Subir Gokarn is currently Chief Economist of CRISIL, India’s oldest and largest credit rating company. In that capacity, he heads the CRISIL Centre for Economic Research, based in New Delhi. He also oversees CRISIL’s portfolio of research businesses, which include an industry research unit and a corporate research unit. Prior to this position, he was Chief Economist and IFCI Chair in Industrial Development at the National Council of Applied Economic Research (NCAER), New Delhi (2000-02) and Associate Professor at the Indira Gandhi Institute of Development Research (IGIDR), Mumbai (1991-2000).
In this first of the two part series with Equitymaster, Mr. Gokarn talks about the current economic recovery, how sound is it? He also shared his views on agriculture and industrial sectors and whether this industrial recovery is for real.
In this second of the two part series (Read Part I), Mr. Gokarn shares his views on the services sector, foreign direct investment, his vision for the economy and according to him, whether India is Shining or not.
The third aspect is the services sector. How would you rate the performance of the services sector over the past few years? What factors would help the growth of services in the next five to ten years?
Mr. Gokarn: I think the two broad factors that explain the competitiveness of the Indian services sector, when I say competitiveness, I don’t just not mean internationally but also domestically. One factor or pattern that we have to watch very carefully is that when you look at growth from a historical perspective, the share of the industry in GDP has been the dominant sort of indicator for the rapid growth. And you have countries in East Asia and China where the share of industry has crossed the 40% mark at some point in their transition. And India has stagnated at around 25% to 28%. This is a serious deviation from historical pattern and it is of worry to me. I do not believe that we can achieve middle-income prosperity without industrial growth. I think we are somewhat different from the pattern of these countries because of our very large domestic market. And that’s where services have become significant.
What has happened is that our economic transformation, which is typically a pattern of agriculture to industry and then to services, we have bypassed industrial in terms of share of GDP. I think there are two drivers for that. Why industry lost out to services is firstly, on account of the tax burden. Industry is a quarter of GDP and they contribute upwards of more than 2/3rd of tax burden. That is a deterrent to competitiveness. And second are labour laws i.e. job security. Services do not have job security except for public sector banks and so on. And that has been critical to the recent growth of services. If we are thinking of revising industry in strategic sense, we have to think of reducing the tax skew from industry and spreading it across other sectors. Without the elimination of job security regulation, I do not think industry is going to benefit.
How is the employment scene keeping in mind the three broader aspects of the economy viz. agriculture, industry and services?
Mr. Gokarn: Exactly following what I just said about services, in sectors where you do not have job security regulations, you have massive employment growth. But that massive is of course on a relatively small base. You cannot sort of expect the service sector to absorb 300 to 400 m people. People who do not satisfy some conditions as far as education status and linguistic capabilities, services at the lower end like security services, courier services and things like that, they will employ anybody. There are no entry barriers there. But they provide no income mobility either. Security guard will presumably earn as much as the end of the life as he is earning when he joined. What difference does he make to the employer? There is no productivity improvement in this field.
I am not at all saying that jobs of this kind should not be encouraged. I rather have people having any job than no job. But from a development perspective, from a growth perspective, if you don’t have people in situations where productivity is increasing, which then gets is reflected in wage increase, you are not going to get development. So, this phenomenon is unique to manufacturing and this is why, rapidly growing countries historically, have been closely associated with rapidly growing manufacturing sectors. If the increase over the 30 to 40 years is 5% to 6% a year, in terms of productivity gains, you are moving from poverty to middle class i.e. the Korean and Taiwanese story. The service sector will either lock you into the bottom or will require very high skills. By high skills, I mean even say, English language skills is important here. So, 400 m people cannot be employed by call centres. It is inconceivable. Also, I am also looking at the protectionist sort of reaction from the US that ITES may not be a long-term sustainable model also. It is not going to die out but as an explosive engine, I am note sure it is going to last very long.
The RBI and the government have taken series of steps towards currency convertibility. In the mid 1990s, in some of your articles, you said that we are not yet ready. Do you think that now we as a country are ready for currency convertibility? What are the risks and benefits involved?
Mr. Gokarn: When I commented on this issue in response to the Tarapore committee report in 1997, I had said that we are not ready. I think my perception was based simply on the risk of rapid exit. When I commented on this issue in 2002 when the reserves were touching US$ 50 bn, I thought we were ready. I think two or three changes have happened in between this period. One is that, the inflow of dollars has now become a structurally sound inflow partly because of our service competitiveness. So, the risk that inflow will dry up suddenly, that risk is much lower than what it was before five years. Second is that, we have a sort of far more, not a complete or a ideal financial system, but a far more attractive financial system as far as domestic investors go. One fear from convertibility is that when domestic investors don’t have adequate investment options, they will take the money out as soon as the opportunity comes to them. That scenario I don’t see prevailing at this point. I think the domestic financial sector, with the entry of private insurance companies, you got a range of investment options, all kinds of flexibilities, all kinds of accessibility to financial services domestically is very very high. The structural change in the financial sector is also a critical factor.
The RBI has recently opened up overseas investment opportunities for investors. How do you view this for a retail investor?
