Any differences in the growth of the 90's to the growth of the 2000's

As the heading states, the subject for the current post is to see if there are any major differences in the reasons for growth that took place in in the 90's and the growth that has taken place in the first decade of 21st century. Currently I am reading a book titled, " Why Nations Fail", the main thrust of the book is that only growth that is backed by inclusive political and economic institutions leads to sustainable growth. In case either of the two are not present, we could see spurts of growth which would not be sustainable in the long run. These days we are seeing many news articles about the growth of private companies over the last decade is not due to any productivity or innovation led growth but due to their ability to obtain natural resources at a low cost. So does it mean the growth has been due to extractive economic institutions?

The main drivers of growth of the 90's was, as expected, the growth of services space especially the trade/hotel/communications space( CAGR of 7%) and the financial services/real estate/business services (CAGR of 7%) in the '90-'99 period. For the next period of 10 years, the main factors of the growth were the above two in addition to the strong performance of the construction sector (CAGR of ~10%). The strong growth of the construction sector is evident in the period from 2004-2009, wherein the growth was in double digits. This was the period wherein the CAGR of the gross capital formation of the private corporate sector and the public sector was ~14% whereas the household capital formation CAGR fell to 9% from 14% for the '90's.

The above data points shows the strong performance of the infrastructure sector. Thus the growth of the 2004-2010 period has been in both non-construction services sector growth plus the construction side growth. 

It is this construction side that is facing issues post 2010, the growth rates for the last 3 years has been 7% in 2010, 8% in 2011 and 5% in 2012. The growth of the mining sector which also was growing at nearly 5% p.a. since 1990 has slowed down to NIL growth over the last two years.The dismal performance of these sectors has been one of the major causes for the slowdown of the Indian economy over the last 2-3 years. The growth of the infrastructure space is the main difference between the growth of the 90's and the growth of the first decade of the 2000.

Does this slowdown have to do with the fact that most of the construction and mining related activities were undertaken or given to companies on a preferential basis and thus leading to an situation of existence of extractive economic institutions? The current fight regarding the coal mines allocation is an instance of the existence of these extractive economic institutions and the instability these institutions are facing due to stronger oversight of the other institutions in the country. Due this the growth from these extractive economic institutions has gone and as evident in the slowdown in the infrastructure growth.

Bubbles: Is it possible for it to be used advantageously?

The first time it heard the word bubble was during the 2000-2001 tech heady days when everything related to computers/software was supposed to be a great money spinner. A bubble is used to describe a situation where the market value of an asset is far higher than its actual intrinsic value. But, the term bubble has another interesting meaning, which i learnt in an economics course. A bubble is nothing but a vehicle for transfer of wealth from one entity to another, it is a vehicle used for such transfers. This is in line with happens practically during a boom phase, there is a transfer of wealth as the buyer of an over inflated asset is primarily paying far more than the asset's actual value to the seller. The actual transfer happens during the act of buying/selling but it manifests only in the bust phase.

Of all the critical issues that a country faces today is the lop sided income distributions and the need to effectuate a redistribution of the same. In effect a transfer of wealth has to take place from one set of people to another set. So can a bubble be used as a method for achieving the same? Now let us look at the various types of bubbles that are generally created,

1. Financial bubble: In this type of bubble, the transfer of wealth takes place primarily through the financial markets like the stock market. The last two bubbles have been financial bubbles.

2. Infrastructure bubble: In this type of bubble, the transfer of wealth takes place primarily through the construction of lot of unwanted physical infrastructure.

3. Inter-generational bubble: This is type of bubble, in which the a transfer of wealth occurs from one generation to another. Generally, these are most prevalent types of bubbles these days, but are very subtle and not as apparent as the Financial bubbles. One type is where there is a transfer is primarily as loans taken by one generation which is repaid by the next. Another example, is the pension system, wherein the second generation pays for the first generation. These type of bubbles take a long time to come into becoming a focus point and once detected the problem becomes quite large to be easily diffused.

4. Information bubble: In this type the primary reason for the transfer is the mismatch in information between one party and another party. This is also know by another name, as corruption

So which of the above, are bubbles through which transfers can take place. Financial and Information bubbles achieve primarily the opposite of what we have set out to achieve. In these bubbles, a small group garners the wealth from the the larger group.

The system that has been used by all till now for achieving the transfer has been through Inter-generational bubbles. Governments have used this either through subsidies, money transfers which have lead to these governments having to borrow money (like Indian government). The costs of which are borne by the future generations. Another system is where the Governments have provided for all expenses of its citizens and have funded the same through high tax rates ( like European countries).

Infrastructure bubble is one system which has lead to increased per ca pita growth across all sectors of the society. This bubble leads to creation of employment opportunities which in tern leads to generation of wealth in the hands of the people. However care has to be taken to ensure that the benefits of this are widespread rather than concentrated on one section of the society, which is easier said than done. Does this mean all the development needs to be undertaken by the government or the entire development should be regulated or it should be a free market without any restrictions. Each of the above options leads to inefficiencies in the system, only government led development would lead to restricted development as the government cannot take up all the works at once. A free market economy without any restrictions would lead to a high level of development however the financing of the same and the ensuing defaults due to the extensive development shall lead to the costs being borne by the populace. This process shall lead to a temporary spurt of development followed by a bust phase.

A combination of the free market and regulated development is ideal combination. Developments in countries like Korea, Japan (pre 1980's) in their earlier phase of development were a kind of this type of development. The entire focus of the country was in developing export industries and developing strong R&D base. This kind of regulated development created a bubble wherein there was a transfer of wealth from the richer countries to population in these countries.