September 3, 2011


SS AIYAR reviews India growth story since 1991(The Elephant That Became a Tiger: 20 Years of Economic Reform in India). He points that when reforms began, critics had claimed that India would suffer a “lost decade” of growth as it was followeing the World Bank-IMF growth model of liberalisation. They warned that multinationals would crush Indian companies, while fiscal stringency would strangle social spending and safety nets. All of these predictions proved wrong with India growing at 8.5% and many Indian businesses more becoming multinationals themselves. However, India continues to be hampered by poor business conditions and misgovernance. Both governance and economic reforms are needed, but progress on the former lags far behind, is thus more urgent, and can help sustain and promote economic reform.

The surprise is his contention that India’s growth is a case of trickle up and not trickle down. He says that a growth rate of 8.5 percent in India is possible only if the bulk of the population improves its productivity.

This fast growth of poor states trickled up to create record GDP growth at the national level. India is mainly a case of trickle up, not trickle down, though fast national growth also produced more revenue that was shared with the states.

If India was indeed a trickle up story, why does government need to do so many social programs? What is the need for NREGA, Food Security bill and several other programs. Why are inclusive growth, inclusive finance and inclusive health on the agenda?

One oft-repeated suggestion to fix discretionary fiscal policy is to have fiscal councils. These fiscal councils should in turn be structured like modern central banks which are independent and focused on its mandate. The results for central banks in recent years have been very good with credible monetary policy and anchored low inflation expectations. As a result, despite huge monetary easing in the crisis, inflation expectations have remained low partly due to credible central banking. Similar results could be achieved with fiscal policy which has so far been discretionary, time inconsistent and election-dependent.

SIMON WREN-LEWIS (Comparing the delegation of monetary and fiscal policy) points how fiscal policy is far more complicated and fiscal councils can never be as effective as central banks. He says that time inconsistency which is used for monetary policy does not apply as simply to fiscal policy. The most obvious difference is that monetary policy involves the delegation of decisions, whereas fiscal policy involves delegation of advice and evaluation. There is far more clarity on impact of long term inflation than on debt policy. So fiscal councils end up being just advisory bodies.

The paper also looks at UK’s Fiscal Council which is charged with producing the official forecast on which budgetary decisions are based. It is unclear whether it can do this while retaining its independence. It would therefore seem sensible to allow Fiscal Councils to comment on what appropriate intermediate targets for policy should be (as some already do), particularly as this may enhance their perceived credibility and independence.

Like the Centre, India’s states have also been meeting its deficits via bond market (called State Development Loan Bonds or SDLs) through auctions in 2006-07. A trio of RBI economists, look at the factors (Determinants of Primary Yield Spreads of States in India: An Econometric Analysis) which determine state bond yields. The paper looks at two broad questions: What is the spread between Centre and State Government bonds? And what determines movement in state bond yields?

For first, the spread varies depending on the business cycle and conditions. During 2008-09, which was characterised by higher interest rates, the spread was moderate (122 bps). However in 2009-10, when interest rate regime was easier, the spread remained high at 86 bps. During 2010-11, when rates have again increased the bond spreads have not firmed up (45 bps). The pattern of past auctions shows that accessing the market at a right time with right size of issuance yields a right price to the SDLs.

On what leads to movements in these bonds, results are surprising. The key deficit indicators do not seem to explain the yield spreads across States. The analysis lends some support to the argument that the States with higher debts pay higher yields as compared with other States. Similarly, there is also evidence that Central transfers to the States help them to raise borrowings at lower spreads.

This is a fascinating paper (Integration in the Absence of Institutions: China-North Korea Cross-Border Exchange) by STEPHAN HAGGARD, JENNIFER LEE, and MARCUS NOLAND. Some economists have shown how commerce prospered in earlier times in absence of formal institutions. So we need not bother having formal institutions if informal ones do the job.

This paper reviews this role of informal institutions debate in a natural experiment setting—trade between North Korea and China. Few Chinese firms trade with North Korea in absence of formal institutions. The paper conducts a survey amidst such Chinese firms and finds Chinese appraisals of the North Korean business environment are generally negative and manifest fear of expropriation of investments made in North Korea. Moreover, they always complain and are wary of ever-changing regulations in North Korea. As a result Chinese firms are smaller in size and limit themselves to trading. Chinese are also not happy with the current system and would prefer more formal systems.

So, the lesson is that informal institutions work only for a limited scale. Firms need proper systems to grow.

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