Three Billion New Capitalists

I was reading through Clyde Prestowitz's "Three Billion New Capitalists - the Great shift of wealth and power to the east" that came in 2005. Like many of the books of the same era including the "World is Flat" it describes opportunities and challenges that is unfolding for America given the revolutionary changes that is occurring in India, China, Brazil & the East Europe-Russia. All these countries were warped in some kind of socio-communism till the late 1980's and (almost) everything came down with a thud with the fall of Berlin Wall. East Europe followed Germany into capitalism and USSR collapsed in 1991, India became almost bankrupt in 1991 and turned into a market economy partially due to the fact that its main export destination went down pinching foreign earning, China was forced to become a capitalist with a host of events including the Tiananmen square massacre in 1989 and Brazil became democratic with a new constitution in 1988. By now the concept of BRIC (Brazil, Russia, India, China) has become a cliché for international economists.

The globalization process started since the 15th century when Turks captured Constantinople in 1453 closing an important trade route for the West with India. So, starting with Portugal, European countries were sending their great expeditions towards India and unimaginable wealth was found in Asia, Africa & Americas accidentally. This process was accelerated with the industrial revolution and Renaissance and by early 20th century the strains of protectionism-mercantilism that came as a reaction for globalization almost destroyed the world with two great World Wars, along with producing diseases of socialism, fascism, Nazism, communism, Maoism & Fabian (India).

This time the challenges are much more than the earlier rounds of capitalism-globalization that occurred till 1980s. The players were relatively small Japan, West Europe along with the big boss - America together accounting for a population of half billion+. But, the challenges that are posed with the rise of three billion new capitalists (from India, China, Russia, Brazil, East Europe) poses totally different challenges. Of fundamental worry is the Export imbalances caused by curency manipulation by Asian countries that causing dollar to be artificially strong and posing threat to everyone in the system.

The book covers a lot of these aspects and the author puts his vast experience in government commissions and private executive boards to explain how each of these challenges unfold and how US can cope up with them. Some of the interesting observations made by the author are:

1. Linkages between various sectors of economy: A lot of macroeconomists believe economies to be working linearly and free market principles can stabilize systems in almost no-time. For example, you lose an industry to abroad due to productivity difference and this will help you to have cheaper product and eventually you currency will depreciate and cost of labor will go down and you will eventually get equal or better industry. But, a lot of cases such things don’t happen. The author gives an example of how US companies like Ampex lost VCR business to Japan, thereby US lost all the additional things like disk storage & recording etc. and Japan built its CCD industry with VCR revolution and this led to Digital Cameras. Thus, by losing one industry US lost a dozen industries.

2. Economies are ecosystems: While dealing with biological & physical systems we are sometimes so amazed and shocked how important certain minor linkages are. Destruction of certain animals/plants or loss of certain soil & water streams can break an entire system just like how faulty screws could potential bring down great machinery. While biologists and ecologists are starting to appreciate such crucial links, economists are late in the game. The author gives an example of Silicon Valley. It is not just a place of producing h/w & s/w. It is a region watered by the great brains of Stanford & Berkeley, powered by thousands of venture capitalists, lawyers, Research labs and corporations and each are important to other. The corporations need universities for talent and Universities need corps for funding, and both require capital from the VCs & investment bankers. You break one linkage and you collapse the whole system. Thus, US should be careful of what it moves offshore and should make a few industries national priorities just like how biologists designate few animals to be endangered.

3. Currency manipulation & Monetary policy: The world system has gotten to a point, where one part of the world (read: America) is mad consuming while a lot of rest of the world is mad saving. Both cannot continue forever. Over saving is as bad as over consumption like what the great depressions showed. Like fat accumulation in the body, a lot of regions including Japan & China have accumulated a massive reserve of dollars (running in trillions) and they have no sound plans for consuming them. The system is thus very precarious and small moves can bring the entire system to a thud. So, major savers should diversify their savings and move a lot of it for domestic consumption. Major economies like China should move their focus from export-centric to serving their huge domestic markets. Interesting suggestions he gave include bringing Japan into dollar zone (effectively ending currency manipulation) and work with Europe & IMF to bring alterative international currencies to reduce the burden on dollar.

4. Energy security: US is spoilt with a couple of decades of cheap oil that brought new beasts like SUVs into the market. This has put it an unsustainable situation of consumer of more than a quarter of world oil. By a combination of activities including support of energy efficient vehicles, tougher standards for SUVs and support for alternate energy sources like oil from shale, tar and ethanol should be pursued to totally eliminate the dependence on Middle east oil as world oil reserves are going to be extremely pressured with the rise of the three billion people.

