China and India seem to be the hot topics in the world economy today. In the international press, there is almost an obsession with these two economies, and how their current growth presages the coming "Asian century". It is not just that they are both countries with large populations covering substantial and diverse geographical areas, and therefore with huge potential economic size. Most of all, they are cited as the current "success stories": two economies in the developing world that have apparently benefited from globalisation, with relatively high and stable rates of growth for more than two decades and substantial diversification.

In India too, the obsession with China is now well-developed, mostly in the form of a longing eastern gaze. The rapid economic growth and structural transformation in China are not just eyed with envy; they are typically invoked to justify the economic policy of choice. Thus there are those who argue that the recent Chinese economic success is because of liberalisation and openness to foreign trade and investment. By contrast, others point out that the early Communist history of land reforms and egalitarian policies formed the essential basis upon which all subsequent change has depended.

In the outside literature, these economies are often treated as broadly similar in terms of growth potential and other features, and this even infects some Indian analyses. But in fact there are crucial differences between the two economies which render such similarities very superficial, and which mean that individual policies cannot be taken out of context of one country and simply applied in the other to the same effect. There are at least ten significant differences.

The first relates to the nature of the economy itself, the institutional conditions within which policies are formulated and implemented. India could be described until recently as a traditional "mixed economy" with a large private sector, so it was and remains a capitalist market economy with the associated tendency to involuntary unemployment. So the need for macroeconomic policies to stimulate demand, as common in capitalist economies, operated in addition to the usual “developmental” role of the state.

China, by contrast, has been for the most part a command economy, which until recently had a very small private sector, and only recognised the legal possibility of home-grown capitalists a few years ago. Throughout the period of "liberalisation", that is the 1990s and later, there have remained important forms of state control over macroeconomic processes that have differed from more conventional capitalist macroeconomic policy. Even in 2004, public enterprises accounted for more than half of GDP and more than two-fifths of exports.

The control over the domestic economic in China has been most significant in terms of the financial sector, which describes the second big difference between the two economies. In India, the financial sector was typical of the "mixed economy" and even bank nationalisation did not lead to comprehensive government control over the financial system; in any case, financial liberalisation over the 1990s has involved a progressive deregulation and further loss of control over financial allocations by the state in India.

But the financial system in China still remains heavily under the control of the state, despite recent liberalisation. Four major public sector banks handle the bulk of the transactions in the economy, and the Chinese authorities have essentially used control over the consequent financial flows to regulate the volume of credit (and therefore mange the economic cycle) as well as to direct credit to priority sectors. Off-budget official finance (called "fund-raising" by firms) has accounted for more than half of capital formation in China even in recent years, and that together with direct budgetary appropriations have determined nearly two thirds of the level of aggregate investment. This means that there has been less need for more conventional fiscal and monetary policies, although the Chinese economy is now in the process of transition to the more standard pattern.

The third difference is quite apparent to all – the dramatically high rate of GDP growth in China compared to the more moderate expansion in India. The Chinese economy has grown at an average annual rate of 9.8 per cent for two and a half decades, while India’s economy has grown at around 5-6 per cent per year over the same period. Chinese growth has been relatively volatile around this trend, reflecting stop-go cycles of state response to inflation through aggregate credit management.

This higher growth in China essentially occurs because of the fourth major difference, the much higher rate of investment in China. The investment rate in China (investment as a share of GDP) has fluctuated between 35 and 44 per cent over the past 25 years, compared to 20 to 26 per cent in India. In fact, the aggregate ICORs (incremental capital-output ratios) have been around the same in both economies. Within this, there is the critical role of infrastructure investment, which has averaged at 19 of GDP in China compared to 2 per cent in India over the 1990s.

It is sometimes argued that China can afford to have such a high investment rate because it has attracted so much foreign direct investment (FDI), and is the second largest recipient of FDI in the world at present. But FDI has accounted for only 3-5 per cent of GDP in China since 1990, and at its peak was still only 8 per cent. In recent times, the inflow of capital has not added to the domestic investment rate at all, but to the holding of international reserves, which have increased by $100 billion per year.

In terms of economic diversification and structural change, China has followed what could be described as the classic industrialisation pattern, moving from primary to manufacturing activities in the past 25 years. The manufacturing sector has doubled its share of workforce and tripled its share of output, which, given the size of the Chinese economy and population, has increasingly made China "the workshop of the world". In India, by contrast, the move has been mainly from agriculture to services in the share of output, with no substantial increase in manufacturing, and the structure of employment has been stubbornly resistant to change. The recent expansion of some services employment in India has been at both high and low value added ends of the services sub-sectors, reflecting both some dynamism and some increase in "refuge" low productivity employment.

