The Sham Economics of Inclusive Growth

As an idea, inclusive growth has a powerful resonance to it. It tugs at our heartstrings in ways that make us fall in line as adoring and unquestioning believers. We are happy that it makes us happy, because we feel this glow in our hearts which, in and of itself, becomes adequate validation of the idea. And that is delusional thinking. When it comes to ideas that drive policies at the level of the government, what matters is how things play out over the long term. The original intent behind the policy is often irrelevant. For instance, the stated intention of socialism was that the working people of the world would unite and create a workers’ paradise. The reality it gave birth to was far different, and we know that too well.

Inclusive growth is similarly flawed. It starts off with a pretense, posing as a morally superior alternative to the rapid growth that fosters inequalities with (allegedly) no respite for the poor, and the slow growth that leaves everyone miserable, as India discovered a while back. It’s a false choice because in the real world an insistence on something that’s not on the table merely sets you up for disappointment. The only available choice is between fast growth and less fast, or slow, growth. Inclusive growth, in practice, leads to growth below your potential, to slow growth, and to all the consequences of slow growth we know very well. This was the central argument of my earlier post, “The fallacy of inclusive growth.” In this article, I take the case further, and look at the seriously flawed, seriously deluded, economics of inclusive growth.

The economics

Since there’s no magic wand in economics, the objectives of inclusive growth can only be achieved by diverting money and resources to socially desirable purposes which are also, typically, less productive. Therefore, when the government has to choose between a six lane highway (that potentially pays its own way through tolls and the fillip to economic activity in the area) and a project at similar cost to supply free medicines to the poor, the nod goes to free medicines. But, no matter what opinion we may hold about its necessity or desirability, it still remains a diversion of resources from an economically more productive use to one that is less so.

What is more, while the purpose is noble—about doing good to the poor—diverting money into less productive uses is also about sacrificing a part of your economic potential, which will show up as slower growth in the GDP. In the initial days, the trade-off may appear acceptable, even sensible, and ideal for display on a t-shirt with the slogan, “SAY NO TO TRICKLE-DOWN ECONOMICS.”

Conceptually, it throws up two very knotty issues. On paper, the sacrifice imposed on the productive economy should show up as equivalent benefit in a less productive side of the economy. In practice—and this is particularly true of countries like India with massive governance problems—the transmission losses can be huge, so that rather than add value, the exercise becomes one of massive value destruction. We end up with the costs exceeding the gains by far, the damages outweighing the benefits.

The other issue, more important and less appreciated, is about the longer term consequences of such policies. This is to do with the power of compounding, as in the compounding of interest (thanks to which your money doubles in seven or eight years currently). When you decide to sacrifice a portion of the GDP today, it may seem tolerable or desirable to begin with. Over time, the loss turns out to be far greater than what you had originally countenanced. Here’s how.

Had it not been sacrificed, the foregone portion of GDP would have automatically contributed to more production and further growth in the next year. A year later the loss is even bigger, because a sacrifice that began as 100 in the first year becomes 108 the next year assuming a growth rate of 8 percent. In turn, it becomes 116.64 in the third year, 125.97 in the fourth year… so it goes, getting bigger and bigger with each passing year. Think of it as a multiplier in the negative which continues to be at play every passing year for the rest of your life, your children’s lives, and beyond.

As policies aimed at inclusion are persisted with over the years, the GDP sacrificed in the initial year, to which is added the sacrifice of the current year, plus the potential increment to GDP foregone in the current year from the sacrifice of the previous year, all these keep on accumulating and increasing exponentially over the years, to show up as a big hole in the economy we are not aware of. We don’t realise it is there because the hole takes the shape not of “what was once, and is no more”, but rather the invisible form of “what may have been, but is not”.

I believe this is a huge point that India’s band of gung-ho, do-gooding politicians, bureaucrats, economists and intelligentsia alike, have never grasped. That is why we are content to keep on repeating the same mistakes over and over, albeit in different labels and guises. The concept of the mixed economy that was meant to combine the best of socialism and capitalism has now made way for the idealism of “inclusive growth” where growth will continue to be fast, at the same time, with real out-of-turn benefits for the poor. And why would that happen? Apparently, for no better reason than that we have willed it so with all our hearts. Indeed? And how did the mixed economy end up giving us the worst of both systems? Well, if you are an Indian, you would know by now that this country that thrives on scarcity never runs short of excuses.

