Asia Research Report—Issues with India and China's Rapid Growth

URATA Shujiro
Faculty Fellow, RIETI

India and China have maintained high levels of growth even as economic growth in many other countries has slowed due to the impact of the global financial crisis, and in 2010 it became clear that China's gross domestic product (GDP) had surpassed that of Japan.

Rapid growth is expected to continue in both India and China in the future, with Goldman Sachs predicting that in 2050 the GDP of India and China will reach 0.8 times and 1.3 times that of the U.S. and 4.2 times and 6.7 times that of Japan, respectively. In response to this situation, the Japan Center for Economic Research has put together a report that analyzes the Indian economy in comparison with China's and sheds light on issues for the future. (This writer was the chief researcher for this report.)

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China's rapid growth began with economic reform (literally "reform and opening") that commenced in December 1978, while India's started with the economic reforms of 1991. Prior to these reforms, regulation meant that factors of production such as labor and capital were employed inefficiently in both countries. The reforms led to them being put to use in a more efficient manner, and this resulted in economic growth. The easing of restrictions on foreign companies, and more so, the introduction of measures to attract them, has triggered an inflow of foreign investment, which has also contributed to economic growth.

In recent years, the policy stances of India and China on foreign investment have been gradually changing. China has been slowly shifting towards a stance of only offering incentives in certain sectors and treating foreign companies in the same way as Chinese firms. India, meanwhile, has been pressing ahead with measures to attract foreign money, such as establishing special economic zones, for example.

Another thing that cannot be ignored when looking at the reasons for India and China's high levels of growth is that the countries' demographics are conducive to economic growth. In both nations, the proportion of the population at productive age (15-64 years) is high, while the proportion of dependents (the sum of the population of children (0-14 years) and senior citizens (65+ years)) is low. Because each working person supports few people, conditions are suited to economic growth (i.e. there is a population bonus).

In China, however, the one-child policy is resulting in an aging population. The proportion of senior citizens is climbing, and before long the population bonus will be spent. In India, meanwhile, the child population is high, so the population of people of productive age will increase in the future. However, unless these people are given employment, the population bonus will not result in economic growth.

Figure: Population of People of Productive Age in India and ChinaFigure: Population of People of Productive Age in India and China

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Many problems need to be overcome. Issues common to both countries include achieving further reform and liberalization, establishing legal frameworks, obtaining energy, improving the environment, and securing human resources.

In both countries, reforms and liberalization have led to rapid economic growth, yet protectionist policies remain in place. For example, there are tariffs on certain imported products, such as automobiles, and restrictions on foreign companies. Although such policies can be justified to a certain extent as ways of nurturing nascent industries, they need to be gradually scaled back to ensure that they do not increase the burden on consumers and other industries and impede economic growth.

In addition, rules concerning foreign investment and domestic laws such as labor laws are administered opaquely in both countries, and this presents an obstacle to entry by foreign companies. To make the administering of laws more transparent, it will be essential to establish highly stable and trustworthy enforcement structures and build systems for ensuring the prompt disclosure of information. Also required will be capable human resources who can administer the law efficiently and fairly.

With regard to energy, coal represents an important source for both countries as both have plentiful deposits. However, factors such as the sharp rise in automobile ownership are increasing demand for oil and natural gas. This trend is expected to continue, so an issue for the countries is to secure supplies of oil and natural gas, for which they are increasingly relying on imports. Although both nations are actively focusing on resources in their foreign policy in order to ensure stable supplies of energy from abroad, they ought to work harder to consider the impact on the environment and use energy more efficiently.

In the area of human resources, an urgent task for India is to nurture people who have received a basic education and can work in manufacturing as well as people who have received secondary or higher education and possess high levels of ability. In China, on the other hand, a rise in wages reflects a clear shortage of unskilled manual workers, who have hitherto underpinned the export of manufactured products. It will be essential to train workers and researchers with high-level ability and promote not just product assembly, but also areas such as the development of new products.

Aside from their common problems, India and China each face issues of their own. India's most serious problem is the underdevelopment of its infrastructure. In India, mobile phones have exploded in popularity, but apart from telecommunications, most aspects of infrastructure, such as distribution (roads, rail, etc.) and electric power have problems. This is interfering with smooth economic activity, and suppressing investment from abroad. Specific problems include the fact that infrastructure is under the control of the government, and popularist politics are preventing the principle that users of infrastructure should be the ones to pay for it from taking root. Another is the low productivity of workers, who are protected by labor unions.

A major problem for China is widening regional disparities and income differentials. Since the economic reforms and liberalization, a large developmental divide has emerged between coastal regions, which have seized the opportunities presented by globalization and achieved rapid growth, and the interior of the country, which has not been able to take advantage of these opportunities. Similarly, income differentials have widened between people who have the ability to enjoy the benefits of globalization and those who do not. In addition to causing social instability, this increasing divide is also limiting consumption, which is hampering the shift away from dependence on overseas demand, a long-standing issue with the country's economic growth, towards growth led by domestic demand. To narrow the disparities, the government will need to reallocate investment, redistribute income, and so on.

India and China are competitors in such spheres as industrial development, and there is friction between them in areas such as trade and investment. However, not only are they making diplomatic efforts to prevent this friction from becoming serious, they are also leveraging their complementary relationship to overcome issues that they both face. Even so, cooperation has only just begun in fields for which it can be expected to produce results, such as infrastructure construction, the tackling of environment problems, and energy development. To move such cooperation forward, the two countries will have to overcome numerous obstacles, such as their mutual distrust and rivalrous relationship.

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In addition to bilateral cooperation, regional cooperation involving Japan and other Asian countries will also be important and effective in overcoming the issues faced by both nations. Especially beneficial will be use of the CEPEA (Comprehensive Economic Partnership in East Asia) framework, which comprises ASEAN (Association of Southeast Asian Nations), Japan, China, South Korea, Australia, and New Zealand, and which is being enthusiastically promoted by Japan. Possible areas of cooperation include laying the groundwork for an FTA (free trade agreement) and developing infrastructure.

The global financial crisis of 2008 showed that the world economic system constructed under the leadership of the advanced countries after World War II had ceased to function properly. One of the reasons for this was that emerging nations such as India and China had developed at breakneck speed and had redrawn the global economic landscape. This malfunctioning world economic system must therefore be fixed as soon as possible.

In November 2008, a summit of the G20 (comprising 20 major countries including India and China) was held to discuss what to do about the global financial crisis, and the participating countries agreed to implement economic stimulus measures on a continuous basis to pull the world out of the crisis. The joint execution of this policy proved successful, and a second great depression was averted. Nevertheless, the world economic system is still not functioning properly.

It was decided to make G20 summits regular and to hold one every year. The agendas of these summits include many key issues for the world economy, including reform of international financial institutions, reform of financial regulation, economic development, the environment, and trade. Hopes are high that India and China, which have successfully grasped the opportunities presented by globalization and achieved high levels of growth, will use forums such as the G20 to contribute to the reconstruction of the world financial system.

India and China's rapid growth is expected to continue over the long term. Meanwhile, Japan faces a shrinking domestic market due to its low birthrate and aging population, and if the country wishes to maintain and augment its current prosperity, it should form closer economic ties with India and China through trade, investment, and so on. For corporations, a strategy of developing, producing, and selling products that meet needs in the vast Indian and Chinese markets will be important. It is therefore desirable for the Japanese government to move proactively to establish the CEPEA as a regional framework for facilitating free economic activity by Japanese companies in India, China, and the rest of East Asia

>> Original text in Japanese

* Translated by RIETI.

January 24, 2011 Nihon Keizai Shimbun

May 11, 2011