Tortoise and the Hare: India and China's divergent paths to growth

Above picture taken by the author at the Student Cafeteria in SH Ho College, CUHK.  It is a demonstration put on by the Student Union protesting the sale of non-Free Trade coffee by Starbucks on campus.

 

“Apparently, sir, you Chinese are far ahead of us in every respect, except that you don’t have entrepreneurs. And our nation, though it has no drinking water, electricity, sewage system, public transportation, sense of hygiene, discipline, courtesy, or punctuality, ‘’does’’ have entrepreneurs. Thousands and thousands of them. Especially in the field of technology. And these entrepreneurs—"we" entrepreneurs—have set up all these outsourcing companies that virtually run America now.” 

― Aravind Adiga, The White Tiger, a novel written as a letter from an Indian entrepreneur to the Premier of China

 

 

For this week's response, I will be responding to a reading from later in the syllabus, Industrial Dynamics in China and India by Moriki Ohara, et al. The book looks at comparative development of China and India post-1980, and takes the view that the two nations' divergent economic paths were due to longer term institutional patterns, reflecting also the economic geography of the two nations.

In Industrial Dynamics in China and India, Ohara and his co-writers lay out a convincing comparison between the economic growth of China and India over the last thirty or so years. The comparison initially launches from the observation that China's burgeoning, swift growth has been primarily due to a strong, labor-intensive manufacturing sector, while India has specialized in software development and business services. This is a telling divergence in many ways, both in the economic results that success in these sectors has lead to, as well as the institutional pre-conditions which allowed growth in these two areas.

First the line is drawn between the two countries' fundamental approach to industry and entrepreneurship: China's “High Volume” approach, and India's “High Profit” strategy. China, starting from a negligible industrial baseline after the Communist revolution, used the power of central government to motivate and accelerate industries deemed necessary for growth. The Chinese had an enormous labor force, which could be dedicated towards low skill manufacturing jobs, so therefore the centralized government shifted capital towards those low-skill industries. The firms in many of those industries, although initially state-run, became increasingly private; however, they still inevitably had some kind of strong business connection to government in order to develop. Private enterprises were and are heavily influenced by the politburo's centralized planning, and there are many institutional obstacles to new entrants. Therefore China's industries, although efficient, were homogenous. Beyond insider connections, the other factors relating to this homogeneity was government financed infrastructure, similar institutions encouraging FDI, and the planning of the Special Economic Zones (SEZs) as export clusters.

Even more fundamental to shaping the industrial blueprint was China's educational system. The socialized education system guaranteed a fairly high quality of primary and secondary education. This allowed China to have a surfeit of literate laborers. However the higher education system lacked the capacity to take in the massive numbers of eligible students, as well as disadvantaging high school students from poorer regions. This gave rise to China's massive number of migrant workers, primarily from central provinces, who have basic skills but lack higher education to allow them labor mobility and skilled job training.  These people had enough education, along with the economic incentive provided by the Chinese government's urban-centric growth policies, to entice them to move from their villages into cities and industrial centers.

In contrast, India's education policy was focused on higher education, both public and private, and the importance of equipping those with the ability to attend a university with skill sets to address more complex problems. Many Indians however were unable to attend primary school, and therefore the largest proportion of the Indian population remain in their ancestral villages and are illiterate. This is part of the equation for the heterogeneity of the Indian labor pool: some are highly skilled technicians or designers, trained at a wide range of institutions with varying backgrounds, while most have acquired little beyond an elementary school education. This has lead to strong, prosperous growth within the services sector, which is easier to enter for entrepreneurs because of the low initial capital costs. Especially those services able to be “off-shored” from other countries were targetted by Indian entrepreneurs looking to utilized a skilled, creative labor base. However the lack of institutional organization and limited investment pools for venture capital has left their manufacturing sector struggling.  On top of this, because most of their population lives in rural villages, insdustrial centers have struggled to compose a cohesive, semi-skilled labor force with anywhere near the same scale that China employs.

