Two oriental giants will compete for economic dominance

Friday, May 20, 2005

Blame me for having ignored India in my latest posts, having mentioned the biggest democracy in the world last time in this post. India will become a global power according to professor Deepak Lal from the UCLA, who looks at number of factors that will favor India over China in the long term. Literacy, demographics and a yet economically still mostly unexplored region could be the foundation for century long growth on the Indian subcontinent, he argues in the follwing article, originally published in India's Business Standard last March and which can also be accessed at the website of the Cato institute. For a compact version, read on.
What are the lessons from the Chinese economic miracle for India? Who is likely to win the race for economic growth - the hare or the tortoise?
There are great similarities in the policies followed and their outcomes in both the periods of economic repression and reform in India and China.
China carried its repression further as it has its reforms than India. But in both countries the liberalization of foreign trade gave a boost to growth.
The major difference has been in their respective investment rates, with China’s at over 40 per cent of gross domestic product (GDP) being roughly twice that of India’s.
India's growth rate closes in on China
But, given the continuing deadweight of the State Owned Enterprises on the Chinese growth path, this has not led to a commensurate difference in their growth rates during their reform periods, with Chinese growth between 1978-98 being 9.7 per cent per annum on official and over 7 percent per annum on the best independent estimates, whilst India grew by 6.1 percent annually from 1991-2000.
But the growth in China has been more labor intensive than India's. This was the unintended consequence of the end of collectivization in agriculture which led to an explosion of labor intensive small-scale rural industry for export.
This export led industrialization was facilitated by the much better and more extensive infrastructure created in China, and by the absence of any social burdens carried by firms in the fast growing non-state sector.
India by contrast continues to hobble the development of small-scale and labor intensive industries with its policy of reservations.
China produces, India leads in information technology services
In both China and India the dynamics of their growth have been provided by areas which the State had overlooked as being of little importance: the small-scale rural industries in China, and the information based service sector in India.
These were the areas where capitalism was allowed to take its natural course and once foreign markets were opened with the liberalization of foreign trade, the native wit and entrepreneurship of the economic agents not subject to the dead hand of the State, generated a dynamism which no planner could have created.
Unlike the Indian, the Chinese policy elite has fully embraced capitalism. The new (often Western trained) mandarins who run the Chinese state recognize, as many in India still do not, that this is the only route to both prosperity and power for their nation - and like mandarins of yore, it is the Chinese State and not any ideology that they serve.
They are desperately seeking ways to remove the remaining vestiges of their dirigiste past: the loss making state enterprises.
India by contrast seems stuck with its 'Left' still unwilling to abandon its past dirigisme.
These differences in the embrace of global capitalism are reflected in both the much greater trade liberalization undertaken by China and its more relaxed attitudes to foreign investment.
Thus whereas exports were 19 per cent of Chinese GDP in 1998, they were about 8 per cent in India. Whilst the stock of foreign direct investment (FDI) was 261 billion dollars in China in 1998, it was a mere 13 billion in India.
Moreover, the foreign investment in China which has flowed to the non-state sector from the Chinese diaspora to finance industrial exports has loosened the constraint on its growth from its weak domestic capital markets.
The multinationals, by contrast, have been lured into joint ventures with state enterprises to service the large domestic market and have usually lost their shirts.
In both countries wherever growth has occurred there have been dramatic reductions in poverty.
India has to overcome fiscal deficits
The fragility of the Chinese financial system is a case in point. Though India's financial system is healthier, it shares with China the problem of unsustainable fiscal deficits fuelled by economically unjustifiable subsidies.
As I have suggested, China might be able to tackle this problem more easily if it used its foreign exchange reserves creatively. By contrast, the political roadblocks to ending the subsidies debauching the Indian budget remain significant.
There are two other advantages which India has over China as part of the legacy of the Raj: the rule of law, and the English language. Even though China has in the most recent revision of its Constitution put private firms on an equal footing as state owned firms, entrepreneurs are still suspicious of the State.
It explains why most of these new entrepreneurs rely on self or foreign financing and are reluctant to put their head above the parapet by listing their companies on the stock exchange. This cannot bode well for the future of Chinese growth.
India's advantage in having a large pool of English speaking people is likely to be eroded in a generation. Apart from the much higher literacy rate in China, it has now decreed that all pupils will have to learn English.
Given its fiercely meritocratic education system, without any quotas or affirmative action, it is on the way to producing one of the most highly skilled populations in the world. This is a danger India needs to guard against, by helping the spread of private schools in the rural areas.
Demographics favour India
Last, but not least, whilst China with the ageing of its population is likely to see an end to the savings bonanza promoted by the demographic transition accompanying its one child policy, when the dependency ratio declines as the birth rate and population growth rate fall, India is just entering its own demographic transition.
These life cycle effects will raise Indian savings for the next few decades. This should allow a substantial rise in India's investment rate, just as after 2010 demographic effects lead to falling Chinese savings rates.
If by then India has completed the second generation of reforms, built up its infrastructure and fully integrated itself into the world economy, we might find that the tortoise overtakes the hare.
This race between the two Asian giants is set to be the most dramatic event of this century.

In order to understand the grasp of the rapid developments in India, follow also this link. Details on the Indian economy can be found in this post.


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