Comparative Performance of India and China - Note

8/2/2019 Comparative Performance of India and China - Note

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Lecture Note (Session 4)

Can India Match China in Manufacturing Sector Performance?

Theme of the Note:

China has emerged as the worlds major exporter of manufacturing goods since 1990.

India is not yet a major exporter of manufactured products to the world. Significantly,Chinas industrial growth rate has been consistently higher than Indias by about one andhalf times, and the gap seems widening. The worlds economic super power UnitedStates (US) now feels that Chine will inevitably tilt global trade and technology balancesin its favor, ultimately becoming an economic, technological, and military threat to it.Business and political leaders in the US now fear that China's growing share of worldexports, especially of high technology and industrial goods, signals the rise of yet anothermercantilist economic superpower in northeastern Asia.

In this context, this lecture note traces the factors explaining Chinas higher productivityand competitiveness in world market for manufacturing bases; and discusses thesustainability of Chinese model of economic growth.

1. India and China in the World Economy:

Today, China and India together account for 40% of the worlds population. Since1980 Chinese economy has been growing at the average rate of over 9%.1 India isfollowing behind China, with an average growth rate of close of 6 per cent a year since1980, with some evidence that growth is accelerating and can be sustained at 8 per cent ayear in the coming decades. Whereas China has emerged as a predominantly industrialeconomy (share of industry in GDP was 46% in China and 27% in India in 2006), Indiabecame a service economy (share of services in GDP was 41% in China and 52% in Indiain 2006). The worlds economic super power United States (US) now feels that Chinewill inevitably tilt global trade and technology balances in its favor, ultimately becomingan economic, technological, and military threat to it. Business and political leaders in theUS now fear that China's growing share of world exports, especially of high technologyand industrial goods, signals the rise of yet another mercantilist economic superpower innortheastern Asia.

With populations of 1.3 and 1.1 billion respectively in 2003, the two gianteconomies of China and India present a huge and fast growing domestic market(demand side) for a range of goods and services, and thus export opportunities forproducers in the rest of the world. This is evident from the fact that in 2003 Chinas vastmanufacturing industry has consumed 20-30% of world trade in aluminium, copper, ironore, stainless steel and zinc. These percentages are expected to rise in the future,

assuming of course, Chinas rapid growth is not a bubble but will be sustained. Thismeans that foreign raw material suppliers depend to a greater extent on Chinese demand.Any disruption in Chinese demand in the short-run can be costly for them. The marketpotential of India and China is also evident from the large flows of FDI to thesecountries, both for production for the domestic market, but also to use exports to the rest

1 Not so long ago, in the 1950s and 1960s, Japanese GDP grew at a rate of about 9% a year for nearly 25years.


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of the world. The fact that India has attracted far less FDI, is not because of the lack ofpotential opportunities in India, but largely because of policy hurdles and otherconstraints on investment.

Besides being a major demand market, India and China influence world economyas major exporters (supply side). Foreign users who depend on Chinas exports of

goods/merchandise for a sizeable share of their total use, could be faced with the prospectof having to search for alternative supply sources if Chinese exports are disrupted forwhatever reason.2 Similar argument holds for Indias exports of services. Therefore,shocks to these two countries import demand (and export supply) are sources of risk forforeigners.

All these simply imply that both India and China have become increasinglyintegrated with the world economy. But China has gone much farther in this regard.China has attracted and continues to attract far more foreign capital (FDI and FII) thanIndia. A major portion (above 70%) of foreign investment inflows into China consists ofFDI. In case of India, foreign investment inflows are mainly in the form of FII (above70%).

2. Performance of India and China in manufacturing sector:

China has emerged as a major exporter of manufacturing goods since 1990 (Table1). India is not yet a major exporter of manufactured products to the world. Significantly,Chinas industrial growth rate has been consistently higher than Indias by about one andhalf times, and the gap seems widening. In India, the traditional hubs of manufacturingsuch as Ahmedabad, Chennai, Kolkata and Mumbai are reasserting themselves as centresof industrial development. But, they are no where near the urban/coastal cities/zones likeShanghai, and Guangzhou in China. China has a significant share of world markets foriron and steel, office machines and telecommunications equipment and textiles andclothing. Moreover, its share has increased significantly over the years. Indias share in

global market with respect to these commodities is no where near Chinas. What isworrisome is that Indias global shares are not growing including the much toutedtextiles and clothing (see APPENDIX for a detailed analysis of Indias comparative

performance in textile and clothing sector).

2

According to Morgan Stanley, low-cost Chinese imports (mainly textiles, shoes, toys, and householdgoods) have saved U.S. consumers (mostly middle- and low-income families) about $100 billion dollarssince China's reforms began in 1978. Cheaper baby clothes from China helped U.S. families with childrensave about $400 million between 1998 and 2003. U.S. industrial firms such as Boeing, Ford, GeneralMotors, IBM, Intel, and Motorola also save hundreds of millions of dollars each year by buying parts fromlower-cost countries such as China, increasing their global competitiveness and allowing them to undertakenew high-value activities in the United States. In an effort to save 30 percent on its total global sourcingcosts, Ford imported about $500 million in parts from China last year. General Motors has cut the cost ofcar radios by 40 percent by building them from Chinese parts.


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Table 1: Worlds Leading Exporter of Manufacturers Top 5

(Share in World Exports)

Country 1980 1990 2000 2007

European Union - - 42.8 44.7

China 0.8 1.9 4.7 11.9

USA 13 12.1 13.8 9.6

Japan 11.2 11.5 9.6 6.7

Hong Kong, China 1.6 3.2 4.1 3.5

India (Ranked 14) 0.5 0.5 0.7 1

Brazil* - 0.67 0.67 0.80

Russia* - - 0.53 0.73

* - Ranked above 15

It appears that China took advantage of the elimination of textile quotas in the USand EU markets in a phased manner (under the Multifibre Arrangement (MFA) since1995) by rapidly increasing its share in the two markets (see APPENDIX).3 India failedto capture this opportunity because of domestic constraints: reservation of garments forproduction by SSIs which restricts scale of production (the reservation was lifted onlythree years ago); high cost of inputs like energy, dyes and chemicals; low labourproductivity and restriction on textile imports. In fact, we are not in a position to competewith China particularly on price. However, ample opportunities still exist for buildinglasting competitive advantage based on creativity in production, skill formation,technological innovation in marketing and distribution, and the creation of supportinginstitutions to help firms and workers adapt continually to volatile markets.

The potential growth of China and India as suppliers of industrial chemicals isalso high, with both having nearly doubled their share in global exports of chemicals.With India emerging as an inexpensive and attractive place for trials of new drugs, andalso the rising confidence of major Indian pharmaceutical companies in their ability toinnovate and compete in the post-TRIPS era, India could emerge as a significantpharmaceutical hub.

In case of automobiles industry, both India and China are emerging as majorplayers in global ancillary automotive products or auto parts component market.4 Field

3In fact, this has triggered safeguard actions by US and EU.4 In case of India this was made possible due to entry of foreign players in the automobile sector in thepost-liberalization period. As part of reforms, India removed entry barriers against foreign automobileproducers and doubled capacity licensing. Prior to reforms there were only three private firms producingpassenger cars in India and their capacity was heavily constrained by govt. through licensing. Foreignplayers started developing local ancillary manufacturers and gave them the technological assistance for


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surveys reveal that current standards of supplier quality in regard to auto components areat, or close to, world standards. In both countries auto component exports are drivenequally by multinational and domestic firms: of the top 10 component exporters in Chinaand India, half are domestic firms. In fact the growing dominance of India and China inthis segment has been putting competitive pressure on established auto parts firms in

industrial countries. (Example: Delphi, the component maker from US has becomebankrupt)

2. Factors Explaining Chinas higher productivity and competitiveness in worldmarket for manufacturing bases:

(i) China welcomed large-scale FDI:

In contrast to Indias homegrown entrepreneurship dependent growth strategy,China followed FDI-dependent approach. The differences in the strategy are functions ofhistory (see Box 1). Chinas Communist Party came to power in 1949 intent oneradicating private ownership, which it quickly did. Although the country is now in itsthird decade of free-market reforms, it continues to struggle with the legacy of that

period. Developments at the microeconomic level in China reflect these historical andideological differences. China has been far bolder with external reforms but has imposedsubstantial legal and regulatory constraints on indigenous, private firms (see Box 1).

The restrictions were designed not to keep Chinese entrepreneurs from competingwith foreigners but to prevent private domestic businesses from challenging Chinasstate-owned enterprises (SOEs). A report issued in 2000 by the Chinese Academy ofSocial Sciences concluded that, Because of long-standing prejudices and mistakenbeliefs, private and individual enterprises have a lower political status and arediscriminated against in numerous policies and regulations. The legal, policy, and marketenvironment is unfair and inconsistent. Some progress has been made in reforming thebloated, inefficient SOEs during the last 20 years, but Beijing is still not willing to

relinquish its control over the largest ones, such as China Telecom. Instead, thegovernment has ferociously protected them from competition. In the 1990s, numerousChinese entrepreneurs tried, and failed, to circumvent the restrictions placed on theiractivities.

