India vs. China: Which is the best role model for the developing world?

by Michael Schuman

Friday, October 29, 2010

China is the Michael Jordan of emerging economies. Just as every up-and-coming basketball hopeful wanted to “be like Mike,” every up-and-coming poor nation wants to “be like China.” And why not? China has boasted an incredible record of alleviating poverty, building industry, creating jobs, and translating economic power into political power. The rise of China has made the West doubt the continued validity of its cherished principles of democratic, fee-market capitalism. Instead, some believe that China's state-heavy, semi-market economy -- or “state capitalism” -- is better suited to the demands of the modern world. The old “Washington Consensus,” based on a devotion to free markets and free enterprise, is being replaced by the “Beijing Consensus.”

But is China's Beijing Consensus really the winning formula for poor nations? Larry Summers, Obama's assistant on economic policy, raised the idea in a recent speech that India's political-economic model, which he labeled the “Mumbai Consensus,” may in the end win the day:

And perhaps – perhaps – in 2040, the discussion will be less about the Washington Consensus or the Beijing Consensus, than about the Mumbai Consensus – a third way not based on ideas of laissez-faire capitalism that have proven obsolete or ideas of authoritarian capitalism that ultimately will prove not to be enduringly successful. Instead, a Mumbai Consensus based on the idea of a democratic developmental state, driven not by a mercantilist emphasis on exports, but a people-centered emphasis on growing levels of consumptions and a widening middle class.

So what's a better model for the developing world – the Mumbai Consensus or the Beijing Consensus?

In the inevitable comparisons between the world's two largest countries and two fastest-growing economies, India usually ends up on the losing end. India's economic growth has consistently trailed China's, and India hasn't eradicated poverty as quickly as China, even when adjusting for the fact that India started its pro-growth reforms a dozen years after China. That's led to a potentially dangerous level of frustration among India's poor. India has struggled to compete with China in large-scale, export-oriented manufacturing, and doesn't attract as much foreign investment as China. The fractured government in India acts more slowly than China's to implement policy or build much-needed infrastructure. Just compare Beijing's ultra-organized 2008 Olympics to New Delhi's embarrassing 2010 Commonwealth Games.

But at the same time, India's economic system has some often ignored advantages over China's:

More balanced growth. Whenever economists talk about China, they focus on the need to “rebalance.” That means China is too dependent on exports and investment for its growth, and needs to increase the role of private consumption to make its growth more balanced. India is already where China wants to be. Consumer spending plays a much bigger role in India's economy than in China's. Thus India doesn't have to implement policies that distort the global economy (like China does with its currency regime). India, in fact, buys more from the rest of the world than it sells. India's growth is thus less susceptible to shocks from the international economy.

More rational companies and banks. Under China's “state capitalism,” the state-owned banking system and big companies can easily fall victim to government mandates and policy priorities, leading to problems like asset bubbles, excess capacity and a weakened financial system. India's companies are more focused on profitability than China's (as you can see from this chart). Historically India's banks tend to have lower levels of bad loans, and though China's nonperforming loan ratio has improved dramatically in recent years,  serious concerns remain that the big government-sponsored credit boom of 2009, aimed at boosting growth during the Great Recession, could eat into Chinese banks' balance sheets in coming years.  The private sector in India also has a lower level of debt. According to data kindly provided to me by Fitch, bank credit to the private sector in China reached 148% of GDP in 2009 compared to only 54% in India. I admit I'm making a sweeping generalization here -- China does have its share of smart companies, from industrial giants like Geely to start-ups like Tencent. But I think it's fair to argue that India's corporate and banking sectors are more professional and healthier than China's.

Democracy. Few things annoy me more than having to sit through mindless praise of China's authoritarian political system, especially from Westerners who don't live under one. Many businessmen believe that authoritarianism in China has been a necessary factor behind the economy's rapid growth. But India proves that countries don't need dictators to create rapid development and gains in human welfare. India's raucous democracy has been able to produce one of the world's best records of economic growth over the past two decades – and preserve people's civil liberties in the process. I'm certain to get comments on this post complaining that India doesn't have a true democracy, that it's all corrupt and unjust. But people do vote and governments do change in India, and that means the vote of the average person does count. Perhaps the convoluted nature of India's democratic policymaking is one reason why the economy doesn't grow as quickly as China's. But would you sacrifice human rights for the sake of an extra percentage point or two of GDP growth? (I wouldn't.)

This isn't to say that India doesn't have problems that need fixing. Its state-owned enterprises are a mess and badly need privatization. Policymakers need to find way of spreading India's growth miracle to parts of the nation still relatively untouched. But at the same time, it is hard to argue that the Mumbai Consensus isn't a serious rival to the Beijing Consensus.

In the inevitable comparisons that economists and businesspeople make between Asia's two rising giants, China and India, China nearly always comes out on top.

