“If you get your politics right, you will get the economy right”

Interview: Lord Meghnad Desai, Professor Emeritus of Economics – LSE

“Progressive taxation will come back…

… I hope it comes back in a more sophisticated way so that we tax expenditure, not income”

“Every society has to be able to show to the people that there is a rough equality of life chances, nobody should feel deprived”

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The Board of Investment has set up an International Advisory Board (IAB) which will assist in graduating Mauritius from a middle income country to a high income one. The IAB is composed of high-profile international business persons and academics who have agreed to put their wide experience at the disposal of Mauritius for the elaboration of a roadmap towards a high-income Mauritius. Its first annual meeting was held early this week in Port Louis.

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Mauritius Times: Lord Desai, you are here to work out, along with a group of high-profile business persons and academics, a roadmap meant to assist Mauritius in graduating from middle-income to a high-income country. Tell us: what’s in your mind?

Lord Meghnad Desai: We are mainly going to be concerned with how Mauritius deals with the many global uncertainties that it faces. It is very important that Mauritius can keep on to its good growth path; it has been so far successful in following good growth policy, but the global economy is right now plagued by much more uncertainty than it is used to be the case before with the crisis in the euro zone and the debt difficulties of a good number of countries. In fact as far as the developed world is concerned, we cannot expect much growth for the next five years in Europe, the UK and the USA; the growth regions are to be found in Asia as well as in Africa. What needs to be done for a country like Mauritius is to turn the economy around and to direct it towards the new growth centres. No doubt it will not be an easy task because the economy is not like a machine, it tends to evolve very slowly. And beyond that, we do not know what the world economy will be like and where it will be in 25 years in view of the ongoing technological changes taking place all the time; we do not have any idea as to where mobile phone and computer technologies will get us to in 25 years, what kind of energy resources we will be relying upon. So we’ll have to take a sort of position which is broadly cautious but based on robust forecasts of how the Mauritian economy can prepare itself for the big changes that are likely to take place globally.

* Economists are absolutely right when they speak in terms of lack of visibility on the world economic front. Is that so?

That is indeed the case. There is so much uncertainty because of two things: first, for about 50 years before the crisis broke out, we were used to having very short cycles during which five or six governments stepped in whenever any crisis, be it a currency crisis or otherwise, cropped up… and the problem was fixed. This time around, in the wake of the big financial crisis, we are in a strange situation where governments are helpless…

* Despite all the billions governments have poured in?

We had to pour in the billions, though I have my own views as to whether the banks should have been saved or not. In the Western world we found that the savings habit had disappeared, households were living off credit, governments were busy borrowing even when they were in full employment situations, the budgets were not in surplus as it should have been… so governments got themselves used to very easy money and, to some extent, the Western world was living off the savings of Asia. Now that debt had to be finally paid back at some stage, and the crunch came via bank failures, which had to do with the risky positions they were taking. Eventually the unsustainability of our lifestyle became untenable. What we also failed to realise was that not only our governments were also constrained but to the extent that we are now operating in a globalised world, governments are no longer special as sovereign borrowers. A sovereign borrower is treated like a large company, and that is where the country’s rating comes into play by pushing up the rates at which governments can borrow as the rating falls.

This new circumstance has made governments less powerful than they used to be. We are not used to a world in which governments cannot solve our problems. There are people, at least in the Western world, respectable economists like Paul Krugman, Lord Skidelsky and so on, who are saying that this is silly, and that governments should actually borrow more money and spend that money on promoting growth… Then the question that you put to yourself is: do you think those 20-25 governments which are not actually doing this are all stupid? I think there are structural problems that governments cannot deal with today the way they were able to do 25 years ago. The Western world will have to get used to a more or less stagnant period ahead while it repays its accumulated debts. Until such time that governments are able to repay the bulk of their excessive debts, we cannot expect any great changes in the situation, especially if we rely on households to pull up the economy.

These are new times, or rather these are times like there used to be in the 19th century. At the same time, the Asian economies have done very well; they have learnt the old virtues of high savings, discipline, hard work, and investment in education. On the other hand, at last, after a long waiting, Africa looks like it is sorting out its political problems and there is now decent growth in many of its countries. In less than ten years, the African continent has more or less been able to turn itself around thanks in large measure to the success registered in many African countries in tackling the governance problem. Once this is fully addressed, the economy will behave.

