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Economic Growth in India

india-lf.gifMy postings on India here on AS have primarily been driven by my interest in the Indian retail sector and how big foreign retailers are trying (and for some failing) to enter the promised land typified by India's consumer market.

This post does not grind down to the micro level but stays in the realms of macroeconomics where I will point you to a tour-de-force article (+comments!) by Nanubhai over at the Indian Economy Blog. In essence, I am only pointing here and I can highly recommend you to drop by the IEB and read it. However, I would like to highlight a couple of things from Nanubhai's post.

As it has been pointed out by many lately (see links in Nanubhai's post) India is on the brink of economic overheating as a result of the blistering pace the economy is going at. Yet, this analysis rests (quite naturally) on the idea of a given rate of trend growth and as you will see this is the main issue here. What is in fact India's trend growth rate?

'Ajay Shah, the Economist, and various investment banks (including Morgan Stanley and HSBC) have repeatedly said that India is overheated – evidenced most clearly by the run-up in inflation, and also by ‘bubble-like’ real estate and equity prices. Skittishness about the policy direction of the current governing coalition supports the prevaling belief that a crash (or, for the less brave, a “cooling down”) is imminent. According to them, economic growth and/or asset prices are both set to decrease in the near-medium term.

They may well be right. Nevertheless, it is worth taking a look at the numbers and seeing exactly what has been powering economic growth in India over the last couple of decades. If we want to figure out where the Indian economy is headed over the next 4-5 years (as opposed to say, the next 4-5 quarters), surely this is better than looking only at the short-term indicators.'

In the following Nanubhai engages in a meticulous analysis of economic growth in India with the aim to establish a foundation to assess the level of trend growth but ever more importantly we are also looking at factors which influence trend growth. And the conclusion ...

Now the real heart of the capacity debate centers around this question: what is India’s trend rate of growth now and what will it be for the next few years? (This is the red italicized number in the previous chart) If you add up the numbers, it seems to me that at a minimum, trend growth is at 8% (5% TFPG + 2% labor force growth + 1% capital deepening) with the capacity to reach 10% (4.5% + 3.5% + 2%) in the coming years. The 6.5% baseline level of growth that the Economist and others use to form their assessments of the Indian economy is fundamentally flawed. Any judicious accounting of the productivity trend over the last 25 years, when combined with stable and high labor force growth, should reveal that, over the long-term, the ‘supply-side’ of the economy is advancing at an accelerating rate.

As we can see, one of the fundamental drivers of growth in India is the growth of the labour force or more specifically the demographic dividend which is defined as the period during the demographic transition where the labour force increases as the economy sees a net gain in workers. There are consequently some important points here and the first is that the demographic transition displays a very direct impact on economic growth but also more generally on the macroeconomic environment and ultimately also macroeconomic indicators. Another crucial consideration here is of theoretical nature and essentially has do to with the nature of the demographic transition's impact on the economy. In terms of Nanubhai's post we can see this in the end where he says ...

'(...) even the most pessimistic observer must see that the [cyclical economic] fluctuations are happening around a steadily increasing mean. Amidst this rapid transformation, India’s progress and prospects cannot be best judged month-to-month or quarter-to-quarter – but rather year-to-year, and in some instances, even decade-to-decade.

In India, we must see this as a golden opportunity to get our house in order: start cleaning up governance and the budget; build infrastructure; and balance growth between the regions. All these things will be much harder to achieve when (and if) the going gets tough.

In other words: don’t worry too much, but don’t get complacent either.'

What we have here is the recognition that whereas India today and for the decade to come will be enjoying, all things equal, a steadily rising growth trajectory this will not go on forever and how India leverages that advantage today has immense effects on the future of the Indian economy. For me (and Nanubhai) to argue as such we are incorporating in our analyses the idea of path dependancy concerning the impact of the demographic transition on the economy. Edward also noted this point in a recent article over at DM on immigration.    

This allows me to finish with a main point ...

If we can accept the conviction that the demographic transition and indeed the demography of a country displays a very direct transmission mechanism towards economic factors, performance, and growth we also need to recognize that this effect is not linear and indeed that this effect is very difficult to model since it is path dependant. This is the real lesson here and it is a basic recognition I believe we need to integrate into our thoughts on this.


