Monday 3 February 2014

Gurumurthy Kalyanaram - An Economic Growth Model for Kazakhstan: Lessons from Economic Experiments

Reproduced from Conference Proceedings in Honor of Professor Uraz Baymuratov, Kazakhstan in Fall 2010.

Introduction - Kazakhstan is a geographically large county with a small and a relatively homogeneous population.  The country is rich in natural resources, particularly oil.  As a new and independent society, Kazakhstan has designed an indigenous constitution and judiciary.  The country enjoys relative political stability.

This essay addresses two important questions:  What is an appropriate model of economic growth for Kazakhstan?  What can Kazakhstan learn from other economic experiments, particularly those of China and India benchmarked against the United States.

China has been growing at an impressive (average) annual growth rate of 10 percent, and India at about 6-7 percent.  The United States has been growing at an average rate of about 2.5 percent in the last 20 years or so.  Of course, the US remains the largest economy in the world at about $15 trillion.  China and India are at about $6.5 and $3 trillion respectively when adjusted for purchasing power parity.

Kazakhstan’s economy stands at about $160 trillion, but the per capita income is at about $11,000, a very high figure compared to China and India.  The high per capita income suggests potential higher disposable income with the consumers who can ignite the economy.  However, the size of market is relatively small given a relatively small population of 16 million.

In this essay, we discuss the experiences of China and India, and make appropriate benchmark comparisons to the United States.  We briefly discuss the four major elements of an economy.  We first discuss the structure of the economies and then the role of foreign direct investment (FDI).  We follow this up with a discussion on the need for social investment and building robust institutions, and the importance of poverty alleviation programs.  We close with brief prescriptive suggestions for an appropriate model of growth and development for Kazakhstan based on the lessons learned from the experiments in China, India and the United States.

The discussions in this essay are largely and sometimes directly obtained from earlier work by Kalyanaram (2009).

Structure of the Economy

The basic structure of most of the large economies with relatively high mass-prosperity is consumer driven.  Consumer spending/investment contributes to 70 percent of the economy in the United States, and about 20-25 percent of the contribution comes from capital investment, and substantially less than 10 percent come from trade.  Small and entrepreneurial businesses contribute more than 70 percent to the US economy.  Most of the western European economies (e.g. France, Germany, and UK) have similar economic structures.  However, the contribution of smaller and entrepreneurial businesses to the economy is not as high in western European economies as it is in the U.S.

In the last 15 years or so, India and China have taken to distinctly different approaches to growth.  India has relied more on small business and entrepreneurial ventures for its growth.  But China, though it has welcomed private capital, has relied more on large-scale enterprises.  In India, private sector and entrepreneurial efforts get almost 80 percent of all financial credits and loans, and in China the comparative figure is about 10 percent (Das 2006, Khanna 2007). India's recent economic success has come largely from newer industries, with a large component of intellectual capital and skills, such as the information technology industry and pharmaceutical research.  From India, a group of world-class companies (competitive global brands) such as Infosys in software, Ranbaxy in pharmaceuticals, Bajaj Auto in automobile components, and Tata in car innovation have emerged.  All or almost all these companies started as entrepreneurial efforts.  Out of Forbes 200 of the World’s best small companies in 2002, there were 13 Indian firms as compared to China’s four (Huang and Khanna 2003, Huang 2006).

Furthermore, India’s growth has been driven by domestic consumer consumption.  Consumer consumption accounts for about 64 percent of India’s GDP, compared to 42 percent for China [the comparative numbers are about 70 percent for United States, 58 percent for Europe, and 55 percent for Japan] (Das 2006).  Almost all the sustained prosperous societies – the United States, Western Europe, and Japan – are economies driven by consumer demand and consumption.  So, empirically, India appears to be in the right mix.

In summary, India’s growth is consumer-driven, while China’s is resource-driven.  India has adopted policies that stimulate consumer demand and foster entrepreneurship, and China has adopted policies that have encouraged resource-mobilization.

The paradox for China is how to transform a trade-oriented economy to a consumer-oriented economy to achieve mass prosperity.  There are many evident challenges to this transformation.

