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India and China in the Global Economy

The economies of India and China have grown rapidly over the past couple of decades, and it is widely accepted that these two emerging giants will transform the global economy in numerous ways over the coming decades. Despite the importance of these countries, their strengths and weaknesses, the sources of their growth, and the missing ingredients to sustain high growth rates—are not widely known. Thus the first session of the conference, “India and China in the Global Economy”, was devoted to providing the background necessary to understand what is happening in the two economies today and how they are likely to evolve in the future.

The speakers in the session, which was moderated by STEP board member David Morgenthaler, made it clear that although the economic growth of India and China has indeed been impressive, it has also been uneven, with some economic sectors developing more rapidly than others. Understanding the two countries’ capacities for innovation demands a closer look at which areas have grown and which still lag. The speakers further agreed that it is a mistake to think of the growth of the two countries as essentially similar. Patterns of economic development in India and China are quite different, and this has an important bearing on forecasts for the two economies and, for that matter, strategies for dealing with the two countries.

THE ECONOMIC SITUATION IN INDIA

Arvind Panagariya of Columbia University opened the first session by outlining India’s departure from a history of restrictive policies on investment, licensing, and production, which were especially tight in the 1960s and 1970s. Since liberalization began in the 1980s, GDP growth has surged. Panagariya suggested that the elephant metaphor did not reflect the recent speed of India’s transformation, which has been more like a tiger. From 2003-2007, GDP growth has averaged 8.6 percent (14-15 percent in real dollar terms). Is this rate the peak of a cycle or can it be sustained?

Panagariya suggested that India’s growth would continue and increase in the coming decade if economic reforms continue and are expanded and large-scale structural changes are undertaken to support growth. Exports have doubled in three years, and software exports doubled in the last two years. The exports-to-GDP ratio is “extremely low,” he said, even though huge increases in foreign investment—over $21 billion—are comparable to that seen in China. India can adapt quickly, as evidenced by India’s telecommunications revolution. From 5 million telephone lines in 1991, India now has over 200 million lines.

India’s demography will very likely help sustain this growth. India’s population is younger than China’s and is exhibiting a rising rate of personal savings. Problems include a reliance on capital-intensive manufacturing, with labor-intensive manufacturing lagging. India still needs reforms in two areas in particular:

  • Labor market inflexibilities limit firms’ ability to respond to changing workforce needs; and

  • The power sector remains unreliable throughout the country

The Indian government is moving on transport issues, but power shortages remain a bottleneck to growth. With a heterogeneous population and



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1 India and China in the Global Economy were especially tight in the 1960s and 1970s. The economies of India and China have Since liberalization began in the 1980s, GDP grown rapidly over the past couple of decades, growth has surged. Panagariya suggested that and it is widely accepted that these two the elephant metaphor did not reflect the recent emerging giants will transform the global speed of India’s transformation, which has been economy in numerous ways over the coming more like a tiger. From 2003-2007, GDP decades. Despite the importance of these growth has averaged 8.6 percent (14-15 percent countries, their strengths and weaknesses, the in real dollar terms). Is this rate the peak of a sources of their growth, and the missing cycle or can it be sustained? ingredients to sustain high growth rates—are not Panagariya suggested that India’s growth widely known. Thus the first session of the would continue and increase in the coming conference, “India and China in the Global decade if economic reforms continue and are Economy”, was devoted to providing the expanded and large-scale structural changes are background necessary to understand what is undertaken to support growth. Exports have happening in the two economies today and how doubled in three years, and software exports they are likely to evolve in the future. doubled in the last two years. The exports-to- The speakers in the session, which was GDP ratio is “extremely low,” he said, even moderated by STEP board member David though huge increases in foreign investment— Morgenthaler, made it clear that although the over $21 billion—are comparable to that seen in economic growth of India and China has indeed China. India can adapt quickly, as evidenced by been impressive, it has also been uneven, with India’s telecommunications revolution. From 5 some economic sectors developing more rapidly million telephone lines in 1991, India now has than others. Understanding the two countries’ over 200 million lines. capacities for innovation demands a closer look India’s demography will very likely help at which areas have grown and which still lag. sustain this growth. India’s population is The speakers further agreed that it is a mistake younger than China’s and is exhibiting a rising to think of the growth of the two countries as rate of personal savings. Problems include a essentially similar. Patterns of economic reliance on capital-intensive manufacturing, with development in India and China are quite labor-intensive manufacturing lagging. India different, and this has an important bearing on still needs reforms in two areas in particular: forecasts for the two economies and, for that matter, strategies for dealing with the two • countries. Labor market inflexibilities limit firms’ ability to respond to changing workforce needs; and THE ECONOMIC SITUATION IN INDIA • The power sector remains unreliable throughout the country Arvind Panagariya of Columbia University opened the first session by outlining India’s The Indian government is moving on transport departure from a history of restrictive policies on issues, but power shortages remain a bottleneck investment, licensing, and production, which to growth. With a heterogeneous population and 5

