by Utsa Patnaik
In a sovereign country, the familiar identity is expressed as follows:
(S – I) = (G – T) + NX … (1)
where S and I refer to private savings and investment, G is government expenditure, T is taxes and other forms of revenue so that (G – T) is the budget deficit. NX is the current account surplus on the balance of payments. In a sovereign economy, if there is a balance between private savings and private investment, then a budgetary surplus would be reflected in a current account surplus, and likewise a current account deficit would accompany a budgetary deficit. Given a balanced budget, a current account deficit would be reflected in an excess of private investment over savings. Likewise, a deficit budget, with a balanced current account, is accompanied by an excess of private savings over private investment.
In a colony, the budget appears to be balanced as part of the policy of “sound finance,” so that (G – T) = 0. But actually, the budget was kept in large surplus every year, since only a part of tax revenue was spent in a normal manner, and this exercised a strongly deflationary impact. Total public spending G was divided by government itself into two parts, which we can denote as GD, the part spent domestically, and as GA, the part spent abroad. GA constituted the total of drain items. These were administratively imposed like the bulk of the “Home Charges,” 87 percent of which comprised military expenses and interest charges on a sterling debt; the size of both was decided by the British government. Thus, the budget, though apparently balanced, was perpetually in surplus when we consider heads of normal internal spending, leaving out the drain items (GA).
This division of the budget was reflected in a corresponding division of Net Exports NX into two parts: we define NX1 as the colony’s total earnings from the world, including Britain, on account of its commodity export surplus taking merchandise, commodity gold, and normal invisible items like freight, insurance, and commission on trade. It is a large positive figure. NX2 is the balance of invisible items charged to the colony that arise from its colonial status. It is a large negative figure that includes all the drain items GA of the internal budget, now expressed in sterling. (In many years – NX2 would include additional items over and above the usual drain items, but let us for the moment concentrate on the simpler picture.) Since all the colony’s global export surplus earnings, NX1, are siphoned off by imposing an equivalent value of invisible liabilities, NX2, it follows that
The commodity export surplus grew especially fast from the early 1890s onward, aided by the depreciation of silver relative to gold, which greatly increased the GA requirement in rupee terms to meet the same level of downwardly inflexible sterling demands as before. Hence, it meant increased taxation, T, on producers. When the limit of tax extraction was reached (or when large scale import of monetary gold took place), the adjustment to increased demands by the metropolis was made through enforced borrowing thrust on India. Thus, NX became negative and – NX2 = GA became larger than (T – GD) when such enforced borrowing took place.
The above framework enables us to see that though while foreigners made payment in full for their import surplus from India, namely NX1, net invisibles equaling at least this amount, namely –NX2, were demanded by the metropolis leaving India’s current account NX in deficit on average. Looking at the UN data on trade surplus in the next section and the estimates of balance of payments,6 we see that no matter how fast the commodity trade surplus grew—India posted the second-largest and rising merchandise export surplus in the world for decades, so that even after deducting net import of commodity gold, the commodity trade surplus increased fast—invisible demands administered by the metropolis and imposed on India grew even faster. The current account was made to remain in deficit and India was forced to borrow, increasing future interest burdens.
Payments made by foreigners took the form of official bills of exchange (Council bills including telegraphic transfers). This sum must be identically equal to the commodity export surplus of India with the world (balance of merchandise plus balance of commodity gold) plus normal trade-associated invisibles like freight, insurance, and commission. We use the term NX1 for this sum and define it as exports f.o.b. minus imports c.i.f. The producers of export surplus were paid out of taxes minus GD; so in the absence of any increase in debt, NX1 would be equal to –NX2 which in turn would equal GA. But when the total of the invisible demands on India, –NX2, was pitched higher than NX1, then the difference would constitute additional borrowing, which would equal –NX2–NX1.
The drain can be approximated at a minimal level, if we leave aside borrowing, by taking either the total of budgetary expenditures set aside for spending abroad, namely GA, or, equivalently, NX1, the actual exchange earnings that made possible this spending abroad on the GA items. But since there was some borrowing, we may approximate the drain at a more accurate (and higher) level, by taking the sum of NX1 and additional longterm borrowing, which would give us –NX2, the actual total of invisible liabilities imposed on India. This always exceeded its commodity export surplus earnings no matter how large the latter might be and kept an entire people as perpetually indebted to Britain as any bonded laborer to his landlord-cum-creditor.
In all this, gold movements play an important if problematic part. India was a large net importer of gold for the period before the Great Depression. It is standard practice by authors to treat all net gold flows as commodity gold and put them in the trade account along with other goods. But this is not a correct procedure, for all gold flows could not have been solely commodity gold. Under the gold standard, the accepted means of settling imbalance in international payments was gold flows, today termed financial gold, as distinct from commodity gold. Further, gold was imported by the colonial government for the reserve requirements of India’s gold exchange standard, and this definitely constituted monetary gold, a subset of financial gold. India’s merchandise export surplus has tended to be substantially underestimated in the literature by treating all financial gold inflow at par with merchandise imports, and conversely, the current account deficit during the Depression years has been severely underestimated, by treating distress financial gold outflow as commodity gold exports.7 The official trade statistics collected at that time could have made the distinction between commodity gold and non-commodity gold but they did not make the distinction explicitly. As a rule of thumb, gold imported or exported by government always constituted financial gold, and not commodity gold.
