India Compared to China, Again

Or should I say “as usual”.

This paper, China, India and the World Economy, by T.N. Srinivasan, is worth reading, or at least skimming.

I like it because the conclusion basically says things I have long thought to be true. �China lacks some of the key institutional foundations of a market economy�, and notes that India has already created some very important institutions that China lacks, e.g. an independent judiciary, an accountable government, etc. India, due to its democracy, is slower to make changes, and it has to make compromises along the way. However, the legitimacy of these decisions is established by the process, where in China the public has to take what it gets from the leadership. This can create a false sense of stability, with major outbreaks of disorder instead of the usual friction and log-rolling of a more representative system.

Note that none of the foregoing is wishing China not to succeed. A successful China is a key to world prosperity and peace. However, the prospect of serious problems for China seems to me to get too little attention. And, the possibility of a successful and prosperous India is a prospect that seems to get too little attention.

I quote the key, concluding paragraphs from the conclusion of the article below the fold, and I highlighted the one I think is most important.

Even leaving aside the political problem of its non-transparent, authoritarian, central political control, China lacks some of the key institutional foundations of a market economy. Perkins (2005, p25) argues and rightly, �China should move away from an industrial policy that targets particular industries and firms and requires all manner of regulatory interventions, and instead move steadily toward an industrial policy that concentrates on general support investments for industry such as improvements and expansion of the education system,� and asks whether China has the institutions that such a market oriented approach requires. One needed institution is a well-functioning and efficient financial sector consisting of commercial banks, markets for debt, equity and insurance and a strong regulatory agency. He finds China lacks one. Another is a legal system, with a competent, efficient, independent and powerful judiciary. In his view, the absence of such a system in China, �makes it impossible to efficiently carry out other important changes in the economic structure through the decentralized processes of the market. Instead decisions have to be pushed up to higher level government bureaucrats in the ministries or elsewhere� (Perkins, 2005, p31).

India has much stronger political and institutional foundations than China. Although India is also experiencing distributional conflicts arising from its sustained growth for 25 years, its vibrant participatory democracy offers non-violent means for resolving them through political compromises. Certainly, political compromises take time to bring about and the very fact that they are compromises often means that desirable economic reforms are politically infeasible to implement. On the other hand, it also means that once implemented reforms should be far more sustainable.

India�s commercial banking system resembles China�s in that it is still dominated by public ownership of nearly three quarters of its assets. Nevertheless it has become more efficient with increasing competition from dynamic new domestic private banks and also foreign banks. India�s National Stock Exchange is becoming one of the world�s most efficient (comparable to the New York Stock Exchange) in terms of transaction costs and transparency. Indeed, the large inflow of portfolio investments, particularly from foreign institutional investors in response to higher returns in India is in part a testimony to the vibrancy of India�s stock market. India�s legal system, though by no means efficient, has been functioning for a long time. Its independence and power are respected by the other branches of government. Thus India unlike China, does not have to create a legal system de novo, an enterprise, which as Perkins (2005) rightly notes, will take at least a generation, if not longer.

To say that India�s institutional foundations, political and economic, are stronger than China�s does not mean that unfavorable comparisons with Chinese economic performance �were irrelevant because China was a dictatorship and India, a democracy,� an excuse that Martin Feldstein (2006) says he once heard from Indian policy officials a few years ago, but no longer does. He concludes,

The optimistic mood in India�s business community, the desire for reforms by the top leadership of the government, and the growing number of relatively middle-class households provide a force for change and a source of support for new entrepreneurial activities. If the political leaders can now persuade the traditional opponents of reform that growth can benefit their constituents and that better new jobs will replace the old, India will see decades of remarkable achievement (Feldstein, 2006)

The debate whether China�s communist dictatorship or India�s democratic system will deliver and sustain rapid and equitable economic growth in the long run dates back to the early fifties, soon after India�s independence in 1947 and China�s communist victory in 1949. Interestingly, with China having outperformed India since Deng Tsiao Peng opened and liberalized the Chinese economy, and India having grown more rapidly since it began moving away from its inward-oriented, state-directed, development strategy, the current debate is on whether stronger institutional foundations of India would enable India to catch up and overtake China. In concluding the paper let me refer to the provocative questions raised by Huang and Khanna (2003) and Huang (Financial Times January 23, 2006). The first article articulated the view that although India was not outperforming China overall it is doing better in key areas and that success may enable it to catch up with and perhaps overtake China. The key areas in which India performed better included (1) the spawning of internationally competitive homegrown small companies. Out of Forbes 200 of the World�s best small companies in 2002, there were 13 Indian firms as compared to China�s four (2). India�s stronger infrastructure in terms of far more efficient and transparent capital markets to support private enterprise so that entrepreneurship and free enterprise are flourishing. In a survey of leading Asian companies through polling of 2500 executives and professionals in a dozen countries by the Far Eastern Economic Review, only two Chinese firms had high enough scores to qualify for being rated among India�s top 10. In the second article, Huang points to the booming stock market in India in contrast to market collapse in Shanghai, and the better functioning of India�s financial system despite its many faults in not discriminating as much against innovative small enterprises as compared to China�s system.

Wolf (2006) also notes some of India�s institutional advantages over China noted earlier: a well-developed private sector; a relatively entrenched legal system; a stable democracy and freedom of speech; a modestly better score on corruption and rule of law in World Bank�s governance indicators. He concludes that India�s prospects for overtaking China depend on implementing difficult reforms in five pivotal areas: deregulation of labour markets and an end to the small-scale sector; revitalization of agricultural growth; increased investment in infrastructure; elimination of fiscal deficits; and, finally, across-the-board privatization and further trade liberalization

Whether or not India overtakes China in the next two decades, it is clear that both countries will be economic powerhouses in the medium term. Undoubtedly, their growth will have significant impacts on the World economy.