India Rising

The Daily Reckoning PRESENTS: The dawn of the Information Age has allowed, among other things, India’s economy to flourish – while providing the West with a seemingly never-ending supply of skilled workers at a fraction of the price it would cost at home. Charles Sizemore explains…

INDIA RISING

Chances are good that you have found yourself in the following situation: You call your phone company or credit card bank to ask a question about your bill, and your call is taken by a friendly man with a distinct accent named “John.”

After some short pleasantries, John walks you through your bill step-by-step – from a call center halfway across the world in India.

Coupled with the trend in globalization, the communications technology revolution of the 1990s has transformed an impoverished, sclerotic, Soviet-inspired state into a booming center of world capitalism in which businessmen like Bill Gates are greeted with more pomp and circumstance than most visiting heads of state. Despite the economic reforms of the past two decades, India’s state sector still resembles the decrepit socialist experiment described above. Perhaps even worse, most of India’s roads are in abysmal repair, and the traffic congestion in most cities is bad enough to make Los Angeles rush hour look appealing. Moreover, living conditions for large segments of India’s population are appalling. The Financial Times reports that there is one toilet for every 1,500 people in some of the poorer parts of Mumbai (previously known as Bombay).

The good news is that the power of information technology has allowed the new economy to largely bypass the state and its rickety infrastructure altogether. It has also brought unprecedented wealth to India’s educated middle class while supplying the West with a vast supply of skilled knowledge workers at a fraction of the price it would cost at home.

This new generation of young professionals is earning and spending at an unprecedented rate for India, and this trend will only continue as they progress through their life cycles – marrying, buying homes, and raising their children – spending ever more in the “keeping up with the Jones’s” tradition of Middle America. Even though the country is still in the early stages of its economic modernization, over the longer term India’s prospects are brighter than those of China, South Korea and Taiwan. In the July/August 2006 edition of Foreign Affairs, Gurcharan Das published an insightful article titled “The India Model” that explains how the country has taken a very different path from most of its contemporaries in Asia. It is one particular development – the emergence of a viable domestic consumer economy – that we at HS Dent find particularly appealing:

“In the past two decades, the size of the middle class has quadrupled (to almost 250 million people)…At the same time, population growth has slowed from the historic rate of 2.2 percent a year to 1.7 percent today – meaning that growth has brought large per capita income gains, from $1,178 to $3,051 (in terms of purchasing-power parity) since 1980. India is now the world’s fourth-largest economy. Soon it will surpass Japan to become the third-largest.

“The notable thing about India’s rise is not that it is new, but that its path has been unique. Rather than adopting the classic Asian strategy – exporting labor-intensive, low-priced manufactured goods to the West – India has relied on its domestic market more than exports, consumption more than investment, services more than industry, and high-tech more than low-skilled manufacturing. This approach has meant that the Indian economy has been mostly insulated from global downturns, showing a degree of stability that is as impressive as the rate of its expansion.”

This is a crucial point; with most of the developed world facing an unprecedented demographic-induced recession or even depression after 2010, countries that have viable domestic consumer markets should fare much better than those that are focused on exporting to the West. This makes India’s growth boom much more durable than that of, say, China. Das’s article points out that personal consumption accounts for 64% of India’s economy, compared to 58 percent for Europe, 55 percent for Japan, and 42 percent for China. As we have noted in the past, U.S. consumption has hovered around the 70% mark for many years, proving that a country can grow and prosper with a consumption-driven economy. In an economy dominated by services and information – like that of the US today and the one developing in India – savings and capital spending become less crucial to sustaining growth. China saves and then invests an enormous percentage of its GDP in building new manufacturing capacity, which puts China at a real risk for over-capacity and deflation in the event of downturn. India, in contrast, appears to be skipping the industrial phase of its development altogether and moving directly to services and information, thus looking much more “American” than any other developing country.

India’s demographics are slowly beginning to look more American. After decades of high birthrates and overpopulation, the country appears to be shifting away from the typical “Third World” population distribution in which perpetually high birthrates insure that the most productive members of society (primarily those aged 20 to 64) are a relatively small percentage of the population. The expense of raising this abundance of children (and the manpower taken out of the workforce to care for them) is an impediment to the development of a modern consumer economy, for better or worse.

