is forced to pay, under certain circumstances: (a) when such a right is provided in the contract between the supplier and operator; (b) when the incident resulted from “wilful act or gross negligence” on the part of the supplier; (c) when the incident resulted from the act of a person “done with the intent to cause nuclear damage”.

From the outset, the American nuclear industry was opposed to the provision for channelling any liability to the supplier. For this would expose them to litigation in the event of accident. They argued that the proposed Indian bill did not accord with the Convention on Supplementary Compensation for Nuclear Damage, which places exclusive liability on the operator and to which India wishes to accede. This mincingly legalistic argument skims over some uncomfortable facts. For one, there is nothing in the convention that prevents signatories from going beyond its provisions or from registering their reservations. The more galling point is that there is nothing in the American legal system that provides the kind of immunity to suppliers that American firms are seeking in India. In any case, the convention has been ratified only by four countries and is not yet in force.

And yet the government has sought to accommodate the Americans by modifying the clause in ingenious ways to shield suppliers from legal action. As of this writing, it is not clear what shape the clause will eventually assume following the debate in Parliament. But the very fact that the government has gone to such lengths is dismaying. What’s worse, the government’s efforts have been justified and endorsed in extraordinary terms by champions of a close embrace of the US. One commentator has argued that stringent legislation would ensure that foreign firms would simply refuse to enter the market. Moreover, it would reinforce the Americans’ impression that “Do India a favour and it can’t reciprocate”. Another columnist reminds us that “there is something called gratitude”.

Such mawkish claims sit awkwardly with the utterly unsentimental fashion in which the US deals with its closest allies: think only of their response to British Petroleum’s oil spill in the Gulf of Mexico. The naiveté of such arguments is all the starker at a time when the Americans are insouciant about our interests in the neighbourhood. Besides, given that we are poised for a dramatic expansion of our nuclear energy sector, our ability to drive hard bargains, and the willingness of suppliers to live with them, should not be underestimated. Admirers of the US would do well to appreciate and emulate that country’s adroitness in using its domestic legislation to advance its international interests.

- Srinath Raghavan is a Senior Fellow at the Centre for Policy Research, New Delhi

The rising power of the Chinese worker (The Economist, August, 2010)

Cheap labour has built China’s economic miracle. Its manufacturing workers toil for a small fraction of the cost of their American or German competitors. At the bottom of the heap, a “floating population” of about 130m migrants work in China’s boomtowns, taking home 1,348 yuan a month on average last year. That is a mere $197, little more than one-twentieth of the average monthly wage in America. But it is 17% more than the year before. As China’s economy has bounced back, wages have followed suit. On the coasts, where its exporting factories are clustered, bosses are short of workers, and workers short of patience. A spate of strikes has thrown a spanner into the workshop of the world.
The hands of China’s workers have been strengthened by a new labour law, introduced in 2008, and by the more fundamental laws of demand and supply (see article). Workers are becoming harder to find and to keep. The country’s villages still contain perhaps 70m potential migrants. Other rural folk might be willing to work closer to home in the growing number of factories moving inland. But the supply of strong backs and nimble fingers is not infinite, even in China. The number of 15- to 29-year-olds will fall sharply from next year. And although their wages are increasing, their aspirations are rising even faster. They seem less willing to “eat bitterness”, as the Chinese put it, without complaint.
In truth, Chinese workers were never as docile as the popular caricature suggested. But the recent strikes have been unusual in their frequency (Guangdong province on China’s south coast suffered at least 36 strikes in the space of 48 days), their longevity and their targets: foreign multinationals.
China’s ruling Communist Party has swiftly quashed previous bouts of labour unrest. This one drew a more relaxed reaction. Goons from the government-controlled trade union roughed up some Honda strikers, but they were quickly called off. The strikes were widely, if briefly, covered in the state-supervised press. And the ringleaders have not so far heard any midnight knocks at the door.
This suggests three things. First, China is reluctant to get heavy-handed with workers in big-brand firms that attract global media attention. But, second, China is becoming more relaxed about spooking foreign investors. Indeed, if workers are upset, better that they blame foreign bosses than local ones. In the wake of the financial crisis, the party has concluded, correctly, that foreign investors need China more than it needs them. Third, and most important, the government may believe that the new bolshiness of its workers is in keeping with its professed aim of “rebalancing” the economy. And it would be right. China’s economy relies too much on investment and too little on consumer spending. That is mostly because workers get such a small slice of the national cake: 53% in 2007, down from 61% in 1990 (and compared with about two-thirds in America). Letting wages rise at the expense of profits would allow workers to enjoy more of the fruits of their labour.
Higher Chinese wages would also be good for the West. This may seem odd, given how much the rich world has come to rely on cheap Chinese labour: by one estimate, trade with China has added $1,000 a year to the pockets of every American household, thanks to cheaper goods in the country’s stores, cheaper inputs for its businesses and stiffer competition in its markets. Just as expanding the global labour force by a quarter through the addition of cheap Chinese workers helped to keep prices down in the West, so higher Chinese wages might start to export inflation. Furthermore, from the point of view of the global economy, labour is a resource, like land or oil. It would not normally benefit from the dwindling of China’s reserves of labour any more than from the drying up of Saudi wells.
Tomorrow’s global consumers
But in the wake of the financial crisis, things are different. Deflation is now a bigger threat than inflation. And with 47m workers unemployed in the OECD alone, labour is not holding back the global economy. What the world lacks is willing customers, not willing workers. Higher Chinese wages will have a similar effect to the stronger exchange rate that America has been calling for, shrinking China’s trade surplus and boosting its spending. This will help foreign companies and the workers they have idled. A 20% rise in Chinese consumption might well lead to an extra $25 billion of American exports. That could create over 200,000 American jobs.
Eventually, this extra spending will help the world economy return to full employment. At that point, foreign companies and consumers may miss China’s cheap coastal workers, who kept profits high and prices low. But there will still be cheap labour to be found inland and in places like India. And Chinese wages were anyway only half the story. The other half was Chinese productivity. Chinese labour costs tripled in the decade after 1995, but output per worker quintupled.
To repeat that feat, as it runs dry of crude labour, China will have to increase its supply of skilled workers. That will require a stable workforce, which stays with its employers long enough to be worth investing in. For that the government will need to relax further its system of internal passports, or hukou, which prevent migrant workers from settling formally in the city without losing their family plot back home. When labour was abundant, it suited the government to have a floating population that made few demands on urban authorities and drifted back to the family farm whenever hardship beckoned. But to maintain fast growth as the labour market tightens, China’s floating population will have to drop anchor.
As the late Joan Robinson, a Cambridge economist, once wrote, “the misery of being exploited by capitalists is nothing compared to the misery of not being exploited at all”. Her quip, written in 1962, was inspired by underemployment in South-East Asia. Since then, capital has busily “exploited” workers in that region and its giant northern neighbour, much to their benefit. Now it is time for capital to invest in them.

A Deeper Hole ( Excerpts from The Economist on US Recession)

A year into America’s recovery the view backwards continues to sharpen—and darken. The Commerce Department’s latest GDP figures show an economy that lost momentum in the second quarter of 2010. But they also include revisions to data going back to the beginning of 2007, covering the whole of the recession. And the recession was worse than previously believed.
The second-quarter figures themselves are pretty lacklustre. Growth slowed to a 2.4% annual pace, down from a rate of 3.7% in the first quarter and below expectations. Exports and consumer spending, the two best engines of a self-sustaining recovery, contributed less to growth than in the first three months of the year. In the 12 months since the unofficial nadir of the recession the economy grew just 3.2%. During the equivalent period after the recession of 1981-82, output leapt upwards by 5.6%.
But the data revisions may provide the bigger story. The updates show an economy that was weaker going into the recession than previously believed, and which declined much more steeply in the immediate wake of 2008’s financial crisis (see chart). These changes confirm the recession as the worst of the post-war years. Economic activity now appears to have declined by 4.1% from peak to trough, easily outstripping the 3.7% dip observed in the downturn of 1957-58 (in 1981-82 the drop was just under 3%). The decline in real GDP in 2009 was far and away the worst annual performance since 1946, when America was dismantling its wartime economy.
This clearer image of the recession may help settle some academic disputes. The downturn bolstered the conviction among some economists that GDP was the rougher of the measures of economic activity. Revisions to GDP, they argued, usually move it closer to an income-based economic gauge—Gross Domestic Income, or GDI—which should therefore be considered more accurate. An esoteric debate perhaps, but with real stakes: during the recession, GDI consistently showed a weaker economy than GDP did. Had policymakers focused on the income-based measure, their reaction might have been speedier and better informed.
Concern has grown over a break in the rough historical relationship between output and employment known as Okun’s Law. Unemployment has seemed “too high”, leading some economists to fret that structural barriers to job growth have become a serious problem. The new revisions solve the puzzle, but only up to the end of the spring of last year. From the third quarter on, the numbers still look out of whack, if less so than before; and, given the current level of growth, the economy is still not producing enough jobs. The updated view may add to fears that long-term unemployment is a significant threat. The longer high levels of unemployment stretch on, the less they can be explained by weak demand.
And then there is the ongoing debate within the Federal Reserve between inflation hawks and those fearing deflation. The revisions, which reveal a larger gap between potential and actual GDP, shift the field in favour of the deflation worriers, who may argue for more accommodative policy at the Fed’s meeting on August 10th.
( Excerpts from The Economist on US Recession, August,2010)

