In an interview with Swarajya, Surjit Bhalla talks about the performance of the economy and the direction it is taking, and how development can be brought about ‘by not doing what we have done in the past’.
Surjit Bhalla, who was recently appointed to the Prime Minister’s Economic Advisory Council, shares his views on the economy, which is riding the wave of reforms under Narendra Modi. In an interview to Swarajya, he says he is ‘exhilarated’ at the new role and how he looks forward to being a part of the policy making that will help propel growth and employment.
We also discussed his latest book “The New Wealth Of Nations” which is about three things: education, education and education. That’s the new wealth of nations according to him. He also shows how low inflation in the western world has been one of the most profound effects of globalisation thanks to expansion in educated labour force throughout the world. Below are excerpts from our conversation:
First of all, hearty congratulations on being appointed to the Prime Minister’s Economic Advisory Council (PMEAC). How has been your experience so far?
It’s been excellent. I have really enjoyed it. It gives one an opportunity to be involved in policy making, indirectly. It’s been quite exhilarating.
What’s the mandate of the council?
The mandate was clearly stated. The council, which has all academics or quasi academics as members, can give their views on whatever issues the Prime Minister wishes or desires to take expert opinion on. This may or may not differ from the view he is getting from the people within the government.
But many say that there was already Niti Aayog which fashions itself as a government think tank. Then, what’s the need for another body of experts?
It’s funny, the period we live in. When the PM hadn’t appointed the EAC, the criticism was why he hasn’t appointed one, now that he has appointed one, they are complaining why he has done so.
Latest GDP data is comforting. One interesting development is that private investment has started to pick up just at a time when the government’s ability to spend it contracting given that 96 per cent of this fiscal year’s budgeted expenditure is already accounted for till August. With bank recapitalisation already in the works, how long do you think it will take for private investment to really take off?
Just to put it on record, I am not speaking for the government while answering this. It’s a strictly personal view. The questions you are asking are very legitimate. Former RBI governor Rangarajan has said that you can’t have GDP growth accelerating if you do not have an increase in investment.
India is a very interesting economy with interesting set of economists. It’s the only place in the world where professional economists believe that interest rates do not affect investment. I have written that the most important determinant for investment is (real) interest rate, back in 2009, so it has nothing to do with the current environment. Anywhere else in the world they laugh at you if you say interest rates don’t affect investment, but not in India. So, what determines investment according to these professional economists? Animal spirits, sentiment, etc, etc.
The rate of investment today is embarrassingly back to what it was in 2004-05. We had it at 35 per cent when we were growing at 8-8.5 per cent. So, for me, it is not a mystery at all that our growth rate has plummeted to the levels it has because of the high interest rate policy pursued by the RBI. We need to ask whose interests is it serving?
I am worried about growth. The RBI believes that we will grow at 7 per cent this quarter and 7.8 per cent in the next. Maybe Indian productivity will zoom up and maybe pigs will fly. We need to ask RBI is there evidence that it can point to that growth will accelerate to 7.8 per cent in next three months?
Is there a record of any economy or any central bank when you are hit with two great economic temporary shocks like GST and DeMo and the central bank increases (real) interest rates in face of these shocks!
Especially given the fact that these two shocks impacted small businesses, MSMEs more, who are also the biggest losers if interest rates remain high.
Exactly. This is what intrigues me. You have all these leftist economists worried about job losses. If an objective examination is done, it’s the poor who lose out. Bottom 50 per cent have lost out more than the other half because of the RBI’s policies. ICICI has raised foreign funds at 3.5 per cent, so did Reliance. If they want to borrow domestically, that would be at 8 or 9 per cent. They are not being hurt that much. Rich corporates are not being hurt. So, the RBI’s policies possibly hurt the poor the most.
But doesn’t the RBI itself say the real interest rate should be in the range of 1.5-2 per cent? Today, RIR is at 2.5 per cent. Earlier, it was even higher.
No, no. Let me correct. First of all, the MPC mandate of RBI is quite explicit. It’s both growth and inflation. What I am saying is growth has been hurt and substantially so. What is RBI’s mandate on inflation? To keep it in 2-6 per cent range. And the glide path that Governor Urjit Patel had charted was to have inflation at 4 per cent by March 2018 and then keep it steady at that level.
