Mumbai as an International Financial Centre

Three fascinating new takes on Mumbai as an international financial centre:

A while ago, I had a blog post – – which collected together the MIFC report and the immense outpouring of responses to it at the time.

How do I think we are faring? Pretty much as expected:

  • India has not yet moved towards a deeper rewriting of the core financial laws, and redefinition of the role and function of government agencies in finance. But there is an increasing acceptance that this task is high on the TODO list of policy-makers, after the Patil, Mistry, Rajan and Aziz reports.
  • Some incremental change has come about, such as currency futures. SEBI is making good progress on strengthening the capital markets which will be the foundation of India’s play in the world of international financial services.
  • Bombay is making a little progress (or maybe not ). See my recent blog post: Two paths to good cities.
  • Participation in IFS production through BPO is continuing to grow rapidly. There is real capability building up in the labour market.
  • India’s de facto integration into the world economy took a knock in the crisis. The gross flows in and out of the country (across capital and current accounts) achieved a peak value of $211 billion in the September 2008 quarter.
    From that peak, there was a drop to $152 billion in the March 2009 quarter – this took India back to a value similar to that seen in September 2007.
    From that bottom, growth has begun again, and in the latest data (September 2009) this number is back up to $175 billion (which is bigger than the value seen in the December 2007 quarter but not yet the March 2007 quarter).
  • In the crisis, we have better understood that small countries like Iceland find it difficult to be a big international financial centre given the lack of a commensurate fiscal backstop. This improves India’s competitive positioning when compared with Singapore, Dubai or Qatar.

Europe VS. USA

In NY Times, Paul Krugman (link) wrote about the comparison of European and U.S economic model, concluding that in the last 10 years, the European model of social democracy led to higher standard of living and, compared to U.S in output per hour and standard of living, and relative convergence of European countries relative to the U.S respectively.

The real convergence is a complex mathematical and empirical issue, so I will rather outline the key patterns of GDP per capita gap between the U.S and Europe and the economic explanation of it. I downloaded the data from the IMF and composed a graph which shows the GDP per capita (PPP-adjusted) in European countries as a percentage of the U.S GDP per capita. Switzerland is the only European country whose level of GDP per capita is more than 90 percent of the U.S level. Ireland, where the output contracted by 7.5 percent in 2009 (link), was once the poorest country in the European Union. Today, its GDP per capita reached 85 percent of the U.S level. In spite of the notorious advantages of the Nordic model, the GDP per capita level of all Nordic countries (excluding Norway), is below 80 percent of the U.S level. The UK GDP per capita is also far below the U.S level (75 percent). The levels of GDP per capita of the less developed countries in European Union (Slovenia, Greece, Portugal, Czech Republic and Slovakia) are all below 62 percent of the U.S level.

Source: IMF, World Economic Outlook

The basic economic question is the length of the gap between the U.S and European countries. To answer the question, we have to set certain assumptions. So, let’s assume that the U.S output will increase by 2 percent in the long run. The economic theory would predict faster growth of less developed countries, since countries with lower levels of standard of living (GDP per capita) tend to follow-up the countries with higher GDP per capita. In economic literature, that is the so-called “catch-up effect”. So, what would happen if the UK economy increased by 3.5 percent in the long run. A quick estimate shows that the time gap between the UK and US is 19 years. So, what happens of the US economy increases by 2 percent in each of the next year while, at the same time, the UK GDP per capita is 75 percent of the U.S level? A fairly quick estimate shows that, if the UK GDP per capita will reach the U.S level in 10 years (although an unlikely scenario), the UK GDP per capita would have to increase by 4.9 percent each year to catch-up the U.S level of GDP per capita. If France’s GDP per capita reached the U.S level in 10 years (assuming 2 percent growth in U.S GDP per capita), it would have to increase the economic growth to 5.3 percent in each of the next 10 years. If the convergence objective is set at 20 years, the French economy would still have to grow at the annual rate higher than 3 percent.

The main question is why the European countries are still behind the U.S level of GDP per capita? There are, of course, many plausible explanations. As far as the GDP per capita is concerned, the difference in the level and growth of productivity is the most important figure in setting conclusions. After all, in the long run, productivity determines the standard of living across countries.

