If you see a Brahmin and a snake, kill the Brahmin first.
—Indian proverb
One generation plants the trees, and another gets the shade.
—Chinese proverb
This book is mainly concerned about the so-called advanced democratic countries, which are verging on sovereign default but really should not be.
But this chapter will deal with India and China, both of which now are so important for the world economy and present some interesting contrasts and similarities with the advanced countries.
Although as a group they have made amazing progress in achieving fiscal discipline in recent years, historically emerging-market countries have had to contend with poorly developed institutions and sometimes violent “birth histories” due to revolutions leading to their creation, which left debt and destruction in their wake. Default on sovereign debt and currencies that deteriorated to worthlessness have been common events with emerging-market countries. In historical analyses of the gold standard, economists have tended to classify emerging countries as “periphery” countries, unable to adhere to gold standard discipline. The implicit assumption more or less has been that emerging-market countries, because of their institutional weaknesses, violent histories, and low levels of per capita incomes, cannot be expected to act responsibly in matters of fiscal and monetary policy.
But India requires some discussion. Indian democracy has proved to be a very resilient institution that has been magnificent in many ways. The modern Republic of India has a birth history that was exceedingly violent and disruptive. In 1947, the departing British partitioned what was the Imperial “Raj India” into what are now three countries: India, Pakistan, and Bangladesh. The partition saw the loss of millions of lives and was quite arbitrary as to the division of lands. For example, what is now Pakistan was a core part of the British Raj India and the Moghul dynasties, which preceded the British.
With such an unhappy beginning, it is amazing that democracy has survived in India. But it’s not all good news. Unfortunately, Indian democracy has proved to be very susceptible to what I have termed the fatal attraction of populism. India is living proof that a country doesn’t have to be rich to be populist.
Chapter 1 spoke of how differences in abilities of various groups can create a major problem for democracies. The low-performing groups, if they have a sense of a separate identity and a history of grievances, will vote for government interventions that are perceived to benefit them rather than subject themselves to the competition of a free-market meritocracy where they believe they will be at a disadvantage. These low-performing groups prefer to try to advance themselves via the government and their elected representatives, rather than depending on the market. This situation constitutes a powerful force for populism particularly if the low-performing groups form a significant part of the population.
Whereas in homogeneous Japan this is a non-problem, in India this is a huge problem—perhaps a bigger one than that encountered in the United States. In India, the big problem is caste and to some extent religion. Although many Indian leaders have sought its abolition and in the cities and modern sectors it is becoming less important, the Indian caste system has been a fundamental part of the Hindu religion and culture. The caste system as it is practiced in India is quite complicated, with significant regional differences. The caste system goes back in millennia. Until recently anyway, it was endogamous (i.e., people did not intermarry out of their own caste). So a sense of caste separateness is a major fact in Indian sociological history.
Table 3.1 presents a simplified breakdown of India by caste and religion. Note that these are estimates and the exact numbers are a matter of controversy in India.
Table 3.1 Indian Caste and Religious Breakdown
Source: Census of India 2001, Wall Street Journal (December 29, 2007)
| Caste or Group | Percent of Population |
| Brahmin (historically priestly and top caste) | 4–5% |
| Other upper (higher) castes (warrior and merchant) | 20–22% |
| Others (Christians, Buddhists) | 9–10% |
| Muslims | 10–12% |
| Scheduled castes (Dalits and others) and scheduled tribes | 24.4% |
| Other “backward” classes | 28% |
As can be seen, the Brahmins and other upper castes make up a minority of Indians. Current emigration, effective discrimination in government against upper castes, and demographic trends will further reduce their percentages. Under the British, these upper or “higher” castes predominated in the Indian civil service. The Indian independence movement was led by then Brahmin-dominated Congress Party. Jawaharlal Nehru, India’s first prime minister, was a Brahmin whose family had its origins in Kashmir. Mahatma Gandhi, the preeminent leader of the Indian independence movement, was of the higher Gujarati merchant class.
Since independence, the world of caste has changed in India. While it is true in urban and modern industrial sectors that caste has been breaking down, it is a very powerful force in the political sphere. Indian democracy has made possible the political ascendancy of the lower-caste groups, including Dalits (formerly known as Untouchables), at the expense of higher-caste groups, particularly Brahmins. Notably in south India, Brahmins have been on the receiving end of reverse discrimination and in many cases have had to emigrate. Extensive quotas have been put in place favoring lower-caste groups in universities and for government jobs. Needless to say, everyone in India who is not in the higher castes wants preferential treatment. This would include India’s roughly 150 million Muslims.
