Faster, higher, richer

Much has been said and written about how China will use the event to showcase its achievements over the past three decades, as it moved from being a Maoist cesspool to its current status as one of the world’s emerging superpowers

Cafe Economics | Niranjan Rajadhyaksha

he 2008 Olympics will open on Friday in Beijing in a burst of pomp and pageantry. Much has been said and written about how China will use the event to showcase its achievements over the past three decades, as it moved from being a Maoist cesspool to its current status as one of the world’s emerging superpowers. The famous Bird’s Nest stadium, the 36 other Olympic facilities, the gleaming new hotels, the super-fast trains from Beijing to Tianjin (where the football games will be played), the world’s biggest airport terminal in the capital city — each is meant to impress.

China is not unique in this respect. Japan did something similar when it hosted the 1964 Olympics in Tokyo. “The autumn of 1964, when the Olympics came to Tokyo, was to be the greatest ceremonial celebration of Japan’s peaceful, post-war democratic revival. No longer a defeated nation in disgrace, Japan was respectable now. After years of feverish construction, of highways and stadiums, hotels, sewers, overhead railways, and subway lines, Tokyo was ready to receive the world with a grand display of love, peace, and sports,” writes Ian Buruma in his 2003 book on the rise of Japan, Inventing Japan: From Empire to Economic Miracle.

Familiar, isn’t it?

Economic resurgence and hosting the Olympics seem to go hand in hand. There is a common feature between the Tokyo and Beijing Olympics — and indeed most of the Olympics held across the world in the postwar years. And this common feature could offer us some clues about when India will be ready to host its first Olympics.

Most countries have hosted their first post-war Olympics when their average incomes have moved into a tight band of between $4,000 and $8,000, calculated using 1990 purchasing power parity, or PPP, dollars. I have taken the incomes data from economic historian Angus Maddison’s monumental research into the world economy since the dawn of the christian era. The record suggests that India should try to host its first Olympics when its average income is somewhere in that range.

Consider two Asian countries that had just about emerged out of mass poverty when they hosted the Olympics, to tell the world that they have arrived. Japan had a per capita income of $5,668 in 1964. South Korea had a per capita income of $7,621 in 1988, the year the Games came to Seoul. Both had recorded around 15 years of astonishing growth by the time the world’s best athletes came to their capital cities to win medals and glory. In another part of the world, Mexico had a per capita income of $4,073 in 1968, a year marked by the slaughter of protesting students to ensure a peaceful Olympics and Black Power salutes on the victory stand. It was not economic success but political unrest that made those Games memorable, a risk that the Chinese are well aware of.

But the incomes rule is not restricted to emerging Asian and Latin American nations alone. Interestingly, even more developed nations had average incomes in the same range when they hosted their first post-war Olympics. Here are some of the relevant numbers: London in 1948 ($6,746), Helsinki in 1952 ($4,674), Melbourne in 1956 ($8,108), Rome in 1960 ($5,916) and Moscow in 1980 ($6,427). The exceptions are few, such as Munich in 1972 ($11,481), Montreal in 1976 ($14,902) and Atlanta in 1992 ($23,298). But when Hitler and his thugs tried to use the Berlin Olympics in 1936 to showcase their achievements, Germany had a per capita income of $4,451.

I am not suggesting any Iron Law of Olympic Bids. But it does appear that countries need strong economies to convince the International Olympic Committee that they can play host to the world’s best sportspeople and thousands of tourists. You need to be rich enough to do the job.

So, when will India be ready? India’s average income right now is around $3,000 in PPP. That is at current rates, and not in the 1990 dollars that I have used in the earlier examples. But a comparison with China today would suffice. Average Chinese PPP incomes will be around $5,500 this year.

How long will it take India to reach that level? Assuming current rates of economic growth and population growth, it will need at least another decade to reach there. In other words, India could think of bidding for the 2020 Games.

