Restatements

“A lie can travel half way around the world while the truth is putting on its shoes.” ― Mark Twain

In today’s hyper media world, news creates its own “mirage of reality”. The challenge is understanding the historical, cultural and technological aspects that underlie the behaviour and continuously reinforce this reality.

We continuously see in the media that we may see the end of American military and economic dominance very soon. This is extremely unlikely any time in the next half a century if not more. It is the most economically vibrant open economy having one of the best demographics in the developed world with a culture of immigrations. Despite the extreme budget stresses, it faces, it is within its power to manage those by altering the social security, healthcare and other benefits it has committed to its people. For example, it can simply change the retirement age. The current election season may seem to suggest that practically everything has broken down in America but that is the resilience of the structure. Imagine the Chinese or Russians having such a noisy debate without tearing the system apart. The constitution gives the President great latitude internationally but his domestic agenda is subjected to approvals of the Congress and the Senate. The system is designed for creeping changes with consensus almost similar to the drag the Indian system imposes. See how much time the GST took to get this far. The notion that all hell will break loose if either candidate get elected is extreme. Obama wanted to end the Afghanistan and Iraq wars much sooner, but could he? Dollar denominated funding remains the core of the global economic system. This works beautifully as persistent current account deficits and deep finance markets in New York keep the global system well supplied with dollars. The USD has continued to decline with these persistent deficits except for 2 intermittent periods. The first rally in the early 1980s driven by Volcker interest rate regime causing the Latam crises, the second was in the mid-1990s when the Asian Financial Crises played out. Both these crises were caused by over-dependence on foreign capital. We are in the 3^rd leg of the dollar uptick with global economies not having recovered yet. Where this will cause a crisis is anyone’s guess? American’s spend over US$600bn on the military more than 4 times the next kid on the block with a completely dominant position on the hemisphere it occupies allowing it massive global displacement power maintaining over 700 bases, with the ability to effect balance of power at any point on the globe. Thucydides made two amazing observations in his book 2,400 years ago, “Your empire is like a tyranny: it may have been wrong to take it; it is extremely dangerous to let it go.” The transition between empires is typically marked by wars. But, however, it is it will be surely less suffocating than the absolutism that would mark a Chinese or a Russian empire. The second observation was, “In other ways, too, the Athenians were no longer as popular as they used to be: they bore more than their share of actual fighting, but this made it all easier for them to force back into alliance any state that wanted to leave it.” The Americans have been involved in every major war across the globe since the 20^th century or have started it. Think the last time the Chinese or the Japanese fought a war, new technologies and postures are only developed during that period. The Saudi’s despite the massive spend on expensive equipment are fighting a war in Yemen and proxy war in multiple other Middle Eastern states and they are being tested to the point which got a senior US official to comment that they are afraid of committing their troops unlike the Iranians for the fear of a significant defeat and its impact on the Royal family. Taiwan is 90 miles from China but the Chinese fear changing the status quo and not because of Taiwan I am sure! At some point all empires decline but now is not that time for America…

In December, 2014 I had written, “China is likely next year to follow with its own depreciation given the impact of lower yen on competitiveness, a sharply declining factory production and increasing real rates.” I had then written an article in August 2015 on China’s economy (http://poleconomyindia.blogspot.in/2015/08/china-everything-overdone.html). Since then the capital outflows have accelerated, the credit cycle has added an estimated US$4.5 trillion (yes the number is right) more than US, Europe and Japan combined in the last 12 months. This expansion continues to finance almost US$5trillion in investment every year in industry and real estate even while it seeks to shut excess capacity in industries like steel. Who will put any capacity anywhere else? Maybe the Chinese authorities are adding 100m urban units in the quest to house all of us also in China!! This credit expansion is already feeding into crazy house prices and accelerating car sales. A UBS report showed the ratio of house prices to household disposable income in first-tier cities had risen to 18 to 20 times from 14.7 times at the end of 2015. "This puts China's tier-1 cities' affordability close to Hong Kong and more expensive than London," the report said. Beijing is looking at the household sector to up leverage backed by real estate to help the corporate sector deleverage, down payments for property have been cut to 20% from 30% in June. Mortgages were up 71% in July and August. Home prices have risen ~28% in Beijing, 33% in Shanghai, 37% in Xiamen and 47% in Hefei in the last year. This happens at a time when US$ continues to rise against the yuan at almost the same pace as the nominal growth keeping GDP trapped at the same levels. As the Fed threatens to raise rates, the yuan weakness will only intensify and one is seeing a surge in Chinese purchases internationally which they are increasingly facing more opposition including American real estate (a trend very similar to Japan in the late 1980s). Excess capacity and continued depreciation of the yuan complicates the global picture, where countries are seeking inflation to reduce the debt burdens. While the economic picture plays out, Xi is consolidating power to rival that of Mao. Such consolidation of power is a sign of weakness and the scale of challenge China faces. From adverse demographics, pollution (https://en.wikipedia.org/wiki/Pollution_in_China#Pollution_statistics), economic health, an increasingly more hostile external environment and a more suspicious suffocating internal politics. Any rapid decline in economic well-being will threaten the legitimacy of the communist party and that is what is causing this ever-precarious balancing like an engineering project unlike a natural healing process that a democracy can adopt. The Soviet Union and Japan both tried to manage this centrally and failed but the communist party knows know other way.