World Trade Organisation

History
At the United Nations conference held at Geneva in 1947, twenty three countries including United States of America signed General Agreement on Tariffs and Trade (GATT). During the same year, a charter was put on the table for setting up, within the United Nations Organisation, of a new agency to be called International Trade Organisation (ITO). Fifty nations signed the charter in Havana the following year, but it was never subsequently ratified by the required number of countries. The purpose of the agreement was to promote international trade free of barriers in the aftermath of World War II, and to draw up proposals for the implementation of policies based on those principles set in the agreement. It covered all the issues like tariffs, quotas, taxes, international commodity agreements and whatever was considered to have a bearing on the development of international trade, and was based on policies of non-discrimination and tariff reductions.
GATT has been expanded and updated through a series of multi-year conferences. The most famous have been the Kennedy Round (1963-1967), the Tokyo Round (1973-1979), and the Uruguay Round (1986-1994). The Uruguay Round ended with the decision to dissolve GATT and establish the more powerful and more institutionalised World Trade Organization (WTO) in 1995. The WTO replaced GATT as an international organization, but the General Agreement still exists as the WTO’s umbrella treaty for trade in goods. Trade lawyers distinguish between the GATT 1994, the updated agreement, and the GATT 1947, the original agreement which is still the heart of GATT 1994.
Introduction
The WTO has nearly 150 members, accounting for over 97% of world trade. Around 30 others are negotiating membership. By definition, the World Trade Organization (WTO) deals with the rules of trade between nations at a global or near-global level. But there is more to it than that. There are a number of ways of looking at the WTO. It’s an organization for liberalizing trade. It’s a forum for governments to negotiate trade agreements. It’s a place for them to settle trade disputes. It operates a system of trade rules. (But it is not a Superman, just in case anyone thought it could solve — or cause — all the world’s problems!). The WTO is like a table. People sit round the table and negotiate, and resolve trade disputes.
Essentially, the WTO is a place where member governments try to sort out the trade problems they face with each other. Therefore, the first step is to talk. The WTO was born out of negotiations, and everything the WTO does is the result of negotiations. Where countries have faced trade barriers and wanted them lowered, the negotiations have helped to liberalize trade. But the WTO is not just about liberalizing trade, and in some circumstances its rules support maintaining trade barriers — for example to protect consumers or prevent the spread of disease.
WTO also ensures that individuals, companies and governments know what the trade rules are around the world, and gives them the confidence that there will be no sudden changes of policy. In other words, the rules have to be “transparent” and predictable.
Principles / Characteristics of WTO Trading System
The World Trade Organisation is based on the following core-principles or characteristics:
1. Trade without discrimination:
The main principle in the charter of the World Trade Organisation is to promote international trade without any discrimination. This principle is further elaborated into two – MFN and national treatment:
(a) Most-favoured-nation (MFN) – treating other people equally: Under the WTO agreements, countries cannot normally discriminate between their trading partners. If a member country grants a special favour (such as a lower customs duty) to another member country, she has to do the same for all other WTO members.
This principle is also known as most-favoured-nation (MFN) treatment. It is so important that it is the first article of the GATT, which governs trade in goods. MFN is also a priority in the General Agreement on Trade in Services (GATS) and the Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS).
However, some exceptions are allowed. For example, countries can set up a free trade agreement that applies only to goods traded within the group —discriminating against goods from outside. Or they can give developing countries special access to their markets. Or a country can raise barriers against products that are considered to be traded unfairly from specific countries. In general, MFN means that every time a country lowers a trade barrier or opens up a market, it has to do so for the same goods or services from all its trading partners — whether rich or poor, weak or strong.
(b) National treatment – Treating foreigners and locals equally: Imported and locally-produced goods should be treated equally — at least after the foreign goods have entered the market. The same should apply to foreign and domestic services, and to foreign and local trademarks, copyrights and patents.
National treatment only applies once a product, service or item of intellectual property has entered the market. Therefore, charging customs duty on an import is not a violation of national treatment even if locally-produced products are not charged an equivalent tax.
2. Freer trade:
First of all it should be noted here that the WTO is not for free trade at any cost. It is all about lowering trade barriers between trading countries. The barriers concerned include customs duties (or tariffs) and measures such as import bans or quotas that restrict quantities selectively. From time to time other issues such as red tape and exchange rate policies have also been discussed.
Opening markets can be beneficial, but it also requires adjustment. The WTO agreements allow countries to introduce changes gradually, through ‘progressive liberalization’. Developing countries are usually given longer to fulfil their obligations.
3. Predictability:
Sometimes, promising not to raise a trade barrier can be as important as lowering one, because the promise gives businesses a clearer view of their future opportunities. With stability and predictability, investment is encouraged, jobs are created and consumers can fully enjoy the benefits of competition — choice and lower prices. The multilateral trading system is an attempt by governments to make the business environment stable and predictable.
One way of making investment stable and predictable is to ‘bind’ the member countries to their commitments. For example, ceilings on customs tariff rates, etc. However, a country can change its bindings, but only after negotiating and compensating its trading partners.
There are other ways as well to improve predictability and stability. One way is to discourage the use of quotas and other measures used to set limits on quantities of imports. Another way is to make countries’ trade rules as clear and transparent as possible. Many WTO agreements require governments to disclose their policies and practices publicly within the country or by notifying the WTO. The regular surveillance of national trade policies through the Trade Policy Review Mechanism provides a further means of encouraging transparency both domestically and at the multilateral level.
4. Promoting fair competition:
WTO is a system of rules dedicated to open, fair and undistorted competition. The rules on non-discrimination — MFN and national treatment — are designed to secure fair conditions of trade. So these rules also apply on dumping and subsidies. Many of the other WTO agreements aim to support fair competition, for example, in agriculture, intellectual property, services, etc.
5. Encouraging development and economic reform:
The WTO system contributes to development. On the other hand, developing countries need flexibility in the time they take to implement the system’s agreements. Over 3/4th of WTO members are developing countries and countries in transition to market economies. During the seven and a half years of the Uruguay Round, over 60 of these countries implemented trade liberalization programmes autonomously. At the end of the Uruguay Round, developing countries were prepared to take on most of the obligations that are required of developed countries. But the agreements did give them transition periods to adjust to the more unfamiliar and, perhaps, difficult WTO provisions — particularly for the poorest or ‘least-developed’ countries such as Bangladesh, Cambodia, Djibouti, Central African Republic, Guinea, Madagascar, Myanmar, Nepal, Uganda, etc. A ministerial decision adopted at the end of the round says better-off countries should accelerate implementing market access commitments on goods exported by the least-developed countries, and it seeks increased technical assistance for them. More recently, developed countries have started to allow duty-free and quota-free imports for almost all products from least-developed countries.
Benefits of World Trade Organisation
The following common benefits of the WTO’s trading system doesn’t claim that everything is perfect, otherwise there would be no need for further negotiations and for the system to evolve and reform continually:
1. The system helps promote peace. Peace is partly an outcome of two of the most fundamental principles of the trading system:
• helping trade to flow smoothly, and
• providing countries with a constructive and fair outlet for dealing with disputes over trade issues.
It is also an outcome of the international confidence and cooperation that the system creates and reinforces.
2. Disputes are handled constructively. As trade expands in volume, in the number of products traded, and in the numbers of countries and companies trading, there is a greater chance that disputes will arise. The WTO system helps resolve these disputes peacefully and constructively.
Around 300 disputes have been brought to the WTO since it was set up in 1995. Without a means of tackling these constructively and harmoniously, some could have led to more serious political conflict.
3. A system makes life easier for all. Decisions in the WTO are made by consensus. The WTO agreements were negotiated by all members, were approved by consensus and were ratified in all members’ parliaments. The agreements apply to everyone. This makes life easier for all, in several different ways. Smaller countries can enjoy some increased bargaining power. Without a multilateral regime such as the WTO’s system, the more powerful countries would be freer to impose their will unilaterally on their smaller trading partners. Smaller countries would have to deal with each of the major economic powers individually, and would be much less able to resist unwanted pressure.
In addition, smaller countries can perform more effectively if they make use of the opportunities to form alliances and to pool resources. Several are already doing this.
4. Freer trade cuts the costs of living. Protectionism is expensive as it raises prices through imposition of import duties and quotas. The WTO’s global system lowers trade barriers through negotiation and applies the principle of non-discrimination. The result is reduced costs of production (because imports used in production are cheaper) and reduced prices of finished goods and services, and ultimately a lower cost of living.
5. It provides more choice of products and qualities. This expands the range of final products and services that are made by domestic producers, and it increases the range of technologies they can use. When mobile telephone equipment became available, services sprang up even in the countries that did not make the equipment. Sometimes, the success of an imported product or service on the domestic market can also encourage new local producers to compete, increasing the choice of brands available to consumers as well as increasing the range of goods and services produced locally.
6. Trade raises incomes. Lowering trade barriers allows trade to increase, which adds to incomes — national incomes and personal incomes. But some adjustment is necessary. Trade also poses challenges as domestic producers face competition from imports. But the fact that there is additional income means that resources are available for governments to redistribute the benefits from those who gain the most — for example to help companies and workers adapt by becoming more productive and competitive in what they were already doing, or by switching to new activities.
7. Trade stimulates economic growth. This is a difficult subject to tackle in simple terms. There is strong evidence that trade boosts economic growth, and that economic growth means more jobs. It is also true that some jobs are lost even when trade is expanding. But the picture is complicated by a number of factors. Nevertheless, the alternative – protectionism – is not the way to tackle employment problems. In fact, the protectionism hurts the employment in the long run. For example, the US car industry, when the US Government designed trade barriers to protect the jobs by restricting imports of Japanese Cars, the American cars became more expensive, fewer cars were sold and there were major job cuts.
8. The basic principles make life more efficient. One of the most important features of WTO is that it provides efficiency in the international trade mechanism. It helps to cut costs because of important principles enshrined in the system. Such principles include non-discriminatory trade, transparency, increased certainty in trade conditions, simplification and standardisation of customs procedures, removal of red tapism, removal of bureaucracy, centralised databases of information, and such other measures that come under the head ‘trade facilitation’.
9. Governments are shielded from lobbying. One of the lessons of the protectionism that dominated the early decades of the 20th Century was the damage that can be caused if narrow sectoral interests gain an unbalanced share of political influence. The result was increasingly restrictive policy which turned into a trade war.
Superficially, restricting imports looks like an effective way of supporting an economic sector. But it biases the economy against other sectors which shouldn’t be penalized — if you protect your clothing industry, everyone else has to pay for more expensive clothes, which puts pressure on wages in all sectors.
Governments need to be armed against pressure from narrow interest groups, and the WTO system can help. The GATT-WTO system covers a wide range of sectors. So, if during a GATT-WTO trade negotiation one pressure group lobbies its government to be considered as a special case in need of protection, the government can reject the protectionist pressure by arguing that it needs a broad-ranging agreement that will benefit all sectors of the economy.
10. The system encourages good government. Under WTO rules, once a commitment has been made to liberalize a sector of trade, it is difficult to reverse. The rules also discourage a range of unwise policies. For businesses, that means greater certainty and clarity about trading conditions. For governments it can often mean good discipline.
The WTO agreements help in reducing corruption and bad government. But, quite often, governments use the WTO as a welcome external constraint on their policies. This cannot be done because it would violate the WTO agreements.
Criticism on World Trade Organisation
Criticisms of the WTO are often based on fundamental misunderstandings of the way the WTO works. Following are most common misunderstandings or criticisms on WTO:
1. The WTO dictates policy. According to critics, the WTO dictates the trade policy on its member countries. But that is not the case; in fact, it’s the governments who dictate to the WTO. WTO is a member-driven organisation. The rules of WTO are based on agreements resulting from negotiations among member governments. These rules are ratified by members’ parliaments. And all the decisions taken in the WTO are virtually made by consensus among all members.
2. The WTO is for free trade. There is another criticism on the World Trade Organisation is that it promotes free trade. According to critics, free trade could hamper the domestic production and serves the interests of giant global companies. Small domestic companies are unable to compete with such multinational companies and would not be able to survive. As a result, unemployment increases and national income decreases. It is true that it is one of the principles of WTO system that the member countries should lower their trade barriers and allow trade to flow more freely. But how low those barriers should go depends on the bargaining of member countries.
Moreover, the rules written into the agreements allow barriers to be lowered gradually so that domestic producers can adjust.
3. According to critics, the commercial interests take priority over development. Whereas, the WTO agreements are full of provisions taking the interests of development into account. Freer trade boosts economic growth and supports development. In that sense, commerce and development are good for each other.
4. Environmental issues. In WTO system, commercial interests do not take priority over environmental protection. Whereas, many provisions of WTO take environmental concerns specifically into account. For example, the preamble of the Marrakesh (Morocco) Agreement establishing the World Trade Organization includes among its objectives, optimal use of the world’s resources, sustainable development and environmental protection.
5. Health and safety issues. Key clauses in the agreements (such as GATT Art. 20) specifically allow governments to take actions to protect human, animal or plant life or health. But these actions are disciplined, for example to prevent them being used as an excuse for protecting domestic producers — protectionism in disguise.
6. The WTO destroys jobs and worsens poverty. Another accusation on WTO is that WTO system destroys jobs and widens the gap between rich and poor. In other words, it promotes economic inequalities internationally. The accusation is inaccurate and simplistic. Trade can be a powerful force for creating jobs and reducing poverty. Sometimes adjustments are necessary to deal with job losses, and here the picture is complicated. In any case, the alternative of protectionism is not the solution. It should be borne in mind that the biggest beneficiary is the country that lowers its own trade barriers.
7. Small countries are powerless in the WTO. But small countries are not powerless in WTO. In fact, they would be weaker without WTO. The WTO increases their bargaining power. In recent years, developing countries have become considerably more active in WTO negotiations, submitting an unprecedented number of trade proposals. They expressed satisfaction with the process leading to the Doha declarations. All of this bears testimony to their confidence in the system.
8. The WTO is the tool of powerful lobbies. This is a common misunderstanding that the system of the World Trade Organisation supports the powerful countries such as US, EU, Japan, etc. Giant corporations get undue protection from the WTO. The answer is that the WTO is a common platform for all the governments. The WTO treats all the countries equally. Therefore, WTO is not the tool of powerful lobbies; in fact, it offers governments a means to reduce the influence of narrow vested interests. The most common feature of the WTO is the negotiations that took place between the governments. These negotiations create a balance of interests. Governments can find it easier to reject pressure from particular lobbying groups by arguing that it had to accept the overall package in the interests of the country as a whole.
The WTO does not support the giant multinational companies. The WTO is an organisation of governments. The private sector, non-governmental organizations and other lobbying groups do not participate in WTO activities except in special events such as seminars and symposiums.
9. Weaker countries are forced to join the WTO. Another criticism about the WTO is that the weaker or developing countries or poor countries are influenced by developed countries or by the WTO itself to join the WTO. In fact, weaker countries do have a choice to join the WTO or not. However, they are convinced to join the WTO, because they can enjoy the benefits that all WTO members grant to each other. They have the opportunity to trade, negotiate, and settle their disputes with advanced countries within the WTO. Whereas, outside the WTO, i.e., under bilateral agreements, smaller countries are weaker and cannot increase their bargaining power esp. with advanced countries.
10. The WTO is undemocratic. Some theorists claim that the system of the WTO is undemocratic. Whereas, decisions in the WTO are generally by consensus. In principle, that’s even more democratic than majority rule because no decision is taken until everyone agrees.
WTO and the Developing Countries
In the World Trade Organisation, there are around 146 members from developing countries, i.e., about 2/3rd majority of the WTO. They play an increasingly important and active role in the WTO because of their numbers, because they are becoming more important in the global economy, and because they increasingly look to trade as a vital tool in their development efforts. Developing countries are a highly diverse group often with very different views and concerns. The WTO deals with the special needs of developing countries in three ways:
• the WTO agreements contain special provisions on developing countries
• the Committee on Trade and Development is the main body focusing on work in this area in the WTO, with some others dealing with specific topics such as trade and debt, and technology transfer
• the WTO Secretariat provides technical assistance (mainly training of various kinds) for developing countries.
The WTO agreements include numerous provisions giving developing and least-developed countries special rights or extra leniency — ‘special and differential treatment’. Among these are provisions that allow developed countries to treat developing countries more favourably than other WTO members.
The least-developed countries receive extra attention in the WTO. All the WTO agreements recognize that they must benefit from the greatest possible flexibility, and better-off members must make extra efforts to lower import barriers on least-developed countries’ exports.
The specific work on developing countries within the WTO can be divided into two broad areas:
1. the work of the WTO committees, and
2. the training for government officials and others.
1. WTO Committees:
The WTO consists of the following committees:
(a) Trade and Development Committee: The WTO Committee on Trade and Development has a wide-ranging mandate. It has the following priorities regarding the developing countries:
• implementation of provisions favouring developing countries,
• guidelines for technical cooperation,
• increased participation of developing countries in the trading system, and
• the position of least-developed countries.
Member-countries also have to inform the WTO about special programmes involving trade concessions for products from developing countries, and about regional arrangements among developing countries.
(b) Sub-Committee on Least-Developed Countries: The Subcommittee on Least-Developed Countries reports to the Trade and Development Committee, but it is an important body in its own right. Its work focuses on two related issues:
• ways of integrating least-developed countries into the multilateral trading system
• technical cooperation.
The subcommittee also examines periodically how special provisions favouring least-developed countries in the WTO agreements are being implemented. The following are the WTO member countries categorized as least-developed countries by the UN:
Angola, Bangladesh, Burundi, Cambodia, Central African Republic, Chad, Congo, Djibouti, Gambia, Guinea, Guinea Bissau, Haiti, Madagascar, Malawi, Maldives, Mali, Mauritania, Mozambique, Myanmar, Nepal, Niger, Rwanda, Senegal, Solomon Islands, Tanzania, Uganda, Zambia, etc.
Some additional least-developed countries are in the process of accession to the WTO. They are: Bhutan, Ethiopia, Laos, Sudan, and Yemen.
2. WTO Technical Cooperation:
The second area of working on developing countries within the WTO is associated with the technical cooperation or the training of government officials and businessmen from developing countries. It is devoted entirely in helping developing countries and countries in transition from centrally-planned economies to operate successfully in the multilateral trading system. The objective is to help build the necessary institutions and to train officials. The subjects covered deal both with trade policies and with effective negotiation.
The WTO holds regular training sessions on trade policy in Geneva. In addition, it organizes about 400 technical cooperation activities annually, including seminars and workshops in various countries and courses in Geneva.
Targeted are developing countries and countries in transition from former socialist or communist systems, with a special emphasis on African countries. Seminars have also been organized in Asia, Latin America, the Caribbean, Middle East and Pacific.
Funding for technical cooperation and training comes from three sources: the WTO’s regular budget, voluntary contributions from WTO members, and cost-sharing either by countries involved in an event or by international organizations.
Challenges to the Developing World
The developing countries under the new WTO regime are faced with a considerable increase in their obligations particularly in respect of government procurements, subsidies, anti-dumping, customs valuation and import licensing procedures. Again, the new obligations that they have accepted in the area of services and intellectual property rights could have adverse economic impact on their development.
The developing world, which consists of two-third majority of the total WTO membership, has not reaped plausible benefits under WTO regime. They also have a strong feeling that their voice is not being heard, and the issues raised by them are not being addressed. However, some noticeable change of strategy at the WTO seems to have taken place in recent years.
Major share of the world trade is controlled by the developed world. According to a survey only 17 countries control 72% of the world trade. A major dilemma faced by the developing countries in the trade liberalisation process is that a country may be able to control the speed of trade liberalisation, but cannot determine by itself how fast its exports should grow. Exports performance depends on quality, price and competitiveness of exportable commodities. Also, to become competitive, investment is required in developing the infrastructure, technology, human resources, and enterprise capacity for new exports, which is a long-term process and not easily achieved. The interesting phenomenon is that the developed world continues to insist on free trade and services and bringing down the tariffs in order to ensure fair competition between local and imported products. While, on the other hand, the developed world itself continues to follow protectionist policies in the case of agriculture to safeguard its costly products against cheaper foodstuff from the developing world.
Suggestions to the Developing Countries:
The developing world has tried to raise its voice on various forums but without much success. Apart from raising hue and cry for better treatment by the WTO and the developed world it should have its own strategy for economic development. Following are the suggestions for the developing countries:
• Identification of core strengths and competitive edge,
• Concentrate mainly on industries which use local raw material,
• Improve efficiencies, lower costs and upgrade quality of products in order to be able to make them export oriented to earn valuable foreign exchange,
• Develop small and medium enterprises,
• Continue to improve productivity in agriculture / fishing in order to remain self reliant in food production and earn good value for their exports,
• Develop human resource through education, training, healthcare and social justice, and
• The Government should reduce its role in running business.
But, unfortunately, most of the developing countries to-day is plagued by inefficiency, corruption, dishonesty, low productivity and a lack of will and desire on the part of elected representatives to improve the status quo. The developing countries cannot prosper on the prescriptions laid down by the World Bank, IMF or regular dole from rich nations. South Asian economies, especially Malaysia, Singapore, South Korea and China are a glaring example of what can be achieved through following a pragmatic path. Even the Indian economy has grown rapidly over the past decade with real GDP growth averaging some 6% annually, in part due to continued structural reform, including trade liberalisation. In recent years, though, Pakistan has also shown a remarkable performance in real GDP growth rate: 8.4% during the fiscal year 2004-05, 6.4% during 2003-04 and 5.1% during 2002-03, but yet there are many reforms to be made especially in manufacturing and service sectors.
The developing countries have a tough task ahead. If they do not take corrective measures they will be rendered producers of raw materials and operating locally produced agro-based industries only. They will, obviously, miss the opportunity to benefit from global trade. According to a research report by David Dollar of the World Bank, the growth rate of the developing countries during 1990s has been 5% (3.5% excluding China against 2% of the rich countries. He believes that there is solid evidence available to prove that this has happened due to participation in the free trade and globalisation process.
According to WTO Annual Report 2002, poor countries need to grow their way out of poverty and trade can serve as a key engine of that growth. But currently products of developing countries face many obstacles in entering the markets of rich countries. Rich counties need to do more to reduce trade-distorting subsidies and dismantle their existing barriers on competitive exports from developing countries.
Conclusion
In the present scenario of the global trade, both developing and developed worlds have their roles to play. The WTO and the developed world must make further concessions for the developing countries, which are in majority and have a very small portion of the total world trade, and are not in a position to compete with the advanced industrialised nations. On the other hand, the developing world has its own responsibilities to share. They cannot continue to live on grant-in-aids and consider others responsible for all their ills, while squandering their own resources. They have to put in serious efforts for overall improvement in the quality of life of their impoverished masses, through sustained economic growth. This would help them achieve their due share in the global trade, rather than see it marginalized further.

