I, Dipankan

Long-Run Macroeconomic Growth over Short-Term High Growth: An Analysis

The economic policy of any country is often an essential parameter to judge the advancement of the State. A good economic policy often concentrates its attention on the attainment of macroeconomic stability, which in due time bears consequential reaps for the nation as a whole. On the contrary, a myopic policy can be effectively described as one which intends to leverage temporal factors in the world economy and/or domestic circumstances to bring about growth, which can lead to fracture marks on the economy after the boom is busted. Thus, economic growth must be both sustainable and stable at the same time.

Any kind of economic growth entails an increase in the market value of goods. Long run growth, however, is the sustained growth of such an increase in value of goods and services that an economy produces over a considerable period of time. Such long run growth depends on a number of factors. Foremost among such indexes are an increase in general productivity, demographic changes, and labour force participation. For example, when productivity increases, the cost of the product comes down, and thus demand goes up, generating higher revenue. Demographics is very important as it is what determines the available resources at hand. A country with a younger populace and high birth rate should do reasonably well in the long run than a country with an ageing workforce and low birth rates. Likewise, discovery of a precious natural resource, say crude oil in abundance, can open up gates of prosperity for any nation. Lastly, the labour force participation is representative of the strength of the work force available to the economy in order to keep its cogwheels running.

The causes for a short-term high growth rate are aplenty. It may be due to a surge in productivity due to external factors, or it may be due to an increase in the overall production in certain sectors (say, agricultural increase in output with sufficient and adequate rainfall). Causes for such growth can even be internal- upcoming national elections, or even a bullish trend in the markets. Such phases are characteristically marked with high rates of loan-giving and availability of credit in the markets, which is wonderfully coined as irrational exuberance. However, despite providing an immediate impetus to the economy, short-term growth spells are mostly taxing on the economy in the long term. As these spells of excessively high growth rates cease, the economy enters into a phase of mild recession- and it certainly takes time to recapitulate and restore itself to pre-boom scenarios. Furthermore, a country dependent on such a variant of growth is held hostage by external circumstances- which are in most cases, beyond control. Thus, such growth is not sustainable and therefore, they must not be the focus of the country’s economic policy. It is essential to remember that while such short term high growth periods may seem luring at first glance, it is ultimately the long-run growth that shall determine the country’s position in the global spectrum.

The Nobel Prize for Economic Sciences, 2018, was conferred to Nordhaus and Paul for their contributions in the development of a theory of sustainable growth and long-run stability. This was an important step in the endeavour to realise an inclusive macro policy to be adopted in order to secure a bright future in this ever-changing world of the twenty-first century. Macroeconomic stability is an essential component of sustainable growth. It acts as a buffer against countless swings of the global economy, negating any impact of crises in some other part of the highly interlinked world today. Developing economies have often experienced far greater macroeconomic instabilities than their industrial counterparts. Policy makers can foster stable macroeconomic policies either directly or indirectly. They can either opt to remove destabilizing policies themselves, which serve as sources of internal shocks- or indirectly, by using policies in response to exogenous developments- thus bettering the stability of crucial outcome variables.

This stability goes hand-in-hand with sustainability- effective measures must be implemented only after a proper computation of all associated aftermaths involved. When it comes to India, we are already being tied down by external shocks from time to time- most prominent of which are the oil shocks. Additionally, the threat of a global trade war is on the radar- and hence we need to secure the Indian interests as early as possible. A lot of positives are on our end. We have a population that is still young, ready to replace the retired. By easing FDI norms, we are attracting investments from all over the world. There is however, a lot more way to cover if we are to sustain this kind of growth over the future.

A fantastic case to understand the consequences of high short-term growth can be a study on India from 2004 to 2008. India witnessed an abnormally large growth rate, exceeding 8.8% a year for these four years. This reflected the outcome of a global economic boom on which India catapulted its growth. However, a lot many of domestic factors can be attributed to the phase as well. This high growth was preceded by liberalization of the Indian economy post the 1991 balance crisis, in which significant steps were taken to make the economy open up to the world. A careful look reveals that India rode on the usual buoyancy in the global economy and easy global liquidity, leading to growth acceleration across all sectors and components that constituted the national GDP. However, the period of high growth from 2004-08 proved to be a major headache in upcoming years for most Public Sector Banks (PSBs). Exuberant bank credit growth during this period led to high balance sheet stress. Raghuram Rajan, who was the 23rd Governor of the Reserve Bank of India, even blamed this exuberance for the excessive increase in Non-Performing Assets (NPAs), which is a cause of worry for the banking sector now. Immediately after this period of high growth, the global recession also impacted the Indian economy- thus snatching away any opportunity to capitalise on the accelerated growth rates during the past four years prior to the Global Financial Crisis.

