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China vs India

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China and India are the two largest states in the world in population. Together they represent 36.7% of world’s population. Their respective growth in 2010 was 10.5 and 9.7%. China’s shifting form an emerging country to an economic power within these last four decades was spectacular. From 1979 to 2017, Chinese real GDP increased nearly 10 % at annual average rate. According to the World Bank, China has “experienced the fastest sustained expansion by a major economy in history—and has lifted more than 800 million people out of poverty.”

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India has experienced a remarkable acceleration of its economic growth over the past two decades, that we could compare in the mid-2000s to that of its neighbor China. The growth rate of real GDP has indeed gone from an average of 3% during the 1970s to 7.4% in the 2000s. That economic “take-off”, partly driven by private investment, has been based on acquisition of strong economic positions in various sectors of activity (chemistry / pharmacy, jewelry, petroleum refining, computer services, business services and so on). Combined with implementation of major social programs, those years of strong growth have led to a decline in extreme poverty and the development of a middle class. These two giants are dynamic, with quadruple growths over the past decade. They are both cultural antipodes of Europe. Yet these two have nothing in common, their strengths and handicaps are the exact opposite of each other, such as the opposite poles of Yin and Yang. Their economy development choices are different even – despite their mass and proximity, they still ignore one another in an almost abysmal way.

In China, an autocratic regime without elections, operates by a monopoly Political and Administrative Committee of the Communist Party, with 72 million members ranked according to an impeccable hierarchy. Society and its institutions are in egalitarian principle, even if the economic progress of the last twenty years has created new and numerous divisions. The business environment is generally “user friendly”, good quality of infrastructure that progresses every year due to massive investments. The welcome given to foreign entrepreneurs is very positive, the numbers speak for themselves, with $80 billion in annual foreign direct investment (FDI) in recent times.

In India, “the greatest democracy in the world” has for the regime or system of caste, a niggling bureaucracy and a dreadful inevitability of inequalities. According to the latest in-depth studies by the Asian Development Bank (ADB), 75% of the population (800 million) are below of absolute poverty level. Running a business in India is still an obstacle course, even though the situation has been improving for ten years. The absolute guardianship of the state over the enterprise has been the dogma for more than forty years after the independence of 1949. Infrastructure remains hopelessly obsolete, even though recently, they have decided to make big projects for roads and other airports. Exports represent just over 10% of GDP while in China it represents 37% of GDP. However, foreign direct investment flows jumped from $6 billion in 2005 to $28 billion in 2007, illustrating that something is beginning to happen in the opening up of the country.

In this essay, in order to compare how these two Asian great powers (India and China) shaped their economic policies to reach a success, I will use the IS-LM model to define expected and existing effects. I first will explain the historically trend of their economic policies in section 1, in section 2, I will talk about the impact of saving rate, in section 3, the effect of export and Foreign Direct Investment in both countries and exchange rate in China, in last section, I will conclude with some adjustments, which should be done to India’s economic policies for country’s economic potential to be fully released.

The financial paradox puts the two countries in opposite situations, there is abundance of capital, savings and investment in China, but a return on capital for investors who remains modest, without a really financial market, while India, in this respect is in a better position, with capital returns invested with much better quality, even if the capital available is much infinite rare than in China. Economic policy choices are also in antipodes apart, even if they are more implicit than explicit. China’s “all-industry” increased the industry to 48 % of GDP, in India is only 28% of its GDP (with a Chinese GDP 3 times higher than that of India). In contrast, the services sector represents 55% of India’s GDP. From there to opposing a China “factory of the world” to an India “office of the world”: it is a nice journalistic facility, but artificial.

In the last 20 years, India and China have started a new course. 1984 is the year of death of Indira Gandhi and the promises of a socialism economic evolution of Nehru. It is also the year of Deng Xiaoping’s speech on the quadrupling the Chinese national income in fifteen years, accompanied by an end-over-head of the Maoist utopia by major reforms. Since then, Chinese GDP has increased by 10% on average, India’s GDP by 7%, with strong annual variations for India (sometime with 2 points of additional growth).