I will not cover the other three significant geographies (Middle East, Russia and Europe) which I have written over the last year which face almost an “End of their known World” kind of situation:

• Middle East (http://poleconomyindia.blogspot.in/2015/10/1979-and-middle-east.html). This spasm which began almost post 9/11 may take over a decade as the three-way fight between Saudi Arabia, Iran and Turkey establishes a new balance;
• Europe (http://poleconomyindia.blogspot.in/2015/04/european-gauge.html);
• Destabilization of Eurasia’s four principal areas – Middle East, China, Russia and the European Union (http://poleconomyindia.blogspot.in/2016/04/power-shortage.html).

In India, the BJP is seeking to revive the ancient glory of the Mauryan dynasty that spread to Iran, Hindu Kush mountains, present day Bangladesh to the southern extremities that ended in present day Andhra Pradesh and Karnataka, not as much in terms of occupying those lands but in terms of dominant influence. This had been the inspiration for Sardar Patel as he sought to unite the various princely states. The Dravidian kingdom have always been elusive for Indian empires until the British. The initial phase post-independence the Congress, as it took over from the British, ruled the state of Tamil Nadu until 1969 when a Dravidian party came to power as the old cultural and historical lines came to the fore and since then no national party has ruled the state. India as we know is a land of extremely diverse cultures and languages united by the geographical enclosure of the Himalayas and ocean of all other sides. It could almost mimic the many cultures and nationalities enclosed in the European peninsula. The national integration of India is project that is work-in-progress and the election of national party to the seat of Tamil Nadu will be an important marker in this project – the day when the populace there believes that a national party can represent their voice. In March 2014, I had stated that, ”India's geography creates the sense of 'self-containment' leads it to exist with itself but we are no longer in 1,000 BC, we are part of the global economic system and technological advances have reduced the physical space in both the economic and militarily dimension.” The current government by the bent of ideology and facing the multiple pressure points of demography and geopolitics is seeking to reshape the geopolitical destiny as Curzon, British Viceroy of India, saw it, "The central position of India, its magnificent resources, its teeming multitude of men, its great trading harbors,... all these assets are of precious value. On the West, India must exert a dominant influence over the destinies of Persia and Afghanistan; on the north it can veto any rival in Tibet; on the north-east it can exert pressure on China, and it is the guardians of the autonomous existence of Siam (Thailand)." I will not comment on the Indian economy which I have written in my previous article (http://poleconomyindia.blogspot.in/2016/04/power-shortage.html).

We are witnessing a rapid aging of the society in the next 25 years across the world. While the current method of measuring dependency restricts is below 15 years plus above 64 divided by those in between or the working age. One can argue that people, given, can medical advances work beyond 64 but so do people start working much later these days almost in their mid-20s. So I will continue to use this method. The remarkable aging will create over-supply in many areas like housing, sports equipment or kid clothing but short supply in labour, military personal and nursing staff. It will also cause an automatic deleveraging of the financial system as people draw down on their savings and do not take consumption loans. This is also one of the reasons why central banking policies are not as effective as in the past. As one can see below, the Germans and the Chinese will see the most dramatic impact play out.