It’s fair to say that if India had not gone down the welfare way of Nehru and his like-minded successors, the sheer power of GDP growth alone would have pulled far more people out of poverty than all the welfare schemes of the government put together. Look at the record of the East Asian tiger economies that began in the fifties and sixties at about India’s level and are now far ahead. Or, for that matter, take the example of China which, beginning from the eighties, has lifted millions more out of poverty than we have. And to think that in 1980, China’s GDP per capita was marginally lower than India’s. Today, they are about three times our level. As any visitor to China will vouch, the difference is striking.

The math

Let’s get down to some simple mathematics. If India is to reach China’s level as of today, of course, we must triple our GDP. At a consistently high rate of growth, say, eight percent, it will take us a little over 15 years to get there. Settle for an inclusive growth rate a mere couple of percentage points lower, at six percent, and you add an extra 5 years to the process. But examples like these are commonplace and cut no ice. Let me then try again, this time with an example about the hole in the Indian economy we never think of.

Assume that India’s trend line growth rate is eight percent per annum. The left-liberal types who run the show these days determine that this growth, high as it may be, isn’t doing any good to the poor. They point, with some glee, to statistics about malnutrition being widespread—surely you’ve heard this, there are more malnourished children in India than all of Sub-Saharan Africa—and it’s pronounced a crying shame. What follows is a mother-of-all welfare scheme, a massive state intervention to eliminate hunger that will run for one year, to be paid for by sacrificing growth for one year. For just one year, the national consensus is that we interrupt our growth process with zero percent growth, on condition that we revert to the trend line growth of eight percent the very next very year onwards. With our soft corner for all kinds of do-gooding, we’re only too happy to give up a year’s growth for a great cause. Besides, isn’t the obsession with GDP a hallmark of the neo-liberal agenda?

Whatever the justification, here is the outcome, and it’s not pretty. A sacrifice of eight percent growth for just one year alone will cumulate, over a period of 35 years, to India’s entire GDP for the current year. Surely, that’s something! That’s not all. Place it further in the context of India’s six and a half decades of independence and the abysmally low growth rates of the first four decades. Now take a deep breath and try and figure out how many Indias of the fifties, sixties and seventies we are missing in our economy today. That is the big hole in the Indian economy we never talk about.

Beyond the math

When you get down to it, the math in favour of rapid GDP growth is compelling. And yet, there are real gains elsewhere too, in ways that cannot be quantified. A globalised world is also an intensely competitive place. Even for little things, you compete with someone, somewhere else in the world. Anyone familiar with the workings of a free market would know that competition rewards the winners disproportionately. Quite often, the winner gets to take it all. If you come first, the entire pot of gold is yours. If you are fractionally behind at second place, you twiddle your thumb.

Rapid GDP growth, in these circumstances, is a huge plus. It gives you that extra edge which nudges out your (overseas) competitor. For example, if you are an exporter with a new six-lane highway to your factory, you will immediately save time and money on freight costs. Sometime later, you discover that you can make do with fewer inventories of raw material and expensive spares because replenishments are delivered so much faster. You now save on financing costs as well. Further, when overseas customers visit your factory site, they like what they see, and they have more faith in your ability to execute orders on time. Put it all together and when the next big export order comes up, you are able to quote a price three percent less than before. You succeed in outbidding your Chinese rival. At this point, you become the winner, and you take it all. Your country keeps the foreign exchange earned, the employment generated, the taxes paid, not to forget, the real savings in social spending now that more people stand on their own feet.

A tale

Two newly set up banks go into business around the same time, the Fat Cat Bank and the Bleeding Heart Bank. The names are not subtle, and you know what they are up to. Yes, they represent two opposing philosophies of business. Fat Cat is about banking the old-fashioned, conservative way, where money is given out based on considerations of security and viability of purpose. Bleeding Heart believes passionately in going beyond the narrow focus on profits to look primarily at the need, and circumstance, of the borrower. Their mission, vision, corporate purpose—whatever you call it—is steeped in an overarching desire to do good to society. More than viability, their officers are trained to assess the sob story behind each loan proposal. The more compelling the distress, the faster the loan gets sanctioned (in a manner of speaking). Needless to add, Bleeding Heart keeps interest rates low and affordable to its predominantly underprivileged clients.