* There is no such governance problem here, isn’t it?

By and large, no. I think that you used to have it 30 years ago. There was a feeling, when I first arrived here and through much of the 1990s, of people feeling being left out of the mainstream of prosperity. It seems to me that the urgency of that feeling is now gone; some compensations have been made. Whilst no society is completely equal, inequality here is not distributed by race as much as it used to be.

People are used to inequality; within every community there is inequality, but the people get angry when the whole community is more or less considerably poorer than the others. That’s when they use politics to get back into the game; sometimes, the politics gets very vicious. I am still not an expert on Mauritius, but it seems to me that there is more of inter-communal peace than it used to be the case 30 years back. I think politics has contributed to this situation by giving everybody a bit of a share in the growth. If you get your politics right so that nobody feels permanently deprived by the way politics is structured, the economy is just a matter of your own hard work, your own investments, and a bit of a gamble – some people win, some people do not succeed. People do not mind provided they all can have a go in terms of equal access to education, resources, opportunities, etc. Some people may benefit, some may not from that access, but it’s up to them to decide whether they are going to work hard or not. Eventually, to the extent that they succeed or they fail, they should be able to know that it is by and large their responsibility if they succeed or fail. It’s a difficult thing to do, but I think every society has to be able to show to the people that there is a rough equality of life chances, nobody should feel deprived.

Of course, when people fail, they tend to blame other people for it; they do not blame themselves, and governments are the easiest things to blame in such cases. Failures can at times lead to communal tensions, but a society can keep these things under some sort of a lid so that they do not blow up. Mauritius, in my view, is one of those successful places where politics has been able to deal with this problem, but one must never be complacent for you never know when the next crisis will come.

* But this issue of inequality will come forth again when the bad times are back, isn’t it ?

It has already come back; it has suddenly moved very sharply to the forth. Look at the Occupy Wall Street and similar movements in London and elsewhere. The OWS slogan, We are the 99%, addressed the growing income inequality and wealth distribution in the US between the wealthiest 1% and the rest of the population. There is the feeling somehow that during the recession a lot of money was given to those who had caused the recession and who happened to be the richest people. Then the government in the west came forward and said to the people that we are all in trouble and we are going to cut those spendings.

Now the consequences of this spate of spending cuts are being visited upon the people, who feel that it was not their fault if the banks failed and people do not understand why the government decided to bail them out with so much money. I think there is a slight misunderstanding here: the government’s current budgetary problems do not arise from the money it gave to the banks; those problems have to do with the government’s overspending during the last 20-25 years. But the people have not understood the connection — and the government has not done the explaining anyway – which is why the people feel that the prevailing inequality is both unjust in its own way but also the prime cause of their misery.

Until now, inequality had been growing in the Western world whereas, roughly speaking, there has been a period of about 50 years between the mid-1920s to mid-1970s when it came down thanks to progressive taxation, high rates of taxation, full employment at the bottom, limit on upper incomes, etc. But as from 1980s onwards, during what we call the globalisation period, inequality began to increase very sharply in the Western world – professional incomes of bankers, CEOs… went through the roof. Even then, people were not complaining because the incomes of most people had risen, everybody was thus able to borrow money… It’s as if people were saying to themselves that you are rich and so am I. But when the crunch came, it suddenly dawned upon them that they were not really rich – they were only entertaining an illusion of being rich. And that is when they began to say that unless this problem of inequality is tackled, they would keep having to be the beast of burden.

Excessive inequality is unfair. The perception is that this inequality is built in and does not allow for any mobility – the rich will always stay rich and their children will go to the best schools and will come back to top positions in the big corporations whilst the 99% will always be left behind. The feeling that inequality might keep on widening has got into the system and, to some extent, we can see echoes of that response in the victory of François Hollande in the French presidential elections. Some of his support came because he said he would go back to progressive taxation. We are now used to lower taxation because of what happened during the last 30 years. But societies were relatively prosperous and were working well when taxation was high at one time, and that was also a time when inequality was under control.