BOX1:WhyChinachooseFDIasthepreferredinstrumentofchange?Giventhecompulsionstogrowfastandestablishthelegitimacyofitsdecisiontobreak

outofold ideologicalmoorings (i.e. introductionofeconomic reforms),thepolitical regime in

China had to choose an effective and efficient instrument of change. Though stateowned

enterprises (SOEs) were by far the dominant sector in the Chinese economy on the eve of

reform,withabout30millionworkersandaccountingforfourfifthsofoutputowningthevast

majorityof

the

machinery,

equipment

and

other

physical

assets

employed

in

manufacturing,

it

couldnotbecounteduponforaleadershiproleinbreakingintotheworldeconomy.Overtime

SOEshadbecomevirtuallybankrupt,borrowing largesumsofmoney fromstateownedbanks

them to become world class. Soon India started exporting ancillary automotive products to the developedworld. Interestingly some domestic players took advantage of this situation and start developing their ownmodels. For instance, Telco, capitalizing on the existence of world-class suppliers of ancillaries in India,started producing a state-of-the-art, indigenously-designed car, the Indica.


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andburdeningthebankingsystemwithhugenonperformingloans.Alsotheywerefunctioning

onthedictatesofthepoliticalregime. Inthesecircumstances, itwouldhavebeenadisaster if

theywerepushedtofendforthemselvesinthecompetitiveglobaleconomyunlessfundamental

reforms could be implemented in the fiscal system, banking institutions and enterprise

governance.Understandably,tohaveembarkedonsuchmajorinstitutionalreformsthatwould

haverequiredthestateandthepartytosurrenderagreatdealofeconomicandpoliticalpower

couldhaveledtounpredictableconsequences,threateningthestabilityoftheregimeitself.

Most importantly at the beginning of the reform process, there was no indigenous

privatesectortoturnto,as itwasvirtuallynonexistent inChina.For long,Chinawastakinga

stepmotherlyattitudetoindigenousprivateenterprise,acknowledgingonlythepropertyrights

of individual enterprises, defined as selfemployed business. Domestic private firms faced

discrimination from the banking system in thematter of availability of credit. Such financial

discriminationwastheoutcomeofawellentrenchedand institutionalized ideologicalhostility

towardsprivatefirms,makingitdifficult,ifnotimpossible,exceptwiththecourtesyofpolitical

connections, to access resources from the banking system. This kind of credit restraints for

private firmswas inplacenotbecauseprivate firmswere inefficient,butbecause theywere

private.

In1988theConstitutionwasamendedtoincludeaclausethatpermitestablishmentof

private companieswithmore than eight employees. But discrimination against private firms

continued.Forinstance,until1998largestChinesebankswereunderinstructionsnottolendto

privatefirms.Asofthelate1990s,morethantwodozenindustries,includingsomeofthemost

importantand lucrativesectorsoftheeconomybanking,telecommunications,highways,and

railroadswere still offlimits to private local companies. However, from March 1999, the

privatesectorwasaccepted,asacomponentof,ratherthanasasupplement,to,theChinese

economy.However,itwasonlyinJuly2001,aftertheannouncementofpresidentJiangZemin,

thatthecommunistpartywouldwelcomeprivateentrepreneurstojointheirranksthatthings

easedsomewhatforthedomesticprivatesector.

Giventhe

fact

that

the

institutional

foundations

for

the

growth

of

indigenous

enterprises(bothSOEanddomesticprivatefirms)werevirtuallynonexistentduetothereasons

mentionedabove,therulingpoliticalregimefound itselfinanunenviablepredicamentwhenit

decided to launch economic reforms. Acutely conscious that as China did not possess

capabilities inmanymodern industries, it had to look forways to encourage an investment

regimethatcouldgiveitthebenefitofanunsurpassableedgeinscaleeconomies,marketreach

andtechnologicalleadership.Withnoviableandcredibleindigenouseconomicagenttoturnto,

itaccepted, in recognitionofground realities,thatFDIcouldbedeployedasakindofchange

agent.Most importantly, due to the absence of a strong indigenous business groupswithin

China,Chinesepoliticalregimedidnotallowanykindofsensitivityaboutaforeignpresenceto cloud their judgment about the limited capability of the domestic entrepreneurs inaccessing

the

kinds

of

finance

and

marketing

skills

that

were

required

in

a

global

market.

Foreign investors have been among the biggest beneficiaries of the constraints placed onlocal private businesses. One indication of the large payoff they have reaped on the backof Chinas phenomenal growth: In 1992, the income accruing to foreign investors with


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equity stakes in Chinese firms was only $5.3 billion; today it totals more than $22billion.5

In China, FDI relaxations came in phases, though in fairly quick succession. Themeasures announced during the 1980s were limited in their scope and range. FDI was, tostart with, accorded a legal status superior to that enjoyed by indigenous private firms.

The 1982 constitution offered protection (Article 18) to the legal status of foreignenterprises operating in China. They were permitted to invest in China and enter intovarious forms of economic cooperation with Chinese enterprises and other Chineseeconomic organisations Article 18 also vows to protect their lawful rights andinterests. As these produced encouraging results, the government removed in 1992 anumber of sectoral and regional restrictions on FDI, shifting simultaneously the

investment approval authority from the central government to local governments.

This had momentous implications for the Chinas growth scenario. The creation of SEZs,which exempts foreign investors from regulation applicable elsewhere in China(particularly relating to hiring and firing and foreign ownership), helped in attractinghuge FDI into China. Moreover, excellent infrastructure facilities, particularly power,

road, and communications also played a crucial role in attracting FDI.

Over the two decades of reform, FDI has emerged as a significant source ofinvestment financing. It amounted to 6 per cent of GDP in the early 1990s, falling to 3.5per cent since 2000, though the absolute amount increased during this period [OECD2005]. Since it launched reforms in 1978, China has taken in $500 billion in FDI, tentimes the total stock of FDI Japan accumulated between 1945 and 2000. U.S. firms haveinvested more than $40 billion in more than 40,000 projects in China. Notably, a majorpart (92% of the total) of the FDI flowoccurred after 1992. Between 1993 and 1997,foreign investments [both FDI and FIE (i.e. firms funded by foreign investment/FDI]accounted for over 53 per cent of the fixed asset investment by non-state firms.

FDI has contributed significantly to Chinese GDP and productivity growth. Thecontribution of FDI to annual GDP growth through capital deepening was on an average0.4 per cent in the 1990s and the contribution to long-term total factor productivitygrowth on an average was 2.5 per cent over the same period. Hence the total contributionof FDI to GDP growth during the 1990s is estimated at about 3 per cent a year. Thispositive link between FDI and GDP has been found at both national and provincial levels.

(ii) Dominant role by Chinese Diaspora:

China has a large and wealthy diaspora that has long been eager to help themotherland. Its money (in the form of FDI) has been warmly received. During the 1990s,more than half of Chinas FDI came from overseas Chinese sources (Hong Kong, Macao

and Taiwan). To overcome rising wage costs domestically, to overcome limitations ofdomestic technology to produce for the world market and to overcome growingcompetition from the other Asian economies non-resident Chinese in Hong Kong, Macaoand Taiwan invest in China. Conscious of the absence of a strong domesticentrepreneurship, Chinese authorities have been very hospitable to non-resident Chineseentrepreneurs.

5 This money does not necessarily leave the country; it is often reinvested in China.


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By contrast, the Indian diaspora was, at least until recently, resented for itssuccess and much less willing to invest back home. New Delhi took a dim view ofIndians who had gone abroad

6, and of foreign investment generally, and instead provided

a more nurturing environment for domestic entrepreneurs. Until now, the Indian diasporahas accounted for less than 10 percent of the foreign money flowing to India. With the

welcome mat now laid out, direct investment from nonresident Indians is likely toincrease. The Indian diaspora has famously distinguished itself in knowledge-basedindustries, nowhere more so than in Silicon Valley. Now, Indias brightening prospects,as well as the changing attitude vis--vis those who have gone abroad, are luring manynonresident Indian engineers and scientists home and are enticing many expatriatebusiness people to open their wallets. With the help of its diaspora, China has won therace to be the worlds factory. With the help of its diaspora, India could become theworlds technology lab.

