Too Close for Comfort

Written by Hadia Majid  •  Region  •  April 2013 PDF Print E-mail

Too-Close-for-ComfortChina and India are two major economic players, uncomfortably located close to each other. But will India be able to challenge and surpass the stronghold of the Chinese economy?

China’s GDP growth rate has been at over 9 percent since 2008, after expanding 2 percent in the fourth quarter of 2012 over the previous quarter. In contrast, India has seen more sporadic spurts of high growth rates – GDP growth stood at 3.9 percent in 2008, went up to 9.6 percent in 2010, while forecasts suggest that India will likely see GDP grow by 6.5 percent in 2013. In addition to their high rates of growth, both India and China have burgeoning domestic markets along with an economy that is largely export oriented. According to the World Bank, China’s exports of goods and services as a percentage of GDP have been in excess of 30 percent since 2010 while India’s have been in excess of 20 percent since 2010. Thus, both economies are major players in the international market with China’s economy currently being the second largest in the world after the United States, with expectations that it will overtake the US economy within the next decade.

Having two major players in such close geo-physical proximity has resulted in some interesting dynamics vis-à-vis the foreign relations of the two nations. Over the last 60 years, the two countries have been involved in several skirmishes on their common border. In recent years, however, both countries have also endeavored to improve their diplomatic and trading relations. Moreover, although China occupies the stronger economic position for the time being, it is unclear if it will be able to maintain that position in the long run, though as stated, it is likely to surpass the US. Hence, the question of whether India or China will be the dominant super-power in the region, and potentially the largest economy in the world, in the next couple of decades is a matter of debate.

Both China and India have witnessed a fairly similar progression of their economies towards the high rates of growth that they experience today. Both countries have evolved from a largely autarkic economy to one that is primarily export- oriented. Yet, there are also some significant differences in the path that the two have chosen to follow. While the Chinese economy was liberalized earlier than the Indian one, China has been focused on attracting foreign investment to enhance its economic performance whereas the Indian government has emphasized on providing support to local entrepreneurs and businesses. China’s success in attracting FDI may be attributed to the openness with which the government has traditionally treated its (wealthy) diaspora. Historically, India’s attitude toward its foreign residents has been more hostile. Today this outlook has reversed substantially and India has welcomed increased involvement of its diaspora in the local economy.  The Chinese model has stressed acceleration in industry while India has tended to underscore its services sector.

The fact that India and China have chosen to focus on different sectors must be evaluated in the context of their national characteristics. Both countries are home to large populations (China’s population stands at 1.3 billion while India’s is 1.2 billion) but income per capita is higher for China than it is for India. Furthermore, China had a health per capita expenditure of US$471 between 2008 and 2011 whereas India’s per capita health expenditure for the same period was at US$41 (World Bank). Finally, according to the CIA Fact Book, adult literacy rates stand at 92.2 percent and 61 percent in China and India, respectively, with the gap between male and female literacy rates being significantly larger in India as compared to China (where adult literacy is defined as percent of individuals who are at least 15 years of age and can read and write).

Given the deficiencies in the current state of human capital in India, the growth prospects for the country will in part be determined by how readily it will be able to move beyond its current emphasis on services to an expansion of trade in manufactured goods. While India’s highly educated and technically skilled diaspora has been instrumental in the advancement of its services sector, it is only in the trade of goods that India can truly take advantage of its large pool of undereducated workers.

The ground-up approach pursued by India with regard to its domestic economy has meant a heavier emphasis on indigenous entrepreneurs. Moreover, India’s deep-rooted democratic institutions have given it systemic resilience. Combine these factors with the demographic dividend that India may enjoy in the next decade or so (while China’s population ages and shrinks as a consequence of its one-child policy) and India might start to outstrip China in the near future. The robustness of India’s more bottom-heavy brand of capitalism is best exemplified by considering the difference in performance between two Chinese provinces. In a 2003 article, Huang and Khanna report that while Zhejiang has focused on local businesses it has also grown at an annual rate that is 1 percent faster than Jiangsu that has relied heavily on FDI to drive its growth.

One major caveat to keep in mind when discussing India’s growth potential is that its strong democratic institutions as opposed to China’s highly centralized and opaque system of government, inspire (both domestic and foreign) investor confidence. The higher level of corruption in the same institutions also make India the less attractive choice for investors. Furthermore, while the demographic dividend will be important in the near future, India will be unable to take complete advantage of that unless the population’s human capital acquisition is also enhanced. However, India faces great challenges with regard to raising educational attainment at both the demand and supply levels. Hence, while India’s attention towards nascent home-grown businesses, its democratic institutional strength and the increased involvement of its diaspora implies that it has the potential to surpass China in terms of economic growth, this potential will only be realized if corruption in government institutions can be properly curbed and the currently undereducated population is fully utilized. 

Hadia Majid is pursuing a PhD in Development Economics at the Ohio State University, USA.

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