While we raise a toast to the champions of the ongoing Global Indian Takeover, it might be useful to spare a thought for the poor souls who pay for these grand acquisitions. When the Tatas and Birlas take over companies, they pay, don't they?
Or surely, the companies being acquired pay, when a part, at least, of the financing comes from borrowing against their assets, as in the case of Corus. At one level, this indeed is the case. At another level, the toiling masses, particularly of the developing countries that run up huge current account surpluses, pay for the greater glory of our acquisitive entrepreneurs.
To see how, we need some rudiments of national income accounting. All the goods and services produced in an economy are either consumed, invested or exported. But all that is consumed, invested and exported together will not add up to gross domestic product — some of what is consumed or invested domestically would be imported, rather than domestically produced.
So to get GDP, you add exports to consumption and investment, and subtract imports. The difference between exports and imports is the current account balance. This is positive, that is, the current account is in surplus, if more of goods and services are exported than are imported. The item would be negative, that is, there would be a current account deficit, if more goods and services are imported than are exported.
So GDP is consumption plus investment plus the current account balance. If the current account balance is positive, consumption is smaller than what is left of GDP after investment. The larger the current account surplus, the more the people of the country squeeze their consumption relative to GDP.
After World War I, the victorious allies made Germany pay huge war reparations. To finance these, the German people had to really squeeze their consumption and export lots of goods. The current account surplus so painfully built up was used to pay off war reparations. This enforced hardship fed popular discontent that a certain corporal-turned-politician exploited to rise to power and launch another world war.
On the other hand, if the current account balance is negative, the economy would be absorbing more goods and services than it produces. Clearly, for developing countries, it makes sense to run a current account deficit, drawing in foreign savings to sustain investment higher than what would be possible on the basis of purely domestic resources.
The problem with running a current account deficit is that someone abroad must be willing to finance it, offering you funds either as debt or as equity ownership of domestic enterprises. To keep such readiness sustainable, the current account deficit must remain small in relation to GDP.
China runs up a current account surplus of around 7% to 8% of GDP. At the same time, it invests upwards of 40% of GDP. That leaves consumption squeezed at around 50% of GDP. With such massive abstention from consuming the output of their hard labour, the Chinese have accumulated over $1 trillion of foreign exchange reserves.
India's forex reserves are of a different kind. China's reserves are China's assets, they truly belong to Chinese entities. Since India runs a current account deficit, its forex reserves represent net foreign investment inflows that are not absorbed in real terms: in other words, liabilities from an Indian perspective that foreigners are entitled to recall.
Most developing countries do not inspire the kind of investor confidence that India evokes, so their burgeoning forex reserves actually represent the fruits of belt tightening on the consumption front and resultant current account surpluses. The cumulative forex reserves of developing economies is estimated to be over $2.5 trillion.
Developing country central banks deploy these forex reserves in government bonds of the US, Europe and Japan, the bulk of it going to the US. Such reverse flow of capital from the developing to the developed countries lowers the cost of capital in these markets.
Abundant availability of capital at low cost, in turn, emboldens the financial intermediaries of the US and Europe to venture into potentially risky areas such as takeover financing by emerging economy managements. The recycled current account surpluses of emerging economies end up at the disposal of talented managements as venture capital, bank finance or something else. Much such management favoured by private equity players and others are from the emerging economies themselves: Tata, HCL, etc.
What these financial intermediaries value is entrepreneurial talent: the ability to take risk, see new possibilities, manage execution of the processes to realise that vision and create new value.
The meek, toiling masses might, indeed, inherit the earth one day; but right now, the entrepreneur is king. Policy must encourage entrepreneurship at large. This, in turn, calls for action on a wide front ranging from the caste system, which makes most Indian risk-averse, to the paucity of power and bank credit.