Some important newspaper articles you may have missed, but can't afford to....

(All these articles are available on the websites and copyrighted by the respective Publication Houses)
The real rot in agriculture
MINT (Hindustan Times), July 28, 2010
Reports of massive foodgrain rotting highlight the need for decentralizing the procurement and distribution process, and freeing up the market for grains
Indian policymakers back in the 1950s believed they could easily live without free markets. Sitting in New Delhi, they would supplant the market with trial and error: Dictate some price or quantity; if supply and demand didn’t happen to match, keep adjusting the price or quantity till they did.
Judging by reports of rotting foodgrains by Mint and our sister publication Hindustan Times this week, it’s clear policymakers at the Food Corporation of India (FCI) and the Union agriculture ministry haven’t shed this belief. Their trial and error ends up only in massive errors: Over the past four years, 600,000 tonnes of grains have been lost in storage, 675,000 tonnes in transit.
Some solution to this problem lies, then, in improving storage and transit. FCI, for instance, promotes “open plinths” (meaning grain stocks aren’t covered), sometimes even leaving them out in the open. Warehouses aren’t big enough. It can try to change all this, but that would mean even more money. Given that FCI already spends more on distribution than procurement, perhaps private entities can do better. Of course, such piecemeal privatization shouldn’t be a panacea; in cases where FCI already works with the private sector, it can even be a placebo.
The actual problem is, admittedly, harder to solve. Even if the government wants to prevent food from rotting, can it really correct years of misguidance?
At its simplest level, the problem is that food rots because FCI procures more than it can store or transfer. The buffer stocks at the end of June came to 58 million tonnes, more than twice what it’s supposed to hold. FCI has ended up holding so much grain because it is required to buy whatever any farmer wants to sell to it. And any farmer would doubtless want to sell to FCI: The government’s minimum support prices (MSPs) for wheat and rice have shot up 65-70% in the last four years.
So what does the government do? Don’t increase MSPs, and farmers will stop voting. Keep procuring, and it will find itself contending not just with rotting food, but also spiralling food prices. After all, if the public knows that FCI stores grain in an inflexible buffer stock, it will expect prices to rise—the recipe for inflation.
If the real crux of the problem is so deeply entrenched, India has to start wondering if the solution has to be more radical. In a January editorial, we suggested that the Union agriculture ministry just be abolished. Once this sector is decentralized—once restrictions on inter-state food sales go away, for instance—foodgrains can travel freely and be bought and sold in a freer market.
That’s when India will finally abandon the fatal conceit that a policymaker in New Delhi can determine true supply and demand.
From subsidies to imbalances
MINT , August 11,2010
Momentum in the Doha Round can help counter the US’ predatory trade practices in global agricultural markets
Biswajit Dhar
Increasing agricultural exports seem to have caught the fancy of the US trade regime in the recent weeks. The trigger for this thinking: President Barack Obama’s statement during the Toronto Group of Twenty summit in June that the outcome of the Doha Round negotiations must ensure new market opportunities in key emerging markets—including China, Brazil and India. More recently, in the Senate committee on agriculture hearing on promoting US agricultural exports, US trade representative Ron Kirk said the US was taking “the lead in pursuing new trade opportunities, with a special focus on the world’s fastest-growing markets, through initiatives with individual trading partners, across economically significant regions…” This strategy, according to Kirk, served as testimony that the Obama administration was “committed to trade policies that keep American farmers and ranchers supplying high-quality food and fibre around the world”.
It is interesting to note that the aggressive posture taken by the US to promote its agricultural exports comes at a time when Washington’s subsidies to this sector are on an increase. Recent figures from the Organisation for Economic Cooperation and Development (OECD) bring out the startling fact that total farm subsidies granted by the US (total support estimate, or TSE, in OECD parlance) increased by a whopping 22% between 2008 and 2009. As a result of this increase, total farm subsidies reached their highest level since OECD started recording farm subsidies in 1986. At the same time, OECD members as a whole have also upped their farm subsidies to a historically high figure of $384 billion. Thus, farm support given by OECD countries in 2009 exceeded a billion dollars a day.
The high doses of support that developed countries provide to their farms make a mockery of the economics of agricultural trade. Instead of relative efficiencies, it is the ability of the countries to provide subsidies that has formed the basis of trade in this sector. The World Trade Organization (WTO) has taken on the onerous task of reining in farm subsidies: It is implementing disciplines for gradual reduction of these subsidies provided in the Agreement on Agriculture (AoA) that was negotiated in the Uruguay Round in the late 1980s-early 1990s. But the inherent defects in the structure of AoA have torpedoed any possibilities of cleansing global markets of these market-distorting farm subsidies.
India and other developing countries have been consistently arguing that the Doha Round needs to be cognizant of the fact that AoA has done little to make any impact on market distortions created by subsidies. India and others say they can reduce their relatively high levels of tariffs only if a parallel movement on reducing farm subsidies takes place. One of the major reasons for the deadlock is that the US has remained fixated on its position: It sees high levels of farm subsidies as an essential component to its domestic policymaking.
In this context, it must be pointed out that the subsidy discipline that AoA has introduced leaves out several significant elements of the subsidies programme. The share of these subsidies that AoA turns a blind eye to was nearly 90% of the total farm subsidies the US is reported to have given in 2007. The subsidies so wilfully ignored include direct income support, where the government basically doles out a regular income to farmers; this has assumed importance as the US has been shifting away from conventional forms of market price and input subsidies, where the government reduces or increases some prices.
The trouble here is that direct income support is conveniently not included in the WTO subsidies discipline: The US and the European Union, which had played a decisive role in shaping AoA, had argued then that this form of subsidies did not distort markets, since farmers’ production decisions were not affected if they receive a regular cash handout from the government. But it is pretty “elementary”, as Sherlock Holmes would say, that a steady flow of income support to farmers would not only help increase their risk-taking capacity, but also help them in selling their products below cost. Evidence has it that US producers have been dominating the global markets in several commodities, including cotton—where the victims of their predatory practices have been some of the poorest countries in central Africa. In fact, so egregious is the cotton case that a dispute settlement panel constituted in response to a complaint brought by Brazil found the US subsidy regime in violation of even the relatively lax WTO subsidies discipline. The ruling of the panel, issued in 2007, was confirmed by WTO’s appellate body the following year.
It is quite clear that the continued US push for increased market access for its farm producers would result in aggravating an already unequal position in global agricultural markets. The only way to counter this tendency is to bring the momentum back in the Doha Round negotiations; this time, member countries must explore lasting solutions for such predatory practices. Perhaps more importantly, India and other developing countries must underline the need to put a comprehensive discipline on farm subsidies. That alone will ensure that the negotiations in the Doha Round culminate in a balanced outcome.
Biswajit Dhar is director general at Research and Information System for Developing Countries, New Delhi.
WTO text on agriculture: return to protectionism
MINT, Tue, Jul 15 2008.
A weak government without a political majority may not play the role it has been playing in recent years in ensuring a better bargain for farmers in developing countries
Farm Truths | Himanshu
The United Progressive Alliance government will seek a vote of confidence in a special Parliament session that starts 21 July. On the same day, a World Trade Organization (WTO) ministerial dialogue on the Doha Round starts.
A key issue that will be discussed is agriculture. India has a view on this that represents and protects its own interests and that of other developing countries and it has emerged a vocal and strong leader of a group of such nations. But things are different now. The government is pushing ahead with the Indo-US nuclear deal and whether it will compromise its stance at WTO under American pressure on at least some key issues that affect million of our farmers is something that will become clear only when the trust vote is over.
A weak government without a political majority may not play the role it has been playing in recent years in ensuring a better bargain for farmers in developing countries. These concerns have attained serious dimensions in the context of global food inflation and the resultant farm crisis in many countries. This ministerial meeting is a final effort to clinch the deal before the present US government’s term ends. With growing concerns about the US economy, there is a genuine fear that the next US president may take a protectionist stand.
The passing of the US farm Bill—which increases farm subsidy by more than $20 billion (Rs86,400 crore) along with restrictive trade practices—by two-thirds majority in the US Congress despite a presidential veto is an indication of the return of protectionism in developed countries. Ironically, even though the present round is called the Doha Development Round, the focus is on opening up free trade that will benefit developed nations, sometimes at the cost of developing ones.
The text of the draft agreements on agriculture as well as non-agricultural market access was released on 10 July. A preliminary reading of the text on agriculture does not suggest anything more substantial than drafts released in May and February. The real issues that stalled the negotiations are the special products and special safeguards mechanisms sought by developing countries to protect their small farmers, and the subsidy enjoyed in developed nations by large farmers and companies into agriculture.
Developing countries have demanded that special products should either be subject to no tariffs or very small reductions. However, special safeguard mechanisms would allow a temporary increase of relevant tariffs in response to increase in import volumes, or decline in price levels. The essential argument for the use of both these instruments is to increase the policy space available to developing countries in managing livelihood concerns, while continuing to integrate into the global economy.
The reasoning behind these measures is the reality that small and marginal farmers in most developing nations, including India, lead an exceedingly precarious economic existence and are not positioned to compete effectively in relatively open agricultural markets, particularly given the levels of subsidies enjoyed by agricultural producers in developed countries. Apart from the fact that such a strategy is required to protect the livelihoods of the rural poor, the special exemptions sought have to be seen in the context of shrinking policy space available to developing countries in helping small and marginal farmers cope with import competition, particularly so when direct production subsidies are not permissible in the WTO framework.
On this issue, there is some forward movement in conceding the demand of the developing countries. According to the proposed formula, “Developing country members shall be entitled to self-designate special products guided by indicators based on the criteria of food security, livelihood security and rural development. There shall be 10-18% of tariff lines available for self-designation as special products19. Up to 6% of/no lines may have no cut. The overall average cut shall, in any case, be 10-14%.”
However, developing countries had demanded 20% of their tariff lines to be designated as special products.
On the second issue of subsidy reduction by developed nations, there is almost nothing on offer. Bound by the European Union’s common agricultural policy (CAP), there is no possibility of additional subsidy reduction other than what is part of CAP. However, the US has already increased farm subsidy through the farm Bill, despite this being condemned by WTO director general Pascal Lamy. The targets for elimination of export subsidy are virtually unchanged.
Even on the issue of opening up their markets, developed countries have stuck to their position. But even these minimal concessions by developed countries are linked to better access for their manufacturing goods in developing countries. Given the present draft text, it is difficult to see the negotiations concluding in this ministerial meeting. Developed countries are ever increasingly taking protectionist stands, while expecting developing countries to open up their markets. If the recent experience of global food inflation and vulnerability of developing countries to international price volatilities is any indicator, opening up of international trade may not be the best option for developing countries.
Himanshu is assistant professor at Jawaharlal Nehru University and visiting fellow at Centre de Sciences Humaines, New Delhi. Farm Truths looks at issues in agriculture and runs on alternate Wednesdays. Respond to this column at farmtruths@livemint.com