China will be showcasing more than its physical infrastructure in Beijing this year. It also wants to prove that it has the world’s best athletes. A quick tour of various online betting sites suggests that China is expected to win more medals this year than any other country. As far as winning medals goes, India is unlikely to emulate its northern neighbour by 2020.

Sad, but true.

Your comments are welcome at cafeeconomics@livemint.com

Price of global warming

Climate change sceptics are wrong for the same reason that financial models have been proved wrong of late

Cafe Economics | Niranjan Rajadhyaksha

The climate change debate is far from settled. Or at least that’s the impression one gets when visiting a new website called www.climatedebatedaily.com. The home page is split vertically down the middle, with global warming enthusiasts and sceptics ranged against one another. One recent academic article on the sceptical side of the fence says that the world should be concerned about global cooling rather than global warming.

So, should we sit back and wait to see what happens?

This is where I think the climate change sceptics get it all wrong. One of the most common arguments they put forward in defence of their scepticism seems convincing at first glance. They argue that forecasting the future of any complex system such as the climate (or the economy) is terribly difficult. The margin of error is huge—and hence we must take the predictions that regularly hit the newspaper with a pinch of salt.

But that’s just the point. Forecasters may be erring on both sides because of the uncertainty involved. The world may not heat as much as expected. Or it may heat many, many times more than what we have been told to expect.

“Although greater uncertainty means climate change might be less bad than we fear—for example, an ‘iris’ effect means increases in cloud cover may slow global warming—it also means it might be much worse,” writes Paul Klemperer, a professor of economics at Oxford University, in a recent article. He draws parallels between the financial models that failed last summer and the climate change debate. “Only last summer, hedge fund managers found their stock market models’ predictions were, in their own words, ‘25 standard deviations’ from the outcomes, just as the Nobel Prize-winning economists who advised LTCM believed the probability that the fund would lose more than half its money was way below a billionth (until, that is, they lost almost all their money).”

In short, the uncertainty about the future course of global temperatures means that it is sensible to buy some insurance against 25 standard deviation climatic outcomes.

How? There are no easy answers to the problem of climate change, which could be the biggest externality the world economy has ever faced. As with the design of most economic policies, the trick is to identify the trade-offs and incentives involved. Economists need to be part of the solution.

The Indian government seems to have got the point. There has been some criticism of the fact that the 13th finance commission has been asked to look at “the need to manage ecology, environment and climate change consistent with sustainable development”. That’s not the job of a finance commission, which traditionally tries to figure out how tax revenues should be shared between the Centre and states. But, the new finance commission could help frame the Indian debate on what economic policies are needed to mitigate the effects of climate change. And that will be a big step forward.

The International Monetary Fund (IMF), too, has jumped into the fray in its new World Economic Outlook (WEO) that has been released this month. It seems like a strange decision at first glance. Shouldn’t IMF leave the climate change issue to scientists and focus more on the global economic slowdown and the spurt in inflation? But climate change could be a huge risk to the global economy.

WEO also has a box on the possible impact of an abrupt climate shock on an illustrative South Asian country that is heavily dependent on agriculture. Think India. There are several possibilities. The dislocations to agriculture and industry will pull down productivity as farmland is lost, industry is relocated and labour is retrained. Foreign demand for this country’s products will be hit “due to reduced competitiveness of the new industries in which the country is forced to specialize”.

The government will be forced to respond through a higher deficit and lower interest rates. These will reduce national savings and increase the current account deficit. The deterioration in the country’s economic performance will drive up risk perceptions and borrowing costs. These higher interest rates will squeeze investment and improve the current account balance.

The questions pile up. By how much should the price of carbon be increased to bring down emissions over the long run? How should the burden of cleaning up be shared between our generation and the coming generations? What part of the task should be left to private markets and what part should be tackled directly by government policy? How should the bill be shared between the rich countries that have been responsible for most of the carbon pumped into the atmosphere till now and the developing countries that will be the world’s biggest polluters in the future?

Economic reasoning needs to supplement climate change forecasting.