Now, Michael Patra in October 2016 had said that the reason for the RBI to cut rate at the time was that the real policy interest rate in India was no longer 1.75 per cent (between 1.5 and 2 per cent) but 1.25 per cent. This was when August 2016 inflation stood at 5 per cent. If it was 1.75, there was no need to cut rate by 25 bp.
Let’s look at what has happened to inflation and real interest rate in the last 14 months of MPC coming into existence. Inflation has averaged at 3 per cent. Hence, real interest rate has been at 3 per cent. I want to ask who is being served by this ultra hawkish stance? The MPC interest rate setting policy goes against not what you, or the government or me stating what should be the policy, but against RBI’s own stated policy, and mandate.
I am not saying RBI should adjust interest rates every month but it should at least adjust interest rates according to the pattern of past inflation and expected future inflation. I am giving you average numbers for last 14 months. And the RBI keeps coming up with estimate saying inflation will go up in the next six months. Last December, when everyone knew that DeMo will slow down growth for sure in short term, the RBI said the inflation will rise to 5 per cent by March 2017. What model did they have?
There is a series of mishaps that have happened with RBI policy for which we don’t have any explanation.
Another question I want to ask you related to GDP numbers is our consistent underperformance in exports. What is your diagnosis of the reasons behind this and what would you recommend the government can or should do?
The popular view is that we need to depreciate our exchange rate by 5-10 per cent. Now, I wrote a book, Devaluating to Prosperity, where I looked at exchange rate policies in the developing world over the last -80 years in which I established that one of the main reasons why China had grown at such a fast pace was because of a deeply undervalued exchange rate. That very same model if applied to India shows that among large economies our exchange rate is more undervalued than even China. (China is now fairly valued as Trump has also found out)
So, what really ails Indian exports? In the last five to seven years, China has vacated a lot of space in textile and other areas. Now, India should’ve walked into that space but we find that instead countries like Bangladesh and Vietnam have. Recently, there was an article in Wall Street Journal on how Kollam in Kerala, which was world’s leading cashew producer, has lost its place to Vietnam. It’s not due to exchange rate, is it?
One of the parameters used in World Bank’s Ease of Doing Business rankings is the effective retention rate of firms – the fraction of earnings not paid out in wages and taxes. In Bangladesh, for every Rs 100 of revenue, it gets to keep somewhere around 60. In India, the figure is close to Rs 40. We have second highest effective corporate tax rate in the world, second only to Japan. Many academic studies have established this. If you cut effective tax rate, the profits will automatically go up. It will help us more than steps like lowering exchange rate.
I think we are moving in that direction. Indirect taxes have already been rationalised. We have a study by Arbind Modi coming up on reforming direct taxes.
As an independent economist, my opinion is we should do two things: lower real interest rates and tax rates, both personal and corporate. Then, there is no reason why we can’t grow at 8 per cent.
But don’t we need manufacturing to boom if we want to boost exports?
Not necessarily. Just take the Kerala and cashew case. Agriculture growth can also help. Even there we have intervened all the time….
You have written in your book that agriculture was a sector that the old elite were too elitist to reform and for the first time in 70 years, India is reforming agriculture sector. What are the reforms that you would suggest to the government on this front?
Yes, for the first time in India, a government is trying to reform this sector. Agriculture is a booming export market. The government shouldn’t intervene in production or distribution, exports or imports. Earlier the farmers weren’t allowed to sell outside the APMC markets. Now, this is changing. These reforms need to be accelerated.
The Prime Minister has set a goal to double the farm incomes by 2022. The previous government’s idea of raising farm incomes was to simply keep increasing Minimum Support Price (MSP) but can the reforms initiated by the current government help double farm incomes in such a short time?
We will have to do an estimation for that. Farm Incomes can’t be doubled in real terms by 2022. But in nominal terms, it is possible. States like Gujarat and Madhya Pradesh have shown that it’s doable. The government has taken several initiatives: increasing investment in irrigation, marketing reforms, DBT reforms, etc. Madhya Pradesh government has recently launched a scheme where farmers selling crops below MSP will be compensated the difference. That’s a big move. I am very optimistic that if reforms continue then accumulatively they can take the agriculture growth which has averaged at 3 per cent to 4 per cent in the next three years.
