Beijing and New Delhi : FT Series

Financial Times (London, England)

February 23, 2005 Wednesday

London Edition 1


HEADLINE: Opening a three-part series, Martin Wolf looks at why Beijing has enjoyed the greater success in stimulating growth – and what New Delhi will have to do to catch up


Almost two out of every five people on the planet are either Chinese or Indian. China alone has more people than Latin America and sub-Saharan Africa combined. The economic rise of Asia’s giants is, therefore, the most important story of our age. It heralds the end, in the not too distant future, of as much as five centuries of domination by the Europeans and their colonial offshoots.

What sort of economic performance have the two giants shown in the past quarter-century? Why did growth accelerate at much the same time in both? Why has China performed so much better than India? Will both continue to grow rapidly? Will India even catch up on China? These five questions need to be addressed if we are to understand the world of tomorrow and, even more, of the day after.

Let us start with what has happened. During the 19th and 20th centuries, the two Asian colossi fell far behind the rapidly growing economies of western Europe and North America. In 1820, China generated about a third of world output(measured at common international prices) and India about another 16 per cent(see chart); by the mid-20th century, China’s share in world output was 5 per cent and India’s 3 per cent.

After both of these giants gained independence in the 1940s, India became the world’s largest democracy and China a communist despotism. Yet, though they differed in their politics, both embraced similar economic ideas. Scarred by their countries’ experience with 19th century imperialism, their leaders feared renewed subordination to foreign economic interests. Both saw capitalism as both unjust and inefficient. Both, as a result, embraced socialist economics.

The pursuit of socialist self-suffi ciency failed. By the 1970s, neither had begun to regain its historic position. Since then, however, a transformation has occurred. Both economies have begun the journey from state controls to the market and from would-be autarky to international economic integration. Both have begun to catch up on the world’s leading economies. But China has done far better than its rival.

In the mid-1970s, the gross domestic products per head of the two giants, at common international prices, were similar, at roughly a twentieth of that of the US (see chart). By last year, however, China’s real income per head had reached 15 per cent of US levels, while India’s was roughly half of China’s level.

If both have done well, China has done far better. Between 1980 and 2003, China’s economy grew at an average rate of 9.5 per cent a year, against 5.7 per cent in India. China’s real GDP per head (in constant domestic prices) rose faster than that of any other economy, while India’s was ninth-fastest. At common international prices, China’s real income per head rose by 300 per cent over this period, while India’s increased by 125 per cent.

Since the beginning of its take-off into accelerated growth, in 1978, China’s GDP per head has risen relative to that of the world leader, the US, in almost exactly the same way as Japan’s between 1950 and 1973, Taiwan’s between 1958 and the late-1980s and South Korea’s between 1962 and the early 1990s (see chart).

But it has done so from a much lower relative starting point. Today, China’s income per head, relative to US levels, is roughly where South Korea’s was in 1972, Taiwan’s in 1966 and Japan’s before 1950. For China, then, these are early days in the catch-up process.

For India, they are earlier still. Not only has its convergence on US GDP per head been slower than China’s but it remains far behind. Relative to US GDP per Head, India is today where China was in 1986. Even in absolute terms it is only where China was in 1993.

Now let us turn to the second question: why did the acceleration in economic growth begin in the two giants at much the same time? The broad answer is that both countries moved from the plan to the market at much the same time and for much the same reason: their economies were performing dismally.

Both of the giants were then able to exploit the opportunities created by their huge supply of hard-working people, on the one hand, and the yawning productivity gap with the world’s leading economies, on the other.

In China’s case the direction of reform has been both relatively consistent and remarkably well managed. In India’s, however, it has been less so. A period of half-hearted reform ended in a balance of payments crisis in 1991. This proved the opportunity for a burst of radical reforms under the direction of the then finance minister (and present prime minister) Manmohan Singh. That came to an end in the mid-1990s and so, in due course, did the economic acceleration.

Now let us look at the third and, in many ways, most interesting question:

what explains the superior growth performance of China, at least hitherto? To answer that, we need to appreciate the difference not just in economic strategies, but also in the polities.

Both are the heirs of great civilisations. But China’s civilisation is inseparable from its state, while India’s is inseparable from its social structure, above all from the role of caste.