True inclusive growth requires long-term vision for agriculture
MINT, Feb 17,2010
It is obvious that agriculture is in crisis but it would be premature and naive to blame this on the monsoon failure
Expert View | Himanshu
The euphoria about the better-than-expected farm performance in the current agricultural year may be short-lived. The drought may not have had the impact that most of us feared, but has still been instrumental in putting agriculture back on the agenda. As if the erratic monsoon was not enough, the massive failure on the price front at the consumer and producer end will be difficult to ignore whether in relation to growth or food security and livelihood.
It is obvious that agriculture is in crisis but it would be premature and naive to blame this on the monsoon failure. The crisis is deep-rooted and is a result of years of neglect, especially in the last decade or so.
Given the declining share of agriculture in the gross domestic product (less than 17% last fiscal), this may not be worrying to those who judge its value in terms of this contribution. But things get more complicated from the point of employment, livelihood and food security.
Agriculture remains the biggest employer, with more than half of the Indian population depending on it for livelihood.
However, its share of total investment is ridiculously low at around 7%, having dropped from an average 10%-plus during the National Democratic Alliance regime and around 20% in the beginning of the 1980s. Although there has been a recovery in absolute terms since the United Progressive Alliance took over in 2004, in real terms, public investment in agriculture has remained less than what it was in 1980-81. It has increased by an average 2% per year in the last 27 years, less than the average rate of growth of agricultural output.
But the neglect in financial investment and allocation is only part of the story. In the last two decades, there has been a collapse of extension services, which are meant to educate farmers on the latest research and techniques to help them raise productivity.
In the Situation Assessment Survey of Farmers in 2002-03, only 8% said they had received information from extension services or through government demonstrations. The slump is linked to the decline in the agricultural research system, which has suffered as a result of under-investment and technological stagnation.
The mismanagement on the price front comes on top of all this. The situation has been worsened by political intervention in agricultural pricing, particularly in foodgrains such as rice and wheat. As mentioned earlier, the procurement and public distribution systems aren’t helping producers or consumers. The drama surrounding sugar cane pricing was only one aspect of this. While farmers struggled to get remunerative prices for sugar cane and consumers paid through their nose, the sugar mills saw profits surge.
The net result has been the deceleration in yields and increased vulnerability to weather fluctuations. Between 1999-2000 and 2007-08, the average rate of growth in yields was 1.3% for rice and 0.1% for wheat. On the other hand, the yield in pulses declined at the rate of 0.2% per annum and that for sugar at 0.4% per annum. The only major crop which saw yields increase by more than three times in the past five years is cotton, thanks largely due to the adoption of Bt cotton.
Compared with this, rice yield grew at 2.7% in the 1980s, wheat at 3.4%, pulses at 2% and sugar cane at 1.2%. Naturally enough, total annual foodgrain availability has declined from 186.2kg per head in 1991 to 160.4kg per head in 2007.
Fortunately, agriculture is back on the agenda. Not because of the farmer’s plight but because of food price inflation, which is fuelling general inflation that has now gone beyond acceptable limits. This is despite the farmer putting up a much better performance than expected. Unfortunately, the government has mismanaged the food economy so badly that even increased production is of no use. How else does one explain the fact that vegetable production has increased 5% but vegetables remain the driver of food price inflation?
Of course, there are limits to what we can expect from the Budget. Partly because agriculture remains a state subject and very little can be achieved unless states also contribute.
But at the Central level, some urgent measures are needed, among them a step-up in agricultural investment, particularly in irrigation in dry-land areas, research and extension. Secondly, there has to be an increased effort to reduce regional inequality with particular attention to the eastern states and dry-land areas. Third, there is an urgent need to reform agricultural marketing, including a revamp of the Agriculture Produce Marketing Committee Act.
Finally, there has to be a concerted effort in managing the food economy, including changes in the procurement and public distribution systems. There is no better time than this to enact the National Food Security Act.
While these are some of the short-term measures that may be essential, there is an urgent need to have a long-term vision for agriculture and farmers for inclusive growth. And that includes a strategy for improving the profitability of agriculture. This is not only essential for maintaining the growth rate of the economy but is necessary if there has to be any meaning to the agenda of inclusive growth. How can one think of inclusion if more than half the population is excluded from the growth process?
Himanshu is assistant professor at Jawaharlal Nehru University and visiting fellow at Centre de Sciences Humaines, New Delhi.
Graphics by Ahmed Raza Khan / Mint
Liberating the farmer
MINT, Tue, Apr 6 2010
The way forward is to facilitate the entry of private, cooperative or commercial investors in any farming segment
Different Angle | Rajiv Kumar
The surprisingly overwhelming response to my previous column (“Farm fresh from Argentina”, 24 March) has amply demonstrated that readers are acutely concerned about the state of our agriculture, because many see it as headed towards a real crisis. Some pointed at the archaic laws that govern land lease and sales and others at the continuing ban on inter-state movement of agricultural produce as major impediment to the modernization of the sector, which are preventing it from benefiting from economies of scale and scope. These are surely valid issues. But the way to overcome these constraints is to facilitate the entry of private, cooperative or commercial investors in any segment of agriculture. These investors will generate the impulses to change the ground realities of archaic laws, the ban on inter-state movement, the tyranny of petty babudom or the dysfunctional working of the entire range of service providers who see their mandate not as providing a particular service but as a licence for generating rents.
In my experience in villages around Delhi, one cannot hope to have an improved supply of electricity for the water pump by installing a captive step-up transformer or to get a “crop loan” sanctioned or even a sale deed registered despite “connections” and the “computerization” of land records, without paying a “reasonable bribe”. To add insult to injury, there is simply zero concern among rent collectors about any accountability or fear of being apprehended. A clear distinction is maintained between the de jure and de facto, and you are constantly reminded that de jure is only dikhane ke vaste (for appearances only). Try and follow rules, and you get only grief. I am quite convinced that this malgovernance in rural India generates the widespread feeling of gross injustice that feeds the Naxalite and other forms of militancy, whose avowed goal is to overthrow such an exploitative state.
Can this chasm between de jure and de facto that has managed to choke off progress in agriculture be eliminated or minimized? The Naxal way out, though glamorous and romantic to some of our urban chic, is doomed to failure. Then there are the well-meaning and sincere civil society organizations that are fighting heroic but localized battles. The hope is that these “fireflies” will be connected and brought together to create a large enough impact. Unfortunately, I have not seen that happening. Perhaps Arun Maira, who coined the term fireflies, can connect them now that he is in a position to do so. Then there are the microfinance guys who rely on social collateral and relatively high rates of interest to try and generate incomes and raise productivity. Yet even the largest of these, such as BRAC and Grameen Bank in Bangladesh, whose efforts are praiseworthy, have so far apparently been unable to make a big dent on rural poverty and stagnation in agriculture.
These efforts do not appear to be a substitute for real commercialization of agriculture and converting the “peasant” into a viable, globally competitive farmer, whose self interest in bringing in new technology and fresh investment coincides with fragmented landholders and rural wage earners.
If such commercialization can be achieved in agriculture, the government’s role will switch from being a supplier of services and inputs to regulation and supervision. This will be liberating and hugely productivity enhancing as experience in other sectors has shown. Civil society organizations will also be far more effective in ensuring that the government and large corporate entities do not collude and connive against the small landholder and wage earners as they will have a much more visible and larger target for their actions rather than the ubiquitous babu or the patwari against whom any opposition is but in vain.
So my suggestion is to start with the other end of the spectrum and encourage modern retail organizations and companies to establish direct supply links with farmers. The ideal will be to replicate the Coop experience in Scotland and parts of Europe where farmers have gotten together to achieve the desired direct connectivity to the market rather than work through layers of intermediaries.
It has been pointed out to me that the National Dairy Development Board experiment with organizing small oilseed producers in Gujarat, on similar lines as dairy farmers, had failed. It would be useful to look at the reasons for that failure and draw the necessary lessons to make it work in the present conditions, which may be different. And we should also consider allowing and encouraging foreign multi-product retail companies to establish their agro-procurement operations for the Indian domestic and export markets. They could bring with them much needed investments in logistics, new technologies and the capacity to fend off the babu.
The small farmers’ interests against those of large retailers can be protected by a vigilant civil society and a robust regulatory mechanism. This will liberate us from the situation where agriculture is starved of investment and new technologies, and wilts as a result of stifling and all-pervasive bureaucratic intervention.
Rajiv Kumar is director and chief executive of the Indian Council for Research on International Economic Relations. These are his personal views. Comment at differentangle@livemint.com

Import surges: courting disaster the WTO way
MINT, Wed, Aug 13 2008
As expected, the World Trade Organization ministerial meeting held in the last week of July failed to achieve anything
Farm Truths | Himanshu
As expected, the World Trade Organization (WTO) ministerial meeting held in the last week of July failed to achieve anything. What followed was an only to be expect ed blame game: the US and European Union (EU) blamed India and China, representatives of developing countries, for the failure even as millions of farmers in India, China and Africa rejoiced at the failure of the negotiations.
Talks broke down on the issue of triggers for the special safeguards mechanisms (SSMs). These mechanisms allow countries to raise tariffs if the import of certain products rises by more than a certain percentage over the quantity imported in the previous three years. This proportion is termed the trigger that invokes SSM. Developed countries wanted the trigger to be invoked at 40%, while developing countries wanted to do this when imports rose 10%.
Why did developing countries adopt such a rigid posture? This question is relevant because it is being asked at a time when food prices are at an all-time high and the threat of a food crisis is very real in many developing countries, especially in Africa. The immediate impact of an import surge is a decline in domestic prices. Higher imports also fulfil the essential role of supplementing a shortfall in domestic supply. So, why should a developing country raise tariffs when prices come down because of cheaper imports? Aren’t cheaper products better for everybody, especially in countries facing a food deficit? Not necessarily.
The overwhelming evidence so far is that import surges of agricultural products have had disastrous consequences on the livelihood of small and marginal farmers in developing countries. The question is, how real are these threats of import surges and what is their exact impact on farmers in such countries.
Food and Agricultural Organization (FAO) has undertaken a series of studies to understand this. Analysis was carried out on data for 1980 and 2003 for 102 countries included in the groups of Low-Income Food-Deficit Countries (LIFDCs), Least Developed Countries (LDCs) and Net Food Importing Developing Countries (NFIDCs).
A total of 12,167 cases of import surges were reported during this period in these countries. The analysis found evidence to suggest there has been an increase in the frequency of import surges after 1995 (when WTO was born). Among the agricultural commodities analysed, the most affected food groups were vegetable oils (India is the third largest importer of vegetable oils in the world), meats and coarse grains. In the case of vegetable oils, import surges occurred once every five years compared with cereals where the frequency was once every 10 years. Vegetable oils, cereals and meats were also the food groups that experienced the highest increase in frequency of import surges after 1995.
All countries have experienced import surges but some have experienced them more often than others. Among those that have are India and Bangladesh in Asia, Zimbabwe, Kenya, Nigeria, Ghana and Malawi in Africa and Ecuador and Honduras in Latin America. In fact, these countries are the ones that suffered the maximum instances of import surges (between 100 and 130) during the 22-year period.
What has been the impact on agriculture?
In Senegal, local production of tomato declined by 50% as a result of a 15-fold increase in imports from EU. In Burkina Faso, local production fell by half because of a fourfold increase in import of tomato paste. In Jamaica, local production of vegetable oils fell by two-thirds due to doubling of imports. In Ghana, rice imports increased from 250,000 tonnes in 1998 to 415,150 tonnes in 2003. The share of “domestic rice” fell dramatically in the country from 43% in 200 to 29% in 2003, resulting in negative returns for two-thirds of rice farmers. In Cameroon, 92% of poultry farmers abandoned poultry farming because of a sudden import surge of 300% between 1999 and 2004 and almost a million jobs were lost between 1994 and 2003. In Cote d’Ivoire, poultry imports increased 650% between 2001 and 2003, causing domestic production to fall by 23%. In Mozambique, domestic production of edible oil fell from 21,000 tonnes in 1981 to 3,500 tonnes in 2002 because of vegetable oil imports, which increased fivefold between 2000 and 2004. Between 1990 and 1997, cotton production in Brazil fell 50% because of increase in imports of cotton lint from 86,000 tonnes to 438,000 tonnes. As a result, 1,289 cotton plants shut down and around 569,000 workers lost jobs.
The list is endless. In most developing countries, import surges have led to loss of livelihood for millions of farmers (many of whom are subsistence farmers).
In India too, allowing unfettered imports in agricultural commodities will spell doom for the economy yet to recover from the worst agrarian crisis of the millennium manifested in farmer suicides. If the Doha Round has to have any meaning, protecting the livelihoods of millions of farmers in developing countries should have greater priority than the commercial interests of farmers in developed countries.
Himanshu is assistant professor at Jawaharlal Nehru University and visiting fellow at Centre de Sciences Humaines, New Delhi. Farm Truths will look at issues in agriculture and run on alternate Wednesdays. Respond to this column at farmtruths@livemint.com



The farm challenge | M.S. Swaminathan
MINT, Fri, Oct 5 2007. 1:05 AM IST
For food and livelihood security, we need to shift focus from unskilled to skilled work
M.S. Swaminathan
In India, the world leader in annual milk production at 100 million tonnes, an estimated 75 million women are involved in growing or collecting the fodder and feed essential for the dairy animals to produce more milk. In contrast, hardly 100,000 dairy farmers are involved in producing nearly 70 million tonnes of milk in the US. This is a good illustration of what Mahatma Gandhi described as “production by masses”, in contrast to the “mass production” technologies of the West. There are two important implications. First, we must improve the productivity and profitability of mass production technologies through labour diversification and not displacement. Second, we must mainstream gender considerations in all areas of agricultural research, education and extension. In other words, agricultural strategies should become pro-poor, pro-women and pro-nature.
Feminization of poverty and agriculture is increasingly becoming a reality. The National Commission on Farmers has dealt with this issue in detail and has urged that appropriate support services including crèches and day-care centres, should be provided to women farmers and farm labour. The National Academy of Agricultural Sciences has prepared a policy paper for the technological empowerment of women in agriculture (Swaminathan, M.S. (Ed.) 2007, Agriculture Cannot Wait, Academic Publishers). Its recommendations should become part of the research and education strategies of our agricultural institutes. Rural women can master new technologies, whether it is hybrid seed production or induced breeding in fish, or information and communication technologies, provided the methodology of training is learning by doing, a method I term “techniracy”.
Our food security challenge today is not only increasing production but, more importantly, enhancing the purchasing power of the rural and urban poor. We need a paradigm shift from unskilled to skilled work in the case of the poor, particularly women, so that there can be addition to the economic value of their time and labour.
Small-scale farming and micro-retail constitute the largest self-employment sector in the country. In both, women play a significant role. Development programmes which could affect their work and income security adversely should be avoided. At the same time, management tools which can confer on small producers the power and economy of scale should be introduced so that their economic survival can be safeguarded. The self-help group (SHG) movement, along with cooperatives, can provide such power of scale both—in the production and marketing phases of farm enterprise.
Last-mile and last-person connectivity has now become possible thanks to new technologies such as the cellphone. It is important to give greater attention to capacity building and content creation. A priority step should relate to the empowerment of rural families with knowledge relating to their entitlements. Knowledge is the key to social and economic development. The goals of “Literacy, health and food for all” can be achieved soon through innovative applications of information and communication technologies (ICT) by, for example, imparting adult literacy to the workers employed under the National Rural Employment Guarantee Programme.
The village resource centres being established by the Indian Space Research Organization at the block level enlarge the technological opportunities available to rural families in areas such as health care, natural resources management and disaster management. There is an urgent need for public-private-people partnerships to reduce the transaction costs and non-performing assets of rural credit through ICT-supported credit and extension initiatives by banks and the corporate sector.
The partnerships should result in socially sustainable and financially viable models of rural digital empowerment. Gram Sabhas should be fully involved in providing policy oversight at the village level. At least one woman and one male member of every panchayat should be trained as knowledge managers. The Jamsetji Tata National Virtual Academy for Rural Prosperity, which represents the celebration of rural genius and creativity, can play a big role in this.
Numerous studies have been made of the causes of farmers’ suicides. The most important cause is the non-remunerative and risk-prone nature of farming, which leads to chronic indebtedness. While the structural dimensions of this sad phase in our agricultural history, such as credit reform and pricing of farm produce, particularly cotton, are receiving attention, the human dimension relating to the widows and children belonging to the affected families needs greater and urgent attention.
The widows are predominantly young. They have some rainfed land ranging from 2 acres to 10 acres. Land is becoming the most precious asset in our country. These women need to be enabled to farm their land in an economically sustainable manner.
Based on extensive consultations with the affected women, I have launched a Federation of Women Farmers for Sustainable Livelihoods, consisting of about 1,000 women farmers to begin with. To give the power and economy of scale to such women farmers cultivating small holdings, they will be assisted to form SHGs.
Every women-farmer SHG will be supported by a gyan chaupal (village knowledge centre) and will be provided with an entitlements pass book, with information on all the schemes, government, non-government and banks, that they can access. These chaupals will be operated primarily by the women/children of the families where farmers committed suicides.
For the purpose of imparting the necessary skills, a Women Farmer Capacity Building and Mentoring Centre will be established in Wardha. The aim is to bring about a paradigm shift from unskilled to skilled work.
Our hard-working farm women and men have helped the country to achieve a fair degree of self-sufficiency in food. Our agriculture is, however, currently at the cross-roads. If farm ecology and economics go wrong, nothing else can go right in agriculture. Farmers need life-saving support in the areas of conservation farming and work and income security.
“Jai Kisan” should not remain merely a slogan. Mahatma Gandhi, during a visit to the National Dairy Research Institute in Bangalore in the early 1930s, indicated his profession in the visitors’ book of the institute, as “farmer”. He thus signalled that farming is the noblest of professions. Revival of this spirit is the pathway to our agricultural salvation.
M.S. Swaminathan is member of Parliament and chairman, MS Swaminathan Research Foundation.
The Indian Century is a special series of guest columns that will run in this space throughout 2007, the 60th anniversary of India’s independence. We invite influential thinkers, academicians and policymakers to write on the opportunities and challenges that lie ahead in the next century. We also welcome your suggestions on people you think ought to contribute to this series. Do write to us at theindiancentury @livemint.com
Economic Times, 4 Jul, 2010, Swaminathan S Anklesaria Aiyar,TNN
Europe could still suffer a meltdown: Swaminathan S A Aiyar
For those who think the Great Recession is over, I have disturbing news. I asked a top Wall Street manager last week what the chances were of a full-blooded European financial crisis. He replied, “100 per cent.”

