The overarching implication of the spate of financial crises that have ravaged Asia, Russia and Latin America is of course that the threat of deflation, driven by a financial crisis is real. In fact, once integration with globalised finance proceeds beyond a point, the state of a country, as reflected by its GDP growth or inflation rate, or even the size of its foreign exchange reserves, need not be adequate to predict an imminent crisis. East Asian economies had performed very differently in the period immediately preceding the crisis, and Brazil despite "qualifying" for a $42 billion IMF package, could not stave off the Real crisis. This has implications for economic policy in a country like India. Principally, policy in the current period should not be directed merely at keeping investors, particularly financial investors happy, but partly at insulating the system from external shocks.

The second lesson is that a slump in export growth in economies which are increasingly more integrated into the world trading system is a major danger signal. This makes the collapse in India's exports in recent quarters a reason not merely to proceed with caution, but in fact to even retract on elements of liberalisation that exceed the requirements set by her membership in the WTO. It could of course be argued that India's poor export performance is more related to the slowing of world trade growth than was true of the East Asian economies, and that the crisis in East Asia itself has played a role in undermining India's export competitiveness. But these arguments only go to prove that the world economic scenario currently is least propitious from the point of view of launching on an accelerated pace of external reform.

Since the slowing of export growth and a widening of the trade and current account deficits are importants catalyst for a collapse of investor confidence, they call for measures to insulate the system against a currency crisis as well. This makes the task of exchange rate management extremely difficult. With the introduction of the unified exchange rate system, the only means by which the Reserve Bank of India can influence the exchange rate is through open market operations. In periods when large portfolio and debt inflows result in a tendency in the market for the rupee to appreciate, the RBI is forced through open market purchases to acquire large volumes of foreign exchange and increase the size of its reserves. This is exactly what happened during the mid-1990s. Those reserves once accumulated are however difficult to run down, since they are an important determinant of the confidence in the rupee. As the East Asian experience indicates, a reserve amounting $25-30 billion is small change if there is a run on the rupee because of a loss of confidence which can arise from a number of factors. This makes burgeoning reserves acquired often at high interest rates and parked as short term funds at extremely low interest, a partial indicator of economic strength.

Being unable to run down reserves without affecting confidence implies that an effort to respond to the loss of competitiveness in the wake of the massive depreciation of the currencies of competitors from East Asia, by managing a depreciation of the rupee, is near impossible. Once the RBI, through dollar sales allows the rupee to depreciate in value, expectations of a further depreciation arise, since the extent of devaluation need to restore competitiveness is indeed large. Even though India has not yet opted for capital account convertibility, there are a number of ways in which speculators can operate on the basis of such expectation. Exporters can choose to delay the repatriation of their export proceeds. Non-residents and foreign institutional investors can hold back on making new deposits and investments as well as repatriate part of their current holdings to forestall losses or capture gains in the wake of a depreciation. And authorised dealers can make short-term (even overnight) acquisitions of the dollar in the hope of booking profits. This is precisely what happened in late 1998 when the RBI chose to experiment with a dose of managed devaluation. The net result of this danger is that while India's exports languish, the rupee remains relatively strong, with periods of even real, effective appreciation.

One implication of this experience is that India just cannot contemplate any further liberalisation of its exchange rate regime. What it possibly needs to do is tighten controls, through a higher rate of capital gains taxation, than the prevalent 10 per cent, on early repatriation of funds invested in the stock market by non-residents and foreign institutional investors. This need not imply much more inflexibility, but it would mean greater instruments in the hands of the RBI to control the level of the exchange rate to some extent. It also means that there would be some control on capital inflows as much as outflows, the necessity of which has been emphasised by the Southeast Asian experience.

Above all, India needs to think of alternative means of pushing out exports then merely relying on the (price) exchange rate mechanism as a driver of export growth. This means that the export strategy should be strategic in nature, and provide special incentives to those areas of export growth which have either the most potential for employment generation or which imply a significant increase in domestic value added.

External vulnerability of this kind has implications for macroeconomic and monetary management as well. If the central bank is saddled with large increases in its foreign assets, money supply can be controlled only by a process of sterilisation involving a reduction in central bank credit. The principal area in which such reduction occurs is with regard to central bank credit to the government. This has two implications. First, it substantially increases the fiscal vulnerability of the state, reducing its capability (as shown in the first section of this paper) to stimulate growth, sustain welfare measures like subsidies and increase outlays on the social sectors like health, education and those aiming to meet the basic needs of the population. Secondly, with the State caught in a fiscal wrench, the only means of macroeconomic management is monetary policy. Here, however, the fiscal crunch forces the government to turn to the open market for even the minimum volume of borrowings it undertakes. In periods when demand for credit from the private sector is also high, as was the case during the mid 1990s industrial boom, this leads to high interest rates. It is only when a recession induced reduction in the private sector's demand for credit eases monetary stringency that the government can manoeuvre interest rates downwards, as has happened recently.

