India is, like China, a vast developing country that is also the heir to an ancient and sophisticated civilisation. It, too, is experiencing a rapid and sustained rise in average living standards for the first time in its long history. But it also remains a poor country. It possesses, like China, a tradition of entrepreneurship and a growing supply of educated and motivated young people. It is trying, like China, to become a player in the world economy, albeit on its own terms.

Yet these two giants differ profoundly. In 2004, for example, India’s exports of goods and non-factor services were 15 per cent of gross domestic product, against China’s 40 per cent. The difference in its openness to the world economy reflects India’s relatively late and tentative liberalisation. Its turning away from inward-looking development only began after its balance of payments crisis of 1991. It has a long way to go.

India’s overall trade is correspondingly far smaller than China’s. In 2005, according to the World Trade Organisation, India was the world’s 29th largest exporter of merchandise products (with members of the European Union treated as separate countries). It generated just $95.1bn in exports (0.9 per cent of the world total), against China’s $762.0bn (a 7.3 per cent share).

India is relatively far more successful as an exporter of commercial services: in 2005, it was 11th in the world, with $56.1bn in exports (2.3 per cent of the world total). China was still ahead, with exports of $73.9bn, which put it in 9th position. But India was far more reliant on exports of commercial services than China.

Yet India has become progressively more open. Between 1990 and 2004, the growth in India’s trade was 6.8 percentage points faster, in real terms, than the growth of its GDP. This drove an increase in the ratio of merchandise trade (the sum of exports and imports) from 13.1 to 25 per cent of GDP, while the ratio of trade in services to GDP jumped from 3.4 per cent to 8.2 per cent.

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Martin Wolf on China

A colossus with feet of clay

>The differences in the composition of trade between the two emerging giants are also profound. In a recent World Bank publication, the authors argue that while “both have been quite successful in expanding their exports and imports, they have done this in very different ways. Broadly, China has relied primarily on exports of finished goods, while India has focused more on exports of intermediate inputs. India’s exports include a number of capital- and skill-intensive goods, while China has emphasised exports of labour-intensive goods – although these are increasingly sophisticated and their capital intensity is rising”.*

These features of India’s trade reflect its pattern of economic development. Unlike the successful east Asian examples, of which China is the most recent, India’s development has not been based on industrialisation and rapid growth of labour-intensive exports of manufactures. It has been built around services and relatively capital- and above all skill-intensive exports.

An important recent paper from the International Monetary Fund notes the extent of this bias towards skill-intensity.** Up to 1980, that bias generated a relatively small, but skill-intensive, manufacturing sector. Since then it has generated an exceptionally large, but skill-intensive, services sector. The share of services in employment was 17 percentage points below those of comparable countries in 2000, even though its share in output was 4 per cent higher.

This bias curbs the growth of export-oriented employment and, no less, the growth in the country’s trade. It also shows itself, in the sectoral composition of India’s exports. The World Bank notes that “pharmaceuticals is one of India’s brightest prospects”. Companies like Ranbaxy, Cipla, Dr Reddy, Wockhardt and Nicholas Piramal have the capacity to embark on substantial research activities. Developing a drug can cost $100m in India, against $1bn in the US. India also has the most plants approved by the US Food and Drug Administration outside the US itself.***

Equally striking is the success of India’s exports of IT services. According to the McKinsey Global Institute, in 2004–05 the Indian offshore IT and business-process-outsourcing industry generated about $17.3 billion in revenues and employed an estimated 695,000 people. By 2007–08, that workforce will, it predicts consist of about 1.5m people, while the industry will account for 7 per cent of India’s GDP. But the supply of skilled people is in short supply: wages are rising rapidly and turnover among engineers is high.

No less important a constraint on the broader growth of trade is inadequate infrastructure, notably, ports, airports, railways, roads and electricity generation. Telecommunications is a notable exception, because of the success of the liberal- isation of mobile telephony.

The story on trade then is one of liberalisation, opening and growth, but also of a still relatively modest impact on the world economy. It is also one of persistent biases against the unskilled-labour intensive products in which one would expect India to have a comparative advantage.

The story on foreign direct investment is also one of slow opening and modest inflows. Between 1990 and 2004 net inflows of foreign direct investment into India rose from virtually nothing, at 0.1 per cent of GDP, according to World Bank statistics, to 0.8 per cent, while China’s net inflows were 2.8 per cent in the latter year. According to the UN’s World Investment Report, India’s FDI inflows in 2005 were still only $6.6bn, while its stock of inward FDI in that year was $45.3bn. China’s inflows in that same year were $72.4bn and its stock of inward FDI $318bn.

Meanwhile, India is not a savings surplus country. Its current account has been in modest deficit: in 2005, for example, that deficit was $8bn; in 2006 it rose to $16bn (roughly 2 per cent of GDP). None the less, India, too, has been accumulating reserves, albeit on a more modest scale than China, because of large net capital inflows: in 2006, net inflows, other than FDI, amounted to $48bn.

By November last year, India’s foreign currency reserves had reached $168bn, up from just $32bn in December 1999. The currency market interventions that generated this increase in reserves were, like China’s, aimed at keeping the notionally floating rupee down and, again, the policy has met substantial success. In real terms, according to JP Morgan, the exchange rate has oscillated within a narrow band since 1993.

India, then, has a growing, but modest, presence in the world economy. Only in a few relatively skill-intensive sectors is its global impact significant. It is still unclear how soon this will change. Will India finally embrace the opportunities in labour-intensive products exploited so magnificently by China? Will it manage to attract bigger inflows of FDI than hitherto? Will its growth
bring with it the deepening integration into the world economy that is such a feature of China’s rise?

The underlying potential of India is evident. But further liberalisation of policies, not least of labour markets and of foreign investment in infrastructure, will be needed if India is to exploit it fully.

* Betina Dimaran and others, Competing with Giants: Who Wins, Who Loses? in L. Alan Winters and Shahid Yusuf (eds), Dancing with Giants (World Bank and Institute for Policy Studies, 2006); ** Kalpana Kochhar and others, India’s Pattern of Development: What Happened, What Follows? January 2006, WP/06/22, www.imf.org/; *** Shahid Yusuf and others, China and India Reshape Global Industrial Geography in Winters and others, Dancing with Giants.