The sixth major difference relate to trade policy and trade patterns. Chinese export growth has been much more rapid, involving aggressive increases on world market shares. This export growth has been based on relocative capital which has been attracted not only by cheap labour but also by excellent and heavily subsidised infrastructure resulting from the high rate of infrastructure investment. In addition, since the Chinese state has also been keen on provision of basic goods in terms of housing, food and cheap transport facilities, this has played an important role in reducing labour costs for employers. In India, the cheap labour has been because of low absolute wages rather than public provision and underwriting of labour costs, and infrastructure development has been minimal. So it is not surprising that it has not really been an attractive location for export-oriented investment, its rate of export growth has been much lower, and exports have not become an engine of growth.

There is another issue relating to trade policy. In China, the rapid export growth generated employment which was a net addition to domestic employment, since until 2002 China had undertaken much less trade liberalisation than most other developing countries. This is why manufacturing employment grew so rapidly in China, because it was not counterbalanced by any loss of employment through the effects of displacement of domestic industry because of import competition. This is unlike the case in India, where increases in export employment were outweighed by employment losses especially in small enterprises because of import competition.

The seventh difference is in terms of poverty reduction. China has been much more successful in this regard – official data suggest that 4 per cent of the population now lives under the poverty line, unofficial estimates suggest around 12 per cent. The poverty ratio in India is much higher, between 26 per cent and 34 per cent according to the 1999-2000 NSS data. The Chinese success in this regard can be related to several features: to begin with, the basic issues in terms of asset redistribution and basic needs provision were the focus of the Communist state until the late 1970s. This also assisted in economic growth: because of the more egalitarian system, there was a larger mass market for consumption goods, which has allowed producers to take advantage of economies of scale.

Subsequently, poverty reduction in China has been concentrated into two main phases: 1979-82 and 1994-96, which were both phases of higher crop prices and rising agricultural incomes. In the first phase, institutional change in the form of allowing peasant production in diversified crops played a great role in increasing productivity and allowing peasants to benefit from rising prices. Also, since Chinese economic growth has been more employment generating, this has also operated to reduce poverty.

Until recently, there was much more focus on "human development" in China, and public provision of health and education. This included universal education until Class X, as well as better public services to ensure nutrition, health and sanitation. However, in recent years, this emphasis has been much reduced and there is greater privatisation of such services in China, which has also led to worsening conditions especially in particular areas. In India, the public provision of all of these has been extremely inadequate throughout this period and has deteriorated in per capita terms since the early 1990s.

In terms of inequality, in both economies, the recent pattern of growth has been inequalising. In China, the spatial inequalities – across regions – have been the sharpest. In India, vertical inequalities and the rural-urban divide have become much more marked. In China recently, as a response to this, there have been some top-down measures to reduce inequality, for example through changes in tax rates, greater public investment in western and interior regions, and improved social security benefits. In India, it is political change that has forced greater attention to redressing inequalities, though the process is still very incipient.

This brings into focus the tenth big difference: that of political systems. It can be argued that the political democracy in India, which now appears deeply entrenched even though it has not translated into universal economic enfranchisement, has played some role in creating more confused but less extreme patterns of economic growth. Certainly, historic and potentially transformatory economic legislation such as the Employment Guarantee Act could only come about because of impact of political changes. Perhaps the ability of the political system to force at least some change of direction in economic policies in India can serve as an important example to the rest of the world, and one of which Indians can justly be proud.

However, in terms of the future prospects, surprisingly both economies end up with very similar issues despite these major differences. There are clear questions of sustainability of the current pattern of economic expansion in China, based on a high export-high accumulation model which requires constantly increasing shares of world markets and very high investment rates. Similarly, the hope in some policy quarters in India that IT-enabled services can become the engine of growth is one which raises questions of sustainability.

The most important problems in the two economies are also rather similar – the agrarian crisis and the need to generate more employment. In both economies, the social sectors have been neglected recently by public intervention. In both countries, the policy message appears to be the same, that the most basic issues are those that require to be addressed first, and if so the other areas of expansion will probably look after themselves.

August 25, 2005.