This situation where a reduction in interest rates is a means of stimulating recovery, but where recovery inevitably leads to higher interest rates, reduces the efficacy of monetary policy as means to stimulate growth. Given the higher reliance of employment-intensive small industries in particular on bank credit rather than other means of raising capital, it is important to ensure that monetary policy does not become a constraint on productive activity. While this does not mean that interest rates must be completely administered, it does suggest that as far as possible the monetary and credit policy of the government should be designed towards the expansion of production and employment.

There is a perception that external vulnerability is essentially a consequence of dependence on purely financial flows, but that flows of foreign direct investment help improve the balance of payments situation. This is based on the presumption that FDI flows are of the relocative kind, in whose case there is a virtuous nexus between such inflows and exports. However, import liberalisation and the liberalisation of foreign investment regulation in economies with home markets of a significant size inevitably encourages FDI directed at the domestic market. In fact, in India liberalisation has encouraged three kinds of FDI flows. First, is a set of flows by transnationals who already control assets in the domestic economy who, in the wake of liberalisation permitting a higher share of foreign equity in foreign controlled rupee companies, choose to enhance their equity stake with relatively small dollar investments. These small investments substantially increase their ability to repatriate dividends from future profits. Second, investments by foreign firms which virtually purchase large domestic market shares by fully or partially acquiring domestic firms that dominate particular markets. The acquisition of Parle Exports, which dominated the soft drinks market, by Coca Cola and the partial acquisition of the Malhotra's blade empire are instances of these. Finally, there is a large inflow into the non-tradable, infrastructural sector, attracted by special concessions, including guaranteed returns, offered by the government for such investments.

It should be clear that in all these cases the initial inflow of investment would be followed by large and persistent outflows on account of imports, royalties, technical fees and dividends, with adverse balance of payments consequences. With the rush for purchase of East Asian assets rendered cheap by deflated prices and depreciated currencies, which we have discussed above, it is even more unlikely that relocative FDI geared to export production would flow to countries like India. Hence rather than liberalise FDI policy across the board, the government should seek to provide special incentives for FDI which uses the country as a location for world market production and discourage flows that bring little by way of technology but are costly in foreign exchange terms.

These features of global and domestic trade scenario implies that despite new trends in FDI, post-reform Indian economic growth is accompanied by persisting external vulnerability. The significance of this phenomenon, however, is not that there is no option but succumb to this heightened vulnerability and hope for the best, but to work out a national economic policy that takes this vulnerability into account. Reduced manoeuvrability does by no means imply no manoeuvrability at all.

However, reduced vulnerability does imply that the kind of developmental agenda that was worked out in the immediate post-War years is no longer adequate. Developing countries cannot return to a strategy of making optimum use of "available" foreign exchange earnings, through import-substitution strategies of the kind that the Feldman-Mahalanobis model epitomised. Such strategies attempted to control the rate of growth and degree of diversification of consumption, on the one hand, and reduce dependence on manufactured imports in the long run, by utilising scarce foreign exchange to create a capital goods sector, in general, and a machine tools sector in particular.

However, the problem with that strategy was three-fold. Firstly, it was really open only to developing countries which in terms of size of the domestic market and resource base were above a critical minimum. Secondly, even in the case of these countries, since the growth of manufactured goods production was determined by the scale and quality requirements of the domestic market, an increase in the ability to produce manufactures was not necessarily accompanied by an increase in the ability to keep pace with international innovations and export manufactures, holding back the rate of expansion of the system in the long run. Finally, given the inequalities within the system and the growing pressures from the well-to-do to obtain access to product innovations that defined international lifestyles to which they were inevitably exposed, the ability of the State to restrict the rate of growth and degree of diversification of consumption was increasingly undermined. Neither the savings rate nor the import-intensity of domestic productions stuck to the trajectory that the strategy charted. Given the parameters within which it operated and the concept of development that it implicitly appropriated, import-substitution was doomed to failure. Thus the alternative we need to consider must go beyond the dirigisme characteristic of "old-style import substitution", even while retaining its principal objective, viz., that of reducing external vulnerability. This is all the more true since the nature of external vulnerability appears transformed in a world dominated by fluid finance capital.