This difference permeates the two countries’ histories and contemporary performance. As Lord Desai of the London School of Economics has noted, “for India, the problem (is) achieving unity in diversity”. China, however, is a “unitary hard state, which can pursue a single goal with determination and mobilise maximal resources in its achievement”.*

These political and social differences explain, in large measure, the contrasts between the two development strategies. China has largely replicated the growth pattern of the other east Asian success stories, though its financial system is still weaker and its economy more open to foreign direct investment than those of Japan and South Korea. Its growth is based on high savings, massive investment in infrastructure, universal basic education, rapid industrialisation, an increasingly deregulated labour market and an internationally open and competitive economy.

India’s pattern of growth has been extraordinarily different, indeed in many ways unique: it has been service-based and apparently jobless. Savings are far lower than in China, as is investment in infrastructure. India’s industrialisation has hardly begun. Literacy is low, while elite education is well developed. India’s formal labour market is among the most regulated in the world. Regulations and relatively high protection against imports continue to restrict competition in the domestic market.

China has accepted both growth and social transformation. India welcomes growth but tries to minimise social dislocation. The Chinese state sees development as both its goal and the foundation of legitimacy. Indian politicians see the representation of organised interests as their goal and the foundation of their legitimacy. Chinese politics are developmental, while India’s remain predominantly clientelist.

Consider, in this light, the following contrasts between the two giants (see charts).

* In 2002, China’s gross national savings were 44 per cent of gross nationalincome, while India’s were only 22 per cent.

* In 2002, China’s trade in goods was 49 per cent of gross domestic product,while India’s was 21 per cent.

* In 2003, China generated 5.8 per cent of world merchandise exports, which made it the world’s fourth-largest exporter, and 2.6 per cent of world exports of commercial services, which made it the world’s ninth-largest. India generated just 0.7 per cent of world merchandise exports, which put it at 31st, and 1.4 per cent of world exports of commercial services, which put it at 21st.

* By 2001, China’s weighted average tariff was down to 12.8 per cent, from 35.6 per cent in 1992, while India’s was still 28.4 per cent, down from 70.8 per cent in 1992.

* In 2003, the stock of inward foreign direct investment in China was Dollars 501.5bn, against just Dollars 30.8bn in India. In the same year, the FDI inflow into China was Dollars 53.5bn (12.4 per cent of capital formation) against Dollars 4.3bn into India (4 per cent of capital formation).

* In 2000, India’s overall illiteracy rate was 35 per cent, against just 6 per cent in China. In 1999-2000, only 47 per cent of all Indian children had passed through five years of primary schooling, against 98 per cent in China.

* In absolute terms, China is now spending eight times as much as India on infrastructure. As a share of GDP it is spending more than three times as much.

* Between 1996 and 2002, private investment in Chinese telecommunications was Dollars 13bn, against Dollars 9.2bn in India. In energy, it was Dollars 14.3bn in China, against Dollars 7.5bn. In transport, it was Dollars 15.9bn, against just Dollars 2.3bn.

* Between 1990 and 2002, China’s agricultural value added grew at 3.9 percent a year, against 2.7 per cent in India and its services grew at 8.8 per cent a year, against 7.9 per cent in India. But China’s industrial value added grew at 12.6 per cent a year, against a mere 6.0 per cent in India.

* In China, the share of the population engaged in agriculture dropped from 68 per cent in 1981 to 45 per cent in 2001, against a slower decline, from 67 per cent to 59 per cent, in India.

* India’s consolidated fiscal deficit is running at 10 per cent of GDP,against less than 4 per cent in China. India’s public sector savings have been running at minus 3 per cent of GDP, against a surplus of 1-2 per cent in the 1990s.

* The formal sector employs less than 10 per cent of all Indians in employment, with only a third of these employed in the private sector. The proportion of the labour force employed in the Chinese modern sector is at least 20 per cent and rising. t is not difficult, therefore, to see why China’s growth has been far higher than India’s. China has not only saved and invested far more, it has exploited, to a far greater degree, the opportunities afforded by the global economy. Its population is also more skilled, while the social and economic transformation it has embraced is more profound.

This, however, brings us to our fourth question: will the two giants continue to grow as rapidly? They certainly can do so. The potential for rapid growth is determined by the gap in average productivity with the world’s leaders and the quality of institutions and policies.