Now, as more join the ranks of the middle class, Indian mothers are having fewer children, yet spending far more money on the ones they have, buying the basic consumer products that earlier generations simply had to do without. To see why this matters to the economy, think of it this way: profit margins are higher for store-bought disposable diapers than for home-made swaddling cloth. Add baby clothes, toys, and private piano lessons to the list of items purchased outside rather than produced at home, and it becomes obvious very quickly that a middle class lifestyle contributes far more to the economy than a traditional peasant one.

The leveling of the Indian birth rate is both an indication of the rise of the middle class as well as a contributing factor in its development. As India’s birthrate continues to decline, the population distribution should start to look more and more like that of the US, circa 1964 (at the end of the American Baby Boom). Expect India to boom as its enormous young population begins to move through its Spending Wave over the next 40-50 years much like the American Baby Boomers of the post-war generation.

India’s clout in the world economy will also continue to grow for another important reason. Unlike China, (whose total population is projected to peak around 2030) and Europe, Russia, and Japan (whose total populations have already peaked) India will continue to grow until approximately 2065.

Despite the overwhelmingly bullish case for India over the coming decades, it is important to remember that India is still an underdeveloped country and is at a much different stage than many other countries labeled as “developing,” such as South Korea or Taiwan. Per capita income is still pitifully low, on par with Iraq or Cuba, and India’s government is certainly not immune from the occasional populist rash of anti-globalization sentiment.

It’s unlikely that India would ever follow the example of, say, Venezuela, but there will definitely be setbacks that rattle investors. Even the United States, with its long tradition of free trade, has fallen into this trap recently, as the political grandstanding that killed the Dubai Ports deal in early 2006 made abundantly clear. Any political maneuvering in India or one of its major trading partners that undermines free trade could cause ugly – though most likely temporary – setbacks. India also has an unresolved conflict with Pakistan that could erupt into war at a moment’s notice.

Needless to say, India is volatile. The world-wide stock correction of this past summer that sent the S&P 500 down 8% took a full 30% cut out of Indian stocks. For this reason, while we are enthusiastic about India’s prospects, Indian stocks must be viewed with extreme caution and are best bought after substantial corrections.

Regards,

Charles Sizemore
for The Daily Reckoning
October 24, 2006

Editor’s Note: Charles Sizemore is an analyst for HS Dent Investment Management and a contributor to the HS Dent Forecast, Harry Dent’s monthly newsletter. Prior to joining the HS Dent research team, Charles covered the markets as a freelance journalist while earning his master’s degree in finance and accounting at the London School of Economics.

For more information on HS Dent’s research on demographics and the economy, please visit http://www.hsdent.com.

How much dirt do you have to move until you get rich?

Yesterday, we were looking at one of the biggest humbugs in the economic world – Gross Domestic Product. Today, we carry on…hoping to get somewhere.

If we pay someone to dig a big hole in the ground, the nation’s GDP will go up. The more holes we dig – the bigger…the deeper – the more the GDP increases. If we dig a hole big enough, the GDP will really soar. You can see why. You could employ a whole army of diggers…a whole fleet of Caterpillar tractors…thousands of gallons of fuel. If there were a small-town with a high unemployment rate, the problem could be easily solved – just dig a big hole on the outskirts of town! Readers will think we are joking. But serious economists have proposed similar things, and many public works projects – such as the Civilian Conservation Corps, in which our own father was enrolled during the Great Depression – did nothing more than that.

Big holes mean big spending, which leads to big GDP increases. And GDP increases means growing wealth for the people, right? Well, if it were really that easy, you’d see a lot more holes being dug. But it’s not that easy because, when you take resources – labor, fuel, machinery – and put them to work digging a gigantic hole, all you have to show for it is a hole in the ground. People are only ‘wealthier’ in the sense that, if they wanted a big hole in the ground, they’ve now got one. Unless you actually wanted dirt moved, you could move the Himalayas and not be a dime richer…because you would have squandered your wealth moving dirt -rather than producing the things that you really wanted.