(iii) No protection for domestic industry:

China did not give protection to domestic firms, something both Japan and SouthKorea did during their periods of rapid growth. Instead, it has allowed foreign firms todevelop new markets for their goods and services, especially high-value-added productssuch as aircraft, software, industrial design, advanced machinery, and components suchas semiconductors and integrated circuits. In fact, many Chinese firms resistprotectionism, because they need to import critical components for their domesticoperations and fear retaliation against their exports (by other countries in caseprotectionism is followed by China). Also, Chinese domestic consumers act as a powerfuldomestic coalition against protectionism. They, especially urban consumers, pridethemselves on driving foreign-brand cars and using mobile phones and computers withcircuits that were designed and manufactured abroad. The result: in the Chinese marketdomestic manufacturers of appliances, motorcycles and TVs, to name a few goods, havebeen able to successfully compete with those from Japan, Korea, etc.

(iv) Critical role played by Township and Village Enterprises:

Most of the industrial units producing lower-end manufactures are not stateowned. Nor are they all owned by individual capitalists. A large proportion of Chinasexplosive industrial growth took place in what are known as Township and VillageEnterprises (TVEs). TVEs are collectively owned industrial enterprises, owned by therespective township or village. Their surpluses accrue not to individual capitalists but tothe township or village authority. These TVEs, have a number of advantages. They arelocated on land owned by the local authority itself, and thus do not have to pay any rentfor land on which factories are situated, resulting in a substantial price advantage. Also, apart of Chinas savings is held by TVEs, thereby lessening the dependence of the TVEs

on costlier bank credit for working capital. However, the TVEs cannot subsidise lossesthrough recourse to the public exchequer. They have to stand on their own financially andcannot exist for a long while making losses. TVEs commanded about 25 per cent of

6 But now there has been a change in the attitude towards nonresident Indian. This was officially signaledin 2003 when the government held a conference on the diaspora that a number of prominent NRIs attended.Since then the practice has been continued every year in the form of Pravasi Divas.


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Chinas total export earnings and joint ventures by 1991, increasing to 36 per cent in1996.

What contributed to the success of TVEs? First, the dramatic and demonstrativeimpact on the growth of the small and medium industries in rural areas was facilitatedthrough extensive decentralisation of power to regional authorities for improving

efficiency in the planning and utilisation of local resources and development of localindustries. Second, the local governments had a strong incentive to promote TVEs asthese contributed substantially to revenues which the local governments could retain forthemselves under the revenue sharing arrangements. Third, FDI came to be favoured inthe development of TVEs. The impressive development of TVEs was primarily due totheir connections to the international market. The presence of FDI became pervasive inlabour-intensive and export-processing TVEs such as electronics andtelecommunications, garments and footwear, leather products, printing and recordprocessing, cultural products and plastics. In the TVEs the areas of highest growth werealso the areas of deepest foreign penetration. The connection with FDI brought TVEs incompetition with SOEs and stimulated the latter to increase productivity and unit scale.

Fourth, major agricultural boom coming in the wake of economic reform in agriculture,with better prices and better land tenure, with the farmers acquiring fixed term land userights in the late 1970s and moving towards full property rights in recent years.

(v) Export-led industrialization or Production for exports:

China followed a export-led growth model. Export units, in addition to catering tothe international market, produce for and compete in the national market as well.Managers and workers from the export units also move on to set up other producingunits, taking their skills and production knowledge with them. Most of the lower range ofmanufactures available in many parts of the world today carry the Made in China label hall mark of Chinas export-led industrialisation. China has been producing these goods

for international markets for more than 20 years now.The policy of dualism in product quality played a significant role in promoting

Chinese products abroad. In China there are two sets of firms one producing highquality products and the other producing low quality products. A lot of shoddy goods areProduced in China, often with no attention to safety Standards. Firms producing poorquality goods cater to the needs of the lower end of the market such as Nepal, Bangladeshand India. Chinese experience shows that lower quality is not always a liability,particularly when the trade-off is between quality and price. For example, in case of toysthey are anyway not going to remain useful for very long (whether it is because theybreak or because children want something new) you do not need very high durability.However, competition has helped weed out units producing the worst goods. For

instance, in electrical fans the number of manufacturers went down from a few thousandto a few hundred. The units that remain produce on a fairly large scale and for a widemarket, including the export market.

(vi) Higher labour productivity:

One of the factors contributing to Chinas competitiveness is the dynamicadvantage of higher labour productivity. This is made possible by the following factors.


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(a) The high level of education of Chinese workers. The virtually universalliteracy of Chinese workers enables higher productivity than Indias current 65 per centor so literacy.

(b) The TVEs model does not lead to the same accumulation of profits in thehands of a few individuals. Also the workers are not made to suffer the consequences of

adjustment, as in the usual privately-owned enterprises.

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As a result, workers woulddevelop closer attachment with such enterprises which, in turn, stimulates higherproductivity. On the other hand, where workers only bear the burden of adjustment, withno attention being paid to its social costs, the only result can be a high level of alienationof workers from the enterprises.

(vii) Rapid transformation in workforce distribution:

The relatively faster industrial growth in China is also reflected in a quickerdecline in the proportion of workforce dependent on agriculture. Around 1980, theproportions in China and India were close to 69 per cent. After two decades, the ratio forChina came down by 20 percentage points, while the decline in India was half of that (10

percentage points) (Table). Given that output per worker in developing countries in non-agriculture sectors is three to four times that in agriculture, Chinas superior industrialoutput performance is largely on account of its ability to bring about rapid transformationof its workforce distribution.

Workforce Composition in India and China

(Percentage of workforce)

(viii) Importance to agriculture:

China and India have taken different reform paths. China started off with reformsin the agriculture sector and in rural areas, while India started by liberalizing andreforming the manufacturing sector. These differences have led to different growth ratesand, more importantly, different rates of poverty reduction.

From the trend growth rates of agriculture and the incidence of poverty in the pre-

and post-reform periods in China, it is clear that the acceleration in agricultural growthduring 1978-2002 (4.6 per cent a year as opposed to 2.5 per cent a year over 1966-77)was the primary factor influencing the sharp drop in poverty, from 33 per cent of the

7 For instance, when Huaxi village decided to switch its textile production line from synthetics to highervalue woollens, it carried this out without laying-off any workers, not even migrant workers. This should becontrasted to the continued opposition of coir workers unions in Kerala to mechanisation, leading to theshift of these processing units across state borders to Tamil Nadu.


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population in 1978 to 3 per cent in 2001 (Table). The better part of this decline occurredin the first reform phase of 1978-84 when agricultural gross domestic product (GDP)jumped to 7.1 per cent a year and rural poverty dropped from 33 per cent to 15 per cent.In India, the most rapid poverty reduction occurred from late 1960s and the late 1980s.This is the period of the so called green revolution and agricultural growth was high due

to the use of modern technologies and the strong policy support to agriculture. Incontrast, agriculture was not a major factor behind poverty reduction during the era ofreforms.

Agricultural Growth and Poverty Reduction in China

Period Growth Poverty (as % of population)

1966-77 2.5 33 (1978)

1978-2002 4.6 3 (2001)

1978-84 (First reform phase) 7.1 15

By making agriculture the starting point of market-oriented reforms, a sector

which gave majority of the people their livelihood, China could ensure a widespreaddistribution of gains and build consensus and political support for the continuation ofreforms. Reform of incentives resulted in greater returns to the farmers and in moreefficient resource allocation, which in turn strengthened the domestic production base andmade it more competitive. Besides, through favoured demand conditions, prosperity inagriculture favoured the development of a dynamic rural non-farm sector (TVEs), whichprovided additional sources of income outside farming. As rural incomes rose, thedemand for non-agricultural output increased proportionately. The rapid development ofthe rural non-farm sector also encouraged the government to expand the scope of policychanges and put pressure on the urban economy to reform as well, since non-farmenterprises in rural areas had become more competitive than the state-owned enterprises

(SOEs). Reforms of the SOEs in turn triggered macroeconomic reforms, opening up theeconomy further. The major elements of farm sector reforms in China are:

(1)Individual farmers secured an incentive to produce more than their obligation toplan, which they could sell in open market

(2)Land reforms (land distribution & tenure system, limiting the number of landless)

(3)Health and education provided free

(4)Heavy govt. investment in power

(5)Rural electrification

(6)

State procurement system dismantled everywhere except for main grain-producing regions

(7)Food rationing system was abolished in early 1990s

(8)Private agriculture trade promoted


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Of these the measures 2, 3, 4 and 5 were initiated by China before theintroduction of economic reforms starting from 1978. The measures 6, 7 and 8encouraged diversification.

(ix) Contribution by indigenous entrepreneurship:

With the benefits of FDI inflow accruing to the economy, the regime feltencouraged to introduce steadily the concepts and institutions of (domestic) privateproperty into the Chinese economy. As a result, there has been an upsurge of indigenousentrepreneurship. Increasing confidence that the state will not confiscate ones propertyand greater access to funds via banking system led to an upsurge of new businessesacross almost all industries, from tissue paper production to semiconductor chipmanufacturing. As a result, the domestic private sector has increased output fivefold from1998 to 2003. During this period it created 18 million jobs while SOEs shed 22 millionand added nine million last year. Subcontracting and export processing operationsundertaken by private firms increased 82-fold from 1996 to 2000. In the garment industrythe share of FDI declined from 7.8 per cent to 4.5 per cent. For a country that had noprivately owned companies before 1980, this remarkable achievement would not havebeen possible but for the catalytic role and the demonstrative impact that FDI hadproduced all over that country.

