China and India: Their Development Paths of and Obstacles to Sustainable Growth - Research Paper Example

China and India: An Essay on their Development Paths of and Obstacles to Sustainable Growth A. Introduction China andIndia have had a great record of economic growth and development since the ‘80s and 90’s respectively. This has made these two economies be the subject of many studies. The highly populated countries began their development processes with humble beginnings. Using the Gross Domestic Product as an indicator, China’s economic size was the same as that of Japan and Korea in the mid ‘60s and 80’s respectively. On the other hand, India’s economic size was the same as that of Japan and Korea in the mid ‘50s and 70’s respectively. Global trade, economic growth and poverty reduction have received impacts from the success of these two economies because of their population sizes. China and India account for two-fifth of the world population. China’s economy is the 3rd largest importer and exporter. This has given it a say in global price levels especially of commodities and manufactured goods. The issue about the sustainability of these two economic giants may be addressed by looking at Japan and Korea several decades ago when they began to catch up with the developed countries. The following paper will examine the processes which initiated their growth and how these economies have been developing in time. It will also look into the structural imbalances and economic hardships that they have overcome in order to maintain sustainable growth process. B. Characteristics of India’s and China’s rapid growth 1. Manufacturing and tradable services The two above are the main engines of economic growth in China and India respectively. At the times these countries were embracing competitive markets as their economic reforms, the world was also experiencing structural changes. Information and communication technology was evolving and becoming an important aspect in trade and production. Global production of various inputs became standardized. With this, vertical specialization gained popularity resulting into various production processes taking place in different countries. With the bust of the IT bubble and the economic crisis of late ‘90s, many firms were forced to increase capital mobility in order to promote efficiency through cost cutting (Kolodko, 48). In this period, labor mobility was relatively stagnant. This led to capital and intermediate products shifting to where labor was readily available and affordable. These provided China and India with an opportunity to engage in global operations since they had skilled/educated labor affordable at competitive rates compared to others similar economies. The most effective engine of growth for any economy is the Manufacturing sector. Demand for Its products is highly elastic to changes in income especially in the world markets. This is seconded by many developed economies whose growth is attributed to industrialization. The manufacturing sector also has a higher potential for an increase in labor productivity. Growth in the manufacturing sector therefore has more chance to result into a dynamic profit-investment nexus and economic growth. The above is in line with the Verdoorn’s law, which states, “growth in industrial productivity and industrial output are positively correlated” (Verdoorn, 9). Since China has been highly populated, the manufacturing sector has been quite relevant to its economy. This is because the sector is characterized by need for intermediate goods, infrastructure, and capital good for its expansion. This led to an increase in employment levels which came timely to reduce unemployment in the rural and urban areas of China. Japan and Korea also had a similar strategy. Their economies are not adequately endowed with resources. These countries there had to determine a way to use their scarce resources optimumly for them to start their catching up processes. Manufacturing sector development was vital for such a goal since it made them integrate into the global economy. The spill-over effect of production in the manufacturing sector is more that in primary output and services. Productivity increase in the manufacturing sector is also higher that in the entire economies. Korea and Japan have also demonstrated that growth rate in this sector is higher than that of the entire economy. This explains the fact that China’s growth has been higher than of China thought the two countries have had relatively similar features in their economy (Cooper, 115) Figure 1: Average growth rate of services, GDP and value added in industry in the fast growth periods Source: World Bank, 2007 From the above figure, is clear that all the countries have been pursuing vigilant industrial policies to boost target industries. Importance of these industries is shown by their growth rate which is above the GDP rate. Most of the leading economies in the world started experiencing development in the service sector after their manufacturing sectors had slowed in growth. This is different in the case of India. Between the year 1981 and 2006, India’s services sector has been recording an average of 55% contribution to its GDP while its industrial sector accounts for 25% (Kolodko, 48). This phenomenon is as a result of globalization in tradable services. The 1990’s were characterized by major developments in computer technology enabling business to operate remotely in tasks such as operation of offshore call centers, business meetings and presentations and filling of tax returns. India imitated China by putting