1. Can India catch up? Can Australia do better? DRAFT, 25 April 2011

2. Long term trends Economic history has much to teach –In the midst of continuous change, different economies move at different trajectories for different reasons –The only way to identify this is to look at the long term

3. Key trends Hunter-gather till appx.10000 years ago –small group, deep social information, low per capita income, high risk of death –Malthusian laws: environmental food capacity Settled agriculture circa 8000 BC-1750 –larger groups (villages), the rise of trade –Societies developed institutions to foster decentralised agriculture India: Caste system created well-oiled agricultural machine –a small surplus led to small towns and cities across the world –Malthusian laws: reduced risk but lower longevity due to disease Industrial circa 1750+ –Rules of the game changed: much greater trade, intense specialisation –Information economy circa 1960+ (post invention of the transistor)

4. India, the superpower of the agricultural epoch Fertile Gangetic plain supported massive population In many ways the cradle of modern civilisation –Leader in philosophy and critical thinking Charvakas –> Buddha –> Sophists –> Socrates World’s economic superpower for thousands of years –Angus Maddison, a great economic historian found that India was the world’s wealthiest in 12 out of the past 20 centuries (first to 11th century AD + 18 th century) Its first century share of World GDP = 33% 11 th century share of World GDP = 28.9% In the 18 th century, India’s economy once again the world’s largest (share of global GDP 24.4% in 1700).

5. The change in rules of the game: Capitalism, mainly 1400-1776 Key causes Critical thinking rediscovered –Islamic routes to recovery of Greek thought –then the Renaissance in Italy –Reformation – the questioning of authority. Francis Bacon and science Economic innovation and new theory of society –banking and incorporation e.g. the Medici family of Florence –Adam Smith and the invisible hand – system of natural liberty –Refinements of theory by F.A.Hayek in 20 th century Political power reverts to the people –Glorious Revolution, constitutionalism, democracy –Thomas Hobbes and John Locke and a new theory of the state and liberty –Earlier: Society at the centre. Now: individual at the centre Not a linear process –lot of backtracking (Marx/Keynes) –the West may yet forget its lessons in liberty

6. Modern economic growth Key results: Slow growth till 1820 Rapid increase after that

7. The great divergence India virtually stagnated while the West shot past. –The West experienced massive increases in productivity By 1950, India’s share had slipped to around 3% of world GDP Today, India’s per capita income is around $3000 in PPP terms, compared with America’s $50,000. India’s share of world trade share is likely to reach 2 per cent soon, but it had 20 per cent of world share in the not too distant past

8. Divergence in quality of life Poor institutional frameworks in India –extremely corrupt political system –low levels of freedom –Difficulty in doing business

9. Inertia in India and China Rules of the game not understood –China and India did not adapt (China has done relatively better than India so far) –Even most Islamic societies have not understood the change Challenge of shifting from agriculture to modern economy –cultural change –policy change –governance change –resistance to allow freedom, which is the crucial ingredient

10. But this is not permanent China is very rapidly catching up Chinese institutional frameworks updated in 1979 Not yet comprehensive liberty but enough to promote rapid growth China will almost certainly become the world’s largest economy by 2016 (Maddison thought 2015, but IMF says 2016)IMF says 2016 –Per capita in China will still be a fourth of that of USA –Ultimately China could become four times the size of USA –And the same with India: it could, as well

11. Key drivers of growth Growth = f(policy, governance, opportunity) –Policy and governance are crucial. –Poor design of institutions (and policy). inevitably lead to misgovernance and corruption. These apply to Australia equally as tothe rest of the world

12. Can India catch up? Bottlenecks in policy and infrastructure: Mobile phone wireless network has overcome communication blockage Physical blockage (infrastructure) requires good governance at all levels India’s policy reforms (shock) of 1991 has by now run its course No further policy reform of significant order has since occurred Intense corruption Failing institutions e.g. judiciary, press Conclusion: Great innovation in India today but constrained by poor governance India will not be able to catch up with the West without radically changing its systems. It will almost certainly, given current trends, end up as a middling power – neither here nor there With reforms in policy and governance, however, nothing is impossible

13. Can Australia do better? Australia has been close to the technical frontier for over 100 years –Australia in 1913 produced 1.02 per cent of the world's output. This edged up to 1.34 per cent in 1981, is 1.19 per cent now, and will shrink to 1.11 per cent by 2016 [Source]Source –However it is per capita income that ultimately matters, and that has increased significantly [cite statistics] But ceteris paribus does not apply, at least any longer –both history and the nature of competition matters –and also that USA is now a declining force in the world strong defence is fundamental to Australia’s prospects –It is not a good policy for Australia to be a “receiver” of the changes occurring in the world Australia must seek to mould the future to secure its future

14. Threat or opportunity? Australia can benefit from the larger pie if it plays its cards well –No medium-term economic analysis should be conducted without serious consideration of the changing world –Competition will become intense, but this is not a zero-sum game! everyone can benefit –Important to get on to the front foot Australia well placed as it doesn’t have the baggage of history with India Build strong economic and cultural relations with India

15. Can Australia do better? But first and foremost: Continue to remain at the policy and technical frontier: open competitive economy –Few signs of increased policy or technical innovation –Too much reliance as supplier of resources Policy: –Minimal but appropriate regulation: marginal SC = marginal SB Reduce unthinking policy response to things that are not proven Ensure infrastructure projects based on CBA –Reduce welfare state and churn –Stop the direct management of schools and hospitals –Reduce excessive regulation of the labour market Governance: –Australia leads on governance, but can be further improved –A lot of group think. CRITICAL thinking must be deliberately fostered: truly independent advice

16. In addition, be strategic about the changing world Adopt a pro-active stance Education exports –need not require people to come to Australia –opportunity to set up branches in India By building stronger relationship with India, Australia can also strengthen its long term security –Not foreign aid but equal partnership! Not supporting India actively develop in the right direction at this stage can become a long term great strategic mistake