The whole case for progressive taxation is going to come back, given the disparities which have set in. Obama is beginning to talk about it; American billionaire Warren Buffet has said that millionaires have to pay more taxes, and this idea is gradually making its way to Europe. In the UK, there is a feeling among the people that the rich not only have a low rate of taxation, but that they avoid that tax by having recourse to an aggressive tax avoidance mechanism through fancy schemes. Eventually, every politician in the Western world especially, will have to go back to thinking about progressive taxation…

* What about places like Mauritius? Is there a case for re-introducing some form of progressive taxation here?

I think progressive taxation will come back. I hope it comes back in a more sophisticated way so that we tax expenditure, not income. A long time back a very distinguished economist, Nicholas Kaldor, argued that by taxing expenditure we are not taxing the savings. Now we ought to constrain our consumption, don’t we, in response to the climate change challenge? Therefore we should tax consumption; don’t go on taxing income. Don’t tax work as it is done in those societies which have one or other form of tax on wages. We may instead go for many more indirect taxes on the use of natural resources, energy, etc… But, as regards tax on income, eventually some kind of idea will make its way back to the effect that if I am making, say, 10 times the average income, I ought to be paying a much higher part of that in taxation than before.

* Are we not already taxing consumption by way of VAT? Do you mean the VAT rate has to be increased?

The usual argument about consumption taxation has been that it is regressive and unfair, but we can always tax luxury consumption as well. You could trade off some of the taxes on incomes by imposing tax on consumption, VAT or an expenditure tax. Eventually the need to have higher savings is going to be very urgent, so progressive taxation will one way or the other make its way back. I also think the kind of super smart schemes to avoid taxation, which have been tolerated while growth was doing well, will henceforth be hunted down by governments seeking to enhance their revenues.

* To come back to the new growth areas you mentioned earlier, given that Mauritius is still dependent very much upon Europe and the USA for its trade and the crisis in Europe is likely to remain that way for quite some time, what do we do in the meantime? And what are the sectors you think we should be targeting?

It really depends upon what you are exporting. If you are at the lower end of the consumption chain and exporting sugar or textile, you will not be very badly hit by the slowdown because even with the slowdown, people are going to have those core consumption commodities. And as long as you manage to remain competitive with respect to costs, you’ll be able to manage. As you get into more sophisticated services like tourism or complex industrial products, you will find that the market will dry up. The centre of gravity of the global economy is shifting from the west to the east, to Asia as well as to Latin America and Africa. Go to China and look at the market there; it’s simply mind-boggling to see how much the Chinese are buying and buying… They seem determined to quench their 200-year-old thirst for goods and services. It is not an easy market to penetrate but that’s where the market is. That also goes for Latin America and Africa. In terms of accessibility, and from a cultural standpoint, these markets are quite convenient for a country like Mauritius. Remember that the UK is targeting the Asian market for its own products, presumably because they feel there is no future selling to Europe – at least for the next 10-15 years.

* Does that mean that Mauritius will have to keep on focusing on tourism, ICT, financial services? What about other sectors?

It is the market that is shifting and not the products or services that you are selling; they are not getting out of fashion. If you look at mobile telephone market in India, for example, it’s mind-bogglingly expanding. There are 900 million mobile telephones in India right now, and when the 3G and 4G come along that figure will shoot up manifold. The same thing is going to happen in China. That kind of growth will not be seen in the West. So even if Mauritius does not manufacture mobile telephone it will have to get prepared to seize any opportunity that may arise in the wake of such phenomenal growth in those places, and take advantage of any spin-off that such phenomenal growth may give rise to.

To get into a new product requires a little bit of more long-term thinking, a lot of investment… This is the kind of thing we will have to thrash out in the open and see where the future is. Technology is changing; it is turning over every two or three years; look at new things happening every now and then in the field of mobile technology – the iphones, ipads… India is trying to produce a laptop costing no more than $100. Those are the kinds of things which one has to be aware of. You may not be a manufacturer of those kinds of products, but you may decide to be a provider of the softwares on which they run or that are displayed in these products. For example, nobody knows when we are going to make real profits out of advertisements on mobile phones, but somebody will some day work out his way to those profits. That’s why you should be preparing yourself to design those advertisements. These are skills which are education and imagination intensive, and I can see Mauritius capable of drawing from its rich history, its diverse cultural reservoir to produce such, what I call, abstract products. As a small island economy, Mauritius is very smart.

* But it does not look like we have that critical mass of technical expertise and skills to be able to go into the making of such abstract products now?

