China and India Exposed

by Pranab Bardhan Pranab Bardhan is Professor of Economics, University of California at Berkeley and the author, most recently, of Awakening Giants, Feet of Clay: Assessing the Rise of China and India. 20.11.2010

BERKELEY - Chinese Premier Wen Jiabao's forthcoming trip to India, following hard on the heels of President Barack Obama's recent visit, will provide another opportunity for the media to gush about the growing global economic clout of China and India. We can be sure that the soft underbellies of both economies will be kept hidden from view.

After a couple of centuries of relative stagnation, these two countries, containing nearly two-fifths of the world's population, have experienced remarkably rapid income growth in the last three decades. In manufacturing and services (particularly software, business processing, etc.), respectively, China and India have made huge strides internationally, and their acquisition of global companies has attracted considerable attention.

But some dubious assertions have, through constant repetition in recent, often breathless, accounts about the two economies, become part of conventional wisdom. Much of what really goes on inside these two large countries is often left out.

For example, in terms of value added (the value of output after deducting the cost of materials and components), China, contrary to popular impression, is not yet the manufacturing center of the world. The Chinese produce about 15% of value added in world manufacturing, while the United States contributes about 24% and the European Union about 20%.

Similarly, while India's information technology-enabled services have gained an international reputation, the total number of people employed in this sector is less than 0.5% of India's workforce. As such, it cannot, by itself, transform the Indian economy.

Chinese growth is widely regarded as furiously export-driven, but domestic investment has in fact been the major component. Even at the height of global trade expansion in 2002-2007, exports (in value-added terms) accounted for only a little more than one-quarter of GDP growth, whereas domestic investment contributed a substantially larger share.

Moreover, contrary to popular belief, much of the dramatic poverty reduction in China over the last three decades was due not to integration into the global economy, but to domestic factors like growth in the agricultural sector (where mass poverty was concentrated). This is attributable largely to public investment in rural infrastructure, and, in the initial period, to institutional changes in agrarian production organization and an egalitarian distribution of land-cultivation rights.

Expansion of exports of labor-intensive manufactures has nonetheless lifted many Chinese out of poverty. That is not true of India, where exports are still mainly skill- and capital-intensive. Economic reform clearly has made the Indian corporate sector more vibrant and competitive, but most of the Indian economy is not in the corporate sector (public or private). Indeed, 92% of the labor force is employed in the informal sector.

Indian poverty reduction has been significant, but not substantial. However, in terms of non-income indicators of poverty - for example, child mortality, malnutrition, and school dropouts - India's performance has been dismal (in some respects worse even than in sub-Saharan Africa).

In the financial media, China and India have become poster children for market reform and globalization, even though in matters of privatization, property rights, deregulation, and lingering bureaucratic rigidities, both countries have in many ways departed from economic orthodoxy. According to the US-based Heritage Foundation's widely cited Index of Economic Freedom, China and India are relegated to the group described as "mostly unfree." Out of a total of 157 countries in 2008, China ranked 126th and India 115th.

Although socialist economic policies in both countries inhibited initiative and enterprise, a positive legacy of that period cannot be denied. It is arguable, for example, that Chinese socialism provided a strong launching pad for growth, particularly in terms of a solid base of education and health, rural electrification, a safety net enabled by equitable distribution of land rights, regional economic decentralization, and high female participation in the labor force. Moreover, a major part of the socialist legacy in both countries is the cumulative effect of the state's active role in technological development.

Unlike in India, where the private corporate sector is the most dynamic sector, in China state-controlled companies are some of the globally more successful. Even in famous private Chinese companies like Lenovo and Huawei Technologies, the ownership structure is highly convoluted, and the boundaries of state and private control rights blurred. The recent purchase of Volvo by the private Chinese automaker Geely generated much publicity, but most of the money was put up by municipal governments.

Powerful political families run many Chinese state-owned enterprises. Indeed, there is some evidence that the overwhelming majority of multi-millionaires in China are relatives of high-ranking Communist Party officials. And, thanks to the large pool of savings generated by Chinese households and state-owned companies, the Chinese economy can for the time being bear the waste and misallocation implied by such crony capitalism.

Without political reform, the long-run viability of such a system is in doubt. Premier Wen himself indicated as much in a speech in August that was widely noted abroad, but largely blacked out in Chinese media. The global media should now go further, and begin to examine the many features of the rise of China and India that depart from the simplistic narrative of the triumph of market reform.

Copyright: Project Syndicate, 2010.

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