On the former point, if China replicated the catch-up performance of Japan or South Korea, relative to the US, it could grow extremely rapidly for another three decades.

On the latter, Transparency International ranks China 71st equal in the world for corruption, a little ahead of India, on 90th equal. In the 2005 Index of Economic Freedom, China is ranked 112th, while India is ranked 118th. The World Bank’s investment climate and “doing business” indicators suggest that China and India both offer problematic business environments, with the law’s delays and the insolence of office a slightly more serious handicap in India than in China (see chart).

The quality of institutions and policies is, in short, poor in both countries. Yet this also indicates the room for large improvements in the years ahead. Bad institutions are both constraints and opportunities.

Now consider the fifth and last question: can India match China? This depends on the performance of both countries. The principal internal constraints on China’s growth are institutional: the lack of a rule of law, the consequent uncertainty of property rights, the inefficiency of state enterprises and the profound weakness of the financial system. Important symptoms of these weaknesses have been the reliance on foreign entrepreneurship and an offshore financial and legal centre, namely, Hong Kong.

Behind these weaknesses lies something more profound: a political system that is unlikely to prove suitable for an increasingly sophisticated economy and society. The political transition from one-party state to a more democratic regime could prove highly problematic. An important symptom of China’s institutional weaknesses is the inefficiency with which capital is used. As Ihave noted elsewhere, China’s investment rate has been substantially higher than those of other fast-growing Asian economies at comparable levels ofdevelopment, but its growth is not.**

The explanation for this is partly the scale of investment in infrastructure needed by such a vast country. But it is also partly the fact that 60 per cent of all loans between 1993 and 2000 went to state enterprises. It is astonishing that, in the world’s fastest growing economy, as much as 40 per cent of existing loans is considered bad. The scale of the waste is breathtaking.

China does not only confront domestic challenges. It may well also confront external constraints. China’s extraordinary success in export markets has been a powerful engine of growth. Yet it is hard to believe that this can continue, now that China is such a huge player in world trade and its own economy is already so open.

The challenges ahead are large, by any standards. But it is a good bet that China will continue to grow rapidly for at least another two to three decades. This will require continuing and painful reforms. But the alternative of letting the economic dynamism slow must seem worse to China’s policy makers.

If China’s growth does remain rapid, can India match it? The optimistic view has been well expressed by Vijay Kelkar, a former senior civil servant.*** Mr Kelkar argues that India’s political stability, well-entrenched democracy, relatively effective financial system, deepening international economic integration and improving environment for provision of infrastructure augur well for future growth.

More fundamentally, India enjoys a greater demographic dividend, with the population of working age expected to rise as a share of the total until 2050, unlike in China, while the quality of the labour force is also improving. The private savings rate should continue to rise as living standards improve and the child dependency ratio falls. Finally, the growth of productivity has been reasonably good in India since 1980, with total factor productivity (the rise in output per unit of input of labour and capital) increasing at about 2 per cent a year.

Yet India, too, suffers from many constraints. Public sector dis-saving imposes a significant limit on capital formation. The political and legal systems, though well developed, are also cumbersome and inefficient. Politics lacks a focus on development. Hitherto, in addition, the growing supply of labour has not been matched by a rise in demand. As a result overall employment has risen at only 1 per cent a year over the past decade. Literacy remains too low. There is also evidence that trend growth has slowed since 1996-97 to below 6 per cent a year.

Faster growth is certainly possible in India. But that will also need substantially higher savings and investment, greater inflows of FDI and significantly more rapid industrialisation.

What then should the world expect of the Asian giants? More of the same is the reasonable answer. Morgan Stanley concludes an excellent analysis with the view that “today it is India and China”.**** This is not wrong, even though it will remain more China than India for some time. Lord Desai concludes, in similar vein, that “China will again become a viable great power; India may become a great democracy”.

As Arvind Virmani of the Indian Council for Research on International Economic Relations has noted, by 2025 China is likely to be the world’s largest and India the world’s third-largest economy, at purchasing power parity.***** The impact of the rise of the two giants on the world’s demand for resources, centre of economic gravity and balance of power will be enormous. Adjusting to such changes has always proved difficult. The rise of China and India is likely to pose the biggest challenges of all.