Ruminations on China and India
In the short piece below Arjun Divecha, Director of GMO’s Emerging Markets Division, shares some of his thoughts on China and India.
China: If you build it, they will come …
India: You’re not going to build it, but they’ll come anyway …
It occurred to me that this is a good metaphor for China and India and the resulting implications for growth and investment return.
Last month I had a long chat with one of the people in China whose views I most respect. He is extremely plugged in with the financial elite and serves on a number of government advisory boards. He told a very convincing story about how things were going to play out in China over the next few years, and which sectors would benefit. However, at the end of the discussion, it occurred to me that the entirety of his story depended on government policy and actions.
In my travels around India over the last couple of weeks, I had multiple discussions with business and financial leaders about what is likely to happen in India over the next few years. None of their thoughts depended on government action. If anything, their main fear was that government intervention/inaction was the thing most likely to slow down or kill the huge growth momentum that exists today.
That, in a nutshell, is the relative case for China vs. India. China succeeds if the government gets it right; India succeeds if the government gets out of the way. Both could happen. Or neither. In both cases, long-term return to investors will depend not so much on the success or failure of the country in GDP terms, but on the ability of companies to deliver high return on capital. So, what drives return on capital?
One of my colleagues at GMO has written about the problems of overcapacity in China (see “China’s Red Flags” by Edward Chancellor) so I won’t spend time on it, but one thing is clear to me: building overcapacity is generally good for the consumer and bad for the producer. Thus, building multiple high-speed rail lines in China almost certainly improves the quality of life for the average Chinese, but it is inconceivable that the return on capital on those rail lines will be high, in pure financial terms. If it were, the U.S. would surely have built plenty of high-speed rail lines by now.
After all, the ability of the U.S. consumer to pay for transportation is considerably higher than that of the Chinese consumer. The fact that no high-speed rail lines exist in the U.S. tells you something about the potential return on capital on high-speed rail in expansive continental geographies.
In short, overcapacity may lead to high social return, but almost certainly leads to low return on invested capital.
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Source: GMO, January 2011.
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