Financial Instability – Is it actually instable!!? -article by Raka De (2nd prize winner of Ecosynthes)

The world economic outlook has been shadowed by rising debt problems in the Euro region and with the contagion expected to affect the other PIIGS nations as well.  There are also concerns about United States’ unsustainable fiscal deficits, which is one of the greatest challenges it faces. The US’ problems have been further aggravated with the unresolved debate on debt-ceiling creating an impression of US’ default on public debt. Back home, the Indian economy grew by 8.5% in FY2011, which is lower than expected but better than the global growth standards. In the backdrop of higher inflationary pressures in the system, RBI continued its monetary tightening measures because of the high domestic inflation which is much above the comfort zone. It increased the repo rate & reverse repo for the 12th time in the last 1.5 years by 25 bps to 8.25% & 7.25% respectively, and has left the doors open for another possible hike of 25bps by the end of FY2012. Other emerging economies such as China and Brazil have also been battling inflation for the past one year.

The financial crises are generally blamed on inefficient banking system, financial deregulation, crony capitalism and others. While all of these elements may be true, the recent preceding and current financial instability overlooks its fundamental reasons. They lie in the distribution of income across individuals and social classes. Deregulation, just intensified the crisis. Of the many origins of the global crisis, one that has received comparatively little attention is income inequality. Attention has to be paid to the impact of inequality on the likelihood of crises. The linkage between income inequality, high and growing debt leverage, financial fragility, and ultimately financial crises, cannot be overlooked. Borrowing and higher debt leverage appears to have helped the poor and the middle-class to cope with the erosion of their relative income position by borrowing to maintain higher living standards. Meanwhile, the rich accumulated more and more assets and in particular invested in assets backed by loans to the poor and the middle class. The consequence of having a lower increase in consumption inequality compared to income inequality has therefore been a higher wealth inequality. As borrowers’ debt leverage increases, the economy becomes gradually more vulnerable to the risk of financial crises.

The historical divide

Recent reports and studies on income distribution in many countries have pointed to stagnating or declining wages, growing rural-urban income differentials, increasing Gini coefficients and other indicators of worsening income disparities. At the same time, discussions are full on the need to provide a decent living for the poor segments of society. In recent years, we have seen new policies and projects targeting income inequality. These include minimum wages policies, cash transfers to poor families, public works for basic employment, micro credit schemes for micro enterprises and others. The justice based criticism on widening of income disparities is joined by macro-economic arguments calling for a new growth model.

Traditionally, many economists have taken an optimistic view concerning the future of global income inequality. A pattern of faster growth in poorer countries is predicted by the traditional Solow growth model. According to elaborations of that theory, a given increase in the manufactured capital stock should lead to a greater increase in output in a country that is capital-poor than in a country that is already capital-rich. Therefore, some economists have reasoned, it is just a matter of time until “less developed” countries catch up with the countries that have already “developed”. The idea that poorer countries or regions are on a path to “catch up” is often referred to as convergence. Describing low-income countries as “developing” assumes that they are on a one-way path towards greater industrialisation, labour productivity, and integration into the global economy.

So, is it right to say that “developing” countries are, in general, catching up with the “developed” countries? A number of studies of GDP per capita growth rates have concluded that lower-income countries are catching up to higher-income countries. However, this has largely been due to the strong growth rates experienced by the very populous countries of China (categorized as a middle-income nation) and India (a low-income nation). Because these two countries have such large populations, they have a disproportionate influence on the average growth rates for low- and middle-income nations. If, on the other hand, we count each country equally, the results suggest that convergence is not occurring in the majority of developing countries. In fact, if we count each country equally the average annual growth rate of real GDP per capita (PPP) over the last decade was 4.8% in the low-income nations, 7.2% in the middle-income nations, and 2.8% in the high-income nations – suggesting further divergence rather than convergence.

Capital Controls

Capital flows never come in at the exact time or in the precise quantity the economists and financial sector wants. Although, there are no immediate imbalances that threaten growth in India, on a contrary of having the only areas of concern are inflationary risks and supply-side constraints.

