Can India catch up? Can Australia do better? - Freedom works By Sanjeev Sabhlok, 15 July 2011

Copyright © Sanjeev Sabhlok Based on personal research and a talk I gave a few months ago Related to my book, Breaking Free of Nehru, and draft manuscript, The Discovery of Freedom.Breaking Free of Nehru Discovery of Freedom My research is ongoing so this presentation is a sketch.

Structure of the talk 1.An explanatory framework 2.India now the worlds largest free market laboratory Can India catch up? 3.A tsunami of competition unleashed But opportunities are increasing rapidly 4.How should Australia respond? Can Australia do better?

1. An explanatory framework

Freedom leads to innovation which leads to growth Any restriction on liberty reduces the number of things tried and so reduces the rate of progress - H.B. Phillips (mathematician) Key message Innovation is not driven by central planners or bureaucrats who pick winners. Such interference: reduces the number of things that people can try destroys wealth by wasting tax revenues in projects that impose no personal consequences for central planners (since they dont lose their house if their Keynesian stimulus fails)

1 2 3 n Two obstacles to freedom Opportunity (technical frontier ) Governments key role: to enable liberty (social reform is outside government control) Ideas dont come from governments Explanatory framework Growth = f (freedom, opportunity) Innovation pushes out the frontier 2) Primitive society interfering religious beliefs insufficient value placed on science and critical thinking People innovate better if the government gets out of their way 1) Bad governance Nanny, paternalistic state: interfering policies interfering regulation Injustice contracts not enforced

Freedom in the West The story of the West: decreasing freedom High levels of freedom Keynesian socialism Hayekian fight back Keynesian socialism By 1970s most major businesses in the world (including the West) had been nationalised (goal: to control societys investment and reduce private savings) Hayekians fought back (Road to Serfdom underpinned Thatchers work) and prevented the West going from bankrupt in the 1980s Bigger and bigger government, fine tuning, Keynesian stimulus, paternalistic regulation = inability to compete (e.g. Detroit) Keynesians actively at work Huge welfare state has been created Currencies successfully degraded Borrowings at untenable levels without productive capacity to repay Results flowing in : Greece, Spain, Portugal, Iceland (next UK and US?) Take over of the academia Few economists know about Adam Smiths system of natural liberty Language of equity (Fabian socialist version of equality) Language of promotion of health (subtle way of introducing paternalism)

Freedom in India Colonialism Keynesian socialism Some freedom Indias story: increasing freedom Colonialism till 1947 – almost zero growth Fabian socialism till early 1990s – poor growth Keynes and Nehru were card-carrying Fabian socialists (linked through Laski) The Keynesians successfully achieved commanding heights in India and duly bankrupted it in India borrowed $5 billion from IMF to prevent default India learnt its lesson and has liberalised (albeit partially)

2. India now the worlds largest free market laboratory Can India catch up?

India is now a test case for the theory of freedom Freedom increasing rapidly since 1990s in India Most sectors liberalised (some not yet) Some sectors are free because the government doesnt work But still very low levels of freedom significant opportunity to increase liberty

Indias output is responding rapidly to increased freedom Recall that India was the worlds largest economy for most of human history In 12 out of the last 20 centuries it was the largest In 6 (of 20) it was the second largest (after China) Its share of world GDP was between 30 to 33% (comparable with its share of world population) Its poor performance between 1750 and 1990 was not due to any innate or genetic reasons Just the lack of liberty

Evidence that liberty works Source: IMFs World Economic and Financial Surveys: World Economic Outlook Database, April 2011IMFs World Economic and Financial Surveys: World Economic Outlook Database Table: Share of world output measured in terms of PPP China will overtake US (at current exchange rates) by 2020

But can (and will) India catch up? Positives Westminster model of liberal democracy and legal framework Indians take to science and maths as a duck takes to water Rapid social change under way Total factor productivity rising rapidly Urbanisation increasing dramatically Negatives Significant misgovernance in education High levels of corruption in government Lot of red tape: difficulty in setting up a business Poor infrastructure and continuing poverty in villages

