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Martin Wolf: What India must do to outpace China
>By Martin Wolf
>Published: February 14 2006 19:56 | Last updated: February 14 2006 19:56
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The “India Everywhere” campaign of the Confederation of Indian Industry 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. It is equally far from certain that India will do better than
China in exploiting its potential. Much reform is still needed. The greater the complacency, the
greater is the risk of doing too little, too slowly.
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.
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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. He suggests that medium-term growth is likely to remain about
6 per cent a year.*
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This is certainly consistent with the trends (see chart). Not only has Indian growth averaged just
under 6 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 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 per cent. Crippled by restrictive labour regulation, employment in organised
manufacturing has remained stagnant at about 6m, or 1.5 per cent of the labour force. The muchvaunted information technology sector employs just 1m – a drop in the Indian Ocean. Unused labour
is not an advantage, but a terrible burden.
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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. The
World Bank’s governance indicators reflect some of these advantages, particularly a vastly superior
score on “voice and accountability” (see chart). It also gives India a modestly better score on the
control of corruption and the rule of law. But it gives a worse one 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 (see chart). The difference in investment rates is the proximate
cause of the difference in growth rates between the two economies.
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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-scale 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.
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This pattern, suggests an illuminating working paper from staff of the International Monetary Fund,
is connected to a long-standing bias towards a skill-intensive pattern of economic development.**
Up to 1980 this bias generated a relatively small, and skill-intensive, manufacturing sector. Since
then it has generated an exceptionally large, but also skill-intensive services sector. The share of
services in employment was no less than 17 percentage points below that of comparable countries in
2000, even though its share in output was 4 percentage points higher. Both of these patterns were
biased against mass employment and, to the extent that profitable opportunities were foregone,
against growth itself. This must change if India is to thrive.
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.
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*Essays on Macroeconomic Policy and Growth in India (Oxford University Press, forthcoming);
**Kalpana Kochhar and others, India’s Pattern of Development: What Happened, What Follows?
January 2006, WP/06/22, www.imf.org
martin.wolf@ft.com
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