Mr. Gokarn: It’s nice to have the feeling that anytime I want, I can go and invest upto US$ 25,000 of assets. It is too trivial a level to start to make the effort in sort of investigating investment options outside. Somebody has got to provide an aggregation. I am sure that the financial services sector will do this at some point, foreign dollar mutual funds or whatever it is. Unless that intermediary activity develops, no individual is going to take US$ 25,000, go out and look for investment options outside. It is happening. It will take some time.
What factors have hindered the flow of FDI into the country? What should the government do in this regard?
Mr. Gokarn: At a very fundamental level, we are constantly making a conceptual error in separating FDI from domestic investment. I can’t understand how anybody would expect FDI to come in, if domestic investment is not coming in. The investment climate is a problem, which is what I argued in my earlier statement. When domestic investors are not investing, how do you expect a foreigner to come in? The two are obviously, co-related to a great extent. If you have a healthy domestic investment climate, then you can say, ok, may be FDI is not coming in. We got to make some changes in the policy to make it more attractive. I think the problem is not on the FDI front. It is on the investment climate front.
In your view, ‘Is India Shining’?
Mr. Gokarn: I prefer not to get into these kinds of judgments. I am a part of the India Today Board of Economist. In the last meeting in January, the discussion was on the feel good factor. I think you got to look at the fundamentals. I think what is heartening to me, as I mentioned in the beginning also, is that this growth has not been one off. It is not just because of agricultural recovery. There are fundamental drivers to the industrial and services sector as well. These are to the credit of the government. These are the result of the policy initiatives or the changes the government has made. India is shining or not gets you into a debate on what’s right and what’s wrong. You can’t deny that there are lots of things that are wrong. There are lots of things that have not been addressed. But I would like to emphasise the strength of the underlying recovery that it is due to some strong fundamentals.
In the last five years, if one were to plot a graph of interest rate movement and fiscal deficit as a percentage of GDP, there seems to be a paradox. What is your view on the interest rate?
Mr. Gokarn: Well, interest rates, again one has to make a clear distinction between structural change and cyclical change. The transition from 1997-98 to 2004, there is a powerful structural change in the interest rate scenario. And that structural change, at the bottom, is the reduction in small savings rate. That was a clearly policy decision that the government took and implemented over a two to three year period bringing it down from 12% to 8%. That helped break the floor on interest rates. But associated with this is also the increasing intensity of competition and increasing efficiency in the financial services. At the same time, there isn’t lot of demand for funds either. The government has been able to borrow money relatively cheap. There has not been a ‘crowding out’ due to government borrowing because there isn’t much private demand for funds.
That scenario could well change very quickly. If the investment revival comes this year, I think looking ahead two years or so, you will start to see a clear tightening of interest rate. But the structural change is dominant and it certainly does not look like it is going back to the days of the late 1990s. I would see a movement fairly in a narrow band.
What is your vision for the Indian economy?
Mr. Gokarn: My vision? My vision for the Indian economy is that we must sort of learn from history, learn from international experience and remove all constraints to industrial growth. Without industrialization, we are not going to get the transformation that we want, out of agriculture, out of poverty and into predominantly a middle class society.
Your favorite books?
Mr. Gokarn: That’s a very difficult question to answer. I review a lot of books. I don’t read them in totality, I sort of pick up a few part that I am interested. I have been reviewing a lot of books for Business World and I have been concentrating on the Chinese economy.
I was particularly sort of moved by a book called “Zhu Rongji and The Tranformation of Modern China” by Laurence J. Brahm. He describes the Chinese transformation in terms of the mindset and the policy and so on through the using Zhu Rongji, recently stepped down as the premier. And it is a fascinating account of the sort of technocracy, if you want to call it that way. How practical policy is framed in China? There is no great sort of vision. At the end of the day, vision may be there but you know, that is not what is driving the process. It is simply finding a problem and coming out with a solution. It is slightly contrast to our approach, which is totally process-oriented. The consequences get a bit sidelined.
The other book is also on China. It is called “China and the WTO” by Supachai, the current Director General of WTO and Mark Clifford, the Asia Editor of the Business Week magazine. And what it describes is the internal process by which China communicated its decision to enter into the WTO with conditionalities. That again is a great example of turning constraints into opportunities.
The personalities that have influenced you the most?
Mr. Gokarn: You know, I never really thought of this. Let me name the five people I worked with in my career in the last 10 or 12 years. If I can sort of attribute any influence, it is to these people. And I hope that I have also influenced them in the process.
Kirit Parikh was the first. For eight years, I was at the Indira Gandhi Institute.
Then it was Rakesh Mohan. I have worked with a year and a half.
Sumar Beri, currently Director General of NCAER, who again have influenced me.
Mr. T. N. Ninan, the Editor of Business Standard. I have had a very long-standing relationship with Business Standard. I have been writing for them for about seven and a half years now. Since I moved to Delhi in 2000, I became a consulting editor with Business Standard, a sort of direct participating in their editorial process. So, I would say that has been an influential activity as far as my professional development.
And now, Mr. Ravi Mohan, who is now showing me the aspect on the business side. Till now, it has been academics and research for me.