5. Focus on Education: Due to the policies that centered on baby boomer generation, US education is in a state of deep shit. There was a time when people could land in life long good employment with a mediocre high school graduation and such laxity has removed focus on a rigorous schooling curriculum. Teachers are underpaid and hence of poor quality, and due to legal action discipline is not properly enforced. Thus US lags the rest of the world in student quality and this must be redressed.

6. End US hegemony: Many of policies of US including the Iraq war are not adding any more friends to the US and now it has been totally isolated. So, it should focus on strengthening international institutions like UN & EU to share its burden and consult with the rest of the world in greater actions. As US is slowly losing its economic superiority comparable changes in defense policy must be made, and defense allocations pruned.

However, I disagree with the some of the observations of the author including his undue fear of wage equalization. Eventually, there will be a wage equalization where US and the rest of the world will come closer. This is because US gotten to where it was, because the great countries of the world were sleeping then. India & China contributed to 75% of world GDP till 17th century and then due to external intervention were totally broke & poor. In the meantime wars weakened Europe, and US got a golden chance to rebuild the world and in the process built a legendary economy. There were more kids and very little old men and so everybody got great safety nets and high school students landed in great jobs. US consumed half of world's major resources with one-twentieth of the population. So, what it reached in early 1980's & 90's were peaks that, in my opinion, can never be reached ever. As other nations start waking up there will be a need for equitable distribution of resources and balancing act will continue. Eventually, US will become like rest of the world consuming what it deserves and that is the best that could be hoped for a nation with scarce history & no ancient culture though they can partially equalized by great entrepreneurial spirit of the 19th & 20th centuries.

But, the challenges that involve the spreading of resources among the old and new owners will be anything but painless and great powers must ensure a smooth transition to ensure the continuity of the world.

Inflation! Why should India care?

There are two people - one a 70 year old man seen the best of his life and in a hospital bed and another is a 18 year old healthy boy playing an aggressive soccer game. Now, a rise/drop of blood pressure for the former by even a few percentage requires immediate attention and intervention by the doctors. But, what about the latter? Should same yardsticks be applied? Should the doctors barge in the middle of the game, and medically intervene if the heart rate marginally increased above 70?

This is the game that is currently going on in India. The pundits at Reserve Bank of India (RBI), worry day-in day-out anxiously watching the inflation jumping around 6%. They have reasons to worry. They follow a lot of practices of the US Federal Reserve, Bank of Japan & European ECB that have set their main mandates as controlling inflation, and growth is a footnote for them. But, at some point those worriers at RBI should ask themselves - are the comparisons valid? Inflation control makes sense for Europe, Japan & US that have had their best times, whose people lead a comfortable life currently, whose growth rates are barely a few notches above ZERO, and small changes in this stable economic equilibrium can wreck people's life-long savings and bring financial disasters. In many sense, they are like the 70 year old man - survivability and maintaining status quo is the key.

But, what about India that has just started to grow. Majority of its people are poor, not many have too much of life-long bank savings to worry about losing a percentage due to inflation, and a lot of development is just waiting to happen. Simply, status quo and economic equilibrium is not an option. If it a'int grows, it dies. As simple as that. In this condition, with growth rates clocking in excess of 9% and bank interest rates above 8%, why does a 6% inflation bother anybody? And a lot of this 6% is due to global factors including global rise in prices of wheat, corn & dairy, along with sky-rocketing oil prices, commodities including metals and increase in transportation costs.

Second, this higher inflation coming after two years of unusually low inflation rates. Before that period, even double digit inflation was not unusual. Thus, another part of the game is a lower base to start out with.

Third, apart from global forces, a lot of inflation is due supply side forces - less availability of developed urban areas, rusty food production and full capacity utilization in industries. A healthy inflation rate can and will encourage more entrepreneurs to add capacity and build more production. Farmers will be eager to increase food production and property developers can wipe out scarcity in good urban development. An artificial intervention, puts water in all these positive developments and precludes natural development that should have happened.

Fourth, increase in interest rates have put enormous strain on government finances and non-plan expenditures have skyrocketed leaving little for capital & infrastructure expenditures and this will cause further damage to this fragile nation badly in need of development.

So, its too early for RBI to nose in and spoil the exciting game. Simply, its interventions are unwarranted and unnecessary - the 18 year old boy can take a bit more increase in heart rate and can enjoy the game. RBI is dealing with a healthily growing country, not some ageing nation.

Last but not the least, RBI is a tiny factor in the world game with gazillions of liquid money. When US Fed, ECB & BoJ are finding it extremely hard to rein in this flood, its preposturous for RBI to think of putting brakes on it. If you are pressing too hard on a wet soap, you know the consequences.

So, RBI should know its limitations, and carefully guide the game externally instead of its fiats to banks. Rollback the interst rates close to international levels and work with the government on producing proper development and consider sector-wise tightening of capital through well-guided regulations.