Presented at the 8th C.D. Deshmukh Memorial Lecture
Good afternoon. I am honored by your invitation to deliver the 8th C.D. Deshmukh Memorial Lecture.
The late Chintaman Deshmukh, a towering figure as RBI governor and later finance minister, helped guide India’s economy through the immense challenges of independence. Perhaps less well known, he also holds a place in the annals of the IMF as a senior member of India’s delegation to the 1944 Bretton Woods Conference, which laid the foundations of the post-war economic order.
There, C.D. Deshmukh had the foresight to insist that the IMF and World Bank address the development needs of the countries that would soon emerge from colonialism.
John Maynard Keynes, deeply impressed by his contributions, is reported to have recommended that he run the IMF. I hope that one day we will have an Indian managing director.
Last year, at this podium, Martin Wolf spoke of the “Challenges to India from Global Economic Upheavals.” Since then, we have seen the threat of two of those upheavals recede, if not fade—the U.S.-China trade conflict and a hard Brexit. But new uncertainties always arise, casting a cloud over the global economy. For example, we are only beginning to see the impact of the coronavirus epidemic, which has struck at the heart of global value chains.
But beyond these headline-grabbing problems, governments around the world are struggling to solve a complex policy problem: how to address the secular stagnation that is reflected in anemic productivity growth, falling inflation, and weakening global trade. This is in part the legacy of the global financial crisis. But it is also the new normal of a maturing, globalized world, reinforced by aging societies in Japan, Europe and the U.S., and posing the fiscal challenge of meeting the needs of their senior citizens.
For the most part, secular stagnation is an advanced economy issue, but one with spillovers that concern the rest of the world. Moreover, secular stagnation may be a preview of coming attractions for some rising and aging middle-income countries.
That said, many of you may be correct in thinking that all of this is a long way from India, which in recent years was the fastest-growing large economy in the world. Indeed, your country—with its young and growing population, and a reservoir of untapped demand—already has shown the potential to play an increasingly important role in the global economy.
That is surely the case, despite the recent slowdown. The latest IMF forecast for the global economy underlined the impact on global growth of India’s sharp slowdown in the second half of 2019, which was caused by weak domestic demand and falling credit growth, and problems in the financial system. Clearly, there are significant balance sheet challenges that must be addressed to return to the levels of growth that India has enjoyed in recent years.
If this happens, and India achieves a sustained takeoff, your country can play a unique role. India could be in a position to help invigorate global growth, transform global patterns of trade, and spur investment and innovation. With the right policies—and a supportive global environment—India could become a source of “secular dynamism,” if you will allow me to coin a phrase. If other countries can find their way as well, secular dynamism in the developing world would become the needed counterweight to the secular stagnation of the advanced economies.
\These are the topics that I would like to focus on today: an important part of the global economy struggling with secular stagnation; how, in this setting, India and other countries can achieve sustained dynamism; and the crucial role for multilateral cooperation in preserving the integration that will best promote both of these efforts.
Secular Stagnation and Productivity
Let’s begin with the advanced economies, which have been stuck in low gear for a decade, leaving it to the emerging markets to lift global demand.
At the heart of secular stagnation has been lagging productivity and flagging investment opportunities.
Along with demographic change and the effects of the global financial crisis that I mentioned, another factor that has been singled out is the waning effect of the IT revolution that began 30 years ago. We may only be witnessing a pause in this revolution. The full impact of big data, artificial intelligence and other innovations on productivity may still lie ahead. But it is too soon to know how that will play out, for better or for worse.
Then there is the slowdown in global trade. This trend was already evident before the recent upsurge of trade tensions. But it has gathered such force and breadth that we must reassess our assumptions about the immutability of open markets and cross-border production chains that have helped drive decades of unprecedented global growth.
This is not just a matter of the U.S. and China, whose Phase I agreement certainly has been welcome. In the year to October 2019 alone, WTO members enacted restrictions covering about $750 billion of trade, reducing investment, slowing job growth, and unmooring global value chains. The IMF predicts a 0.5 percent hit to global growth this year as a result.
The global trading system, as we know it, is under threat, and we could come to regret this road we have embarked upon unless cooler heads prevail.
Reinvigorating global growth and restoring support for integration is the best remedy to these dangerous trends, and in recent years, the IMF, the G-20 and individual governments have devoted time and resources to that challenge.