GDP figures only make any sense at all when people are buying the things that add to their real wealth. If a city were bombed flat, for example, the GDP would go up as they rebuilt it; but they would be no better off. Nor are they better off when they are merely substituting one service for another of equal value. We mentioned yesterday what happens when a man pays someone to cut his lawn for him. If he did it himself, the GDP would remain the same. If he pays a neighbor to do it, the GDP goes up. If he pays his neighbor to mow his lawn…and his neighbor pays him to mow the neighbor’s lawn, the GDP goes up twice. Is anyone any richer? No.

But what about when a man hires his neighbor to cut his lawn so that he can watch a baseball game on TV? The nation’s GDP goes up. The man has given up money to get leisure. His neighbor has given up something, presumably leisure, to get money. Who’s better off?

We don’t know…but the society of these two men is hardly any richer.

But the real digging in the last few years has been to provide people with better houses. Whole mountains have been moved to provide roads, water, sewage, and foundations.

Surely, people are better off as a result, no? They have newer, bigger, better houses – equipped with granite countertops. The house is a tangible, useful thing. The householder can live in it. He can rent it out. He can pass it on to his heirs. Yes, the GDP went up – estimates vary about how much the housing boom of the 2002-2006 period added to GDP, with about 2 percentage points as the consensus view – but real wealth must have gone up too. Didn’t it?

We spoke about how easy it would be to make people rich if all you had to do were to dig holes. That didn’t seem like such a good idea; but suppose all you had to do was to build houses? Ah…there, you’d have something of real value at the end of it.

Why do policy makers hesitate? Why do they not just sign up plumbers, roofers, carpenters and the whole jolly cast of house builders to put up houses everywhere? ‘Give [us] your tired, your poor, your huddled masses,’ they could say to the whole world, ‘and we will give them a new split foyer…with granite countertops!’

Of course, there are other things of value, not just houses. Take automobiles, for example; if you can increase people’s real wealth – and the GDP – simply by building things of value, why not build more cars? Hummers! Yes, of course…GMC trucks too.

GM is in trouble – Ford too. Here’s a way to increase the GDP…and put Ford and GM back in business. And not only that, it would be a way to rebuild America’s failing manufacturing capacity.

Are you beginning to suspect that there might be a fly in the ointment, dear reader? We are.

If it was so easy, why didn’t the Soviets didn’t think of it? They had factories. They had labor. They had plenty of raw materials. They had a GDP too…and had GDP numbers that were the envy of the world, or at least that part of the benighted world that believed them. But instead of making people rich…the Soviet economy made them poor. Thanks to central planning, the Soviets were able to turn their economy into a value-subtracting system. The finished products were worth less than the raw materials that went into them.

What is the problem?

The problem, dear reader, is that wealth is not really measured in things – neither in houses nor automobiles. In fact, these things can actually hinder the creation of wealth, since they take resources from projects that might be more productive. And they then cost money to service, especially if they were purchased on credit. A house needs to be maintained; taxes need to be paid; it needs to be heated and cooled; it needs insurance; it needs furnishings. A new house is a blessing to a family that can afford it; it is a curse to a family that can’t.

In the great housing bubble of the 2000-2006 period, the dirt moved…but it left a big hole in the nation’s real prosperity.

More news:

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Chuck Butler, reporting from the EverBank world currency-trading desk in St. Louis:

“Japanese Finance Minister, Omi, fired a warning shot to the markets last night to stop taking liberties with the yen. Omi told the markets that the Finance Ministry ‘will keep closely monitoring currency moves and take appropriate actions if needed.'”

For the rest of this story, and for more market insights see today’s issue of The Daily Pfennig

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And more views:

*** “One market that is doing very well for us right now at Resource Trader Alert is OJ, and I anticipate it will go even higher,” came the report from our commodities guru, Kevin Kerr. “There are so many reasons this crop is in trouble. Let’s look at them again.”

“The OJ market has been on fire and the chart shows the parabolic movement. The USDA report that came out last week was absolutely abysmal. Juice skyrocketed $28 and is getting very close to $200.

