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Growth, volatility and euphoria
Raghav Gaiha & Vani S Kulkarni | March 20, 2007
This year's estimated 9.2 per cent growth is particularly impressive as this is despite agricultural growth decelerating from 6 per cent to 2.7 per cent, and this has been more than made up by manufacturing and services.
This has lead to a spate of somewhat euphoric predictions about India breaking into the ranks of lower middle income countries, catching up with China and surpassing it.
While the constraints of a fractured polity, tottering infrastructure, exasperating bureaucracy, and rigid labour markets are not overlooked, an important dimension of economic performance (volatility of growth) is. If growth acceleration is accompanied by greater volatility, the welfare gains may well be limited.
Considering that growth trajectories are seldom smooth - mainly because policy reversals are not uncommon, economic activities are often disrupted, prices fluctuate, and capital flows change course - and individuals are risk-averse, there is a divergence between average growth rates and corresponding certainty-equivalent rates.
If the latter are lower, as is generally the case, volatility reduces welfare for a given degree of risk aversion. A recent study, based on a cross-country analysis, sheds light on whether volatility of growth rates has increased in recent years and the underlying factors (Gaiha, R. and G. Thapa (2006) Growth, Volatility and Inflation - A Cross-Country Analysis, Rome: PI, IFAD).
However, the higher the share of agriculture, the lower was the volatility.
Finally, controlling for these and other effects, the volatility decreased in the period 1995-2004.
Consider the simulations for India and China.
In conclusion, the trade-offs between growth and volatility matter but run the risk of being submerged in bouts of euphoria over growth acceleration.The authors are Visiting Scholar and David Bell Fellow, respectively, at Harvard's Centre for Population and Development Studies