What exists today in India is a government, both at the union (national) and state levels, that is increasingly run at least in the ostensible interests of lower castes and other disadvantaged groups. The private sector, on the other hand, has managements dominated by upper caste groups. Then there are the complications of regional politics and coalition national governments.
This is not a healthy situation. Strong populist pressures show themselves in the Indian budget. In India, the problem is not unfunded entitlements for old-age medical and retirement benefits, as in advanced countries. It is subsidies for basic necessities. Forget about retiring and Bismarkian old-age pensions. In still-poor India, it is the unfunded “here and now” and day-to-day survival that counts for a substantial portion of the overwhelmingly lower caste groups. The government, with an eye to the next national election, has introduced a plethora of subsidy programs estimated at some 2.4 percent of GDP and aimed largely (though not exclusively) at lower caste groups. Such terms as “right to work” and “right to food” have been incorporated into the Indian political lexicon. These subsidy programs come at the expense of infrastructure, education, and the private sector in general.
There is an old expression found in many cultures, “Better to teach a man to fish, rather than giving a man a fish.” The Indian government, contrary to this homespun advice, is giving away a lot of fish. In India, the inefficiencies and waste resulting from the democratic process are sometimes called the democracy tax. The tax is quite high.
A second point unrelated to caste. The American constitution contains strong protections for property rights. The American Declaration of Independence and the US Constitution were written in 1776 and 1787, respectively. Adam Smith’s Wealth of Nations was published in 1776. The same concepts of natural law and private property percolated on the American side of the Atlantic as in Britain. Of course, American property rights have been eroded over time by constitutional amendments and Supreme Court decisions, all derived from the populist pressures of democracy. But the starting concept of property rights still remains embedded in the American political psyche as a bulwark against populism.
But India’s constitution and political psyche is heavily influenced by Nehruvian socialism and the leftish 1930s London School of Economics, not Adam Smith. Regarding property rights, India has flip-flopped on this, with property rights by constitutional amendment being downgraded to legal versus fundamental.
India today is running a union budget deficit it estimates will come in at 5.9 percent of GDP. Throw in the states’ deficits and a much higher number emerges. India’s sovereign debt/GDP ratio (general government gross debt/GDP) is just below 70 percent (Table 3.2). But keep in mind that in this respect, India has one “advantage.” The bond markets due to India’s history aren’t going to finance a massive run-up in India’s debt. Unlike the United States and even as Greece was as a privileged member of the Eurozone, public-sector India is on a very short leash in the international markets. Unfortunately, the offset here is that India indulges in a great deal of financial repression. India’s banks, the bulk of which are government owned, are forced to overinvest in Indian government bonds. Similar policies exist in the insurance industry. A second offset, equally unfortunate in our opinion, is that India has been a favorite recipient of soft loans from the World Bank and other donors.
Table 3.2 A Quick Summary of Statistics for the Republic of India
Source: IMF, data for 2011
| General Government Gross Debt/GDP | 67.0% |
| Investment/GDP | 35.0% |
| Current account/GDP | −3.435% |
| GDP per capita (US dollars) | $1513 |
| Consumer price inflation | 8.858% |
| Unemployment rate | N/A |
| Official reserve assets | $290 million |
| Population | 1.206 billion |
Investors who visit India can be easily fooled. India’s larger companies are among the best run in the world. The information technology and pharmaceutical sectors are cases in point. Corporate governance standards are high, managements are world class, technologically savvy, and English is the working language, not just an ornament trotted out for foreigners. But these companies have to compete with a malevolent government.
The Indian rupee has seen a major decline in 2012. Somewhere in the next one to three years, India will have its own crisis. As this book went to press, the Indian government under Prime Minister Manmohan Singh had initiated a number of reforms which have certainly gotten the markets excited. If these reforms actually happen, perhaps I am being too pessimistic. We’ll see.
Excluding debt from the international associates like the World Bank, the bulk of Indian foreign debt is private rather than governmental. Despite a relatively comfortable foreign reserve position at the moment, if the crisis of 1991 is any guide, if another crisis happens India will simply run out of foreign reserves and the rupee will stay on its downward slope. Hopefully, then genuine big reforms will be enacted and some rollback of recently introduced welfare programs will occur.
It’s very simple. China is not a democracy in the sense the word is usually used. China does not have elections or rival political parties. The underlying populist urges in Chinese society—which certainly exist as in any other society—do not have the usual democratic channels to manifest themselves. Overall, we would conclude that China has not been put at risk of default by the excesses of populism.