Role of Foreign Direct Investment

India has achieved its growth through a combination of improvement of skill sets, diversification of the economy, stimulation of consumer demand, entrepreneurship and competition.  China’s growth comes from domestic investment in new factories and equipments, which is about twice as high as in India, and foreign direct investment (FDI), which is almost ten times as high as in India.  China has adopted the model of investing resources to propel growth and India has adopted a model of efficiency and productivity to stimulate growth (Huang and Khanna 2003, Khanna 2007).

Empirical studies have shown that the relationship between economic growth and the amount of foreign direct investment (FDI) is ambiguous at best.  Foreign Direct Investments in primary sector appear tend to have a negative effect on growth but investments in manufacturing sector appears to be positive.  But the impact on the service sector is ambiguous (Alfaro 2003).  There are several macro-economic illustrations of the tenuous relationship between FDI and growth.  For example, Japan, Korea, Taiwan and others achieved remarkable growth with relatively low FDIs.  On the other hand, Brazil which was the darling of FDIs in 1960s stumbled.  In the 1980s, China received very little FDI, and yet the country grew faster and more virtuously than its later growth.

Thus FDI appears to be neither strongly correlated to nor be causative of the economic growth.  Generally, FDI is a result of growth.  In summary, China may have achieved substantial growth in 1990s and in the last decade through huge (but not so efficient) infusion and utilization of FDI.

Social Investments and Institutions

Social investments have to be prioritized in the total composition of all the investments.  Research shows that social investments have a statistically significant effect on growth and income but FDI does not have such an effect (Sen 1997, Alfaro 2003, Wu 2008).  China’s social investments such as investments in primary and secondary education have been consistently lower than India’s comparable investments.  So it appears that China’s well celebrated physical infrastructure investment may have come at the cost of other important social investments.  India has quietly and persistently improved its educational provisions, especially in rural areas (Khanna and Huang 2003).

While there are many flaws to the Indian educational system, there is a fair amount of autonomy and freedom and entrepreneurship in primary, secondary, and higher education. And this has increasingly created a more relevant and market-oriented education (be it teaching of English language or the content of the curriculum). For sustainable economic development, the quantity and quality of human capital will matter far more than those of physical capital. India seems to have adopted the right education policy, and China is also beginning to rethink its investment in primary and secondary, and rural education.

In addition to the democratization of its polity, and liberalization of its economy, the autonomy and democracy of India’s financial institutions and corporations make India an alluring investment destination.  The norms and regulations of the financial markets, and the enforcement and supervision by Securities Exchange Board of India of these regulations are credible, if not perfect.  They have made the Indian stock and bond markets transparent and investor-friendly (Swamy 2005). India’s stronger infrastructure in terms of far more efficient and transparent capital markets is enabling the growth of entrepreneurship and free enterprise (Huang 2006).

Empirical research (Khanna, Kogan and Palepu, 2006) now shows that each successful society develops its own set of governance institutions, standards and practices.  While there may some de jure similarity in standards, there is no de facto convergence.  India has evolved fairly robust and indigenous governance institutions and standards (e.g., dispute resolution bodies such as courts, recognition and protection of private and intellectual property rights, a well-developed private sector, and  a modestly better score on corruption and rule of law in World Bank’s governance indicators) over the last 50-60 years (Swamy 2005, Wolf 2006).  It may take China the next 30-40 years to develop its own institutions and standards (North and Thomas 1971, Swamy 2005).
 
Role of Poverty Alleviation Programs

While India has been consistent in liberalizing its economy in the last two decades, it has also kept its attention on the challenge of poverty.  Accordingly, India has designed and implemented poverty alleviation programs with varying degrees of success.  India’s focus on alleviating poverty as growth program is both effective and prudent given the large numbers -- over 300 million Indians live in poverty (The comparable number for China is about 100 million).  China, on the other hand, has focused more on top-down economic trickle down with aggressive tax rebates and other incentives to large firms. 
Per recent World Bank Reports (2007 and 2008), a 10 % reduction in poverty would both boost the growth rate by about 1% and increase the foreign direct investment by about 8%.  So for India to continue its impressive growth, one of the critical components of the strategy has to be poverty reduction programs that add assets to the society (Prahalad 2004, Sen 1997).  And this is where political pluralism has been so advantageous.  The relentless focus on the poor and disfranchised by various political parties particularly the Indian socialist and regional parties has been very beneficial for economic growth.   The balance that the Indian political and economic policy makers have achieved is now the recommended economic strategy by the recent World Bank Reports (2007, 2008).  This policy is a direct result of the wonderful pulls and pushes created by the political democracy.