Britain’s Capital Exports and the Diffusion of Capitalism
Returning to the inapposite remarks by Galbraith on the “trivial” nature of Indian finance, they indicated he was unfamiliar with the work of Hilgerdt or Saul on the international pattern of trade and payments.8 Unfortunately, he was not exceptional in this respect. There is to this day little recognition in the literature that the large capital exports from Britain, especially during the last three decades of the nineteenth century, that speeded up the construction of roads, railways, and factories in Continental Europe, the United States, and Canada depended crucially on Britain’s ability to siphon off India’s gold and foreign exchange earnings, as it did the earnings of other smaller colonies. These earnings not only offset the deficits that Britain was running on its current account with these regions, but it helped to offset additional deficits owing to its capital exports to these same regions.
In his valuable study, Saul did not talk explicitly of “drain” from India, for he appears to have had little knowledge of the tax-financed nature of its export surplus.9 His main concern was tracing Britain’s balance of payments with different regions of the world from the 1880s to the First World War, and this showed a striking picture. Britain incurred large and rising current account deficits with the European Continent, North America, and regions of recent European settlement, while it posted a huge and rising current account surplus only with its tropical colonies, preeminently with India. Further, Britain exported capital, entailing capital account deficits, to the greatest extent to those very same n
ewly industrializing regions of European settlement, with which it ran current account deficits. The two deficits added up to mounting balance of payments deficits with these regions.
Saul estimated that in 1880 Britain’s deficit with the United States plus Continental Europe was over £70 million, and pointed out that the £25 million credit that Britain showed vis-à-vis India, which was India’s entire commodity export surplus that year, meant that “Britain settled more than one-third of her deficits with Europe and the US through India.”10 By 1910, the balance of payments deficit that Britain had with Europe, the United States, and Canada combined had reached £120 million. That year India’s global commodity export surplus was a massive £57.8 million but a slightly larger sum, £60 million, was shown by Britain as owed to it by India.11
Saul says: “The key to Britain’s whole payments pattern lay in India, financing as she probably did more than two-fifths of Britain’s total deficits.”12 The total amount £60 million (comprising its managed trade surplus of £19 million that year plus £41 million invisible liabilities politically imposed by Britain and shown as its total credit with India in 1910) was pitched a little higher than India’s actual export surplus of £57.8 million vis-à-vis the rest of the world in that year. The balance, £2.2 million, would have been either a drawing down of the Secretary of State’s balances or shown in the accounts as addition to India’s debt to Britain, or a combination of the two.
India’s merchandise trade grew remarkably fast during 1901 to 1913, with total trade doubling from £148 million to £300 million, at over 6 percent per annum; the average annual commodity export surplus was £ 25.7 million, 60 percent higher than in the earlier decade. The industrializing countries were expanding their demand for foodstuffs and raw materials from tropical regions. As usual, these fast-rising earnings were appropriated by Britain via a corresponding rise in the annual issue of Council bills.13 While shipping shortage constrained trade during the first two years of the war, India’s trade grew even faster during 1914 to 1919 with total trade value nearly doubling again over the five years (see Figure 10.1).
The rupee appreciated rapidly against sterling during the war years, from Rs.15 to Rs.9.5 per £1, as shortage of shipping led to import compression while the belligerent powers demanded Indian jute for the millions of sandbags used in trench warfare. Silver rupees started to be melted down as their market value in terms of gold soon exceeded the official exchange rate. Merchandise export surplus earnings averaged £63 million during 1915–19, reaching an unprecedented £114 million in 1919 (see Figure 10.2). These earnings, even after deducting commodity gold imports, were far in excess of the annual expenditures charged to India under the usual drain items. Repaying at least part of India’s managed sterling debt out of its record earnings would have benefited Indians by reducing interest burdens, but no matter how large its external earnings, they were always appropriated and an entire subject population was kept perpetually indebted.
Figure 10.1: Total Merchandise Trade of India, 1900–1920
Source: United Nations Historical Data (1962). Rupee-based trade data for 1914–1919 are from the Statistical Abstracts, converted to sterling, using exchange rates available in U.S. Financial Statistics. The last figure is a two-year average.