Concerns about excessive capital flows into emerging markets have recently been more acute as a result of new US attempts to avoid deflation through aggressive monetary expansion, while the emerging markets have already been living with these problems since the last recession. The capital flowing out of emerging markets supplied the initial impetus to the financial crisis, but the flawed institutions and incompetent regulators aggravated and catalysed the issue. Speculative capital flows simply increase the risks of policy mistakes. The US, of course, is betting that prudent management of these risks is going to favour policies that would help unwind imbalances in the world economy and allow the American economy to de-leverage without having to fall into deflation or recession over and over again.

For India, the short-term surge of capital flows is an opportunity as well as a potential threat. From a longer term perspective, purchases of Indian shares by international institutional investors are uniquely important for the Indian economy. Equity capital flows into the country are already constrained by percentage limits on ownership in industries like banks and media, and by the relatively small free float of the Indian stock market. Foreign borrowing by the Indian companies, always the riskier option vis-a-vis equity flows, is still effectively controlled and capital controls are and will be imposed for the sake of financial stability.

Areas of Concern

Two years into the official recovery, some things about the great recession are well known. Many other vital facts and contours are only beginning to emerge. A very distressing, on-going feature of the downturn is the havoc it is wreaking on the young – a mancession.  A lesser well known fact is that the recession continues to debilitate younger working populous of the countries. Employment, home ownership, and wage increases are bypassing the youth.  The combinatio­n of high operating costs due to taxes, restrictiv­e regulation­s, and government mandated charges are raising the entry cost to hire and acquire an additional unit of labour. The result is less employment­. The minimum wage, a noble effort to increase the living standards of workers, has done the opposite by pricing the unskilled youth out of those jobs with low marginal value, producing higher unemployme­nt, and not less. 88% of those people on minimum wage have no college degree, implying that a lack of education is reducing the labour-force to its lowest-and­-worst use.

Future economic stability and growth depends on putting people to work and raising labour productivi­ty. The higher productivi­ty will raise the GDP per capita, thus ensuring higher tax collections, without causing adverse implications on the standard of living. After raising taxes, loopholes in income and corporate taxes, will move significant amounts of capital away from commodities, options, futures, derivatives and into emerging markets that are  to be looked forward to by the end of this decade.

World Economics

The latest Global Economic Prospects report, projects that global real GDP growth (in 2005 U.S. dollar terms) will moderate to 3.3% in 2011, after a strong 3.9% rebound in 2010 that was led by 7% gains in developing countries. Looking ahead, developing countries are projected to continue outpacing high income countries through 2012. A recovery in foreign capital inflows supported the rebound in developing countries, but flows were highly concentrated among a small subset of larger middle-income countries with deep financial markets. And left unchecked, excessive flows can lead to destabilizing asset bubbles and abrupt currency valuation swings that can do lasting damage to economies. Annual double-digit price increases for food price inflation is pressuring low-income households. And if global food prices continue to increase, a repeat of the conditions of the 2008 “food crisis” cannot be ruled out.

Over the past 30 years the globalised economy has been predicated on unending expansion, and many argue that the resulting wealth is in fact illusory. Whilst economic expansion remains the goal of a growth-based economy, inflation – its antithesis – is paradoxically an inevitable consequence of economic growth.  The battle to keep inflation low has become a major preoccupation for governments the world over.


The debate on global imbalances in the world economy and the need for reducing current account surplus and deficits has linked the controversy on income inequality within societies into a macro-economic perspective. In some countries, increasing current account surplus are linked to declining real wages and less social welfare benefits. In order to push for a more balanced growth, increases in the wage level and expenses in social security may be one of the ways forward.

As financial instability plays out on the world stage, it is likely to become increasingly apparent that a stable and more equitable system of finance must be a key feature of a sustainable future economy. The role of money should be overhauled so that it works to facilitate the global exchange of goods and services without unduly rewarding those private interests which control it. A small tax on financial speculation, would go a long way to reducing the damaging effects of short-term speculation whilst simultaneously creating a fund which can be used for any number of humanitarian purposes.

A further suggestion would be to limit the type and quantity of resources which are traded and speculated upon in financial markets. If essential resources such as oil and gas, and basic agricultural produce such as rice and wheat, are produced not primarily for profit but to ensure that basic needs are secured around the world, then the market speculation and price fluctuations of these essential resources would be significantly reduced, imparting a particular benefit to those in the developing world.

