Economic Growth: Comparison between India and China - Report Example

Economic Growth: Comparison Between India and China 2006 Introduction China and India, the world’s two most populous countries with a billion plus people each, began its growth trajectory relatively recently. China turned from a centrally planned economy to a market-oriented one in the late 1970s while India, which was a socialist mixed economy since its Independence in 1947, set on its liberalizations policies in 1991. The restructuring of the economies has resulted in fast growth in both countries, particularly in the recent years. While China has been growing at over 9 percent per annum, India is not far behind, at 8 percent per annum. In an increasingly interconnected economy, both economies have depended crucially on each other, on other countries in the region and on western economies. The aim of this paper is to study the pattern of growth in the China and India, the factors that have led to the fast growth and the problems in each of the economies that might pose as roadblocks to sustained growth. Pattern of Growth China recorded growth rate of Gross Domestic Product (GDP) of 9.9 percent in 2004-05. Of the GDP at purchasing power parity of $8.859 trillion in 2004-05, 14.4 percent was contributed by agriculture, 53.1 percent by industries and 32.5 percent by the services. On the other hand, 49 percent of the labor force was occupied in agriculture the same year while 22 percent was engaged in industry and 29 percent services (CIA). Thus, while the population has been predominantly agriculture, China has made great strides in industries, particularly manufacturing industries, so that a greater share of the GDP is contributed by this sector. India’s GDP at purchasing power parity in 2004-05 was $3.6111 trillion, which grew by 7.6 percent over the previous year. The sector-wise composition of GDP for the same year was 20.6 percent by agriculture, 28.1 percent by industries and 51.4 percent by services. However, 60 percent of the labor force was occupied in agriculture, 17 percent in industries and 23 percent in services. Hence, while two-third of the population still depends on agriculture, the services, which contributes to less than a quarter of the employment, has been the fastest growing and contributes most to GDP (CIA). The fast growth in India has led to expectations that, unless something unforeseen happens, India will overtake Germany as the third largest economy in three decades and by 2050, China will overtake the United States as the largest. Further, India, China and the United States will then contribute half of the global output and be the world’s most industrialized nations (Business Week, 2005). China’s fast growth in per capita income is shown by the following graph (Economist, 2005). China has grown on the back of strong manufacturing growth. It has emerged as the center of mass manufacturing of electronics and automobile components. The availability of cheap labor has driven industrial giants in the United States to outsource parts of the manufacturing capacities to China. In contrast, India has emerged as the hub for software and business process outsourcing for companies in the United States and Europe looking for lower costs (Business Week, 2005). There is increasing inter-connection between India and China as well. With the increasing ease of communication and China and India being the largest users of the Internet, there is a growing trend of designing in India for manufacturing capabilities in China. However, despite the high growth in GDP, both China and India have relatively lower per capita income, making them middle-income countries in terms of purchasing power parity. Growth in China is concentrated in the coastal areas and about 150 million people continue to live in poverty. Income inequalities are equally severe in India. Demographics The one-child policy in India has resulted in a rapidly ageing population in China. In contrast, India’s population growth has slowed from 2 percent a few years ago to 1.5 percent now. India’s fertility rate of 3.7 children per woman, however, is still higher than China’s 1.7 and Europe’s 1.4 (Deutsche Bank, 2006). The high birth rate in India, combined with increased life expectancy and lower infant mortality, has meant that India now has a high share of young population. About 30 percent of the population is below the age of 15 and about 30 percent above 35 years of age. In contrast, 50 percent of the population in China and 60 percent in Europe are above 35 years of age (Deutsche Bank, 2006). A major demographic advantage of India is its large pool of English-speaking young population that is driving the service-led economic growth. Also, the huge numbers of engineers – half a million graduate as engineers in China and India together compared to 60,000 in the United States – has given the two countries the strength to go ahead with the manufacturing and service growth respectively (Business Week, 2005). A study by McKinsey Global Institute (cited by Business Week, 2005) forecasts that the number of life science researchers in China and India will rise by 35 percent to 1.6 million while it will fall by 11 percent to 76,000 in the United States. Growing income in the hands of the young urban population has also resulted in rise in consumption in both the countries. As a result, China has emerged as the world’s third largest market for passenger cars and the largest for cellular phones. India’s consumer market is also in a catching up mode. Foreign Investments Foreign investments in China have been the strongest force driving economic growth. Nearly $40 billion foreign direct investments (FDI) flows into China every year, which amounts to about 25 percent of FDI flowing into all developing countries. On the other hand, FDI flows into India were just about $5 billion in 2004-05 (RBI). China’s FDI flows are largely attributed to the ethnic Chinese connection in Taiwan, Hong King, Singapore, Japan and South Korea from where 80 percent of the FDI flows. Since 1978, when China opened up its economy, initiated market reforms, including tax regime and privatization. Despite liberalization in India since 1991, which removed the upper restriction for foreign investments in most industries, abolished the monopoly restriction policies and has automatic FDI approval for most sectors, India is less open than China in attracting foreign investments (Sullivan, 2003). FDI in China has come in assembly and processing for exports in the special economic zones that has extended to the rest of the economy more recently and also been protected by development of financial markets. Besides, a supportive legal framework exists for investor