Shankar Acharya: Nuggets of wisdom

A PIECE OF MY MIND

The Delhi conference season is in full swing. It's not just high-profile business events organised by WEF, CII, FICCI, etc. Academic conferences, sponsored by think-tanks and foundations, are also in full bloom. Last week, there were back-to-back ones on a couple of hardy perennials: "Capital Flows" and "India, China in the Global Economy". Let me share a few interesting tidbits from the varied menu on offer.

Barry Eichengreen (of Berkeley) presented a thoughtful paper in which he outlined four very different schools of thought on free capital flows across borders to developing countries: First, the textbook case for free capital movements in search of efficient capital allocation; second, an advocacy of free flows based on foreign capital as a vehicle for technology, modern management and pressures for institutional reform in the host country; third, a cautionary tale associating capital account liberalisation with instability and financial crises, and emphasising the critical importance of sequencing reforms; and finally, the challenges posed by capital surge and the associated problems of real exchange rate appreciation.

It's interesting to note how mainstream academic views in the West have matured over the last decade. Back in the mid-1990s (and despite the "tequila crisis" of 1993/94), the US Treasury and the IMF were leading the charge in favour of rapid implementation of capital account convertibility (CAC) in developing nations, including through espousal of enabling amendments of the IMF's Articles of Agreement. At that time, one didn't hear too much about the latter two schools of thought in Eichengreen's list. The Asian financial crisis of 1997/98 and the Russian debt default of 1998 provided a couple of hard knocks in the school of experience. More recently, the astonishing rise of China and the recent spurt in India's economic growth (both without the benefits of CAC) have contributed to muting the demands for CAC implementation in developing nations.

It is now both more commonplace and reassuring to find mainstream Western economists emphasising the importance of prior conditions (fiscal consolidation, banking reform and mature financial regulation) to CAC and appreciating the relevance and suitability of "intermediate" exchange rate regimes for poor, labour-surplus developing countries. Thus, Eichengreen is comfortable with the view that "it is more prudent that capital account liberalisation wait on the prior implementation of other reforms to avoid precipitating a crisis". He also seems to applaud China's policy of maintaining partial capital controls and taking recourse to "sterilised" foreign exchange intervention to maintain a competitive real exchange rate policy aimed at nurturing rapid, labour-intensive growth. Presumably, by extension of the same logic, he would bless similar policies in India.

Barry Bosworth (of Brookings) and co-authors presented an account of US trade with China and India. Their paper is rich in analysis and data. I will limit myself to a couple of points. First, as the table shows, the US has a huge imbalance (net deficit) in its goods trade with China and a more modest one in its trade with India. The table also brings out the smallness of India's goods trade with US in comparison to China. In the authors' words, "India represents a sharp contrast to China in the small size of its goods trade. Although India's GDP is a third that of China's, its global trade is only about 12 per cent as large, while its trade with the United States is less than 10 per cent as large."

More surprising are Bosworth's findings that "China's global trade in services is substantially larger than India's"... and that "the United States reports a larger volume of services trade with China than India," despite all the hoopla about outsourcing of US service jobs to India. Digging deeper, Bosworth notes that in "recent years, India has consistently reported a level of exports to the US of Business, Professional and Technical (BPT) Services that is twenty times that recorded by the US as an import "" $8,700 million in 2003 versus $402 million, for example , in 2003". This is an astonishingly huge discrepancy. According to Bosworth, most of it is attributable to accounting quirks on the Indian side, notably the inclusion of earnings of Indian software workers residing in the US (even if they intend to stay more than a year) and the inclusion of "internal sales of services to local affiliates of US firms as part of its exports". These definitional differences in the concepts of service exports are massive. Surely, the RBI and/or the government need to bring out a lucid explanation of these differences and their implications for the economic analysis of India's service exports.

Turning to the third and last tidbit, Alan Heston (of Pennsylvania) explored the puzzles that arise when he tried to reconcile the national GDP growth rate estimates of China and India with those thrown up by the purchasing-power- parity (PPP) estimates of GDP constructed by the long-running International Comparisons Project (ICP), which are reported in the Penn World Tables (PWT). (By the way, Heston is a co-progenitor of this 40-year-old enterprise of producing GDP estimates for countries based on internationally comparable prices). Specifically, the big puzzle is that if the PWT data are accepted at face value then the ratio of India's per capita GDP to China's (PPP-adjusted) is a plausible 0.6 in 2003 and an utterly implausible 2.43 in 1952! No serious scholar credits the latter figure; most would put the ratio somewhere between 1 and 1.2.

To help resolve this puzzle, Heston turns to some revised estimates of output and prices for China prepared by scholars Angus Maddison and Harry Wu. Maddison and Wu have re-estimated China's GDP growth rates downwards from 9.6 per cent per year to 7.9 per cent (for reasons given in Heston's paper). Heston also assumes that in 1952, India's and China's per capita GDP were equal at PPP prices, that is , the ratio was unity, which is within the independently estimated plausible range of 1 to 1.2 noted above. Armed with these adjustments, Heston arrives at a much more plausible time series of estimates for the ratio of India's per capita GDP to China's (both PPP-adjusted). The second table presents the comparisons.

What all this says to me is that the comparison of GDP and growth across countries at PPP prices is a tricky business. So also are such comparisons done at official currency exchange rates. Both types of data have value and relevance "" you just need to be very careful when to apply which type for what purpose!

I hope these tidbits provide food for thought.

* Barry Eichengreen (2007), "The Cautious Case for Capital Flows", mimeo., paper presented at NIPFP-DEA Research Conference, December 4-5, New Delhi
** Barry Bosworth, Susan Collins and Aaron Flaaen (2007), "Trading with Asia's Giants", mimeo., paper presented at ICRIER India, China and Global Economy Conference, December 6-7, New Delhi.
*** Alan Heston (2007), "What Can Be Learned About the Economies of China and India from the Results of Purchasing Power Comparisons?" paper presented at ICRIER India, China and Global Economy Conference, December 6-7, New Delhi.

The author is Honorary Professor at ICRIER and former Chief Economic Adviser to the Government of India. The views expressed are personal