Your comments are welcome at cafeeconomics@livemint.com

India needs new fiscal pact

The deficit number that will be announced in the new Budget this week should be consumed with a pinch of salt

Cafe Economics | Niranjan Rajadhyaksha

Finance minister P. Chidambaram will stand in front of the nation on 29 February and deliver what could be the final Budget of this government. He will almost certainly announce that the government has met the fiscal deficit target that was announced a year ago. He is also likely to say that the government is on course to meet the deficit targets imposed upon it by the Fiscal Responsibility and Budget Management (FRBM) Act of 2003.

But the official deficit number will be misleading. The official Budget numbers will look impressive because of strong revenue growth rather than spending discipline. But the government has been running a parallel deficit that has been kept out of its books through accounting fudges. If we add these off-budget liabilities—including oil and food bonds worth close to 1% of gross domestic product, or GDP, that have been sold to offset the losses on fuel and food subsidies—to the official Budget figures, then the government’s finances will not seem as impressive as claimed by the finance ministry.

Several economists have already pointed this out. The International Monetary Fund (IMF) says in its latest staff report on India that if off-budget bond issuance and the deficits of state governments are added to the official government numbers, then India’s fiscal deficit is around 7.25% of GDP. That’s intolerably high. “Overall fiscal consolidation has…stalled. (The) general government deficit has hovered at just over 7% of GDP since 2004-05.”

The fiscal gains of the past few years are, thus, part illusion.

Even if one ignores the excursions into smart accounting, India’s fiscal record is not as impressive as it seems at first glance. True, the fiscal deficit for 2007-08 is far lower than what it was at the beginning of this decade. But India’s fiscal deficit is still far higher than the budget gap in most other emerging markets. China, for example, has a small budget surplus.

This government has frittered away a wonderful opportunity to put its finances in order and get rid of our most persistent macroeconomic problem. India has witnessed an economic boom that is unmatched in its history. Tax collections have soared. But so have expenditures. Other countries— notably the US in the 1990s—used strong economic growth to set their financial houses in order. We haven’t.

The recent record suggests that the Indian government—irrespective of the party in power—is incapable of being fiscally disciplined in even the most benign economic circumstances.

The only instances in the recent past when there have been serious attempts to control deficits were in the early 1990s and the early years of this decade. In the early 1990s, the stiff conditions attached to the IMF loan forced the government to slash its deficit. And then in the early years of this decade, the National Democratic Alliance government agreed to tie its own hands by passing the FRBM Act in 2003.

Other countries have also used fiscal responsibility laws to curb government profligacy. New Zealand introduced a Fiscal Responsibility Act in 1994. In the US, after the failure of the Gramm-Rudman-Hollings Act during the Reagan era, the Budget Enforcement Act of 1990 paved the way for a bipartisan push to balance the budget there. The European Union’s Growth and Stability Pact of 1997 is another exemplar legislation.

The most practical way to avoid such fiscal stress is to tie the government down with binding constraints. FRBM has been a welcome piece of legislation. In its original form, this law expected the Union government to bring down its fiscal deficit down to 3% of GDP and wipe out its revenue deficit by this year. The government later pushed the deadline to 2009.

Despite the burgeoning off-budget liabilities, there is little doubt that FRBM did help prevent worse fiscal excesses. The problem is that the FRBM law has given numerical targets till 2009—and targets that were impressive at a time when the deficit was close to 6% of GDP and economic growth was sluggish. But these targets now look quite modest.

And there are no numerical targets for the years beyond 2009. Given the economic boom and strong growth in tax collections, India now needs a fresh set of stiff and binding deficit reduction targets. Or a new fiscal pact that will force the government to further cut its deficit over the next five years.

High deficits are not an economist’s irrelevant obsession. The Reserve Bank of India (RBI) is under immense pressure to cut interest rates, despite resurgent inflation. But what the central bank’s critics often do not say is that India cannot run a slack monetary policy when it also has such a loose fiscal policy. One of the two policy screws has to be tightened at this juncture—to keep effective demand and inflation under control.