The Chinese economy historically outpaces India's by just about every measure. China's fast-acting government implements new policies with blinding speed, making India's fractured political system appear sluggish and chaotic. Beijing's shiny new airport and wide freeways are models of modern development, contrasting sharply with the sagging infrastructure of New Delhi and Mumbai. And as the global economy emerges from the Great Recession, India once again seems to be playing second fiddle. Pundits around the world laud China's leadership for its well-devised economic policies during the crisis, which were so effective in restarting economic growth that they helped lift the entire Asian region out of the downturn. Now, however, India may finally have one up on its high-octane rival. Though India still can't compete on top-line economic growth — the World Bank projects India's gross domestic product (GDP) will increase 6.4% in 2009, far short of the 8.7% that China

announced in mid-January – India's economy looks to be rebounding from the downturn in better shape than China's. India doesn't appear to be facing the same degree of potential dangers and downside risks as China, which means policymakers in New Delhi might have a much easier task in maintaining the economy's momentum than their Chinese counterparts. "The way I see it is that the growth in India is much more sustainable" than the growth in China, says Jim Walker, an economist at Hong Kong–based research firm Asianomics.

India's edge is due to the different stimulus programs adopted by the two countries to support growth during the downturn. China implemented what Walker calls "the biggest stimulus program in global history." On top of government outlays for new infrastructure and tax breaks, Beijing most significantly counted on massive credit growth to spur the economy. The amount of new loans made in 2009 nearly doubled from the year before to $1.4 trillion – representing almost 30% of GDP. The stimulus plan worked wonders, holding up growth even as China's exports dropped 16% in 2009.

But now China is facing the consequences of its largesse. Fears are rising that Beijing's easy-money policies have fueled a potential property-price bubble. According to government data, average real estate prices in Chinese cities jumped 7.8% in December from a year earlier — the fastest increase in 18 months. The credit boom has also sparked worries about the nation's banking system. Many economists expect the large surge in credit to lead to a growing number of nonperforming loans (NPLs). In a November report, UBS economist Wang Tao calculates that if 20% of all new lending in 2009 and 10% of the amount in 2010 goes bad over the next three to five years, the total amount of NPLs from China's stimulus program would reach $400 billion, or roughly 8% of GDP. Though Wang notes that the total is small compared with the level of NPLs that Chinese banks carried in the past, she still calls the sum "staggering." Policymakers in Beijing are clearly concerned. Since December, they have introduced a series of steps to cool down the housing market and restrict access to credit by, for example, reintroducing taxes on certain property transactions and raising the required level of cash that banks have to keep on hand in an effort to reduce new lending.

India, meanwhile, isn't experiencing nearly the same degree of fallout from its recession-fighting methods. The government used the same tools as every other to support growth when the financial crisis hit – cutting interest rates, offering tax breaks and increasing fiscal spending – but the scale was smaller than in China. Goldman Sachs estimates that India's government stimulus will total $36 billion this fiscal year, or only 3% of GDP. By comparison, China's two-year, $585 billion package is roughly twice as large, at about 6% of GDP per year. Most important, India managed to achieve its substantial growth without putting its banking sector at risk. In fact, India's banks have remained quite conservative through the downturn, especially compared with Chinese lenders. Growth of credit, for example, was actually lower in 2009 than in 2008. As a result, economists see continued strength in India's banks. A January report by economic-research outfit Centennial Asia Advisors noted that based on available data, "there was no sign that domestic banks' nonperforming assets were deteriorating materially." Nor do analysts harbor the same concerns that India's monetary policies are sending prices of Indian real estate to bubble levels. "India's growth, though less stellar, does have the reassuring factor that the [risks of] asset price bubbles are less," says Rajat Nag, managing director general of the Asian Development Bank in Manila.

India maintained robust growth without Beijing's hefty stimulus in part because it is less exposed to the international economy. China's exports represented 35% of GDP compared with only 24% for India in 2008. Thus India was afforded more protection from the worst effects of the financial crisis in the West, while China's government needed to be much more active to replace lost exports to the U.S. More significantly, though, India's domestic economy provides greater cushion from external shocks than China's. Private domestic consumption accounts for 57% of GDP in India compared with only 35% in China. India's confident consumer didn't let the economy down. Passenger car sales in India in December jumped 40% from a year earlier. "What we see [in India] is a fundamental domestic demand story that doesn't stall in the time of a global downturn," says Asianomics' Walker.

The Indian economy is not immune to risks. The government has to contend with a yawning budget deficit, and last year's weak monsoon rains will likely undercut agricultural production and soften rural consumer spending. But rapid growth is expected to continue. The World Bank forecasts India's economy will surge 7.6% in 2010 and 8% in 2011, not far behind the 9% rate it predicts for China for each of those years. Indian Prime Minister Manmohan Singh, when speaking about his country's more plodding pace of economic policymaking, has said that "slow and steady will win the race." The Great Recession appears to have proved him right.