Development Bank Research Bulletin

India’s demographics may bring a bumpy ride for the economy

Having a large and young labor force is believed to be good for GDP growth. It has been well-received that current demographic structure of Indian population is working toward India’s favour in the next two decades when young Indian children grow up and enter the labor force. Chinese economy, which benefited and is still benefiting (but for not too long) from the 1970s babyboomers, however, will start to slow down because of the aging population .

However, young labor force can take its toll too. A study by Nir Jaimovich and Henry Siu shows that it is the “restless” workers that makes an economy volatile. Based on historical data from major industrial countries, they find that volatility of an economy is positively correlated with the share of young workers (15-29 years old) in the labor force.

To show you the result also graphically, below several charts from the paper are shown. The charts (please click for enlarged imanges) plot the business cycle volatility (the pink line) alongside with the “restless” worker ratio (the blue line) for the seven major industrial countries. The two statistics seem to track each other very well. History may not be a perfect guide, but the evidence collected by economists seems to suggest that demographics is a good predictor of economic volatility. So, Reserve Bank of India, watch out! Your inflation rate is too high!

The Young, the Old, and the Restless: Demographics and Business Cycle Volatility (PDF file)

We investigate the consequences of demographic change for business cycle analysis. We find that changes in the age composition of the labor force account for a significant fraction of the variation in business cycle volatility observed in the U.S. and other G7 economies. During the postwar period, these countries experienced dramatic demographic change, although details regarding extent and timing differ from place to place. Using paneldata methods, we exploit this variation to show that the age composition of the workforce has a large and statistically significant effect on cyclical volatility. We conclude by relating these findings to the recent decline in U.S. business cycle volatility. Using both simple accounting exercises and a quantitative general equilibrium model, we find that demographic change accounts for a significant part of this moderation.

Indian households save more than Chinese!

According to a new report by McKinsey “Putting China's capital to work”, Chinese households save 23.8% of their disposable income, not particularly high compared to the saving rates of Asian tigers in their high growth period.

Indian households save 31.9% of their income, a ratio that is much higher than Chinese. The current saving rate of French is 16.6%

Chinese = high saving rate? Myth busted!

The report points out that the high total saving rate of China is mostly the result of higher corporate saving rate, which stands at twice world average. The report however also cautions readers that the higher household saving rate of Indians could be the result of small and micro businesses reporting themselves as households.

Nevertheless, the Chinese saving rate could be overestimated too, as Chinese disposable income, the denominator of the ratio,  is severely under-reported because of the huge underground economy.

Note that saving rate of an average Chinese household could be much lower than the headline number. In 2003, 1.86% of the wealthiest Chinese households control 60% of the total stock of liquid financial assets in China, and they certainly have much higher saving rate than poor people. A McKinsey survey indeed shows that the lowest income quintile of Chinese households save only 20% of their income.

Goldman Sachs: China makes largest progress in energy efficiency than other developing countries

Goldman Sachs publishes a note "Improving energy intensity across the BRICs"  (pdf file). There are several interesting take-away points:

(1) China’s energy use per unit of output in industry fell by 56% between 1994 and 2003, which is the largest energy-efficiency improvement progress in developing world. In the same period, India only achieves reduction of 30%, and Brazil almost makes no progress.

Why is everyone blaming China for using too much energy?! China uses more energy simply the population is larger and the economy is still in the early stage of industrialization, and as such a large economy, China is already making much better progress than others.

(2) Russia remains the most energy-intensive countries in the world, The country’s energy intensity is close to three times that of US.

Not surprising, considering that the government is subsidizing energy (for Russian residents) to such an extend that electricity is almost free. By the way, Venezuela always consumes a lot of gasoline, because the price is heavily subsidized. I always say that letting market to determine the price is the best weapon against energy waste.

(3) In China, non-industrial sector is twice more energy-intensive than industry.

I have no idea why!

(4) Projection results show that BRICs (except Russia) will consume much less energy per capita than the current level in more developed economies (U.S., Japan, etc) when  they reach the same income level of developed economies.

I.e., both now and in the future, Americans will remain the heaviest user of energy, even on per capita term.  Why do Americans still point fingers at developing countries and keep on blaming China for exhausting the energy resources of the planet?