Dependency Ratio by Country	2015	2040	Change
China	37.4	59.1	58%
Germany	52.2	77.7	49%
Japan	63.1	81.2	29%
Russia	42.5	53.8	27%
France	58.1	70.2	21%
UK	54.7	65.8	20%
US	52.5	62.5	19%
Mexico	51.6	51.0	-1%
India	51.8	46.4	-10%

 

The US continues to consume (-$460bn) and the German (+$286bn) and Chinese (+$348bn) continue to export. The oversized role on both sides of the scale continues. But at some point, the impact on American industry and labour will play out, as it is doing now in American elections. At some point, the Chinese gaining competitiveness via devaluation to the rising cost internally will become an issue with other developing countries, although that point maybe some more time away. And, at some point the German export engine just becomes too overbearing not only to the Americans but also to the Euro Area, which has happened quite some time back and Brexit and constant disillusionment of the European voters with mainstream parties is all part of this continuing situation. This is the core point (China and Germany maintain employment at the cost of other countries) leading to rising protectionism across the globe.  

The fourth industrial revolution is coming. This will see the convergence of many technologies which have the ability to change the face of many industries. Internet of Things, Artificial Intelligence, 3D Printing, use of Big Data, nanotechnology and space based technologies will change the way we live to the way of war. Group of Head of Innovation at HSBC stated, “It is possible to imagine multiple ways in which IoT can enhance banking – for example, wearables could provide biometric authentication, payments can be embedded within household items and geo-targeted offers could expand into a more personalized service while providing more security.” DARPA, US defense research government outfit, (same that invented ARPANET the basis for future internet) is already working on space based solar technologies to power battlefield units like tanks and laser weapons held by soldiers or potentially developing space based precision guided projectiles. Not only the cycle time of the change be much shorter that we have witnessed before, given the globalized (telecom, MNCs, news…) world, we will witness much more rapid deployment.

The more these changes threaten the past rhythm of our daily lives, the more we shall look for inner forces to stabilize ourselves…

And, finally global leadership will be tested like never in this period of great upheaval. In December 2013 I had pointed out, “The ability of true leadership is to negotiate the constraints put by the system. There will be compromises and promises broken but states are not given firm direction by idealists but by realists and great leader is one who is a realist led by ideals.”

“Accidents happen. Our bones shatter, our skin splits, our hearts break. We burn, we drown, We Stay Alive.” ― Moïra Fowley-Doyle, The Accident Season

India – Future Fast Forward

“Life can only be understood backwards; but it must be lived forwards.” ― Søren Kierkegaard

The Indian economy when the bricks of the regulatory wall started being brought down one by one in 1990s altered trend growth to a measly 3.9% over the next decade. It is only from 2000 with the significant increase in capital expenditure on factories and infrastructure did the growth levels change dramatically to 13.6%. This was aided in great measure by a benign environment globally till 2008. But then not only the world turned bad but the corruption in natural resource allocations destroyed business confidence and impacted the banking sectors’ ability to create new credit. While capex dipped below levels seen in the 1990-2000 period the household sector driven by new aspirations continued to spend although the pace was impacted by the slow-down in rate of income creation.

In Current US$	1990	2000	2010	2015	Gr 1990- 2000	Gr 2000 – 2010	Gr 2010 – 2015
GDP	327	477	1,708	2,074	3.9%	13.6%	3.9%
Gross Capital Formation (% of GDP)	24.9%	24.1%	36.5%	35.0%	3.5%	18.4%	3.1%
Adjusted National Per Capita Income	322	390	1,177	1,420	1.9%	11.7%	3.8%
Household Final Consumption Expenditure (% of GDP)	68.0%	64.6%	56.0%	58.0%	3.3%	12.0%	4.7%

Source: World Bank

Our view of the future is usually a linear extrapolation of the past. For example, if GDP were to grow at 5-7% over the next 10 years the following outcomes are reasonably certain:

• Our GDP would be $3.4 – 4.0 trillion, 4^th largest in the world after US, China and Japan. We would be a third of China today and lower than even Japan which had 25 years of zero-growth!!;