In other words, the high government deficit restricts RBI’s ability to cut interest rates

Your comments are welcome at cafeeconomics@livemint.com

A menu of dilemmas

Governments will have to negotiate many tough choices in their battle against rapidly rising food prices

Cafe Economics | Niranjan Rajadhyaksha

The images from the global food crisis are grim. A smouldering slum in Haiti after food riots there. Thai farmers protecting rice farms from looters. Winding queues outside provision stores in the Philippines. Soldiers guarding grain supplies in Africa. World Bank president Robert Zoellick says that the near doubling of food prices over the past three years could push 100 million people deeper into poverty. Finance minister P. Chidambaram has said that the diversion of crops to make biofuels rather than feed people is a crime against humanity.

Tough words. The food crisis could be a temporary scare that will wither away with the next harvest. Or, it could be the first section on the road to a bigger humanitarian calamity. Either way, what has happened in these past few months should ideally be a wake-up call for a world that did not pay too much attention to agriculture over the past couple of decades.

There will be several policy dilemmas to deal with in the months ahead. Here, I will outline a few.

First, whom should the government protect: farmers or consumers? High food prices are good news for those who are net sellers of the stuff. Their relative incomes would rise. But higher prices of food will feed inflation expectations in the rest of the economy and could lead to spiralling demands for wage hikes in the industrial and services sector. Interest rates would rise. Higher wages and borrowing costs will eat into corporate profits.

Second, what should be done to boost farm output? The current rush to ban exports of some types of food and cut import duties on others is a temporary fix. The only viable long-term solution is to increase farm productivity and output. But artificially suppressing food prices will be a disincentive for farmers to work harder and take more risks. So, there is an inevitable tension between the short-term and long-term measures needed to tackle food shortages.

Third, if price controls and fiscal measures to keep down food prices will harm incentives to increase farm output, what should the government do to protect poor consumers? The only viable strategy right now is to let the food subsidy rise. This means the government buys food from farmers at market rates and sells it through the public distribution system at low prices. The difference will be met through the budget. But then there is also the task of keeping the fiscal deficit under control. I think a higher food subsidy should be balanced with deep cuts in other subsidies. That’ll be a political minefield.

Fourth, who will come up with the money and technology needed to boost long-term farm output—the private sector or the government? It is unlikely that debt-ridden farmers will have either the money or the appetite to take large risks at this point of time. The government needs to step in. But how? Till around the mid-1980s, public investment accounted for a majority of the total government spending on agriculture. Since then, subsidies have become the more important intervention. By the early years of this decade, public investment was a little more than 1% of gross domestic product (GDP) while subsidies were more than 6% of GDP. The government needs to figure out ways to reverse the balance between the two—spending far more money on rural infrastructure rather than subsidies.

Fifth, what role can global trade play? The Doha round of trade talks has made little progress in breaking down trade barriers on agriculture. We are now seeing opportunistic cuts in import duties as countries try to ship in cheaper food. But then there are also bans on exports as countries try to keep food within national borders. Yet, there is still the broader issue of what can happen to the liberalization of global trade in agriculture.

World Bank’s Zoellick said in a recent speech: “If ever there is a time to cut distorting agricultural subsidies and open markets for food imports, it must be now. If not now, when?” The entire premise of the trade talks was that agricultural subsidies in Europe and the US were artificially keeping down the global price of food and other farm commodities such as cotton. Open trade would push up their prices and help millions of impoverished Asian and African farmers.

“Wouldn’t the removal of these distorting policies raise world prices in agriculture even further? And, in fact, aren’t these price effects the main channel through which agricultural trade liberalization in the North is supposed to benefit the South?” asks Harvard University economist Dani Rodrik on his blog.

With food inflation a growing threat, the unexpected policy lesson is that the subsidies that the European and US governments give to their farmers are keeping the price of food down globally. So, in effect, these are subsidies that are paid by taxpayers in rich countries to help urban consumers in poor countries.

Are our trade negotiators barking up the wrong tree by asking the rich nations to cut the subsidies they give to their farmers?