(x) Reform of PSUs in China:

FDI flow, when it started pouring in a massive way, was mainly restricted to thecollectives and joint ventures in provinces and selected regions. As benefits startedflowing from FDI, with the surge of domestic entrepreneurship, the regime could affordto shift gear: in the 15th Party Congress in 1997 president Ziang Zemin declared that thestate did not have to dominate every sector or have majority ownership in everyenterprise in order to maintain broad control of the economy and decided to focus only ona few enterprises and privatise those that did not fall in this key category. The

government announced its policy of grasping the big and letting go the small: graspingthe big meant restructuring and consolidating Chinas largest SOEs and letting go thesmall meant that the government committed itself to support privatisation of smallSOEs. The focus is now on the sanctum sanctorum of the command economy, heavyindustries, mining and defence oriented, some 500 or so key SOEs. Recently, a StateOwned Asset Supervision and Administration has been established in order to strengthentheir management autonomy and financial performance. In several cases, management ofspecific assets for securing better efficiency is being arranged, as a face saving way,through the instrumentality of joint ventures, with restrictive rights for foreign investors.

(xi) Absence of a land market:

In fact, in China as a whole, land is not yet a commodity, not yet real estate. Thiswas a major advantage the country had in its march towards industrialisation (this isespecially the case of TVEs). Of course, a lease market is growing in China and this islikely to put an end to the advantage it has in land not being a commodity.

(xii) Cheap capital:

Capital in China is substantially cheaper than in India. Chinas savings rate ismore than 40 per cent compared to around 28 per cent (in 2003-04) for India. The savings


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are deposited with the state-owned commercial banks in the closed financial system,which has little autonomy but to follow political guidelines in its investment decisions. Apart of this savings is held in the TVEs, lessening their dependence on costlier bank creditfor working capital.

(xiii) Trial and error approach:

China follows trial and error approach in implementing reforms. The adoption ofnew measures through experimentation rather than a predetermined blueprint increasedthe likelihood of the success of reforms since it implied a learning by doing approachor, in the words of Deng Xiaoping, one of crossing the river while feeling the rocks.This was peculiar to the Chinese reform process in which the government made sure thateach new policy was field-tested at length and determined to be successful in selectedexperimental districts before it could be applied nationwide and the next measureintroduced.

(xiv) Centralisation of decision making:

In both Indian and China there was political will to carry out reforms, but inpractice outcomes were shaped by the different patterns of governance. India is adebating society where political differences are expressed freely. Policymaking isexposed to the pressure of various interest groups and there are long debates beforedecisions are taken. The lengthy bureaucratic procedures, intended to ensure checks andbalances in the system, often delays decision-making and implementation. This exerciseis compatible with the needs of a free and dynamic polity but in practice is a key reasonfor Indias slow pace of economic reforms.

China, on the other hand, is a mobilising society where decisions are takenfaster and state power is backed by mass mobilisation. As a result, implementation ofdecisions is more effective although there is lack of more elaborate debate in China on

major reforms. Another key factor in the effective implementation of reforms in Chinawas the ability of the leadership to set both clear objectives and time frame for transitionto the reformed regime. This is made possible due to centralization of decision making.

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On the other hand, in the context of a highly pluralist society like India, consent is moredifficult to achieve, and so neither clear objectives nor time frames for transition can beset.

3. Future challenges facing Chinas Growth Story:

The infirmities in Chinas microeconomic, institutional and entrepreneurial basesseem to raise many doubts on the sustainability of its superior performance. Theinfirmities are as follows:

(a) Growth of labour and savings is expected to slowdown in future:In China, the share in population of persons in prime working age (15-59) is

projected to fall to 53.3% by 2050 from the present (2005) level of 67.7%. Also the

8 However, as the economic system opens up further and prosperity increases, it will become harder andharder to reconcile the centralised political set-up with the more liberal economic system. Indeed, this isone of the most important challenges before China today.


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dependency ratio is projected to rise, from 57% to 88% by 2050.9 Analysts say this is theoutcome of (a) draconian and coercive one-child policy instituted in 1979 and (b) declinein fertility in the decade before. Chinas high savings and investment rates (42% and 39%of GDP respectively in 2004) are also unlikely to be sustained indefinitely into the futuredue to the expected fall in the working age population.

But, Indias position on this front is more favourable than Chinas. The share ofpopulation in the age group 15-59 in Indias total population is projected to rise slightlyfrom 60% in 2005 to 61% in 2050.10 Also dependency will fall slightly from 67% to 64%during the same period. Indias saving and investment rates (around 30% in 2004-05) arelikely to increase further for life cycle as well as other reasons.

(b)High capital out ratio:The incremental capital-output ratio for China is much higher than in India. This

evidently means poor utilisation of capital resources or low productivity of resource useor misallocation and wastage of capital resources. The best and widely acknowledgedevidence of wasteful capital expenditure is the oversupply (or excess capacity) of

infrastructure services, housing and consumer goods in the urban areas in China. Reasonsfor the over investment are:

(i) One reason for this is high rate of urbanisation in China, which requirescapital-intensive physical infrastructure.

(ii) With the introduction of fiscal decentralisation in 1984, local governmentswere made responsible for economic development of their regions withoutfiscal assistance from the national government. This strategy was to encouragelocal governments to earn revenue via tax and non-tax revenues by promotingthe industrial sector (including TVEs) with a sound infrastructure provided bythem. Accordingly, local governments expanded industrial activity bybuilding infrastructure with the help liberal bank credit.11 But one major

problem with this industrial expansion was that the local officials and partycadres expanded industrial activity beyond meeting the tax targets set for themby the higher authorities. This happened because of two reasons: (a) to keepopen unemployment under check to avoid a potential political threat to theregime and avoid social unrest; (b) party officials at the local level discoveredthe advantages of industrial promotion, as their incomes and career prospects

9 However, the other side of the story is that China still has more than half of people of working age

employed in agriculture and rural activities. It this section of the workforce could be successfullyredeployed in non-farm activities (say through technological improvement) then there would beproductivity gains. Perkins (2005) estimates that Chinas non-farm workforce could be increased byanother 70 to 100 million in the next decade through this process depending upon the expansion of seniorsecondary and university education.10 Moreover, with a much larger share of the workforce employed in agriculture and other low productivityactivities, India has greater potential than China to experience significant productivity gains fromintersectoral shift of labour.11 Though the local governments faced a hard budget constraint, they apparently had informal access toliberal bank credit, as the banking system is ultimately subservient to the party and the higher bureaucracy.


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were closely tied to the record of economic development achieved duringtheir tenure in a particular bureaucratic and party position.12

(c)Lack of efficient financial sector:China doesnt have a well-functioning and efficient financial sector consisting of

commercial banks, markets for debt, equity and insurance and a strong regulatory agency.High domestic savings are deposited with the state-owned commercial banks, which haslittle autonomy but to follow political guidelines in its investment decisions. In the early1990s, when China was registering double-digit growth rates, Beijing invested massivelyin the state sector.13 This not only promoted many commercially unviable projects, butalso created excess capacity (see point above), leaving the banking sector with a hugenumber of nonperforming loanspossibly totaling as much as 50 percent of bank assets.

At some point, the capitalization costs of these loans will have to be absorbed,either through write-downs (which means depositors bear the cost) or recapitalization ofthe banks by the government, which diverts money from other, more productive uses.

This could well limit Chinas future growth trajectory. The soft budget constraint facedby the banking system manages to survive as (a) the financial sector is still closed and (b)government repeatedly writes down bad loans with fresh infusion of capital.

As regards the other arms of the financial sector, bureaucrats remain thegatekeepers, tightly controlling capital allocation and severely restricting the ability ofprivate companies to obtain stock market listings and access the money they need togrow. These policies have produced enormous distortions while preventing Chinasmarkets from gaining depth and maturity. It is widely claimed that Chinas stock marketshave a total capitalization in excess of $400 billion, but factoring out non-tradeable sharesowned by the government or by government-owned companies reduces the valuation tojust around $150 billion.

