China Needs Democracy for Next Big Leap

The IMF reckons India will grow by 6.5% in 2016, against China’s 6.3%. The World Bank estimates India will grow by 7% in 2017 against China’s 6.9%. Many Indians are rejoicing.

Caution, please. First, we are light years behind China in absolute economic measures and may take a century to catch up. Second, China is slowing sharply rather than India accelerating fast.

China grew at 12-14% in the 2000s. Why will it fall to below 7% in coming years? Technical experts will point to enormous sums invested by China in useless infrastructure and housing after the Great Recession of 200809, a false “Keynesian stimulus“ that created ghost towns and roads to nowhere.

Earlier, China was a paradigm of efficiency, with four dollars of investment producing one of output. But today China invests 50% of GDP for barely 7% growth, a capital output ratio of 7:1, as bad as India in the worst UPA days.

China’s slowdown has political roots, not just economic ones. Poor countries are far behind developed ones in productivity and institutional development, so even modest reforms can yield great leaps forward. The capacity to copy successful techniques is enough for fast growth. China in the 1990s beat the US in exports because, while its productivity was only one-fifth as high, its wages were one-tenth lower. Over time its wages rose, but its productivity rose faster as it caught up with the best technologies in the West.

Similar catch-up has enabled many countries (including India) to rise from low-income to middle status (defined as $1,045 per capita by the World Bank). But only a handful have made the transition to high-income status ($12,746). This is sometimes called the middle-income trap: countries that reform enough to make the first transition fail to make the second transition. China was at $6,807 in 2013, but is slowing so sharply that a high-income transition looks some way off.

Now, slowing is natural as an economy grows bigger and richer. Rich economies at the technological cutting edge have to develop entirely new technologies, and cannot gain effortlessly by copying the successes of others. They have to shed labour-intensive industries.

As China prospers, its low-wage units are migrating to Vietnam and Indonesia. It needs to develop innovative skills and strong institutions of its own. Many middle-income countries (notably in Latin America ) have failed to do so, and so remained in the middle-income trap.

Economist David Dollar has shown that, barring a hand ful of oil-rich countries, all middle-income nations that moved to high-income status had to become democracies with strong civil liberties and independent judiciaries.These seem essential for nurturing innovative capacity and the accompanying property rights and accountability.

Spain and Portugal rose to high-income status only after the departures of dictators Franco and Salazar. Japan attained high income only after becoming a democracy.

South Korea and Taiwan were poor countries that skyrocketed into middle-income status under dictators. But that phase came to a sticky end in the Asian Financial Crisis. Both countries then evolved into democracies, after which they soared to high-income levels. Singapore is the richest Asian tiger. Some question if it’s truly a democracy, but it certainly has rule of law and fair elections.

So, efficient autocracies can spark fast growth -as in China -but end in the middle-income trap unless they evolve into democracies with civil rights and independent judiciaries. However, the Chinese Communist Party is dead against democracy, and President Xi is a hardliner.

He is enacting economic reforms to switch China from export orientation to domestic orientation. But history suggests that this will not suffice. After the Great Recession, China sustained rapid growth through massive credit creation. It now has a total debt-GDP ratio of a whopping 250%. History suggests an unhappy ending for all countries with such a high ratio. Xi can manage for many years yet, but the day of reckoning will come.

So, the IMF expectation of a Chinese slowdown is well grounded. Indeed, China may have entered a middleincome trap.

Indians shouldn’t rejoice. Yes, we have a democracy that holds free elections. But we have a lousy civil rights record.The police refuse to register complaints, khap panchayats kill social dissenters, mobs intimidate minorities, police torture and fake encounters are common. Court cases last decades. Over a million cases are pending. There is no equality in practice, in social or economic relations, for dalits, tribals and other minorities. We have barely entered middle income status and yet exhibit signs of being trapped in it.

Democracy and economic reforms are not enough. We need strong civil institutions that deliver accountability and justice. Then alone will we attain our potential.

Swaminathan S. Anklesaria Aiyar is a research fellow at the Cato Institute with a special focus on India and Asia.