Now hold it right there! Just because China’s lack of democracy has helped contain its excess populist urges doesn’t mean I am advocating an extreme authoritarian government. China has its own set of excesses, the result of what has been called the East Asian Model of economic development.
Investors, however, are going to have to understand China even if it is opaque, not a democracy. The Chinese economy, by some measures, is now the world’s second largest. Hard landing, soft landing, civil unrest, dominant economic superpower—the forecasts flow freely regarding China. The fact that good data is hard to come by regarding China does not seem to inhibit many outside observers. But you have to have a view.
My view is that China is not on the default sick list. But its torrid GDP growth rate of the recent past cannot continue, even if the rest of the world does well, which is unlikely. It’s not just the law of big numbers making last year’s numbers harder and harder to beat. The official target for real GDP growth in 2012 was 8 percent. Assuming the reported numbers are reasonably correct—and that’s a big assumption as will be discussed—8 percent is no longer regarded as feasible by most observers. The recent weaknesses in global nonagricultural commodity prices in part reflects a Chinese slowdown that is already underway.
There are two negatives hanging over China’s GDP growth. First is the flawed Chinese economic model. Following the state-directed, protectionist, export-driven East Asian model pioneered by Japan and influenced by China’s one-party state, China has been misallocating capital for years. Growth will slow down in future years and not go back to the faster earlier levels unless there are major economic reforms. China’s marginal productivity of capital has to decline. Capital cannot be wasted on the scale China has been so doing without the marginal productivity of capital declining. This slowdown due to declining productivity will be noticeable and permanent. This conclusion is reached based on the defects in China’s economic model and not on conditions in the rest of the world.
Second, export-oriented China has to contend with a Europe in deep recession, a United States close to recession, a Japan in stagnation and India near crisis. The Chinese model depends on exports and the 2012 global environment is not a friendly one for exports. Chinese economic results in 2012 will be a disappointment.
China’s core problem is its following the mercantilist East Asian model of both overemphasis on capital investment at the expense of consumption and overemphasis on exports via subsidies, an undervalued exchange rate, and significant protectionism. China’s banking system is a tool of the state, and at the direction of the state overlends to capital and real estate projects that are not commercially viable. China’s banks periodically require bailing out by the government. Parenthetically, it’s hard to see how investing in Chinese banks makes any sense at all.
The following should be kept in mind:
Now here’s an optimistic thought. The idea that China is about to disintegrate or be afflicted by serious public disorders is at variance with Chinese history. Yes, there are thousands of local protests each year. Yes, China has its share of dissidents. But take a look at Chinese history. Chinese history has a 2,500-year pattern of disorder, ascending dynasty (increasing order), dynastic peak, declining dynasty (increasing disorder), disorder. I would argue that China is in the Ascending Dynasty phase at the moment. I would argue, for example, that the Bo Xilai incident is basically noise—not much different in significance than John Edwards’s problem with his mistress.
Some might argue that the current Communist regime is not a dynasty in its pure feudal sense. But I would argue that the differences between the current Communist “dynasty” and prior dynasties are basically superficial. For example, the country remains centrally controlled, thought is tightly managed, and the thousand-year-old Imperial Examinations have simply been replaced by the Gao Kao college entrance exams.
Yes, succession is no longer hereditary—Hu Jintao’s son is not becoming the new emperor and, alas, the Communist emperor is not permitted at least in public a bevy of concubines. But even in the case of succession, the leaders are chosen from a select group where having the right parents counts. (The Qing emperors’ sartorial choice of resplendent yellow robes puts the current Communist emperors’ choice of attire to shame!)
The Chinese population has experienced more than two hundred years of war and turmoil that effectively only ended under Deng Xiaoping. This period of turmoil began with the White Lotus Rebellion in the 1790s, which resulted in millions of deaths and weakened the ruling Qing Dynasty. The White Lotus Rebellion was followed by the Taiping Rebellion (1850), disastrous wars with the British (1840,1860), and the Japanese (1894), fall of the Qing Dynasty (1911), invasion by the Japanese (1937–1945) and then the Chinese Civil War. Disorder only ended with the demise of the highly disruptive Cultural Revolution and the death of Mao in the 1970s.