Implication for the relationship between growth and environment : as a country gets richer, it will use less energy (because industry becomes more productive and structural shift to service sector will also save energy). The best weapon against pollution is economic growth, not to turn Africa into a zoo.

Will India collapse in balance sheet crisis? a worse scenario analysis

Special note: this analysis is more a stress-test/worse-scenario type of exercise and "thought experiment". I don’t think a crisis is imminent for India, neither do I think it is a large-probability event. An external debt crisis is in particular impossible. The analysis however, by dissecting the problem, helps you identify the weakest links of the system and hopefully may help inform policy-makers in addressing the problem ealier than later.

Will India collapse in balance sheet crisis?

My evaluation is that: India’s national balance sheet is unsustainable in the long term, but financeable  in the short term. Nouriel Roubini has the same opinion in his article “A balance sheet crisis in India” (PDF file)

First, let me tell you why it is unsustainable in the long term. When evaluating a country’s vulnerability to crisis, we need to examine the overall balance sheet of the country, which include not only the corporate and banking sector, but also the government sector.  This is particularly true in India and China, where the liability can be easily moved between balance sheets of the banking sector and the government as a result of strong state intervention in the economy.

In both India and China, governments are heavily involved in loss-making projects. But the losses are recorded differently.

In China, government forces state-owned banks to extend so-called “soft loans” to industries and enterprises favored by the government’s fiscal goals, and thus the huge losses are recorded in the banking sector as non-performing loans.

In India, the government directly involves in subsidizing these “white elephant” projects,  and then finance the expenditure through issuing government bonds to captive state-owned banks. Indian government thus accumulates huge public debts, which amount to more than 400% of its annual revenue.

We have to understand that, although the losses are recorded differently in India and China, if we examine the balance sheet of the country as a whole, they are not better than each other. If Chinese government increases its public debt to the level of India, she can use the revenue to write off the bad loans of the banking sector for many times. Similarly, if Indian government is to default or restructure on its debts, or there are doubts among depositors about the government’s repayment capacity, Indian banking sector will be broke over night as more than 35% of Indian banking sector’s total assets are in the form of government securities. Currently, government papers are treated as very safe and capital and loss reserve is not allocated to safeguarding against potential future losses, which results in misleading capital adequacy ratios.

In a worse scenario, such structure can cost you dearly. According to Professor Roubini, anything that can go wrong tend to go wrong together:

“Note also that if a bank run were to eventually occur—when and if depositors become concerned about the quality of the bank assets and the sustainability of government  debt—the ability of the Indian government to stem the run via explicit guarantees of deposits may be limited. A solvent government running a low deficit and with little debt may credibly guarantee deposits since it has resources to finance a bailout of the financial system. But an insolvent government cannot credibly backstop the banking system and promise to protect deposits given that the cause of the run is, in the first place, concerns about the solvency of the sovereign. Thus the risks of a bank run and the necessity of a deposit freeze become more severe when the government is effectively insolvent or semi-insolvent.”

Will Indian government default on its debt? India’s public debt to GDP ratio is some 85% and the government is still running large fiscal deficits every year, and even if India can maintain its 7%-8% economic growth rates and the interest rates do not go up, the debt ratio is heading toward 90% by the end of this decade, maybe even faster with the coalition government that will certainly spend more. However, high debt ratio alone will not trigger crisis. India’s public debts have long maturity terms (which however also means that banking sector will experiences large losses when short-term interest rates hike), and are mostly denominated in local currencies (which make India relatively free from crisis in external sector).

Nevertheless, everything that can go wrong will go wrong. When the balance sheet is unsustainable in the long run, it becomes very fragile in the short term too, as participants in the economy are forward-looking. Nothing will happen if India can maintain high growth and low interest rates, and (2) No large scandals happen in state-owned enterprises and banks. But if any one of these factors (growth, interest rate, confidence in public sector) goes wrong, investors will start to reevaluate the situation, and some of them may start to think: hey, the whole system is unsustainable in the long run, someone will eventually have to pay the bill, and I don’t want to be the last one to liquidate my position! 

One may point out that European countries also accumulate huge public debt, and why don’t you worry about them. Well, since when has India become a developed country?

