March 20, 2007
In this brave new world, Chindia’s uneven rise continues
“Chindia” is the word coined by the Indian politician, Jairam Ramesh, to denote the two Asian giants that contain 38 per cent of the world’s population between them. Nor is size their only similarity. Both are heirs of ancient civilisations; both were, until recently, desperately poor; and both are among the world’s fastest growing economies. Yet the differences are also striking. By looking carefully at them one can learn more about their prospects for continued growth. The economists’ technique of growth accounting helps shed a bright light on the story. A recent paper by Barry Bosworth and Susan Collins of the Washington-based Brookings Institution does just that*. It compares performance over the 1978-2004 period, but the years since 1993 are particularly interesting, since they succeed India’s post-1991 reforms. The remainder of Martin Wolf’s column can be read here (FT.com subscribers only). Discussion from our guest economists is free.
Fred Bergsten: Martin Wolf’s excellent article on Chindia fails to note one critically important difference between the two countries: their openness to the world economy. Their sharp differences on this variable probably explain an important part of both the gap in productivity growth between them and their relative impact on the world economy.
China is vastly more open than India. The annual growth in its trade exceeds the total level of India’s trade. It receives more foreign direct investment each year than India has attracted cumulatively since its independence in 1947. India’s ratio of trade to GDP has increased substantially in recent years, reaching a level about equal to that of the United States, but remains less than half that of China.
This far greater exposure to global competition undoubtedly explains an important part of China’s superiority over India in productivity growth. It clearly explains why China has a far greater impact on the world economy.
A country must possess three characteristics to be a global economic superpower: size, dynamism and openness. China, along with the United States and the European Union, exhibits all three while India has yet to embrace the third.
Posted by: C. Fred Bergsten | March 22nd, 2007 at 5:29 pm | Report this commentWillem Buiter: I will put three question marks behind the Chindiaphoria I discern in Martin’s column.
First, a cyclical question mark. Both India and China are in the terminal stages of a credit boom. So there will be a cyclical slowdown in both countries. If the monetary and fiscal authorities act in time (they appear to be well behind the curve in both countries) and if they have the right instruments and the political will and freedom to use them (doubtful in both countries) the credit boom can end with a whimper. A hard landing seems more likely, however.
Second, a domestic political question mark. Domestic political risk to growth is seriously under-priced by the domestic and global communities of investors. In China economic liberalisation is proceeding side by side with continued political repression through the monopoly on political power of the Communist Party. The rapidly growing aggregate material wealth and rising average prosperity level are accompanied by equally spectacular increases in inequality and, more recently, even by growing numbers of people that are worse off and often reduced to living in absolute poverty. The sustainability of such a social-political-economic configuration has never been tested. India has had an open and representative form of government for sixty years. I believe this to be an important socio-political safety valve. Unfortunately, India needs such a safety valve. It is hamstrung by the widening gap between the urban and rural communities, the continuing debilitating effects of its caste system, and by its atrocious record for educating its underpriviliged in general, and its women in particular. The Naxalite, terrorist movement is a serious internal threat to security and stability, and it is by no means the only one of its kind. There is no evidence that the political establishment is about to come up with a policy that is tough on domestic terrorism and tough on the causes of domestic terrorism. Blaming Pakistan won’t do.
Third and probably most importantly, an environmental questionmark. Environmental supply-side constraints on growth in Chindia don’t get mentioned in Martin’s column. The same omission invalidates the growth accounting exercise by Bosworth and Collins, reported by Martin, which uses the standard Solow-type growth accounting framework, where the growth of output is the sum of the contributions of physical capital accumulation, labour input growth and total factor productivity growth. The measure for the growth of labour inputs allows both for changes in the number of bodies and for changes in the skills and knowledge embodied in the labour force, proxied by education, schooling and training. As is so often the case in these exercises, output is seriously mis-measured and a key input - the services yielded by the stock of environmental capital - is ignored completely. For Chindia, this omission matter even in the medium run. In the long run, it is the eight hundred pound gorilla that will make off with most of the promised growth bananas.
The environmental supply-side constraints I want to focus on are not India’s and China’s contribution to global climate change and to other global environmental externalities, although these are of growing significance. It is the local (national) natural resources of clean fresh water and fertile land (some would add clean air as well) that are not only important domestic ‘consumer durables’ but also key inputs into the production of the goods and services that are captured by conventionally measured GDP indices.
Although both are in principle renewable or restorable given enough time, energy and other resources, they are in practice being depleted at a spectacular, increasing and unsustainable rate. As these resources are either under-priced or not priced at all, their depletion (environmental capital depreciation), which should be deducted from the net real output or real national income measures used in the growth accounting exercises, is ignored. Output is therefore overstated.
