Hindi-Chini Bhai Bhai?

Earlier this month I formed part of a small group of Indian economists invited to a workshop in Beijing comparing the economies of India and China. The conference was organised by the newly-established Centre for China in the World Economy at Tsinghua University.

A conference comparing India and China is no longer particularly noteworthy, but some aspects of this event were distinctive. It was an initiative of a Chinese institution, not sponsored by a multilateral organisation or a Western research institution.

For the maiden activity of a new institute focused on China's integration into the world economy, it was striking that they chose to focus on the experience of India.

The level of respect and attention paid to the Indian experience by the Chinese analysts, and academics, and the degree of self-criticism on aspects that are often lauded by Indians came as something of a surprise.

Indian commentators admire China's high rates of saving and investment, the buoyancy of its manufacturing, and its success in attracting foreign direct investment. Chinese participants at the conference provided a somewhat more nuanced view.

Perhaps somewhat inaccurately, they considered India's growth performance to be only slightly below that of China, despite a much lower savings and investment rate. Accordingly, India was considered to be using its resources more efficiently than China.

While acknowledging the dynamism of the manufacturing sector, Chinese prowess in manufacturing received short shrift. One Chinese observer referred to Chinese manufacturing workers functioning as "coolies" adding relatively little value-added.

Indian expertise and success in higher margin activities (such as information technology and pharmaceuticals) were seen as a more impressive indicator of indigenous capacity.

Not reflected at the conference, but as reported in a recent Financial Times survey of China (December 7, 2004), there is now questioning of China's over-reliance on foreign trade and foreign direct investment.

In the FT survey, a senior fellow of China's Academy of Social Sciences is quoted as saying that it is absurd that exports plus imports should be as high as 60 per cent of GDP for an economy as large as that of China.

He also notes the flood of foreign direct investment flowing to China is substantially stimulated by inefficient and distortionary incentives offered by a myriad of local jurisdictions competing for modern employment. These ought to be reduced or eliminated, but the central government finds it difficult to exercise effective control.

Current Chinese concerns on the politics of economic reform also came as somewhat of a surprise. Despite considerable political concern in India about widening income inequality, there is little conclusive evidence to suggest significant secular change in the personal distribution of income in India over the last two decades.

By contrast, the recent Chinese experience has involved a clear widening in the personal distribution of income.

There is also concern that the developmental pattern of the 1990s has favoured cities over the countryside, even though the recent Chinese revolution famously began with the introduction of the personal responsibility system in agriculture in 1979.

The different experiences of the two economies are reflected in their different patterns of urbanisation. There has been relatively little change in India's rural:urban split despite accelerating per capita income growth, reflecting relatively equal wage growth in the two sectors. China is today urbanising rapidly, reflecting the widening income gap between the two sectors.

Widening inequality is therefore becoming a political issue, and there was accordingly considerable interest (with some misunderstanding) in the results of the recent Indian general elections.

As the FT survey notes, China's new leader Hu Jintao has shifted focus away from big business in order to be seen as sensitive to the concerns and needs of the roughly 800 million Chinese classed as rural residents.

The political similarities with India are striking even if the underlying reality differs. While proud of their fiscal and administrative decentralisation, the Chinese were candid in admitting that they too faced problems of local protection and barriers to internal trade in much the way that we do. Corruption is a serious, and intractable, problem for the political leadership in both countries.

Much of the discussion at the workshop revolved around the links between the state enterprise sector (referred to in China as state-owned enterprises -- SOEs), social protection, and the financial sector.

At the workshop it was pointed out that the burden of social protection was moved from the state to the SOEs in 1979, as part and parcel of the decentralisation reforms introduced by Deng Xiaoping in that year.

The decentralisation was instrumental in stimulating the town and village enterprises that have provided so much dynamism to the Chinese economy, but the reform of the SOEs was not embarked upon till much later, in 1993, and, like India, is very much work in progress.

A series of articles in a recent special issue of The McKinsey Quarterly (McKinsey and Company, Inc. 2004. "China Today," The McKinsey Quarterly 2004, special edition, New York) provides additional perspective on the dimensions of the problems facing the SOE sector.

While in 2003 SOEs generated no more than 17 per cent of the country's GDP, they employ half of the work force, and control 57 per cent of industrial assets.

Over the years the state banking system has propped up these failing businesses to maintain employment and fulfil their social protection obligations, but at some cost to the banking system. Similarly, the costs of unremunerative infrastructure projects also end up in the banking system.

Efforts are under way to put in place a social security system less dependent on public enterprises. At the same time, a massive recapitalisation and restructuring of the public banks is being initiated.

In a move reminiscent of current proposals to use our reserves for infrastructure, a sum of $45 billion (4 per cent of GDP) from China's foreign exchange reserves was transferred to an investment vehicle for holding capital in two large state-owned banks.

Following recapitalisation and restructuring, these banks will prepare themselves for a flotation on international equity markets. It is expected that these banks will actively seek strategic investors. This is in sharp contrast to India's ideological reservations on the same issue.

The situation with the equity markets is distinctly less favourable in China than in India, with the institutional structure considerably less robust and sophisticated, and the role of the equity markets in capital allocation correspondingly less well developed.

What conclusions should one draw for India from all this? As Tarun Khanna (of the Harvard Business School) observes in The McKinsey Quarterly, the Chinese government has continued to be more interventionist in resource allocation than the Indian government.

On the other hand, it has had a greater commitment to competition, as reflected in its trade and tariff policies, and its policies towards foreign direct investment.

Neither country has been as yet successful in setting up efficient and transparent regulation in the infrastructure sectors. India's relative success in financial sector regulation gives some encouragement that in due course such a culture will be established in other sectors as well.

Notwithstanding major bureaucratic and political rigidities, India's reform model is succeeding in combining increasingly efficient resource allocation with relatively egalitarian growth.

We should derive confidence from the successes of the last two decades and stay the course. China has much to offer us and we must learn from it. Surprisingly, we may have just as much to offer in return.

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