T C A Srinivasa-Raghavan: Bird, plane or India?

OKONOMOS

"Takeoffs in countries that are more service-intensive are more likely to be sustained."

Ever since Walt Rostow coined that evocative phrase "" takeoff "" to describe sustained economic growth in countries that had been stagnant, economists have been keeping a sharp eye out for symptoms of an economy becoming airborne.

So it is not surprising that India's economic performance of the last five years has got everyone whispering excitedly. "Is this the long-waited takeoff, or is India flattering to deceive?"

Some say this, others say that and so the debate goes on. Rather endlessly and, as some would say, a bit pointlessly as well. But there may be some good news for the optimists now. In a recent paper* Joshua Aizenman and Mark Spiegel say, "Takeoffs... in countries that are more service-intensive are more likely to be sustained."

This is something of a poke in the eye for those who are saying that without there being a significant increase in the share of manufacturing in GDP, not to mention a sharp rise in employment in it "" mainly of unskilled people doing simple, repetitive things "" judgement on India's takeoff will have to be suspended.

Aizenman and Speigel say no, hang on a minute, see what we have found. They do the usual thing "" a cross-country examination of data pertaining to "factors associated with takeoff". They took 241 "stagnation episodes" from 146 countries.

And what they found was this: "...de jure trade openness is positively and significantly associated with takeoffs. A one standard deviation increase in de jure trade openness is associated with a 55 per cent increase in the probability of a takeoff in our default specification."

They say that the other staple, capital account openness, also makes a difference, although (ha!) they add, "this channel is less robust." This should not be hard to understand "" even for those who think capital account openness is the miracle cure. It is based on very a simple fact: foreign savings matter only at the margin and it is domestic savings that drive growth.

Also, "open capital accounts can be associated with greater output growth volatility, as countries with open capital accounts in our sample appear to be less likely to experience sustained takeoffs conditional on the occurrence of a takeoff."

The most important thing, however, has got nothing to do with trade openness or open capital accounts. Those things help, certainly, but only at the margin.

What matters, say the authors, is output composition and economic structure. "Countries with output bundles that were more commodity-intensive exhibited a smaller share of sustained takeoffs, while those that were more service-intensive exhibited a greater share of sustained takeoffs."

It is easy to see why countries that depend on commodity exports can go into a nosedive if there is a sudden downturn in commodity prices. But it is less easy to see what happens to countries that, having taken off, suddenly get hit by the opposite price effect, namely, a sharp increase in commodity prices. Unfortunately, the authors have not examined this side of the coin.

From the policy point of view, this is an extremely important paper and needs to be read by the likes of Montek Singh Ahluwalia. "The service sector is likely to be more stable," say the authors and if this is so, it has very clear implications for exchange rate and interest rate policies.

The hugely silly idea that these can be left entirely to the mercies of the markets "" which often consist of a large number of scallywags looking to make a quick buck by betting on instinct without actually producing anything "" needs to be reviewed.

*Takeoffs, NBER Working Paper number 13084, May 2007
http://www.nber.org/papers/w13084