“The crop estimates reiterated all the points I have been telling my subscribers. First and foremost, the orange crop has been decimated by citrus canker and other hurricane-related diseases that are just now really taking a toll, and will continue to for several years to come. On top of all that, the lack of migrant workers to harvest the fruit means that what little of the crop is edible is going to rot. So the USDA numbers could be the tip of the iceberg.

“I have been busy over at RTA as we grabbed profits on corn and huge profits on OJ. As both markets had less-than-happy crop reports, that meant it was payday for our long positions. Sure, but what’s a 150%, 200% or even 300% return – you don’t want that, right? LOL!”

*** We have previously expressed our admiration for our neighbor north of the 49th parallel. In spite of cold weather, bugs, loneliness and vast areas of desolate forest, the Canucks are doing okay.

Unlike the Americans, they are major exporters of energy…and they enjoy a positive trade balance. Not only that, they have surpluses in their federal government accounts, and are actually paying down their debts.

Shrewd investors are making bets on Canada, typically on its currency or its energy company. But along comes a suggestion from Grant’s Interest Rate Observer that caught our eye – a company swimming against the tide of history, and having a rough time of it – a paper company.

Abitibi is in the business of supplying paper products. One of its major product lines is newsprint. In case you haven’t heard, the newspaper industry is in trouble, thanks to the Internet. The electronic media is stealing away readers and advertising. Naturally, suppliers to the newspaper industry are feeling a little down in the dumps, too. They check their order books and find that there are fewer and fewer sales. Nor can they raise prices, because the entire industry has an over-supply.

Abitibi’s share price has fallen from a high of C$25 to a current low below C$3, or only half of book value. Speaking of Canadian paper stocks, an expert remarked, “I’ve never seen them this cheap.”

A general insight: things that are extraordinarily expensive tend to regress to a mean at which they are less expensive. Things that are extraordinarily cheap tend to regress to a mean in which they are not so cheap. Abitibi, and the entire paper industry, could be at a cyclical low. Or it could be headed to recycling.

*** Hedge-fund managers are not the only ones with a ‘heads I win, tails you lose’ pay scheme.

CEO pay often works the same way, says Paul Krugman in the New York Times.

In the 1970s, Krugman points out, executives earned about 40 times as much as the average worker. But then came the Reagan revolution. And with it came a new confidence in what ‘the market’ could achieve. By ‘the market,’ they meant financial incentives as opposed to social pressure, status, duty, convention, politics, raw fear or other motivating forces.

Professors of finance came along just when they were needed, with theories suggesting that corporate performance might improve if CEOs had more of a stake in the outcome. And so, America’s CEO got a break. The average full time working stiff earns $34,268 a year. Thanks to options and other incentives, CEO pay in America soared from 44 times the average to 367 times.

Some of this money came from the bull market on Wall Street. Options appreciated along with everything else, whether corporate performance improved or not. And if share prices didn’t go up, corporate compensation committees – often composed of friends and colleagues of the CEO – would sometimes cut the guy a bigger break, changing the pricing options or backdating them so that they paid off.

Cablevision Systems even gave stock options to a dead man, says Krugman, backdating an options package of a deceased CEO so his heirs could cash in.

Yesterday also brought news that the average pay on Wall Street has now reached almost $300,000, or about five times the average of the rest of the nation. Not only are they rich compared to everyone else, they are getting richer all the time. Brokers, analysts, and traders have seen their pay increase 21.9% in 2005 and 11.8% in ’05. Pay increases in the rest of the economy have been only nominal.

Of course, Krugman draws all the wrong conclusions from this. He thinks there is a problem of ‘corporate governance’ that requires ‘reform.’ He doesn’t seem to realize what is going on. The hustlers among the new proletariat – sharp talking CEOs, brokers, traders, analysts, and hedge-fund operators in expensive suits – are taking the slow-witted capitalists for a ride. But that is the way the system is supposed to work. A fool and his money are supposed to part company. Hedge-fund managers, overpaid CEOs, and custom kitchen designers merely speed along the process.