Overall, political pluralism and democratic polity have proved to be excellent prescription for India’s economy (Huang 2008).  Sure there have been many false starts and erroneous policies but there have been no calamitous decisions.  The country has not gone through traumatic experiences of Latin America (where many economies collapsed because they followed market-economy without adequate supervisory mechanisms) or other parts of Asia (Asian currency crisis) or East European countries (inflation and stagnant growth). As Sen (2005) has observed, “India's long argumentative tradition and toleration of heterodoxy, going back thousands of years, has greatly helped in making democracy flourish with such ease.”  China does not have the benefits of political pluralism.
Some Prescriptive Suggestions for Kazakhstan.

So, what do we learn from the experiences of some the larger socio-political-economic experiments?

First, to achieve mass-prosperity the economy must be substantially consumer-driven.  This involves some important policy decisions.  The society and the government must encourage and support private and entrepreneurial efforts in high-value added areas such agriculture and food processing, bio-technology, genetic engineering, and nano-technology so that there is more disposable in the economy.  Simply put, Kazakhstan through its fiscal, monetary, and industrial policy must devise mechanisms to place more disposable income in the hands of consumers.

However, it is important to achieve a right balance between consumption spending and savings.  Future expansion of the economy which depends on capital accumulation and technological changes should not fall victim to a short-term consumption-oriented economy.
 
In order to become a large consumer-oriented society, Kazakhstan must also consider serious approaches to increasing the size of its economic market. Given the instability in the neighboring societies, a Union of the nature of European Union may be challenging.  Kazakhstan must, therefore, devise explicit mechanisms to encourage and liberalize its immigration policy much like what Australia has done.  Kazakhstan must invite and offer incentives for professionals to migrate to Kazakhstan.  In the recent past, Ireland has followed such a selectively liberal immigration policy which has redounded very favorably to its economic growth.  This will have the effect of not only increasing the size of the economic market but also building foundations for increased innovations and new ideas.  Recall that the United States, too, has welcome waves of immigrants over centuries, and benefitted from their energies, entrepreneurship, and new ideas.

Empirics show that foreign direct investment, while it is a useful catalyst, is not an efficient mechanism for growth and mass-prosperity.  Kazakhstan must encourage and support productive foreign direct investment but long-term prosperity is optimally accomplished through consumer-oriented economy.

Second, the government must invest huge resources in primary, secondary and tertiary education in science and math, and diffusion of English language.  The public spending on education, according to the most recent available data from World Bank is about 2.8% of GDP, compared to 3.2% of GDP and 5.7% of GDP in India and the United Stated.  Unfortunately, private spending on education in Kazakhstan is not large compare to developed countries. So, the future of education is heavily dependent on public spending.  Children, under the age of five, are most nimble in learning languages.  Therefore, the policy makers must encourage and subsidize very large numbers of accessible and inexpensive English-medium pre-school, primary, secondary, and tertiary schools. 
English language is critical because it is not only language of global communication, but also language of innovations, technology and markets.  For example, most software development for telecommunications, genome or nano- or bio-technology, in-silicone modeling and other high-valued added products and services is based in English language.  A natural facility in English language, and science and math are important for global integration, and technological innovation.  However, learning English in adult life does not generate that natural facility.

Third, poverty alleviation programs are important component of growth model.  According to World Bank, Kazakhstan managed to substantially reduce the poverty rate from about 35% in 1996 to about 15% in 2002. Kazakhstan must continue the serious poverty alleviation programs which add productive assets to the society.  Such programs not only reduce social disparities and tensions, but they also add to the size of the economic market by placing income in more number of people.

Finally, Kazakhstan must consider developing robust social, political and economic systems.  In this regard, Kazakhstan has made substantial progress in drafting and nurturing a constitution and a constitutional democracy.  Still a lot of work needs to be done on this area.  For example, Kazakhstan received a score of -0.78 out of possible 2.5 on rule of law (with more positive score indicating better rule of law) based on governance indicator developed by Kaufmann at al. (2009).  Independent and reliable dispute resolution mechanisms (e.g. arbitration and mediation) including judiciary must be developed so that both individuals and businesses have confidence in and platforms for fair adjudication of disputes.

