China vs India: Differences, similarities and prospects

Benjamin Ford, Senior Economist, Export Finance and Insurance Corporation Remarks to 3rd Annual Asia Trade and Export Finance Conference, Singapore, 8 September 2011

Introduction
Comparing China and India is an activity with a long history. Both countries have long fascinated Western policy makers and analysts, but, at least until recently, they were fairly small players in the world economy. The emergence of China as a big economic power has been accompanied by a more relaxed, albeit still important, economic transformation in India. This morning I would like to examine some of the reasons for this divergence and then speculate on which country might be more successful in the medium-term. Why is this important? Because both countries, just by virtue of their size, have the potential to be dominant economic powers in Asia and globally. They are already having an effect on global economic, trade and financial relations. And they are a key source of activity in an otherwise soft global economic landscape. In short, they matter now and are likely to matter in the future. So what aspects of China and India are we going to focus on this morning? I will cover three (Slide 1): Their role in the world economy How big is their share? And how much bigger could it be in the next few years? A comparison of their relative strengths, disadvantages and prospects India and China have pursued different approaches to industrialisation, and, not surprisingly, this has delivered different outcomes. The medium term and beyond If the common view prevails, China and India will become even more economically and politically influential. But it is worth exploring what could go wrong. It is also worth remembering that in Asia, China and India arent the only large rapidly industrialising countries.

Changing world economic landscape

The balance of world economic activity and influence is evolving fast as can be seen in Chart 1, the output share of the G7 countries the US, Canada, the UK, Germany, France, Italy and Japan has declined from over half to just over a third. At the same time, the share of world output of China, India and Brazil has more than doubled in the last 30 years to 22 per cent. These trends are likely to continue IMF projections suggest that China, India and Brazil will account for 28% of world output in 2016.

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Slide 1: Shifting economic weight

Shifting economic weight.rise of Chindia

Chart 1: Changing world economy
Purchasing power parity valuation of country GDP

1980

2010
Rest of World 38%

2016

Rest of World 35%

Rest of World 39%

G7 35%
India 3% China 2% Brazil 4%

G7 56%

G7 39% India 5% China 14% Brazil 3%

India 7%

Brazil 3% China 18%

GDP: $11 trillion

GDP: $74 trillion

GDP: $105 trillion

Source: IMF, EFIC

But dig a little deeper and a few interesting features become apparent: Chinas rise has been simply extraordinary in 2010, its economy was 47 times larger than it was in 1980. But it isnt just a China story. Because of attention China garners, it is easy to forget that countries such as Vietnam, Indonesia and Saudi Arabia have also become more significant players. The rise of China and others has not come at the expense of other countries. The world economy has expanded significantly since 1980 - total 2010 world output (again measured in PPP terms) is more than six times larger than it was in 1980. Slide 2: Millennial GDP shares

.or is it the re-emergence of Chindia?

Chart 2 - Millennial GDP shares
60 50 40 30 20 10 0 0 1000 1500 1600 1700 1820 1870 1913 1950 1973 1998 2010 2016
Sources: EFIC, Maddison, IMF

Share of world GDP, 1990 PPP

The emergence of EMEs like China and India should probably be rebadged as a re emergence. Using historical estimates of GDP that go back to 0 A.D by Angus Maddison, you can see that China and India were the largest economies in the world for centuries. It was not until the 19th Century that Western Europe finally caught up and the United States began its ascent.
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Comparison of their relative strengths, disadvantages and prospects

China and India had similar levels of per capita GDP (at market exchange rates) in 1980, but China grew much faster and had overtaken India by the early 1990s. Since then growth in China has been so fast that its per capita income is now more than three and a half times that of India. Slide 3: Per capita GDP

Same starting point.but China has pulled ahead in per capita GDP terms
Chart 3 - Per capita GDP
5 US$, 000's 5

