Thursday, November 27, 2014

India’s Chinese Dream

SEOUL – In recent years, China and India have both emerged as global economic superpowers, with China leading the way. But, with Chinese growth slowing and the need for structural change becoming increasingly acute, will the economic-reform efforts of India’s new prime minister, Narendra Modi, enable the country to catch up?

Since the 1980s, China has experienced unprecedented economic growth, fueled by abundant low-cost labor, high saving and investment rates, substantial market reforms, outward-oriented policies, and prudent macroeconomic management. Its leaders now hope to achieve high-income status by developing more technologically sophisticated industries.

India’s economic performance has been less remarkable. Economic growth began to accelerate dramatically in the early 1990s, owing to trade liberalization and other economic reforms. Then reforms stalled, the fiscal and current-account deficits soared, and annual GDP growth fell to 4-5%.

As a result, China has pulled ahead, with per capita income last year standing at $11,850 – more than double India’s $5,350. The question now is whether Modi’s push for faster growth can narrow the income gap in the coming decades.

The most important factor working in India’s favor is its “demographic dividend.” In China, population aging and low fertility rates are already causing the prime working-age population, people aged 15-59, to decline. From 2015-2040, this group is expected to shrink by more than 115 million. Meanwhile, India’s prime working-age population will increase by 190 million.

But favorable demographics alone will not bring about the kind of growth that has made China the world’s second-largest economy. India’s leaders must develop a comprehensive plan to eliminate barriers to economic competitiveness, expand employment opportunities in manufacturing, and improve workers’ education and skills.

As it stands, India ranks 60th in the world for economic competitiveness – much lower than China, which, at 29th, is closing in on high-income countries like South Korea (25th) and France (23rd). The reasons for this are not difficult to discern: India performs poorly on the fundamental drivers of long-term economic prosperity.

Indeed, despite steady improvements, public health and education levels remain low (102nd worldwide). Moreover, the lack of adequate transport, communication, and energy infrastructure (85th) is undermining India’s productivity growth. And India lags behind China in the efficiency of its product and labor markets (ranking 85th and 99th, respectively). Only by addressing these shortcomings can India attract sufficient investment and boost economic growth.

At the same time, India should expand labor-intensive manufacturing, thereby creating employment opportunities for its growing pool of workers. Given that manufacturing contributes only 15% of India’s total output, compared to 31% in China, there is considerable room for growth.

In a sense, India has the advantage of being able to learn from China. China transformed its agrarian economy by building a strong, labor-intensive industrial base, shifting workers from agriculture to manufacturing and construction, and improving productivity across all sectors. Today, the agricultural sector accounts for only one-third of total employment in China, compared to one-half in India.

India’s structural transformation and sustainable growth will hinge on its efforts to build a flexible labor market, centered on the easing of outdated and complicated employment laws. The legal protections of workers in India’s formal sector exceed those of most developed countries, as well as China, with mandated requirements rising as the number of employees increases. As Jagdish Bhagwati and Arvind Panagariya have pointed out,excessive labor-market regulations deter Indian entrepreneurs from employing unskilled workers and developing labor-intensive manufacturing, implying that the Indian government should redouble its reform efforts in this area.

Equally important, Indian workers – especially young people – need opportunities to upgrade their skills continuously. The McKinsey Global Institute estimates that, of the potential global oversupply of 90 million low-skilled workers in 2020, 27 million will be in India. Meanwhile, the country will face a shortage of 13 million medium-skilled workers.

Despite India’s educational expansion, especially at the secondary and tertiary levels, its system of higher education, including technical and vocational education and training, remains inadequate. Though India’s public vocational education and training systems are well institutionalized, they lack the scale, curriculum, financing, and incentives needed to prepare young workers to meet the demands of rapid globalization and technological advancement.

The good news is that Modi seems committed to boosting India’s competitiveness by improving its business climate. For example, he has already announced measures to promote foreign direct investment in insurance, defense, and telecommunications, including higher infrastructure spending and new tax incentives for savings and investment. India’s government will also sustain its predecessors’ efforts to strengthen vocational education and skills training.

What Modi’s plan lacks is a strong focus on expanding India’s labor-intensive industries. That, together with the planned reforms, would enable India to seize the opportunities that arise with favorable demographics and achieve Chinese-style growth.

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    1. CommentedShoshon Tama-Sweet

      Too often, the focus is trade liberalization, attracting Foreign Direct Investment, and a concentration on exports. What India needs is free markets internally. This means making it easier to start businesses- In Rwanda, for example, it only takes a couple of days to start a business, and one-stop-shop to pay taxes. Barriers to market entry need to be reduced. Harmonize economic regimes across states. Invest in infrastructure, especially electrification. While employment protection is too strong in the formal market, it is non-existent in the informal market; easing rules in the former should be balanced with protections in the latter. Modi has mandate, but only a short window of time. He needs to stage and plan his reforms very strategically. But internal changes will bring the health, prosperous, balanced growth India needs; that needs to come before the international focus, otherwise it may not come at all.

    2. CommentedBing Lui

      "India has potential." Now ask yourself how many times have you heard that before? But the problem seems to be that the potential never seems to be quite realized. Let us hope this new guy in charge, Mr. Modi, is really up to the job. I am optimistic as the problem areas have been clearly pointed out by many writers, including Mr. Lee who authored this particular piece. In short, the problems are well known and what happens next is entirely up to Mr. Modi.

        CommentedFalak Arora

        India's advantage of being a democracy is also its biggest handicap. It serves as a deterrent for implementation of economics policies bitter in the short run but fruitful in the long run. Arun jaitley bowed to this pressure and so the budget wasn't as risk assuming as expected

        CommentedShoshon Tama-Sweet

        Not exactly. This isn't communist China, where an incredibly powerful central state can impose policy, and execute a few recalcitrant elites to hammer the point home. India has many religions, thousands of languages, a diverse political system- implementation in India is simply more difficult than in China. But its a trade off- they can also vote, speak their opinions, elect local officials. Financial growth is not the only social good.