Your comments are welcome at ­cafeeconomics@livemint.com

Escaping caste traps

An experiment by two economists shows people can lose out even when there is little overt caste discrimination

Cafe Economics | Niranjan Rajadhyaksha

A neat little experiment conducted by two economists in 2004 tells us a lot about a very contemporary debate —the persistence of caste traps. It is useful to revisit their experiment at a time when the reservations debate has flared up once again. This experiment suggests that caste is a deep-rooted problem that can persist despite laws banning discrimination as well as more specific interventions such as selective reservations.

Karla Hoff of the World Bank and Priyanka Pandey of Pennsylvania State University collected a group of 622 boys and girls at a junior high school in a village in Uttar Pradesh. They wanted to find out the effects of caste on performance. These students were in classes VI and VII. Half were from the so-called upper castes and the other half from the so-called lower castes.

The children were asked to solve a maze. Those who successfully completed the game were rewarded with money. So, there was a clear economic incentive to play the game for the benefit of the researchers. At first, the castes of the participating children were kept secret. There was very little difference between the success rates of children across castes during this part of the experiment.

Then the castes of the participating children were publicly announced during a second round of the experiment. The lower-caste children suddenly performed significantly worse during this round. The number of mazes that they successfully solved fell by a quarter.

The results of these trials show that people can continue to be victims of caste and racial stereotypes even when there is no legal discrimination in a society. We are aware of how biases affect the way people from certain castes are perceived. The problem here is different: Stereotypes become self-fulfilling. People tend to unconsciously behave in accordance with the way they are stereotyped. Similar experiments have been conducted in the US. One shows how the performance of black Americans taking the Graduate Record Examination (GRE) slipped when they filled questionnaires asking them to reveal their race.

Such experiments show that people tend to conform to stereotypes—and could lose out in life though there is little overt discrimination.

There are several reasons to be wary of jumping to any grand conclusions from the results of one experiment. First, the Hoff-Pandey trial was conducted in rural Uttar Pradesh, a region that has seen far less social reform, economic development and mobility than many other parts of India. So, it is an unrepresentative region in many ways. And the results cannot be used for national policy.

Second, the current debates on reservations in education are focused on the intermediate castes rather than the lower castes. Members of these castes have never suffered the brutal discrimination that the Dalits faced over the centuries. I doubt the caste factor would be so important in case the two groups of children solving the maze were from the “upper” and “intermediate” castes.

One solution is to create or support a “big push” to break the fetters of caste stereotypes. “Policies attempting to reduce inequalities need to be highly cognizant of the prevailing cultural norms. In the low-caste case, for example, simply giving supply-side incentives or reservations alone may not solve the problem. The tug of the prevailing norms can be stronger than material interests. The flip side of this logic produces a classic “big push” type of argument. If some small group of individuals who are typically discriminated against does manage to break the norms and succeed, the effect can be powerful. They can serve as role models for many others and remove at least the norm-induced barrier,” says Harvard economist Sendhil Mullainathan in a recent paper.

This happened in Maharashtra with the success of B.R. Ambedkar, who showed millions that there could be a life beyond the traditional demeaning jobs that others in his caste were condemned to. One example: Narendra Jadhav, who grew up in the slums of Mumbai, rose to become chief economist of the Reserve Bank of India and is now vice-chancellor of Pune University, writes in his autobiography how as a child his aim in life was to become a petty gangster. That was what his peers became. It was the Ambedkar movement that led Jadhav to the road to success. He, too, is now a role model for the next generation of Dalits.

Finally, hear what the World Bank says in its World Development Report 2006: “Discrimination and stereotyping have been found to lower the self-esteem, effort and performance of individuals in the groups discriminated against. This reduces their potential for individual growth and their ability to contribute to the economy.”

Caste is a tricky issue and there can be no easy answers. But, it is unfortunate that the debates all around us depend more on passion rather than fact. Meanwhile, cynical politicians such as Arjun Singh can play the divide-and- rule game.

