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What India must do to catch up with and outpace China
Martin Wolf

          THE "India Everywhere" campaign of the Confederation of Indian Industry (CII) took this year's annual meeting of the World Economic Forum, in Davos, by storm. If public relations were the route to economic success, India would be a world-beater.
Indians were indeed everywhere, while the Chinese were relatively invisible. Since Indian economic growth is now forecast at 8.1 per cent this fiscal year (to March 31 2006), confidence is running high. Yet confidence has an evil twin: complacency. It is far from certain that India's growth rate is now durably and decisively above the average of the past quarter of a century.
Hitherto, China has taken the lead. Over the past 25 years, its economic growth has averaged just under 10 per cent a year. According to Angus Maddison, the economic historian, Chinese gross domestic product per head, at purchasing power parity, rose almost twice as fast as India's.
Will this relative performance change? More important, might it change because of a surge in India's growth? Shankar Acharya, a former chief economic adviser to the Indian government, argues persuasively against this view, in the introduction to a forthcoming book [Essays on Macro-economic Policy and Growth in India (Oxford University Press, forthcoming)]. He suggests that medium-term growth is likely to remain about 6.0 per cent a year.
This is certainly consistent with the trends. Not only has Indian growth averaged just under 6.0 per cent over the past 25 years, but a five-year moving average has deviated remarkably little from this level. While Indian growth has exceeded 7.0 per cent in the past three calendar years, this followed three years when it averaged just 4.7 per cent. Much of the recent growth surge has been cyclical rather than structural.
Why, then, might a reasonable analyst anticipate a surge in India? There are three broad reasons: first, Indian demography is relatively favourable; second, India has better institutions than China; third, India has more room to improve its policies and investment performance. These points have force. But they also describe potential, not performance.
According to United Nations forecasts, India's dependency ratio (the ratio of those above and below standard working age to those of working age) will indeed fall below China's, but only in 2030. Moreover, both countries will still retain the opportunity to improve the quality of the labour force and to shift workers out of agriculture.
Unfortunately, India has done a particularly poor job of absorbing its labour force into productive employment. Between 1993-94 and 1999-2000, for example, the economy grew 6.5 per cent a year and employment just 1.0 per cent. Crippled by restrictive labour regulation, employment in organised manufacturing has remained stagnant at about 6.0m, or 1.5 per cent of the labour force. The much-vaunted information technology sector employs just 1.0m -- a drop in the Indian ocean. Unused labour is not an advantage, but a terrible burden.
It is true, again, that India has a number of institutional advantages over China: a well-developed private sector; a relatively entrenched legal system; a stable democracy; and freedom of speech. India is also modestly better on the control of corruption and the rule of law. But it is considered to be worse on regulatory quality and government effectiveness. Of the latter there can be little doubt: China's ability to mobilise resources remains far greater than India's, as demonstrated in its vastly superior performance in provision of infrastructure.
This brings us to the third reason -- the potential for policy improvement. India has a large opportunity to raise the investment rate, which remains well below Chinese levels even after the recent revisions to the latter's GDP. The difference in investment rates is the proximate cause of the difference in growth rates between the two economies.
Behind the huge gap in investment are significant and enduring Indian policy failures. Huge fiscal deficits are one example. Still more important have been the deep-seated obstacles in the labour laws, the reservation of production to the small-sale sector and even in trade policy -- to rapid expansion of labour-intensive production. That, in turn, helps explain the biggest discrepancy between Chinese and Indian growth: Chinese manufacturing grew at close to 12 per cent a year between 1990 and 2003, while India's grew at just 6.5 per cent, well below the 7.9 per cent achieved by India's services.
The improved performance of the Indian economy in the last quarter century is both a fact and an achievement. Yet it could be better still. It will not become better, however, without substantial further reform. As Mr Acharya points out, change must occur in five pivotal areas: deregulation of labour markets and an end to the reservation of production to the small-scale sector; revitalisation of agricultural growth; increased investment in infrastructure; elimination of fiscal deficits in the current budget; and, finally, across-the-board privatisation and further trade liberalisation.
Yes, all this will prove difficult. But it is also hugely important. India stands on the threshold of accelerated growth, but it will not cross it without a great deal of assistance.
FT Syndication Service


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