Total economic size, assuming unchanged governance 1.India will overtake USA by 2030 (10 year lag to Chinas) 2.India could overtake China by 2050 (consistent with Citibanks forecast) and remain the worlds largest economy thereafter Three reasons why this will happen 1. Democracy - Indias democracy makes it resilient –democracy as shock absorber - Chinas authoritarianism makes it brittle 2. Private sector driven - Led by Indian private companies –Many are now multinational –Significant number of billionaires

Third reason why India will become larger than China by 2050: Young population By 2050, nearly 40 per cent of Chinas population will be older than 65

But catch-up is not about GDP. It is about per capita GDP Indian per capita income still 10 times less than that of the West India could achieve per cent of Western per capita income by 2050 But it cant catch up – ever, with current governance. With good governance India could catch up by 2050 (or at least in the early second half of this century) However, no current political party is capable of delivering improved governance. That is where the work Ive been doing since 1998 comes in: - India Policy Institute India Policy Institute - Freedom Team of India Freedom Team of India I hope that leaders can be found to lead India to freedom

3.A tsunami of competition unleashed But opportunities are increasing rapidly

Catch-up hypothesis has its limitations It assumes that followers copy But thats not true - myth that the West is safe at the high end/ design end - design space being taken over by India and China Intense innovation occurring in India (and China) Cut-throat price competition within the huge Indian market - goods now often nearly 90% cheaper Huge reversal of brain drain as we speak - the best Indians arent leaving – they now get plenty of opportunities at home - Indian experts settled abroad are returning (given strong perceptions of racial discrimination, as well) - many best Western managers now working as expats in India Many multinational companies have an R&D base in India Many good Western universities have establshed branches in India World class Indian universities fast coming up

Examples where India is already a leader IT $50 billion worth of IT outsourcing to India Microsofts major development centre in India Hollywood has outsourced much animation to India Mobile phones 600 million mobile phone subscribers Lowest charges in the world Drugs Half the worlds vaccines produced in India, and significant share of generic drugs) Hospitals (of world-class standard) and medical equipment Cost of heart surgery = $2000 Cost of delivering a baby = $40 Finance Major Wall St companies now conduct backoffice operations from India. Steel Indian firm now owns large share of world steel plants. Rapid growth of Indian multinational companies Hundreds of examples documented in many recent books

Mammoth competitive pressures building up in the West Creative destruction is underway on an unprecedented scale 1.Competition from India and China is just one of many pressures 2.Advanced technology is making thousands of jobs redundant Customer as producer (supermarket checkouts, airport baggage check-in) Robotics will at least partially replace teachers, personal assistants, surgeons, and others A business or society that does not anticipate and adapt will die – quickly! e.g. Detroit lost 25% of its population in the last ten years

But the expanding pie is creating huge new opportunities Economic growth is not a zero-sum game! As the pie expands, new opportunities arise New goods, better goods, cheaper goods Opportunities for Australia include: significantly increased exports - India is already Australias third largest export market billion worth of exports in ) cheaper imports (including outsourcing of high-end services) huge investment opportunities in India (education, e.g. TAFEs) increased tourism to Australia

4. How should Australia respond? Can Australia do better?

Australia remains well inside the technical frontier Positives Relatively better managed than most other nations E.g. relatively deregulated and flexible financial system But huge restrictions on freedom, and significant inefficiencies Heavily padded bureaucracy, and a big government that directly operates schools and hospitals (and buses!), invariably inefficiently Paternalistic policies and onerous regulation of most activities Redistributive welfare state with significant wastage (churn) Old, ailing infrastructure Taxpayer funds increasingly being dumped into Keynesian black holes Well-entrenched habits of picking winners, fine tuning, and crowding out of R&D investment by government (education, green energy) – always based on false assumptions

How can Australia do better? Blocking freedom was fine with a less competitive world. It wont cut it now: 1.Increase freedom: Get out of the way All padding and Keynesian policies should come to an end - Many suggestions in Breaking Free of Nehru are applicable to Australia as well Step back from the abyss of the super-nanny (granny?) state 2.Be strategic: Shape the future Inform but dont spoon-feed businesses! (let them do their homework) - business associations do better than DBI, for instance Build policy partnerships with India - be seen to be Indias friend (support its growth for mutual benefit), e.g.free trade agreement - build strategic networks with Indias governance system to influence the right kind of change –e.g. Australia could develop an exchange program for policy staff and executives to work in the Indian government for 12 months in one rotation, and vice versa Note: Ive not highlighted geo-strategic imperatives that clearly support stronger ties with India - that is a very significant issue as well.