Economic Growth in the US ... The Short and Long Term

money.jpgThat the US has been and is slowing down considerably in the third and fourth quarter of 2006 should not surprise many readers I suppose. However, some of those illusive questions remain and most importantly is the question of whether we will have a hard landing (for example 0% GDP growth in the 4th quarter, i.e. a recession) or a soft landing (e.g. 2-2.5% GDP growth). I won't stick my neck out on either of the two scenarios but obviously US economists are watching the data closely. This also includes the US econ-bloggers and some of the best have recently been following the discussion closely. Let us begin with Dave Altig who furnishes us with the November reports on industrial output and retail sales which seem to hail a somewhat brighter future than we might have expected.

Your first present this week was the November retail sales report, suggesting that rumors of the consumer's demise may be greatly exaggerated.  More modest glad tidings came today in the form of a November industrial production report that at least wasn't as bad as expected.

However, the real issue here is inflation and whether a rising inflation was going to linger despite lower growth rates. As such, it has long been one of the ground pillars in the most ardent pessimists' views that the inflation would stay afloat despite a considerable GDP slowdown thus prompting a situation resembling the much dreaded stagflation in the 1970s. So should we adjust to the rear-mirror view here? Well not quite yet as Dave quotes Mark Vitner (from Reuters)...

All we wanted from this holiday season was a little more growth and a little less inflation, and Santa looks like he has delivered. This is just a great report," Mark Vitner, an economist at Wachovia Securities in Charlotte, North Carolina

But as we dig deeper through Dave's analysis and sources we clearly need to hedge our bets but whether we are going to fall into stagflation seems a bit more unlikely I would say. Another place to look for excellent commentary on the recent data releases in the US and general economic outlook is over at Mark Thoma's place where Mark reports on the recent Fed watch by Tim Duly asking, where is that recession? Mark's piece has so many interesting points and references and I can only recommend you to read it. 

One thing which is of particular interest though to the immediate state of the US economy going into 2007 is this where Mark shows why might want to be optimistic on domestic consumption ...

(...) let’s take the inflation adjusted estimate of real retail sales from the St. Louis Fed – last time I noted that this was a good estimate of real personal consumption expenditures. In real, annualized terms, retail sales are up 13.2% in November. And suppose real retail sales are flat in December. Then 4Q07 real sales will be up 4% over the previous quarter.

Needless to say, 4% consumption growth would pretty much put to rest any idea of a recession in 4Q, especially if trade makes a positive contribution as October’s contraction in the trade gap implies. And if 4Q comes in reasonable (consider the implication of strong consumption and a mix of other components that effectively cancel each other out), the Fed is not likely to change policy until they get 1Q07 numbers in late April.

However, as I am interested in demographics my radar also did pick up on Mark's elaboration on one of Bernanke's recent speeches in which the chairman highlights the effects of the retiring baby boomers on US trend growth, or more specifically; the transition mechanism between the labour force participation rate and trend growth.

This one in particular from Bernanke is interesting ...

Even if productivity growth is sustained at a reasonably good rate, the slower expansion of the labor force will imply some moderation in the rate of growth of potential output over the next few years. In the very near term, that slower growth in the labor force needs to be taken into consideration when assessing the sustainability of given rates of expansion in economic activity.

And also this one from the Fed in Philadelphia by Charles I. Plosser is noteworthy ...

Of course you might ask, what is trend growth?  Well, over the years I have told this group that the easiest way to think about trend growth is to look at the growth in the labor force and the growth in productivity—add them together and you can come up with a rough estimate of the sustainable trend growth in real GDP.


In fact, over the next decade or so we might expect to see trend growth decline further as the growth rate of the labor force slows. Although we frequently note the role of productivity in determining trend growth, the contribution of labor force growth is often overlooked. As the baby-boomers retire, demographic analysis suggests that the growth in the overall labor force will slow.  Moreover, we are no longer getting the boost in the labor force from a growing number of women entering the work force, and we also have somewhat lower fertility rates.

There is clearly a stark difference between the short term and long term in this post and I do believe that it is likely that the US is drifting below the (current) trend growth mark going out of the 4th quarter, the long term trend in the LPTR notwithstanding. Nevertheless, there are interesting things going on here and what we see above is a very sound attempt to piece together some of the causal links and transition dynamics I think.