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Why Economic Growth Cannot Be Created on an Excel Sheet

Nov 27, 2018

Vivek Kaul

Earlier this month I was a part of a discussion at the Tata Literature Live. During the course of the discussion, one of my co-panelists started talking about the age- old India growth story.

And the argument offered went something like this (and I am paraphrasing here): "India is currently a $2.6 trillion economy. It will continue to grow nominally at 12% per year. Assuming a 3-4% depreciation of the rupee against the dollar, and a growth rate of 8% [12% minus 4%], India will be a $10 trillion economy in less than two decades."

Even before my co-panelist finished speaking, I found myself saying: "only if life was as simple as an excel sheet".

First, let's try and understand, the $10 trillion-dollar argument. As per the World Bank data, India's gross domestic product(GDP) in current prices in 2017 was around $2.6 trillion. GDP in current prices (or nominal GDP) does not take inflation into account.

The GDP in current prices in 2017, in rupee terms, was Rs 167.73 lakh crore. Assuming $1 was worth around Rs 64.5 during the course of 2017, the Indian GDP in dollar terms works out to $2.6 trillion.

Let's say if one dollar was worth Rs 67 during the course of 2017. What would have happened then? In that case, the Indian GDP would have been around $2.5 trillion instead of $2.6 trillion, as it actually was.

The point being that if the value of the rupee falls against the dollar, the growth in Indian GDP shrinks in dollar terms. Over the long-term, the Indian rupee has been losing value against the dollar, which is why my co-panelist assumed a 3-4% depreciation of the rupee against the dollar. This brought down the growth rate of Indian GDP in nominal terms in dollars to around 8%.

Now at a growth rate of 8%, the nominal GDP of India in dollar terms will cross $10 trillion in 18 years. At the end of 18 years, it will be around $10.4 trillion.

In theory all this sounds very good. It is as simple as dragging the cells on an excel sheet and coming up with the right answer. But real life, as I said, is not as simple as an excel sheet. There are various countries at various points of time, which have been expected to grow at a very fast pace. But they haven't. An excellent example of this is Iran.

As the American economist Tyler Cowen writes in his new book Stubborn Attachments: A Vision for a Society of Free, Prosperous, and Responsible Individuals: "The Shah of Iran, for instance, tried to bring his country into the modern age very rapidly. Growth rates were high for a while but in the longer run could not be maintained. Since the Iranian Revolution, Iran's economy has backslid."

And Iran is not the only example of this phenomenon. As Ruchir Sharma writes in The Rise and Fall of Nations: Ten Rules of Change in the Post-Crisis World: "The most accurate records go back to 1950 for 150 countries, and they show 43 cases of superfast growth, in which the economy grew at an average annual rate of 7 percent or more for a full decade... It also includes many vanishing acts that grew superfast one decade only to disappear the next, including Venezuela, which vanished in the 1960s, Iran in the 1970s, and Syria and Iraq in the 1980s."

In fact, Sharma makes a similar point in another book titled Breakout Nations: In Pursuit of the Next Economic Miracles: "During the 1950s and the 1960s the biggest emerging markets - China and India - were struggling to grow at all. Nations like Iran, Iraq, and Yemen put together long strings of strong growth, but those strings came to a halt with the outbreak of war...In the 1960s, the Philippines, Sri Lanka, and Burma were billed as the next East Asian tigers, only to see their growth falter badly."

The one thing that the history of economic growth teaches us is that economic growth over the long-term should never be taken for granted. This is something that Indian fund managers, who are in the game of being perpetually bullish don't seem to get. History doesn't support their argument, even though excel does.

The other point that needs to be made here is that the countries that were supposed to do well, but did not, are much smaller in size than India is. This basically makes things even more difficult for India.

As Sharma writes: "Very few nations achieve long-term rapid growth. My own research shows that over the course of any given decade since 1950, only one-third of emerging markets have been able to grow at an annual rate of 5% or more. Less than one-fourth have kept that pace up for two decades, and one tenth for three decades. Just six countries (Malaysia, Singapore, South Korea, Taiwan, Thailand, and Hong Kong) have maintained the rate of growth for four decades, and two (South Korea and Taiwan) have done so for five decades."

While, as Indians, we want India to grow at a fast pace and pull out millions out of poverty and offer them a good life, one cannot ignore history in the process. It's good to be optimistic but not at the cost of being realistic.

This is not to say that India does not need to grow at a fast pace. It does, simply because over a long term, even a small difference in the rate of growth can make a huge difference in the overall well-being of a nation.

As Cowen writes: "Looking into the more distant future makes the question of the economic growth rate all the more important. For instance, a two percent rate of economic growth, as opposed to a one percent rate, makes only a small difference across the time horizon of a single year. But as time passes, the higher growth rate eventually brings about a very large boost to well-being. To make this concrete, here's an experiment: redo U.S. history, but assume the country's economy had grown one percentage point less each year between 1870 and 1990. In that scenario, the United States of 1990 would be no richer than the Mexico of 1990."

An extreme example of the same, as Cowen writes, is something like this: "At a growth rate of ten percent per annum, as has been common in China, real per capita income doubles about once every seven years. At a much lower growth rate of one percent, such an improvement takes about sixty-nine years."

That's the power of compounding.

While, we should hope and work towards this power of compounding helping India, let's not like fund managers do, assume it all the time, at least not over a period of decades, because history doesn't really go with that assumption.

Regards,

Vivek Kaul
Vivek Kaul
Editor, Vivek Kaul Publishing

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Vivek Kaul is the Editor of the Diary. He is the author of the Easy Money trilogy. The books were bestsellers on Amazon. His latest book is India's Big Government - The Intrusive State and How It is Hurting Us.

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1 Responses to "Why Economic Growth Cannot Be Created on an Excel Sheet"

S K LIMAYE

Nov 29, 2018

Waiting for your article on GDP vs GDP !

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