In February, the Greek fiscal crisis sent Indian markets crashing. This was the beginning of a European crisis that is not over. Wall Street experts believe it will get much worse. If so, the global financial system could freeze again, causing a double-dip recession.

Optimists say governments will surely rescue all large European banks. Very probably. But the US financial system froze despite government rescues of AIG, Citibank, Morgan Stanley, Goldman Sachs and General Motors. The British system froze despite rescues of Northern Rock and the Royal Bank of Scotland.

Rescues keep insolvent institutions alive, but only after imposing huge losses on shareholders, creditors and those having outstanding transactions. Citibank is alive, but its share price fell from $60 to $1 during the meltdown, and has edged up to just $ 3.70 today.

Nobody wants dealings with financial institutions that are tottering. When dealings freeze, credit freezes, and then all business freezes: the economic machinery cannot work without financial lubrication. The biggest Indian companies with the soundest balance sheets found credit cut off when global markets froze in 2008. A European meltdown may not be as bad, but will be troublesome.

Banks have a small amount of their own equity and a pile of borrowings. Some European banks in 2008 had debt 50 times their equity. By borrowing 50 times their own money, they could magnify profits 50 times. But they magnified risks and potential losses too, and these wiped out some premier banks.

US institutions had unwisely borrowed to invest in mortgage-related securities. When housing prices collapsed, so did mortgage-related securities, bankrupting many US institutions. Most big European banks survived because, while many had borrowed heavily, they had invested in government bonds. These are called gilts, because they have traditionally been regarded as good as gold. Indeed, the international Basle rules provide that banks can treat gilts rated AAA as having zero risk.

Alas, Greece showed in February that even European governments could become incapable of honouring their debts. As panic spread, Greece, Portugal and later Spain lost their AAA rating. European banks that had virtuously invested in AAA gilts suddenly found themselves holding devalued securities. This fall in assets threatened to wipe out many top banks. To prevent this, European governments in June engineered a rescue package of 750 billion euros, covering not just Greece but all European nations.

The aim was to save banks holding gilts of southern Europe, and stop the Greek crisis from spreading. It had an immediate calming effect on markets. But analysts soon realized that this did not solve the underlying problem of high, unsustainable government debt in southern Europe. Most European countries have unwisely decreed high wages and generous retirement and medical benefits that they can no longer afford, and this long-run problem was exposed pitilessly by the recession.

Britain has now declared that the financial emperor has no clothes. It refuses to keep up the pretence that all problems can be solved by fresh stimulus packages, each entailing additional government debt. The new British government has opted instead for structural adjustment, earlier reserved for spendthrift Third Worlders. This austerity will cost jobs and income, but will eventually reduce government debt and increase domestic savings.

Southern European countries have similar problems. Bankers can shrug off the travails of small countries like Greece and Portugal. But Spain is a big country, and bankers worry whether it will weather the storm. If it falters, panic will spread to Italy. This is a G-7 country with enormous outstanding debt, amounting to 120% of GDP. Italian bonds are widely held by European banks.

If these bonds sink, they can sink the biggest European banks. Optimists say governments will find a way out. They can oblige the European Central Bank to print euros and buy all European gilts in distress. This will ruin the reputation (and value) of the euro, but may be politically preferable to a financial meltdown.

After 1990, Japan resorted to financial fiction to keep its banks going, at the cost of economic stagnation for a decade. Europe could replicate this. Neither a meltdown nor decadal stagnation bode well for the global economy. Better outcomes are possible. Maybe Europe will find a way to grow out of its troubles painlessly. The chances are that it won’t.

Economic Times, 1 Aug, 2010, 09.26AM IST, Swaminathan S Anklesaria Aiyar,TNN
Microfinance - the banks of the future?
The Reserve Bank of India is preparing a discussion paper on new banks. Meanwhile , SKS Microfinance, India’s largest microfinance institution (MFI), has just raised a whopping Rs 1,600 crore through a public offering. SKS and other MFIs could evolve into banks. Bangladesh’s microfinance pioneer, Grameen Bank, is a regular bank.

The RBI severely restricts bank licensing . It prohibits industrial houses from opening banks because of a potential conflict of interest: such banks could give unwarranted but preferential credit and write off loans to related companies and other favoured borrowers . This is a valid concern, given India’s weak corporate governance.

The RBI wants the next generation of banks to focus on rural lending, to promote financial inclusion. However, rural operations are perilous. All government regional rural banks have suffered heavy losses.

Rural operating costs are high because of poor logistics and scale diseconomies (rural deposit accounts and loans are very small by urban standards). Agricultural defaults in many states are high since political loan waivers have encouraged wilful default. Banks find it politically impossible to seize the land defaulters have pledged. So, despite RBI guidelines and directives to state-owned banks on financial inclusion, they have not penetrated the countryside. By contrast, MFIs have.

Historically, MFIs started as non-profit NGOs. They depended on donations for expansion , and so could not grow fast. To expand their reach, many NGOs converted into for-profit Non-Banking Finance Companies (NBFCs). These NBFCs raised equity from various sources. For every rupee of their own funds, they could borrow six rupees from banks. This enabled them to expand fast.

They raised ever-larger sums for every expansion. Today, major MFIs raise hundreds of crores at a time. Till now, private equity players have been willing to provide the money . But SKS has grown too big for this and needs the stock market for future subscriptions . SKS is now bigger than some banks, with almost seven million borrowers, Rs 5,000 crore of loans and 21,000 employees.

RBI guidelines say new banks must have equity capital of at least Rs 300 crore, and no promoter group should have a stake of over 10%. The SKS issue of Rs 1,600 crore shows major MFIs can raise more than enough equity , with a wide shareholder base.

Other MFIs (Spandana, SHARE) may launch public issues within a year. This causes much heartburn among NGOs, who fear the social ethos of MFIs is losing out to commercial orientation. Maybe, but the traditional NGO approach created only small boutiques of rural credit, whereas rural India needs giant networks. Giant networks require massive capital, which can be attracted only by for-profit corporations . Besides, scale economies will permit giant MFIs to lower their interest rates to poor clients.

The RBI has said that NBFCs — like Religare and Bajaj Finserv — can apply for bank licences . But these urban giants lack the rural skills and reach of MFIs.

However, MFIs may not want to become banks. MFIs are free of RBI regulation, and have flourished in the consequent freedom to innovate and expand. The RBI takes ages to approve bank branches, while MFIs open several every month. MFIs have cheap, flexible staff, but as banks they will face high, unionized wages and inflexibilities.

As banks, they will have to put 25% of their money into government securities and 6% with the RBI, suffering losses on this count. Political loan waivers could devastate the loan discipline that keeps their repayments today at 98-99 %. Some MFIs want to do nonfinancial things like selling consumer goods cheaply to borrowers, which will be difficult for a regular bank.

However, a bank status will let MFIs accept deposits, hugely reducing their cost of funds. Instead of borrowing from banks at 12-14 %, they can gather deposits at 3-6 %. This will also help their clients, who want savings avenues.

A half-way solution — and an excellent first step — will be to allow major MFIs to accept deposits. This will help lower their lending rates while providing savings outlets to poor villagers.

In the 1990s, several NBFCs went bust and could not repay depositors, so the RBI now bans all NBFCs from accepting deposits. Nonprofit MFIs can accept deposits, but not forprofit MFIs, which are formally NBFCs.

This rule must be changed. Major MFIs have an excellent track record in both social and financial terms, and should not be treated like run-of-the mill NBFCs. Rather, major MFIs with equity capital of over Rs 300 crore (the benchmark for new banks) should be allowed to accept deposits. This will immediately improve financial inclusion. And some deposit-taking MFIs may evolve into full banks. That’s the way to go.

Economic Times, 20 May, 2010, 05.22AM IST, T K Arun,ET Bureau
The case against costly spectrum
The entire debate on spectrum allocation is as if only the government and the telecom companies (telcos) mattered, without reference to the people, the primary stakeholders.

Two arguments favour making spectrum pricy through auctions. One, spectrum is a scarce resource whose value escapes the government when companies make capital gains selling their allocated spectrum (which is what selling stake in these companies achieves). Two, this is needed to fairly allocate spectrum among multiple claimants. Neither argument is persuasive.

Spectrum auction is far from the only way for the government to capture its value. A tax on capital gains or windfall profits would do just as well, when a company unlocks the value of its spectrum via sale of stake or spectrum when that is permitted.

In fact, the state appropriates a share of the value created by spectrum when it takes a share of the revenue of telcos. HUL or Tata Motors only pays corporate tax and does not share its revenue with the government, but Bharti and Vodafone do. But this is not all.

The spread of telecom boosts economic growth. By the network effect: the greater the number of people connected to the network , the greater the value of being connected for each person. With ubiquitous phones, decisions get taken faster.

Productivity increases — a CEO calls up his driver before he leaves his room so that by the time he reaches the building entrance, his car is waiting for him; a multi-location video conference clinches a crucial decision that would otherwise have called for many high-value mandays of travel.

The entire IT-BPO success story is thanks to India's telecom revolution. Phones have multiplied the incomes of selfemployed tradesmen (carpenter, etc). Rural producers realise better prices because their phone tells them the mandi price. Such enhanced incomes, cumulatively, drive up demand for goods and services. If there had been no telecom revolution, would Bangalore have seen a real estate boom?

The government captures a share of this additional output through direct and indirect taxes. But creating larger output, which is the tax base, is not telecom's only contribution to tax revenue. Telecom has also enabled a tax information network, which has raised the share of tax collections in GDP — direct taxes grew at more than 30% a year even as the nominal economic growth was around 15%.

If we assume that without the telecom revolution, India's GDP growth would have been one percentage point lower and that the tax/GDP ratio would have been one percentage point lower, the increase in tax revenue just in 2009-10 attributable to telecom is Rs 90,000 crore, assuming the lower growth since 2003-04 , when the teleocm revolution gained scale.

India's most certainly would not have had its telecom revolution had spectrum been as expensive in 2003, as 3G spectrum now, that is, close to Rs 68,000 crore.

Some argue that call rates would not go up because of higher spectrum charges because competition would force players to hold tariffs . This might be true for a specific phase of the industry's growth but is not sustainable, and will show up in slower expansion and lower quality of services. India cannot continue to have a world class telecom industry, even if its capital costs (spectrum fees capitalised becomes just that) are many times higher than they need be is plain silly.

Upfront spectrum fees transfer investible resources from the non-government sector to the government. They jack up the cost of telecom services or slow down their expansion and quality improvement and, vitally, impede roll out of real broadband —1 gigabits of data per second (what Google is planning for US homes and is also envisaged in the US national broadband plan).

Instead, if the government keeps spectrum cheap, and focuses on the larger tax base created by faster growth of telecom, its revenues would be bigger over time and the Indian people would be better off.

But, in the absence of auctions, how do we allocate the spectrum to companies? The answer has two parts. In telecom, the degree of competition is determined by the total availability of spectrum and the minimum spectrum required by each player. Suppose four players are possible.

Who these players are matters a lot to telcos, but next to nothing to consumers, so long as all of them are competent. Take lots, have a beauty parade, make the telco CEOs do the Iron man — whatever the method of selection, it should not impact the cost or quality of telecom services.

However, the bigger problem in this model is the obsolete idea of dedicated spectrum for a telco. India needs to invest in technology that will create a real-time spectrum exchange, so that all the spectrum is available to all the telcos to service their customers, with the exchange matching demand for and supply of spectrum at every point of time, the usage charge accruing to the government right then and there. Just because this departs from the legacy model of the west, it does not mean that we should not put people first.

Costly spectrum only serves to transfer investible resources to the government and slow down telecom spread. Indian teleocm needs huge investments in broadband to secure what will soon be a competitive norm: 1 Gb per second. Cheap spectrum and fast telecom spread boost GDP growth and yield more revenue than when spectrum is costly.

Economic Times, 6 May, 2010, 06.17AM IST, T K Arun,ET Bureau
Food security not by food alone
Politics runs the risk of being reduced to the art of the passable — it has to be approved by the legislature, by the omniscient television anchors, by sulking editorial writers forced to cede ground to the TV anchors, and, most crucially , by Sonia Gandhi. The food security Bill was drafted for Ms Gandhi’s favour and has been shafted by her displeasure.

Food security, hostage, in any case, to the attention deficit of our minister for food and sugar and cricket and Maharashtra politicking, is now all gummed up in a wrangle over how many people should be covered, how many should be left out and how many times the empowered group of ministers should defer their meeting on the subject.

What all this bustle over the bill misses out is the simple fact that food security is not achieved primarily by distribution of food. The rural employment guarantee scheme is about food security — it offers 100 days of employment so that people do not go hungry in those spells when regular work, primarily related to raising crops, is not available. The entire Bharat Nirman programme, the rural roads programme, the urban renewal mission, the skills mission , the grand national highway building schemes, all generate jobs and incomes and thus enhance food security.

Does this mean that there is no need to focus specifically on access to food, that official energy should be expended on growth? Not quite. In a country like India where millions of people live on the margins of subsistence , guaranteed access to food is vital. However, any programme to do this must not assume it to be its solitary burden to feed the poor of the land, it must take into account the many government programmes that concurrently work for the same goal.

Let’s take, say, Kumti Majhi, a Kondh tribal, who leads a precarious existence collecting forest produce. He can afford food if his income is supplemented, say, through an employment guarantee scheme. Equally , he can afford food if the food itself is made available at a subsidised price. Should he be given both an income supplement and subsidised food?

Or should that extra money going to him be used to build an all-weather road from his hamlet to the nearest road? Suppose a bauxite mining project comes along and takes away the land off which Kumti lives, and the colour of his water source turns an angry red, the shade of the sores that now erupt on his body. Where will he turn for food security?

The point is that food security does not, cannot exist in isolation. It is a function of a person’s location in the overall economic and political structure of society. Unless that environment turns benign, piecemeal efforts at easing the pressure on some part of the life of the poor will fail to particularly benefit the poor. Turning that environment benign is a function of politics, not of any particular law.

Enhancing incomes of the rural poor and cheapening the supply of food come together in raising farm output, essential to meet the rising demand for food across the world, not just for conversion into fuel but also to feed the changed food preference of people with improving living standards.

