Why Chidambaram should not be overconfident about India’s economy

P-CHIDAMBARAMVivek Kaul  

In the recent past, politicians belonging to the Congress led United Progressive Alliance have often remarked that India will be back to a high economic growth path over the next few years. The latest such comment came from finance minister P Chidambaram on January 16, 2014. As Chidambaram said “As global economy recovers and as new measures take effect, I am confident that Indian economy will also get back step by step to the high growth path in three years.”
This confidence seems to suggest that high economic growth in India is a given and come what may it will come back. But history suggests that is clearly not the case. Economic growth can never be taken for granted.
The Global Emerging Markets Equity Team of Morgan Stanley in report titled 
Tales from the Emerging World dated January 14, 2014, points out “In a recent paper, former [American] Treasury Secretary Lawrence Summers warns that of all the factors that drive economic growth the one with the most clearly proven predictive power is simple regression to the mean.” Regression to the mean is a technical term which essentially means that a variable that is highly distinct from the norm tends to return to “normal”. Summers has co-authored the paper titled Asiaphoria Meet Regression to the Mean with Lant Pritchett.
In simple English what Pritchett and Summers are saying is that high economic growth rates tend to revert to their long term averages. As they write “Episodes of super-rapid growth tend to be of short duration and end in decelerations back to the world average growth rate. Both China and India are already in the midst of episodes that are historically long and fast.”
Hence, high economic growth rates can never be taken for granted. “The growth rate, even in successful economies, will tend to revert to the long-term average for all economies (which is about 1.5 to 2 percent). Summers[along with Pritchett] analyzed all 28 nations that, since 1950, have experienced periods of “super rapid growth” of more than 6 percent a year. These booms tend to be “extremely short lived,” with a median duration of nine years, and “nearly always” end in a significant deceleration, with a median deceleration of 4.65 percentage points to an annual GDP growth rate of just 2.1 percent, or “near complete regression to the mean.” In short, the nations catching up most rapidly now are increasingly less likely to continue catching up in the future,” the Morgan Stanley authors point out.
As mentioned, periods of high economic growth rates last for a median period of 9 years. The research paper considers data up to 2011. And by that time, 
the economic growth in India had lasted for a period of around 8 years. In China, it had lasted 32 years.
While Indian politicians might like to think that it is just a matter of time before economic growth comes back, that may not be the case. As Pritchett and Summers write “The single most robust and striking fact about cross-national growth rates is regression to the mean. There is very little persistence in country growth rates over time and hence current growth has very little predictive power for future growth.” Given this, just because the Indian economy has grown at a high growth rate between 2004 and 2011, that does not mean that it will continue to do so in the future as well.
Pritchett and Summers do not get around to explaining the major reasons behind why this happens (the research paper is still work in process). But one of the reasons they point out is the rule of law. As they write “we suspect that the reason for slowdown that will come in China and India is for a similar reason but which will manifest differently given the very different politics. That is, in neither country does investor confidence rely on rule of law.”
But there is other research which points out why poor countries are not able to sustain high economic growth beyond a point. As the Morgan Stanley authors point out “New research, however, shows that “development traps” can knock countries off the catch-up path at any income level. The challenges of developing industry — backed by better banks, schools, regulators, etc. — do not accumulate and confront an economy all at once. They continue to harass an aspiring nation every step up the development ladder.” This is already playing out in India.
In fact, countries flatter to deceive, do well in one decade and don’t do well in the next. “In some cases, development traps can drag newly rich countries back to the middle income ranks, as has happened in the last century to Argentina and Venezuela. Since the late 1950s, many nations have also slid back from the middle to the lower income class, including the Philippines in the 1950s, and Russia, South Africa and Iran in the 1980s and 90s. On average, more nations regress to a lower income level than advance to a higher one. And every decade tosses up new convergence stars — from Iraq in the 1950s to Iran in the 60s and Malta in the 70s — that burn out in the next decade,” Morgan Stanley authors point out.
Hence, sustained economic growth is a very rare phenomenon. And just because India has grown at a fast economic growth rate in the past, it may not do so in the future. The highly optimistic UPA politicians need to start by at least appreciating this point. 

The article originally appeared on www.firstpost.com on January 21, 2014 

(Vivek Kaul is a writer. He tweets @kaul_vivek) 

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About vivekkaul
Vivek Kaul is a writer who has worked at senior positions with the Daily News and Analysis(DNA) and The Economic Times, in the past. He is the author of the Easy Money trilogy. Easy Money: The Greatest Ponzi Scheme Ever and How It Is Set to Destroy the Global Financial System , the latest book in the trilogy has just been published. The first two books in the trilogy were published in November 2013 and July 2014 respectively. Both the books were bestsellers on Amazon.com and Amazon.in. Currently he works as an economic commentator and writes regular columns for www.firstpost.com. He is also the India editor of The Daily Reckoning newsletter published by www.equitymaster.com. His writing has appeared across various other publications in India. These include The Times of India, Business Standard,Business Today, Business World, The Hindu, The Hindu Business Line, Indian Management, The Asian Age, Deccan Chronicle, Forbes India, Mutual Fund Insight, The Free Press Journal, Quartz.com, DailyO.in, Business World, Huffington Post and Wealth Insight. In the past he has also been a regular columnist for www.rediff.com. He has lectured at IIM Bangalore, IIM Indore, TA PAI Institute of Management and the Alliance University (Bangalore). He has also taught a course titled Indian Economy to the PGPMX batch of IIM Indore. His areas of interest are the intersection between politics and economics, the international financial crisis, personal finance, marketing and branding, and anything to do with cinema and music. He can be reached at vivek.kaul@gmail.com

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