The water constraint is likely to be the first one to become binding in both China and India, certainly within 10 years. It will impair even the production of those goods and services included in conventional GDP measures. By 2020, OWEC (the Organisation of Water Exporting Countries) may well be more influential than OPEC, and the folly of the current unrestrained dash for growth in India and China will have become clear for all to see.
Chindia urgently needs to re-orients its growth policies towards environmental sustainability. Pricing all water and power use (including agricultural) at long-run marginal social cost would be a good start. Without such a radical re-orientation, the 21st century may well become the century of China and India for a very different reason from the one prophesied by the current uncritical Chindia cheerleaders.
Posted by: FT Economists' Forum | March 22nd, 2007 at 5:45 pm | Report this commentJeffrey Frankel: It is indeed extraordinary that a pair of countries that not long ago were the world’s biggest economic laggards are now the world’s biggest engines of growth.
The recent developments, including the evidence cited in the Bosworth-Collins paper and Martin Wolf’s column, shed light on some of the most important questions in growth theory.
The first question is the hypothesis of Alwyn Young, popularized in Paul Krugman’s famous article “The Myth of the Asian Economic Miracle,” that the success of Asian countries was mostly based on force-fed capital accumulation, and that it would therefore run into diminishing returns, as opposed to growth in total factor productivity (TFP). (The latter might, in turn, be attributed for example to catchup with the West, or else to something called Asian values.) Apparently capital accumulation explains only roughly half the economic miracles on China and India. The rest is TFP after all, though liberalization seems a more likely explanation for it than Asian culture.
Second is the question whether fiscal expansion is good or bad for growth. On the one hand, old-fashioned mainstream macroeconomics says that fiscal expansion boosts growth in the short run. On the other hand, most growth theory says the opposite, at least in the long run: large public sectors are usually wasteful, inefficient, and distortionary, while fiscal deficits soak up saving and crowd out private investment.
The case of India seems to illustrate neatly that both are true. India’s growth first took off in the 1980s, before economic reforms. Why? Fiscal stimulus to aggregate demand. But by 1991 the deficits were unsustainable, and the country suffered a crisis. Then came the political will for serious market reforms, which produced a supply-led longer-term acceleration in growth. But some serious adjustment problems probably still lie ahead in the paths of both countries: large budget deficits in India and large bad bank loans in China.
The third big question is whether political liberalization needs to come before or after economic liberalization (the old “Pinochet vs. Gorbachev” question). The answer seems to be that economic growth can be achieved either with or without democracy (which is also what much of the academic literature has found: Alesina, Ozler, Roubini and Swagel; Persson and Tabellini). But of course democracy is to be preferred on other grounds.
Posted by: FT Forum - Jeffrey Frankel | March 22nd, 2007 at 5:48 pm | Report this commentRobert Wade: I keep looking out for literature which tackles the question raised by China’s and India’s investment/GDP figures. Given the standard understanding of the primary importance of “strong” property rights for economic development (as in the arguments of North, de Soto, et al.), how come China has been able to support extraordinarily high rates of investment for decades?
The puzzle arises because no-one would say that China’s property rights regime comes close to the standard picture of a “strong” property rights regime. Yet it evidently works. Indeed, the same puzzle applied in Taiwan in the 1950s to the 1980s (and maybe beyond): a thin formal property regime, as we understand the idea in the West, yet very high and sustained rates of investment. On the other hand, India has long had a much “stronger” formal property rights regime than either China or Taiwan; and lower rates of investment.
Some economists have claimed that “anonymous” banking (legal opening of bank accounts without having to give evidence of identity) is an important part of the answer to the China puzzle: officials of the state have had difficulty identifying who has resources they could appropriate. But I doubt that this could be a big part of the answer. How do Chinese property owners assert their right to (a) dispose of property through sale, gift, or the like, and (b) prevent others from removing their claim to ownership? The answers presumably differ for elites, workers and peasants, with workers and peasants much less able to secure protection for (a) and (b) than elites.
China’s strength is in industry, India’s in services. One of Kaldor’s growth laws suggests that relatively high growth of industrial output generates relatively high growth of non-industrial (including service) productivity. But relatively high growth of service output does not have the same propulsive effect on growth of industrial productivity.
If this “law” holds, the difference in specialization between China and India works to China’s longer term growth advantage, including in services. Hence the question: what is the evidence for and against Kaldor’s proposition in the context of countries of the Chindia type?
Martin says “It is hard to identify significant constraints on China’s growth in the medium term… Failure to reform would also be a danger.” For the next several years at least, China is highly vulnerable to a recession in the US.