protection. China’s entry into the World Trade Organization in 2001 has motivated foreign investors even further (Sullivan, 2003). While the Chinese manufacturing sector has grown phenomenally as a result of huge doses of FDI, foreign investment into India has been more in terms of Foreign Institutional Investment (FII), that is, portfolio investments in the stock market. Although FII inflows into India has grown, following the inflow of funds in search of higher returns, these investments have been highly volatile in nature and does not result in capital formation of the economy directly. Besides, most of the FDI that has come into India is mostly in the services sector, mainly in software and business process outsourcing, which does not have any trickle-down effect on the rest of the economy. As a result, infrastructure sectors like power, roads and bridges and telecommunication has lagged behind due to paucity of funds in India while infrastructure in China is as sophisticated as the western world (Business Week, 2005). Only recently, telecommunication has been opened up for foreign investors in India and the government is actively wooing foreign investors in the oil and gas exploration. The power sector, which for long has been a seriously constraining factor, has seen some activity in recent years, with electricity distribution partly privatized and foreign companies entering power generation in India. India’s 75 percent FDI inflows are concentrated in the states of Maharashtra, Tamil Nadu, Karnataka, Andhra Pradesh and Delhi. Similarly, 90 percent of FDI inflows into China is concentrated in Guangdong, close to Hong Kong and other coastal areas (Sullivan, 2003). Foreign Trade China has grown largely as a result of strong export growth. Hence, it had a current account surplus of $29.1 billion in 2005 from its export of $752 billion f.o.b in the same year (CIA). Machinery and equipment, mostly electronic and automobile components, make up the bulk of the exports. On the other hand, it imported $631 billion, also mainly of electronic and automobile components. 21 percent of its exports are destined towards the United States while it imports mostly from Japan (16.8 percent), Taiwan (11.4 percent), and South Korea (11.1 percent). Thus, China has emerged as a strong regional player in east Asia whereby it imports from neighboring countries, adds value to the products and exports to the United States and Europe. In the process, China has built up enviable foreign exchange reserves of $795 billion in 2005, which it invests in U.S Treasury bonds. China’s currency is considered to be undervalued, at 8.1943 yuan to a dolar in 2005, and maintained at the level by the government to give importers an advantage. In contrast, India runs a current account deficit of $13,19 billion as in 2005, largely as a result of huge oil imports, which make up nearly 70 percent of India’s oil basket. Its exports of $76.23 billion, one-tenth of China’s exports, are composed of traditional products of textiles, gems & jewelry, leather goods and commodities besides software exports in the recent years. On the other hand, India’s imports of $113 billion (2005) was composed of mostly petroleum, fertilizers and chemicals, which are essential for the economy. Problems Despite the fast growth in China and India in the recent past, the two countries together contribute 6 percent to global output, half of that of Japan (Business Week, 2005). In both nations, the fast growth has not reduced income inequalities and the large population means that they have to continue to grow as fast so as not to fall back in poverty once again. Rapid financial flows towards Asia, in particular to China and India, have meant that there are global economic imbalances. The global growth rate has grown at a robust 4% per annum for the last four years, as noted by the World Economic Outlook released by the IMF. Growth has been particularly high in China and India. However, much of the growth has been led by exports from these economies and domestic consumption has been weak. As a result, while the United States, the main importer, has built up a formidable current account deficit, most other large economies have trade surpluses, leading to what the IMF terms “global imbalances” (Guha & Daneshkhu, 2006). In an increasingly inter-linked global economy, it is no longer possible for policy makers to manage their individual economies exclusive of what is happening elsewhere. Economists believe that falling dollar is the result of imbalances in international capital flows – growing current account deficit in the US government and current account surpluses in other major economies with the backdrop of largely dollar-denominated trade and capital flows. A breakdown in the global economy as a result of such imbalances bodes ill for both China and India, both of the economies being increasingly dependent on western economies. There are problems of the domestic economies in China and India as well. In particular, the levels of bureaucratic red tape and corruption are high in both the countries (Sullivan, 2003). This deters many foreign investors despite the lure of high returns. Fast growth and urbanization makes the environment susceptible to serious damages that harm the economy in the long run. Most seriously, the growth in China and India has concentrated within a small section of knowledge workers while a vast section of the population remains untouched. Further, in India, infrastructure is still far short of requirements, with severe shortage of electricity and transport bottlenecks damaging the reputation of the centers of software and Business Process Outsourcing growth. Conclusion Thus, China opened up its economy in 1978 and has been growing at a phenomenal rate since the 1980s. India opened up the economy a decade later, in 1991, and has grown fast since the beginning of the new millennium. China has grown on the basis of its manufacturing industry, depending largely on exports of automobile and electronic components. In contrast, India’s growth is largely service-led, with software and business process outsourcing being the major sectors. Hence, both countries crucially depend on global growth for its rates of growth to be sustainable. Despite the fast growth, however, both countries have only a small share of global GDP and because of their huge populations, per capita income is pitiable. The income inequalities have widened as a result of the recent growth pattern. Sustenance of growth in these countries depends on development of their physical and social infrastructure, widening the base of growth and reducing roadblocks in terms of bureaucratization and corruption. 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