Increasing farm output is a huge challenge that will call for enormous resources, both financial and policy. Paucity of political will to forge and implement reasonable compensation/rehabilitation policies for people displaced by projects has, in combination with steady scaling back of outlays on major irrigation, created a looming water crisis, with groundwater near exhaustion in most places. For farm output to go up, there has to be sizeable investment in surface water management, meaning dams, reservoirs, canals and displacement.

The YSR government of Andhra Pradesh was effective because it stepped up irrigation investment significantly. Raising food output will call for not only augmented water supply but also better know-how , embodied in hybrid or genetically modified plant varieties and high-tech inputs, and in improved crop husbandry practices.

These cannot be absorbed by the current scattered structure of farming in India : farmers would need to pool their resources to form farmer companies or cooperatives to secure the organisational form required to carry out modern agriculture . Modern farming is capital intensive . And would not be able to accommodate large-scale underemployment as traditional farming does. A lot of the surplus labour would be absorbed by fastgrowing urbanisation.

If the rest are not to become polarised into a handful of rich peasants whose landholdings steadily grow and a disgruntled landless, jobless mass, a great deal of organisational innovation is called for. That too is part of food security. In fact, of internal security. The only way to overcome the bureaucrat’s tendency to compartmentalise, and hold on to the holistic picture, is for politics to always be in command. Will someone please approve?

Economic Times, Aug, 2010, 05.46AM IST, T T Ram Mohan,
The world falters, India booms
The divergence between macroeconomic policies in India and those in the advanced economies in recent months has been striking . Fiscal tightening has been under way since fiscal 2009-10 itself. Monetary policy too has been progressively tightened in recent months although it is not as tight as some would like.

In the advanced economies, talk of exiting the fiscal stimulus has not been matched by strong action everywhere. There are serious doubts as to whether this is the right time to begin a big exit despite the fact that public debt has reached its highest levels in years. Monetary tightening is not happening. In the US, the Fed is expected be accommodative in its forthcoming monetary policy announcement.

The divergence in policies between India and the advanced world reflects divergences in underlying economic conditions . In July, the International Monetary Fund’s World Economic Outlook revised its forecast for world economic growth from 4.2% in April to 4.6%.

But this is based largely on expectations of high growth in emerging markets. There is not the same optimism about economic prospects in the advanced economies . Nouriel Roubini, who is credited with having the forecast the global financial crisis, maintains that a double-dip recession is very likely, especially in Europe and Japan.

The global financial crisis drew a massive and concerted response from governments in the advanced economies. A massive fiscal and monetary stimulus was adopted. The stimulus worked. It helped a slide into another protracted depression. The world economy recovered and then it appeared to gather steam.

So what has gone wrong with the script in recent months? Well, Greece was undoubtedly a big shock to the world economy . Not because Greece in itself poses a problem for the world economy but because it was a symptom of a broader malaise : fiscal overstretch.

We have known that governments can spend their ways out of trouble in a recession , but economists insist this is possible only so long as government borrowing does not breach certain limits. There is a sense that once government borrowing reaches 90-100 % of GDP, markets will become averse to supporting further government borrowing.
When Greece happened, people started looking closely at fiscal deficit projections, public debt-to-GDP ratios and current account imbalances in the advanced economies and were horrified at what they saw. They concluded that there was no choice but to cut back on the fiscal stimulus.

Unfortunately, it appears that the recovery is not strong enough to withstand a big exit. Governments in advanced economies are in a fix as to how fast to move in respect of exiting the fiscal stimulus. There is not much that monetary policy can do to provide more stimulus when interest rates are as low as they are today.

It is not just the absence of freedom of action in respect of fiscal and monetary policy in the present conditions that worries markets. There have been renewed concerns about failures in the banking sector. Banks in the advanced economies hold large amounts of government debt, so the Greek debt crisis revived fears of another banking crisis.

Regulators in the EU ran stress tests on 91 banks. They claimed that the tests showed that the banks could withstand a setback to the world economy except for seven small banks. But the tests have been criticised as being not adequately stringent . Whether there is an implosion in banking again or not depends on whether the EU economies can muddle through long enough without a major default.

The Indian situation presents a refreshing contrast. Most forecasts for Indian economic growth have been revised upwards and the revisions are seen as credible despite the uncertainties in the world economy. Growth is expected to be anywhere in the range of 8.5-9 %. There is a clear roadmap for an exit from the fiscal stimulus. Monetary policy has become tighter with fighting inflation the priority now.

The PM’s council of economic advisers thinks the projected rise in the savings and investment rate in 2010-11 and 2011-12 provides a firm basis for a return to growth of 9%. In 2007-08 , our savings rate was 36.4%. It declined in 2008-09 and 2009-10 thanks to government dis-savings caused by the need to provide a fiscal stimulus . Thanks to the fiscal corrections introduced subsequently, the savings rate is expected to rise to 35.5% in 2011-12 , enough to finance an investment rate of 38%. An investment rate of this order, in turn, can easily deliver growth of 9%.

But this begs the question: what happened to the coupling thesis? In 2008-09 , we found that we were far more dependent on global economic conditions than we had supposed. As the global crisis peaked, our growth rate dropped to 6.8%. Why should things be any different if the advanced economies were to go through another recession?

There are reasons to expect a different outcome now. We were coupled with the world economy not so much through trade as through our dependence on capital flows. In a time of financial crisis, there is a flight to safety and out of emerging markets. This impacts domestic interest and exchange rates. It also impacted corporate investment in India as corporate investment had been financed by foreign borrowings to a greater extent than suspected.

In the months ahead, these adverse factors may not come into play. A setback to global growth is unlikely to translate into a financial crisis. Investors are bullish about growth prospects for India and are unlikely to exit en masse if the world economy falters. Indian companies unwound much of their exposure to foreign debt during the crisis and will not have run up similar exposures again.

These propositions will be tested if there is a double-dip recession in the advanced economies. If they hold up, that would give us a new basis for confidence as to India’s growth prospects. Unlike in 2003-08 , growth of 9% would be less vulnerable to the vagaries of the world economy. It would be more investment-driven with infrastructure as a key driver. We would then be having the best of both worlds: the benefits that go with integration and the lack of vulnerability that comes with being driven by domestic demand and financed by a high savings rate.

Economic Times, 24 Jun, 2010, 06.35AM IST, T T Ram Mohan,ET Bureau
Boom or no boom, India can grow at 9%
The Indian economy grew at an average of 9% in 2004-08 . This burst of growth surprised people since it had not been immediately preceded by any burst of ‘reforms’. Some commentators now think that this burst is a something of fluke linked to the global economic bubble. The global bubble burst following the sub-prime crisis. So, these commentators believe that a return to the 9% trajectory is unlikely in the near future.

They are likely to be proved wrong — and sooner than thought earlier. Until recently, it appeared that the Indian economy would grow at 8-8.5% in 2010-11. Only in 2011-12 would growth touch 9%. On present showing, there is every prospect of the Indian economy growing at 9% in 2010-11 itself.
This optimism is based on the latest figures for growth in the recent past. In 2009-10, the Indian economy grew at 7.4% even as the world economy struggled to come out of the worst financial crisis in a century. Not many had expected such a strong recovery following the fall in the growth rate to 6.7% in 2008-09. The recovery in 2009-10 was strong despite agriculture doing badly on account of drought. Agriculture grew only by 0.2%.

What conclusions can we draw from the recent growth experience? The first and, perhaps, most important conclusion is that growth of close to 9% in 2004-08 was not entirely the outcome of the global boom and cannot be construed as something of a bubble. If that were the case, the deceleration in growth rate in the Indian economy in 2009 and 2010 should have been as sharp as that of the global economy and the subsequent recovery as slow. Neither has happened.

Global economic growth (in PPP terms) declined from an average of 4.9% 2004-07 to 1.2% in 2008-09, a decline of 3.7 percentage points. India’s growth declined in the same period from 8.9% to 6.5%, a decline of 2.4 percentage points. (These are calendar years). In 2010, the IMF expects world economic growth to rise to 4.2%, which is 0.7 percentage points away from its pre-crisis average. For India, growth is projected at 8.8%, almost the same as the pre-crisis average.

The figures for world economic growth are exaggerated by the inclusion of numbers for India and China. Take away India and China from the world growth figures and the contrast between India’s performance and that of the rest of the world after the crisis becomes even starker. The bottom line is clear: India’s return to a 9% growth trajectory is not contingent on the world economy returning to its so-called bubble growth rate of the pre-crisis years.

This does not mean that Indian growth is de-coupled from the rest of the world. India’s relatively low trade to GDP ratio (of 16%) does give it some insularity from the world economy. But, as we saw in the recent crisis, a more potent mechanism for transmission of contagion is capital flows. India’s vulnerability to capital flows is on two counts.
One is that investment exceeds saving. This gap was 1-1 .5% in recent years. In 2008-09, it widened to over 2.4%. This is mainly because the savings rate fell more sharply than the investment rate as the government sought to contain the impact of the global slowdown on the Indian economy by boosting government expenditure. This caused the fiscal deficit — or government dissaving — to increase.

With the planned return to FRBM targets, the savings rate should go up but investment is likely to exceed savings in the near future. In the medium-term, we will continue to be dependent on foreign capital to support our growth.

We found during the recent crisis that the savings-investment gap understates our vulnerability to capital flows. Capital flows in 2007-08 amounted to 9% of GDP, vastly in excess of the current account deficit. A significant portion of the increase in corporate investment, which led to the increase in India’s investment rate in 2003-08, came from external sources.

For a higher growth rate to be sustainable, the savings rate needs to go up so that it can substantially finance a higher investment rate. This will happen given the fiscal reforms under way. Secondly, corporate dependence on external funds must go down. This happened consequent to the crisis but companies must be careful not to revert to the earlier position.

Thirdly, the growth rate of 9% that many people forecast for 2010-11 assumes good monsoons and a sharp revival in the growth rate of agriculture. It is also based on significant investment in infrastructure. If we can move towards the target of 4% growth in agriculture through substantial investment in the sector, not only is 9% growth achievable but growth will be that much more sustainable. Similarly, growth driven by an expansion in infrastructure rather than exports will make for greater sustainability.

Getting back to a growth rate of 9% is not the issue. The issue is making economic growth relatively immune to the vagaries of the world economy. An increase in the savings rate and a focus on agriculture and infrastructure hold the key to sustainable growth.

Economic Times, 18 Feb, 2010, 04.27AM IST, T T Ram Mohan,ET Bureau
Don't overdo fiscal consolidation
Finance minister Pranab Mukherjee defied the economic advice given to him when he chose to peg the fiscal deficit at 6.8% of GDP in his last budget. He reckoned that a massive stimulus was the need of the hour and that consolidation could be addressed once the economy was back on its high growth path. His critics thought he had erred on the side of excess.

Mr Mukherjee is being proved right. His critics are busy revising their growth forecasts upwards with each passing quarter. The CSO’s advance estimate for growth for 2009-10 is 7.2%. The FM forecasts growth of 8%. Since GDP growth figures in recent years have tended to be revised upwards, there is every chance that growth will end up close to the FM’s forecast of 8%.

Any acceleration in growth does wonders for fiscal consolidation. A basic premise in discussions on fiscal consolidation is that a high level of deficit is an impediment to growth. This is not borne out by our experience in the past decade.

We began the decade with forbidding levels of fiscal deficit and public debt. Then came the boom years, 2004-08 , that helped lower deficit and debt levels. There has been a setback in the past two years following the global crisis. With growth picking up again, the issue is not whether consolidation will happen. It is: what level of fiscal consolidation is desirable in the short-run and in the long-run ?

The short-run prospects are promising . For 2009-10 , the FM had assumed real growth of around 6.5%. We know that actual growth will be higher — say, 7.5-8 %. The fiscal deficit in April-November 2009-10 was 76% of the budget estimate. In the remaining months, strong industrial revival should boost tax revenues. Some of the expenditure can always be held back. For 2009-10 , the FM should, therefore, be able to report a fiscal deficit lower than the estimate of 6.8% — say, 6.6%.

In 2010-11 , a number of favourable factors will kick in. First, the growth rate should be higher and this will translate into higher tax revenues. Secondly, there is greater commitment to disinvestment . Thirdly, some portions of the stimulus to spending will automatically be withdrawn, namely, the farm loan waiver and the Sixth Pay Commission arrears. Fourthly, we can expect some of the cuts in excise duty and service tax effected last year to be reversed.

The absence of the farm loan waiver and Sixth Pay Commission arrears by themselves should shave 0.7% off GDP in 2010-11 . Thus, the fiscal deficit should decline to 5.9% without taking into account the three other factors mentioned above. The FM should be able to meet the general clamour to lower the fiscal deficit to around 5.5% of GDP in 2010-1 without having to sweat too much.

It would be unwise to attempt any withdrawal of the stimulus beyond that. As the RBI’s latest macroeconomic review points out, some of the recovery in growth is on account of the Pay Commission effect. In the second quarter, GDP grew by 7.9%. Take away the Pay Commission effect and the growth rate is 6.5%. Much of the stimulus, which amounted to 3.5% of GDP last year, needs to be retained for now.
It is the long-run fiscal outlook that worries most commentators. They would like the FM to indicate how, and how quickly, we will return to the FRBM target of 3% of GDP for the Centre. Here again , there are favourable factors. An acceleration in growth to 9% will contribute towards consolidation. So will the introduction of the goods and services tax, which is expected to boost tax revenues.

BUT the pressures on spending are relentless . Experts believe that we can drastically prune subsidies with a stroke of the pen and increase allocations for the social sector and public investment. If the experience of two decades of reform is anything to go by, this is sheer delusion. The idea that subsidies should be targeted only at those below the poverty line does not have popular support. National Rural Employment Guarantee Scheme (NREGS) is seen as socially and politically valuable and is here to stay. Defence expenditure can be expected to escalate sharply as the race with China intensifies.

Governments everywhere are getting bigger, not smaller. A recent article in the Economist points out that since 2000, government spending as a proportion of GDP has risen in the UK, US, France, Canada and Germany. In the UK, government spending has shot up from around 37% to over 50% of GDP, thanks to increased spending on health care and education . In the US, government spending has risen to over 40% of GDP. Social security and medicare have been key drivers.

India’s public spending (Centre plus states) of 28% of GDP looks tame in comparison . Our public services — in health, education, irrigation, roads, power, etc — are woefully inadequate. Public spending on these items is bound to rise, no matter that private involvement goes up. We cannot escape the general trend towards an increase in the government expenditure /GDP ratio. Government will have to spend more. It lacks the ability to prune subsidies drastically.

Something has to give. It has to be the present FRBM target of 3% of GDP for the Centre. The target needs to be revised upwards.

There is no need to be alarmed at the suggestion. The FRBM targets were set keeping in mind the Eleventh Finance Commission recommendation that public debt/GDP ratio be brought down to 60%. This ratio was the norm set under the Maastricht Treaty for the European Union where growth rates averaged below 3% even before the financial crisis. The targets were set at a time when the Indian economy was growing at 6-7 %.