There are already plenty of signs of “over-accumulation” in electronics, automobiles and several other sectors, as also in the built environment (airports, for example). In the medium term it may be possible to rely much more on the expansion of domestic demand than, as now, export demand. But this switch may need exchange rate controls and capital controls - among others - that run counter to WTO obligations and western demands; not least to protect the banking system with its extraordinarily high load of non-performing loans.
The switch may “need” these controls; but the controls may be fiercely opposed by the - to put it rudely — “brainwashed generation” of returning MBAs and PhDs in economics who believe that fast economic liberalization and a bonfire of social controls is the only way forward. Presumably Martin means to endorse this faith when he says, “Failure to reform would also be a danger”. With China now growing and investing so fast, why not a period of policy stability?
All the more so because China has built up huge potential for internal conflict. Proletarianization has occurred in the past quarter century on a scale far bigger than ever before in human history. Several hundred million worker households are living in classic proletarian conditions, as earlier social protections are gutted. Now a domestic Chinese capitalist class is forging ahead (having been held back earlier by the reliance on FDI), and doing its utmost to shift state policy even more in its favor, as though the revolutions of 1912 and 1949 had never happened. Class polarization poses a different kind of “constraint” on China’s growth than what economists normally have in mind, but a real one nevertheless.
Posted by: Robert Wade | March 22nd, 2007 at 5:52 pm | Report this commentBrad DeLong I have to protest against Robert Wade’s “Proletarianization has occurred in the past quarter century on a scale far bigger than ever before in human history. Several hundred million worker households are living in classic proletarian conditions, as earlier social protections are gutted…”
What planet is he living on?
Wade’s “earlier social protections” include the death of 25 million–or is it 50 million–during and after the Great Leap Forward. Wade’s “earlier social protections” include the enserfment of Chinese farmers into plantation communes of 10,000 or so crafted to maximize the extraction of surplus for the benefit of non-farm investment and of the Party.
For all but a tiny fraction, “proletarianization” in China has been experienced as a vast improvement in living standards and economic security above what China experienced in the 1950s, 1960s, and 1970s.
Nobody sane today can talk about the pre-Deng regime in China as one of “social protections” that have been “gutted” since.
Posted by: Brad DeLong | March 22nd, 2007 at 7:22 pm | Report this commentBrad DeLong: I would add a fourth worry, in addition to the environmental, infrastructure, education, and political legitimacy worries that have already been aired. The People’s Bank of China is acting like the world’s most enormous hedge fund in reverse. Unless there is significant inflation in China or a rapid reversal of global imbalances, the PBoC is likely to have to write off the largest amount of capital of any institution anywhere, anytime, anyhow–with either China’s savers or China’s taxpayers holding the bag. The political consequences of that may be a further important source of risk.
Posted by: Brad DeLong | March 22nd, 2007 at 11:15 pm | Report this commentWillem Buiter: Brad is right as regards the folly of entrusting $1.2 trillion or so of the nation’s foreign assets to the PBC to be managed using methods that might be just about appropriate for a smallish (certainly no more that $50 bn) stock of foreign exchange reserves kept on hand to prevent disorderly foreign exchange markets or excessive exchange rate volatility. Even the announcement that some fraction of this external wealth (probably between $200bn and $300bn) would be taken out of the PBC’s balance sheet and invested in higher yielding assets is rather late and far too little.
The Chinese central bank is of course not the only one guilty of investing much of the nation’s gross stock external assets as if they were liquid foreign exchange reserves. Hong Kong, Taiwan, Russia, Japan, Korea, Thailand, Brazil and other countries that view themselves as past victims of abuse by the IMF and other multilaterals have likewise over-insured themselves against the risk of a future foreign exchange crisis and of having to go cap-in-hand to 700 19th Street.
As Brad points out, these assets have been invested so conservatively that there is hardly any risk attached to their return. Instead there is a near-certainty of the largest capital loss in human history. There is a good reason why central banks are so reluctant to mark their assets to market.
Most of the assets held by the PCB and other central banks are financial instruments that are in zero net supply. Their gross suppliers (first and foremost the US government) must be thanking their lucky stars that a sufficient number of ’suckers’ were born at just the right moment to absolve the issuers of these instruments of much of the painful duty to generate future primary (trade) surpluses to service their debt. If the PRC ever develops the concept of the class action suit, those responsible for the mismanagement of the country’s financial assets would be worthy targets.
Posted by: Willem Buiter, London School of Economics | March 23rd, 2007 at 11:04 am | Report this commentWillem Buiter: I actually enjoyed Robert Wade’s disinterment of ‘proletarianization’ - a word one doesn’t come across much anymore. Proletarianization refers to the growth of a class of people who don’t own any means of production other than their personal labour. I would refer to such persons as ‘workers’ or ‘employees’, but ‘proletarians’ does sound both more muscular and more oppressed.
