The Growth Future—India and China
by Arvind Subramanian, Peterson Institute for International Economics
Op-ed in the Business Standard, New Delhi
August 19, 2008
© Business Standard
Can China and India sustain their current growth rates? A traditional answer to this question is conditional: yes, provided they continue to implement policy reforms. But historical experience allows a less guarded answer. There are few examples of countries that have grown as strongly and for such long periods as India and China have—6 percent and 10 percent, respectively, for nearly three decades—and then suffered a sharp slowdown or collapse. If history is a reliable guide, then barring major upheavals, economic growth looks likely to continue in both countries until some threshold level of prosperity is attained.
But why does growth beget more growth? One mechanism is simply that growth signals the fact of profitable economic opportunities, which encourages investors to rush in, first in response to these opportunities but then in response to each other—this is growth as a confidence trick—creating a virtuous circle. If countries are relatively poor, if their markets are large, and if their policy framework is basically sensible—all of which are true of China and India—the chances of the growth-begetting-growth dynamic taking hold are high.
But in addition to the signaling effect, growth may itself cause changes that have in turn a growth-reinforcing effect—a kind of positive feedback loop. A good example is education. For long, development economists bemoaned the poor levels of educational attainment in India, directing their critique at the government's failure to supply better education. But economic growth changed the education picture dramatically. It increased the returns to, and hence the demand for, education. And if government supply remained weak, consumers simply turned to the private sector to meet their demand for education. Improvements in educational attainment over the last 15 years are attributable in part to more rapid growth.
An important question then is whether India and China can take the positive feedback loop for granted, especially in relation to two key determinants of long-run growth: state capacity or effectiveness and the private sector's entrepreneurial capacity. In other words, is it inevitable that over time growth will itself improve the quality of private entrepreneurship and public institutions? Consider each in turn.
Policy reforms have created the conditions for the private sectors in both countries to flourish. Yasheng Huang of MIT in his new book, Capitalism with Chinese Characteristics, argues that the Indian private sector, especially the indigenous part, is more efficient and entrepreneurial than its Chinese counterpart.
One crude measure of relative sophistication or entrepreneurial capability is how much direct investment (FDI) these countries are exporting, especially to richer countries and especially in sophisticated sectors. Based on new data on mergers and acquisitions, Aaditya Mattoo of the World Bank and I calculated that India's FDI exports to the OECD countries overall and even in the manufacturing sector were substantially greater than China's (measured as a share of GDP). China is rightly considered the world's manufacturing powerhouse and export juggernaut, and yet in the manufacturing sector, Indian entrepreneurial and managerial capital (in the form of FDI) has been more successful than China's in taking control of and managing assets in the sophisticated markets of Europe and the United States. So, while both private sectors have improved, India can claim today that it is ahead of China in fostering entrepreneurial capitalism.
Turn next to institutions. In the case of China, the focus of the world, and indeed the disappointment, has been the absence of the positive political feedback loop: Growth and the attendant economic freedoms have not led to greater political development and openness. Implicitly, there has been less concern about the effect of growth on the state's economic capacity. Over the last thirty years, the Chinese state has successfully created physical infrastructure and delivered essential services.
Contrast that with the Indian experience. While there are many exceptions, and at the considerable risk of overgeneralizing, the Indian state, despite rapid economic growth, has deteriorated over time. Whether it is providing basic law and order, ensuring sanctity of contract, or delivering public services, the stench of decline is hard to ignore. For example, on a crude measure of government effectiveness on which I compiled data across time, India's performance declined sharply: In the early 1960s, India was in the top 5th percentile of countries in the sample, slipping to the middle of the pack in recent years (see Subramanian 2004, "The Evolution of Institutions in India and its Relationship with Economic Growth" [pdf]). The education example discussed earlier is an exception to the growth-institutions dynamic, made possible only because of private alternatives to state supply. For the core public-sector functions, where such an alternative does not exist, the growth-institutions dynamic has been weak or nonexistent.
So, growth in India has come with a more entrepreneurial private sector but accompanied by deteriorating state capacity. China has a vastly superior state capacity but an indigenous private sector that is still finding its feet. Which combination augurs better for the future?
There is a fundamental asymmetry between state and markets. It is easier to create markets than it is to create state capacity or to prevent its deterioration. Creating markets is a lot about letting go, establishing a reasonable policy framework, and allowing the natural hustling instinct to take over. In other words, hustling is the natural state. Building state capacity, on the other hand, is quite different. It involves overcoming collective-action problems, mediating conflict, creating accountability mechanisms where outputs are multiple and fuzzy and links between inputs and outputs murky, and contending with the deep imprints of history. In Weber's memorable words, building public institutions is like the "slow boring of hard boards."
In that light, China's task of improving its private sector seems easier to accomplish than India's task of arresting institutional decline. So, while China and India can probably both count on more years of high growth, the odds still favor China pulling off that feat than India. That, and not just the meager medal tally, should be what India mulls over as the curtain descends on the Beijing Olympics.