Monthly Archives: August 2010

China and India have grown quickly in the last two decades thanks largely to industrial policies through the 1980s that, while leading to missteps and gross inefficiencies, also led to export baskets that are far more sophisticated and diversified than expected given the countries’ income per capita. With the eyes of the world looking to growth in Asia to help keep the global economic recovery on track, how China and India work together will greatly affect the outcome.  Though similar in some ways, the countries face respective challenges that are quite different.

Our analysis begins with a research paper by Jesus Felipe, Principal Economist with the Central and West Asia Department of the Asian Development Bank, Utsav Kumar, Consultant with the Central and West Asia Department of the Asian Development Bank, and Arnelyn Abdon, Consultant with the Central and West Asia Department of the Asian Development Bank.  According to the authors’ research, China and India each embarked on policies in the 1950s and 1960s designed to achieve industrialization. “Both favoured the capital-intensive route, to a large extent as part of an import-substitution strategy that aimed at avoiding foreign dependence, although with significant differences between the two. The important point is that both countries developed a broad industrial base during the planning period that helped them accumulate capabilities that are now allowing them to grow.”

Sophistication

Simply encouraging industrial growth, with or without the accompanying mistakes, does not account for the incredible growth China and India have experienced.  Their growth rates would not be possible but for the fact that they have also developed sophisticated export baskets.  By “sophisticated” we mean that China and India, as emerging economies, have been able to take market share away from developed, or “rich,” nations by producing and exporting the same goods that the rich nations export.  By way of comparison, consider Brazil.  It is also growing rapidly, but its exports are not sophisticated.  Brazil relies on its natural resources for growth.  Its abundance of minerals, ore, natural gas and now, off its coast, oil make the country an attractive trading partner for the likes of China, India and other industrialized nations.  Not surprisingly, two of Brazil’s biggest companies are an energy conglomerate, Petrobras (symbol PBR), and a miner, Compania Vale do Rio Doce (symbol: VALE). However, Brazil has not, yet, reached the capacity to compete with developed nations for exports of goods.  In contrast, the bulk of exports from China and India are capital and labor intensive.

An examination of the chart below, which compares export sophistication with GDP per capita, one can see that the export baskets of China and India are more sophisticated than their income levels might suggest. (Note as well how much of an outlier Ireland is on the chart—given its current bank and debt woes, one could apply a famous quote from the movie “Blade Runner“: “The light that burns twice as bright burns for half as long - and you [Ireland] have burned so very, very brightly…”)

[SOURCE: www.voxeu.org, China and India: Those Two big outliers]

What Happens Next Has Global Implications

Now that China and India have risen to new heights, how they get on with one another matters greatly.   China recently overtook Japan as the world’s No. 2 economy. That event has caused some to focus on potential competition between China and the No. 1 economy, the United States.  However, China’s biggest competitor may very well be India, rather than the U.S.  A recent column in The Economist explains, when taking a wider Asian perspective, China and India are “two Asian giants, which until 1800 used to make up half the world economy, are not, like Japan and Germany, mere nation states. In terms of size and population, each is a continent—and for all the glittering growth rates, a poor one.”

One key area to watch is the balance of power.  China has increased spending on defense, aerospace and cyberspace.  However, that spending still pales in comparison to what the U.S. spends on the same efforts.  Thus, China is more likely to unnerve its neighbors with its new navy and other defense measures than the U.S.  The Economist points out that recent weeks “have seen China fall out with South Korea (as well as the West) over how to respond to the sinking in March, apparently by a North Korean torpedo, of a South Korean navy ship. And the Beijing regime has been at odds with South-East Asian countries over its greedy claim to almost all of the South China Sea.”

One must also be a student of world history to understand that not everything revolves around the U.S. For instance, India and China fought a war against each other nearly 50 years ago.  It would be naive to think that the 1962 clash over disputed territories in Tibet and Kashmir does not color the countries’ relations today.  It is also easy to conclude that China has pulled significantly ahead of India so that it will have the dominant bargaining power for some time to come.  But again, looks can be deceiving.  The Economist notes that India has the greater long-term prospects of the two countries.  “While China is about to see its working-age population shrink (see article), India is enjoying the sort of bulge in manpower which brought sustained booms elsewhere in Asia. It is no longer inconceivable that its growth could outpace China’s for a considerable time. It has the advantage of democracy—at least as a pressure valve for discontent. And India’s army is, in numbers, second only to China’s and America’s: it has 100,000 soldiers in disputed Arunachal Pradesh (twice as many as America will soon have in Iraq). And because India does not threaten the West, it has powerful friends both on its own merits and as a counterweight to China.”

For now, investment dollars are flowing into China at breakneck pace as many investors seek safety from the economic troubles in the West and some return on their investment.  China has used the investment to build up infrastructure, an area of weakness in India.  However, while industrialization on the scale seen in China has not yet taken place in India, the focus on heavy-machinery based industrialization and emphasis on tertiary education has allowed India to build capabilities that, post-reforms, have led to its expansion into core activities. India’s failure lies in not being able to exploit its comparative advantage in the labor-intensive sectors, even after reforms. That said, the savvier investor may want to bypass China for India on a longer-term basis.