Is the Elephant Catching Up?

“I think we should see China as inspiration, rather than as a competition…as inspiration we should see what a country can do in three decades if it is focused and has very strong faith on what it needs to do.” — Raghuram Rajan

China and India, the Dragon and the Elephant, have long been heralded as the two shining stars of Asia — the only countries that can, and eventually will challenge the massive economies of the West. The fact that every fourth person on the planet is Indian or Chinese plays no small part in this. As both liberalized and moved from underdeveloped to developing countries, they were in the ones that stood out, growing at a break-neck pace year after year. Even today, with global growth stagnating and several Western countries worried about spiraling into deflation, the outliers have remained true to their name, achieving strong rates of growth.

In the time that has passed since India’s liberalization in the ’90s, much has been made of its pace of growth, especially in comparison to China. There has always (rightly) existed a perception that while India is indeed doing well, they are unable to match the progress made by China. China has been the superstar of the past few decades, achieving rapid growth, dominating manufacturing and acquiring political clout along the way, while India has stumbled along. There are various theories as to why China is doing better than India — faster decision making in a dictatorship, stronger manufacturing sector, less corrupt bureaucracy and so on.

Did China have a headstart?

China’s economic reforms began in 1978, when the Premier Deng Xiaoping allowed private businesses and opened up the economy to foreign investment. India’s reforms began over a decade later in 1991, where, on the brink of a balance of payments problem, Manmohan Singh (then the Finance Minister) actively pursued policies that structurally reformed the economy. Several authors argue that comparing India and China today is like comparing apples and oranges; India is still behind because it began reforming its economy later, by which time China had already moved to the path of consistently strong growth. Does the data bear this out?

In 1980, China’s GDP was 202 billion dollars. By 2000, its GDP expanded to almost 1200 billion dollars — roughly a six-fold increase within 2 decades. India’s GDP was almost 190 billion dollars in 1980. That’s not too much of a difference, clearly. However by 2000, India’s GDP grew only to about 475 billion dollars — less than half of China. If you calculate India’s GDP two decades after reforms, it shoots up to 1.7 trillion dollars — which, while impressive in isolation, barely compares to China’s 6 trillion dollar economy. Clearly, the headstart did make a significant difference to where the countries are today.

However, attributing all the difference to just the 13 year headstart and ignoring China’s supreme dedication to reform would be a fallacy. Besides opening up the economy, they also focussed on building China’s infrastructure and human capital, as evidenced by the manufacturing hub it has become. India suffered what every democracy suffers, and more so than usual — minority governments, separate executives for State and Centre, all with a rapidly growing population.

Where the countries stand today

China is undoubtedly far bigger, and far more influential in the global economy (evidenced by The Economist having a separate section for China). Today, China leads India in most major indicators but one — rate of economic growth. In the financial year 2015–16, India’s economy grew at 7.6 percent, whereas China’s grew at 6.9 percent, which is its slowest in the last 25 years. That’s not to say India is doing something extraordinary — growth has yet not reached the heights of 8–9 percent seen in the bygone decade. China seems to be slowing down — and moving into a terminal phase of decline (relatively).

There are multiple reasons for this slowdown in China. The clearest one is ageing of China’s working population. While millions of Chinese toiled over the last few decades to make China what it is today, the one-child policy implemented in the ’70s means that there are now fewer people to take forward the mantle. Technically termed demographic dividend, the gains with a younger population are immense. On the outset, it clearly leads to higher productivity. It also has a dual benefit — a younger population means that there are less old people (and young children) to support, channelling savings into banks. China enjoyed this dividend from the ’80s till the last decade. However, it is slowly feeling the growing pains of its people (it also reversed its one-child policy in 2015).

There are other factors too — a weak global economy is a bad thing for China. China’s economic growth has been strongly export-led, with its strong manufacturing sector exporting a variety of goods — from electronics from machinery — to the rest of the world. Since the 2008 financial crisis, USA’s economy has been stagnant, while half of Europe is worried about falling into deflation. This means poor demand for China’s goods, harming its growth as well.

Fig 1: Slowing Chinese exports

This means that China can no longer depend on exports to lead its growth — indeed, it is trying to increase domestic demand to fuel growth. But with the structural imbalances in the economy — weakening demographic dividend, increases in the wage rate and overinvestment. This overinvestment has been fuelled by the government spending heavily in manufacturing and raising debt. However, weak domestic demand means that growth is not picking up. If the government continues to push more and more investment in the economy, it could lead to a catastrophe later, as China would have accumulated too much debt, which is already extremely high.

Fig 2: China’s GDP Growth Rate

What 2017 holds for India

It is clear that India’s elevation to the fastest growing economy of the world is more because China is slowing down, than because India is growing faster. But the Elephant is definitely catching up. 2017 could have been a watershed moment in the history of this rivalry, when India finally seizes the moment to steadily push farther away from China. All the signs were there — India’s projected growth rate was 7.5 percent, with a landmark GST tax legislation to be in effect, which would reshape India’s tax structure.

Meanwhile, China continues to stutter, with some analysts are predicting the growth to fall to as low as 6 percent — certainly not bad, especially in today’s environment, but no longer record-breaking. But alas — India’s Prime Minister decided to demonetize 86 percent of the country’s currency on November 8, 2016. What has followed is a sharp weakening of local consumption, investment and thereby growth projections for 2017. Some analysts have colourfully described it as ‘shooting oneself in the foot’, ‘scoring an own goal’ and so on.

Without passing judgement on the decision to demonetize currency, I believe the timing was ideal — it is better to implement strong legislation while on the way up rather than down. Demonetization will also have its benefits economically in the future, by way of larger deposits in the formal banking system and hopefully greater tax revenue collection. So while 2017 may not be the year India ‘breaks out’, it does represent a crucial junction for the country. With the next decade having the largest working population by proportion, the right policies can see India leap ahead of China in terms of size by 2035. The only way for the Elephant is up.

Fig 3: Rise in India’s GDP

Originally published at www.freelunch.co.in.