Commentary

India vs. China

This article appeared in India’s Business Standard, March 15, 2005.

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 greater similarities rather than differences 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 and the ending of planning 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.

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 per cent per annum on the best independent estimates, whilst India grew by 6.1 per cent per annum 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 freedom to hire and fire as well as the absence of any ‘social’ burdens carried by firms in this fast growing non-state sector.

India by contrast continues to hobble the development of small-scale and labor intensive industry with its policy of reservations, and refusal to repeal the archaic labor laws it inherited from the Raj.

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, who continue to block the necessary privatization of its public enterprises.

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 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. However whilst labor intensive industrial growth seems to be spreading faster to the hinterland in China through fierce locational competition for joint ventures with foreign investors, the Hindu heartland in the eastern Gangetic plain still remains mired in its ancient equilibrium.

While inequality had increased in China since the planned period, there is no clamor in an ostensibly Communist country for egalitarianism. This is because like India, China for millennia has been a hierarchical society.

It was the foreign Enlightenment virus of socialism which for half a century infected their intelligentsia, but whereas the Chinese seem to have overcome it, India’s intellectuals unfortunately still remain deeply infected.

From this it would seem that there is no contest in the growth race between the hare and the tortoise. But there are some signs that appearances maybe deceptive.

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.

Nevertheless, India currently has a head start in both the instruments it can provide for savings as well as in the mechanisms through the financial system for their efficient deployment.

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.

When Forbes recently published a list of the top 50 Chinese millionaires, the individuals complained, as the tax authorities showed an interest.

It explains why most of these new entrepreneurs rely on self or foreign financing of their firms 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 everyone from the age of five will have to learn English — the commercial and scientific lingua franca of the world.

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 and abandoning the Mandalism which has already done great harm to its system of university education.

If affirmative action is extended to the private sector, it would further handicap India in its ongoing race with China.

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.

Deepak Lal is professor of international development studies at the University of California, Los Angeles, and an adjunct scholar at the Cato Institute.