Author details

Raka De

Name of the Institute  :  International Management Institute

Course                         :  Post Graduate Diploma in Management (PGDM)

Year                            :  2nd Year

Global Financial Instability by Mansi Gupta (winner of Ecosynthesis)

“It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of
foolishness, we had everything before us, we had nothing before us…”

Charles Dickens

Such is the global state of affairs today that you would not be called a Cassandra to predict that it might only get worse from here. And, would you not call the lurking Contagion, a looming doomsday in the air? Well, some might say “all is not that unwell”. But, the roaring waters might soon start flowing post the danger mark.

It might just be too little, too late constructing a dam, then. And we may see why?

Let us turn around the tables towards the earlier considered to be “too big to fail” developed economies. These economies marred with heavy debt burdens and weak growth prospects don’t seem to be proving themselves as the ‘messiah’ of the global financial recovery in the immediate future. And I doubt they were ever seen as one in the past four years of crisis. The ‘emerging economies’, also seen as the engines of growth during the slowdown, are battling the problems of their own, and despite brighter growth prospects, are vulnerable to financial reversals and stubborn inflationary pressures. To add to the global agonies, the fears of sovereign defaults by
the countries, earlier seen as a ‘normal phenomenon’, leading to a colossal financial contagion only proves how fragile an International Financial System we are putting up with. And as, the global investors move towards safety and where the higher interest rates take them to, amidst the low interest environment and high levels of uncertainties, the effects of volatile asset allocations remain worrisome. The role of these variables as the indicators of the next financial crisis, albeit a much bigger one, largely remains to be probed.

The catastrophic disaster hit the slow recovery from the worst of the financial crisis in March
this year when The Great East Japan Earthquake and tsunami did not churn out major losses only to the Japanese economy but
,also swelled unrest in the oil producing countries. The importation of crude oil supporting 61% of Japanese energy demands 1
got affected adversely when the catastrophe forced the manufacturing companies including the automobile giants to shut some of their centers, causing global oil prices to fall

Fig 1: Oil Price Movement in March’ 11 (Source: Hidden Levers)
just below USD 100 a barrel2.

Tokyo, Commodity Online, March 11, 2011
CBS News, March 11,2011

A question that might arise is that where did the impact of the Middle East strife; the much acclaimed Jasmine Revolution and Libyan unrest subside to as reflected in falling oil prices during that period? In late February 2011 to early March 2011, before the Japanese catastrophe, the oil prices were peaking at USD 125 -115[1] a barrel due to Libyan unrest that supplies 2% of world’s daily crude oil demand. The prices calmed with Saudi Arabia and OPEC increasing spare supply to make good of the cut Libyan supply. But the important take away here is for how long will this supply-demand mismatch continue with the shrinking OPEC pool, as evident in Figure 2

.Fig 2: Shrinking OPEC oil pool dampening global oil prices (source: Nomura)

The global fault lines cranked further under the weight of US ballooning debt – increasing fiscal deficit and the debate over raising the US debt ceiling. With US being the epicenter of the world wrecking financial crisis in 2008, the debate over raising the debt ceiling from USD 14.3 trillion to USD 16.4 trillion fueled fresh rounds of speculations over the sovereign default by the World’s largest economy! With the current US GDP estimated to be at USD 15.003 trillion (as on July 29, 2011)[2] , and the debt to GDP ratio at a staggering 98%, the non-conformity of opinions between the Republicans and the incumbent Democrats led to everyone doubting the political willingness of the US over adopting a sustainable fiscal course of action. Of course, this debate led S&P, one of the three prime credit rating agencies globally, to downgrade the triple-A rating of the US Treasury, which it held for nearly 70 years to a tad lower to AA+, at par with Belgium’s and New Zealand’s and lower than almost a dozen nations world wide! Of course, the impact of such a downgrade on investors’ sentiments and money markets was then a little undermined keeping into consideration, the state of the global affairs and the lurking Euro Zone crisis.