By contrast, Indias domestic financial system has far greater depth and widerinternational linkages. This is despite the low gross domestic saving rate in India.Though, like China, Indias commercial banking system is still dominated by publicownership of nearly three quarters of its assets, nevertheless it has become more efficientwith increasing competition from dynamic new domestic private banks and also foreignbanks (Discuss separately). For instance, compared to Chinas bad loans estimated to bein the range of 20-50 per cent of its GDP, the commercial banking sectors gross NPAswere minuscule at 2.8 per cent of GDP in 2002-03 and have declined during the pastdecade. Indias capital markets operate with greater efficiency and transparency than do

12 The cadre evaluation system (an overlooked aspect of the political reform in China), put in place in 1979,powerfully shaped local official behaviour by linking both the remuneration and advancement of localleaders to performance on economic as well as socio-political norms (Susan Whiting, 2001). Economicnorms centred on the promotion of industrial development [Provincial and local officials were no longerjudged on their political loyalty alone, but also on their ability to develop local industry (OECD, 2002)],while socio-political norms mandated the financing and provision of public goods. Interestingly, both tasksrequire higher revenue in the hands of the local governments.13 Indeed, Beijing has used the financial markets mainly as a way of keeping the SOEs afloat.


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Chinas. Indian stock and bond markets generally allow firms with solid prospects andreputations to obtain the capital they need to grow. In a World Bank study published in2002, only 52 percent of the Indian firms surveyed reported problems obtaining capital,versus 80 percent of the Chinese companies polled. Indias National Stock Exchange isbecoming one of the worlds most efficient (comparable to the New York Stock

Exchange) in terms of transaction costs and transparency. Indeed, the large inflow ofportfolio investments, particularly from foreign institutional investors in response tohigher returns in India is in part a testimony to the vibrancy of Indias stock market.

(d)Neglect of indigenous domestic industry:Chinas export-led manufacturing boom is largely a creation of FDI, which

effectively serves as a substitute for domestic entrepreneurship. Few of the Chinese theseproducts are made by indigenous Chinese companies. During the last 20 years, theChinese economy has taken off, but few local firms have followed, leaving the countrysprivate sector with no world-class companies to rival the big multinationals.

China forestalls the rise of a politically independent (domestic) private sector.

The economic reforms in China strongly favored state-owned enterprises (SOEs),granting them preferential access to capital, technology, and markets. The reforms alsofavored foreign firms/investment, which enabled them to claim the lion's share of China'sindustrial exports and secure strong positions in its domestic markets. The end result isthat Chinese economy/industry was left with inefficient but still-powerful SOEs,increasingly dominant foreign firms14, and a domestic private sector as yet unable tocompete with either on equal terms.

China's private firms are not yet significant global players. Despite more than twodecades of economic reform, China's leading domestic industrial and technologycompanies are still primarily SOEs, which remain inefficient and dependent ongovernment-subsidized loans, and foreign firms.15 Among SOEs and foreign firms, the

later wield strong influence over Chinese economy than former.16 These claims arecorroborated by the following facts: Foreign-funded enterprises (FFES) accounted for 55percent of China's exports in 2003. The share of exports of computer equipment producedby FFES rose from 74% to 92% over the last decade. Today, wholly owned foreignenterprises (WOFES)17 (as opposed to joint ventures) which account for 65 percent ofnew FDI in China, dominate high-tech exports from China. Between 1998 and 2002,FFES increased their share of total domestic high-tech sales from 32% to 45%, while theshare of that market held by SOEs, fell from 47% to 42%. Also, in the same period, theshare of exports of high-tech products (e.g. pharmaceuticals, aircraft, electronics, andcomputers) produced by FFES increased from 74% to 85%.

14 China's high-tech and industrial exports are dominated by foreign, not Chinese, firms.15 In spite of this, SOEs account for the bulk of advanced industrial production in China, boast the country'sbest research and development (R&D) capability, and spend the most resources to develop and importtechnology.16 This is because the SOEs have failed to invest in the type of long-term technological capabilities thattheir Japanese, South Korean, and Taiwanese predecessors built during the 1970s and 1980s.17 In the 1990s, China permitted a new FDI trend to develop: a shift away from joint ventures and towardwholly owned foreign enterprises.


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India, on the other hand, developed a softer brand of socialism, which aimed notto destroy capitalism but merely to mitigate the social ills it caused. For democratic,postcolonial India, allowing foreign investors huge profits at the expense of indigenousfirms is simply unfeasible. It was considered essential that the public sector occupy theeconomys commanding heights, to use a phrase coined by Russian revolutionary

Vladimir Lenin but popularized by Indias first prime minister, Jawaharlal Nehru.However, that did not prevent entrepreneurship from flourishing where the long arm ofthe state could not reach. While China has created obstacles for its entrepreneurs in thepost-reforms period, India has been making life easier for local businesses during the lasttwo decades or so.

As a consequence, entrepreneurship and free enterprise are flourishing in India.18Indian industrial growth and exports have high domestic content and local ownership. AsIndia provided a more nurturing environment for domestic entrepreneurs, it managed tospawn a number of companies that now compete internationally with the best that Europeand the United States have to offer. Further, entrepreneurship is spreading to newergroups of firms whose strength lies not in accumulated wealth or political patronage but

mastery over production technologies which are rapidly spreading overseas Infosys,Wipro, Ranbaxy, Dr. Reddys Labs, Bharat Forge, etc. Not only is entrepreneurshipthriving in India; entrepreneurs there have become folk heroes. Nehru would surely beappalled at the adulation the Indian public now showers on captains of industry (e.g.founder of Infosys Narayana Murthy). These success stories never would have happenedif India lacked democracy, a tradition ofentrepreneurship, decent capital market anda decent legal and property rights systems to support Murthy and other would-bemoguls.

(e)Adverse consequences of high business risk:In China, Chinese Communist Party (CCP) controls all aspects of organized

business life, including industry associations, leaving few avenues for firms to worktogether for legitimate common interests. CCP officials exercise wide discretion indefining, implementing and changing those rules which were developed in the post-reforms period, especially at the local level. CCP officials manipulate economic policiesto pursue particular local goals. Some engage in this manipulation because they arecorrupt, others because they directly own or operate firms. Most, however, do it becausethe political elite encourage them. Rules constantly shift under manipulation bygovernment officials. To survive or work within such a business environment Chinesefirms have developed over the past two decades what is called industrial strategicculture. The following are the salient features of this culture.

18

A measure of the progress: In a survey of leading Asian companies by the Far Eastern Economic Review(FEER), India registered a higher average score than any other country in the region, including China (thesurvey polled over 2,500 executives and professionals in a dozen countries; respondents were asked to ratecompanies on a scale of one to seven for overall leadership performance). Indeed, only two Chinese firmshad scores high enough to qualify for Indias top 10 list. Tellingly, all of the Indian firms were whollyprivate initiatives, while most of the Chinese companies had significant state involvement. Some of theleading Indian firms are true start-ups, notably Infosys, which topped FEERs survey. Others are offshootsof old-line companies. Sundaram Motors, for instance, a leading manufacturer of automotive componentsand a principal supplier to General Motors.


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(i) The business risks inherent in this business environment (or China'sunreformed political system) have motivated/encouraged many Chinese managers toseek short-term profits/gains. Most industrial firms in China have not increased theircommitment to developing new technologies. This is despite their increasing operationalefficiency, sales revenues, and profits. Their total spending on R&D as a percentage of

sales revenue has remained below one percent for more than a decade. R&D intensity(R&D expenditure as a percentage of value added) at China's industrial firms is onlyabout one percent, seven times less than the average in OECD countries.

(ii) Most Chinese firms focus on developing privileged relations with officials inthe CCP hierarchy and the bureaucracy and forgo investment in long-term technologydevelopment and diffusion.

(iii) Chinese firms routinely focus on obtaining "exceptional" treatment from keyofficials: special access to markets or resources, exemptions from rules and regulations,or protection against predation by other officials.

(iv) To maximize these exceptional benefits, as well as to avoid entanglements

with other firms and their patrons, many Chinese companies avoidassociating/networking with each other, risk sharing and collective action within theirindustry. This has been prompting Chinese firms to run their R&D projects in relativeisolation. In the national R&D census in 2000, Chinese industrial firms reported that theyspent 93 percent of their $2.7 billion total R&D outlay in-house, but only 2 percent oncollaborative activities with universities and less than 1 percent on projects with otherdomestic firms.

(v) Chinese firms tend to engage in excessive diversification. Often suchexcessive diversification produces damaging results. For example, many of China's mostfamous firms have made unsuccessful forays into ancillary businesses: Haier (fromhousehold appliances into computers, mobile phones, and televisions), Fangzheng (from

computers into tea, steel, software, and financial services), and Shougang (from steel intobanking, auto assembly, and semiconductors). Huawei, China's best technology firm andmaker of network equipment, has recently made a questionable entry into the mobile-handset market, where sales prices and margins have fallen dramatically for the last fiveyears and 37 licensed vendors produced excess inventories of 20 million phones last year.