You don’t have to do everything. The thing about a small island economy is that it only has one resource: its people. The quality of education you provide to the people, the way you equip them and the infrastructure you set up to use that education to produce goods and services – that is the crucial point. Obviously, nobody expects you to have or to produce everything; you are not going to be a large manufacturing nation ever – you do not have the capacity anyway.

For example, Mauritius has done very well in the financial services sector. But the world is constantly changing – in the financial services sector itself, aggressive tax avoidance treaties are no longer viewed with much sympathy. India itself is worried about its tax treaties with Mauritius and Singapore. In a sense, one has to see further ahead and anticipate what kind of changes can be expected. Do we comfort ourselves by saying that this will go on and on or that the Indians are just bluffing? Shouldn’t we instead work out a contingency plan just in case the treaty goes, so as to avoid having a big hole in the economy? How do I then leverage what I have set up already to attract compensating business from other countries? This consideration should be uppermost.

When I first came to Mauritius 20 years ago, I was amongst the first people to say: Get out of sugar! This attracted me a lot of criticisms from some people who argued against this proposition because they insisted that sugar was the life-blood of Mauritius. To which I replied that this may be the case, but you are going to get out of sugar anyway! The point is that one should never get too reliant on one kind of product line because the world is moving fast. Having made yourself an offshore financial centre, you have to reckon that the world may change. I am not saying that it will change, but one cannot just ignore signals in prevailing dynamic global conditions.

* Should we get out of India?

I think you should start preparing yourself for the likelihood that things may move very quickly – due to the unpredictability of Indian politics. It may even be an irrational thing for India to do – which I think it is – but in politics whenever a government is on the run, they always do the populist things, not necessarily the right things. I was in India a fortnight ago, and I could see that these things were beginning to acquire a certain salience. So you better get prepared for it, for all the changes that may foreseeably shape up. I am not saying that this is going to happen, but you cannot afford not to get prepared… just in case.

* But coming back to moving Mauritius towards a high-income status, how long will that be in the future?

20-25 years. Who knows? You can make a compound rate calculation and come to assume that you’ll reach such and such destination in so many years. You could also say that India will become the second or third largest economy in the world by 2050 if it goes on growing by, say 10% every year. There has never been in the world history anything like that. The world works through cycles and crashes and shocks. The point is that you have to plan 10, 15 years ahead but you need to look again at your economy’s orientation every five years.

Over the time I have been coming to Mauritius, its economy has been transformed. I remember being here some 10 years ago and facilitating a discussion about how to turn the Mauritian economy and what new sectors to go into, etc. Those kinds of discussions have always to be done. Right now, the biggest danger facing Mauritius is that the whole financial thing may just go. Besides, apart from the political uncertainty facing India, the Subcontinent runs the risk of losing its growth dynamism very quickly due to a governance paralysis and an anti-growth populism prevalent there. The old-fashioned Congress policies of the 1960s seem to be coming back… I do not think Congress will win the next election, but there is no certainty that whoever comes to power will be friendlier. India’s growth rate right now has skipped below 7%, and it’s quite likely that it may not revive for some time to come from this level. Now this raises two problems. Even if India does not change its tax policy, its growth rate will slow down and Mauritius will be impacted by that slowdown because a lot of people are investing money in India via Mauritius in the hope that it will keep growing at a higher rate. That will not play out as it was the case in the past. Even Indians are investing abroad now and you have to be aware that India could become a much slower growth engine than what it has been for the last twenty years. This is a serious possibility…and risk.

* So we have to move to other places?

Yes. China. Indonesia. Russia. Myanmar, which has not had investments for the last 50 years, is going to explode within the next years. One has to be super smart. You know, I am not worried about Mauritius in a big way. You will be able to make it. Of course, you have to remain vigilant. I am always very impressed when I come to Mauritius to see the Mauritians more worried about their country that the world is worried about Mauritius. I have a lot of confidence in Mauritius’ ability to tackle its problems. The question is: what would constitute a danger to Mauritius? If the politics were to become too contentious, then the government would be unable to act. That’s what’s happening in India where the government has paralysed itself. If you get your politics right, you will get the economy right.

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* Published in print edition on 18 May 2012

Tags:François Hollande, International Advisory Board, Interview Lord Meghnad Desai, Lord Skidelsky, Nicholas Kaldor, Paul Krugman, VAT rate