Prof. Bhagwati has got it wrong

Prof. Jagdish Bhagwati has written an invited article on the front page of Economic Times today (Jan. 9). He has made a strong case for Narendra Modi’s Make in India (and sell abroad) campaign and has urged the Prime Minister to overcome the ‘populist’ anti-reformers both politically and intellectually. His is an attempt, self-confessedly, of providing the latter and in the process, he derides all those critical of export-oriented growth as paper tigers. Mine is obviously a ‘paper-tigerly’ response to his arguments.

One, there is a fallacy of composition in the strategy of export-oriented growth as a panacea for growth of all the economies. All countries cannot be export-oriented at the same time as they cannot all be exporting to Mars. Obviously some of them would have to be import-oriented to be able to accommodate others’ export-oriented growth. And if there are limited markets abroad to compete for, more difficult will be the export-oriented strategy more are the number of players. Moreover, there is a first mover’s advantage.

Two, this strategy has to be in contradiction with a domestic demand driven approach. This is so because it requires a continuous decline in the cost of production, a significant proportion of which is the wage cost, to outcompete the rivals. Two ways in which you can keep the relative wage costs down is by depressing the wages and/or increasing the productivity of labour relative to the competitors. Both these involve a fall in the share of wages in the economy (as has been the case with the Chinese or other such experiments). This squeezes the domestic demand in the economy in the long run either through a fall in incomes (wage fall) or unemployment (through labour displacing technological expansion). This contradiction is clearly visible with the Chinese today, who are finding it difficult to move from an export-oriented strategy towards a domestic demand driven strategy. And in this race to the bottom, if you don’t win, you end up losing on both ends, neither will there be an external market created nor a domestic market remaining.

Three, the other part of the cost, raw materials, requires the corporates to be given a free-hand in terms of exploiting the natural resources. Corporate scams across the Third World today are mere reflection of how desperate they are to grab the resources without paying for the same, all in the name of outcompeting the ‘external’ rivals in this race. The extent of environmental degradation domestically coupled with exploitation of the resource-rich-but-politically-weak countries abroad surely should be a matter of concern even for these export enthusiasts.

Four, even if we assume that growth is delivered, it will surely be inequitable for the working masses in general for the second reason. What Prof. Bhagwati misses is that he equates the interests of the corporates who surely benefit from such a strategy with the majority of the population. His argument is so unabashedly anti-working class that he says that the mistake Clinton made in the 1990s was that he didn’t crush the labour unions once and for all so that they could never raise their ugly head again finding voices through some of the democrats elected during Obama’s time!

Five, his argument that growth is a radical pull up because it generates resources for social spending for those left-behind is also flawed because these policies also come with a baggage of controlling government deficit (broadly tax income less expenditure). If this is coupled with concessions in taxes for the corporate sector (in the name of incentivising production), there is a twin attack on fiscal expenditure. Add to this a downward inflexibility in military expenditure in the name of ‘nationalism’, the axe invariably falls on the social sector spending itself.

Last but not the least, all this growth, if delivered, would still be in control of the importing nations. If for some reason, they hit a roadblock in terms of providing a market, as is happening today, it will have a cascading effect on the export-oriented economies who would have lost the fall back options in the very process. Chinese talk of a ‘new normal’ and difficulties in achieving it is merely a recognition of this problem.

Here I have not even discussed the implications of ‘parking’ of funds by the foreign institutional investors in the capital markets in the emerging economies. I have kept the focus purely on the trade side of it as Prof. Bhagwati has. I am sure these are yet again paper tigers for him but such economists need to be told every now and then that they should be upfront and say that they are talking on behalf of the rich and the elite instead of calling names to those who stand with the working people.

PS: His anger against Prof. Sen (the only Nobel Laureate in Economics from India) is quite intriguing though!

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5 Responses to Prof. Bhagwati has got it wrong

  1. Atul says:

    Hey Rohit- I have read your article. I am no supporter of J Bhagwati or such economists (who else do u mean)- neither do I belong to the rich and the elite. I like to go by the merits and demerits of an argument. I have many reservations to the points that you have raised. Some of them which immediately came to my mind are as follows:

    You say: “All countries cannot be export-oriented at the same time as they cannot all be exporting to Mars!”

    1) Do you mean to say, that just because all countries cannot be export-oriented, India should compromise and take a back seat? Why? There is also a whole lot of literature on Global Production Networks. Countries can export and import at the same time, depending on the comparative advantage of the particular good/service.

    2) I dont agree to your argument that a continuous decline in the cost of production necessarily means a reduction in wage cost- could you give me real examples please.

    3) How can you ascertain that domestic demand falls only due to a fall in share of wages (which you claim) in the long run? In the long run, what about other factors that come into play- like the millions of unemployed getting jobs due to increase in industrial activity? Doesnt this lead to an increase in domestic dd?