This brings us to the first aspect of the alternative strategy incorporating intervention: it must transcend the dichotomy between production for the domestic market and production for export. In its archetypal form that dichotomy is reflected in arguments that make a case for industrialisation based on the home market because international inequality provides grounds for 'export pessimism'. In the debate on the transition to capitalism that led up to the industrial revolution, one issue of contention was the relative roles of purely 'internal' factors in the form of structural change, as opposed to 'external' factors like the effects of commercialisation and the growth of markets in determining that transition. Whatever the merits of those contending arguments with regard to the principal determinant, one thing appears clear with hindsight. Successful capitalist industrialisation cannot occur in a context "insulated" from world markets, but requires consciously engaging those markets as part of the strategy of growth.

We use the term "engaging" advisedly. World markets are not benign, autonomous forces that spur efficient Third World industrialisation. On the contrary they embody all the inequalities characteristic of the world system. Engaging those markets involves therefore using all the weaponry in the hands of a developing country, including the power of its State, the foundation that its home market provides, the ability of its scientific and technical personnel to override the domination implied in the control of technology by a few transnational firms and the advantages of the late entrant (varying from low wages to a less codified legal framework), to prise open those markets that inequality suggests are hermetically sealed for them.

This brings us to our second point. A successful growth strategy has to be based on an activist State. There is no relationship between the existence of an activist State and autarky or, for that matter, insularity. One valid criticism of the import substitution years in countries like India is that it neglected exports. While exports cannot constitute a basis for growth in a large developing country, in an interdependent world one cannot finance the imports that accompany the process of growth without an export thrust. It is for this reason that all successful late industrialisers, including the so-called NIEs, had pursued a "mercantilist" export policy which emphasises pushing out exports at whatever cost. Such a policy involves a continuous restructuring of the production base of the system in both quantitative and qualitative terms, which requires both technology and investment. Investment matters for two reasons: first, the larger the size of investment the larger the share that can be devoted to modernisation as opposed to 'expansion'; second, since for any incremental capital output ratio, higher investment implies higher growth, capacity expansion proceeds at a pace that allows the incorporation of new technology at the margin. For these and other reasons, the rate of growth of manufacturing exports of an economy is dependent on the investment ratio.

Development economics in the early years singled out investment as the key to growth. In fact the group of highly-distinguished development economists headed by Arthur Lewis who authored the well-known Measures document of the United Nations (1951) made raising the investment ratio the cornerstone of their recommendations for development in the underdeveloped countries. The emphasis shifted only with the neo-classical critique of the late sixties . It was the efficiency of resource use, as emphasised by neo-classical writers, which gradually came to occupy centre-stage; what mattered, according to this perception then, is the economic regime within which development took place, whether or not this regime was conducive to the achievement of efficiency of resource use. What a regime conducive to such efficiency on the neo-classical argument would do to the investment ratio was never discussed, a reflection essentially of a shift of attention from the macro to the micro issues underlying the development process (and of course to a "marketist" stance in this micro discussion). In short, the investment ratio dropped out of the picture as a significant phenomenon to concentrate attention upon.

More recently, however, a range of writings from authors of rather widely differing persuasions has argued that the successful cases of industrialisation in East Asia was largely explained by an increase in factor inputs into the production process, including capital inputs in the form of high rates of capital accumulation. That is, it is not greater efficiency of resource use per se, but larger outlays of inputs at a given level of efficiency that explains success. At one level this argument is supported by evidence on cross-country Total Factor Productivity (TFP) growth estimates using purchasing power parity data, which suggests that over 1970-85 "productivity" in South Korea, Taiwan Province of China, Singapore and Hong Kong grew much slower than Egypt, Pakistan or even Bangladesh. However, the TFP index, favoured normally by the World Bank, is based on assumptions such as full employment of resources and perfect competition, rendering it inadequate for real world analysis.

A more useful way of analysing the phenomenon is to undertake cross-country correlations of investment ratios, output growth rates and export growth rates. An analysis based on twenty years (1968-88) data for 25 developing countries showed a close correlation between output growth and the investment rate (or the ratio of investment to income). Similarly there was an extremely close relationship between output growth and export growth. If it is investment which drives output growth then the high correlation between output growth and export growth must make itself visible in terms of a high correlation between investment ratio and export growth, which it does.