• We would likely be the 3^rd or 4^th largest consumer market in the world with per capita income in the $2,500 range substantially below Western European or US levels of $40,000+;


• The redistribution of income driven by this growth would result in a bulging middle-class – shown by the “Seekers” in the chart below:

	Income Levels (Rs)	2015	2025
Deprived	<0.09 million	35%	22%
Aspirers	0.09-0.2 million	43%	36%
Seekers	0.2-0.5 million	19%	32%
Strivers	0.5-1.0 million	1%	9%
Globals	>1.0 million	1%	2%

Source: Mckinsey

But the future is an uneven path with potentially surprising outcomes -  no one in the mid-19^th century imagined America emerging as the foremost economic power in the world and everyone in the early 1980s thought that Japan will become the largest economic power, and till a few years back most people thought China will take over the world.

China (which swung the other way into state-pumped manufacturing and infrastructure build) is seeking to rebalance its economy with consumption to GDP moving from 36% of GDP to say at least 50% to reduce reliance on investments and exports and get this to levels closer in the developed countries like US, Japan, Germany or UK which are in excess of 50%. At current level it is company of countries like Saudi Arabia, Algeria Iraq or small countries like Singapore. Also, it wants to continue to grow rapidly at 7% to continue to provide employment opportunities as for centralised government a young angry population would be threaten stability, especially a single party regime. This would imply consumption growth in excess of 10% but investment and credit which is inordinately high proportion of GDP continues to grow at 4% and 10% plus respectively. This is an impossible equation over ten years with credit to GDP already at 260% and very low productivity of incremental capex spend. A good rebalancing means GDP growth below 3% with consumption growing at ~5% and investment growing below zero. But this means negotiating the multiple vested interests built over last 30 years which create their own uncertainties. (http://poleconomyindia.blogspot.in/2015/08/china-everything-overdone.html)

Coming to India - there are many imponderables in the linear extrapolation theory as it negotiates the next 10 years:

• It is given the substantial global over-capacity across industries and the shape of our banking sector, low investment growth is baked in over the next few years. The pace of investment growth may recover to high single digits later part of the decade as these issues get resolved. Plus, given the low level of capital formation in India, any buildout of factory or roads or ports drives productivity improvements. But in another scenario, if the government is able to lift the infrastructure related investments or even get large scale investments in defence related platforms to India (i.e. shifting F-16s manufacturing to India), it can potentially improve growth trend by ~2% for the horizon. This can change GDP outcome by almost $1 trillion.


• While the projections of the super-normal growth of the Indian middle class sound promising - it is unlikely in this age of technology we will see such a massive re-distribution of income over a such a short horizon. The advent of robotics (with a combination of our complex labour laws) could reduce employment across segments – automatic harvesters in agriculture, precision arms in manufacturing or robots for customer service at a bank. Further, technology creates significant winners for successful ideas, look at Facebook, Apple, Google or Uber. The other implication of this is potential unrest which consequently results in a political response in income redistribution plans which could hold back growth potential. The more positive implication of continued population growth (even China turns negative by somewhere around the early 2020s with significantly aged population) would be India providing a qualified labour force to a world of declining population. But nonetheless a larger middle class would mean greater pressure on governance – October 2013 I had said, “The citizens are demanding better services (infrastructure, policing etc) and higher accountability of the elected officials / bureaucracy. This can be only met by more decentralized but accountable system otherwise the edges will fray.”


• We will surely have a very large consumption base:
• Our taste patterns while currently less homogenous will become more homogenous as population is more mobile providing scale in individual market segments like food and clothing;


• Education, Health and Consumer Durables will see great demand but innovation will drive down costs leading to widespread adoption. For example, MOOCs or their participants may replicate content on a global scale and thereby reducing the pricing of content. Consumer durables may reduce cost by transferring all the functionality onto a wearable or a mobile;


