The Hindu Business Line : Throwing light on prosperity

If India has to rediscover the magic of investments in public infrastructure, it has to generate revenue surpluses. But this can happen only if the government is sensitive to the needs of the private sector, the principal source of savings and taxes, says G. Ramachandran.

DIWALI is Diwali in many parts of India and is Deepavali in some parts. But there is a unified theme. Diwali is a two-in-one festival of lights that marks the victory, as always, of good over evil and the worship of wealth. Diwali would be dull without wealth and the expectation of better incomes. Diwali gives us an opportunity to examine what drives global prosperity.

This examination shows that low-income countries are poor because they pay too much to their governments and public sector. The governments and public sector of low-income countries typically fail to serve their economies and their citizens.

This examination also shows that high-income countries are rich because they carefully calibrate the payouts to their governments and public sector to the general level of incomes. The governments and public sector of high-income countries typically succeed in serving their citizens and their economies.

That is, poor countries are elitist; rich countries are egalitarian. If India has to become rich, it should shed its elitism and embrace all-round egalitarianism.

For long, most Indians have believed with unsuspecting acceptance that they are poor because they are not rich. `Poor' and `not rich' are somewhat tautological descriptions of the same state of affairs. Tautology does not throw new light on the causes leading to some characteristics. For example, it is tautological to believe that a short tree is short because it is not tall.

It is tautological to believe that a low-income country is one that does not have high incomes. Tautological explanations of poverty and affluence have served the political leadership in the poor countries.

The explanations based on theories of exploitation of the low-income countries by the high-income countries were very popular in the context of propping weak leaders who were engaged in aggressive and bitter battles for control over their nations' resources and peoples' minds. But these explanations have seldom served the economic needs of ordinary people.

Regulation pertinent to the private sector has been associated with the control over minds. Nationalisation of utilities, mines, manufacturing, production of fertilisers, food procurement and distribution, and banks has been associated with the control over resources. But incomes in low-income countries have continued to be low in absolute and relative terms long after their political leaders had won the battles for control over resources and minds. Low-income countries also continue to perform below expectations. Sixty-four countries, including India, had a per capita income of less than $735 in 2002. Fifty-four countries, including China, had a per capita income between $735 and $2,935.

By contrast, fifty-six high-income economies had a per capita income above $9,076 in 2002. Both India and China have a long way to go. They can. They will, if they care to understand what drives incomes.

Tear the tautology

Tautological explanations of poverty and prosperity may satisfy the political leadership and the bureaucracy of the 118 countries that comprise the World Bank's list of low-income and lower-middle-income economies. However, these explanations should not satisfy the political leaders and the bureaucracies of China and India. China and India together constitute about 40 per cent of the world's population. If vacuous reasoning could satisfy such a large population, then the world as a whole will be a poorer place.

Moreover, China is the world's second largest economy in purchasing power parity (PPP) terms. India is the world's fourth largest economy in PPP terms.

If two of the world's largest economies remain ignorant of or confused about what contributes to the prosperity of their peoples, the world would have missed an opportunity to spread prosperity in an era characterised by greater global co-operation and integration of economic activity and research.

Quite clearly, the world needs a better understanding of what could mitigate India's gross poverty and what could make China richer.

The usual suspects

China seems to have acquired a better understanding of the factors that contribute to per capita income. It had a per capita income of $4,390 in PPP terms in 2002. By contrast, India's per capita income was $2,570 in PPP terms. Even as China has pulled past India over the last two and a half decades, India continues to search for the magic combination that would fuel a handsome rise in prosperity at the level of the ordinary Indian.

This search involves some well-known factors such as capital, savings, welfare spending, subsidies, education, economic freedoms, technological advances, exports, fiscal and revenue deficits, and investment in public infrastructure.

The role of `governance by government' in spurring economic growth and incomes has been kept out of the magic combination. Similarly, the magnitude of salaries and pensions to employees and past employees of government and the public sector has been excluded from the analysis of factors that determine per capita incomes.

Inverse relationship

The analysis of modal incomes in government and the public sector relative to the modal incomes in the private sector was presented in `Hope rekindled for the people' (Business Line, July 10). The thrust of the recommendations based on the analysis was on why India has to rebuild its government, bureaucracy and the public sector so that ordinary people could be served.

Governments and bureaucracies serve economies in many ways. They use a combination of services and regulatory policies to spur desirable economic activity and disincentives to discourage dysfunctional activity. When a country's government and bureaucracy succeed in spurring desirable economic activity and discouraging dysfunctional activity, the general income level rises. The rise in prosperity is usually regarded as proof of good governance.

But when a country's government and bureaucracy are insensitive or indifferent to factors that spur desirable economic activity and discourage dysfunctional activity, the general income level may not rise.

That is, there could be a `disconnect' in the context of governance, salaries and pensions in government and the public sector, general economic activity and incomes in the private sector. Salaries and pensions in government and the public sector could remain unconscionably high when the disconnect is deep and almost unbridgeable.

The analysis of (1) per capita PPP income rank published by the World Bank in July 2003 and (2) the prosperity of government and public sector relative to the private sector shows there is an inverse relationship between the prosperity of the government sector and prosperity of the total economy.

India's per capita PPP income rank is 145. Its government sector is the most prosperous relative to its general economy.

Te US' per capita PPP income rank is 5. Its government sector is marginally more prosperous than its private sector.

The rank correlation between per capita PPP income rank and the prosperity of the government and public sector relative to the private sector is minus 0.78. The inverse relationship is extraordinarily significant. The chances that policy-makers would be misled by this inference are less than two in thousand.

Non-monetary spurs

The inverse relationship highlights the importance of good governance. Governance is a qualitative input to national prosperity. The adverse effects of poor governance can seldom be mitigated by large doses of foreign aid and foreign direct investment (FDI).

Good governance will lead to higher income levels, better tax inflows and, perhaps, larger outlays on public infrastructure. But economies such as India have chosen to give away most of their savings and taxes to their employees in government and the public sector.

Therefore, they do not generate fiscal surpluses that can be invested in public infrastructure. If India has to rediscover the magic of investments in public infrastructure, it has to generate revenue surpluses. But revenue surpluses will be generated only if the government is sensitive to the needs of the private sector, the principal source of savings and taxes.

Sensitivity and responsiveness to the needs of the private sector are the principal issues that define reform and good governance. However, these are non-monetary inputs to economic activity. There are no known monetary substitutes for these. To earn decent incomes, backs have to bend!

(The author is a financial analyst. Feedback may be sent to indiagrow@sify.com)

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