Friday, September 25, 2009

China and India: Idiosyncratic Paths to High Growth

Kaushik Basu, Chairman, Department of Economics and Professor of Economics and International Studies at Cornell University, has just been appointed Chief Economic Adviser to India’s Finance Ministry. In a recent article he looks at the parallel and contrasts between China and India. Here are a few key points.
  • The mainsprings of development in these nations are widely different, even though their trajectories of growth are converging.
  • Industrial recession in the US, Europe and Japan has caused big hardships for the export-oriented Asian economies. Serious though this crisis may be, it does not alter the longrun prospects of China, India and the other Asian economies.
  • Thinking in terms of broad categories, such as socialism and capitalism or big and small governments, and trying to link these to growth is the wrong way to approach the problem. Markets and incentives play a critical goal for development to occur, and, as long as the government has the intelligence to weave these into the policy fabric, the stage is set for economic take-off. Further the Chinese government has intervened in macroeconomic markets by keeping tight controls on capital and has kept its exchange rate deliberately undervalued in order to break into global markets with its exports.
  • With the growth spurt that occurred over the last five years and the rise of the Indian corporations as global investors – on this India’s rise has been more striking than that of China – India’s medium to long-run prospects look very good. In addition, one development of the last five or six years that augurs well for both India and China, and especially the former, is the growth of trade and the flow of foreign direct investment between the two countries.
  • One common feature of both China’s and India’s growth experience is the salience of the savings rate and the investment rate. China has always had a fairly high savings rate -- the rate never dropped below 30% from 1977 onwards and, as we know, China’s growth rate showed particular robustness from 1978. For India the sharp rise in savings in the early 1970s did not immediately translate into growth. I believe that there were some infrastructural bottlenecks that held back the economy. And, in any case, by the late 1970s and certainly the early 1980s it was evident that the economy was growing faster. Interestingly, India has witnessed another very sharp rise in its savings rate over the last four years. The rate climbed up from 24% to 34% – according to the latest Economic Survey, the savings rate is 37.7% (Government of India 2009). For the first time India is saving and investing at rates which have been associated with the Asian tigers. This is so recent that this has not yet been analysed sufficiently. But this augurs extremely well for the country.
  • Despite the market-oriented reforms of 1978-80, which were significant in comparison to the draconian control of the Chinese state previous to that time, in China the “socialist planning system still operates, ….the labour responsibility system determines where a person can work legally and where it cannot, … all land is owned and controlled by the State,” and the Chinese Communist Party continues to vet all senior appointments in firms and “even if the CEO is not a party member, there will be a party member (or group of members) ostensibly junior(s) in the organisation who can over-rule him on ‘ideological’ grounds, …in China banks are not intermediaries but instruments of the State… .” These quotes are from Virmani (2006), who in his comparison of India and China has repeatedly stressed the importance of free-market policies.
  • India’s big problem now is that its government is in the wrong places. It is not a problem of size as much as location. In terms of the fraction of the national income that is produced by stateowned enterprises, India is not an outlier in Asia; and compared to the communist and former communist nations, India is a very privatised economy. While the output emerging from stateowned enterprises in 1990 in India was 14.1%, the figure for China in 1985 was an astonishing 70%. Though state-ownership has been declining, even today it is around 50% in China, which is way higher than other Asian nations. It is not just that, as Huang observes, “As late as 1998 much of the Chinese officialdom held private ownership in utter contempt”. In 1978, South Korea had a larger share of output coming out from the state-owned sector than India. The ranking had changed by 1990 but that gap was not large. Indonesia looks similar to India; Malaysia has a distinctly larger share of state production and the Philippines is the most privatised economy – with a large part of that, at one time, in the firm private grip of Marcos.
  • Where government is needed and inadequately available in India is in the provision of infrastructure and in the social welfare sector. On infrastructure the awareness is now high in government and there is reason to expect large changes over the next five years. On social welfare the situation is still bleak. Poverty is still very high with around 250 million people below the poverty line (and India’s poverty line is quite a bit below one dollar a day). If the poor and the dispossessed develop some other identity – for instance, based on caste or regional origin, then this can be politically destabilising. Government needs to do much more in eradicating poverty.
  • The risk of political destabilisation is there also for China and may be even greater than what India faces. These risks manifest themselves in different ways in China. I have attributed a large part of China’s success, despite its government’s overtly interventionist behaviour vis-à-vis the market, to the fact that it was intelligent intervention. Contending with the same argument Yao argues that China succeeded because it has had a “disinterested government”, meaning it has not played one group against another but has been a neutral referee. This is a valid argument. But what stands out even more is that China has had the luck of an intelligent government. It has cleverly held back damaging intrusions into the market. This, however, always has the risk of changing. As argued, when an agent is as powerful as China’s government is, it can easily fall prey to the temptation of exercising that power in the interests of itself or a small group. This can also be not a response to temptation but self-preservation in times of turmoil. China’s excessively pliant civil society could cease to be that under times of stress, for instance, a period of growing unemployment or inflation. Its attempt to dislodge those in power can easily result in a siege mentality on the part of the government, whereby it becomes impossible for it not to exercise the vast powers that it already has.
Read Prof Kaushik Basu's article "China and India: Idiosyncratic Paths to High Growth" published in the Economic and Political Weekly, Sept 19-25, 2009.

A shorter version of the article is published in the Hindustan Times newspaper, "Use your head".

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