(f) Reliance on imported foreign technology:

Chinese firms continue to rely heavily on imported foreign technology andcomponents. Chinese industrial firms are deeply dependent on designs, criticalcomponents, and manufacturing equipment (hardware) they import from the UnitedStates and other advanced industrialized democracies. Import of soft technology -

licensing (i.e. licenses for the use of imported equipment), know-how services, andconsulting - account for a smaller proportion of imports. This is severely limiting thecountry's ability to wield technological or trading power for unilateral gains. Mostimportantly, there have been few efforts in indigenising (i.e. absorbing and masteringthe knowledge embodied in the imported equipment) the imported technology. This is incontrast to the practice of firms in South Korea and Japan in the 1970s and 1980s. Duringthese times firms in these countries tried to catch up with the West by absorbing and


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indigenising the technology embodied in the hardware. Chinese firms remain weak in thisrespect making it unlikely that they will rapidly emerge as global industrial competitors.

(g)Incredible legal system/rule of law:Chinas developing capitalism is not solidly based on law, respect for property

rights and free markets. The business climate in China remains capricious and oftencorrupt (see above discussion). Local governments protect their own counterfeitingoperations as a source of local revenue. The Chinese government continues to be thepolicy maker as well as the judiciary. As long as this continues there is no way the legalsystem will be credible. Chinas intellectual property right protections, although strong intheory, are in fact impossible to enforce in much of the country.

On the other hand the property rights regime is firmly entrenched in India. Theprotection of private ownership is certainly far stronger in India than in China. The ruleof law, a legacy of British rule, generally prevails. Moreover, India developed muchstronger legal infrastructure to support private enterprise. Indias legal system, while notwithout substantial flaws, is considerably more advanced. Corporate governance has

improved dramatically in India. In a survey of 25 emerging market economies conductedin 2000 by Credit Lyonnais Securities Asia, India ranked sixth in corporate governance,China 19

th.

(h)Ill-effects of FDI:FDI replaced many independent business units in China that were earlier carrying

out contract production for foreign firms. In some of the indigenous industries parexcellence, such as ivory and jade sculptures, carpets, personal ornaments, silk,handicrafts, porcelain and so on, domestic entrepreneurs had excelled for hundreds ofyears; for many it was worrying that a sizeable presence was permitted for foreign firms.The increase of FDI was being accompanied by a continuing decline in contractual

arrangements that indigenous entrepreneurs had earlier worked out with foreign buyers.A trend sharply different from what has been observed in other developing countries (forexample, what indigenous firms did in the 1960s and 1970s in Taiwan and Korea). Inthese countries, in the production of labour-intensive export products, local investorslearned the skills and crafts and displaced the foreign producers. What happened in Chinais the reverse of what has been happening in many other developing countries wherethere had been strong FDI alliances through technology licensing and marketingarrangements with local entrepreneurs.

(i)Limited product innovation:China's institutions and the industrial choices of local firms have restricted the

ability of Chinese firms to develop new products and services. The share of total salesrevenues accounted for by new products at Chinese industrial firms was flat, at about 10percent, throughout the 1990s. In contrast, new products account for 35 percent to 40percent of sales revenue for industrial firms in OECD countries. Chinese firms lag behindfirms in other developing countries as well: in 2000, for example, new productsaccounted for about 40 percent of total sales revenues in Brazil's electrical machineryindustry. And because of overlapping investments, fragmentation, and the weakness ofindustry associations, even those firms in China that make new products often find


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themselves engaged in vicious price competition, which prevents them from reaping highreturns from their innovations.

(j) Weak domestic technology supply base:

Chinese firms have also failed to develop strong domestic technology supplynetworks. In 2002, Chinese firms devoted less than one percent of their total science andtechnology budgets to purchasing domestic technology. China's best firms are among theleast connected to domestic suppliers. China's homegrown mobile telephone standard, td-scdma, has received central government support, but thus far none of China's majortelecommunications operators have agreed to commit to it, preferring a foreign standard,wcdma, instead. Thus Chinese technology suppliers do not enjoy a strong "demand pull"from the best domestic firms to stimulate their own innovative capabilities

(k)Possible social upheaval:The rapid economic growth achieved in the last 25 years has generated political

tensions and distributional conflicts in China.19 If this aggravates in the course of further

economic growth and if political reforms do not materialize, it could lead to a violentcollapse of the government. Although the ruling party appears to be firmly in control,and has enough muscle to put down forcibly the growing number of localised protests,and prevent them from escalating into an organised nationwide opposition to communistparty rule, without political reforms towards a participatory democracy, force alonecannot stop such an opposition from emerging.

Even todays modest slowdown is causing unrest. Many people feel that too littleof the countrys spectacular growth is trickling down to them. Land grabs by localofficials are a huge source of anger. Unrestrained industrialisation is poisoning crops andpeople. Growing corruption is causing fury. And angry people can talk to each other, asthey never could before, through the internet. As The Economistmagazine has recently

put it peace and prosperity may depend on the very sort of political reform the[communist] part has tried so hard to avoid.

Although India is also experiencing distributional conflicts arising from itssustained growth for 25 years, its vibrant participatory democracy offers non-violentmeans for resolving them through political compromises. Certainly, politicalcompromises take time to bring about and the very fact that they are compromises oftenmeans that some desirable economic reforms are politically infeasible to implement. Onthe other hand, it also means that the implemented reforms would be far moresustainable.

19 Remember Tiananmen square incident in 1989? The student revolt for democracy staged in TiananmenSquare was crushed because the Communist Party feared spiritual pollution, a euphemism for the dilutionin legitimacy of authority. This had its roots in the decades of economic planning. [Subramanian Swamy,Political structure and economic reforms, EPW, March 5, 2005, p.935]


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(l) Slow down in economic growth:As a recent special report on China published by The Economist magazine

explains, the first decade of the present century, with its relentless double-digit growth,may well have seen the peak of Chinas economic exuberance. A sudden crash is notimpossible: there could be a botched attempt to tackle either the property bubble or what

the prime minister calls the uncaged tiger of inflation. But an immediate upset is stillunlikely: inflation is not yet out of control, still (5.5%) far below the 27.7% it reached in1994. The danger is more in the medium term: growth will inevitably slow over the nextdecade, as China settles into its status as a middle-income country, and the burden ofcaring for an ever larger number of elderly people in a slower economy may makemiddle-class life far more uncomfortable.

As a result of the impending slowing in economic growth, the love affair betweena communist party that calls itself the vanguard of the proletariat and its actual, middle-class supporters is now under threat. To compensate, the party will have to usher inwrenching change. It is struggling to shift China away from the current unsustainablemodel, where growth is propelled by vast investment and export-led manufacturing.

(m)Managing state-owned enterprises:Chinas state-owned businesses have an insatiable appetite for capital, which

many of them waste. Curbing state companies means taking on all of the well-connectedpeople who ride on their coat-tails, including parts of the middle class. The partys creedmeans nothing to most such people. The party is secretive about recruitment to its 80m-strong ranks. But an official report in 2008 said that, of new applicants for membership,by far the biggest category comprised university students over the age of 18. Althoughthe decision by these young careerists to sign up shows the partys clout, they have verydifferent ambitions from those of the old ideologues.

(n) Sustaining urbanization:The party will also have to work harder to sustain the urbanisation that has fuelled

the economy. China has done the easy part: attracting underemployed young ruralresidents to urban jobs. But the supply is beginning to slow. It would help if farmerscould sell or mortgage their rural land and use the money to help gain a stronger footholdin the cities. But the party remains overly fearful of privatising farmland, partly foratavistic fears of a destitute peasantry, and partly for ideological reasons.

Worse still, the system of household registration, or hukou, defines even long-staying urban migrants as rural residents, cutting them out of housing, education andother benefits (i.e. treating them as second-class citizens). No wonder that the migrantsare increasingly restive. Of the tens of thousands of protests each year, most are stillrural, typically by farmers enraged by inadequate compensation for land appropriated fordevelopment. However, urban unrest, such as recent riots by factory workers in thesouthern province of Guangdong, is now more common. If the party is to keep the peacein cities and if it is to continue to attract migrants in sufficient numbers, it needs to findways to turn them into full-fledged city-dwellers, with the consumer power to match.

Here it runs up against the middle class most directly. To give migrants the samehousing and other benefits as urban hukou holders, and to build a proper social safety-net


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will be expensive. And if more tax is the solution, then the middle class could well begindemanding a greater political say.

4. Why India Lags behind China?

Though India and China share some similarities (see box) in their developmentpath, both are now at different stages of economic development. The reasons for the gapin economic development and other benchmarks between India and China are as follows.

(1) Indias economic reforms began only in 1991, against late 1970s (1978) inthe case of China.

(2) India national savings rate is half that of Chinas.

(3) The FDI level in India is 90 percent less than of China.

(4) Despite substantial tariff reductions in the post-reforms period, India remains arelatively more protected economy.