Now that we are on to a growth trajectory of 8-9 %, we can afford to set the fiscal deficit/GDP target at a higher level. We could have a variant of the golden rule for fiscal policy whereby government borrowing is permitted only for investment. The limit for the fiscal deficit could be set higher than 3%, with separate sub-limits for current expenditure and investment.

Fiscal consolidation is required. But, we must be careful not to overdo it, whether in the short-run on in the longrun . In the short-run , it must not come in the way of the economy getting back to its high growth path. In the long run, it must not come at the expense of badlyneeded expenditure on the social sector or expenditure that is growth-inducing.

Economic Times, 13 Aug, 2010, 06.10AM IST, Manoj Pant,ET Bureau
Why do countries sign RTAs?
The proliferation of regional trading arrangements (RTAs), especially after 1990, has sparked a lot of interest. Prof Bhagwati, a staunch multilateralist, has likened them to ‘stumbling blocs’ to the multilateral focus of the World Trade Organization (WTO). This author too has written in past articles that the rush to contract RTAs is probably traceable to the perceived failure of the WTO meetings, particularly after the Doha round of 2001. As countries perceive that the multilateralism of WTO is falling apart, they are rushing to get into regional alliances as a defensive response. Presumably, RTAs act as an insurance against protectionism, particularly for small and developing countries. Small countries, it can be argued, conclude RTAs with large countries before they are excluded by other countries doing the same — a kind of first-mover advantage. But do developing countries benefit from these RTAs? Are these benefits economic in terms of market access? These are two issues I will take up in this article.

First some facts. The number of RTAs was negligible — around 20 — till about 1990 or so, and increased exponentially to over 300 by 2005, and are close to 400 today. In addition, around 75% are now operational. Second, more than 50% of these are between developing countries, including the so-called transition economies. Third, according to a World Bank estimate — usually read with a bucket of salt next to you! — if we exclude RTAs involving countries that have close to aero most-favoured nation (MNF) tariffs, the share of world trade in RTAs falls from 33% to about 20%. Finally, 85% of these RTAs are free trade agreements (FTAs) rather than Customs unions (CUs). In the former, countries retain their tariff-setting independence vis-a-vis non-RTA members. Last, most countries are members of multiple RTAs. This feature is particularly true of developing countries, especially those in the African continent.

What about the theory? The gains from an RTA stem from the fact that some countries are excluded from the RTA. Hence, members of RTAs have tariff advantages in other RTA markets vis-a-vis non-RTA suppliers. If the non-RTA member loses an RTA market only on account of the tariff preferences available to RTA members, this is called trade diversion. However, trade increase within the RTA due to removal of tariffs is called trade creation. Without going into the relative intricacies of calculating the net effect of trade diversion and trade creation, one implication is that the RTA must lead to increased trade among the RTA members if the RTA is presumed to have been beneficial to the members of the RTA.

What is the evidence? One simple calculation would be to look at the share of intra-RTA trade compared to total global trade of all the RTA countries before and after implementation of an RTA. As a rough approximation, one can argue that this must increase if RTAs have been beneficial. Since there is a time gap between the signing of an RTA and the actual implementation of tariff concession, a rough rule would be to look at this ratio a few years before and after the implementation of an RTA. Such a calculation for major RTAs is shown in the accompanying table.
The conclusion is obvious. Barring Mercosur, in no other RTA has there been a significant increase in intra-RTA trade after implementation of the agreement. The logic of taking just few years before and after was to try to isolate trade increase that can be attributed to the RTA alone, that is, trade that is not influenced by other well-known factors such as incomes, prices, etc, and that would have occurred anyway.

It must also be remembered that an RTA has administrative costs in terms of implementing the system of rules of origin, cumulation, etc, that are an integral part of such agreements. It is debatable — I have seen no calculations — whether the small percentage increase in RTA trade — as in the case of Asean — justifies such costs.

So, RTAs do not give a significant market access benefits to members. Yet, RTAs continue to flourish. In fact, India, a latecomer to RTAs, is now stepping up efforts to contract a number of RTAs. Why this rush for RTAs? Are there any important non-economic benefits they confer on contracting papers? For answers to this, watch this space next month.





Economic Times, 9 Jul, 2010, 05.55AM IST, Manoj Pant,ET Bureau
Trade and development
Over the last three months, I have looked, in these columns, at some dramatic changes that have taken place in world trade between 1995 and 2005. The period chosen is important. First, it coincides with the first phase of trade negotiations under the World Trade Organization (WTO) when industrial tariffs had fallen in most developing countries.

Second, it does not include the recession years after 2007 and represents some normality in world trade. Third, since it includes the East Asian crisis years after 1997, it would, if at all, show a bias against trade of developing countries of Asia.

Ithen looked at some implications of these trends for the world in general and India in particular. Of these trends, three are worth repeating. One, the dominance, in terms of both magnitude and growth, of developing country trade (south-south , or SS, trade) over trade between developed and developing countries (north-south , or NS, trade). Second, the emergence of regional trade hubs in the developing countries.

Third, the dominance of intra-regional trade over interregional trade. In this column, I will look at some implications of these patterns for development issues.

First, consider the issue that Prof Jagdish Bhagwati and others have red-flagged : that regional trade arrangements (RTAs) may be a ‘stumbling block’ to multilateralism. Since most of the RTA developments took place since about 1991 or so, it may well be argued that the dominance of regional trade is testimony to such fears.

RTAs would be harmful if they replace competitive global trade with inefficient trade. However, given declining tariffs since 1995 and the bigger stumbling block of uncoordinated ‘rules of origin’ included in all RTAs, two points may be worth noting.

One, what is the advantage of RTAs that require considerable bureaucratic capital to tie up? Second, do traders actually use the RTA trading route given that the complicated spaghetti bowl of rules of origin agreements may be a bigger stumbling block than MFN tariffs?

It is possible that RTA trade is driven by multinational corporations (MNCs) and reflects traditional market segmentation or sharing arrangements. But then, these are not issues to which answers exist in traditional neoclassical trade theories.

In addition, it is possible that the international politics of the new plurilateral world order is driving trade. Here, RTAs simply ratify existing trade patterns for political gains and, thus, cannot be said to replace multilateral trade.

Consider the other developmental issue that is now hotly debated. The issue of trade and inequality. If trade is driven by countries’ resource endowments (land, labour or capital ), then it is impossible that trade can drive income inequalities between countries (or within a country).

This proposition is fairly well known. However, much of the empirical evidence indicates that trade is driven more by technology than resources.

To the extent that developed countries are technological leaders, it could well be argued that trade could lead to income inequality between countries. The argument is that technology, being a scarce resource, is able to command a greater premium that other inputs to production . Yet, what we are seeing today is growing SS rather than NS trade.

Since technologydriven trade is generally a feature of NS trade, the responsibility for growing income inequality in developing countries in the last decade or so can hardly be place at the door of NS trade. It is necessary to look within.

Finally, the data on growing regional rather than multilateral trade deserves attention. Much of the trade between developing countries is trade in inputs as world transport costs have declined dramatically. This is also part of the process of internationalisation of production where MNCs now dominate trade.

These MNCs (many quite small firms) source inputs globally according to comparative advantage and sell products in final markets that are largely regional. This, thus, implies that a study of trade policy must concentrate more on issues of why firms trade rather than why countries’ trade.

The dominance of MNCs breaks down the simplification of perfectly competitive trade and, hence, the elegance of traditional trade theories. This has another important implication : countries will now be linked more closely not merely by trade but by tax policies as MNCs move production around to minimise their world tax liabilities.

This is one area where developing countries are far behind developed countries.

The bottomline is that the changing nature of world trade also necessitates changes in trade policy. In this short essay, I have noted that as MNCs dominate trade, FDI policies might need to take precedence over standard export-import polices.

Second, study of taxation of foreign companies must be given greater importance in developing countries, particularly in matters like transfer pricing.

Finally, it is unlikely that the world will ever return to the kind of multilateral trade that traditional trade theory posits as the first best policy: the underlying framework of perfect competition no longer exists.

With global trade increasingly dominated by multinationals, focus may shift to FDI policies from export-import policies. As MNCs redeploy production across the world to save tax, developing countries need to redraw their taxation rules. In absence of perfect competition, multilateral trade as we have known it all along may now exist only in textbooks.
Economic Times, 9 Oct, 2009, 05.30AM IST, Manoj Pant,
Recession: Are we out of the woods?
Over the last few months there seems to be some agreement among commentators that the world may have seen the end of the current recession. This is largely based on some evidence from the worst-affected areas like the US and the EU that the rate of decline in output is slowing down. This is also true for emerging countries where the rate of growth of GDP seems to be inching back to the 2007 levels.

Over the last one year or so I have been arguing in this column that the current recession has clearly Keynesian features. The stimulus which individual countries have been effecting over the last two years does seem to be guided by the same considerations.

The attempt to keep trade non-protectionist through a series of global meets seems also to have been guided by the experience of the 1930s Depression when such policies accentuated the impact of the initial downturn and probably extended the recession by a few years. Very broadly, the lesson seems to be that the non-cooperation of the 1930s was something that countries must avoid today.

Academic work will continue to ascertain the typology of the current recession — was it Keynesian or simply a consequence of unregulated financial markets? However, it is clear that the period 2007-2009 shared one common feature with the Depression of 1930s: in both cases outputs and prices fell globally. This made this recession somewhat different from previous episodes in the early eighties and in the early years of this century.

These were restricted to one set of countries (developed countries or East-Asian economies) and were set off by known causes like the oil price hike of the 1970s or the crony capitalism of the East-Asian economies. From a macro point of view the most important distinction from the current recession is that in the previous episodes there was no generalised fall of both prices and output.

Hence the previous episodes were more problems of structural change as compared to the clearly Keynesian nature of the current episode. An understanding of this distinction gives some indication of the task ahead for all countries.

It is interesting to note that the strict monetarists have already started bemoaning the increasing fiscal deficits in countries. This needs some consideration. If we accept that the current recession was Keynesian in nature then the fear of deficits is unjustified. In Keynes, the motivating factor was the breakdown of expectations on the part of both consumers and producers.


While I have discussed this in more detail earlier (ET, January 9, 2009) the essential element is a set of events which leads consumers to start ‘saving for a rainy day’ and producers then use this increased savings (reduced consumption) as an indication that demand is falling and hence cut production. This sets off a set of self-fulfilling expectations which can only be negated by the operation of a non-myopic agent (the government ) which has to come in to ‘pump prime’ demand. This pump priming is what we now call government ‘stimulus’ in each country.

Since in a recession falling incomes imply that government tax revenues will also go through a cyclical downturn, it is common sense that this ‘stimulus’ must come through higher fiscal deficits. In other words, the stimulus is the fiscal deficit itself. Hence, removal of this stimulus (reduction of the fiscal deficit) must imply that all parameters are back to the pre-2007 levels. This is not so clear.

First, we now know that the US demand was based on excessive consumption financed by excessive savings in the rest of the world. Yet, today it is clear that the ‘zero savings’ behaviour in the US is clearly not going to return. The US savings rate (out of disposable income) fell to around 1% in 2006 but is now up to around 5%.

In other words, someone in the rest of the world has to make up the 3-4 % decline in savings if global demand is to return to the 2007 levels. It is not clear that the level of optimism in other countries (to negate Keynesian expectations) is near the required levels. It is often forgotten that the US accounts for about 25% of world demand so that the level of potential increased in consumption required in emerging economies like India and China is going to be insufficient.

This is particularly true given that China has shown no inclination to reduce its huge trade surpluses of over $2 trillion.

Till structural changes in world demand work themselves out it is clear that the stimulus must continue. How long? Difficult to say. Wait till signs of optimism return. Positive inflationary expectations is probably as good an indicator as any.

(The author is professor of economics, Centre for International Trade and Development, School of International Studies, JNU)

Economic Times, 11 Sep, 2009, 12.34AM IST, Manoj Pant,
WTO talks: Waiting for Godot
‘Another one bites the dust.’ This line from a rock song by a popular band of the nineties might well become the national anthem of the WTO ministerials since Doha.

Once more a ministerial has gone by in New Delhi and, if media reports are anything to go by, there is now a ‘consensus’. All the members agree that WTO negotiations must continue particularly in the context of the current world recession which has been on for about two years. And rightly so. The memories of the last recession of the 1930’s informs us that unilateral actions on tariffs led to a decline of world trade by as much as 30% in those days. From all reports, the decline today is no longer of that magnitude. The fact that a multilateral organisation for trade negotiations exists today is surely a contributing factor here.

While developed countries in particular are bound to go through some protectionism, the mere existence of the WTO has put some limits to obvious methods of protectionism like tariffs and non-tariff barriers like new domestic regulations. At least countries have to be inventive in their protectionism which makes the actual impact on trade less than an all out tariff war.

Then why do we still have a feeling of ‘déjà vu’? After the recently concluded ministerial in New Delhi, the media reported that while all major countries like the EU, the US, China, etc, feel that successful conclusion of the Doha round is now possible, India’s commerce minister Anand Sharma said that there is still work to be done. Where are we now then?

It is now clear that ministerials are no longer going to take talks forward at least in the Doha round. Ministerials are mainly meant to clear the political air about forward movement in negotiations. What is the actual position? First, as far as agriculture is concerned, we now know that no country can obtain complete exemption from exposing its agricultural sector to imports.

India cannot be an exception. Short of dropping the AOA ( Agreement on Agriculture) from the WTO negotiations (which I have strongly supported in these columns) the ‘single undertaking’ of the Uruguay round of 1995 (reiterated in the Doha round) makes opting out of the AOA an impossibility. Developing countries like India will have to use the gaps between their bound and actual tariffs to keep out imports. We now have special and differential treatment (SDT).

In the Uruguay round, the trigger mechanism (for import restrictions) kicked in when agricultural imports exceed 3% of domestic consumption. Developing countries like India are now arguing for the trigger to apply when imports exceed 20% of the average of the previous three years’ imports. Countries like the US (I suspect this is actually a Brazilian demand) would want this to be higher.

There are other issues like special products. There is the US position (or lack of it!) on cotton imports. But the main point is that conclusion of the Doha round is in the technical phase and this cannot be sorted out in ministerials where politics intrude. So maybe the commerce minister is making a political statement.

Second, in NAMA there seems to be some agreement on the formula for tariff reductions. Developed countries have now added the issue of sectorals—zero duty agreements on selected sectors which go beyond the usual tariff cutting formula. These could be bilateral agreements which are currently permitted only for developing countries. So, in this sense, a new agenda item calling for significant research work by developing countries has been introduced.

Third, and this is I think what the commerce minister is talking about, is the issue of service negotiations. He is right ( if media reports are correct) that forward movement here is really where India’s interests lie. India’s favourable foreign exchange balance owes more to service sector exports (remittances, software, and tourism) than to trade in manufactured goods.

But the problem is that service negotiations will necessarily impinge on a country’s domestic legislation and I doubt if countries like the US would ever agree to this. For service imports are not subject to traditional border restrictions but are determined by domestic legislation like immigration rules, taxation of foreign companies, etc,. The positive list approach to service sector negotiations makes it possible for countries to avoid commitments on politically difficult issues.

So, ‘waiting for Godot’ I think is a correct description of the current ministerials. Yet, even the current state of development of the WTO rules offer useful restrictions on obvious protectionism. As I have argued earlier, the current fight in agriculture is between the agricultural producers (the CAIRNS group) , the US and the EU. Why should India be proactive?