Fig 3: US Debt from 1940 to 2010 (source: Whitehouse Budget Historicals)

And, just when everyone would have had laid their hopes and bet on Euro Zone, it disappointed with the fears of disintegration and sovereign defaults lurking in the air. Policy indecision led to renewed financial instability across the globe, with the eyes set upon the European Commission Bank (ECB) and the biggies in the Euro area, the likes of Germany and France. With the doubts resurfacing in spring this year, and been strengthening with every passing day, notwithstanding the strong policy measures as pledged in the EU Summit held on July 21, 2011. And I wonder why would the worries subside without a substantial political willingness to draft a fool-proof policy framework for an economic-cum-political union to withhold its existence? Of course, the resulting formation of a horrible acronym PIGS (or PIIGS, with Italy included) was but obvious, howsoever undesired! Portugal, Ireland, Greece and Spain, and now, the anxieties including Ita to form PIIGS, refers to the most debt laden economies of Europe and with Greece almost on the brink of a sovereign default.

[1] The Economist, March 3, 2011

[2] US Department of Commerce, Bureau of Economic Analysis

How ugly is the situation and why might it lead to a much worse contagion amidst the dead slow global recovery, can be estimated from the fact that S&P Europe 350 index shows negative total returns (-2.75%) and price returns (-6.19%) for a period of one year[1]. The index level has also sharply declined from 1121 on June 1, 2011 to the till date 936.24 value recording a 16% fall in a span of four months as evident in Fig 4.

Fig 4: S&P Index Level Performance (Source: S&P Europe 350 Index)

The economy of Greece last bailed out by ECB and IMF in May 2010 with a Euro 110 billion loan just brought in a breeze of respite, which could only bought a little time

for Greece to put its financial house in order. And of course, the task was no child’s play and proved to be herculean with Greece’s debt to GDP ratios at staggering 142.8% in 2010, as compared to Euro zone’s average of 85.3%[2]. The European Financial Stability Facility (EFSF) created on May 9, 2010 with a mandate to safeguard financial stability in the Euro zone by raising funds in the capital markets to finance loans for euro area member states is being seen as the lender of last resort with a safety net of Euro 440 billion, as approved by ECB, IMF and Euro group, most recently Germany. This safety net however, seen to be contentious, “too little too late”, is expected to buy Greece an year’s time considered precious for it to bring about a breeze of financial stability.

The French Societe Generale (downgraded from Aa2 to Aa3) and Credit Agricole (downgraded from Aa1 to Aa2) ratings fall by another prime credit rating agency globally, Moody’s Investor Services sent a fresh round of financial instability shocks down the global economy on Sept 14, 2011. The fears of French banks’ exposure to debt laden Euro economies have resulted in sharp falls in the prices of French banking shares.

Fig 5: Greek debt in comparison to Euro zone Average (source: Bloomberg)

[1] S&P Europe 350 index, as on August 31, 2011

[2] Bloomberg Markets

Italy is now taking the centre stage of the Euro debt crisis, amidst the fears of default and its exposure to Greek junk bonds. And of course, why should it not hog the lime light with its debt to GDP ratio being at a whopping 120% and economic growth recorded at a mere 0.3%? [1]

Fig 6: Growing Chinese Exports (Source: Trade Economics, September 2011)

The emerging economies more recently raised to the clout of the ‘world’s savior’ with their brighter growth prospects and glitzy numbers are heating up with their central banks trying to put forth their best foot forward in cooling down the economies.

Closer home, the Chinese saga often ridiculed for its ‘grotesque’ economic policies depending on high exports and low domestic consumption, has been a subject for world wide criticism for not doing its bit enough for the global financial stability. With the Chinese exports registering a growth of 31.3% to USD 1.58 trillion in 2010[2], more than India’s GDP which stood at USD 1.38 Trillion[3] at current prices in 2009 which meant USD 1.49 Trillion in 2010 considering 8.5% GDP growth, the road ahead for the Chinese dragon without bolstering domestic consumption and CPI inflation levels at 27-month high hovering around 6.2% since July 2011[4], shall remain a bumpy ride.

The domestic turf, the ‘Emerging Indiabattles against the central bank’s worst enemy, the stubborn inflationary pressures, with the RBI increasing the policy rates 12 times since March 2010, the latest being a 25 basis point hike on September 16 with the repo rate now standing at 8.25%[5]. Of course, whether such a policy stand often accusing RBI of killing growth by India Inc

. is effective in curbing food and overall inflation which stands stubbornly tall at over 10% much above RBI’s comfort level of 4-5%, remains largely debatable. And as if the gargantuan inflationary levels were not enough to make D Subbarao sleep deprived, the recent Rupee slide due to investors’ fears over Euro crisis, moving Rupee 50-to-a-dollar mark, raised importer’s worries and crude oil imports expensive.  The rising borrowing costs are putting business profitability and margins under pressures, questioning the current monetary policy stand of RBI. The moderated growth numbers undermine investors’ sentiments leading to capital flights.