4 China 3

2 India 1

0 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010
Sources: EFIC; IMF

Why such a large divergence? I want to introduce three that get a lot of airplay: China focussed on industrial production while India focussed on services That is, China launched its economic transformation by using abundant, low-wage labour to establish manufacturing for export industries. In contrast, India developed a service export sector focussed on IT and BPO. As a consequence India had a much lower rate of investment than China and therefore capital deepening was less prevalent1. China derived substantial benefits from foreign direct investment China encouraged FDI by multinationals looking to set up export-oriented manufacturing operations, and was able to benefit from foreign intellectual property and know-how. In contrast, India followed an importsubstitution policy and relied on domestic resource mobilisation and domestic firms. China reformed earlier and more aggressively than India - China began reforming its closed, centrally planned, non-market economy in 1978. In contrast, India always had a large private sector, but its product, input and labour markets were subject to rigid state controls until the hesitant and piecemeal reforms of the 1980s. Only after experiencing a serious macroeconomic crisis in 1991, did the reform effort become more determined and the reforms broader. Political differences are thought to have played a big role in the two countries different pace of reform.

Lets boil this down to say that the consensus view is that India has a different growth path from China, with a greater role for modern services, a smaller role for manufacturing and a much lower investment rate.
Thereasonforthefocusonservicesissubjecttomuchdebate.Incontrasttotheexogenousviewarticulated above,itisalsoplausiblethatservicesgrowthwasendogenous.Thereason?ThegovernmentinIndia,unlikein China,neglectedinfrastructuredevelopment.Sobottlenecksdevelopedonroadsandatports,manufacturing costswentupandmanufacturerscompetivenessdeclined.Inthesecircumstances,therationalentrepreneurial responsewouldbetolookforanindustry,likeBPO,thatdoesntshipstuffacrossphysicaltransportnetworks.
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1

Sectoral profile There is much truth to such an assessment, but there are some important nuances. For example, a growth accounting analysis by Bosworth and Collins challenges the conventional wisdom that China's growth is more dependent than India's on investment rather than on efficiency gains. Slide 4: Growth contributions

Different sources of growth. and sectoral strengths

Chart 4 - Contribution to GDP growth

100 Percent
4 3 7 6

Chart 5 - Sectoral value-added

Percent
50

Employment

80
39 40

24

Services
35

Capital investment Total factor productivity Education

20

33

60

28

40

27 43 47 28 12

28

Industry
58

20

29

India 22

Agriculture
9

0 1978-1993 1993-2004 China

Sources: EFIC, Bosworth and Collins

China

1978-1993

1993-2004 India

10

20

30

40

50

60

Sources: EFIC, Bosworth and Collins

Interestingly, it appears to be the other way around. Over the decade to 2004, TFP has in fact accounted for a bigger slice of GDP growth in China than in India (Chart 4). Thanks to economic reforms, India's TFP growth has improved from its paltry 0.2% a year in the 1960s and 1970s before the economy was opened up, but it is still much slower than in China. Worryingly, the figures also show that India's TFP grew more slowly in 1999-2004 than in 1993-99. Since 2004, TFP growth has probably spurted (although the figures are not yet available), but this may reflect a cyclical boom. The conventional wisdom also suggests that Chinese workers have shifted largely from farming to factories, whereas India's growth has been driven largely by services, from call centres to writing software. This differential can be seen in the share of value added contributed by industry in China (58%) and services in India (50%) (Chart 5). However, service jobs have expanded more strongly in China than in India. Since 1993 the rate of increase of China's service-sector jobs has been four times that in industrial jobs and has exceeded that in India. China's real output of services has not only grown almost as fast as its industrial output, but also faster than India's services.

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Capital efficiency vs overinvestment China has long had a higher investment ratio than China, although the gap has narrowed in recent years. At 49% of GDP, the investment ratio in China has reached an historical high level. In India, the investment ratio has increased strongly of late, rising by about 13 percentage points of GDP in just the last decade. However, at around 37% of GDP, India's investment ratio is still far below that in China. Slide 5: Investment ratio

Investment share of GDP. capital efficiency.overinvestment

Chart 6 - Investment ratio
60 50 China 40 30 India 20 10 0 1980
Sources: EFIC, IMF

Investment, % GDP

60 50 40 30 20 10 0

1985

1990

1995

2000

2005

2010

A popular argument is that China is over investing. That is, creating excess capacity. It is also argued that Chinas investment is inefficient in that as the ratio rises it has a proportionately smaller effect on output growth. That is, China gets less bang for its buck. In contrast, some suggest that Indias investment ratio is not really low rather, they argue that Indias investment is more efficient. That is, it gets more bang for its buck. There is probably some truth to these claims especially about China. After all, it is hard to see how fixed investment close to 50% of GDP can be sustainable it is also difficult to believe that an economy can be so efficient that it reinvests 50% of GDP into new capital stock without eventually facing massive overcapacity. But it is also hard to take comfort from the idea that Indian investment is more efficient all I see when I go to India is a massive under supply problem, particularly in infrastructure.