Emerging markets are fragile in nature. Let’s review some famous Murphy’s laws:
(1) Anything that can go wrong will go wrong.
(2) If there is a possibility of several things going wrong, the one that will cause the most damage will be the one to go wrong. Corollary: If there is a worse time for something to go wrong, it will happen then.
(3) If anything simply cannot go wrong, it will anyway.
(4) If you perceive that there are four possible ways in which a procedure can go wrong, and circumvent these, then a fifth way, unprepared for, will promptly develop.
(5) Left to themselves, things tend to go from bad to worse.
(6) If everything seems to be going well, you have obviously overlooked something.
(7)It is impossible to make anything foolproof because fools are so ingenious.
(8) Whenever you set out to do something, something else must be done first.
(9) Every solution breeds new problems
I more and more feel that Mr. Edward A. Murphy is such a damn-good economist! World-class!

Recommended Readings:

Deutsche Bank Research: India’s public finances: do they matter? (PDF file)

Also two of my previous articles on India's banking sector:

Why is India’s financial system less solvent than China’s

Fix Mexico’s banks, not China’s

Time of India: "India 12th wealthiest nation in 2005"???

Times of India: “India 12th wealthiest nation in 2005: World Bank”?  Also in the Hindu

Oh my god! India? Wealthiest nation?  Pankaj Mishra's op-ed "The myth of new India" published in the Hindustan Times makes some very good and sober comments on this type of media euphoria: "Mittal is as much an Indian success story as Sergey Brin, the Russian-born co-founder of Google, is proof of Russian's imminent economic superstardom."

A foreigner, if he never walks out of his Indian hotel and reads only Indian newspaper headlines, will certainly get an impression that Indian is the heaven.

Everyday, you are bombarded by headlines like “Asian Development Bank president: India to become a developed nation soon”,   “Indian banks beat Asian peers” “India to beat China in 10 years: BBC survey” (by the way it was actually a survey of Indians),  “No one has actually made any money in China” , so on and so forth.

Any rankings released by any small organizations, so long as India ranks better than Pakistan or China in one of the numerous components of the ranking system, will be highlighted on the same day on Indian newspapers.

The same is true for China, but never to such an extent. Many Chinese are proud of their country as the 4th largest economies in the world, not realizing that the “wealth” has to be divided by 1.3 billion fellow countrymen, and in an terribly unequal way. But I never see any Chinese newspaper headline that portraits China as one of the “richest” or “wealthiest” nations.

When you read Chinese newspapers, except the state media People’s Daily (which by the way cannot be found in most newspaper stands on the streets. i.e., no one buy it), I will say when it comes to economic news, there is not much difference between Chinese newspapers and Indian newspapers. This is not to say that Chinese media is in any sense free, but that Indian newspapers, at least when it comes to economic news, are as propagandist as Chinese ones. The difference is that: Chinese newspapers are forced to, while Indian newspapers choose to, to please readers.

There is a joke that goes like the following. China and India are the same although one has the strictest media censorship in the world while the other has free media. In Chinese newspapers, you always find a lot of articles about the need for reform and how many hidden dangers are ahead of the economy. In Indian newspapers, you will find the same thing: banking sector problems, pollutions, labor unrest......... in China though!

There are actually quite a few academic studies that try to find out the reason why media industry, even with perfect degree of freedom, will still purportedly propagate biased information. One of the reasons, as many researchers point out, is that readers believe only what they want to believe, and when the benefit of finding out the truth is much smaller than the cost, no one bother to find out.

I think it is quite true. If you cannot do anything about the poverty, why bother emphasizing it on a daily basis. The other day, I saw a BBC article, which highlights the number of Indians living under $1/day. A local Indian commented below the article that: “why do you throw out a number every several days about the poverty of India. We don’t need you to tell me that we are poor. We can see it everyday when we goes to work. We don’t need you to repeat it”

It's qutie true. After you spend you real life in a sweatshop, why don't you want to review your real tough life again when you go home to relax.

Deutsche Bank’s take of China, India, Brazil and Mexico: Reports

Below I put together a collection of country research reports produced by Deutsche Bank Research, on several important emerging economies. Let's see what are Deutsche Bank's take of Goldman Sachs's BRICs.