• Ecommerce on which billions have already been spent by angels and VCs will need to innovate on their business models to produce profitability. A viable product pricing will continue to be high as customer acquisition cost (at least Rs.250), logistics (at least Rs.80 including returns) and overhead (say Rs.30) means Rs.360 has to be recovered at optimized business model levels. If the product is sold at a commission of 20%, average ticket sold needs to in the Rs. 2,500 range for new businesses. For the likes of Amazon, of course break-evens are much lower. This makes the lower end of the market inaccessible and most business models will be created to tap into “Seekers”, “Strivers” and “Globals” which comprise only 20% of the population today. Models where delivery is based on the internet like tax services or travel advice or movie tickets the break-even pricing will be much lower allowing them to access a deeper market;


• Consumption of financial services will increase but with massive competition and therefore pricing compression from tech disruptors, which traditional players will be forced follow. Given the convergence of financial needs, as businesses get access to financial intelligence they will cross-sell - insurance to mutual funds to foreign exchange to bank deposits to payments.
• The linear model also assumes that the current economies will retain their place and there will be no event that unravels any of the economies including India getting into a potential war with Pakistan. Pakistan and China, despite their internal weakness, realise that India is going through a phase of defence build-up which once completed in the next 5-7 years will make adventurism much more difficult (i.e. multiple missile programs, new forward bases in Arunachal Pradesh, acquisition of new age aircrafts and UAVs, naval carrier development). Then again India may in 2019 elect a motley government. I had written in April this year (http://poleconomyindia.blogspot.in/2016/04/power-shortage.html) how practically all of the principal areas of Eurasia – fragmentation in Middle East, economic and political crises in Europe, multiple challenges for (oil price, dependence on Putin and rapid population decline) Russia and stresses on the economic model of China - are in the phase of destabilization. For example, it is very likely that the EU will face a break-up or become a much reduced body in the next 8-10 years or the Chinese economy may go into recession as the rebalancing program unhinges under the weight of global slowdown and banking crises. It is very difficult to chart the implication of these “non-linear” events on the growth of India - impact will be deep but finally relative equations are all that matter.

Having said this, GDP growth is simply a function of population and productivity. That India will continue to see population growth 1+% is a certainty. We have a very low stock of capital investments (infrastructure, education, healthcare) and consequently investments will have meaningful impact on productivity is again certain. India will continue to grow at a fairly high rate in a struggling world – our growth is very attractive with an ability to pay reasonably for capital in world drowning in negative rates. Looking at it another way, India a 7% growth results in global GDP expanding by $140bn which the entire EU with $16trn GDP base is struggling to do!! However, higher levels of coupling and connectivity also mean easy transmission of global issues to India. Finally, in an always uncertain world, velocity (speed and direction) of change and evaluation of risk are the only two elements that matter.

Beyond what is at play

Beyond the current elements at play for India what is crucial is putting in place a legal and enforcement architecture:

• Land laws – the point at which it should reach is man in a city buying a piece and being able to build a house without the myriad of laws and requiring bribes to be paid. Industry or state being able to procure land to build infrastructure or factories;


• Labour laws allowing free hiring with protection for labour against exploitation, fair wages and pension;


• Build the bankruptcy architecture and enable banks to take quick decisions to enable the free hand of market forces take over;


• Allow private education with a regulator to boot;


• Build water transport related infrastructure and rules – it is much cheaper always to use sea transport versus land;


• Independent enforcement by agencies like police, anti-corruption bureau or the Central Bureau of Investigation;


• Courts architecture expanded to enable quick dispensation of justice.

These measures can expand growth potential while allowing a growing population an infrastructure to remedy their grievances.

And, there is hope in the new generation which has the courage to experiment and do new things. There is beyond the well-publicized e-commerce related start-ups, there is technological innovation in the areas of product / hardware (defence, nano-tech or new age chemicals) and business services which has the potential to revolutionize select industry verticals.

To be hopeful in bad times is not just foolishly romantic. It is based on the fact that human history is a history not only of cruelty, but also of compassion, sacrifice, courage, kindness. What we choose to emphasize in this complex history will determine our lives. If we see only the worst, it destroys our capacity to do something. If we remember those times and places -- and there are so many -- where people have behaved magnificently, this gives us the energy to act, and at least the possibility of sending this spinning top of a world in a different direction. And if we do act, in however small a way, we don’t have to wait for some grand utopian future. The future is an infinite succession of presents, and to live now as we think human beings should live, in defiance of all that is bad around us, is itself a marvellous victory. - Howard Zinn