First there was decoupling. Then, when Asian markets fell, there was recoupling. Now, with Asia seeming to recover faster than the West, there is re-decoupling. No doubt, we will soon be onto de-re-decoupling.
The train metaphor is a good one for the global economy, with national economies coupled together like boxcars on a long freight train. The question is not whether the boxcars are hitched together or not. They are. GDP growth will vary country to country, but the growth rates of major economies will rarely, if ever, head in opposite directions.
The question, rather, is what is the locomotive pulling the other cars? Until recently it has been the US, at $14 trillion the largest economy in the world by a factor of 3. In recent decades, America has run an annual trade deficit consistently, helping to develop and sustain export-led economies in Asia. Meanwhile, American households have consumed themselves into debt. The US personal savings rate has fallen since the early 1990s, and went negative in 2005.
The US is unlikely to continue to be the locomotive engine of the world economy in the coming years. A weakening dollar will make it less attractive for America to import goods from overseas. American households will begin to save to rebuild their balance sheets. Indeed they have already begun to do so; the US personal savings rate hit nearly 7% in May, the highest level since 1993. Finally, America?s massive and growing national debt makes future tax increases all but inevitable, which will further dampen US economic activity. In short, America?s shopping spree is over. If the global economy is a freight train, think of the current economic crisis as a switchyard, where the rolling stock is being shunted back and forth, arranged in a new order. Once the cars are lined up, a new locomotive will need to pull the train out of the yard.
China, already the world?s third largest economy and sitting on two trillion dollars in foreign exchange reserves, is already poised to power the world economy. Does India have what it takes to be, along with China, a twin engine of the world?s growth? The answer is yes, but only if India Inc. adapts its business model from that of a follower to that of a leader.
Today India?s economy is built around being a boxcar, not a locomotive. India?s IT industry is a case in point. The likes of Infosys, TCS and Wipro have managed to build multi-billion dollar companies by providing services around intellectual property that resides in other companies, in other countries. Need SAP installed? Need a chip designed? Need a new software product tested? Call the Indians.
The inherent limitation in the IT services business model is that it is not scalable. Microsoft generates $58 billion in revenue with 93,000 employees. Infosys has 10,000 more employees than Microsoft, while generating less than one-tenth the revenue. Leaders like Microsoft build products that can be standardised to earn outsized margins through economies of scale; this creates cash to fund additional R&D and new production innovations in a virtuous cycle. Followers sell customised services around those innovations, and must content themselves with squeezing the remaining drops of profit out of someone else?s product.
There are signs that India?s economy is changing from follower to leader. India?s IT services majors have recognised the need to develop and commercialise their own intellectual property; TCS alone applied for 58 patents in fiscal year 2009. These filings represent an important mindset shift towards developing ?non-linear? revenue models that will give companies better economies of scale than a pure service business does. It is only a matter of time before an Indian software programmer, tired of toiling offshore to build someone else?s intellectual property, starts out on his own and develops the world?s next Windows, SAP or Oracle.
In pharmaceuticals too the push is on to develop unique molecules in India. Glenmark, Dr Reddy?s and Lupin are leaders in this respect, investing the time and money needed to bring new drugs through from research to clinical testing and ultimately to the market. They aim to capture the high margins that patent protection affords, leaving the more modest generic profits for others to capture later.
Innovation is the fuel that drives the engine of economic growth, whether new software products, new drug molecules or countless other discoveries in industries yet to be conceived. India has all the tools to create an innovation ecosystem such as exists in the US and Europe: technical skills, entrepreneurial drive and abundant risk capital. The shift from boxcar to locomotive will not happen overnight; we are the very beginning of a decades-long process whereby India will transform itself into an innovation-led economy. India?s brains and China?s brawn make a formidable twin-engine locomotive; they will keep the world?s economies coupled together and chugging along through the 21st century.
The author is global head of M&A & private equity at Elara Capital Plc