For China, no doubt we can apply the theory “mandate of heaven” of an imperial system revisited by Communism. The Communist Party has the monopoly of power, it imposes an iron political authority supported by an implicit social contract that produces high growth. This is the meaning of Deng Xiaoping’s slogan of 1992, “the socialist market economy”, where the adjective “socialist” comes before the market (which every Chinese understands immediately), a way of saying that one can practice free enterprise and enriching himself, but at the price of the absolute political silence.

In India, there is a much more insidious way, a sort of monopoly of a postcolonial elite, whose goal is the preservation of its privileges. Two centuries of colonization followed by independence have not fundamentally altered the social order. Facade democracy and the right to free speech and free press exonerate this elite of responsibility to provide the mass education, drinking water, roads, telecommunication services and so on. If the link between political practice and economic success is not always clear, China gives better results, starting with savings and investment.

China boom of the last twenty years is associated with a very remarkable savings rate, around of 40% of the GDP. This huge of savings allows a high investment rate and produces a virtuous cycle, where construction of infrastructures encourages creation of factories, which themselves creates a favorable climate for the progress of the company, based on a healthy emulation (sometimes bubbling in case of China). In this case, China behaves exactly like its neighbors in East Asia: Japan since the sixties or dragons since the seventies. Eastern Asian countries are indeed all (with the exception of Philippines) in the exclusive “Club” of countries that save more than a third of their GDP. There is therefore a form of cultural model of savings, exceptional compared to most emerging countries (Brazilian savings rate: 15%).

In India, in the same period, savings were half as much as in China, even though it has recovered recently. This result an environment of relative capital scarcity, which is measured in the fixed investment rate relative to GDP (which stands at nearly 34% today against 47% in China). The political pressure is such that the Indian budget is in a situation of chronic deficit as the current account (-4% of GDP in India against + 10% of GDP in China), just as public debt is close to 90% of GDP (compared to 27% in China).

China has no hidden virtues that India would not have, it is simply reaping the benefits of the successive land reforms of the Deng Xiaoping years. The increase in Chinese agricultural yields, through a redistribution of ownership (from the Maoist people’s communes to the cultivation rights of individual farmers) has allowed a massive transfer of agricultural product surpluses to infrastructure and industry. It is true that this vast movement has slowed down in recent years, when the urban middle classes have emerged much faster than the peasantry. In India, land ownership remains largely feudal, dominated by large landowners who reign over sharecroppers. It is clear that too, the weather conditions are not the same, but it is the agrarian structure, more than the rain or the good weather, that makes Chinese macroeconomic performance more or less independent of the climate, while in India (just like in Morocco by example), a good monsoon raises GDP growth by two points.

India has on average half of yields as much as those of China twenty-five years ago. In 2007, China produces 63 quintals of rice per hectare, India 32; 48 quintals of wheat against 27; 42 of cotton against 10; 17 tons of vegetables per hectare against 12. It is not enough to produce, but you must also convey. The obsolescence of roads and Indian rail condemns 20% of agricultural production (and 40% of fruits and vegetables) to rot on the road, for lack of an adequate chain of warehouses and transport, refrigerated or not, without taking into count the levy of the grants at transition of provinces. The construction of decent roads (10 times less kilometers of highways that China, half as many paved roads) alone would by some estimates, jump 3 points of GDP growth.

The Chinese growth model set up in the 70s and based on strong cost and price competitiveness, has allowed China’s economic development. The Chinese growth model introduced at the end of 1970s, based on the exports promotion of low value-added goods and the satisfaction of domestic demand, made it possible to satisfy the national preference, precisely economy development. China has based its development strategy on exports promotion, which is based on two main pillars: low production costs and a weak currency. This model has allowed a strong economic development for China but is running out of steam at the beginning of the 21st century.