(5) Restrictive labour laws and onerous red tape have been spoiling Indiasinvestment climate.

(6) Sectoral caps/restrictions on FDI. Together with restrictive labour laws andpoor infrastructure facilities this has hindered FDI inflows to India.

SomesimilaritiesbetweenIndiaandChina(a)Chinaand Indiaaretwoof the largestagrarianeconomies intheworldaccounting

forthebulkoftheworldspoorestpeople.(b) Both countries started off with similar levels of living with wide geographical

variations,andeconomicandsocialdiversities.

(c)Bothcountriesembarkedonthecourseofplannedeconomicdevelopmentroughly

aroundthe

same

time.

But,

China

followed

the

Soviet

model

much

more

closely

than

India.

(d) Both countries opted at roughly around the same time, for the heavy

industrialisationstrategyasthequickestroutetosustainedeconomicdevelopment.

(e)Bothcountriesperiodicallyfacedfoodandforeignexchangeconstraintsinthecourse

oftheirindustrialisationeffort.

(f)BothChinaandIndiafollowedagradualistpolicyofareformprocess inresponseto

emerging challenges, given domestic economic constraints and the demands of political

stability.

(7) Growing inadequacy of Indias infrastructure constitutes a major obstacleto private investment and export potential.

(8) Bankruptcy laws (strong exit barriers to manufacturing industries),judiciarysystem (slowliness in resolving commercial disputes) are inefficient in India. In thissense, China has not been hurt particularly by its having no conventionally defined legalsystem.

(9) China has better investment climate than India.

(10) SSI reservation in India has been hurting the progress of small businessunits.


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(11) Availability of land for development has become a major issue in India.

(12) India lags behind China in the educational attainment of its workforce.

(13) India is a sprawling, messy democracy driven by ethnic and religioustensions, and it has also had a longstanding, volatile dispute with Pakistan over Kashmir.

China, on the other hand, has enjoyed two decades of relative tranquility; apart fromTiananmen Square, it has been able to focus almost exclusively on economicdevelopment.

(14) Poor performance ofPSEs.

Some of the areas in which India performed better than China include thefollowing.

(a) The spawning of internationally competitive homegrown companies.

(b) India has a fairly successful regulatory structure that can enforce a fair balancebetween entrepreneurial initiative and market discipline.

(c) Efficient and transparent financial markets This support privateenterprise so that entrepreneurship and free enterprise are flourishing. Also Indiasfinancial system is not discriminating as much against innovative domestic enterprises ascompared to Chinas system.

(d) A relatively entrenched legal system.

(e) A stable democracy and freedom of speech.

(f) A better score on corruption, rule of law and property rights.

If, with all the assets that we possess, we are lagging behind China, theexplanation has to be sought, not in the halting flow of FDI per se, but somewhere else.In a dynamic global economy, we cannot afford to have an investment regime (meaningFDI regime) with certain preset dos and donts. Unfortunately, this is exactly what Indiais trying to do. In China FDI has been positively encouraged to play in the rural sector forthe development of TVEs and also in the restructuring of several SOEs in the second halfof the reform decade. In a globally interdependent world, FDI shifts across the world inresponse to comparative advantages. These advantages vary and shift from time to timeand from one country to another. To use the expression of Jagdish Bhagwati, it is akaleidoscope where light and shade play truant. A country must have the agility andflexibility to reach out and work with FDI, wherever it suits its national interest.

China has demonstrated the absurdity of armchair archaic conventional argumentsagainst foreign investment. If China could manage a high rate of FDI inflow without

compromising its sovereignty, it does not make sense for our political class to nurse allthe time a kind of vague and unspecified apprehension that FDI could erode our securityand sovereignty and that we would be a plaything in their hands. In our economy wherepublic and private sectors have grown in partnership and taken together are striving toscale commanding heights, we have to shun any kind of about paranoia about FDI. If Iwere to point out a single lesson that our political regime has to learn from China, it isthis quality of learning from experience and allowing different economic agents to exploitand develop the potential that we possess. While China has been over the years perfecting


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that quality and pushing the country forward, we have on the contrary perfected the art ofblunting whatever instruments of change we possess. Instead of seeking refuge inprotection, as many Indian manufacturing associations are demanding, the better responseis to upgrade productivity, so as to increase the quality and price competitiveness of onesown industry. Vietnam, for instance, which is even more liable than India to being

swamped by Chinese exports, has been able to meet the challenge by improving its ownquality in areas like beer, plastic goods and cycles. There is no other way than increasingproductivity for Indian industry to meet the challenge posed by Chinese exports

It is observed that Indias prospects for overtaking China depend on implementingdifficult reforms in five pivotal areas: deregulation of labour markets and an end tothe small-scale sector; revitalisation of agricultural growth; increased investment in

infrastructure; reduction of fiscal deficits; and, finally, across-the-board

privatisation and further trade liberalisation..


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APPENDIX

WTO and the Indian Textiles and Clothing Sector

1. Importance of Textiles and Clothing sector for India:

The textile and clothing (T&C) sector is an important one in the Indian economy.Textiles and clothing items have been significant in Indias export basket, accounting fornearly 20 percent of total exports during the 1990s. At present, the textiles industryaccounts for nearly 12% share of the country's total exports basket. In addition, thissector is the second largest generator of employment (35 million or around 10 percent ofthe workforce), a significant earner of foreign exchange, and contributes 4 percent and 14percent to GDP and value added in manufacturing, respectively.

Since T&C industry employs semiskilled and unskilled labor, in terms ofcomparative advantage and employment generation the sector has special importance forIndia. India has a competitive advantage stemming from its large and relatively low-costlabor force, a large domestic supply of fabrics, and the industry's ability to manufacture a

wide range of products. India has a very strong and diverse raw material base formanufacturing natural and artificial fibers. Furthermore, India also has capacity-basedadvantage in textile and spinning, and Indias textile industry covers the entire supplychain.

2. Agreement on Textiles and Clothing (ATC) under WTO:

Before the ATC took effect, a significant portion of textile and clothing exports fromdeveloping countries to the industrial countries was subject to quotas (the major quotaimposing countries were US, EU countries and Canada) under a special regime [calledMulti-Fiber Agreement (MFA)

20] outside normal rules of the General Agreement onTariffs and Trade (GATT). Liberalization of the textiles and clothing sector was to be in

four stages, with half of the integration to take place in the first three stages (1995-2005)and the second half to take place in the final phase in 2005.21

However, importing countries have had a great deal of flexibility over the elimination ofquotas and items for which quotas were not binding were liberalized earlier. The removalof quotas on the most restrictive categories was back loaded (i.e. to differ to a laterdate) by importing countries until the end of the transition period. Only 20 percent of theproducts subject to quotas were integrated in the first three phases of the ATC. Thisimplies that the removal of quotas on the remaining 80 percent in 2005 has the potential

to lead to sharp shocks including job and income losses in some developing countries.For instance, the final stage, beginning on January 1, 2005, witnessed the removal of 701quotas by the United States, 167 quotas by the European Union (EU) and 239 quotas by

Canada.

20 Under MFA (1947-94) countries whose markets are disrupted by increased imports of textiles andclothing from another country were able to negotiate quota restrictions (WTO Glossary).21The starting point for an automatic liberalization process was MFA.


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The elimination of quotas on T&C is expected to have a significant impact on theproduction, exports, and employment in exporting countries in general. It is alsoexpected to have positive impact on the welfare in importing or quota-imposing countriesthrough reduced consumer prices and increased efficiency following enhancedspecialization. Estimates of the gains as a result of the phasing out of the ATC quotas

range from $23 billion to $324 billion. The estimates of the increase in welfare for theEU are around euros 25 billion. The welfare impact on the United States is estimated at$7.3 billion. For the major exporting developing countries, a WTO study concludes thatalthough there will be increases in market shares for China and India, China willgain significantly while India will increase its market share only modestly. This studyestimates that developing countries where quotas were not restrictive are likely to lose.For other developing countries and regions such as Mexico, Bangladesh, Indonesia, thePhilippines, and Hong Kong SAR, simulations suggest that the quota elimination maylead to a decline in the U.S. market share. Latin American and sub-Saharan Africancountries are expected to reduce exports of clothing significantly.

3. India and ATC:

In December 1994 in separate treaties with the EU and the USA, India agreed toa comprehensive liberalization of import policies for textiles as quid pro quo for the ATC(Agreement on Textiles and Clothing) which promised to phase out the MultifibreArrangement (MFA) quotas in the US and EU markets. Accordingly, the reform processbegan in early 1995 with the removal of QRs on imports of many textile products (wooltops, synthetic fibers, textile yarn and some selected industrial fabrics). Selected textilefabrics, textile products and apparel items were made eligible to be imported againstSpecial Import License (SIL) given to the exporters. It was also agreed that theseproducts would be free from import licensing altogether at specified future dates (1998,2000 or 2002), and tariff rates would be reduced to levels of between 20 and 40 percentby 2000. These moves are considered as Indias major commitment towards liberalisationof textile imports.

