Monday, February 20, 2012


Internet Poster's Question:
I am not a economist, but just a simple question: What does India really make to warrant its economic growth? Only thing that I have experienced is the frustrating call center service from India. Don't think India really export any agriculture, natural resources, or anything else high tech. So really, what is India doing to generate wealth?

My Answer:
GDP does not equal the trade imbalance, or even exports. It is a measure of goods & services provided. Keep in mind that Earth does not export anything to Mars, Pluto or other planets, and yet you would agree that us Earthlings have become wealthier from 4000BC til present day. Earthlings enjoy televisions, internet, cellphones, and all the comforts we know despite never exporting to Mars and Pluto. That is because wealth doesn't merely come from exporting, it comes from producing. India has a large domestic industry, producing a multitude of goods, as well as various services like tailors, spas, restaurants, etc. to a population that equals 1.2 Billion people, the same as Earth's entire population in 1850.

Is India self-sufficient? No. It lacks one key resource: oil, which is by and far India's largest import. The largest export industries for India are textiles, agriculture, steel, automobiles, pharmaceuticals, and the smallest of its exports are its IT related services like call centers and software. Will India improve its exports? Yes, slowly. Why does India have tiny exports? Part of it is that India did not open its economy until the early 1990s; China, by contrast, opened its economy in the late 1970s / early 1980s as part of Nixon's ping-pong diplomacy. A closed economy does not trade very much with outside economies, usually achieved with high tariffs to discourage trade, and restrictive rules regarding foreigners opening shop in the country.

Why were China and India once closed economies? Security. A closed economy is immune from sanctions and other trading decisions of a foreign market. An open economy can become (dangerously) reliant on some key component, say, rubber, that can be turned off by the foreign supplier at any time, or used to extort the fledgling nation. During WW2, the allies stopped trading with Germany, and Germany suddenly lost key items like rubber and helium. This led to them trying to use hydrogen instead of helium on their airships, and that led to the Hindenburg fire. Also, foreign companies can engage in hostile takeovers of domestic companies, or product dumping, and this also leads to a security problem. For example, Domino's Pizza in the U.S. was known to sell a large pizza for $5 in a market that ordinarily charged $12, a ridiculously low price that lost them money; however, this ensured all competing pizzerias in the area went out of business, after which Domino's Pizza would raise their prices to $20. For a fledgling nation with small companies, the potential for a larger foreign company to use this practice was a threat.

Why did they open their economy? Trade imbalance. Despite being a closed economy, certain items, like oil, needed to be imported. These imports need to be paid in a currency the seller desires. Oil is sold in U.S. dollars, and the only way countries like India and China can acquire U.S. dollars is by (i) exporting, (ii) foreign direct investment (FDIs), or (iii) borrowing. Borrowing only delays the problem, since if they borrow U.S. dollars, they owe more U.S. dollars at a later date. FDIs are when, say, an American company wants to create an Indian subsidiary. All the Indian construction workers to erect the offices, employees, and local computers and other goods, need to be paid for in rupees, the local Indian currency. The American company exchanges some of its U.S. dollars for Indian rupees to achieve this in order to invest rupees into their Indian subsidiary. This currency exchange leaves India with some U.S. dollars and the American company with Indian rupees. India can then spend those U.S. dollars to buy oil. Exports are the simplest to explain: Indian companies sell some item to the consumers in the U.S., and are paid U.S. dollars. The U.S. is actually a really bad exporter, as our trade deficit shows, but the U.S. dollar can be spent to buy oil, which is by and far the most valuable product sold for U.S. dollars.

China actually has a problem in that it has too much U.S. currency. How on earth can you have too much? Because U.S. currency can only be spent in certain ways, such as buying oil, and China acquires more U.S. dollars each year than its need to buy oil. The excess money it then re-invests into U.S. treasuries, earning interest, since it can't spend it. The U.S. treasury interest is only 5% whereas China's domestic market is growing at 14%, so it would much rather invest that money for higher growth than 5%, but can't.

This is also why the world watches with bated breath as several oil-producing nations have been grumbling about the weakening U.S. dollar and contemplate selling oil for other items, like a basket of currencies. Iran, under recent trade sanctions by the U.S. and Europe, is rumored to be in negotiations to sell oil for Chinese yuan. If oil is no longer U.S. dollar denominated, it radically changes the global trade dynamics, since much of the value of the U.S. dollar is in buying this key commodity. It is also why the U.S. has such huge vested interest in the middle-east.

I hope that helps give an introduction to world economics and currencies.

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