Crouching Tigers, Hidden Dragons (The huge challenges facing India and China)

kickok1975

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The economic momentum isn't unstoppable. China and India face huge obstacles to growth

Plenty of forces can still throw the Chinese and Indian economies far off course. The economic fundamentals of both nations, with their enormous populations of young workers and consumers, point to strong growth for decades under almost every forecast. But it is instructive to remember that financial crashes, coups, political strife, and plain bad management have derailed many other miracle economies from Southeast Asia to Latin America. And the same huge populations that can translate into economic power for China and India also could prove to be a double-edged sword if social, political, and environmental challenges are not deftly managed. Indeed, growth doesn't have to slow all that much to pose serious social problems. Both China and India need annual growth of at least 8% just to provide jobs for the tens of millions joining the workforce each year. Fear of worker unrest is a big reason Beijing has kept stoking its boom with massive lending and growth in the money supply, despite economists' warnings that it is setting the stage for a nasty bust. If India grows only 6.5% a year, which seems a respectable rate, its jobless rate would still jump, resulting in another 70 million unemployed by 2012, forecasts India's Planning Commission.


Slower growth also could keep China and India from fulfilling the widespread predictions that they will become superpowers. For example, in forecasting that India will rank just behind the U.S. as the world's No. 3 economy by mid-century, with a gross domestic product of $30 trillion, Goldman, Sachs & Co. (GS ) assumes 8.5% average annual growth. But what if India grows at less than 6%, its average for the past 20 years? By 2050, it would have only a $7.3 trillion economy -- smaller than Taiwan's even then and just 2.6% of global GDP, notes Stephen Howes, the World Bank's former chief India economist. Worse, India's masses would remain extremely poor. "If you don't grow fast enough, will you have social forces that bring everything to a stalemate?" asks Infosys Technologies Ltd. (INFY ) CEO Nandan M. Nilekani. "That's the worry."

To achieve the high growth predictions, China and India will have to overcome formidable challenges. Some of the biggest:

ENVIRONMENT
Both countries have paid a steep ecological price for rapid industrial and population growth, with millions of deaths attributed to air and water pollution each year. Air quality in big cities like New Delhi, Chongqing, and Bombay is among the world's worst. And forests are vanishing at alarming rates.

Enforcement of environmental laws in both nations is poor. Many power plants and factories depend on coal and don't invest in clean technologies. China is one of the world's most wasteful users of oil. If it does not act quickly, the long-term costs of health problems linked to the environment and the required cleanup will skyrocket. A growing scarcity of water in both nations could slow industry within two decades.

POLITICAL BACKLASH
China's Communist Party harshly represses dissent. But virtually each week brings new reports of big protests in cities and villages over corruption, pollution, or worker abuse. They underscore China's lack of democratic institutions and the widening gap between rich and poor. Serious challenges to Communist rule can still erupt, especially if the economy stalls. Judging from history, the process could be tumultuous.

India has a democracy, but it also has extremely unbalanced growth and rampant corruption. The surprise electoral defeat of the ruling Bharatiya Janata Party by a more populist coalition led by Sonia Gandhi's Congress Party in 2004 served as a warning of mass discontent. The new government also is reform-minded, but the pace of economic liberalization has slowed. Further electoral setbacks for reformers are possible if the poor don't see the benefits of growth. Tensions between Hindus and Muslims have eased after bloody riots in 2003 and 2004. But communal violence remains a threat.

FINANCIAL CRISIS
Debt and currency crises have derailed many high-flying emerging markets. India needed an International Monetary Fund bailout in 1991. China withstood the 1997 Asian financial crisis mainly because they lack convertible currencies. Also, Beijing controls the banks. Bailouts and the banks' near-monopoly over China's vast domestic savings have kept them solvent despite mountains of bad loans to state firms.

In 2006, however, Beijing will start letting foreign banks compete for deposits and domestic loans. That could put more financial pressure on state banks. China also is starting to loosen its currency controls a bit. China has plenty of foreign reserves now. But if Beijing can't whip its banks into shape, there's a danger that financial market liberalization will go wrong, leading to a crash. India's financial system is in stronger shape, but its public finances remain a mess, with budget deficits at the federal and state level reaching 10% of GDP.

HEALTH
Perhaps China's biggest worry over the long term is inadequate medical care for its rapidly aging population. In 20 years, China will have an estimated 300 million people age 60 or older. Yet only one in six Chinese workers now has a pension plan, and just 5% have guaranteed medical benefits. What's more, many retirees will not be able to rely on children for support. Beijing promises to build a broader safety net, but adequate health care and pensions could consume a huge portion of GDP and deplete China's economic strength in the future.

