Wednesday, April 20, 2011

The China of India is…

… the state of Gujarat. Steven Pearlstein explains:

The biggest obstacle to India’s industrialization remains the lack of infrastructure, and no state is tackling that more aggressively than Gujarat. The entire state has been turned into one large public works project, with billions of dollars in investment being poured into dams, canals, power plants, highways, gas pipelines, electric grids and ports. The state is even assembling the land to create industrial cities along the path of a high-speed rail freight line that the central government is planning between Delhi and Mumbai.

Gujarat’s notoriously efficient, autocratic and incorruptible chief minister, Narendra Modi, is a strong adherent to the Asian-style industrial policy who believes that if you build it, they will come. And they have, bringing oil refineries, shipbuilding facilities, steel and auto plants and LNG terminals. With 5 percent of India’s population, 15 percent of its industrial production, 17 percent of its capital investment and 22 percent of its exports, the joke is that Gujarat has become the China of India.

Rajan Shah started Harsha Engineers in Ahmedabad in 1972, back when textile mills were what passed for Gujarat’s manufacturing base. Harsha got its big break in 1997 when Timkin, the giant ball-bearing maker in Canton, Ohio, decided to stop making the metal cages that are used to hold its bearings and rely on Harsha instead, and the company has grown steadily ever since. Shah figures he still has a 10 to 15 percent cost advantage over global competitors, thanks in part to Gujarat’s low wages and the ready availability of good design and production engineers. But just in case, he’s opening a second plant — in China.

But economic hurdles remain in India:

Despite such successes, India has a long way to go to modernize an economy where 80 percent of economic activity takes place in the “informal” sector. Beyond the more obvious problems of corruption, poor infrastructure and a low-productivity workforce, too much of the formal economy is controlled by a handful of family-run conglomerates who are quick to use their political and financial muscle to move into any sector that shows promise. In a nation of naturally entrepreneurial people, this creates headwinds for independent companies trying to attract talent and capital. It contributes to the growing concentration of wealth in the hands of a business elite that by all accounts has grown increasingly disconnected from the rest of the country. And it has encouraged many of the best and the brightest either to leave the country or follow the golden path into real estate and finance rather than manufacturing or government.

It also has an effect on foreign investors, who are keenly aware of the dangers of trying to compete against the local oligarchs. Enron tried it and wound up losing $1 billion on an ill-fated energy project. And I found it telling that Wal-Mart, which for years has been pushing hard for the government to relax rules that prevent foreign firms from opening stores in India, may chose to continue its joint venture with the Bharti family rather than go it alone.

A somewhat closed financial system is also restraining growth. India’s central bank is most proud that its tight restrictions on the flow of borrowed money into the country minimized the impact of the recent global financial crisis on India. But business executives complain that those same restrictions also prevent the development of a corporate bond market that is badly needed as a source of infrastructure funding. They require banks to keep so much of their deposits on reserve, or directed to low-return loans to farmers, that the cost of borrowing for businesses and consumers is two percentage points higher than it needs to be. It also doesn’t help that Indians continue to put much of their savings into gold rather than into a financial system that would recycle it into the economy.

Can Keynesians be anti-Keynesian?

Dave Altig, senior vice president and research director at the Atlanta Fed argues:

One of the interesting things about the article is that among the economists cited as being among the critics of "Keynesianism," you find the names John Taylor, Robert Mundell, and Kenneth Rogoff. I find that list interesting because if you follow the links I attached to those names you will find work with models that are decidedly Keynesian in structure. Works by Taylor and Rogoff are, in fact, seminal contributions to the "New Keynesian" paradigm that dominates macroeconomics today.

As far as I know, none of these men have repudiated the basic worldview that motivates the referenced work. In fact, as recently as last year John Taylor approvingly described, as he has many times, a key characteristic of the paradigm for monetary policy that was in place the decades before the financial crisis:

"… the central bank has a strategy, or rule, to adjust the interest rate depending on economic conditions: In general, the interest rate rises by a certain amount when inflation increases above its target and the interest rate falls when by a certain amount when the economy goes into a recession."

I added the emphasis to the last part of that passage as it is a feature of the so-called Taylor rule that is entirely built on the foundation of the New Keynesian model.

How, then, to explain the Keynesian predilections of the economists mentioned as presumed carriers of the anti-Keynesian mantle? The source of the confusion, I think, goes back to the historical, but somewhat obsolete, distinction between so-called Keynesianism and monetarism. The latter was, of course, personified in Milton Friedman and his dispute with what was the orthodoxy in the three decades following the Great Depression. Lost in the early-days labeling, however, was the fact that the disputes were more about the empirical details of theory rather than the theory itself.

In particular, Friedman did not deny the effectiveness of policy in principle but rather its wisdom or impact in practice. This sentiment is exactly the one he expressed in his prescient and transformative 1968 presidential address to the American Economics Association:

"In the United States the revival of belief in the potency of monetary policy was strengthened also by the increasing disillusionment with fiscal policy, not so much by its potential to increase aggregate demand as with the practical and political feasibility of so using it."

[…] My point is not to dispute or defend the truth of the Ricardian proposition. My point is that it has absolutely nothing to do with whether one believes (or does not believe) that the New Keynesian framework is the right way to view the world. The essential policy implications of the New Keynesian idea (like the old Keynesian idea) is that changes in gross domestic product can be driven by changes in desired spending by households, businesses, foreigners, and the government in sum. You can believe that and still believe in fiscal policy ineffectiveness, as long as you believe that total spending is unaltered by a particular policy intervention.