The end! Should you wish to discuss, please write to me at

EXTRA SLIDES – IN NO PARTICULAR ORDER

More info about the framework used in these slides: My book, Breaking Free of NehruBreaking Free of Nehru also freely available on the internet Draft manuscript, The Discovery of FreedomThe Discovery of Freedom available on the internet – comments appreciated

Quick historical overview Hunter-gather: till appx.10,000 years ago Secret of success: muscle power, local knowledge Outcome: small groups, low per capita income, high mortality (Malthusian laws applied) Settled agriculture: circa 8000 BC-1750 Secret of success: animal power, local division of labour, some trade - Caste system of India led to well-oiled agricultural machine, hence successful Outcome: some agricultural surplus, small tows and civilisation, low per capita income, high mortality (Malthusian laws applied) Modern Economic Growth: Industrial: circa Secret of success: brain power, global division of labour, global trade - Different rules of the game to the agriculture epoch Outcome: growth without end, Malthusian laws no longer apply

The result: Modern economic growth Key characteristics Relatively slow till 1820 (10s of times the pre-1000 growh rate) Rapid increase after that (100s of times the pre-1000 growth rate) Effectively, the industrial revolution is less than 200 years old Source: Madison >> The Western economies started growing: an unprecedented phenomenon!

Key changes since : The use of reason Critical thinking - Islam, through Cordoba, helped recover Greek thought The questioning of authority - Reformation Induction and the scientific method – Francis Bacon 2: Constitutionalism and liberty Origin of democracy - Magna Carta -> Glorious Revolution Theory of the modern state: Thomas Hobbes, John Locke - Society was earlier the centre. Now the individual 3: The secret of wealth creation (free market) Commercial institutions created - Modern banks, corporations (e.g. Medici family of Florence) Invisible hand (Adam Smith) - (Refinements by F.A.Hayek) Detailed discussion in my draft manuscript, The Discovery of Freedom (available on the internet)

India was the world superpower till 1750 Indias performance in recent centuries is atypical It was the wealthiest region during the agricultural age Largest arable area till the USA came to the scene Remained the worlds wealthiest in 12 out of the last 20 centuries - First century World GDP share = 33% - 11 th century World GDP share = 28.9% world GDP share = 24.4% (similar share of world trade) Has India been a victim of its long-standing success? Caste system was well-suited to its agricultural society - It is no longer suitable, but is now very difficult to change Intellectual stagnation Major philosophical schools and scientific advance (e.g. number system) Charvakas and Buddhas ideas transmitted to Greece –> Sophists –> Socrates The breakthroughs of the modern world arose in Italy (Renaissance)

Why did India struggle even after the end of colonialism? Cause 1: Socialist ideology By quirk of fate, Nehru the Fabian socialists set Indias policies - Rejected Milton Friedmans specific advice - Rejected von Misess views on Indias productivity Cause 2: New rules of the game not widely understood Indian education system flooded with socialists Economics education extremely poor Cause 3: Arrogance about Indian history and culture False pride that refuses to believe that the West could actually offer any learnings to India Caste system not suited to dynamic societies.

Per capita income shot up in the West, then Japan, then…

Visual depiction China will become the worlds largest economy by 2016 (Maddison thought 2015, but IMF thinks 2016)IMF thinks 2016 Per capita in China will still (in 2016) be only a fourth of that of USA Ultimately China could become four times the size of USA China India

Comparative growth of India and China

China will overtake US in real exchange terms by 2020 Source: The Economist, 25 June 2011

India positives Total factor productivity is rapidly rising Wherever the government has privatised (or is absent) significant progress has been achieved IT sector and private sector IT education Mobile phone wireless network Source of the graph:

India is already Australias third largest export market ($19.8 billion) in Source: Composition of Trade, DFAT.Composition of Trade, DFAT Already fifth largest two- way trading partner Will become second largest trade partner in the next decade

India key negatives One of the worlds most corrupt governments Low levels of freedom - Failing institutions e.g. judiciary, press Insufficient focus on infrastructure - However, it now has the largest private sector investment in infrastructure Difficult in setting up a business Labour market inflexibility