Two mega-themes about India and one disturbing one about America

1. India’s per capita income in PPP terms recently breached $3000 and its savings to GDP ratio stands at a healthy 32%. Cross-country experience suggests that India’s savings ratio should touch ~40% in FY15 and will continue to rise until India’s per capita income reaches $8000 (in PPP terms) and will max out at 46%. The disproportionate rise in the quantum of India’s savings over the next decade heralds tremendous opportunities for financial intermediaries -- as the Indian saver looks to channelize these savings into not just bank accounts but into stocks and bonds as well.

2. This rise in per capita income will also propel consumer aspirations not jsut towards staples, but also things like jewelery, bikes, cosmetics, etc. In fact, "aspirational" stocks have been outperforming consumer essentials.

3. Much has been written about the growing income inequality in America. The top 1% of Americans owns 34% of America’s private net worth, according to figures compiled by the Economic Policy Institute in Washington. The bottom 90% owns just 29%. That also means that the top 10% controls more than 70% of Americans’ total net worth.

With the Republicans controlling Congress now, they have decided to spend $700 billion on extending the Bush tax cuts to those with incomes above $250,000 a year. Why not rather give that money to the unemployed -- as they, rather than the rich, are more likely to spend it out. What a contrast to the Indian side of the story -- with their savings attitude being favored.

So how does income inequality come about? Free trade, suggest some. Here are some relevant ideas...

The Stolper-Samuelson theorem states that:

"An increase in the price of a good will cause an increase in the price of the factor used intensively in that industry and a decrease in the price of the other factor."

So, say if a shoes costs more, the intensive factor (labor) increases and other factors such as corporate profits (more precisely, returns on capital) decrease. But US, with it higher capital-to-labor ratio, will help its citizen have higher wages than others. Now here is the twist. Free trade will tend to equalize wages internationally. This means Mexican and Chinese wages will rise as U.S. wages will fall. It’s called the Factor Price Equalization theorem:

...when the prices of the output goods are equalized between countries as they move to free trade, then the prices of the factors (capital and labor) will also be equalized between countries. This implies that free trade will equalize the wages of workers and the rents earned on capital throughout the world. The theorem derives from the assumptions of the model, the most critical of which is the assumption that the two countries share the same production technology and that markets are perfectly competitive.

But the twist within the twist is what is called the Leonteif Paradox. Arrived by the Russian economist Wassily Leonteif, who won the Nobel in Economics, the Paradox is simple yet profound.

"...the US—the most capital abundant country in the world by any criterion—exported labor-intensive commodities and imported capital-intensive commodities."

So, why on earth, will US do such a thing?

"Leontief himself suggested an explanation for his own paradox. He argued that US workers may be more efficient than foreign workers. Perhaps U.S. workers were three times as effective as foreign workers. Note that this increased effectiveness of the American workers was not due to a higher capital-labor ratio, because we assume that countries have identical technologies and hence identical capital- labor ratios.

It means that the average American worker is three times as effective as he would be in the foreign country. Given the same capital-to-labor ratio, Leontief attributed the superior efficiency of American labor to superior economic organization and economic incentives in the U.S. However, Leontief found very few believers among economists."

Russians, like Americans, had wonderful technologies by their side but what the former lacked and the latter provided was incentives. It is technologies and human capital that have become the comparitive advantages of the Ricardian model. Indians too are no good being Indian, but once they transform themselves into American workers is when the real boost of effeciency factors in.

I would like to end with a note on Obama's recent visit to India. He bought with him a full contingent of American elite businesspeople who helped set the business tone of the visit. Obama hardly has any business to do with India except encouraging enterprises. Visit to terror-hit centres and interactions with terrifically dumb Indian students is at best a wonderful facade. There was talk about free trade and this is what I'm excited about.

Free trade, one commentator long back, renamed it better as "managed trade”. It is a dense web of bargaining and deal-making among governments and multinational corporations, all with self-interested objectives that the marketplace doesn’t determine or deliver. Every sovereign nation, the US included, uses its vast arsenal of policies to pursue its national interest.

But there is a catch here. Western Europe, whatever its problems, manages economic policy to maintain modest trade surpluses. Japan manages to insure far larger surpluses in recessions (its export income subsidizes inefficient domestic employers). China strives to acquire a larger, more advanced industrial base at the expense of worker incomes and bank profits. Germany and Japan, despite vast differences, both manage to keep advanced manufacturing sectors anchored at home and to defend domestic wage levels and social guarantees. When they do disperse production and jobs overseas, as they must, they do so strategically.

By contrast, Washington defines ”national interest” primarily in terms of advancing the global reach of our multinational enterprises. The distinctive power of America’s globalized companies is reflected in trade patterns. Nearly half of American exports and imports are not traded in open markets — the price auction idealized by neoclassical economics; but within the companies themselves, moving materials and components back and forth among their far-flung factories. A trade deficit does not show on the company’s balance sheet, only on the nation’s. And in recent years, much of the trade deficit has reflected the value-added production and jobs that companies moved elsewhere.