Both nations also could face full-blown crises with AIDS, tuberculosis, avian flu, and other infectious diseases, and their health systems have been slow to mobilize. At least 5 million Indian adults are infected with HIV, one of the world's highest rates outside sub-Saharan Africa. India's National Intelligence Council predicts the number could pass 20 million in 2010. The U.N. estimates the number of Chinese with HIV could hit 10 million in five years. Some 200,000 Chinese also die annually of TB. And a serious flu epidemic could kill millions. "Many investors don't appreciate the economic damage a serious outbreak would cause in our crowded cities," says Subroto Bagchi, chief operating officer of Bangalore info-tech services firm MindTree Consulting Ltd.

WAR
India and neighboring Pakistan have fought three times since their independence in 1947 -- and have had many border skirmishes over Kashmir. Now, both nations possess nuclear weapons, so a war could be catastrophic. New Delhi and Islamabad have recently eased tensions and begun peace talks. But the rise to power of a radical Islamic regime in Pakistan, or election of a stridently Hindu nationalist government in India, could easily reignite tensions. China's biggest flash point remains Taiwan. Beijing has cooled its fiery rhetoric lately, but still vows to invade should the island declare independence. Any war in the Taiwan Strait would likely involve the U.S. and possibly Japan -- China's two biggest trade partners -- and paralyze shipping in and out of China's southern ports. It also would likely result in long-term Sino-U.S. tensions that would spill into trade.

It's too much to expect for any developing nation to avoid military, financial, environmental, and health crises for decades. But the test for a great power is how well it manages a great crisis.
 

Ray

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Are wars good for the economy? What is the relationship between wartime spending and economic growth?

One of the more enduring myths in Western society is that wars are somehow good for the economy. Many people see a great deal of evidence to support this myth, after all World War II came directly after the Great Depression. This faulty belief stems from a misunderstanding of the economic way of thinking.

The standard "a war gives the economy a boost" argument goes as follows: Let's suppose that the economy is in the low end of the business cycle, so we're in a recession or just a period of low economic growth. The unemployment rate is high, people may be making less purchases than they were a year or two ago, and overall output is flat. But then the country decides to prepare for war! The government needs to equip its soldiers with the extra gear and munitions needed in order to win the war. Corporations win contracts to supply boots, and bombs and vehicles to the army. Many of these companies will have to hire extra workers in order to meet this increased production. If the preparations for war are large enough, large numbers of workers will be hired reducing the unemployment rate. Other workers may need to be hired to cover reservists in private sector jobs who get sent overseas. With the unemployment rate down we have more people spending again and people who had jobs before will be less worried about losing their job in the future so they'll spend more than they did. This extra spending will help the retail sector, who will need to hire extra employees causing unemployment to drop even further. A spiral of positive economic activity is created by the government preparing for war, if you believe the story. The flawed logic of the story is an example of something economists call The Broken Window Fallacy.

The Broken Window Fallacy is brilliantly illustrated in Henry Hazlitt's Economics in one Lesson. The book is still as useful today as it was when it was first published in 1946; I give it my highest recommendation. In it, Hazlitt gives the example of a vandal throwing a brick through a shopkeeper's window. The shopkeeper will have to purchase a new window from a glass shop for a sum of money, say $250. A crowd of people who see the broken window decide that the broken window may have positive benefits:

After all, if windows were never broken, what would happen to the glass business? Then, of course, the thing is endless. The glazier will have $250 more to spend with other merchants, and these in turn will have $250 to spend with still other merchants, and so ad infinitum. The smashed window will go on providing money and employment in ever-widening circles. The logical conclusion from all this would be ... that the little hoodlum who threw the brick, far from being a public menace, was a public benefactor. (p. 23 - Hazlitt)

The crowd is correct in realizing that the local glass shop will benefit from this act of vandalism. They have not considered, however, what the shopkeeper would have spent the $250 on something else if he did not have to replace the window. He might have been saving that money for a new set of golf clubs, but since he has now spent the money, he cannot and the golf shop has lost a sale. He might have used the money to purchase new equipment for his business, or to take a vacation, or to purchase new clothing. So the glass store's gain is another store's loss, so there hasn't been a net gain in economic activity. In fact, there has been a decline in the economy:

Instead of [the shopkeeper] having a window and $250, he now has merely a window. Or, as he was planning to buy the suit that very afternoon, instead of having both a window and a suit he must be content with the window or the suit. If we think of him as a part of the community, the community has lost a new suit that might otherwise have come into being, and is just that much poorer.

(p. 24 - Hazlitt) The Broken Window Fallacy is enduring because of the difficulty of seeing what the shopkeeper would have done. We can see the gain that goes to the glass shop. We can see the new pane of glass in the front of the store. However, we cannot see what the shopkeeper would have done with the money if he had been allowed to keep it, precisely because he wasn't allowed to keep it. We cannot see the set of golf clubs not purchased or the new suit foregone. Since the winners are easily identifiable and the losers not, it's easy to conclude that there are only winners and the economy as a whole is better off.