There are good theoretical reasons why a high investment ratio ceteris paribus should give rise to a strong export growth performance. International trade in the different commodities grows, over any period, at different rates. Given these growth rates in world trade, the rate at which a particular underdeveloped country's exports grow would depend to a very significant extent upon its production-structure and the rate at which this structure is changing. In particular since the underdeveloped countries are, by and large, saddled with production-structures specialising in commodities with relatively stagnant world trade, success on the export front depends crucially upon the ability to transform the production-structure rapidly in the direction of commodities where world trade grows faster. And the rapidity of this transformation is linked to the investment ratio: the higher the investment ratio, the faster the transformation of the production-structure and hence the greater the ability to participate in the faster-growing end of the world trade, i.e. the greater the rate of export growth.

An activist State is needed not merely to raise investment rates, but to coordinate the export thrust. The evidence from east Asia suggests that such coordination was crucial, because a mercantilist industrial policy rather than market determined comparative advantage was crucial in establishing a foothold in international markets.

There is enough evidence that economies like South Korea and Taiwan Province of China pursued similar strategic and anticipatory industrial policies as a run up to their competitive success. Hence, even when a high investment rate is realised through the agency of private entrepreneurs, the government needs to ensure that an adequate share of such investment is allocated to sectors selectively chosen as thrust areas for exports and embodied in technologies and plant scales that enhance international competitiveness. During the import-substitution years when the thrust of policy was to build a domestic industrial base using the economic space provided by a protected market, state policy was largely directed at regulating the adverse consequences - in the form of concentration, monopolistic pricing, uneconomic scales and a skewed production pattern - of inadequate competition or rivalry. Many of these problems are now being directly dealt with by the "cutting edge" of international competition in a more liberalised world. However, openness and competition alone do not guarantee export success, as a range of experiences have shown. Some degree of intervention by the State seems necessary. But that intervention has now to take on a new form, with the emphasis on matching microeconomic investment decision-making with a coordinated or "planned" export thrust.

An important instrument in realising the objectives of this new form of intervention is monetary policy. The evidence seems to suggest that interest rate differentials and are a useful instrument for realising an export thrust of the kind described above. This automatically suggests that financial liberalisation of a kind that does not permit such differentials, and weak banking systems in which such policies can be misused need to be reformed, with the imposition of capital adequacy norms and transparent procedures. Such policies also imply some degree of sequencing of any process of "liberalisation" aimed at dismantling structures characteristic of the earlier import-substituting strategy. Industrial liberalisation (of licensing laws, output controls and direct price controls) must take precedence over trade liberalisation, and both of them over the liberalisation of the financial sector. For all these reasons, coordination by the government is crucial.

Activism of this kind has as its corollary two features. First, an activist State pursuing a mercantilist growth strategy should be in a position to discipline its industrial class. Second, activism requires the mobilisation of adequate resources by the State to sustain that strategy. The need to discipline the industrial class arises because, even while departing from the detailed physical controls characteristic of the import substitution years, the strategy being elaborated here requires a substantial degree of strategic targeting and coordination by the State. Through incentives, on the one hand, and measures to enforce compliance, on the other, the government must be in a position to influence investment decision-making at a microeconomic level. Based on the segment of the world market that is being targeted, the coordinating agency should be able to influence the choice of product, technology, scale of production and price.

Needless to say, imposing such discipline requires the backing of other sections of society, which defines the third prong of an alternative strategy. Social support for a strong State is most often won in a situation where land reforms have dismantled structures that provide the base for a collusive elite. The vital necessity of land reforms is underscored by the fact that even the successful east Asian capitalist economies owe their success inter alia to the post-war land reforms that they had.

But land reforms are needed not merely as an instrument of mobilising political support. A thrust towards land redistribution and greater social expenditures in the rural areas which are best undertaken under the aegis of directly elected decentralised governing bodies (e.g. the panchayats in India), is essential also for widening the home market immediately, ensuring a rapid increase in agricultural output (as has happened in West Bengal, India, for example), and increasing the potential for direct and indirect employment generation. To that end land reforms would have to be accompanied by investments in the agricultural sector - in irrigation and water management and other kinds of rural infrastructure - that permit an acceleration of industrial growth. This would not only broaden the base of development but also create decision making structures through devolution that are crucial for generating the strength and the accountability needed to make the State capable of functioning as a disciplining force.