Fig 7: Rupee to Dollar Movement in September 2011 (Source: Exchange

[1] CNN Reports, Aug 2011

[2] Trade Economics data, September 2011

[3] World Bank, World Economic Indicators

[4] Chinese Business News, September 27, 2011

[5] CNBC- TV 18, September 29, 2011

Needless to say, rampant consumerism, seeking material goods without the ability to afford them, is often attributed to be one of the main causes for the current global economic crisis and financial instability, but the question remains for how long?? The ballooning fiscal deficits world wide and the rising debt levels for developed economies; capital flows volatility and inflationary pressures in the emerging economies make them jostling with their own share of worries. The huge bail out packages pledged world wide to give a momentary respite to the economies almost on the verge of a breakdown, remains questionable and fuels speculations to the billion-dollar question: Are we living in the era of another bubble formation with the next financial crisis just around the corner, waiting to gulp down the investors’ sentiments and confidence putting the global economy on the edge?? The tremors of double dip recession and sovereign defaults can be experienced often now and then. And of course, as optimists hope for some sanity to prevail in the global financial systems, I hope the Cassandra in me soon puts her worries to rest.

Signing off with a tune that is buzzing in my mind:

“Along a trail that’s winding always upward,
this troubled world is not my final home…
But until then my heart will go on singing
until then with joy I’ll carry on…”

–          Until then by Ray Price, 1996

Until then, Amen!

Written by:

Mansi Gupta, Master of International Business

Delhi School of Economics, Delhi University

Batch of 2012

Nobel economists 2011

Nobel Prize

Every year since 1901 the Nobel Prize has been awarded for achievements in physics, chemistry, physiology or medicine, literature and for peace. It is an international award administered by the Nobel Foundation in Stockholm, Sweden. In 1968, Sveriges Riksbank established The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel, founder of the Nobel Prize.

Thomas J. Sargent and Christopher A.Sims are noble prize winners of 2011 in the field of economics.

Both nobel prize winners are americans and are 68 years old.They worked separately and through their research work devised tools to analyze how growth and inflation are affected by interest rate and taxes.Their research work which was done in 1980s and 1970s has been of alot of help to bankers and policy makers.Sargent is a professor at NYU and Sims is a professor at Pricneton, they got the honour for their “emperical research on cause and effect in macroeconomy”

                            Christopher A.Sims

Thomas J.Sargent

Articles invited for Ecosynthesis

Ecosynthesis- Magazine of EconIMI

The yearly magazine will be soon launched this year.The theme that we have decided is Global Financial Instability which has been affecting the whole world from a last few years.


Financial instability occurs when shocks to the financial system interfere with information flows so that the financial system can no longer do its job of channeling funds to those with productive investment opportunities. Indeed, if the financial instability is severe enough and is spread across the globe, it can lead to almost a complete breakdown in the functioning of financial markets across the entire world, a

situation which is then classified as a global financial crisis. Indeed this global financial crisis can be attributed as the reason for the world wide recession.

The global financial instability could be felt when the global economic crisis begun in July 2007 with the credit crunch, when a loss of confidence by US investors in the value of sub-prime mortgages caused a liquidity crisis and had a ripple effect around the world.

Recovery from the global recession was underway, when S&P lowered US credit rating to one notch below AAA to AA+. Adding to the difficulties is the concern that the downgrade is only one of the many issues roiling global markets. The European debt crisis is spreading, with Italy and Spain coming under the gun after Greece, apart from the fact that the current   U.S. economy is weaker than many investors had thought and all this have led to fears of another recession as all the economies of the world including India dependent heavily on the world superpower i.e. US . The major concern here is “Are the developing countries still developed”?


Another serious concern affecting the world economy is economic disparity or global surplus. At the heart of global imbalances is a mismatch between saving and investment. Deficit countries do not save enough relative to their investments, and surplus countries do not invest enough given their high savings. Thus capital will flow to the country that is most profitable as investors want to invest their capital in the country that would give them maximum return. Thus the key question that arises is “Where to invest?”