The faulty logic of the Broken Window Fallacy occurs all the time with arguments supporting government programs. A politician will claim that his new government program to provide winter coats to poor families has been a roaring success, because he can point to all the people who have coats who didn't have them before. It's likely that there will be several new stories on the coat program, and pictures of people wearing the coats will be on the 6 o'clock news. Since we see the benefits of the program, the politician will convince the public that his program was a huge success. Of course, what we do not see is the school lunch proposal that was never implemented to implement the coat program, or the decline in economic activity from the added taxes needed to pay for the coats.

In a real life example, scientist and environmental activist David Suzuki has often claimed that a corporation polluting a river adds to a country's GDP. If the river has become polluted, an expensive program will be required to clean up the river. Residents may choose to buy more expensive bottled water rather than cheaper tap water. Suzuki points to this new economic activity, which will raise GDP, and claim that the GDP has risen overall in the community although the quality of life surely has decreased. Dr. Suzuki, however, forgot to take into account all the decreases in GDP that will be caused by the water pollution precisely because the economic losers are far more difficult to identify than the economic winners. We do not know what the government or the taxpayers would have done with the money had they not needed to clean up the river. We know from the Broken Window Fallacy that there will be an overall decline in GDP, not a rise. One has to wonder if politicians and activists are arguing in good faith or if they realize the logical fallacies in their arguments but hope the voters will not.

Now on to the war.

From the Broken Window Fallacy it is quite easy to see why the war will not benefit the economy. The extra money spent on the war is money that will not be spent elsewhere. The war can be funded in a combination of three ways:

1. Increasing taxes
2. Decrease spending in other areas
3. Increasing the debt

Increasing taxes reduces consumer spending, which does not help the economy improve at all. Suppose we decrease government spending on social programs. Firstly we've lost the benefits those social programs provide. The recipients of those programs will now have less money to spend on other items, so the economy will decline as a whole. Increasing the debt means that we'll either have to decrease spending or increase taxes in the future; it's a way to delay the inevitable. Plus there's all those interest payments in the meantime.

If you're not convinced yet, imagine that instead of dropping bombs on Baghdad, the army was dropping refrigerators in the ocean. The army could get the refrigerators in one of two ways:

1. They could get every American to give them $50 to pay for the fridges.
2. The army could come to your house and take your fridge.

Does anyone seriously believe there would be an economic benefit to the first choice? You now have $50 less to spend on other goods and the price of fridges will likely increase due to the added demand. So you'd lose twice if you were planning on buying a new fridge. Sure the appliance manufacturers love it, and the army might have fun filling the Atlantic with Fridgidaires, but this would not outweigh the harm done to every American who is out $50 and all the stores that will experience a decline in sales due to the decline in consumer disposable income.

As far as the second one, do you think you'd feel wealthier if the army came and took your appliances away from you? The idea of the government coming in and taking your things may seem ridiculous, but it's not any different than increasing your taxes. At least under this plan you get to use the stuff for awhile, whereas with the extra taxes, you have to pay them before you have an opportunity to spend the money.

So in the short run the war will hurt the economy of the United States and their allies. It goes without saying that flattening most of Iraq to rubble will decimate the economy of that country. Hawks are hoping that by ridding Iraq of Saddam, a democratic pro-business leader can come in and improve the economy of that country in the long run. The economy of the United States could improve in the long run due to the war for a couple of reasons:

1. An increased supply of oil
Depending on who you ask, the war either has everything to do with Iraq's vast oil supplies, or absolutely nothing to do with it. All sides should agree that if a regime with better American relations were set up in Iraq, the supply of oil to the United States would increase. This will drive down the price of oil, as well as driving down the costs of companies that use oil as a factor of production which will certainly help economic growth.
2. Stability and Economic Growth in the Middle East If peace can somehow be established in the Middle East, the U.S. government might not have to spend as much money on the military as they do now. If the economies of the countries in the middle east become more stable and experience growth, this will give them more opportunities to trade with the United States, improving both the economies of those countries and the U.S.

Personally I do not see those factors outweighing the short term costs of the war in Iraq, but you can make a case for them. In the short term, however, the economy will decline due to the war as shown by the Broken Window Fallacy. Next time you hear someone discuss the economic benefits of the war, please tell them a little story about a windowbreaker and a shopkeeper.
This is food for thought.

A could know point since the above post mentioned war.
 

kickok1975

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This is food for thought.

A could know point since the above post mentioned war.
Unfortunately, Bush and his collegues didn't see this way. The current Obama administration recognizes such problem but facing mountain high resistance from interest group and Republican party (GOP) on any reform. US defense department could bankrupt America for years to come
 

Ray

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One bird in hand is worth two with Bush!
 

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