    4) What do you mean by corporates- a clear definition is required? Do they include Own Account Manufacturing Enterprises? Corporates? Does it include national oil companies? Once you define corporates Ill ask the next question.

    When you say government deficit? What do u mean? Both fiscal and revenue deficit? A fiscal deficit may meet the requirements of FRBM by still having high quality expenditure- capital social expenditure as compared to revenue O&M expenditure

    How will the axe fall in social expenditure if the pie gets bigger (more revenue) owing to greater tax collections due to a positive buoyancy greater than 1 of various taxes (assuming GDP growth)?

    • rohitazad says:

      Hi Atul. I am sorry for the delay in my reply and thank you for engaging with the arguments made by me. Let me respond in the same sequence:

      1) I am saying that there are serious limitations to export-oriented growth strategy: (a) unless the markets of exports (imports for the recipients) is expanding, it is difficult to maintain this strategy; (b) this is further made difficult by the fact that China has a first mover’s advantage, so you have to first nullify their advantage; (c) moreover in a period where potential external markets themselves are undergoing a severe and protracted crisis, it is a strategy not worth pursuing. In fact, it is no accident that a country like China today is facing a severe problem maintaining their strategy.

      2) The only way in which you can outcompete your rivals in an export-oriented strategy is by keeping the real exchange rates low. So, nominal depreciation is not going to work. And any depreciation in real exchange rate requires a relative decline in your cost of production, two of which are wage and domestic raw material costs. Relative wage costs (and absolute as well when your competitor like China is keeping its own real absolute costs down) can only be brought down either by bringing the real wages down or by increasing labour productivity, both of which bring the wage share down. An increase in income inequality in China and other exporting nations is a reflection of that. I will not go into the working conditions of these workers as this has been documented well (textile workers of Bangladesh are a good example).

      3) What is required for my argument to hold is a fall in the share of wages even if the employment grows. One is not saying that the domestic demand will necessarily fall but that its relative share will fall (all this after assuming that the export strategy has delivered which itself might not happen). And this might create problems especially if your export markets dry up.

      4) Corporate sector as defined in the national account statistics.

      5) With the obsession with the FRBM where the deficit has to stay within a certain limit of GDP, expenditure is totally dependent on the revenue and if to begin with you are well beyond that limit, you will have to cut down on expenditure (as a proportion of total revenue). Add to this a downward inflexibility on military expenditure and the axe will likely fall on social expenditure. Once the limit has been met, the social expenditure can only grow at the rate of the growth of tax collection minus other heads under non-social expenditure.

  2. Safdar says:

    I wonder why the government subsidies, which surely would make a big part of the equation, do not find a mention here, to boost competitiveness with the international rivals, and the likely impacts.

  3. Shivkumar says:

    Hi Rohit,

    Actually just read your blog! Your piece brings in some freshness into conventional but irrational thoughts. You just brought that out. I am explaining what I meant by irrational.

    Irrational because export oreinted economies perforce keep costs low by currency devaluation.
    This results in a monopsony situation — typical being the accumulation of U S dollars across the world with just one country being the exception.

    The result is that inflation is imported, whereas the dollar region is the prime beneficiary of low inflation. The relationship is somewhat akin to that of a land owner and serf !

    So the irrationality is that dollar zone is allowed to have a high fiscal deficits ( 12 per cent of the GDP), whereas serfs have to make do with 3 per cent. Where is this deficit funded from? Global accumulation of dollars through reserves that are invested in U S $ debt. The distortion is again evident from the low interest rates in the dollar regions and high interest rates in the non-dollar regions. So to argue that costs of production will go down in export oriented economies is clearly incorrect and borders downright nonsense (no apologies to prof Bhagawathi’s erudition!).
    Export oriented also means imports. To create export oriented capacities, energy is the primary input. The reality is that India is a net energy importer. So if energy costs are in excess of export earnings, the purpose of exports stand defeated. it is somewhat like the paan shop selling paan at less than the cost of the beetle leaves! That leaves to improverishment of the seller and eventually the beetle leaf farmers! The resultant effect in China, forget the glitz of Shanghai or Biejing, costs have translated into over exploitation of resources environmental degradation!

    Export oriented economics does not bring in economic security. it in fact increases vulnerability. Most countries vulnerable to sanctions stem from the fact that their trade is in U S dollars. Besides, export oreinted as you pointed out does not mean fiscal corrections. it in fact is fiscal distortions!

    But there is an even more sinister element ! U S defence expenditure is $600 billion in 2015. India’s foreign currency reserves are $341 billin, China’s $1.6 trillion and Russia’s $500 billion.( Isn’t this exactly the same relationship between Landlords and serfs !
    I am stopping here for the moment. But as I conclude, let me add. You have just enlisted me as a reader and I am moving the ID into my favourities !

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