itself in the global supply chain of services especially in business processes outsourcing, information technology and software development sectors. This is much attributed to its English speaking and educated large pool of low cost labor that is targeted by global companies with aims of reducing costs. Communication and the banking sectors have been the leading sectors in India. In 2006, 50.5% of India’s GDP has been attributed to the services sector. India has undergone deregulation reforms in its services sector in order to reap the highest gains form increasing demand in global services sector. The growth in the services sector has been between 6%-8% in the last two decades. This is not as much the same in China which has been 10% (Cooper, 113). If the service sector had a positive relationship with the manufacturing sector, a higher growth rate of this sector would be likely in India. 2. Changes in Demographics The large number of working-age labor available in India and China is also responsible for economic miracle in this region. Availability a constantly productive labor in an environment with sufficient capital leads to higher outputs and per capita income. If technological advances are also present, this growth is much faster as witnessed in India and China. The above countries have recorded reduction in their dependency ratios. China’s dependency ratio fell from 78% to 48% between ’75 and 2000 while that of India also fell from 77% to 64% in the same period where the two countries were beginning to experience vast economic growth rates (Mason, 09). The above two countries have had a more human capital of high quality than many other countries. This is indicated by literacy levels. China’s literacy level was 64% while India’s was 41% during the beginning of their catching-up period. This grew to 91% and 62% in 2003 and 2001 for China and India respectively. India choice of English as the preferred language for higher education has given it an advantage over China that resulted into a knowledge boom in its boarders. Demographic changes may however be a challenge to an economy if not followed by policy changes as those in India and China. A large pool of human resource may lead to social instability instead of economic growth if not complimented by job opportunities (Sin, 61). Figure 2: Age dependency ratio of the world, India, Japan, China and Korea, between 1950- 2050 Source: United Nations Population Division (UNPD 3. Contribution of International Trade For many countries which began their catching up process with low per capital incomes, trade is important to ensure sustained economic growth. Low per capital incomes indicates little local demand for products. There is therefore need for increased exports in order to increase the demand levels in the economy. This is called vent for surplus and its lead to increase production, economies of scale and higher competitiveness in global markets. This ultimately led to profit-investment nexus and capital Accumulation for China Without change in trade policies for China which led to increased exports, the country could not have experience its economic boom even with high FDI and labor availability. This is because of lack of sufficient domestic demand. Differentiating itself form Korea, Japan and China, India main focus of export trade is in form of services which account of for one-third of its gross exports. However, the share of India in global exports is estimated to be around 1.3 % has less than that of China (Senhadji & Montenegrao, 89-91). Imports have not been of focus in studies of China’s and India’s rapid economic development. Imports are important aspects that led to growth of Korea, Japan, China and India. The two decades period that represent dramatic improvements in performance of these economies are characterized by increased imports with China and India having 12% and 10% annual growth of imports. Between 2003 and 2006, China and India have increased their imports by 10% and 8% respectively. With such growths in imports, there in need for increased exports in order for these two countries to earn foreign exchange. Since demand for exports cannot be created in the short-run, the two economies have been experiencing severe current account deficits. This is because the export sector requires major developments in infrastructure, technology, business environment and human resources (Senhadji & Montenegrao, 105). The importance of foreign direct investments in growth and development on China and India should not be underestimated. Foreign investments account for a considerable high number of trade in these two countries. The Chinese economy has 60% of its imports and exports funder by foreign parties. India’s services sector has about 50% of its outsourcing services being investments by foreigners. Local entrepreneurs however dominate its software development export market (Senhadji & Montenegrao, 75). 