Compounding and Foreign Policy

In today’s Business Standard, Nitin Pai writes about something he’s mentioned a few times before – that India’s best China/Pakistan/US policy is “8% growth”. Unfortunately a lot of space in his piece talks about appointments in ministries and cabinet formation, and he doesn’t directly touch upon why 8% growth is a viable foreign policy (it is possible he had mentioned this but got edited away).

There are two primary reasons why strong economic growth makes for good foreign policy. Firstly, a fast growing economy means that others will want to get their share in it. If you are growing at a rate much higher than the other big economies, other countries will want to piggyback on your growth. They will want to trade with India, invest in India and  get India to invest in their respective countries. And for any of this to happen, the foreign country will need to have an overall good relationship with India – if they piss off India, they can get left out of partaking in India’s economic growth. And that will ensure good foreign relations.

The second reason has to do with compounding. Assuming that India can afford to spend only a fixed percent of its tax revenues on defence (being a democracy, the government will always have commitments towards welfare and infrastructure spending which cannot be touched), and assuming that taxes as a proportion of GDP are constant, this means that India’s defence spending is likely to be proportional to the GDP.

With 8% growth, India’s real GDP expected to double in about 9 years’ time. Or, our defence budget can double in 9 years’ time. With only about 5% growth (as we have now), in 9 years our GDP, and consequently our defence budget, will only increase by 50%! That is the power of compounding, and that shows you how increased economic growth can lead to greater defence spending, by keeping proportion of defence spending constant!

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