As a contrast, India’s long term growth has been impressive. Despite variations in the long term growth rate, the average growth over any decade has consistently grown, and has not gone into the red for a single time. Economic growth has also stabilised itself- partly due to growth rates stabilising itself within each sector, and partly because India is shifting towards the services sector, which generally ropes in a stable growth rate along with it. It is thus pertinent now to spend money on much-needed public investment, while reducing misdirected subsidies and unsolicited entitlements at the same time.

Sustaining a growth rate higher than the present 7.5%, in excess of 8%, would require effective structural reforms, contributions from all domestic sectors, and support from the global economy. Achieving this would require a well-planned reform effort that maintains the reform momentum and expands its scope, and succeeds in decisively reversing the slowdown in investment, availability of credit, and exports. Additionally, India must begin to spend heavily in promoting the research culture. All major developed economies today have voluminous research output every year. In comparison, we fare poorly: we have learned more to duplicate than to innovate. The celebrated economist Paul Romer, who won the Nobel this year credited new and implementable ideas as essential driving forces for the economy. Once growth is made more inclusive, and a target is set to enhance the performance and efficiency of the Indian public sector, sustainable growth can be reasonably expected. Thus, if we can maintain and build on this stability, India would venture steps towards being an economic prowess soon.


The Economics of Sustainable Growth

The names of the winners for the 2018 Nobel award for Economics have been announced. The Sveriges Riksbank Prize in Economic Sciences in memory of Alfred Nobel was divided equally between William D. Nordhaus and Paul Romer, both of American descent, for their contributions in integrating climate-change and technological analysis with long-run macroeconomic analysis. While Nordhaus studied the impact of climate change on macroeconomic variables, his counterpart Romer’s domain of research comprised of the growth in the economy with technological innovations over time. The fact that the Nobel was awarded to Nordhaus and Romer together intends to drive home a strong message: that we need growth, and that such growth must be sustainable.

While economic growth is always appreciable, it will soon cease or run into negative rates unless the growth is sustainable. What we mean by sustainable here is the ability to maintain the growth rate at a constant level over a good period of time. A sustainable market economy has to be competitive, well-governed, green, inclusive and integrated. However, market failures may very well be a part of the quest to attain a sustainable growth. The risk of market crash due to unregulated markets is very much a threat today. Such unregulated sectors often function erratically; degrade the environment and typically tend towards monopolistic power. The thirst for such a grip on power results in an attitude which excludes the basal segments of the society from their idea of economic progression. Thus, laws have been framed to correct such faulty market behavior that may crop up.

William Nordhaus, one of the recipients of the treasured Nobel, has been a pioneer of what can be termed “green accounting”– which is, simply put, a method to approximately estimate the amount of environmental damage when measuring economic growth. It was based on his presentation of the economic model that measuring the economic costs of climate change was made possible. Nordhaus developed the DICE and RICE models to understand the economics of the vagaries of climate change. The Dynamic Integrated Climate-Economy model (DICE) is an effective computer algorithm that aggregates multiple factors including carbon cycle, climate science and other dependencies to predict how viable steps taken to slow greenhouse warming would be. Today, when concerns about climate change and its ramifications are widely being debated, his contributions have swept the world with unforeseeable impact. It is his work that underpins the policy framework of the United Nations Intergovernmental Panel on Climate Change which released its new report just a day before the announcement of the Nobel Prizes in Economics- nothing short of a beautiful co-incidence.

Paul Romer, on the other hand, has made key contributions for sustained economic growth, basing his ideas on the importance of innovation. He makes it explicitly clear that physical capital constitutes only about one-third of the variation in income per capita across countries. The failure of the Soviet Union was a perfect example backing his claim; the Soviets went all out on investing in infrastructure, and yet could not realise the desired growth. The other two-thirds have their origins in a concept that economists refer to as total factor productivity. Romer has developed a theory of economic growth with endogenous technological change — that is, growth can depend on population growth and capital accumulation, instead on the unilateral investment on public infrastructure. In contrast, Robert Solow, who formulated the Solow model (or the neo-classical theory of growth) believed that productivity was exogenous to capital inputs. His endogenous growth theory integrates the development of newfangled ideas to the number of people working in the knowledge sector (say, for example, in research and development). These new ideas make the regular agents of manufacturing more productive – conveniently put, ideas enrich the total factor productivity. His theory is significant for more reasons than one. Those who innovate new technology may not always be able to latch onto the returns that the technology brings, while benefitting the economy as a whole. Hence, there may not be enough incentives to innovate. Romer’s endogenous growth theory has helped formalize the analysis of a number of relevant public policies such as promotion of investment in human capital, supporting research and development projects, and designing and enforcing intellectual property rights- hence providing enough incentives for the innovators to come forward with their ideas.

Nordhaus’s and Romer’s theories and contributions are important steps towards understanding the recipe for a sustainable growth-driven economy. The foundations of each of their propositions, that of impact of climate changes on the economy, and the importance of technology generated growth, has certainly opened up new avenues that can be further explored in detail. Both these models provide for sustainable growth, which is what the world precisely needs to adopt in order to permit emerging markets to make significant strides en-route to becoming developed economies.