The removal of quotas on textiles and clothing in 2005, under the Agreement onTextiles and Clothing (ATC) was expected to have a substantial impact on majorexporting countries.22A quota free regime represents an opportunity (as India has beenconstrained by quotas) as well as a challenge (as there will be increased competition andno guaranteed markets). Indias ability to benefit from the quota elimination will dependon the degree to which the existing constraints are removed.

The structure of the global T&C industry renders some countries morecompetitive. The T&C industry employs semiskilled and unskilled labor, providingdeveloping countries with a comparative advantage.

23However, in addition to labor

costs, lead times and flexibility in production have become increasingly important. Themass retailers in developed countries, specially the United States, require flexibility and afast turnaround. This implies that some developing countries are better poised to gain

22 It is also expected to have a substantial impact on major importing countries, in particular on consumerprices and employment23 It is estimated that developing countries as a whole would have income gains of about $24 billion a year,export revenue gains of about $40 billion, and employment generation of 27 million jobs (IMF and WorldBank 2002).


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than others. Many early studies concluded that China and India will be the majorbeneficiaries of the quota elimination while many other developing countries may losetheir export markets. A few recent studies however find that India may lose in theaftermath of the liberalization.

4. Trends in Trade in Textiles and Clothing: Where does India Stand?

Globally, Indias market share in world exports of textiles and clothing increasedonly marginally over the years (i.e. since 1980) whereas Chinas share increasedsignificantly (see Table). Most importantly, after 2005, Chinas share in worldtextiles and clothing exports increased significantly by 5.9 and 6.2 percentage points

respectively. In contrast, Indias share in world textiles exports increased only by0.2 percentage points and in the case of clothing the share remained the same.

China dominates US and Japanese markets for both textiles and clothing and EUmarket for clothing. China has gained significant new ground in the US and EU textilesand clothing market after 2005 (see Tables). Except the US textiles market, in all others

India has a smaller presence. And, compared to China, Indias market share in Japan isnegligible. Furthermore, after 2005, India could increase its share in the US and EUtextiles and clothing markets only marginally.

These trends clearly shows that China was able to successfully utilise the exportopportunity opened by the removal of quotas on the textile and clothing products by themajor quota imposing countries (US and EU). Most importantly, after the removal ofquotas on majority of the textile and clothing products, which happened after 2005, Chinahas gained larger access to these major markets. A study by the U.S. International TradeCommission predicts that China is expected to become the "supplier of choice" for mostU.S. importers (the large apparel companies and retailers) because of its ability to makealmost any type of textile and apparel product at any quality level at a competitive price.

The same study also observes that other low-cost countries, particularly India, willbenefit, as U.S. importers try to reduce the risk of sourcing from only one country.

Country-wise Share in World Textiles Exports (%)

Country 1980 1990 2000 2005 2008

EU - - 36.2 33.5 32.1

China 4.6 6.9 10.3 20.2 26.1Hong Kong, China 3.2 7.9 8.6 6.8 0.2

USA 6.8 4.8 7 6.1 5.0

Japan 9.3 5.6 4.5 3.4 2.9

India 2.4 2.1 3.6 3.9 4.1Source: International Trade Statistics, WTO (Various Issues)


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Country-wise Share in World Clothing Exports (%)

Country 1980 1990 2000 2005 2008

China 4 8.9 18.2 26.9 33.2EU - - 28.4 29.2 31.1

Hong Kong, China 12.3 14.2 12.2 9.9 0.8

Turkey 0.3 3.1 3.3 4.3 3.8

Bangaladesh 0.0 0.6 2.6 2.3 3.0

India 1.7 2.3 3 3.0 3.0USA 3.1 2.4 4.4 1.8 1.2

Country-wise Share in US

Imports of Textiles (%)Country-wise Share in US

Imports of Clothing (%)

Country 2000 2005 2008 Country 2000 2005 2008

China 12 26.9 34.1 China 13.2 26.4 34.7EU 17.4 14 12.6 Mexico 13.6 8 5.2

Canada 12.5 9.1 6.6 Hong Kong, China 7.1 4.7 -

India 7.4 9 10.4 EU 4 - -

Mexico 10.2 7.8 - Korea, Rep. of 3.8 - -

Pakistan - - 7.0 India 3.1 4.2 4.1Top 5 59.5 66.9 70.7 Indonesia - 4 5.3Source: International Trade Statistics, WTO(Various Issues)

Viet Nam 6.7

Bangaladesh 3.3 3.2 4.4

Top 5 41.7 47.2 56.2

Note: Figures in italics indicate top 5

Country-wise Share in EU

Imports of Textiles (%)Country-wise Share in EU


Country 2000 2005 2008 Country 2000 2005 2008

EU 63.1 67.5 66.7 EU 38.9 44.9 47.6

China 3.8 7.5 9.9 China 9.4 17.9 22.4Turkey 3.9 5.3 5.8 Turkey 6.4 7.9 6.7

India 3.7 3.8 3.7 Hong Kong, China 5.5 - -

Pakistan - 2.3 2.6 Tunisia 3.1 - -

US 3 - - Romania - 3.5 -

Top 5 77.4 86.4 88.8 India 2.9 3.4 3.6Source: International Trade Statistics, WTO(Various Issues)

Bangaladesh 2.8 3.4 3.9

Top 5 63.4 77.6 84.2

Note: Figures in italics indicate top 5Country-wise Share in Japanese

Imports of Textiles (%)

Country-wise Share in Japanese


Country 2000 2005 2008 Country 2000 2005 2008

China 41.2 52.3 55.8 China 74.7 80.9 82.8EU 13.9 12.4 9.9 EU 7.5 7.1 6.2

Indonesia 6.5 6 5.8 Viet Nam 3 2.7 3.3

Korea, Republic of 8.1 5.6 5.1 Korea, Republic of 4.8 1.9 0.9

Taipei, Chinese - 5.2 5.3 US 2.4 1.3 -

US 7 - - Thailand - - 1.2

Top 5 76.9 81.5 81.8 Top 5 92.3 94 94.4

India 3.5 2.7 2.5 India 0.7 0.6 0.7


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The other performance indicators of Indian T&C sector are hardly encouraging.The growth of T&C exports has declined after 1995-96 (note the opening up of the IndianT&C sector began in 1995), whereas the growth of imports has increased (see Table).However, after 2005-06 (developed countries removed a major portion of their textilequota after 2005), export growth started picking up, but it is still much below the level

achieved during 1987-88 to 1994-95.Export and Import of Textiles - Growth (%)

Period Export Import

1987-88 to 1994-95 11.79 6.32

1995-96 to 2004-05 5.62 16.96

1995-96 to 2007-08 7.14 18.07

2005-06 to 2007-08 8.45 9.41

1995-96 to 2002-03 4.98 14.22

Source: Instructor's calculation based on Handbook of Statistics of the Indian Economy,2008-09 (RBI)

The growth of production of many of the T&C products has slowed down after

1995-96 (see Table).Production of Textile Products (Growth %)

Cotton

cloth

Mixed/blended

cloth

Man-made fibre

fabrics

Spun

yarn

1990-91 to 94-95 3.54 10.20 - 5.45

1995-96 to 99-00 -0.91 9.23 11.68 4.12

2000-01 to 04-05 0.01 -1.39 6.89 0.24

2005-06 to 08-09 3.94 2.16 3.59 1.37

Source: Instructor's Calculation based on Economic Survey (Various Issues)

5. Constraints facing the Indian Textiles and Clothing industry:

The (export) opportunities unleashed by the removal of the quotas at the end of2004 are tempered in India by domestic policy constraints and business environment. Inother words, Indias ability to maximize the gains from the abolition of the ATC quotas isconstrained by certain factors. They include the following:

5.1. Structure of the industry:

Indias T&C sector has been dominated by small producers, is fragmented, andthere is little vertical integration in the apparel industry. Indian manufacturers set upseveral small plants instead of a single large one, to take advantage of labor laws.Consequently, the Indian T&C sector loses out on reaping economies of scale andtherefore a lack of investment on modernization or to upgrade obsolete machinery with

consequential impact on quality and standardization.24 Until 2001, most of the textile andclothing sector was reserved for the small-scale sector. An important policy change inrecent years has been the progressive dereservation of woven readymade garment and

24 As a result, they have on average 10 to 20 percent of machines that Chinese plants have. Only 3 percent of total cloth production is from the organized sector and 12,000 of the 14,500 are hand processingunits.


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hosiery and knitted products from SSI sector. This should help to form an integratedsupply chain.

5.2. Delay in delivery:

In the absence of quotas, retailers will likely choose suppliers based

Documents

Comparative Performance of India and China - Note