Amidst the above explanation, it is clear that Innovation could be one of the major factors that could lead to a sustainable economy. Innovation is one of the keys to survival, adaptability, and responsiveness in times of change and uncertainty. Innovation matters across the economic spectrum, to the for-profit sector, to nonprofits, for academic and educational institutions at all levels, and for government. Thus we can safely say that Innovation is essential to the future economic prosperity and quality of life.

So in the light of above scenario we have chosen theme for our magazine as prevailing ‘Global Financial Instability’ which will cover articles on ‘are developed countries still developed ?’, ‘global surplus’, ‘where to invest ?’ and ‘sustainability through innovation’


For the article writing competition topics are as discussed above:

  1. Global financial instability
  2. Global surplus
  3. Are developed countries still developed?
  4. Sustainability through innovation

Points to be noted

  • Please maintain a word limit of 1500-2000 words.
  • Articles should be completely original and devoid of plagiarism. Mention the references at the end of the article.
  • Article can be written by an individual or in a team of two.
  • Please write in font size of 12, Times New Roman and 1 line spacing
  • Mention your Institute name, Year and course at the end of document.
  • Save you word document as Name_Collegename.doc or Name_College name.docx
  • Send your articles at with subject as

‘Ecosynthesis4_Article_College name_ your name’

  • Last date for sending articles is 6th October 2011, 11:59 p.m.

What you get?

  • Top 3 articles will be published in the magazine and on our blog
  • Best article will get a prize money of Rs 3000/-
  • All the published articles will get a certificate of recognition.
  • Best article shall get a special mention in the magazine

so what are you waiting for????grab your pen and write down your thoughts to us.

India’s information revolution: A journey towards inclusion and integration

India’s ICT (Information, Communications and Technology) revolution and its attendant benefits have been much talked about. The first phase was driven by home grown skilled engineers developing code and applications for foreign clients who found it cheaper to ‘outsource’ such labour to Indian companies. The unprecedented opportunity that was created soon acquired an unstoppable momentum that led to the birth of many other firms, initially clustered in Bangalore, and later spreading to other inexpensive locations across the country. Alongside, another massive revolution was taking place. Deregulation of the telecommunications market in the mid 1990s and the subsequent technological progress and persistent innovation made it possible to deploy wireless networks at very low costs. The success has been characterized by increasing tele-density, declining prices, and elimination of waiting lists. In 1994, fewer than 1 in 100 Indians owned a phone. A little more than 15 years on, tele-density has increased to about 60% and subscriber numbers are growing at a rate of about 15 million per month. Voice calls in India are amongst the cheapest in the world

The impact of both these developments has been tremendous. Software and IT are the largest contributors to India’s exports; NASSCOM expects software services exports to reach USD 47 billion in fiscal 2011.  In addition, the IT industry accounts for 5.8% of India’s GDP generating  2.23 million jobs directly and an additional 8 million through spillover effects on other industries. Besides these estimable quantitative impacts, India’s IT prowess has been recognized globally.  It has also been instrumental in instilling in India and Indians a new found confidence that was hitherto missing. On the other hand, increased mobile connectivity has been responsible for catalyzing growth rates across Indian States. Academic research has shown that Indian states with higher mobile penetration can be expected to grow faster, and by 1.2% points for every 10% increase in the penetration rate.  Furthermore, this positive effect becomes pronounced when the level of mobile penetration exceeds a critical mass of about 25%.  Mobiles currently provide more than 600 million points of connectivity in India, through which information flows.  Citizens with access to telecommunications can tap into the economic growth opportunities much more easily than those who are unconnected.

While both these developments were significant, they largely occurred independently of each other, thus precluding the benefits that could accrue due to greater integration between IT and telecoms. As India enters its second phase of ICT growth it seems that this may be about to change. This phase will be led by high speed data, applications, processes and new infrastructure and therefore demands the coming together of the two industries. The trigger to the second phase of growth is the envisaged Public Information Infrastructure (PII) initiative, which the central government is about to begin. It combines access, shared or dedicated with applications to deliver public services on a scale that no country in the world has ever done or even imagined. Although ambitious, if implemented right, it has the potential to revolutionize information and governance infrastructures in India permanently.