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6 THE DRAGON AND THE ELEPHANT cultural variety, India does well in sectors where COMPARING THE TWO COUNTRIES product differentiation is required and less well Sean Dougherty of the Organisation for in industries that require scale. Economic Co-operation and Development (OECD) Secretariat presented findings from two recent OECD surveys of China and India, THE ECONOMIC SITUATION IN CHINA highlighting sources of growth, productivity, and regulatory reforms. According to Nicholas Lardy of the Peterson Rooted in the dramatic shifts of the 1980s, Institute for International Economics, scale is a growth in both countries is sustainable, but key difference between the two countries. Dougherty drew some distinctions between Contrary to popular impression, China and India them. Total Factor Productivity (TFP) growth are not comparably sized global giants. China’s rates are important. Capital deepening—that is, trade is six times larger than India’s. Even more an increase in capital intensity, usually measured striking, the increase in China’s trade level in as capital stock per labor hour, also plays a 2007 ($433 billion, valued using MER) was dramatic role in growth, especially in China, and greater than India’s total trade. India’s share of is the “major explanatory factor” in the the global economy today is still less than half of differences between the two countries’ per what it was at independence in 1948. India’s capita annual growth. India averaged 4.8 economy is expanding rapidly; but its trade is percent between 2000 and 2005, about half of still less than 1 percent of the global total, China’s 8.1 percent annual per capita GDP whereas China’s trade is the second or third growth rate (Figures 1 and 2). This difference is largest. A similar disparity exists in foreign also seen in the R&D expenditure differences: investment. R&D intensity in India is <1 percent; in China it For these reasons, Lardy expressed more is 1.4 percent (Figure 3). optimism about China’s growth than about Research outputs are a better measure of India’s. The competitive environment in China performance than inputs. Although there are no is more favorable and intense than it is in India, good measures of scientific outputs, and there is where certain sectors are protected from import considerable uncertainty about international competition. In China, with reduced tariffs comparisons, a common output measure is domestic firms face competition not just from publications in leading peer-reviewed journals foreign imports but from foreign firms operating with contributions worldwide. In 10 years from in China. China spends three times as much on 1995 to 2005 Chinese articles in high-impact infrastructure as India. scientific journals increased more than 16 times, China’s main challenge is to rebalance its while Indian articles merely doubled (Figure 4). growth strategy, moving toward one that relies India has competitive costs and wage levels, more on domestic demand and less on exports. but it needs larger-scale firms to compete Currently, household consumption is only 36 successfully. Dougherty confirmed the percent of GDP, whereas in India that figure is observation that labor market restrictions in 50-60 percent. For sustained economic India are that country’s greatest challenge. At development, India needs more manufacturing, a the state level, though, India is deregulating and more liberalized trade environment, and more making labor markets more flexible. In China, flexible labor markets. where private firms are more productive than The conventional wisdom is: “India does public firms, there is a great need to extend software; China does hardware. Those are their privatization. China is restructuring rapidly and paths to expansion.” But China’s hardware deepening regional specializations. exports are growing much faster than India’s India’s financial markets are more software exports, which make up less than 5 developed than China’s but India has a greater percent of India’s GDP. India will need to take need to reduce regulatory restrictions in advantage of relatively low wage rates to build financial product markets. Currently, India has up its labor-intensive manufacturing sectors.

