Friday, February 09, 2007

India's Disadvantage Relative to China

After the text version of my speech at the Ludwig von Mises Institute conference on financial markets in Las Vegas nearly two years ago was published, I received almost unanimously positive reactions. Except for the angry e-mails from a few people from India who apparently felt I insulted India's national pride by arguing that China's potential economic strength was much bigger. Ii tried to calm them down by pointing out that I still believed that India would grow much faster than the West, only not fully as fast as China. But however offensive some Indians may consider this fact is, it is nevertheless a fact.

China's GDP per capita is more than twice as high than India's, whether measured at current exchange rates or estimated PPP. Yet China have continued to have faster growth, although the growth differential have recently narrowed. And this despite the fact that India's economy is much more overheated, as was noticed by The Economist recently. Money supply and credit growth is much faster than in China, as is consumer price inflation. And in sharp contrast to China and its large current account surplus, India has a significant current account deficit.

The problem for India is that it is the idiot savant of the world economy. While India's IT-sector is of first class quality, it actually employs a a mere 0.5% of India's workforce. India have little of the broad based labor intensive manufacturing that have helped lift hundreds of millions of Chinese out of poverty.

Meanwhile, for most castes in India, the Confucian cultural emphasis on education, thrift and entrepreneurship that underpin's China's boom, is completely alien, making it very unlikely that most Indians will be able to achieve anything like the high productivity of India's small elite of IT-professionals.

Even so, India is again likely to greatly outperform the West. Especially once China moves up the value chain , India should be able to overtake some of the low cost manufacturing jobs currently held by China. And India is expected to have a more favorable demographic situation than China a few decades from now, as China's "one child" policies result in an increasing burden of old age retirees. But despite this, China's prospects are much stronger because it has a culture more conducive for wealth creation than India.


Blogger Libertyfirst said...

I'm at risk to be at least partially O.T., as I want to ask a question about the chinese economy.

In a previous article you claimed that the chinese economy is built upon solid foundations, in this article you say it is in better conditions than India and in your Auburn speech you say that their reliance on exports toward the US (and the over-exposition to dollars) is a short-run problem.

If my summary is correct, I almost completely agree with this issue.

The doubt I have is about the relevance of malinvestments in China. Actually, chinese FDI depends on the unsustainable US consumption levels, which make production in China profitable, in exchange for chinese savings which fuel the US government with cheap interest rates on T-bonds.

The Chinese banking system is claimed to be inefficient and corrupt, but the high savings level and US demand overcomes this problem.

When US consumption will contract and US t-bonds will be released on the market, China will lose:

1. Financial wealth in devaluated dollars, which may be partially offset by purchases of devaluated dollar assets (but the Congress may not like it);

2. A market full of consumers whose inflationary folly has increased the returns on investments in China;

3. The expertise of US firms which "use" chinese savings to fuel the folly of the US macroeconomic situation.

When this will occur, and it seems that everybody considers it a necessity, the high chinese savings rate will help restructure the chinese capital structure toward domestic consumption, thus making the recovery due to the malinvestment easier. But, at that point, the inefficiency of the financial institutions may become more relevant, under the hypothesis that this inefficiency is actually overcome by western firms operating there.

I'm not sure that what I wrote makes sense, but the production cow of the globalized economy may bear a great part of the weight of the recession because capital-intensive markets are more prone to recessions, due to their higher responsivity to monetary distortions, switching costs, and factor specificity.

My conjecture on FDI-driven financial efficiency is just a special case of the usual Austrian hypothesis of capital restructuring costs and consequent high investment volatility.

I'm sorry for the length of the comment.

12:16 PM  
Blogger stefankarlsson said...

Well, I was actually not arguing that a severe U.S. downturn would not harm China. It sure would do so because of the high Chinese dependence on exports to the U.S. Exports to the U.S. would fall both because of the direct effect from the recession and because Congress would likely erect more trade barriers as China is likely to be blamed.

That would certainly also mean a lot less FDI, which as you say would reduce financial efficency.

But while that would significantly reduce growth in the short-term perhaps even push China into a recession, I don't think that will threaten China's long term growth prospects unless that growth downturn causes so much unrest that China returns to Mao Zedong-style communism, which I find unlikely.

The high savings rate along with the cultural conduciveness to education and entreprenteurship creates a strong structural growth prospects. And while China's financial insititutions are ineffecient and undeveloped they are improving. And Hong Kong have a very highly developed financial market which to an increasing extent is made up of mainland Chinese companies. And while it may fall, FDI from America, Europe, Japan and overseas Chinese (including Hong Kong-Taiwan) is not likely to end completely.

And by the way: my speech was in Las Vegas, not Auburn.

6:47 PM  
Blogger Balaji said...

India will yet again prove that it is not a country to be easily understood by ignorant foreigners. As you have said yourself, IT accounts for just 0.5% of Indian workforce and less than 5% of GDP, that means that 9% GDP growth is majoritly cotributed from somewhere else.

It's the manufacturing, the world thinks China's sole property, that India clocks huge growth rates (excess of 11%). In just last 2 weeks, Indian companies have catpulted into world's top producers of Steel & Aluminum, and India's Pharma, Oil refinery, Auto and others too hungry for more. While China leads in Manufacturing it is hopelessly scattered and once India consolidates with the acquisitions in the past year is going to give a run for money for Chinese concerns (name atleast one big Chinese private company in Fortune 2000).

Infrastructure problems can be fixed much more easier than cultivating entrepreneurial spirit and democratic political processes.

Thus, while the morons in the West keep their infatuations for China, most of their boardrooms would have already shifted to a country that they still think as a third world nation.

4:03 AM  
Blogger Libertyfirst said...

Ok. Thanks.

11:05 AM  
Blogger Aditya Dash said...

I am curious about your conclusion regarding the lack of Confucian values in Indian culture. From my experience Indian culture is heavily influenced by Confucian values, probably a result of trade in ideas. We exported Buddhism and imported Confucianism. Besides speaking about Confucianism the highest honor was reserved for government bureaucrats not entrepreneurs. Historically traders did not enjoy a high social status in China. The reason being that trading did not create any value.

11:50 AM  
Blogger stefankarlsson said...

Aditya, given the fact that adult literacy rate is just 61% (lower than in Rwanda) and the fact that in this 61%, people who can do little more than signing their names is included, it doesn't as though education is considered valuable among most Indians. Dito with thrift, as India's national savings rate is just half of China's.

10:26 PM  
Anonymous Anonymous said...

i agree with Balaji, the West is actually ignorant of all the aspects of India. The political situation and the corruption levels in India are really bad, but the infrastructure is really changing fast.
when all this is cleared up, the country will be unstoppable thanks to KPO's BPO's and takeovers. And India is not a scialist economy but more inclined to capitalist. i think that there is enough manpower too in India and the new generation is huge more than 60% of the country's population, not aging like China. I think there are enough reasons to put your money safely on India.

9:38 PM  

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