Robert appears to worry about proletarianization. I would have thought that whether being dependent on wage income alone is a good thing or a bad thing depends rather on the level of the wage. I would prefer being a rich wage slave to being a poor rentier. In China and India, real wage growth has lifted hundreds of millions of ‘proletarians’ out of abject poverty. Let’s have more of that.
Posted by: Willem Buiter, London School of Economics | March 23rd, 2007 at 11:25 am | Report this commentMartin Wolf: I apologise for the delay in responding to these fascinating comments on my piece on Chindia.
I agree with Fred on the difference between China and India. China is indeed much more open, a point I have made in other contexts. I should have made it again.
Willem has raised three fundamental points. Of these, the cyclical one seems to me (and, I think, to him also) the least fundamental. Yes, there will be cyclical instability in these rapidly growing economies, just as there was in the US in the late 19th and early 20th centuries. But that did not stop the US and it is unlikely to stop Chindia either.
The second concern is domestic political risk. I agree there are obvious political risks in both countries. The difficulty, obviously, is deciding how big they are. What is happening is unprecedented in scale and speed, after all. My guess is that they will probably continue to grow and reform, without a political breakdown. But India’s weakness is indeed its horrifying caste-based social system, while China’s is its equally horrifying communist-mandarin political system. These systems are deeply rooted in the two societies’ past. How they will change and adapt to the very new economic and social circumstances is simply unclear. I agree that the risks cannot be ignored.
The third concern is environmental. Here I tend to be more optimistic than Willem because other societies (including our own) have done quite a good job of internalising environmental externalities as they have become richer. I can’t see why they shouldn´t ultimately manage this too. Evidently, water must be properly priced. When it is, the massive waste of today will end. I agree that the growth accounting exaggerates the true growth rate. I am just not sure how big an adjustment to growth would be required.
Jeff makes a point that I wanted to stress as well: these exercises suggest that Alwyn Young’s conclusions on Asia don’t apply to the giants. Indeed, I made the point indirectly, by referring to the comparison with east Asian countries, other than China. It does appear that China and India are generating higher factor productivity growth than other east Asian countries.
On fiscal deficits, I am fairly clear that they do not help long-run growth, at least if they are used to finance wasteful spending, as has certainly been the case in India. If the borrowing is used to finance valuable investments, the outcome would, presumably, be different.
Finally, the question of the politics of rapid growth remain open. It is probably true that China has done better than India with its centralised resource-mobilising state over the past three decades. But the same system inflicted terrible damage under Mao. My own reading of the literature on politics and development is that authoritarian regimes have a higher variance of performance: often much worse than democracies, but also, in a few cases, better. This is not surprising. A genuinely competent and benevolent despot will suppress inefficient rent-seeking behaviour and maximise economic performance. This is impossible in a pluralist democracy.
But most despots are neither competent nor benevolent: take a look at Mugabe’s Zimbabwe. Even if one leaves aside all the other reasons for supporting democracy, risk aversion is another good one. Under democracy, one can get rid of a bad government without a civil war. The US is going to show this in 2008.
Robert has, as always, raised important points. I agree with Brad’s comments on Robert’s use of the word ‘proletarianisation’. I won’t add to that. But I would like to take up Robert’s comments on investment and property rights. I don’t find it surprising that investment is high in countries with weak property rights. After all, in China a very high proportion of investment is still undertaken by the state or state-owned companies. The point is rather that investment is wastefully high, while private sector companies seem to be starved of credit. This is surely a consequence of defective property rights. Think of it this way: China invests about two and a half times as big a proportion of GDP as the US and grows about two and a half to three times as fast. Given that China is so far within the productivity frontier, that does not look such a wonderful performance to me. I would have thought defective markets are a part of the reason.
I do tend to agree with Robert that India’s weakness in industry is a problem. It is a reflection of the consistent bias against labour-intensive activities in India’s policy-making, reinforced by the power of organised vested interests.
Finally, I can only underline my agreement with Brad and Willem on the horrifying waste of valuable resources in the vast foreign exchange reserve accumulations of China and other emerging market economies. They have given the US a free lunch. That will hurt the US, when it finally stops. But, worse, as Willem puts it (and I have remarked in previous columns), these countries are facing “the largest capital loss in human history”. On the present path, it seems inconceivable that this loss will not end up at well over $500bn. If China were a democracy, surely people would ask why the Chinese government is investing $250bn more every year (close to 10 per cent of GDP) in the liabilities of the world’s richest countries, mainly the US, at low interest rates and with an absolute certainty of vast capital losses. This really is a grotesque scandal.
Posted by: FT Forum - Martin Wolf | March 28th, 2007 at 10:00 am | Report this comment