First, the European disease is mostly the result of high tax burden. High tax rates diminished the incentives to work, since each additional hour of labor reduced worker’s marginal productivity. Hence, as professor Mankiw explains, the rise of European leisure (link) is mostly the result of fewer working hours. In addition, early retirement is a common phenomena across Europe. By 2030, each worker will support one retired individual in Germany. The coming of Europe’s pension crisis (link) is a consequence of generous PAYG pension systems. Lower employment-to-population ratio led to higher tax rates to finance the financial liabilities for the retired. In addition, high government spending and periodic budget deficits discouraged productivity growth.

Second, another key to the explanation of the anemic growth rates in Europe is rigidity of the labor market. In many European countries, labor costs are very high (link). If the cost of labor market entry is high, people prefer longer studying and working in the shadow economy. The shares of shadow economy are relatively high in all European countries (link). The highest rates of shadow economy are in the following countries:

1. Slovenia 27%
2. Greece 26%
3. Italy 24%
4. Spain 21%
5. Belgium 20%
6. Germany 15%
7. France 13%

Source: ATKearney (2009), Friedrich Schneider (2005)

Third, Europe’s relative decline compared to the U.S, is not a consequence of the lack of R&D investment. High percentage of R&D investment in the GDP is not a cure for the real cause. In fact, European universities rank far below the top universities in the world. In the field of engineering and computer sciences, the first non-US university is in the 15th rank. Europe’s brain-drain is a known phenomena since many bright European minds immigrate to places such as the U.S, Canada and Australia. The outcome is deteriorating international ranking of universities and low efficiency of R&D expenditure on misguided projects such as the intention of the European Commission to build a “European MIT” (link) to boost Europe’s global technology leadership.

Without higher growth of GDP, productivity and market working hours, European countries will hardly sustain the convergence towards the U.S level of GDP per capita. To boost economic growth, bold structural reforms are required to cut the rates of shadow economy, reduce tax and social security burden, decrease government spending and deregulate the labor markets.

GDP, Manufacturing, Confidence, and Earnings — All Up

To round out the first month of 2010, reports this past week all painted positive business signs for the year to come.

As we’ve been predicting for quite some time, GDP for Q4 was anything but lackluster. The gross domestic product rose at a 5.7% annual pace, the Commerce Department reported Friday, up from a 2.2% rise in the third quarter. The growth rate was the fastest pace reported in six years.

Another regional manufacturing report out from Chicago-land showed additional expansion in January. Their index rose to a healthy 61.5% in January from 58.7% in December. Any readings above 50% indicate business expansion and it is clear now in that region that expansion continues to accelerate.

And in further good news for the retail sector, the University of Michigan consumer sentiment survey beat expectations moving higher to a reading of 74.4 for January. The reading is now at a two-year high and a full point and one half better than economists’ consensus expectations.

Also on Friday, President Obama proposed a $33 billion package of tax credits for small businesses as part of his plan to boost job creation.

Obama wants to give small businesses a $5,000 tax credit for each net new employee they hire this year and companies that reduce their payrolls at any point this year would not be eligible for the any of the hiring credits and or wage bonuses.

Further, earnings reports for Q4 and positive business expectations for Q1 continued to roll in this week during company earnings releases and conference calls.

On Friday, Honeywell (HON) said it earned $698 million, or 91 cents per share, beating expections by a penny per share. The firm reaffirmed a full year 2010 profit forecast of between $2.20 and $2.40 per share on revenues of $31.3 billion to $32.2 billion. Their CEO, Dave Cote said, “we are encouraged by the improving order trends and stabilization in many of our end markets.”

Microsoft also beat by a penny this week. Late Thursday, Microsoft said it earned $6.66 billion, or 74 cents per share, up from $4.17 billion, or 47 cents a share, in the same period a year earlier. Their revenues rose 14% to $19.02 billion.

But perhaps the strongest of company news came from Apple Computer (APPL) on Wednesday. The firm reported earnings that surged well past Wall Street estimates.

The iMaker said it earned $290 million, or 34 cents per share (a dime above estimates), on sales of $3.24 billion (250M above estimates) in the three months ended March 26. In the same quarter a year ago, Apple earned only $46 million, or 6 cents per share, on revenue of $1.91 billion.

As everyone now knows Apple released the iPad later in the week, but speaking specifically to earnings on Wednesday, CEO Steve Jobs noted, “Apple is firing on all cylinders.” The comments were indeed in line with our observations of PC shipments that rocketed higher in Q4.

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