Like the Germans, who still fear inflation because of the post–WWI experience with hyperinflation under the Weimar Republic, the Chinese people are tired of turmoil. Historically, China has alternated between periods of ascent and strong dynasties and periods of weakened dynasties and disintegration. China is in an ascent phase at this time. I regard books predicting the imminent collapse or disintegration of China as nonsense. The Chinese people do not want revolution and will put up with a lack of welfare benefits, as have been granted by the bankrupt advanced countries. The Chinese people want Louis Vuitton, Chanel, and the good life as they imagine it is lived in the West. (Come to think of it, in the sagging West a lot of people want the good life as the Chinese imagine it in the West.)
For the benefit of those unfamiliar with this, Table 3.3 is a simplified version of Chinese dynastic history. Note that the Qin and Sui Dynasties were short lived but were immediately replaced by another Chinese dynasty, not a period of disorder. The relatively shorter-lived Yuan Dynasty was one imposed on China by a foreign conqueror who did not fully “Sinicize” and was ultimately kicked out and replaced by the Chinese Ming Dynasty.
Table 3.3 Timeline of Chinese Dynasties
| Dynasty/Period | Dates | Number of Years |
| Qin Dynasty | 221 BC–206 BC | 15 |
| Han Dynasty | 206 BC–220 AD | 427 |
| Six Dynasty Period (Disorder) | 220–589 | 369 |
| Sui Dynasty | 581–618 | 38 |
| Tang Dynasty | 618–906 | 288 |
| Five Dynasty Period (Disorder) | 907–960 | 53 |
| Song Dynasty | 960–1279 | 319 |
| Yuan Dynasty | 1279–1368 | 89 |
| Ming Dynasty | 1368–1644 | 276 |
| Qing Dynasty | 1644–1911 | 267 |
| Republic Period (Disorder) | 1911–1949 | 38 |
| People’s Republic | 1949–present | 63 |
Note the long life of most of the dynasties. Four of them lasted longer than the entire lifespan of the American Republic, which began operations under its Constitution in 1789. The current Communist Dynasty is a relative youngster, having been in power for only 63 years. Certainly, China’s political system will evolve, but anyone predicting its early demise or disintegration is going against the record of Chinese history. To repeat: China is in the ascending period of a dynasty in which order increases.
Chinese data are, in many cases, totally unreliable. Let’s start with general government gross debt/GDP. The IMF data in Table 3.4 only presents a ratio on a gross basis for China. It is unclear why a net number is not given. As can be seen, the general government gross debt/GDP as reported by the IMF (Table 3.4) is very low at 25.8 percent. But another respected source, Eurostat, reports this ratio at 43 percent. There are so many unknowns with the Chinese sovereign debt ratio. One is the amount of borrowing by local government related entities, which are heavily indebted to the banks. Then there is the fact that China has some $3.3 trillion in foreign exchange reserves. Part of these are offset by borrowing by the central bank (PBOC) from commercial banks, which resulted from sterilization operations. China’s strong reserve position is largely the result of the huge trade surplus of prior years and the attempts to hold down the value of the currency by buying dollars. Chinese government debt has risen, not from populist entitlement programs, as in the West, but from borrowing to finance infrastructure and real estate. Most of this debt is owed domestically, not internationally. There are prophets of doom sounding the alarm that the Chinese sovereign debt situation is as bad as that of the West. I’m not one of these, but at the end of the day nobody can be completely sure. Still, with its huge foreign reserve position, China cannot, as some have done, be compared with Greece or Italy.
Table 3.4 A Quick Summary of Statistics for the People’s Republic of China
Sources: IMF, data for 2011, Reserves from newspaper accounts
| General Government Gross Debt/GDP | 25.8% |
| General Gov’t Expenditure/GDP | 22.6% |
| Investment/GDP | 48.3% |
| Current account/GDP | 2.8% |
| GDP per capita (US dollars) | $5,413 |
| Consumer price inflation | 5.4% |
| Unemployment rate | 4.1% |
| Foreign reserves (approx.) | $3.3 trillion |
| Population | 1.348 billion |
Let’s take a second number, GDP growth. Thanks to Wikileaks, it has become known that Chinese officials themselves have questioned the reliability of China’s GDP numbers. Provincial estimates of growth don’t add up to the national numbers. The national numbers are released quickly after each quarter ends and, unlike in the United States, are never revised. Even without political bias, the national numbers would seem to be highly inaccurate and unbelievable. Analysts will be watching statistics such as electricity consumption and cement output as well as global commodity prices.
Note
1. Amartya Sen, The Argumentative Indian: Writing on Indian History, Culture and Identity (New York: Farrar, Straus and Giroux, 2005).