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Why we may return to Swadeshi economics
August 07, 2007
The developments stated above have to be viewed in the context of a well-critiqued document published by the Asian Development Bank [Get Quote] -- Export or Domestic Led Growth in Asia -- in May 2005.
The authors -- Jesus Felipe and Joseph Lim -- analyse the strategy adopted by countries in the post-East Asian foreign exchange crisis. Pointing out to the fact that as part of the 'package of solutions' to reinvigorate these economies post the exchange crisis of the late nineties, a number of policymakers in the region proposed shifting (some of them more openly, e.g., Thailand, and some others less so, e.g., Malaysia) to a 'new development paradigm' based on domestic demand-led growth.
In fact, the recently ousted Prime Minister of Thailand Thakshin announced upon taking the helm of government in January 2001 that he was determined to move the country away from mass manufacturing for exports into domestic demand-led growth through a series of policies.
The country's policymakers made big efforts toward shifting economic policy to reduce the country's over dependence on external demand and foreign capital. The high growth rates achieved by Thailand in recent years seem to vindicate their new approach.
In effect, Thakshin's approach was to seek a transformation from export-led growth into domestic demand-led growth. Thakshin's objective was to alter Thailand's production structure with a view to reducing the country's dependence upon exports. The key was to create demand among households and businesses without creating another bubble.
In August 2004, the Thai government published a white paper -- Facing the Challenge: Economic Policy and Strategy -- explaining clearly the economic agenda that Thakshin had been trying to implement since he came into office on January 2001.
The idea was to balance past excessive dependence on external demand, urban-based mass manufacturing, and unproductive asset-building on one hand; with structural development in domestic demand, traditional sectors (e.g., agriculture, SMEs, and rural households) and entrepreneurs, and improvement in the pricing power of Thai goods and services on the other.
Encourage domestic consumption
In effect, Thakshin's plan was to revive domestic demand (by boosting private consumption), in addition to exports. This is what has been referred to as a dual track strategy, as opposed to the single-track model followed by many countries in the region, namely, producing for exports.
The net effect of this strategy is that slowly but steadily, countries especially in Asia are concentrating on domestic consumption and investment to engine their growth. As a net effect they are not in any way over-dependent on exports for their growth.
In fact Thakshin's growth strategy is fallout of economists who have hypothesized that the East Asian crisis had very different roots. After several decades of being presented as the optimal growth strategy, the export-led growth model that the East Asian countries followed ultimately gave in and even harmed its growth prospects.
Some economists have put together a critique of the export-led growth model and proposed a shift toward domestic demand-led growth. Most of them have argued that the emphasis on export-led growth of most East Asia countries had a series of negative effects, which are listed as hereunder:
First, it prevented the development of domestic market growth.
Second, it put developing countries in a 'race to the bottom' among themselves.
Third, it put workers in developing countries in conflict with workers in developed countries.
Fourth, there is a relationship between export-led growth and financial instability by creating over investment booms.
Fifth, due to the emphasis placed on global goods and commodity markets, this model has aggravated the long-trend deterioration in developing country's terms of trade.
Sixth, exports fuelled through a weak currency -- unless counterbalanced by appropriate monetary intervention -- could be inflationary. Since the global experience on this is that monetary intervention could have a limited role, weak currencies coupled with export-driven economies lead to inflationary pressures.
Finally, and most importantly, export-led growth has reinforced the dependency of developing countries on the developed world, thus becoming vulnerable to slowdowns in the latter's markets
Export-oriented economies are extremely dependent on foreign (mostly Western) demand. The problem is that any economic recessions in Europe, Japan, or US translate into slow growth in the developing world. To sum up these economists argue that the export-led growth model followed by East Asian countries for several decades is not an optimal strategy any longer and it is risky and dependent on the consumption pattern of others.
End of export-lead growth?