We’ve advocated structural reforms that can potentially strengthen confidence and boost investment. That is to say, initiatives ranging from infrastructure development to tax incentives for innovation, education and health spending, and product and labor market reforms. We’ve seen some successes, but not enough results.
Too often, it has been left to the central banks to be the first and main responders to the lassitude of private investment in national economies. They have done heroic work and it has mattered. We reckon that last year, global growth would have been 0.5 percent lower without their support. But despite those efforts and vigilance, growth remains subdued and financial vulnerabilities are building again, especially sovereign and corporate debt.
Markets—with their vast stores of capital—signal that they have low expectations that business investment will take off again.
As a result, the search for yield—wherever it can be found in a world of low interest rates—has become a fact of life. As investors seek out new sources of higher returns, emerging markets have seen portfolio capital inflows, and not a little capital flow volatility. Yet many developing countries still hunger for stable investment capital that could support faster, sustained growth.
Investors, including advanced economy pension funds placing much of the savings of the growing population of the soon-to-be elderly, are hesitant to make long-term investments in the developing world.
These are the very places where large-scale infrastructure projects could make such a difference, and where sustained growth could help offset secular stagnation.
Too many developing countries in need of capital and the technology that comes with it have just not reached the point of being truly “investable”. The obstacles include opaque and inadequate legal frameworks, corruption and other governance shortcomings, and in some cases import restrictions and onerous regulation. The potential exists for a high rate of return, but the risks to realizing the fruits of your investment are still too high.
Without addressing these issues, it will be much harder for developing countries to attract the stable, long-term capital that could boost economic dynamism and drive convergence of living standards with the advanced economies.
All of which brings me back to India, and its great potential to become a source of secular dynamism.
This country has long worked to address its home-grown challenges of development and to be investable. Reforms have produced high growth and lifted millions out of poverty, and the Indian economy has made great strides in global integration.
The success of your service sector is especially noteworthy: India has become one of the largest exporters of information, computer and telecommunications services, and those services have been a key driver of productivity growth. This may be the modern path to development.
These successes have positioned India to take advantage of the demographic dividend presented by your growing population. By investing in that young workforce, and advancing reforms that stimulate investment and trade, India could pursue a road to convergence that was unimaginable a generation ago.
The stakes are high. How long will it take for per capita GDP in India to reach half of the level of the United States? In preparation for this event, my colleagues ran some numbers.
At an average of 9 percent growth a year, it would take 15 years. At 7 percent, that would be 19 years. But at 5 percent growth—just a bit over last year’s fourth quarter growth—it would be 23 years. Clearly, 5 percent growth isn’t ideal, and higher growth is better.
What’s behind the most recent numbers? While credit availability and financial sector bottlenecks are often-cited issues, along with impaired balance sheets in parts of the corporate and financial sectors, there are still other longer-standing issues providing a drag on growth. For one, Indian agriculture has lagged, the impact of which was evident last year in falling rural consumption. Export growth has slowed over the past decade.
Most troubling, unemployment has risen, and labor force participation has fallen. It is particularly low for women—who should be a source of economic dynamism, as they have proved to be in many other economies.
India also needs to fully realize its comparative advantage in manufacturing, where it remains constrained by the small scale of production, low productivity, trade restrictions, infrastructure gaps and a host of other shortcomings. This is the case even as engineering, electronics, and pharmaceuticals have emerged as leading exports, and while services have boomed.
India’s Links to Global Value Chains
One route to a stronger manufacturing sector is to deepen linkages to global value chains, especially the use of foreign intermediate goods in producing exports. Policies that limit these linkages, for example tariffs on those intermediate goods, constrain the emergence of the vibrant and globally competitive manufacturing that can create Indian jobs.
So far, the impact of global trade tensions on India has been limited, ironically because its trade integration remains relatively limited compared with other Asian exporters. Nonetheless, the potential for reverberations through the investment channel could be significant over the medium term—especially if those trade tensions worsen.
Nonetheless, India has an opportunity to emerge as a global manufacturing hub as foreign companies reassess their production base in China. But so far, India appears to be lagging ASEAN in this respect. For example, a recent Nomura Securities study of 56 companies that had relocated from China found that 26 moved their factories to Vietnam—but only three to India.