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INDIA AND CHINA IN THE GLOBAL ECONOMY 7 approaching China’s. In GDP growth, China’s far more restrictions than any OECD economy. demographic dividend will tail off in the next 10 With fewer restrictions, China has managed to years, while demographic rates in India will be more flexible in supporting new, higher risk, promote savings growth. Despite their problems, technological developments. the future looks bright for both economies. Education outcomes in India are improving, +6.0 +5.0 4.8 3.9 +4.0 +1.8 2.7 +2.4 +3.0 +1.8 +2.0 +2.0 1.3 +0.5 +1.9 +1.0 +1.0 +0.8 +0.8 +0.6 +0.1 +0.1 +0.0 +0.2 -0.7 -0.1 -0.6 -1.0 1950-1979 1980-1989 1990-1999 2000-2005 -2.0 Participation Demographics Capital intensity TFP FIGURE 1 Sources of India’s per capita GDP growth (% annually). (Participation: the effect of the participation rate; Demographics: the effect of the share of the population of working age; Capital intensity: the effect of the level of capital per worker; TFP: total factor productivity.) SOURCE: Dougherty.

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8 THE DRAGON AND THE ELEPHANT +10.0 9.1 8.7 8.1 +8.0 +2.5 +4.4 +3.7 +6.0 +4.0 3.5 +5.1 +0.3 +3.0 +4.8 +2.0 +2.6 +0.0 +1.8 +0.1 +0.9 +0.5 +0.0 -0.3 -0.1 -0.5 1950-1979 1980-1989 1990-1999 2000-2005 -2.0 Participation Demographics Capital intensity TFP FIGURE 2 Sources of China’s per capita GDP growth (% annually). (Participation: the effect of the participation rate; Demographics: the effect of the share of the population of working age; Capital intensity: the effect of the level of capital per worker; TFP: total factor productivity.) SOURCE: Dougherty. Expenditure Researchers 20 15 10 5 0 -5 <1.0% 2.3% 1.4% R&D intensity : -10 FIGURE 3 R&D Expenditures and Researchers (% annual change 1995-2004) SOURCE: Dougherty

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INDIA AND CHINA IN THE GLOBAL ECONOMY 9 change society structures themselves? One 450 China India factor is intellectual property rights protection, 400 but there are different sides to that issue. In 350 China, a vigorous sharing of ideas is the flip side of fairly lax intellectual property protection. By 300 that same token, some argue that intellectual 250 property protection in the United States may 200 have gone too far, hampering innovation. In terms of quality of life, a questioner 150 asked, did disregard for environmental 100 safeguards in the early years of China’s growth 50 allow the economy to grow unimpeded? As its leaders become attuned to environmental issues, 0 will growth slow down? Over a third of China’s 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 population lacks access to clean water. Yet the focus on growth will probably not change in the FIGURE 4 Articles published in high- next three to five years, Lardy replied. With impact journals. SOURCE: Dougherty China’s per capita income at $1,600 (measured at MER), the country is unlikely anytime soon to institute the same environmental measures as OECD countries. In response to another questioner, DISCUSSION Panagariya cited three factors in rebutting pessimism on India’s long range prospects for Responding to a question on the state of developing an innovative economy: innovation in both countries, Panagariya said • India’s history of democracy over the that India was still “well inside” the technological frontier. Dougherty considered past 60 years gives it a foundation for both economies to be inside the frontier. The stability and adaptation, while China growth rates shown above (Figures 1 and 2) faces an uncertain political transition in represent a measure of innovation. By some the coming years. measures, China’s R&D expenditures are high, • India’s demographic dividend is much but it is very hard to assess the real state of greater than China’s. innovation. • Assuming that ultimately rapid growth To what degree do we need to look at slows down, India’s experience of high society-wide structures and legacy issues, asked growth is more recent, while China’s Marco di Capua, U.S. Department of Energy may sooner run its course. representative in Beijing. How does innovation

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