Were we getting paid for Productivity

Hello,

One of the constant arguments I have heard about why India will come out unscathed & grow leaps and bounds in the next few decades is the supposed assumption that somehow we are better than others. We are told that we are better than China because we are not as dependent as China in terms of Exports, we are told we are better than Europe since Europe is facing a decline in population & has huge problems which we don’t and finally we are seemingly better than US since else why would US companies set up Software enterprises here in India if they could get the same workforce back there.

The fact that is being missed in all this is that the whole economic cycle runs on the concept of productivity. We produce – We consume and We produce yet again. It’s a cycle with a no stop signs or even pause signs.

The question that comes is if we are so productive and we are so intelligent (as one of my friends said as to giving a reason why Indian Software companies were great), why did we not grow as much before the 2000. While we tend to think that our best growth came after the start of the Economic Liberalization, the truth is that we had recorded our best growth rate in 1988 when the Indian GDP grew at 8.258%. We overcame this high only in 2005 when we grew by 9.033%.

The United States reached its Economic peak way back in 90’s with it hitting the peak which coincided with the IT bull run of 1999. Once the Dot Com bubble burst, there was a significant decline with the economy starting to state at a bottomless pit (one which Japan had fallen long back & was still wondering where the bottom would be). China while being a big exporter was no match to the United States and India had not attained the kind of software status it does now. India was noticed since we were the people who worked on ensuing that the change over from 1999 to 2000 did not stop the world but that was more of a one time opportunity than a long term career.

The Economic cycle runs on the following premise – The Central Bank prints money which is used directly or indirectly by the government and the private sector to generate employment using the knowledge and skill of the populace & hence growth and this growth is sort of a perpetual machine. The model of Capitalism is that since money is allocated to the most efficient, the machine can run without much glitch for a very long time till kingdom come.

But that works if every component works as thought it would and there is not much of deception to make it appear that something is working when it’s clearly not working. In 2001, the fact that US would go into a recession was starting to stare at the face of the Central Bank (Fed) and it had to do something to ensure that the US economy did not go into such a decline. But people have limited spending power and if they aren’t able to see a good future will curtain even more of their spending power which inturn can become a vicious cycle with it becoming a race to the bottom.

It was under such circumstance that the Fed decided to push for easy money by keeping interest rates low. The idea was that with interest rates being low, it will encourage people to take risks and start business & enterprises that will generate jobs and growth and hopefully kick start the economy.

Unfortunately easy money means that people will also take risks that they will not take in a normal environment. This was the key to the continuations of the housing bubble (which started way back in 1995 when GSEs like Fannie Mae began receiving government tax incentives for purchasing mortgage backed securities which included loans to low income borrowers) where money was chasing something limited (houses) and hence prices went higher and higher till one fine day when it stopped rising and instead started to fall.

India and China grew in these years precisely because of the US housing boom. People were able to afford a great number of products which they may not been able to earlier since their houses seemed to be growing exponentially and banks were eager to provide them funds against the same houses at higher and higher base prices. As the money supply kept going on, we in India and China were able to export what we produced / serviced to our hearts content since we had cheap labour and technology had cut the time gap we had between us and them.

But were we really able to grow because of our intelligence or cheap labour is a question that has multiple answers. Yes, we think we are intelligent but intelligence alone cannot work without there being supporting factors – factors like the advantage of a weaker currency. It was a combination of multiple factors that meant that both of us (along with many other countries) grew at a rate nearly double our historical average.

But the question is, can we continue in this way for long. Both India, China  & elsewhere (other than US / Japan & Euro) are facing unprecedented high inflation which is eating into our advantages. Add to it, the slowing growth has meant it’s now a double dhamaka. The way banks are being saved both in US and Europe will mean more money chasing fewer good (read commodities) which should keep the inflation higher for extended periods of time.

In India, with the government in a limbo, schemes that are supposed to help the poor is instead ensuing that the poor remain poor. The price rise has also meant that the government is now bearing more and more subsidy burden at a time when tax revenues are coming down. Public sector banks are getting way undercapitalized and this will affect in how they lend (which due to the high interest rates is already slowing down).

While China seems to have escaped from many of the consequences, I feel that its just hiding to emerge as a flash fire would when banks which have lent hugely to the real estate sector in China start feeling the heat of a fall in prices. Add to it, since its more dependent on US, any further decline in US will have a considerable impact on the local economy.

All in all, I believe that the situation is as bad as it was before the recent Greek rescue made it appear that problems have nearly been solved. In fact I would go as far as to say that the way the rescue has been affected will give rise first to a spike and then a fall of a greater measure.

Cheers

Prashanth

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About Prashanth

Have been a full time participant in the stock markets since 1996. Run a Yahoo Group where focus is exclusively on discussions of the Indian Markets using Technical Analysis as the tool (groups.yahoo.com/group/technical-investor)
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