4. Contribution Of Investments And Domestic And External Financing In Growth Investments have been of great importance in China and India’s economic growth. Investments have a characteristic to increase demand and improve productive capacity of any economy. Investments also complement some elements of growth including skills Acquisition, technological advancements and institutional development. China can be said to have adopted investment-driven industrial strategy just like Japan and the republic of Korea. With trade expansion, increasing investments in physical assets and factors of production such as human resources has seen China record impressive track records in its growth. Contribution of investments in the GDP has been increasing in China to a point of surpassing that of Korea and India. Increase in investment levels in China had been as a result of favorable interest rates, tax policies, increase direct government investments and growth in private investments. FDI have also contributed heavily to the size of investment levels in China. India and China have had different investments ratios. India has been lagging behind in its twenty years of rapid economic growth compared to China even though the former has shown expansionist trends. Gross fixed capital formation (GFCF) in GDP has been 40% and 25% in China and India between 2004 and 2006 China (Senhadji & Montenegrao, 49). China has had high saving rate as from the time its economic expansion was just beginning. This saving has been intermediated in the banking sector which has been populated by government banks. The savings were majorly used in investments through development of China’s infrastructure. This explains why China has been highly relying of FDI for productive investments. China also set strict measures on outward capital flows in order to protect its savings from capital flight. Its financial markets (bond and shares) remained underdeveloped in its catching up period. Table 1: Contribution of consumption, investment, government expenditure and net export to GDP growth Source: Authors’ calculations based on World Development Indicators and Japanese Bureau of Statistics (Historical & MBS). India’s rate of saving is not as high as that of Korea, Japan and China. The current level of India’s saving rate is 26%. The government of India has had tough times in in its bid to boost investments with such low levels of savings. For India to reach its targeted annual GDP growth of at list 7%, the country need to increase its capital formation of GDP ratio to be at list 30%. If the average Incremental Capital Output Ratio rises to above 4.12, a high ratio of capital formation to GDP would be necessary. It is important to note that India’s the average Incremental Capital Output Ratio has been above 4.12 since 2001. India must therefore engage in activities resource mobilization efforts China (Senhadji & Montenegrao, 106). Impact of FDI on economic growth has been higher in China compared to that of India. This is because China attracted market seeking and efficiency seeking foreign investments into its economy due to its good business environment and infrastructure. 400 out of fortune 500 TNC have preferred China as their intended destinations. FDI is highly associated to the developments in the manufacturing sector of China as it is for the services sector of India. Remittances for the world have been very high in India and China with a figure estimated to be around $24 billion between 2004 and 2007. This has helped India in cushioning its economy for trade deficits. C. Sustaining Economic Growth: Impediments and Opportunities From economic occurrences, it can be estimated that its takes 60 years for an economy to shift form take-off to maturity (Rostow, 56). Also, countries with relatively low incomes grow faster than those with higher income levels. However, this trend changes when they reach take-off period when their fast growth is levels. China and India are likely to fool this process if their economies do not experience any form of shocks or disturbances. This is because they are still in transition to maturity and their incomes are lower than those of many developed economies. In the 20 years of the takeoff period, China, Japan and Korea had per capita growth rates of 8% 7% and 6% respectively. India had 3.7 in its first decade and 5.8 in its second. This is because it has not yet deployed the full effectively of its economic growth engines. This is because of its high population growth rates of 2% compared to that of China of 1.3%. China is therefore more likely to follow the development paths of Korea in its third decade recording a growth of 7.5% in its third decade (Wan, 51). Though the two countries have a great potential for continued growth, there are several impediments to this progress, this is because of imbalances and constraints that put at risk the sustainability of their growth rates. Obstacles that these two economies face in the growth are discussed below. 1. Sectorial imbalances There has been great sectorial imbalance in both India and China in their agriculture, services and manufacturing sector. China’s services sector is far behind that of manufacturing if consideration is made of their contributions to GDP. The services sector contributed to 41% of GDP compared to over 60% in developed economies in 2006 (Wan, 65). The agricultural sector in China has also been diminishing. This indicates fast urbanization and industrialization. There is need for China to modernize agriculture since its large population is endangered with the continued low agricultural productivity. India’s agricultural sector has been performing well just as the services sector. Agriculture was one of the sectors that took it to the takeoff stage of economic growth. India has better arable land resource and with the right technology, agriculture can drive its economy to march that of China. The industrial sector has however lags behind in India. India is believed to be capitalizing in the other two sectors in order to specialize on its strengths. Consumption and investment are also affected by the imbalance in services and manufacturing. Income elasticity is higher in the former while there is less elasticity of substitution between products of the two sectors. With the continued increase in income levels in China, the country is likely to experience a fall in domestic demand and overcapacity in the manufacturing sector which may lead to an economic crisis in the country like it did to South East Asia. The situation in India is the opposite of that in China. The manufacturing sector has been contributing to its GDP at a constant rate while that of services has been increasing. The manufacturing sector has a higher multiplier effect. India must invest in this sector to improve its productivity (Wan, 78). The two countries should also improve the labor input demand in their industrial sectors in order to absorb their large pool of unemployed human resource and reduce poverty levels. 