The economy also requires robust and viable banking system.  The central bank must be independent and separate.  Predictable and prudent policy in giving loans and credits to small businesses and individual consumers is necessary to make the economy consumer-oriented.  In addition, there must be autonomous regulatory bodies to monitor the capital market so that there are no bad-faith activities that corrode the economic confidence.

Of course there are other important issues that are critical to Kazakhstan’s future development, but we have not been able to discuss them in this essay.  For example, Kazakhstan has its own specific social, cultural and geographic characteristics that are important to take into account.  Given a relatively small population, in would be of great interest for Kazakhstan to consider neighboring countries’ markets.  Empirical research shows that instability in neighboring countries has adverse affect on economic growth of a country (Murdoch and Sandler 2002, 2004).  Therefore, Kazakhstan’s active leadership role in regional cooperation and stability is also crucial. 

References

(1)  Alfaro, Laura (2003), “Foreign Direct Investment and Growth: Does the Sector Matter?”, Working paper, Harvard Business School, Boston, MA.
(2)  Das, Gurucharan (2006), “The India Model”, Foreign Affairs (July/August). 
(3)  Huang, Yasheng (2008), “The Next Asian Miracle”, Foreign Policy (July/August).
(4)  Huang, Yasheng (2006), "The microeconomic rise of India," Far Eastern Economic Review, March. 
(5)  Huang, Yasheng and Tarun Khanna (2003), “Can India Overtake China?”, Foreign Policy (July/August), pages 74-81.
(6)  http://data.worldbank.org/country/kazakhstan
(7)  http://data.worldbank.org
(8)  http://gurumurthykalyanaram.blogspot.com/
(9)  http://kalyanaram-gurumurthy.blogspot.com/
(10)  http://kalyanaramgurumurthy.wordpress.com/
(11)  Kalyanaram, Gurumurthy, “India’s economic growth and market potential: benchmarked against China,” Journal of Indian Business Research, Vol. 1, No.1, pp 57-65.
(12) Kaufmann, Daniel Aart Kraay and Massimo Mastruzzi (2009),  "Governance Matters VIII: Governance Indicators for 1996-2008", World Bank Policy Research June 2009.
(13)  Khanna, Tarun (2007), Billions of Entrepreneurs: How China and India Are Reshaping Their Futures – And Yours, Harvard Business School Press.
(14)  Khanna, Tarun, Joe Kogan and Krishna Palepu (2006), “Globalization and Similarities in Corporate Governance: A Cross-Country Analysis”, Review of Economics and Statistics (February), Vol. 88, No. 1, pages 69-90.
(15) Murdoch, James C. & Todd Sandler (2002),  Economic growth, civil wars, and spatial spillovers.  Journal of Conflict Resolution 46(1):  91–110.
(16) Murdoch, James C. & Todd Sandler (2004) Civil wars and economic growth:  Spatial spillovers.  American Journal of Political Science 48(1):  138–151.
(17)  North, Douglass C., and Robert Paul Thomas (1971), “An Economic Theory of the Growth of the Western World”, The Economic History Review, Volume 23, No. 1, pages 1-17.
(18)  Prahalad, C.K. (2004), The Fortune at the Bottom of the Pyramid: Eradicating Poverty through Profit, Wharton School Publishing.
(19)  Sen, Amartya (1997), “On Economic Inequality” Radcliffe Lectures.
(20) Sen, Amartya (2005), “The Argumentative Indian: Writings on Indian History, Culture and Identity”, Penguin Publishers.
(21)  Srinivasan, T.N. (2006), “India’s Economic Growth and Global Integration: Experience since Reforms and Future Challenges”, Jackson Hole Symposium presentation.
(22)  Swamy, Subramanian (2005), Financial Architecture and Economic Development in China and India published by Konark Publishers, New Delhi India.
(23) Wolf, Martin (2006) “What India Must do to Outpace China,” Financial Times, February 14.
(24) World Bank Report (2007), India: Strengthening Institutions for Sustainable Growth.
(25)  World Bank Report (2007), Unleashing India’s Innovation, edited by Mark A. Dutz.
(26)  World Bank Report (2008), The Growth Report: Strategies for Sustained Growth and Inclusive Development.
(27)  Wu, Yanrui (2008), “Comparing Regional Development in China and India”, Research Paper No. 2008/13, World Institute for Development Economics Research.

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