There is a growing sentiment among investors that India will be “the next China” – a huge, fast growing developing country whose plentiful cheap labour force will drive down the price down of manufactured goods and whose demand for construction materials will drive up the prices of commodities. It is also increasingly popular to argue that India will do better than China in the coming years, because its democratic system and rule of law are more conducive to the development of globally competitive private companies.
It’s a pretty story, and it has elements of truth. But here are two big reasons why it is off-target.
1. Economic growth stems from high savings, not from political systems.
The fashionable argument used to be that China grew at a fast 9-10 per cent a year because its authoritarian political system could ram through unpopular reforms and commandeer national savings at low interest rates to build infrastructure. India grew more slowly, at 5-6 per cent a year, because its democratic system throttled both reform and infrastructure.
This theory is beginning to look dodgy now that India is heading toward a structural growth rate of 8 per cent. In fact, there is little evidence that political systems ever had anything to do with the China-India divergence. The differential growth rates are explained first by China’s higher savings rate, which is around 40 per cent of gross domestic product versus 20 per cent in India. The savings rate is in turn a function of two things: agricultural productivity, which has consistently been about twice as high in China as in India since the 1970s, and demographics. A population dominated by a young workforce generates high savings; the savings rate falls as the population ages.
In agriculture, India still lags China dramatically, because in most places land tenure has not been reformed and the majority of farmers are tenants or indentured labourers. The backward agricultural sector will be a drag on growth for years to come. Demographics, however, favour India. Beginning in the next decade China’s population will begin to age rapidly and the savings rate will fall. India, however, is just entering an era of “demographic dividend”, driven by a young workforce that will probably last for about three decades.
Another factor behind the divergence is that China is fundamentally egalitarian and India is fundamentally elitist. China’s leaders, though repressive, have pursued broad-based growth in large part because their legitimacy rested on little else. India’s leaders have largely represented the interests of the highest castes in a very stratified society. Growth has not been as important as preserving the elite’s privileges.
2. Rule of law is not that important for early-stage economic growth.
It is true that India has done better than China at creating private firms with real international competitiveness: think of Infosys or the Tata Group conglomerate, which have no Chinese counterparts. But this is only marginally the result of India’s superior legal and financial market framework – and more important, is irrelevant for growth.
India’s internationally competitive firms are mainly the reflection of a horrendously difficult domestic investment environment. Companies that have survived this harsh climate could only do so by being ferociously efficient users of capital. As India’s investment environment improves, however, capital will become more abundant and, rates of return will fall. In other words, to sustain higher rates of economic growth, India must paradoxically become a less efficient user of capital.
In China, it is certainly true that a poor legal and capital-markets environment will discourage the development of knowledge-based firms. And foreign financial investors will find it difficult to generate consistent returns from Chinese equities. But this is irrelevant to economic growth, which is predicated on China’s gigantic comparative advantage in high-volume, low-margin manufacturing.
Moreover, it is an often overlooked fact that China’s rampant disregard for intellectual property laws has been very important in laying the foundations for broad-based consumer growth in the future. China has had a more or less explicit policy of stealing foreign technology and then producing it on a vast scale at very low cost. This enables domestic consumers to enjoy a far higher level of consumption of things like refrigerators, cell phones, and personal computers than their incomes would have implied in earlier eras.
In sum, there can be no question that India’s structural growth rate is rising to the 8-9 per cent range, while China’s will likely fall to under 8 per cent sometime in the next decade. Financial investors will tend to find Indian equities more rewarding than Chinese.
But because of low agricultural productivity and a stratified society that produces an elitist policy bias, India is unlikely to replicate the turbo-charged economic growth of China, which saw peaks of around 15 per cent in 1993 and around 13 per cent in 2003. And China’s far more equal urban income distribution (only 3 per cent of urban households earn less than US$1000 per year, compared with 53 per cent in India) means that India will continue to lag in broad-based domestic consumption.
Moreover, India has the disadvantage of entering its high-growth phase at the moment when world commodity prices have been driven to historic highs by China, whereas China enjoyed two decades of fast growth in a era of low commodity prices. India may be a more efficient user of resources, but the prices of its inputs are set by China. India has a bright future, but it looks a lot different than China’s.
The China Economic Quarterly is an independent newsletter devoted to analysis of the Chinese economy and business environment since 1997. It draws on the 25 years of combined experience of its editors, veteran financial journalists Joe Studwell and Arthur Kroeber, and also publishes articles by leading China-focused economists and journalists. This column appears exclusively on FT.com on alternate Mondays.