Saul’s study documented the important “balancing role” that India played in the multilateral trade system centered on Britain during the period of the gold standard, but he does not seem to have been aware of the linking of trade with taxes that made for the drain. A balancing role, whereby a country uses its surplus external earnings from one region to offset its deficits with other regions, is normal and legitimate if such earnings are obtained under normal trade conditions. But Britain did not have a legitimate surplus with India; it could link taxes with trade solely owing to the direct political control it exercised. Without such control, it could not have appropriated India’s entire net global external earnings to balance its own deficits, for this was only possible by imposing manipulated invisible items on India’s external account while charging these to the Indian budget. The detailed 1962 United Nations trade data matrix for different countries shows that Saul’s conclusion was correct, that in the pre–First World War period India’s earnings paid for two-fifths of Britain’s deficits. Saul certainly realized that Britain treated Indian export earnings as its own since he pointed out that in effect Britain used Indian goods, which were largely duty-free on the Continent and North America, to jump the tariff barriers that Britain’s own export goods faced.
Figure 10.2: Merchandise Export Surplus of India, 1901–1919
Source: United Nations Historical Data (1962).
India’s role, however, was not limited to offsetting Britain’s current account deficits. “But this was by no means all, for it was mainly through India that the British balance of payments found the flexibility essential for a great capital exporting country.”14 Saul went on to say: “The importance of India’s trade to the pattern of world trade balances can hardly be exaggerated.”15
In fact, Britain would not have been a capital exporting country at all, great or otherwise, if it did not have complete control over colonial exchange earnings, since with the rest of the world it ran current account deficits of such a magnitude that it would have needed to borrow capital. The present-day world capitalist leader, the United States, also has been running large current account deficits with the world, but without access to colonial transfers in the old form that Britain had enjoyed. Not surprisingly, the United States is not an exporter of capital but is the world’s largest debtor.
The Interwar Period: Changing Magnitude of the Drain
Folke Hilgerdt prepared a study for the League of Nations for 1928 of the merchandise exports and imports of the major trading countries and regions of the world.16 Figure 10.3 shows the network of world trade, summarizing the pattern of multilateral trade by depicting flows between the major regions and countries, though not all countries. The data for India are not given separately but included in the broad region labelled “Tropics.” The arrows point toward the country/region with the trade deficits, and point away from the countries/regions with the trade surpluses. Saul adopted the opposite convention while depicting the network for 1913 in a similar form, but with arrows pointing toward the trade surplus countries.17
The figures in million U.S. dollars from the Hilgerdt network diagram are shown in Table 10.3.18 (Note that surplus of country A with B is different from deficit of B with A, as the export f.o.b. from country A to B is a smaller figure, than import c.i.f. of the same goods by B from A.) Only two regions posted overall merchandise trade surpluses with the world, namely the United States and the Tropics, of $880 million, and $690 million, respectively. The notable feature is that all arrows but one pointed toward the United Kingdom, indicating its heavy trade deficit, totalling $1,680 mn. (the largest in the world for a single country) with only one arrow that pointed away, toward the Tropics with which the UK had a trade surplus of $210 million. The United States had surpluses totalling $1,830 mn. with every region of the world except the Tropics, against which it ran a massive deficit of $950 million. The Tropics, in turn, had trade surpluses with every region in the world totalling $1,040 mn. except UK, with which it had a deficit of $350 million. The deficit with the UK was the result of most of the Tropics, India being the largest component, being part of the British Empire with compulsory free trade.
The UK had trade deficits with every region other than the Tropics, the largest deficits being with Continental Europe and the United States, continuing the prewar pattern. Europe, other than Germany and the UK, ran large overall deficits on merchandise trade. The trade of the temperate regions of recent settlement was balanced, with the surpluses earned from Europe being almost the same as the deficits incurred with the Tropics and the United States.
The data, in current dollars, available from the later (1962) United Nations historical study of merchandise trade series for different countri
es from 1900 to 1960 gives the sources and destination imports and exports for selected years.19 Analyzing these data in Table 10.4, we separate India’s trade with the United Kingdom and its trade with the rest of the world. A comparison of 1928 with 1900 shows the large rise in the Indian subcontinent’s merchandise trade balance with the rest of the world (excluding the UK) from $151 million to $497 million. After deducting its negative balance with the UK, India’s overall merchandise trade balance more than trebled from $114 million to $392 million, with its rising earnings being appropriated by the United Kingdom (after allowing for the balance of commodity gold). Indian SC refers to the Indian Sub-Continent comprising today’s India, Pakistan, Bangladesh, and Sri Lanka.
TABLE 10.3: Merchandise Trade Balances of Major Regions and Countries in 1928 (USD million)
Figure 10.3: The Multilateral Trade Network in 1928
Rise and Decline of India’s Trade in the Interwar Period
As in other primary product exporting regions, India’s trade showed a roller-coaster pattern of rapid growth up to 1928 followed by collapse after that up to 1933, with a slow recovery thereafter. Looking at countrywide annual data on exports and imports, we find that India posted the second-highest merchandise export surplus globally from 1900 to 1928 (though it lagged far behind the United States, with Argentina just below India). Export earnings by India from the rest of the world scaled their highest level of the post–First World War period, by 1925 at $1.4 billion (or £282.86 million), while export surplus reached $450 million or £92.57 million.