The “High Volume” strategy allows those Chinese entrepreneurs well-connected enough to establish their own factory with the labor and capital to simply outproduce and underprice the available manufactured goods on the world market. This strategy, implemented over many industries, has guided the massive engine of Chinese manufacturing growth, as well as one of most efficient supply chains in the world through its interconnected system into South East Asia (a benefit which India does not enjoy due to geography as well as institutional blocks to international capital controls and regulations). It is questionable whether China can transition to real technological innovation within their specialized industries, however, as there is simply more profit and volume able to be made by outproducing and outpricing other manufacturers based on current technology, rather than out researching them.  This would also require opening up their protected industries to competititive entrepreneurs, which presents a threat to current, highly-connected firm owners and SO'Es. This is a part of what Paul Krugman refers to as “growth by perspiration,” because it is based on high volume, low-skill labor investment. This has lead to a homogenous oligarchy of leading firms in China. Although competition is definitely still high in the specialized sectors, it is based around pushing down prices, rather than quality or innovative shifts.

The “High Profit” approach is less of a centralized plan and more a result of market forces within the economic landscape of India. India's individual entrepreneurs are looking to enter the market in areas where they can make the highest profit possible, which usually means that competition is the lowest. In this way, India's economic growth is not based on out-competing or out-producing, but rather on out-innovating. The heterogenous workforce of India has lead to incredible achievements of entrepreneurship, based off innovation and an inexpensive supply of skilled, specifically trained labor. This growth can be seen in software and business services, such as call centers. Ohara notes that the government has also been quite skeptical of money becoming pooled in monopolistic industries, especially primary goods manufacturing, however the software and services sector was often passed over by regulators, allowing entrepreneurs in these industries to grow more freely.  Also, India's infrustructural problems, such as terrible roads and limited ports, presents higher risks to potential industrial development.

The repercussions and results of these two approaches to post-colonial development will become more clear as time goes on. At this point in the game, it seems that China's approach has been more successful, with growth rates causing their GDP per capita to skyrocket, bringing more people out of poverty than any other period in history. China's economic ties with other countries have also strengthened its political positions in the world—it aims to become the hub of the East and a competitive player in both South America and Africa.

However, one can point to its homogenous, centralized strategy as the system's very flaw. The vast inflow of money and capital have put significant pressure on a still infant banking system, which, although heavily regulated by the government, has a high level of underperforming loads and has developed a significant shadow banking system. This underground system is necessary to finance the fast-paced growth, but it also poses a large danger to the system's stability as many of the debt packages have not been properly securitized. I hope to talk more about this in next weeks post.

India, with its strong services sector, has much potential in many other areas of its economy. Although disjointed, growth has still been at over 3%, and some might argue that as more of the population is lifted from poverty, that growth will accelerate faster due to a more skilled work force, a mature services sector, and a growing creative pool of entrepreneurs.  Hopefully, their regulatory and infrustructural policies will likewise progress. This is obviously an optimistic scenario but not unrealistic. Regardless, India serves as a model for growth in the services industry in the developing world and will only growth in its importance of the Asian development story in the 21st century.

Cross-Pollination

In my international trade class we have been discussing the idea of external economies of scale. The external economy describes a situation that if an industrial sector has a critical mass of firms within an area, knowledge spill off, and training within that industry will actually lead to mutual gains and improved productivity amongst the firms. China used this principle as part of the inspiration for their SEZs, especially those in the Pearl River Delta, to create strong industry. This strategy obviously paid of with fast growth.

India still is lacking this critical mass, but they organically developed innovative entrepreneurs to fill that need (albeit currently to a much lower extent).  They still lack centralized coordination of these entrepreneurial efforts, either from government (as China did) or from private investors (who have been reticent to join the still highly risky business environment in India). However, the Chinese model is susceptible to global shifts in capital -- some manufacturing is moving to South East Asia, where labor is even cheaper, and even back to the United States, where productivity and proximity to markets is higher, according to a recent report by the Boston Consulting Group.1 India, however, through its more natural growth economy, has already developed the services industry to support high growth within industry and growing demand from a rising labor class, although to this point much of their work has flowed off-shore. If India did achieve the critical mass for clustering and economies of scale, while retaining their independent, heterogeneous character, maybe they could achieve the same astronomical growth as other East Asian nations have, but more sustainably and across many industries.

China is the triumphant player coming out of the first decade of the 21st century. However, there is a scenario by which China's strategy might render its sprinting growth rate unsustainable. India, although lagging and disorganized, may end up being the tortoise in this race, and come out a long term victor in Asia.

 

1 http://www.bcg.com/documents/file84471.pdf