2. Technology Upgrading Most of high-tech production processes are owned by foreign entrepreneurs. The IT sector in China exported US$128 billion. China imported US$91 billion worth of IT components. This show that China’s integration is narrow though extensive. In 2008, 89% of exports from China were process trades with FFEs being responsible for 85% of these. Since most of intermediate products imports are exempted from custom charges, the revenue accrued are lower compared to those of normal trade. Most of the returns in the exports go to foreigners who own large brands in China. Domestic enterprises are left with little ability to have any power in price determination or any other competitive strategy to be employed (Verdoorn, 5). China and India should learn from Japan and Korea’s policy of setting up good business environment for growth of small and medium enterprises while focusing on improvements in technology and new high value adding output. There was great absorption and deepening of technology in the manufacturing sectors of Korea and Japan and this exerted growth to their current robust economic state. China’s output in the manufacturing sector is the third largest in the world. However, its patents amount to only 35% of those in USA and 25% of those in South Korea (Steinfeld, 85). This shows that China is more of a manufacturer than an investor. China and India should focus on improving their technological state in order stay competitive in the global economy. Many developing countries are now engaged in production of labor intensive goods. This may worsen the terms of trade of these two countries if they do not invest on technological improvements, research and development which will improve their efficiency in production. 3. Demographic Trends And Wage Levels In general, the level of wages in the informal has not been at per with economic progress in China and India. This has a negative effect to private consumption in these economies because increased income through increase wages lead to increase domestic demand in any country. In these times of economic reforms in the two countries, informal wages should be adjusted in order to ensure social safety. The rural parts of China derive a considerable proportion of its income form remittances from migrant workers in China. This remittances are estimated to be about US115 million (Steinfeld, 87). Therefore, low wages by migrant workers leads to reduced income in rural areas and therefore low demand in this region. This has resulted to lack of the rural market sector in China’s economy. Since the levels of consumption were not sufficient to boost economic growth, China has been relying on investments as the driver to its economy. Investments may be disadvantageous compared to consumption since they lead to overheating in the economy is some instances. Overheating lead to bottleneck such a shortages in energy levels in the country. After 2002, investments also led to increase in demand for construction materials and certain minerals. Since inventories of enterprises are hence likely to accumulate leading further reductions in price levels. The scenario shows that consumers, producers and the government are worse-off. Due to this, China has been embarking in balancing growth. Its government has embarked on improving the efficiency of consumption and investment. Trends in the modern global economy do not facilitate economic growth which is only led by investments. China should be cautious to avoid too high investment growth since this leads to unsustainable economic growth rates. It is important to evaluate the effect of demographic characteristic of China on long-term economic growth. China’s population can be said to be aging. This is because the ratio of people with ages between 5 to 24 years to the total number of productive population has been on a decreasing. This ratio dropped form 33% in 1990 to 23% in 2005 (Verdoorn, 7). With the one-child policy currently present in China, the ratio is expected to continue falling. This therefore shows that the supply of labor that has been high will drop in time leading to an increase in wage rates to bring the labor market in equilibrium. China might therefore experience reduced economic growth since its large pool of skilled laborer has been an important factor leading to its fast economic progress in the past two decades. It is estimated that China’s will record a 65% growth in the population above 65 and a 5% reduction in the population below 14 by 2040. China should embark on researching on how to transfer some funds from its education sector, which is expected to receive lower number of students, to offset the rising cost of providing health care to the elderly. China economy may be under crisis in several years to come since its pension liabilities may reach 140% of its future GDP (Sin, 61). India is better off since trends in its demographics show that the working population has been on the increasing and is expected to maintain such progress until 2045. India should however make necessary arrangements to provide employment opportunities to accommodate such increases. Without this, India will land in high unemployment levels and consequently, increased dependency ratios. 