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Foreign direct investment The role of foreign direct investments in the growth of China and India has captured the attention of analysts. China has historically attracted far more FDI than India as a share of GDP, particularly in the early stage of its economic transformation. This divergence has eased over the last few years and both countries received FDI inflows of about 2% of GDP in 2010 (according to UNCTAD). Slide 6: Foreign direct investment

Foreign direct investment.feast and (relative) famine

Chart 7 - Foreign direct investment
6 5 4 3 2 India 1 0 1980 1985 1990 1995 2000 2005 2010
Sources: EFIC, UNCTAD

Inflows, % GDP China

6 5 4 3 2 1 0

The pattern of FDI inflows has been consistent with each countrys industrial structure and policy imperatives. Chinas need for FDI was related to its export oriented industrial structure for example, it created special economic zones to attract foreign investment by exempting investors from regulations applicable elsewhere in China. In contrast, Indias private sector was insular and protected, at least until recently, by government restrictions on foreign ownership in certain sectors. Arguably, FDI is becoming less important to China as its works its way up the manufacturing value chain from low end manufactures to complex capital goods. It also runs a massive current account surplus and has very little need for external funds. In contrast, FDI is (or at least should be) becoming more important to India to fund its related current account and infrastructure deficits.

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The business climate and the role of the state in the economy The conventional wisdom is that: India has an entrepreneurial and dynamic business environment whereas China is dominated by large state-owned enterprises. It seems more accurate to say, however, that Indias economy is dominated by large incumbent conglomerates. This is a legacy of the countrys inward looking development approach. The economys reputation for entrepreneurial flair seems to derive from its success in the IT and BPO sector. This has been an undoubtedly successful sector, but it probably prospered precisely because of the absence of government involvement and regulation. Chinas reputation as an economy dominated by state-owned entities also has some truth most estimates suggest that they account for a large chunk (around 40% of economy-wide assets). But such enterprises only represent about 5% of the total number of enterprises and China has a surprisingly vibrant (albeit poorly measured) private sector. Slide 7: Investment and business climate

Investment and business climate. State looms large regardless of system of government
India China

Perception: Entrepreneurial and Perception: Economy dominated dynamic business environment Nuance: Dominated by large incumbent conglomerates by large state-owned enterprises Nuance: Private sector surprisingly vibrant (but poorly measured) Doing business: Significant government interaction required in both countries Procedures, costs and licensing hurdles similar Similar challenges with policy inconsistency and governance

On politics, the conventional wisdom is that Chinas political system is more conducive to rapid economic development and that Indias multiparty democracy is messy, unstable and slows development. But digging deeper into the data on the business climate and governance, the political system turns out to be a bit of a distraction. Significant involvement with the state and lower level authorities is required in both countries. The costs of doing business securing licenses, stepping through procedures etc are very similar in both countries. Both countries have issues with policy inconsistency and governance, notably corruption.

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The medium term and beyond

The consensus view is that China and India will continue to grow rapidly over the next 40 years most think that Indias growth will probably outpace Chinas in a few years time, primarily because of Indias more favourable demographic profile it is younger and the population is faster growing. Slide 8: The Asian century?

Future prospects.the consensus on the Asian century.can India catch China?

GDP shares
Chart 8 - Regional GDP shares in 2050 (US$)
ROW, 7% Europe, 18%

Growth rates and per capita income

Carnegie China
Per capita GDP GDP share Per capita GDP GDP share Per capita GDP GDP share 46,265 29%* 15,384 9%* 38,646 24%*

ADB
47,800 22% 41,700 14% 98,600 14%

Citigroup
55,000 21% 40,000 23% 90,000 10%

India
LAC, 10% US, 14%
Sources: EFIC, ADB

Asia, 51%

US

Source: EFIC, ADB, Citigroup, Carnegie Endowment for International Peace Note: All per capita GDP projections are in PPP$ except for Carnegie *Share of total G-20 GDP in 2050