Central to the PII is to establish four national data centers and eventually provide high speed data connectivity to the 250,000 panchayats and urban local bodies, which form the backbone of local governance. This will have far reaching impact not only on governance and public delivery systems but also on competitiveness. The key is to create a high speed, meshed broadband network at the center, state, district, block and panchayat levels that is open, secure and interoperable. The PII will create access, connectivity and systems to integrate – geographical and sectoral boundaries and applications to revolutionize how we access and process information. If all the multiple layers – broadband platform, UID platform, GIS platform, security platform and payment platform – are combined, the opportunities are limitless. The PII aims to create connectivity among the various government schemes, departments and sectors. For example, there will be a server for UID, a server for income tax, a separate server for NREGA, for food distribution, for passports and even driver’s license. So, while all of these vertical silos will remain the plan is to link them. Each state will have its own servers. The federal government will have four or five major locations for servers and each would be linked with certain security.  Once the infrastructure is in place, the nature and kind of public services that can be delivered on these pipes will only expand to include education, health, and other citizen services obviating expensive and periodic visits to the babus.

According to Mr. Sam Pitroda who is spearheading the PII initiative, at the core of the PII is the greater access to information that it will enable. In the same way that access to telecommunications became an important catalyst to realizing productivity and efficiency improvements, access to information has the potential to change the manner in which public services are delivered thereby making it potentially possible for the benefits of economic growth to be shared. Historically, in India information has always been controlled by few, be it the Brahmins, the British, or more recently the Bureaucrats. Michael Porter, on a visit to India in the 1990s predictably concluded after extensive research, that the scarcest commodity in India was information. So, the marginalized actually have never had the opportunity to grasp and use information effectively. But for that to occur effectively, telecom and IT i.e. access and applications must come together to offer meaningful services at affordable prices and with universal coverage. The aim of the PII is just that.

Such ubiquitous Internet/Broadband infrastructure will have a huge transformative impact. We know that broadband is a key driver of economic growth and the competitiveness of nations (See OECD (2008) Broadband and the Economy). Recent research by the World Bank finds that for every 10-percentage-point increase in the penetration of broadband services, developing countries can see an increase in economic growth of 1.3 percentage points. The impact of broadband in India should be potentially higher since it will overcome the constraint posed by the weak infrastructure. Combine with this the public services that could be delivered with the PII and we have an unprecedented opportunity for the benefits of economic growth to be shared. Let’s hope that this project does not disappoint.

 This article is written by Rajat Kathuria who is a professor of Managerial Economics at IMI New Delhi.


Sex Ratio and High Savings Rate in China: An Out-of Box Explanation – by Arindam Banik

Article is written by Arindam Banik  who  is Professor of Economics at International Management Institute, New Delhi.

Conventional explanations determining consumption are well-known. Keynes[1] conjectured that the marginal propensity to consume is between zero and one, that the average propensity to consume falls as income rises. Hence, current income is the single determinant of consumption. Keynes’s validated such conjectures based on household data and that too based on short time series. Interestingly, studies based on long time –series found no tendency for the average propensity to consume to fall as income rises over time. Irving Fisher[2] finds that the consumer faces an inter-temporal budget constraint and chooses consumption for the present and the future to achieve the highest level of lifetime satisfaction. Thus as long as consumer can save and borrow, consumption depends on the consumer’s lifetime resources. 

Modigliani[3] in his life-cycle hypothesis emphasizes that income varies somewhat predictably over a person’s life and that consumer’s use saving and borrowing to smooth their consumption over their lifetimes. This suggests that consumption depends on both income and wealth. In contrast the permanent income hypothesis (PIH) is a theory of consumption that was developed by Milton Friedman[4]. In its simplest form, the hypothesis states that the choices made by consumers regarding their consumption patterns are determined not by current income but by their longer-term income expectations. Hence, short-term changes in income have little effect on consumer spending behavior.