Chinese authorities, like other Asian countries, have pursued a development strategy based on export promotion as mentioned above. From 1978 with the reforms implemented by Deng Xiaoping, Chinese economy was gradually opening to the rest of world. That’s opening was accelerated in the 90s and culminated with its accession to the WTO in 2001. This growth model has allowed Chinese authorities to meet their objective, the development of the country, with a growth rate of two numbers until the crisis of 2007. Since 2008, its growth has contracted. Over the last three years, it oscillates around 7-8%. The growth of its trade surplus since the mid-1990s demonstrates the success of the model based on export promotion. It went from $13 to $549.5 billion between 1990 and 2008. The Chinese growth model that prevails until the mid-2000s is partly based on strong cost competitiveness. The relatively low wages of Chinese employees, is a factor that attracts foreign companies to relocate. China becomes the workshop of the world. East Asian and Western companies are establishing into China in order to benefit from these advantageous production conditions.

Exchange rate policy also remains a tool mobilized by the Chinese authorities as part of their economic development strategy. The relative depreciation of the yuan accentuated the competitiveness of Chinese products in foreign markets, which is already relatively high, given the low level of production costs. This price competitiveness ensures opportunities for export sectors – including foreign companies located in China – which contribute mainly to the creation of wealth and jobs in China. The gradual appreciation of RMB since it was pegged to a basket of currencies in 2005 (with two-year interruption period during the Great Recession, 2008-2010) shows that the exchange rate policy has becoming less central in the development strategy.

It is hardly saying that, the Indian economy rate acceleration has been a source of questioning. Thus, for many economists, it comes under the “enigma”, the “mystery”, the “miracle”, or a “revolution” that would be modestly “understand”. In fact, from typical example of a failed development strategy in the 1970s, India has become a country considered by international investors as “emerging” economy. The main features of this emergence scenario are, however known. The implementation of economic reforms was certainly a major factor in accelerating India’s growth. While the actual magnitude of the effects of these reforms on productivity is still highly debated, the fact remains that they have profoundly changed the nature of Indian economy. From 1980, Indian authorities implemented a series of reforms that moved India away from the “socialist” model, adopted at the time of its independence in 1947.

Political leaders had indeed organized a growing state intervention in the economy that manifested itself through a rapid increase in planned expenditures and the output of public enterprises. The important support of Indian capitalist class for the independence movement, however, explains that the Indian model will always remain distant from the Chinese communist model. Historically, the growth of Indian economy is often linked to the successive economic and financial liberalization reforms of the country, first introduced in the 1980s (reforms called “pro-business”), then in the 1990s, following the 1991 balance of payments crisis (reforms described as “pro-market”). As noted, the appreciation of the extent of respective impact of these reforms on growth is, however, the subject of intense academic debate: Some economists consider that the reforms of 1980s were decisive, while some conclude that it is rather those occurring since 1991 that explain the acceleration of the pace of Indian growth.

Other studies point out the difficulty of highlighting a causal link between reforms and growth, notably because a significant part of Indian economic “take-off” is attributable to traditional or so-called “unorganized” service sectors. Composed of very small, often informal, companies not directly affected by regulatory or commercial reforms (although the presence of indirect effects is likely). Thus, even if communication services (including IT), financial services and business services (including those related to outsourcing) have experienced a marked acceleration in their growth since the 1980s (for example, services in the 1993-2002 period), trade and social and personal services continued to benefit GDP until the early 2000s.

Following a survey made by experts in the field, they recommend several reforms that aim to reduce the tax system such as lower insurance taxes and the telephone and a reduction in corporate tax rates. In short, they were obstacles to economic development that needed to be removed. The government, following this advice, has implemented reforms that they believed as necessary and the most significant are the reductions made in corporate taxes, which will be reduced to 40% and 55% for domestic and foreign firms successively as well as the restructuring of income tax rates, particularly for the highest tranches.

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