Politics to blame for 2012's economic woes

PHOTO: Politics to blame for 2012's economic woes
Above photo is Congress general secretary Rahul Gandhi (wearing turban) greeting party leaders at an election rally in Sanand, Ahmedabad district.

Economist forget most of the time that it is politics that drives economics.

That is the lesson of the about-to-be-completed 2012.

In two articles, one today and the other next week, I will suggest how politics turned 2012 into such a difficult year and how it will take politics to move the global economy forward in 2013.

As 2012 draws to a close, it leaves the global economy in an unexpected place.

Structurally, it looks very different from what was expected at the beginning of the year.

Based on previous post-recession experiences, recovery from the Great Recession of 2007-2009 should have been more pronounced than turned out to be the case.

The United States grew at a rate of one to 1.5 percentage points lower than most experts had predicted.

By the end of 2012, most of Europe is back in recession.

Japan's GDP (gross domestic product) growth has not moved much beyond a zero growth rate.

What is most disappointing is the loss of growth momentum in the BRICS (Brazil, Russia, India, China and South Africa); all of them slowed down to the point where they ceased to act as the engine that was supposed to pull the rest of the global economy at a faster clip.

There were reasons why these surprises occurred. They are to be found in the structure of politics.

The political systems in many parts of the world are unable to deal with the tensions that exist in their societies.

This has resulted in a paralysis in the making of policy.

A brief overview of some unexpected political developments will help us to understand the state of the global economy in 2012 and to guide us towards making 2013 a better a year.

The economic slowdown in the US widened income disparities in the country.

The rich were less affected than the less well-to-do.

The widening income divide sent people looking for solutions.

The wealthy decided that a large government the country could not afford was the real problem.

Its financing was creating a burden of debt which the future generations will find difficult to service. Smaller state

The rich promised a smaller state.

Those who were deeply hurt by the downturn looked to the state to help them out by creating jobs, providing them with unemployment insurance while they were out of work, having a system in place that would ensure that illness would not drive them into bankruptcy.

The Republicans, under Mitt Romney, based their economic programme around the interests of the top one per cent.

The Democrats, under Barack Obama, focused on the bottom 99 per cent. Political arithmetic was on Mr Obama's side and he won handily.

It is extraordinary that Mr Romney and his associates were genuinely surprised by their defeat.

A different kind of divide beached Europe.

This was between the north of the continent and the south.

The European Union's ill-conceived expansion was based on the assumption that subsidies and cheap money from the north will win the economic support of the south.

This support was needed to keep the north supplied with human skills and markets.

It was better to receive such an infusion of human capital from the southern and eastern parts of the continent than from the labour-rich countries in North Africa and South Asia.

But the price of this integration of consumer and labour markets turned out to be too large for the northern political systems to tolerate.

The north forced a model of austerity on the south that further impoverished the citizens of that part of the continent.

The outcome was not politically sustainable. Several governments fell in the south, most recently in Italy, once a part of the European core.

The political systems in China and India, the two giants of Asia, turned out not to be in line with the respective demands of their economies.

Politics, but in different ways, was the reason for the economic slowdown in both China and India.

In the former, the old and successful development model has run its course.

It was based on extraordinarily large domestic savings rate to finance investments in both the public and private sectors.

Initially, most investments were made to create capacity for using the country's cheap and abundant workforce to produce consumer goods for the markets in the West.

Later, some of the investment went into building apartments and shopping malls for the tens of millions of people who were entering the middle class.

That model with significant increases in wages and growing domestic demand for the goods and services the existing production structures cannot produce needs to be reshaped.

This is being resisted by the tens of thousands of party and government officials who rely on these investments for their livelihood.

Economic reform

In India, politics is standing in the way of economic reform without which the country cannot go back to the near double-digit rate of GDP growth it has the potential to achieve.

The Indian political system is now fractured with regional parties now collectively more powerful than the national organisations.

The next phase of reform needed to take the country back to the rate of growth achieved after the first phase was made operational is politically difficult for most regional parties to digest.

How should the structure of politics change in these different parts of the world for 2013 to be less horribilis?

I will take up this question in this space next week.