It’s not feasible to double incomes in real terms by 2022. If several policies fall in place, then it is doable to double incomes in nominal terms, and with low inflation, that will be a substantial acceleration in farm incomes. It is good to have doubling farm incomes as a target
In your book, you call low inflation as one of the most profound effects of globalisation. In the west, inflation has remained consistently low for the past 20 years because cost of production remained low thanks to increasing supply of quality labour so much so that situation remained unaffected even when oil prices multiplied during this period. How do you see inflation playing out in India in future? Will it remain low here too?
My forecast is that inflation is unlikely to rise substantially anywhere in the western world. Because inflation is about wages and they cannot rise much because of the huge expansion in educated labour force in the rest of the world. Earlier, the belief was that all prices lead to inflation and in the 1970s they did indeed. But from 1998 to 2008, oil prices went up by much higher than they did in 1970s. They quintupled from $14.4 a West Texas intermediate barrel in 1998 to $72 in 2007, before peaking at around $160 in 2008. Inflation? It actually went down. India was one of the few countries where inflation went up but that was because of misguided policies of the UPA government. Today, the median inflation rate in developing countries is 3.5 per cent. And I don’t see this median going up by much. Inflation will likely remain in the 1-3 per cent range for advanced economies, and 2.5 to 4.5 per cent range for emerging economies. The gap between the two (median inflation in developing economies minus median inflation in advanced economies) is now close to 160 basis points and likely to remain so in the future (and possibly the gap will trend lower). Oil prices have ceased to make much impact on medium term (six months or more) inflation. The world has changed radically in the last 30 years. As I argue in my book, global expansion of education has had and will continue to have lot of effects.
For the western world, even if we were to ignore the education expansion, we have automation now which would ensure that cost of production doesn’t go up which means inflation doesn’t rise much, isn’t it?
Yes. It can even bring inflation down further. But one of the negative side effects of automation, artificial intelligence, etc is loss of jobs. The governments will have to step in. In the book, I discuss how this can be done. One way is basic income to the unemployed or unemployable and other way is negative income tax for working population as suggested by Nobel Laureate Milton Friedman. To put it on record, I am not a fan of Universal Basic Income (the universal part is a problem) but I feel that the traditional ways of helping the poor won’t work in future.
You say that inflation is going to remain mild for the foreseeable future. And as we very well know that Phillips curve is broken: inflation is low, so is unemployment. Given this scenario, how relevant is monetary policy regime as an instrument for attacking inflation in India’s context?
There are scholarly studies that show that inflation targeting hasn’t worked. How do we decide that it hasn’t worked? You look at the countries that attempted targeting inflation and compare them with countries that didn’t take that road. The latter ones don’t have a higher inflation rate. I was never a votary of the inflation targeting regime and certainly not a votary of the kind of regime that’s been practised by the current MPC. I think in the next few years, inflation targeting will likely go the way of dinosaurs. As I have said, the traditional ways of analysing inflation no longer hold.
Then should we have some modified version of Taylor’s rule?
You know, interestingly enough, Taylor’s rule also suggests that we are off kelter. In fact, let me put it out there that there is no known model of inflation behaviour that the present RBI is following. If somebody knows of such a model then we would all be educated.
One of the most hawkish central bankers in the world is Michael Patra. He has an article, about three four years ago, saying that nominal income targeting works best. The Taylor rule, in a convoluted way, is about targeting nominal income. That’s what we should target in my opinion. The rest of the world has moved towards targeting nominal income. That’s why they are so worried about low inflation. They want inflation to rise because nominal incomes are not rising by much.
The new wealth of nations is education. That’s the one line summary of your book. You estimate that while the financial wealth of the world is $256 trillion, educational wealth of developing world is $330 trillion. People at the bottom have educational wealth and therefore maybe inequality is not as bad as it is made out to be. Analysts didn’t consider education as a wealth while analysing poverty trends in the 1980s. Are they making the same mistake while analysing inequality?
I hope that this is the contribution of this book (estimating monetary value of education). Economists have done thousands of studies saying education has a rate of return and any asset that yield a rate of return, is by definition, wealth. All you have to do is take stream of returns and discount it. So, this is the first study that goes into measurement of education as wealth. Some have correctly pointed out that my discount rate of 7.5 per cent is too high and should instead be 5 per cent. If you lower the rate, the wealth is that much higher. So, that is the criticism I have got!
You asked about income. The effects of education are already incorporated in income. We don’t know where income is coming from. I am saying that it broadly comes from education.