What will it take to play a more important role in global value chains? The answer is a combination of infrastructure investments, a reduction of tariff and non-tariff barriers, and reforms that encourage the emergence of larger and more productive manufacturers.At the end of the day, success requires creating employment. As argued in a recent IMF study, India’s investment in tertiary education has been associated with strong growth in the high-skilled service sector. A demographic dividend can only materialize if India can complement this by spending directed at primary education to broaden access to quality education and reducing the still large gender gaps in labor force participation. Without these efforts, together with labor market reforms aimed at protecting people – versus protecting jobs– a growing population could become a drag on growth, and income inequalities will only widen.
Let me offer one caveat on labor force skills. Technological innovation is rapidly driving down the cost of capital goods, and the growth of automation and artificial intelligence potentially threatens the business model of low-wage, labor-intensive industries. The experience of the past 30 years suggests that disruptions caused by new technology come in ways we cannot predict, and with a speed that leaves assumptions of best practice in ruins.
By one estimate,14 percent of the global workforce—that is to say, 375 million workers—could lose their jobs in this decade as a result of automation. While the advanced economies are more exposed, India won’t be exempt. Some 9 percent of Indian workers could lose their jobs.
Regardless, it is important to remove the constraints that have limited integration into global value chains. Indian businesses must become more agile in a world in where constant innovation will determine the winners.
So far, I spoken about what countries can do to help themselves. But in my tale of two economic realities — secular stagnation in aging advanced economies; and potential secular dynamism in youthful developing economies, most prominently India — the prospects for success of each depends on both and thus on an international system that ensures integration and cooperation. Let me end by turning to the crucial role of multilateral cooperation.
The Role of Multilateral Cooperation
Why is cooperation so important at this juncture? India and other countries aspire to rising living standards for their people, living standards that over time converge toward those of the richer countries. It is hard to see how that can happen smoothly and reasonably quickly without global markets for their goods and services and capital and technology to spur the growth of production and employment. For advanced economies, if U.S. and European bond yields are any indication of returns at home, their savers would benefit greatly from the opportunity to invest in profitable enterprises in fast growing and dynamic economies.
For all this to happen, we will need to address the misgivings about multilateralism and economic integration that have arisen. Those misgivings arise from genuine concern about the disruptions and spillovers that accompany tighter global economic integration or that stem from inappropriate trade policies. But they also arise from fear of the impacts of technological change on the future of work.
There is not time today to delve deeply into the question of how best to address these concerns and fears. Suffice it to say that the history of the 75 years since the end of World War II has shown that our differences can be bridged by cooperation, and particularly in a multilateral setting.
I began today by citing India’s role at Bretton Woods, where countries with common purposes charted a new course for the international community.
If anything, there is as great a need as ever for cooperation. So, for the sake of this discussion let me conclude by describing the core issues that demand our common attention—where solutions can help promote a stronger global economy.
· First, we cannot ignore the frictions surrounding economic integration. We have to solve the conflicts emerging over trade and global value chains. We need to ensure that the global, cross-border flow of capital is not destabilizing, but produces benefits for all countries.This means working together constructively to find practical solutions on protection of intellectual property; unfair competitive practices; unreasonable restrictions on investments; and the buildup of tax havens that benefit multinational corporations and deprive resources to countries large and small. If all of this means serious WTO reforms, then we need to get to it.
· Second, we’ve paid a lot more attention over the past decade to addressing the spillovers that have proven so disruptive to global growth and stability. But there is much more work to do, especially to ensure that secular stagnation and disinflation do not spread. This relates to the capital flows I just mentioned—how to mitigate the disruptive shifts in market sentiment that can send economies reeling. The IMF is taking the lead, trying to develop a more robust set of policy tools that can be used to promote stability in the face of spillovers in a volatile world. That work needs to be taken forward.
· Finally, we face a host of existential threats that can only be addressed by the provision of global public goods. Each of these could be the subject of a separate speech: climate change; cyber-threats; the ownership and use of data; new pandemics; and migration.
These 21st century problems will not solve themselves, especially if we stick our heads in the sand. It is clear that individual countries cannot address them on their own.
Yes, each country can put its own house in order, to create an investable business climate and secure a stable economy. But that will not be enough. We have to move beyond squabbling to carve out room for multilateral problem-solving. We know what happens when countries squabble, when they go it alone. Working to a common purpose is the most effective means of building prosperity—in the present moment, to address secular stagnation and to create room for new, dynamic economies like India to emerge to the benefit of all.
There is a great deal of work to do, work that will require a commitment to our future commensurate with the commitment that C.D. Deshmukh and his peers brought to an earlier era. I hope that our children and grandchildren can look back on how we respond to these challenges with the same respect that this lecture series embodies. Thank you.