Your comments are welcome at cafeeconomics@livemint.com

Finders and seekers

Innovation has many dimensions

Cafe Economics | Niranjan Rajadhyaksha

This year marks the 125th anniversary of the patron economist of innovation. Joseph Schumpeter was born on 8 February 1883 — and his work on innovation and the role of the entrepreneur continues to be a beacon to economists, businessmen, management consultants and venture capitalists. Economist Lawrence Summers has said that the 21st century will be the century of Schumpeter.

It is usually believed that true innovation emerges out of the tinkering of smart people in labs, garages and university dorms. Think of Larry Page, Sergey Brin and Google. But there is also the structured innovation that comes from large companies. Think of the team of engineers at Tata Motors who designed the Nano. We usually tend to underplay the importance of the corporate innovation, especially if it is part of a slow-burn process of incremental advance.

Schumpeter often wrote later in his life that large companies, too, could be hotbeds of innovation. “By the mid-20th century”, writes his biographer Thomas K. McCraw, (Schumpeter) was arguing that innovation “within the shells of existing corporations offers a much more convenient access to the entrepreneurial functions that existed in the world of owner-managed firms”. In other words, it isn’t necessary to start your own firm to satisfy your entrepreneurial urges; you can do it within the innards of a large company.

Innovation has many dimensions. One of the most fascinating research programmes that I have come across in recent years is that of David Galenson, a professor of economics at the University of Chicago. In a series of papers that he has published over the past decade, Galenson has identified two types of innovators — the conceptual innovators and the experimental innovators.

Galenson says that the conceptual innovators are the finders. They make bold leaps and challenge the existing way of looking at the world and doing things. This group mostly does its best work at an early age. The experimental innovators are seekers who gradually reach their goal, taking one step at a time. Their best work usually gets done later in life.

Galenson derives his insights by studying artistic achievement. He has recently published two new papers for the National Bureau of Economic Research (NBER) in the US. Take the movies — and two directors born in 1930. Jean-Luc Godard changed the grammar of cinema when he was in his 30s, but declined later. Clint Eastwood did not pick up the director’s megaphone till he was past the age of 40; and his best directorial work has come in his 60s. Godard directed Breathless when he was 30 while Eastwood made Letters From Iwo Jima at the age of 76. Galenson says that Godard was a conceptual innovator while Eastwood is an experimental innovator.

Cinema is just one arena where Galenson has picked his insights. The same patterns of innovation can be seen in other arts such as architecture, poetry, painting and novel writing. So Pablo Picasso was a conceptual innovator. Paul Cezanne was an experimental innovator. Among poets, T.S. Eliot was in the first category while Robert Frost was in the second. Among novelists, Ernest Hemmingway produced his best work at an early age while William Faulkner gave us his classics later in his life. “The elegant and sophisticated poetry of Cummings, Eliot, Pound, and Wilbur grew primarily out of imagination and study of literary history, and was formulated conceptually, while Bishop, Frost, Lowell, Moore, Stevens, and Williams produced poetry rooted in real speech and experience, drawing on the observed reality of their daily lives to innovate experimentally,” wrote Galenson in a 2003 article.

Galenson’s insights can be adapted to the world of business and innovation. Some businessmen strike like lightning at a young age. Others gradually come into their own later in their life. It is fair to say that Bill Gates was at his best in the early years of Microsoft. Sam Walton changed the retailing industry only much after he had moved into middle age. His innovations took place at a glacial pace, and were not the result of one inspired idea but gradual learning born out of experience. Steve Jobs seems to have magically transcended the divide.

Other economists too have tried to understand the interplay between drastic and incremental innovation. One group, for instance, believes that upstream firms usually produce drastic innovations while downstream firms tend to use these drastic innovations to produce their own incremental innovation.

Coming back to Galenson’s two categories of innovators, perhaps the distinction between the seekers and finders extends to national innovation systems as well. Would it be correct to say that the US is a nation of seekers while Japan is a nation of finders? And what about India? And Indian industry? Are we more finders or seekers? I invite readers to write in with their answers to these questions.

