Thursday, April 10, 2008

The Rewards of Excess

Take the risks and build infrastructure; the benefits exceed costs

Shyam Ponappa / June 28, 2005

It is interesting but not obvious that despite the problems of collapse, the material benefits of an unbridled expansion tend to exceed what could have accrued from slower-paced, more responsible growth, because expansion provides its milestones as achievements.

Back in the 1980s, my colleagues and I used to watch slack-jawed as columns of Japanese tourists trooped through our magnificent, chocolate-coloured granite office tower in San Francisco that was named for Bank of America's headquarters. Japan loomed over the future the way this building dominated the cityscape, and seemed to be buying up all of America. Then the Japan story unravelled with the real estate bust.

From the Japanese perspective, it may have been a more difficult adjustment: after an economic slump for well over a decade, Japan does not seem to have quite such an ominous tread any more. But while Japan may seem less omnipotent, let us not ignore the most significant facts reflected in its well-heeled streets. For one thing, most people in Japan have enjoyed excellent living standards even while the economy has been in difficult straits for over a decade.

The graph below shows GDP per capita in constant 1995 US dollars for Japan, Germany, and the US. Clearly, the Japanese people have been doing very well materially, even compared with the other major economies.

If this is what a collapse is about, is it something to be wished for, even engineered?! More seriously, my purpose is not to gloss over Japan's problems nor, more to the point, our own, so much as to draw the attention of those who gloat about how badly the Japanese economy is doing, to the fact that day-to-day living there is at a level that is hard to imagine for the beleaguered residents of India's major cities. There is no room for this kind of smugness. What a long way up we have to go to get to where they have fallen to! Likewise, the sceptics harping on the empty buildings in Shanghai and Beijing are missing the point that it will take our people decades to enjoy the material comforts that many of China's people do today, much of which results from the process of building that capacity.

South-east Asia too went bust eight years ago, and is supposedly limping along. This may be true when judged by certain measures. But if you stop in Thailand for instance, whether in Bangkok, at one of its beach resorts (except where the tsunami hit), or up in the hills near Chiang Mai, the level of comfort manifest in the living standards of even the not-so-wealthy is palpably better than for many of the reasonably affluent residents of India. As in Japan, Thailand reflects the South-east Asian experience, where people have had much better material comforts than in the previous decade despite the effects of a bust.

Building more hurts less than building less

It is interesting but not obvious that despite the problems of collapse, the material benefits of an unbridled expansion tend to exceed what could have accrued from slower-paced, more responsible growth, because expansion provides its milestones as achievements. This counter-intuitive finding is in “Crises and Growth: A Re-Evaluation,” a working paper for the National Bureau of Economic Research by Romain Rancière, Aaron Tornell, and Frank Westermann ( The study, reported in a number of publications including The Economist of December 11, 2003, gives the example of India and Thailand, citing how the stable credit policies in India between 1980 and 2001 led to a doubling of GDP per head (100 percent), while in Thailand, despite the recession induced by the crisis of 1997, the increase was almost 150 per cent. So, the most important lesson for us is that, as The Economist put it, an occasional crisis may be a price worth paying for faster growth.

Policy implications

The implications for our policy are that we would benefit from a conscious decision to (a) keep money inexpensive (as we now seem to be doing), and
(b) foster capacity building and risk taking.

These two taken together—capacity building and risk taking—imply encouraging projects that have reasonable odds of success in an objective evaluation, or in other words, basically sound projects.
We need not go overboard and court disaster by encouraging bad investments or weak financial institutions, or follow irresponsible monetary or fiscal policies. What we must do, however, is to focus on building capacity in infrastructure ahead of demand, not capacity that lags behind our needs from the start, as has happened thus far.

This requires a new set of ground rules and practices that we must develop and put in place that recognise the reality of capital flows: expensive if you are desperate, difficult to find if you behave unpredictably, simply out of reach if you abrogate contracts.
We need to cultivate the practice of relying on contractual obligations (the rule of law), and there needs to be support from a rationalised “policy framework” that we must, as it were, fashion from whole cloth: laws, procedures, and clearances in each sector that work easily and inexpensively together to produce the results sought, unless something is wrong.

An example of leading capacity is the Dabhol project: many argued that it was too much electricity at too high a price. The project was derailed for political reasons, instead of fixing our distribution policies and laws, so that more electricity could be sold more cheaply to more buyers in more places, rather than being constrained by archaic laws and procedures and unrealistic administered prices.
Now, we have a situation of acute power shortages in Maharashtra with average tariffs of Rs 5.50 per unit cited by FICCI. This is much higher than the level that led to the controversy over Dabhol in the first place. There are many who continue to stall efforts to restart this project with the misguided reasoning that taxpayers will have to bear the brunt. They need only stop to consider:

- what the costs already are,

- what the additional costs would be of not restarting it, and

- who bears the costs today.

An example of rationalisation in a sector would be an integrated approach to transportation, instead of the fragmented set of separate aims and activities for airlines, railways, roads, and shipping; another example could be integrating energy, power, and fuels. Difficult, but possible; and more important, necessary.

The reason these attributes are especially pertinent to us is that, whether by default or design, national economies follow a trajectory, and we have been decidedly risk-averse. This approach would be contrary to our conservative, cautious approach so far, and more in line with the aggressive, systematic, risk-seeking approach of Japan and China, Thailand, and Malaysia.

In the words of Rancière et al. in “Systematic Crises and Growth,” CESifo Working Paper No. 1451, April 2005 (, “weak institutions lead to severe financial constraints and low growth. Financial liberalisation policies that facilitate risk-taking increase leverage and investment. This leads to higher growth, but also to a greater incidence of crises. Conditions are established under which the costs of crises are outweighed by the benefits of higher growth”.

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