GDP: US$292 trillion

As a result, China and India will account for a larger share of the world economy in 2050 than they do now. Interestingly, under the ADBs (optimistic) scenario, Asia as a whole including China and India - will account for just over half of the global economy in 2050 (at market exchange rates), up from 27% now. Most long range projections also suggest that Chinese and Indians will be much richer on a per capita basis in 40 years (although only half as rich as the US in per capita terms). But, again, lets not get carried away. These projections are unlikely to come true they never do and it is best to see them as a framework for thinking about how the region could develop over time. Intuitively, we probably know that Asia is going to become more important over time, but lets not pretend we can accurately project per capita GDP in 2050. Indeed, this is something the ADB also acknowledges it makes the point that Asias rise is not preordained and that a number of things could go wrong. One is that China and India get stuck in a middle income trap. That is, get stuck at a relatively comfortable level of income but unable to take the next leap to developed nation status. China, for example, is attempting to shift from being export led to consumption led. In such a scenario, the economy becomes more balanced and open: exports decline in importance, the exchange rate becomes more flexible, capital account restrictions ease, and reserve accumulation slows. Such a transition is going to be difficult; arguably Japan has struggled to reduce its dependence on exports, which casts doubt on Chinas ability to do so, given that it has in many ways followed a similar development model. So to sum up, although nothing is pre-ordained, as long as China and India can navigate the middle income trap, they (and the rest of Asia) will be even more significant economic players in the future.

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Other markets The ADBs projections for Asia as a whole in 2050 raise the question of which other countries might also expand significantly. Believe it or not, there are other interesting economies outside the China India nexus! Take Indonesia. It sailed through the crisis in 2009, growing by 4.5%, and continues to prosper the economy will probably expand by about 6.5% this year. The country has the worlds fourth largest population and a favourable demographic profile. It is also increasingly linked to China and India, which are sucking up the countrys exports of coal and agricultural products. The political situation also seems to have been remarkably stable and the sovereign is on the cusp of getting an investment grade credit rating. Slide 9: Other markets: Indonesia

Other attractive markets.Indonesia is ramping up infrastructure spending

Source: Nomura, Ministry of Finance (Indonesia)

But Indonesia is not without its challenges. It still has to show that it is serious about tackling issues like poor infrastructure a planned increase in infrastructure investment should help. The government also needs to secure the passage of a new land acquisition law, which would facilitate the purchase of private land for public investment purposes. Still, the countrys huge labour force and cheap wages roughly one third that of China will work in its favour and attract interest from multinational producers looking for alternative bases, especially labour-intensive sectors such as textiles and footwear. Another interesting market is Vietnam. At the moment, the government is grappling with twin deficits a rarity in Asia and a still overheating economy.

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Slide 10: Other markets: Vietnam

Other attractive markets.Vietnam.not just about low-cost manufacturing?

Source: World Bank

It appears that a slow but steady sectoral transformation is taking place, with traditional tradable sectors industry and agriculture experiencing lower growth. Until recently, Vietnams appeal has been its ability to produce labour intensive manufactured products and generate a large amount of surplus food items and agricultural commodities for exports. This process has been assisted by significant inflows of FDI and the interlinking of Vietnams economy with the rest of the world through trade agreements. However, these traditional tradable sectors have seen a steady decline in their growth rate over the last two decades as the country has become a less competitive manufacturing location compared to other countries. As a result of this sectoral progression, Vietnams service sector has emerged as a significant sector in the economy and has been the biggest contributor to the countrys overall growth rate.

The medium term and beyond

Let me wrap up: China and India have different economic models and therefore have achieved different economic outcomes, but we shouldnt get carried away by this these two economies are more similar than many think, particularly in the role the state plays in economic and business affairs. Indias fundamentals mean its economy could grow at a China like rates, or even faster, at least for a period of time. But . China will be an important regional and global player for many years yet. For the Indian economy to stand a chance of being larger than Chinas, it would have to grow much faster than Chinas (and Chinas growth would have to slow down) for a number of years. Such a sustained period of Indian outperformance seems unlikely. More importantly, none of this should be considered pre-ordained. There is always the possibility that one, or both countries, get stuck in a middle income trap.

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