A version of this was published by firstpost on April 30th, 2012 at http://www.firstpost.com/economy/is-india-fumbling-the-future-argentina-style-292708.html

Is India fumbling the future, Argentina-style?

Rajeev Srinivasan on what we can learn about India’s failing institutions from Argentina’s debacle

Argentina did something recently which not many Indians would have paid much attention to: but we probably should look a little more carefully at it. What happened there was that the government of President Cristina Fernandez de Kirchner nationalized a Spanish-owned oil company, YPF.

While Argentina possibly had justifiable reasons for doing so, the net result has been that foreign and domestic investors will look askance at the country. It is anyway not doing so well on the macroeconomic front and it could use some FDI flowing in. From the outraged howls emanating from Europe, it would be safe to say that Cristina made a big boo-boo.

Compare this to India. Some years ago, a female Prime Minister suddenly nationalized banks in India. (Not to be outdone, in 2001, Argentina froze all bank accounts in what was dubbed Corralito, in order to prevent capital flight). Recently, in a display of childish petulance, the UPA government decided to overrule a Supreme Court order in the case of Vodafone and its tax obligations by unilaterally modifying relevant rules retroactive to 1962! This, I suspect, means India can kiss goodbye to quite a bit of FDI, which India too needs, mostly to offset its large current account deficit and budget deficit.

Thus, both countries are going down the slippery slope of strong-arming those who are foolish enough to invest: a short-term gain with sure long-term pain. Both of these may turn out to have been unwise actions. But it turns out there are other, surprising similarities as well between Argentina and India. In fact, if you look at the data here, it appears as though Argentina is generally doing much better than India! India’s growth is less, current account deficit and budget deficit (in particular) are much higher, and its currency has fallen far more this year (13.68% vs. 8.15%).

GDP growth % Inflation% Current account balance, GDP % Budget balance GDP % 2012 Currency to $, Apr 1, 2012 Currency to $, Apr 1, 2011
Argentina 7.3 N/A -1.4 -0.7 4.38 4.05
India 6.1 9.1 -2.8 -5.8 50.7 44.6

Fig 1. Comparative data. Source: The Economist, Apr 7-13, 2012

It is an obscure fact that in the 19th century many people thought that the race for economic superstardom would be between the United States and Argentina. Imagine them two hundred years ago: both large countries, thinly populated, with much good farmland. In both, European colonists had managed to subdue (and in some cases, exterminate) the native populations.

In the case of Argentina, the migrants were mostly southern Europeans, especially from Italy. In the case of the United States, the migrants were mostly from northern Europe. But in both cases, they were, as migrants often are, pushy and energetic. So an impartial observer in the 19th century would have given both of them high marks for potential to be superpowers.

At the beginning of the 20th century, Argentina was one of the richest countries in the world, based largely on its agricultural exports. But then something remarkable happened: Argentina faltered, it was subject to endless military coups; eventually Juan Domingo Peron, a military officer, took over. Later his widow Evita (of “Don’t cry for me, Argentina” fame) was in charge. To this day, Peronists are in charge. What happened to Argentina?

According to Daron Acemoglu and James Robinson, two well-known development economists, the answer lies in their recent book, Why Nations Fail: The Origins or Power, Prosperity and Poverty, where they study institutions. They posit that “… while economic institutions are critical for determining whether a country is poor or prosperous, it is politics and political institutions that determine what economic institutions a country has”.

The authors argue that institutions can be either ‘extractive’ or ‘inclusive’. If it is the former, then there is a vicious cycle; if the latter, a virtuous cycle, they claim. They quote the “Iron Law of Oligarchy” on their blog, which is that “… Extractive economic institutions always create struggles for control, and they tend to attract would-be elites bent on extraction, and whoever comes to power takes over a system without checks on their power. The outcome is to re-creation of extractive institutions under a different guise.”

Thus Argentina fell victim to a model: their original elite immigrants created large, exploitative estates where they used essentially slave labor from the conquered natives, which is a good example of extractive institutions. (Pakistan’s twenty-two zamindari families that control everything might be another example).

The original immigrants to the US did not end up creating extractive economic models (well, if we forget the small matter of African slaves and tobacco plantations in the US South – but then, they did fix that through their Civil War), and ended up being far more inclusive.

But Argentina thrived for a while, and it was in the 20th century that its lack of inclusiveness began to hurt. Those who took power in the coups were not the original elites, but they soon became indistinguishable from them, because they all had the same objective: extraction.

Why should all this concern India? Well, I hope it is obvious that India, too, suffers from elites who have formed extractive institutions, or perpetuated them. The imperialist British had created institutions that were meant only to loot the country (not for the nothing was the principal official in a district called a “Collector” – his job was to collect taxes.) After 1947, a new ‘elite’ came into the picture, Brown Sahibs, who found it convenient to perpetuate the extractive economic institutions.

And India’s political institutions have not been able to get the country out of this death spiral. Indeed, they were not designed to; and with the passage of time and the clever use of technology, the ability of the political elite to manipulate the electorate has grown by leaps and bounds. It is not unreasonable to wonder whether there have been crypto-coups in India that has kept the same bunch in power.

If the Argentina-US example at the turn of the 20th century can be put in the context of India-China rivalry now, the prognosis for India is poor. China, with its extractive political system, built a somewhat inclusive economic system, which has enabled many to climb out of poverty. India, like Argentina, may fail to loosen the extractive nature of its economic system, because the political system benefits greatly from it.

If that unfortunate eventuality happens, India will be doomed to Argentina-like irrelevance. Already there are suggestions that the ‘I’ in BRICS should be Indonesia, not India, given India’s recent downgrade by S&P.  India’s beloved leaders, then, would have fumbled the future, yet again.

1085 words, 29th Apr 2012

Correction: In an earlier version, the table had a wrong caption: the Re-$ exchange rates are for April 1, 2011 (not December 31, 2011) and April 1, 2012