While inequality has been highest it has ever been in the US, the world inequality has been lowest since at least 1870 i.e. before globalisation. World inequality has thus come down. One statistic I really like is that 40 per cent of world’s poor population, particularly in China and India, saw their per capita income grow by 6 per cent per annum over the last 35 years while the same was 1.5 per cent in advanced world. So inequality has definitely reduced.
That’s because of the great performance by India and China….
No, no. Wait. Latin America, Asia, Middle East, Eastern Europe have done very well. One part that hasn’t done well is sub-Saharan Africa.
No, I meant to say that when we look at world inequality, it has certainly come down but when we dive deeper and look at countries individually, we see inequality has gone up. Some rich people (at the tails) in poor countries may be skewing the overall figures. We know that inequality in both China and India has gone up.
Well, as it happens, I am presenting a paper which shows that the claim made by Chancel and Piketty that inequality in India is at its highest level is very very questionable. There is no known model of savings behaviour that their estimates correspond to just like there is no known model of interest rate or inflation behaviour that RBI’s estimate correspond to. (chuckles) Both are identical in their wrongness.
Let’s discuss individual countries. For India, real consumption inequality has remained constant since 1983 according to NSS data. Take countries that have gone through structural transformation: China, Laos, Cambodia, Vietnam, Eastern Europe. In India, earlier the inequality was low but economists didn’t price things properly (especially of rationed goods) before the reform, or transformation, in these economies. The access to services, be it housing or even things like telephone connection etc, was limited for the general population. A bureaucrat could get you a HMT watch from the factory and things like that used to happen. Same was the case in Russia, China and other countries. Inequality, as was measured before the structural change, was very different. In China after the initial burst of inequality, it has remained the same. In UK, it has come down from its peak in 2008. So, there are very few examples of countries showing significant increase in inequality.
You call education as the most transformative force in human history and that education is the new wealth of nations. You also establish a strong correlation between level of education and size of middle class in a country. Education clearly is the most important area when it comes to middle class. But I believe that it’s one of the most ignored areas when we talk of reforms. What would be your recommendations to improve this sector in India?
In 1980s, the common refrain in the US was Johnny goes to school but he can’t read. Today, in India, Sita goes to school but she can’t read. The reason I give this parallel is because it is natural. When you have huge expansion, you don’t have availability of teachers. You can build a school but not teachers in short order.
We have a mega problem that government plays a large role in education where teachers can’t be fired even when they don’t even show up. It’s well known in the government.
We need to improve the quality of education and the accessibility to everyone. For that we will need money. My one suggestion would be that a student pays the same amount of money as college fee as he or she paid in high school. Equality of education is very important.
Education is the single most important ladder for the poor to climb into middle class but the students from poor families attend public schools which are pathetic to say the least and one wouldn’t be off the mark to remark that they are an obstacle to the poor climbing out of poverty. So, how do we reform the public school system?
You know this gets into very severe problems. What is very damaging to education system is the reservation system. Let’s face it.
One of the points that I make in book is that we have had very elitist policies in education from the beginning, started by Nehru that emphasised college education at the expense of primary and secondary education. Now, most developing countries expanded the base. We did exactly the opposite. Now, who did it benefit? - The upper classes, the top five per cent, bureaucrats’ children, the rich, etc. I can’t conceive how we went that way.
Part of the reason for reservation is because we had very distorted and elitist system to begin with. Then we grafted.
You know I say about economy and the policies that have been followed as that of peeling an onion. You peel one layer and you cry. You peel another, you find out more bad about economic policies and you cry even more. Everything possibly wrong that policymakers can do, we have done. It is sad that we have followed the policies that we have.
Lastly, how do we develop states like Bihar, Uttar Pradesh, and other states in the Eastern India? If we can do that alone, whole lot of our problems will get solved.
By not doing what we have done in the past.
We have talked about several of the determinants of growth. The government of the day is quite keen on developing 200 poorest districts in the country. One of the biggest reforms the Modi government has done is bring sanitation centre stage. It was never thought as important because the urban rich didn’t suffer from poor sanitation. But the rural rich did suffer from lack of sanitation; the rural poor suffered much more. Broadly, our policies have been very elitist. This is now beginning to change under Modi, whether it is defecation or Ganga cleaning and rejuvenation and so on. People are beginning to question the government that why they should pay taxes if they are not getting the services. So, things are starting to change. I am quite optimistic.
On that note, we can end the interview. Thank you, Mr Bhalla for such a detailed discussion on the economy.