Roubini: Reevaluating “Chindia”: The story of the elephant and the dragon

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The report below comes courtesy of Nouriel Roubini’s team of analysts at RGE.

The emerging market powerhouse known as “Chindia” is becoming a focal point of global attention as China and India show themselves to be growth dynamos of the coming Asian Century. But examining these countries’ intrinsic differences, is more illustrative than listing their similarities—and the two countries are likely to be on a divergent path over the next five years in the areas of growth, economic policy and politics.

China and India both entered the 20th century with large chunks of their populations in subsistence farming with medieval living conditions. Large numbers of people are leapfrogging generations of economic growth and development to join a modern services and manufacturing economy in the 21st century. Both societies are changing quickly, with different sectors and elites in the vanguard not just at home, but also in the international sphere. But the similarities between the two countries conceal underlying differences, such as India’s democratic, capitalist English common law vs. China’s authoritarian, state-led models of development. As fault lines in China’s export-led growth model emerge, bigger bets are being placed on India’s enormous potential.

India’s growth surge is occurring despite the government, China’s largely because of it. China’s economic miracle is a state-led, industrial revolution catch-up story, reflecting the efficiency of a strong, relatively centralized state in control. The main players are parastatals or foreign firms, which this communist country has protected from labor unrest. The ostensible results are superb: gleaming infrastructure, unprecedented for a country at China’s per capita income levels, with bullet trains, airports, roads, urban and increasingly extra-urban infrastructure, as well as productive capacity far exceeding current needs.

In contrast, India’s economic renaissance is led by a private sector struggling under the tethers of the “License Raj”—a mixed-economy hodgepodge of central planning and private capitalism with multiparty coalition governments that make U.S. gridlock politics look lightning fast. Businesses are thriving amid rising entrepreneurship, foreign investment, global competition and innovation but are facing bottlenecks of all kinds—whether overloaded transport infrastructure or petty corruption along transit routes that drives up transport costs. Much of the growth has come from entirely new sectors like information technology or internationally traded services that capitalize on India’s comparative advantages with a very large, cheap pool of English speakers, many with a very strong education and technical skills.

Looking ahead, China’s demographics are less than favorable for growth, but should support rebalancing. In 2011 China’s dependency ratio will bottom out, and its 15-29-year-old population will peak. The total working-age population will begin to decline in 2015, but labor supply constraints are already looking acute. In contrast, India is will see a demographic dividend, but structural factors will likely keep the country from fully capitalizing on it. India’s population and labor force will continue to expand through 2050, and the 25-39 cohort will not peak until 2030. The bulk of the increase in labor force will occur during this decade, with the median age rising to 28 by 2020. However, concerns about the poor quality of social services, low affordability of private sector services and a shortage of high- and low-end labor skills suggest that skill shortages will keep up the wage-price spiral.

China’s trend GDP growth will decline from about 10% in 2010 to 8% or so by 2015. Consumption will narrowly outpace GDP growth by 2012 or 2013, but structural factors will bring down the savings rate. Rising capital costs and nonperforming loans will constrain investment, which will begin to decrease as a share of GDP. By 2015, services’ share of GDP will rise while that of manufacturing and agriculture will decline slightly. India’s trend growth rate will rise above 9% in 2011-15 and will outpace Chinese growth starting in 2014. The rising services’ share of GDP will be offset by a declining agricultural share of GDP, while industry’s share is unlikely to increase. The saving-to-GDP ratio will exceed 40% by 2015, reducing consumption’s share of GDP and pushing investment’s share of GDP above 40% by 2014.

Nobody could accuse Chinese policy makers of being ignorant of their economy’s weaknesses, but they have not done much to address them either. The current Five-Year Plan looks much like the previous, and will sound the right notes for reform. The problem, as always, will be in the follow-through. The main constraint is China’s political economy, in which provincial leaders are rewarded for delivering strong growth and state-owned banks are hardwired to push out as many loans as hamstrung regulators will bear. The coming political transition in 2012-13 will make policy makers risk averse in the near term, but we are hopeful for change after 2013. On the political side, greater institutionalization within the Chinese Communist Party (CCP) and government should shift the country gently toward a rule-of-law system and away from the current rule-by-law model, where might makes right. There are signs that China is already heading down this path, with groups outside of the CCP having greater influence on policy making, but the process is likely to accelerate after the 18th Party Congress in late 2012.

India’s reforms in the 1990s and early 2000s laid the groundwork for the economy’s stellar performance, but the second phase of structural reforms has moved at a snail’s pace. Spending on populist social programs doubled between 2003 and 2009, yet did not enhance rural sustainability or the quality of services due to corruption and cost and implementation inefficiencies. The share of health care and education spending in total government expenditure has barely increased, while spending on ill-targeted subsidies has risen. With the government failing to provide key services, private sector investment in health care, education, labor training, utilities, infrastructure, R&D, agriculture and rural credit—sectors considered critical to increasing trickle-down effects, reducing structural inflation and benefiting from demographics and migration—will rise. Political aspirations to sustain 9-10% GDP growth will keep the economy vulnerable to overheating and asset bubbles, which would force policy makers to suppress private demand via tight monetary policies until supply-side bottlenecks ease over time. This, along with an unfavorable current account deficit financing structure, poses the biggest risk to India’s growth story.

As for corruption, increasing participation in civil society, use of technology in government projects, freedom of press and expansion of an educated middle class will gradually increase transparency and bring about institutional changes in administration and the judiciary. But this will happen from a very low base and will be a drawn-out process, given India’s centralized system, the immense disparities between states and the government-elite class nexus.

Source: RGE Monitor, February 23, 2011.

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