Globalisation is fundamentally a centralising tendency, drawing disparate economies and sectors into the vortex of a world controlled by a few decision makers. It also replicates this centralisation in economies which it integrates into the world system, creating strong domestic interests that support the case for an open economy and a marketist strategy. The suggestion that the nation state is no more a meaningful category comes from those who find in an "integrationist" strategy greater economic benefit than from any strategy of reserving domestic space for domestic interests, so that some forces that advocated protection and state intervention in the 1950s, now support a liberal economic regime. The problem however is such a regime marginalises the disadvantaged, who constitute a majority in most developing countries - a majority which because of centralisation cannot make the case that the attenuation of the nation state challenges their already meagre standards of living. This however offers an opportunity to forces seeking an alternative to blind marketism. They constitute the social base which can legitimise the effort to reckon with the adverse consequences of globalisation. This implies that political and economic decision-making needs to be decentralised so that segments who believe that there must be an alternative to unbridled marketism can find a voice. It also means that any alternative strategy must immediately address their basic needs so as to consolidate their support for that alternative.

Thus an alternative growth strategy does involve economic "reforms", though not of the kind dictated by the Fund and the Bank to all developing countries. The objective of the reforms must be to widen the home market, to provide the broadest possible basis for development through appropriate structural change. But broadening of the market without a stimulus for its expansion can be counterproductive. And a State faced with macroeconomic disequilibria is hardly in a position to provide that stimulus. This implies that macroeconomic disequilibrium reflected in high budget deficits, has to be corrected through direct taxation and a reduction in inessential expenditure. Through greater discipline in tax-enforcement, changes in tax laws, removing certain kinds of exemptions, and an adjustment of rates for top income brackets, the revenue from income taxation should increase.

With greater resort to direct taxation, the tendency towards garnering revenue from indirect taxes and administered price-hikes would have been reversed which itself would be an anti-inflationary measure. Even so however it is also necessary in addition to protect the poor from the effects of such inflation as would occur. And this is best done through an extension of the public distribution system, both geographically into the rural areas as well as in terms of its commodity coverage. To keep the strain on the exchequer of such an extension of the public distribution system within reasonable limits, there should be an adjustment in the targeting of this system, towards the poor.

The other component of macroeconomic disequilibrium which plagues developing countries like India, viz. the deficit on the current account of the balance of payments, is dealt with more directly in the strategy being proposed. The growth of income and exports here are not made dependent on the pursuit of an open economic regime, but are a fallout of the activism of the State. This implies that the combination of selective but stringent import controls and an export thrust itself provides the basis for a correction of balance of payments disequilibria. Further, growth in a broad-based development strategy is not dependent on access to international finance, but uses the foothold offered in part by the home market. This implies that even the direct link between growth and vulnerability, or dependence on 'hot money' flows is snapped, achieving the principal objective of the alternative traverse.

The important feature of this package is that its focus on the expansion on the domestic market implies emphasising employment generation and the provision of adequate and sustainable livelihoods to the population. This is especially important not only because of the obvious welfare and equity implications, but because, in the absence of such development, the political and social tensions unleashed by the inequalising effects of globalisation are likely to become very difficult to contain.

Thus a package of policies of this kind would not merely help accelerate growth with some attention to equity, but would break the nexus between even a minimal rate of growth and an acceleration of dependence on foreign finance. Any access to finance would essentially serve to raise the rate of growth beyond that critical minimum, which is not subject to the uncertainties that the external vulnerability stemming from dependence on international capital generates. It is thus that the "opportunity" offered by the rise to dominance of finance capital can be used by a developing country to engage international markets. That is the virtuous circle that commends itself in the new environment is one in which an effort by an activist State to engage international markets for goods and services provides it with the foundations needed to engage international capital markets and use them as one more weapon to further prise open unequal international markets.

December 26, 2001.

1) The neo-classical critique was elaborated among other places in Little, Scitovsky and Scott [1970].
2) See, for example, Krugman 1994; Akyuz and Gore 1994; Singh 1995.
3) Young 1994.
4) See Patnaik & Chandrasekhar 1996.
5) For example, Vice-Minister Ojmi of Japan's Ministry of International Trade and Industry is reported to have summed up Japan's industrial policy perspective as follows: "The MITI decided to establish in Japan industries which require intensive employment of capital and technology, industries that in consideration of comparative cost of production should be the most inappropriate for Japan, industries such as steel, oil-refining, petrochemicals, automobiles, aircraft, industrial machinery of all sorts, and electronics, including electronic computers. From a short run static viewpoint, encouragement of such industries would seem to conflict with economic rationalism. But, from a long-range viewpoint, these are precisely the industries where income elasticity of demand is high, technological progress is rapid, and labour productivity rises fast." Quoted in Singh [1995].
6) Wade 1991, Amsden 1989.
7) This point is now recognised even by mainstream political economists such as Dani Rodrik (1999) who have pointed out that a general political movement against globalisation may be the result of not taking into account more seriously, the social consequences of globalisation.