Given the way I have outlined the plot, how the story ends can be guessed at. But, it’s not the endpoint that interests me as much as the theatre that precedes it. Bleeding Heart Bank starts off in a blaze of glory and publicity. The media is fulsome in its praise with glib talk about a “paradigm shift” in banking practices pioneered by this institution. Compelling stories of poor borrowers and their smiling faces make it to prime time on television and to positions of prominence in the print media. The widow with three small children who gets going with a small-time catering business, the old man forsaken by his sons who gets a new lease of life with a paan-shop… I’ll say no more because your imagination is as good as mine.

In contrast, Fat Cat Bank is either ignored on a good day, or pilloried on a bad day. It’s held out as the quintessential bad apple, symptomatic of the unbridled pursuit of profit that is at root of everything wrong with free markets and naked capitalism.

As I said before, how the story would end can be guessed at. However, it’s still worth recounting how it would play out. In spite of the “good” work done, the laws of economics eventually catch up with Bleeding Heart. They find out that the cost involved in handing out small loans at low interest to a multitude of borrowers is a money losing proposition. And then, without attention to viability, a large part of the credit portfolio ends up as non-performing loans. The extra provisioning pushes up costs even more. The losses mount, capital is eroded, its net worth is wiped out, and pretty soon, it’s in the queue for a tax-payer funded bailout.

In contrast, Fat Cat Bank survives and goes from strength to strength. Over the years, the ventures financed by the bank end up generating employment for many, and opportunities for ancillaries and suppliers. In an irony of sorts, what was achieved initially by Bleeding Heart—amid publicity and the popping of flash bulbs—is accomplished quietly and without fuss, by Fat Cat Bank.

The moral

A simple tale contains the germ of a compelling idea at the heart of economic development. Broadly speaking, there are two components to development. Firstly, there is the “outcome”, which is what we all look for, and which gets measured in terms what we have in our hands. The other component rarely commands our attention, and is simply the “process” by which outcomes are delivered.

A colour television, for example, defines the point of entry into the lower middle class. If you don’t have it, you don’t make the cut. A good way to acquire a colour television is to save money out of income from a gainful economic activity and then buy it. In this case, the “outcome” (ownership of a colour television) is ensured by a “process” which involves a productive vocation leading to income, and thence to savings.

On the other hand, there’s an alternative way that was pioneered by the DMK in Tamil Nadu. It made the colour television a campaign promise, a showpiece of their election manifesto. In this example, the outcome was delivered, but without thought to the process. (Note: delivering outcomes by piling up the debt, running the currency printer at full speed, or raising taxes to punitive levels, don’t count as “process”.)

As the iron law of economic development goes, outcomes are sustainable only when they emerge naturally and effortlessly as the end product of a robust process. When outcomes are delivered by government fiat, without a process to back it up, you’ve picked up a fight you cannot win.

The big idea

If there’s one lesson from the success of the East Asian tigers, and now China, it’s that development takes off for good when we get the big ideas of our times right. India wasted the first four decades after independence because the big ideas of those days were delusions. The idea that the state should control the commanding heights of the economy, the idea that private enterprise motivated by profit is inherently evil and must be tightly regulated by licenses, quotas and permits, the idea of the mixed economy that would (magically?) combine the best of socialism and capitalism while leaving out the worst… these were the big ideas that dominated those miserable days. Once we got our big ideas wrong, broadly speaking, everything else that followed veered off course too.

Why this should be so, isn’t too hard to figure out. Big ideas work like plate tectonics in Geology; they set off tectonic shifts that work its way at a subterranean, subconscious level, comparable to Continental Drift in method and certainty of eventual outcome—albeit on a much compressed timescale. You don’t see it happening but, ever so steadily, it catches up with and subdues other forces in its path, even as popular attention is riveted to the frantic activity above ground.

As the big idea of our times, inclusive growth is a dud. Thanks entirely to the seduction of this idea, we have ended up passing a series of big laws to deliver big outcomes, with no thought to the process to lead up to the outcomes. If only development could be propelled by passing big laws, surely the Bushmen of the Kalahari Desert would long ago have called a tribal council, passed laws giving their tribesmen the right to food, jobs, education, healthcare, and by now acquired veto power in the UN Security Council.