(The author is professor, Centre for International Trade and Development, JNU)

Economic Times, 9 Jan, 2009, 01.38AM IST, Manoj Pant,ET Bureau
Recession: Role of expectations
By now even the non-economist is familiar with the name of John Maynard Keynes. Given the global nature of the current economic downturn and its persistence, most commentators agree that we are probably in Keynesian world like during the Great Depression of the 1930s. That depression persisted for almost the entire decade of the 1930s. As I have argued earlier in these columns, this is not likely to happen now as today there exist institutions of international cooperation in trade and finance.

During the 1930s, countries pushed unilateralism as the antidote to growing unemployment. It took a war to teach countries the virtues of cooperation starting with the US-backed Marshall Plan of the late 1940s. And, of course, there was Keynes who taught that, contrary to popular intuitive wisdom, thrift and ‘saving for a rainy day’ was the worst thing governments could recommend. Yet, what commentators have not really spelled out for lay audiences was the specific role that Keynes gave to ‘expectations’. Understanding this is crucial to defining policy measures to combat recessions.

The remarkable features of Keynes’ thesis was not that there can exist large-scale unemployment of even those willing to work at any wage but that this unemployment can persist. So producers can leave large capacities unutilised even while there are many workers looking for some job to do. The paradox is easily explained when one brings in ‘expectations’. A producer sees declining demand, expects it to continue and hence cuts back on investment and planning for future production. The consumer sees jobs disappearing, expects this to continue and start saving for a rainy day.

The cut in consumer demand further justifies the producer’s expectations; he cuts back further on building capacities thus fuelling the consumer’s expectations and the ‘race to the bottom’ continues. Why don’t the two see how they are making things bad for each other? The answer lies in what micro-economists call the ‘isolation paradox’. Each individual takes a rational decision on his own but individual rationality does not imply collective rationality. Unfortunately, there is no ‘market’ to make consumers and producers come together: they work in isolation. Ergo, someone with a less myopic and individualistic view must step in: hence the role of the government in coming together to break the logjam of unilateral decision making. The government can presumably take decisions on expenditure that would never be rational for our producer and consumer.

With this simple discussion it is easy to see how certain polices have not worked to ease the downturn. Consider the US subprime crisis which was the first harbinger of the current downturn. The authorities wrongly attributed the crisis to a lack of liquidity. Subsequent measures to increase bank liquidity have had no impact and the recession in the US is deepening day by day. The reason is that the subprime crisis was a manifestation of the crisis in the market for real estate not the cause. Creating greater liquidity in banks does not address the root cause which was adverse expectations on real estate prices. Similarly, the one-time tax refunds to American taxpayers did not amount to an expected increase in long-term income of consumers and hence had no impact on market demand.
Coming closer to home, monetary policy here has also not worked for the same reason. In October alone the government has infused about Rs 1,80,000 crore into the banking system which is more than what was withdrawn earlier under the inflationary control measures. Call money market rates have fallen subsequently from around 20% to around 5% now. At the same time, interest rates have gradually drifted down while inflation has also cooled off.

Yet, production estimates are down drastically from one year back, income-tax recoveries on direct and indirect taxes are also way below targets and pessimistic business expectations continue. In addition, all over the country small producers in the textile and metal industries are closing shop like never before. Even in the organised sectors, layoffs have started and hiring will surely freeze in the coming months. All this will further fuel pessimistic expectations. In a demand-led recession measures which target individual response, like interest rate cuts via increased liquidity, cannot address the crisis of confidence which sustains most recessions. In fact, falling real interest rates will further trigger expectations of losses from holding real assets and even the expected demand increase for real estate will not be forthcoming.

So what is the solution? As the above indicates, both at the global level and in India, government expenditure which pumps in incomes and generates expectations of sustained demand is the only solution. It is heartening that in India the FM has agreed that this is not the time to be watching fiscal deficits. As we have noted, the problem is a failure of markets and market solutions will not work without causing a lot of pain.

Economic Times, 12 Dec, 2008, 02.17AM IST, Manoj Pant,ET Bureau
Global recession & the future of trade
In this column last month (ET, Nov 14) I had argued that there is no doubt now that the world is in for a major demand recession, largely triggered by the financial crisis in the US, which is now converting into a contraction in real demand for goods and services globally.

This is mainly because the US by itself accounts for about 30% of world demand. I had also argued that while this recession is probably the worst since the 1930s, there is a crucial difference: the level of coordination among countries in financial and other markets is quite significant today.

Lack of this coordination (both domestically and internationally) was a major lacuna in the 1930s. The main problem with this lack of coordination is that the required demand corrections rely entirely on markets which are typically known (a la Keynes) to fail in such times.

World bodies can ensure multilateralism as unilateral actions are, in such circumstances, known to be actually irrational. I had also noted in last month’s column that a principal casualty of world recessions is world trade: the so called ‘beggar thy neighbour’ policies of the 1930s. In this article I will look at two issues: which countries are most likely to hit by the downturn in world trade and what the role the WTO must play in these circumstances.

That trade and global commerce is the first casualty of world recessions is well known. As unemployment drops in countries there are increasing political demands (more so in democracies) to ‘keep jobs at home’. One has already seen this in some of Barack Obama’s statements in the US.

While most are probably pure political rhetoric, he is unlikely to be able to wriggle out of his promise to subsidise producers for every job created at home. While developed countries may be able to follow this method in creating distortions in world trade, developing countries are likely to adopt the easier alternative of raising tariffs on imports. But, as is well known now, such tariff responses are likely to invite retaliation: one country’s exports are obviously another country’s imports.

The result of these ‘tariff wars’ is a general drop in world trade. In the 1930s, tariff wars were set off by the US Smoot-Hawley Act of 1930 which raised tariffs on imports. While estimates vary, most studies show that the effect of the resulting tariff wars was a fall in world trade by around 30-35%. This certainly aggravated the recessionary impact of a fall in world demand.

Today, it is likely that non-tariff barriers (NTBs) are likely to take the place of open tariff wars as countries respond to domestic political compulsions to tackle growing unemployment at home. The US today faces around 8% unemployment while many countries of the EU have already hit double-digit unemployment rates.

Who are the biggest losers in these trade wars? Mainly small countries. These countries by definition rely on world demand as the domestic demand is insufficient to accommodate production capacities. Scandinavian countries and countries like Hong Kong, Singapore, Taiwan, Switzerland, etc., are the likely candidates.

Not surprisingly, while the US was a prime trigger for tariff wars in the 1930s, the trade downturn did not hit it to the same extent as other countries more dependent on trade. Closer to home, one will see these trade impacts hitting countries of Southeast Asia. In India too, small-scale firms in industries like textiles, gems and jewellery, auto parts, etc., are already feeling the heat of downturn in world demand. In tariff wars these firms, which rely to a large extent on world markets, will see things get worse.

What can be done? As I have noted earlier in these columns, the main difference today as compared to the 1930s is the existence of international coordinating institutions. For trade we today have the WTO, which coordinates tariff concessions between countries.

However, the failure to close the Doha round of trade negotiations during the past seven years or so has made many observers doubt the efficacy of the WTO in fairly regulating world trade. Yet, paradoxically, the role of the WTO is far more critical today in preventing tariff wars.

It is, therefore, essential for the WTO to use the current world economic crisis to try to obtain final closure of the Doha round. It is unfortunate that the Doha closure was postponed recently mainly because of a rather silly US stand on what import surge in agriculture constitutes a reasonable trigger for safeguard action by developing countries. Again, the recent draft which brings in sectoral level negotiations in NAMA is likely to muddy the waters.

Why is the WTO losing credibility? The main reason is its inability to tackle political compulsions in the US and EU (for, example over agricultural negotiations) while putting pressure on developing countries where the political repercussions of agricultural negotiations are much more severe: they are perceived to impact the livelihood of over 60% of the population. But can the WTO bell the cat? It has to now.

Economic Times, 14 Nov, 2008, 12.00AM IST, Manoj Pant,
World recession: The way forward?
According to recent data, both the UK and US economies have shrunk (or at least certainly not grown) in the last quarter. It is more than likely that similar data will obtain for most of the other OECD countries in coming months.

We can also be certain that the shrinkage will continue (on a year-to-year basis) in the next year. Given the classical definition of a recession as two or more quarters of shrinkage of economies, it would then be reasonable to assume that the world is headed for a major demand contraction in the coming year.

As the financial meltdown translates into a decline in wealth (the stock markets and real estate markets) and income (reduction in jobs), the world economy will suffer an almost certain contraction in the coming year. As I had argued in this column last month, (US financial meltdown and India: ET, Nov 10) the similarities with the Great Depression of the 1930s are quite stark.

Two questions then are pertinent. First, are we in for four to five years of bad times as in the ‘thirties and how important is the US to the solution? Second, what role can India and China play in any recovery? The last question becomes particularly important given the invitation to these countries to the meeting of the G20 in Washington in the middle of this month.

But first things first. It is interesting that some commentators have claimed credit for predicting the recession. The usual argument is that the US was living beyond its means as reflected in its huge and growing trade deficits. (One has been hearing this at least since 2000!) However, the growing trade deficits were matched by increasing inflow of foreign investment into the US.

At the end of 2007, the stock of net foreign investment in the US was about $2.5 trillion and the surplus in yearly trade in services like royalties, education, etc., was about $130 billion. Obviously, the rest of the world did not share the same pessimism about the US economy. What seems clear is that the US economy (surprisingly like India in Asia) is a net importer of commodities but a net exporter of services.

The recession is mainly due to a failure of expectations (as Keynes told us) which can be expected but never predicted. The US simply happens to be the country where this failure of expectations manifested itself at the earliest. However, as history warns us, pessimistic expectations are contagious and spread rapidly.

Recognition of this cause of any recession holds the key to understanding how 2008 is different from the 1930s. The world economy today boasts of several global coordinating mechanisms unlike in the ’30s. Thus, for example, there is a remarkable degree of coordination today between central banks of various countries. Similarly, the WTO is a useful mechanism to combat trade protectionism. We now know that tariff wars led to a major contraction in world trade in the 1930s.

The main problem in unilateral trade protectionism is that it is then extremely irrational for any one country to reverse protectionism: only multilateralism works. This was in fact the rationale for the GATT agreement of 1948. Given the globalised nature of today’s world, only multilateralism can reverse pessimistic expectations which also tend to be self-fulfilling.

Does the US have an important role to play? The accompanying table gives some information. A recession is always demand led. As the table indicates, the US has remained dominant, accounting for about 30% of world demand in 2007. It then stands to reason that the easiest recovery from recession will come about through demand recovery in the US. It is also important to realise that, in this Keynesian world, mere increase in liquidity will not solve the problem of expectations.

Governments will have to play an active role in stimulating demand thorough direct expenditure. It is not then surprising that the first attempts in the US to stimulate demand by refund checks to individuals failed: given adverse expectations the refunds only found their way to new savings.

From the accompanying table it is also clear that both China and India still constitute a very small part of world demand. Hence it is unlikely that normal demand expansion in these countries alone would lift world demand.

However, developing countries also hold about 75% of world foreign exchange reserves of about $6 trillion. In addition, the population demographics disfavour demand expansion in the developed world. Hence, in innovative allocation of these reserves in developing countries along with a careful reading of Keynes lies a possible solution to the recession. The Great Depression shifted focus from the Commonwealth countries to the US. Will the next shift be to Asia? Is India ready? Only time will tell.

(The author is professor of economics, Centre for International Trade and Development School of International Studies, JNU)

Economic Times, 10 Oct, 2008, 12.02AM IST, Manoj Pant,
US financial meltdown and India
The current financial meltdown shares one common link with the Great Depression of 1929 and the east-Asian crisis of 1997. In all cases the real sector precipitating the crisis has been real estate. The 1929 crisis also followed the bursting of the “South China Seas bubble” where unscrupulous middlemen sold non-existent real estate in the South China seas.

In the east-Asian case, there were dubious real estate purchases by “friends” of bankers and politicians. Hence the title of “crony capitalism”. The current crisis has a similar real counterpart — the crash in the market for real estate in the US.

All the crises also had a common financial counterpart in that excess liquidity with banks financed the sale of monetary assets linked to real assets like real estate. However, the level of coordination of banks during 1929 was somewhat different in that US banks then were largely small regional banks and the Federal Reserve bank played a dubious and delayed role in coordination.

Finally, the east-Asian crisis was due to flow of excess liquidity from the west to the east (aided substantially by IMF actions) while the current crisis is financed by flow of excess savings from the east to the US. The main point of the above is the important link of this “financial crisis” to the real sector. Therein I think lie some lessons for India.

But first a little recap of the current crisis. Readers may recall that during the period 2001-2003 or so, real rates of interest were zero or negative in most OECD countries. This led people to borrow money for returns of even 3% or so.

Some of this money did find its way to the commercial real estate sector in India but this was limited because of the current restrictions on FII investments in real estate. Another portion of these funds found its way into the Indian stock market.

Within the US also, the low interest regime led people to renegotiate their mortgages. This process essentially involved people borrowing from banks, paying off their mortgages and repurchasing them at lower rates of interest.

The financial sector then “securitised” these mortgages thus making them tradeable monetary instruments. As long as rest of the world’s savings kept flowing in this process could continue. More importantly these mortgages then became part of the asset structure of investment banks.

Speculation in mortgage values, however, is only sustainable if real estate prices rise. This in fact happened after 2002 and prices peaked in 2005. However, there were irrational expectations that such price rise would continue.

Unfortunately, the demographics of the US population could not support such expectations.

In the year 2005, only 27% of population was in the age group 0-19 and about 13% were aged 65 or more. Furthermore, the graying of the population is obvious given that by 2050 about 20% of population will be aged over sixty five. In other words, there was unlikely to be any sustained demand for real estate. Coupled with the undersaving by American households, it was clear that the mortgages could never really be encashed.


The decline in the value of the homes led to a fall in the real wealth of most American households. This declining wealth effect was made worse when the financial meltdown fed into the stock market where most Americans have invested. This sudden decline in wealth led to cutbacks in expenditure which will accentuate demand contraction as time goes on and incomes also start falling.

How would the Indian economy be impacted? For one, unlike the US there is a clear bottom to the present (welcome) correction in the real estate values in India. For the Indian demographics (50% of population aged around 25) ensures that at some lower value there will always be someone willing to invest in the Indian dream of owning a home. The exorbitant real estate values today are due to speculation much like in the US, but in India the demographics establish a floor to prices.

Second, exports to the US now account for only about 16% of India’s total exports so the impact on domestic demand will be minimal.

Third, the crashing Indian stock market generates little wealth effect. Finally, it must be remembered that cost-cutting by US firms and EU firms (mostly service exporters) may well lead to greater dependence on Indian IT services which are still low-cost and labour-intensive.

The bottom line? The real impact on India will be minimal although financial variables like the exchange rate and equity prices will undergo correction as speculators exit. More important, the favourable demographics implies that the economy is unlikely to be severely demand constrained.

Even more important, the regulatory systems in financial markets are well in place and large volume capital convertibility limited. Who needs to worry? The EU in particular.