Smith, Ricardo and the FM

Will high food prices strangle growth? The differing views of Adam Smith and David Ricardo can shed light

Cafe Economics | Niranjan Rajadhyaksha

Is it time to revive a dusty debate that goes all the way back to the birth of modern economics? That old dispute could help us understand a contemporary issue: How will high food prices and volatile farm output affect economic growth in the long run?

That there are concerns on this score is evident. Global food prices have been on fire over the past year. Farm productivity is stagnant. Arable land is being lost to urban expansion and climate change. Food security of the poorest could be under threat.

In his Budget speech of 29 February, finance minister P. Chidambaram made several mentions of the risks from high food prices and the near-stagnation in agriculture. He noted that capital formation in agriculture has increased from a low of 10.2% of India’s gross domestic product (GDP) in 2003-04 to 12.5% in 2006-07. He also added that farm investment has to rise further to 16% of GDP if India is to sustain 4% growth in agricultural output. While Chidambaram seemed more concerned about the immediate impact of sluggish farm output on inflation, there should be longer-term concerns about the impact on economic growth as well.

The 18th century English economist, David Ricardo, believed that societies would be forced to cultivate increasingly less fertile land as demand for food expanded. Food prices would rise, pushing up wages and rents. This would leave a smaller part of the national income for profits. Low profits would make new investments unattractive to the capitalist class. Ricardo believed that the capitalist economy would eventually settle into a stationary state of zero growth.

Ricardo was proved wrong. The discovery of the Americas led to a sudden increase in the supply of high-quality land. Technical improvements increased farm productivity. Relative prices of food have fallen dramatically over the past century. But the Ricardian belief that an agricultural pinch would act as a constraint on economic growth got a fresh lease of life in the development debates of the 1950s.

The early development debates in the 1950s in India and elsewhere took a lot from Ricardo’s glum talk about constraints on growth. Our textbooks told us how India has to ration scarce savings, foreign exchange and food if it is to grow.

Prime Minister Manmohan Singh mentioned these issues in a speech he gave on 7 February 2007. “In the past it used to be said that India’s economic growth was being held back by a trinity of internal and external constraints—a foreign exchange constraint, a food and wage goods constraint and a savings constraint. Today, we can say with confidence that we have broken each of these constraints,” he said. He also added that India now faces a new set of constraints such as poor infrastructure and the shortage of skilled manpower.

Have we really broken the food and wage goods constraint? Perhaps. But what if we haven’t? Would India be condemned to low economic growth because food inflation will push up wages and compress profits? Not necessarily, if we go by the perspective of another old economist Adam Smith.

Smith came before Ricardo. His was the more optimistic view. This 17th century Scottish economist believed that the division of labour and specialization would spur innovation and growth. No stationary state for him.

In a recent blog post on economic history, Mark Koyama of Oxford University compared the two views of economic growth. “There are, broadly speaking, two different perspectives in economic history: a Ricardian/Malthusian perspective…emphasizes the significance of the constraints that bound pre-industrial economies… This view was certainly the dominant view amongst economic historians in the post-war period and it seems also to have dominated discussions in development—particularly the emphasis on importance natural resources, savings and population control and the comparative neglect of institutional considerations that typified the approach taken in the 1950s and the 1960s follows from a Ricardian paradigm,” writes Koyama. He earlier described “Smithian growth based upon falling transactions costs and increases in specialization and the division of labour.”

Coming back to our own day and age, the question then is: Will higher food prices be an inevitable Ricardian constraint that will damage long-term economic growth or will more reforms in agriculture and related industries such as retailing help spur growth through more specialization and falling transaction costs?

It perhaps seems a bit odd that what Smith and Ricardo wrote around 200 years ago should continue to be so relevant in the 21st century. But then great economics is like a great book. Every new generation finds fresh meanings and insights from the old classics.

So: Smith or Ricardo? Who’s your choice?