Why economists don’t get it

There’s been much angst recently over the seemingly abrupt way in which the Indian economy has turned for the worse. Given the multiplicity of depressing macro-economic indicators, it is no surprise. GDP growth has slowed to a nine-year low, inflation is stubbornly high, the central government’s borrowings are out of control, our Current Account deficit has hit unprecedented levels and the Indian rupee has lost nearly a quarter of its value against the dollar in less than a year. The concerns are valid but somewhat misplaced. The fact is, once you know what the big ideas driving the economy are, and once you have a fair sense of what it’s capable of doing, and undoing, you would know that the macro-economic numbers are nothing but footnotes to the big ideas of the times.

Looking back, India’s economy was headed south the moment inclusive growth took over as the big idea for our times, the moment our resources began flowing into causes that added to the warmth in our hearts, but little else. It was just a matter of time before tectonic forces caught up with ground level forces. And what are these ground level forces? Well, typically, you’ll come across economists studying them using toys like GDP growth rate, employment, inflation, fiscal and current account deficits, currency exchange rates, to name a few.

Not surprisingly, our economists never saw the rot coming. Most of them look upon their craft as a science, and subject it to all the rigors of science. It means they are dependent on data to show up before they can form a conclusive opinion or make a definite call. By the time the data had presented itself, the picture was bleak and the rot was obvious to anyone who cared to look at it objectively. If you notice your school going child is spending more time at play and none with her books, you fear for her grades and would intervene immediately to get her to mend her ways. An economist would take the stand that nothing definite can be said at this point, not until there is concrete data to back up your assumption that her grades will likely suffer. When the data does come, in the form of a report card awash in red ink, it may be too late.

And that is my grudge against India’s economists. Too many of them are in the business of looking at numbers in order to make predictions about the future. I disagree. In trying to get a sense of where the country is headed, I also like to look at the people behind the numbers. It’s not a bad idea. At school, there were many kids whose math scores could be safely predicted all the while. As we go through life, many things happen to us in the form of consequences of the actions we take. And the actions, in turn, are determined (and preceded) by our thoughts and ideas. In the same way, the macro-economic indicators that economists are so fond of are nothing but a numeric representation of the consequences of all the economy related actions taking place in the country. And these things don’t happen randomly or in a vacuum. On the contrary, they arise as a corollary, or a follow-up, to the thoughts and ideas dear to the ruling establishment—those who lay out the broad contours of policy, those who determine the general direction for the country.

If you happen to be an economist, this should a sobering thought. The macro-economic numbers that take up so much of your time actually emerge at the fag end of a chain which begins with ideas that translate into actions, leading to consequences, and unintended consequences, that finally get captured as data. One way to be ahead of the curve is to evaluate the ideas for what they are worth. If it can be determined with some certainty that the ideas are rotten, it’s only a question of time before the numbers on the ground begin to reflect the rot.

That is why the debates in economics are unlike those in literature. In literature, it’s possible to make a reasonable case that the fiction of James Hadley Chase merits the Nobel Prize. Likewise, in economics, you are always free to advocate whatever is the currently popular delusion but there is a difference. Sooner than later, the consequences show up on the ground. In economics, delusions may well begin with euphoria but they always end in trauma. In literature, you can safely take your reverence for Chase to the grave.

To conclude, why democracies fail

The subject, why some countries prosper while many others fall by the wayside, has attracted diligent academic attention over the years. I have no doubt it’s all a very complex, nuanced territory with many shades of grey to it. Without appearing to underestimate the complexity, here’s a simple rule why democracies that appeared to have got things right for a while would suddenly fall off the radar.

Typically, a developing country that is also a democracy would put in place market oriented reforms only after exhausting all the alternatives, when the country finds itself poised at the edge of a cliff. Reforms generate prosperity and inequality in equal measure, which go on to foster both a sense of entitlement, and a sense of injury that feeds a class of malcontents. With waning appetite for sacrifice and savings, left-liberal types emerge from the sidelines to take over the government, or to force a shift to the left. Once again, the big ideas are about delivering instant outcomes. Once again, the nitty-gritty about the “process” gets the short-shrift.

At this point, the fall from grace is cast in stone.

(Author’s note: This article is a continuation of my earlier post, “The fallacy of inclusive growth“. The third and final article in the series will consider why inclusive growth necessarily breeds corruption. l also recommend that my 2nd article on CRI, “Between BPL and APL, the need for an AAPL” may be read for a more complete sense of the flaws in the idea of inclusive growth.)