Blecker, a celebrated economist summarises his views as follows: "The current emphasis on export-led growth in developing countries is not a viable basis on which all countries can grow together under present structural conditions and macroeconomic policies." (Blecker 2003) Palley (2002), another noted economist, has gone further and contends that the export-led growth model followed by many developing countries during the last few decades was part of the so-called 'Washington consensus' emphasis on trade liberalisation.
As a solution, Palley proposes a new development paradigm based on domestic demand-led growth.
It is in this connection one would like to quote from the speech of Ma Kai, Chinese Minister, National Development and Reform Commission. Explaining the Chinese philosophy that governed the preparation of the 11th plan approach paper, which incidentally was to rely on the expansion of the domestic demand as an economic model and growth strategy for China in the next five years.
Kai stated recently "we will promote development by relying on the expansion of domestic demand, take the expansion of domestic demand, especially consumption, as a major driving force, and transform economic growth from being driven by investment and export to being driven by consumption, investment, domestic and foreign demand combined in a balanced manner.
This transformation is targeted at solving the problem that China's economic growth has relied on investment and export excessively and domestic consumption does not play its due role.
During the 10th Five-Year Plan period, the domestic capital formation rate increased from 36% to 44.8%, while the consumption rate decreased from 61.5% to 50.7%, and foreign trade dependency rose from 39.6% to 63.9%. If such kind of growth continues, though successful in short-term fast expansion, it will lead to a more extensive growth mode and instability of the economy.
In the 11th Five-Year Plan period, we will adjust the relationship between investment and consumption, rationally control total investment, and strengthen the driving force of consumption in economic growth. We will adjust residents' income distribution, raise the income of urban and rural residents, and enhance the consumption capacity of residents, particularly rural residents and low-income population in urban areas.
We will speed up the transformation of foreign trade growth mode, and promote the switch of the dominant feature of foreign trade from volume expansion to quality improvement."
How high rates of indirect taxes hamper consumption in India
In short, the death of Washington consensus -- especially that of export driven growth model - is yet to be formally announced one has surely to think of life after that. As usual, the government of India is yet to recognise this tectonic shift in global economics. In the early 90's it was a standard slogan -- export or perish.
Now it may not be as yet to announce export and perish, yet it seems that globally export driven economies are having a revisit of the fundamental assumptions governing their economy and notably on the export driven economic model. Consequently, internal demand and domestic consumption are fast emerging as the engine of growth and development.
All these mean that this changing paradigm calls for a re-look at domestic markets by exporters in particular and business in general. Crucially, to aid domestic consumption, the government too has to play its part.
One factor that inhibits domestic consumption is the high incidence of indirect taxes -- we end up paying 16% to central government and another 12.5% as VAT to state governments aggregating to approximately 30% or one fourth of retail prices. This is one of the highest in the world. Obviously indirect tax reforms are crucial to boost domestic consumption.
Pointing out to such high incidence of indirect taxes on the final retail prices the report of the National Manufacturing Competitiveness Council states in its report on the National strategy for manufacturing "Domestic indirect taxes are often singled out as a major reason why Indian manufacturing is uncompetitive. For instance, many studies argue that total taxes on manufactured goods are 25 to 30% of the retail price in India, compared to 15% in China. Indirect taxes contribute 50% to the difference in retail prices between India and other low-cost countries. Lower duties would also boost the domestic market and permit synergy (exploitation of economies of scale, attracting FDI) between domestic and export markets. Therefore, there is a case for reduction of domestic indirect taxes both from the point of boosting domestic demand as well as improving export competitiveness."
This is the only way to lower inflation in India, boost consumption and in turn ensure a consumption driven manufacturing boom in India.
PS: Given the fact that export-driven growth model is fraught with extreme risks caused due to a multiplicity of factors, a revisit to Swadeshi economics -- of encouraging savings within a country, converting such fiscal savings into physical savings by providing appropriate investment climate, ensuring appropriate returns for such investments within a particular country through stable laws and lower taxes and ensuring that the domestic consumers are benefited -- is inevitable.
The author is a Chennai-based Chartered Accountant. Comments are welcome at firstname.lastname@example.org.
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