Measured income and measured consumption contain a permanent (anticipated and planned) element and a transitory (windfall gain/unexpected) element. Friedman concluded that the individual will consume a constant proportion of his/her permanent income; and that low income earners have a higher propensity to consume; and high income earners have a higher transitory element to their income and a lesser than average propensity to consume. Accordingly it was thought that the key determinant of consumption is an individual’s real wealth, not his current real disposable income. Permanent income is determined by a consumer’s assets; both physical (shares, bonds, property) and human (education and experience). These influence the consumer’s ability to earn income. The consumer can then make an estimation of anticipated lifetime income. Empirically, transitory income is the difference between the measured income and the permanent income. This can be calculated simply by subtracting the measured income and the permanent income.

Hall’s random-walk hypothesis combines the permanent-income hypothesis with the assumption that consumers have rational expectations about future income.[5] It implies that changes in consumption are unpredictable, because consumers change their consumption only when they receive information about their lifetime resources. Laibson has suggested that psychological effects are important for understanding consumer behaviour[6]. In particular, because people have a strong desire for instant gratification, they may exhibit time-consistent behaviour and may end up saving less that they would like.

The high Chinese household savings rate is however, somewhat puzzling and hence contradicts the above theoretical explanations. Why are high household savings a general East Asian and more specifically Chinese phenomenon? Explanations such as poor social safety net, weak pension system, inadequate health coverage, are often cited as powerful ingredients. Interestingly, in recent time, for example in China, social safety has improved and the insurance coverage has expanded over the last decade or so. Quite likely, household savings rates are expected to decline, or at least not increase. Yet, household savings as a share of disposable income almost doubled from 16 per cent in 1990 to over 30 per cent in 2008 and has been rising rapidly in recent time.

Shang-Jin Wei and Xiaobo Zhang’s[7]study reveals an interesting explanation in this aspect. For the last few decades China has experienced a significant rise in the imbalance between the number of male and female children born to its citizens. There are approximately 122 boys born for every 100 girls today, a ratio that means about one in five Chinese men will be cut out of the

marriage market when this generation of children grows up. According to them a variety of factors might have contributed  to the imbalance. For example, Chinese parents often prefer sons. Ultra-sound makes it easy for parents to detect the gender of a foetus and abort the child that’s not the “right” sex for them, especially as China’s stringent family-planning policy allows most couples to have only one or two children. China has too many boys now.

The Shang-Jin Wei and Xiaobo Zhang study compared savings data across regions and in households with sons versus those with daughters. More interestingly, not only did households with sons save more than households with daughters on average, but that households with sons tend to raise their savings rate if they also happen to live in a region with a more skewed gender ratio. Even those not competing in the marriage market must compete to buy housing and make other significant purchases, pushing up the savings rate for all households. In addition, parents invest more in the education of their sons, and push them to work harder. There may also be spillover from a boy’s education to a girl’s education.  In other words, parents want their sons to marry, and they figure that girls are more likely to want to marry rich boys. What about girls’ parent and their education? Arguably, the girls’ parent may have less incentive to invest on their girl child’s education assuming that they are all available in the marriage market.

Thus it appears that concerns relating to gender ratio imbalance in China may create both economic and social problems.  The worry is that the result may actually be a real threat to the Chinese social system. So China should not be quite so gung –ho about her high household savings rate.

[1] John Maynard Keynes, The General Theory of Employment, Interest and Money, Macmillan Cambridge University Press, 1936.

[2]  Irving Fisher, The Works of Irving Fisher, 14 volumes ( William J. Barber, ed., assisted by Robert W. Diamand and Kevin Foster; James Tobin Consulting Editor) ,Pickering and Chatto,1997.

[3] Franco Modigliani, “ Life Cycle, Individual Thrift, and the Wealth of Nations,” American Economic Review, Vol. 76,pp.297-313,1986

[4] Milton Friedman, A Theory of the Consumption Function, Princeton University Press, 1957.

[5] Robert E. Hall, “ Stochastic Implications of the Life Cycle-Permanent Income Hypothesis: Theory and Evidence,” Journal of Political Economy, vol.86, pp. 971-987,1978.

[6] David Laibson, “Golden Eggs and Hyperbolic Discounting”,  Quarterly Journal of Economics, vol.62, pp.443-477, 1997.

[7] Shang-Jin Wei and Xiaobo Zhang, The Competitive Savings Motive: Evidence from Rising Sex Ratios  and Savings Rates in China,  Working Paper no.15093, National Bureau of Economic Research, 2009.