China 2020: challenges ahead (PDF file)
China should be able to achieve high growth for another decade, moving its GDP above that of most industrial countries. Challenges however include a fragile banking sector, rising unemployment, large government debt, and corruption within the one-party political system.

India rising: a medium-term perspective (PDF file)
GDP per capita will double in 2020. Favorable demographics, increasing investment in education and infrastructure and further integration with the world economy are the factors behind DB’s projections. IT-related services, textiles, and the auto-ancillary industry and pharmaceuticals are expected to gain dynamism given India’s comparative advantage.

Brazil: O pais do futuro? (PDF file)
Grow at an average of 3.3% year. Competing against China, Brazil is likely to maintain its position in niche high-tech sectors where it has a competitive advantage. Increased Chinese demand for commodities will provide Brazil with an opportunity to move up the value chain in commodity-related sectors.

Mexico 2020: Tequila sunrise (PDF file)
Geographic closeness to the US gives it an unique advantage. There is fair chance that Mexico’s industrial profile will make a successful transition from low value-added to more sophisticated products.

China or India, who’s got sweatshops?

China is known for its labor-intensive low-wage manufacturing. But according to Mercer Human Resource Consulting: software engineers, sales staff, financial analysts and factory workers all earn more in China than India.

AVERAGE ANNUAL PAY-CHINA (in British Sterling)
Project manager: £12,173
Software engineer: £6,998
Accountant: £4,677
Sales rep: £2,649
Production worker: £1,214

AVERAGE ANNUAL PAY-INDIA (in British Sterling)
Project manager: £5,220
Software engineer: £5,344
Accountant: £2,956
Sales rep: £2,464
Production worker: £964

According to a report in The Australian, in the newly-completed Toyota factory in Guangzhou, China, workers, 3500 of them, are paid about $2.70 an hour. Note that these are assembly-line workers, not IIT-educated genius.

Labor regulations never get you higher pay; Market foreces and your own skills do!

Liberalization of imports harms India?

Ashok Sharma in the Indian newspaper Financial Express argues that unilateral and unconditional lowering of tariff for sugar imports harm India

“... the institution of TRQ for sugar import is unilateral and unconditional. We have not in exchange negotiated for raising our low bound tariff rate of 45% on soyabean oil. The policy of unilateral and unconditional liberalisation of imports will weaken India’s negotiating position at WTO. It will endanger domestic production as had been the case with vegetable oil and oilseeds.”

If this were true, then why don’t India raise tariff to 1000% or close the economy completely from international trade then? This should be able to gain India formidable negotiating position at WTO, according to the theory of Mr. Sharma.

Sometimes, busting a myth requires just a little bit of counterfactual thought experiment.

India loses one-third of income tax to the U.S., because of brain drains

India has been suffering from loss of talents because of migration of highly-educated people to the U.S.  Several economics professors have put out a hard number to quantify part of the loss.

According to a study done by  Mihir A. Desai, Devesh Kapur and John McHale, the foregone income tax revenues associated with the Indian-born residents of the U.S. comprise one-third of current Indian individual income tax receipts.

This however only counts in  the fiscal cost, which is but a trivial component of the total loss India incurs. Had there engineers stayed in India and had they been able to make the best use out of their talents in India, India would have been a much more innovative and technologicaly-advanced country by now.  Certainly here we have to assume that the institutions and business enviroment in India could allow them to make the best use of their talents, which certainly is a very strong and unrealistic assumption.

The Fiscal Impact of High Skilled Emigration: Flows of Indians to the U.S. (PDF file)
Abstract: Easing immigration restrictions for the highly skilled in developed countries portend a future of increased human capital outflows from developing countries. The myriad consequences of these developments for developing countries include the direct loss of the fiscal contributions of these highly skilled individuals. This paper analyzes the fiscal impact of this loss of talent for a developing country by examining human capital flows from India to the U.S. The escalation of the emigration of highly skilled professionals from India to the U.S is examined by surveying evidence on the changing nature of the Indian-born in the U.S. during the 1990s. The loss of talent to India during the 1990s was dramatic and highly concentrated amongst the prime-age work force, the highly educated and high earners. In order to estimate the fiscal losses associated with these emigrants, this paper first estimates what these emigrants would have earned in India, and then integrates the resulting counterfactual distributions with details of the Indian fiscal system to estimate fiscal impacts. Two distinct methods to estimate the counterfactual earnings distributions are implemented: a translation of actual U.S. incomes in purchasing power parity terms and an income simulation based on a jointly estimated model of Indian earnings and participation in the workforce. The PPP methods indicate that the foregone income tax revenues associated with the Indian-born residents of the U.S. comprise one-third of current Indian individual income tax receipts. Depending on the method for estimating expenditures saved by the absence of these emigrants, the net fiscal loss associated with the U.S. Indian-born resident population ranges from 0.24% to 0.58% of Indian GDP in 2001.