4. China and India after Global Financial Crisis Even though China’s economy has been growing faster than India’s, the latter’s growth can be termed sustainable than that of the former. This is shown be how the two countries reacted to the most recent Global Financial Crisis. India and China undertook similar measures against the effects crisis by reducing interest rates, reducing taxes and increasing government expenditure. However, India’s measures were not as large as those of China. India stimulus package was worth approximately $36 billion in 2010 while that of China was $585 billion for the same year. The stimulus packages accounted for 3% of India’s GDP and 6% of China’s GDP (World Bank, 46). The number on non-performing loans in China was also higher than that of India in the same period. India’s real estate sector maintained its stability in the period of the crisis by not having its prices rise to bubble levels unlike the real estate prices in China. These differentials can be explained by the level of dependence of thso countries to international trade. China’s exports accounted for 35% of its GDP in 2008 while those of India were 24% of its GDP. India’s domestic consumption (57% of GDP) has also been relatively higher than that of China (35% of GDP). These are some of the factors than guarded India from adverse negative effects of the crisis. India’s growth rate may not be as high as that of China. However, their economy is more sustainable from economic shocks in the global markets. It is however predicted that the two countries economic growth rates will be 7.6% and 8% in 2012 and 2013 for India and 9% for China in those years (World Bank, 56). D. Conclusion Period taken by countries, with low income levels and high populations, to integrate themselves into global trade and catch up with the developed nations is long. However, China and India are in process of reaching the levels of these developed economies. Their progress has been quite remarkable due to availability of a large pool of affordable human resource that is well educated. Their rapid economic growth is characterized by a short industrialization process attributed to international capital development and standardization of leading sectors which are manufacturing fat China and services sector for India. Market reforms and liberalization of trade have also contributed highly to ensuring optimal factor mobility to productive sectors. Developing countries should emulate China and India in determining their comparative advantage and specializing in it so as to improve their terms of trade. Reforms are necessary in such leading sectors in order for developing countries to integrate themselves in the global supply chain. This will lead to an investment-profit nexus which in turns leads to increased capital accumulation rates. Reduction in the dependency ratio in China, Republic of Korea and Japan is also responsible with their fast economic growth. Manufacturing sector is the leading sector in China and this has led to economic progress through industrialization, urbanization and increased demand in factor inputs. India has on the other hand specialized on its services sector to integrate itself in the global supply chain. Imports and exports are both vital for economic prosperity. However, caution should be taken by countries to avoid current account deficits associated with net imports. There are various challenges that have faced and are likely to face India and China in their objective to be developed countries. These include sectorial imbalances evidenced by higher contributions of its services sector to its GDP compared to its manufacturing sector. China’s manufacturing sector contributes much higher to its GDP that the services sector. If the two sectors are balanced, these two countries will experience more rapid and sustainable economic growth. Technological advancements are also important for these two countries so as to maintain their favorable terms of trade over other countries. Investment generated demand is not sustainable in cases of low domestic demand. China and India should therefore work on balancing savings and investments for them to create domestic demand sufficient for securing their economy form global shocks. Wage levels should also increase at the same rate as productivity in their sectors to ensure social safety. Finally, China should formulate policies that check its increasing older population and reducing working-age population. This will protect its large pool of labor which is highly attributed to its impressive economic performance. Works Cited Cooper, R. (2005). ‘A Half-Century of Development’, Working Paper 118, Center for International Development at Harvard University: Cambridge MA. Print. Johnson, R. (2004). ‘Economic Policy Implications of World Demographic Change’, Economic Review, First Quarter, Federal Reserve Bank of Kansas City. Print. International Financial Statistics, January Issue, IMF, East Asia Quarterly Brief, World Bank, December 31, 2011. Print. Kolodko, G. (2002). ‘Globalization and Catch-up in Emerging Market Economies’, WIDER Discussion Paper 2002/51, UNU-WIDER: Helsinki. Print. Mason, A. 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