Minimum wage, China vs India: is cheap labor the real answer for China’s success in manufacturing?

China has been said to be the World’s factory and cheap labor is said to be the reason why China attracts most of the manufacturing activities away from developed countries as well as from other developing countries.

Africa’s wage level is much lower than China, but they are never on the radar screen as threat to China’s position though. Nevertheless, let’s make a more relevant comparison between China and India.

India has a hard time in attracting manufacturing firms to move there. Many Indians attribute the “failure” to “that’s because we don’t have cheap labor; we focus on service industry with higher value-added”

Let’s compared the minimum wage of China and India to get a idea of who really has cheap labor.

Take China’s Guangdong province as an example. This province is where manufacturing activities agglomerate and where most immigrant workers from inland provinces are employed.

The hourly minimum wage in Guangdong province of China (Effectively July 2006- July 2007) :

Shenzhen (Special Economic Zone) and Guangzhou (two core cities, where manufacturing activities are moving out): 
4.66 Yuan/hour ( = 0.58 USD= 26.7 Rs.)

Shenzhen (outside SEZ), Foshan, Dongguan, Zhuhai, Huizhou, where most of the “sweat shops are actually located:
4.02 Yuan/Hour (=0.5 USD = 23.1 Rs.)

For India, I heard that the minimum wage is  between 7.5 -12.5 Rs./Hour.

(Please correct me if I am wrong; and if anyone can provide me with the minimum wage level, the actual enforcement, and the coverage of workforce,    in typical manufacturing-intensive regions in India, it would be most helpful for me to make a more representative  comparison)

So, minimum wage in China's manufacturing sector is between two to three times that of India!

You may argue that laws are never actually enforced in China. Well, indeed, complicated laws usually get circumvented in China. That’s why the most common violations of labor laws in China are, among others, paying normal wage for overtime work, insufficient safety and health work conditions, insufficient compensation for work-related injuries, no compensation for lay-offs...  These laws get circumvented because employers always managed to maneuver the vague language of the laws in favor of themselves. 

Minimum wage requirement however is in general complied by employers particularly in foreign-owned factories, because it is so easy for regulators to monitor and verify, particularly considering that most factories in the area are in the formal sector and not small workshops.

The most power force however is the market: today if you pay lower than the amount required by the minimum wage, I doubt you are able to recruit any skilled workers to work in Guangdong province, and most employers find it not worthwhile to go down the skill ladders. Labor cost after all constitutes only small fraction of the cost in typical factories producing electronic equipments and employers do not want risk having lower quality of disgruntled workers.  For details see my previous post in the Bulletin: “Unlimited labor supply in China? Not anymore! Wages are hiking!”

As a matter of fact, this is exactly why the minimum wage is set to the level where it is now, i.e. almost equal to market-clearing prices. The employers basically control the whole legislative process.

But still, the minimum wage level in Chinese “sweat shops” is much higher than in India where unions have bargaining power in the legislative process of labor laws.

Well, maybe the difference is not that high. First, living expenses in China is higher; second, Chinese workers in “sweat shops” typically have at least 9 years of education.

After all, it is the whole package: infrastructure, administrative efficiency, and education level of workers, flexibility of hiring and firing, etc. that are driving the location decisions of manufacturing firms

Update:

In a report by Deloitte and Touche "India and China: The Reality Beyond the Hype", it is cited that, according to IMF data, typical monthly wage for manufacturing workers in China is almost 4.7 times that in India. But I am not able to verify the number  it from the original source.  (Hat tip: PSD Blog)