March 2, 2015

MBA Chat: China, India and the Cost of Democracy

SMITH BRAIN TRUST -- Alex Triantis, dean at the University of Maryland’s Robert H. Smith School of Business, interviewed Anil Gupta, the Michael D. Dingman Chair in Strategy, Globalization and Entrepreneurship, on Feb. 24, 2015, in a lunchtime discussion with MBA students. The topic was “Asia’s Rise and Its Implications.” Much of the discussion centered on the different development arcs, in recent decades, of China and India, and what the future holds for those two powerhouse economies. China’s astonishing growth has been the big story in recent years, but Gupta suggests that may change in the not-so-distant future. Following is a transcript of part of the discussion, edited for clarity and concision.

Anil Gupta: China is now, of course, the center of the Asian economy. It's about 35 percent or 36 percent of Asia's GDP, and China is now a middle-income country, with about $7,000 or $7,500 per capita income. But the challenge for China is that it is slowing down rather rapidly. The official GDP growth rate for 2014 is around the low-7 percent range. But many economists think that the figures may have been massaged a little bit, and that the actual numbers may be closer to 5 percent or 5-and-a-half percent. India is a much poorer economy. In per capita terms, it is a quarter that of China. But, at the same time, because it started the opening up and reform process in 1991, as opposed to China in 1978, India is now beginning to pick up steam. In 2015, India may start growing at a faster pace than China.

Alex Triantis: Let’s focus on China. You talked about the slowdown in growth, and there's been a lot of discussion about that. What do you see as the key factors that are causing the slowdown? What may be repercussions of China’s slowdown for the global economy?

AG: The slowdown in China's growth is in part a consequence of the stage of China’s economic development i.e., how far China has come since 1980 and where it is today. Just as trees slow down their growth rates as they become taller, China’s economy was bound to slow down. That was inevitable and we’ve seen this earlier in the case of Japan and South Korea. In this sense, the slowdown is not at all surprising. I would add, however, that at least in part, the slowdown is also a result of man-made policies. Take the one child policy. As a direct but long-delayed consequence of this policy, China's labor pool (i.e., people in the 15 to 64 age range) is shrinking by about one percent a year. It’s impossible to reverse this trend quickly, if at all.

The second policy-driven factor is that the Chinese government has built an economy that is driven by supply-side logic rather than demand-side logic i.e., you build infrastructure, you build manufacturing capacity, you create employment, you keep inflation low, and and you grow the GDP. By and large, I believe that these have been good policies. However, all policies have unintended consequences. The challenge for China is that it is now somewhat trapped. The Chinese economic engine is very good at growing via fixed asset investments and exports but not very good at growing via innovation or boosting domestic consumption.

Sure, China still needs to invest in infrastructure. But, there is no way that the country can keep increasing fixed asset investments at the same pace as the last 5 or 10 years.

So the labor pool is shrinking, fixed asset investments cannot keep growing at anywhere close to the pace in the past, and exports are slowing down. It’s very hard to see how the government can reverse any of these trends.

AT: You mentioned some things that you wished India had done sooner. Now we are seeing some changes in India, with the new government, the new Modi government. I'm curious what new path you predict we may see—how the government will change policies in order to become pro-business?

AG: I think the starting point is the economic ideology of the government. To simplify it a little bit, but not grossly: Does the ideology favor distribution at the expense of growth or does it favor growth over distribution at least in the short-term? Of course, in the long-term, the two are connected. Without growth, you have nothing to distribute. And, without distribution, you cannot sustain growth.  But, in the short-term, you do need a bias. The government that has been in power since May 2014 is a very pro-growth government. Given where India is right now, that's the kind of bias that one would want at this point.

The second thing is that, in a democratic system, it’s extremely important for the party in power to have a clear majority. A government formed out of an unwieldy coalition would have a difficult time launching bold reforms. Thus, it’s good that, unlike the previous government, the Modi government has a solid majority in the Parliament.

Of course, in comparing China and India, one can always have an interesting debate about which system is better for economic growth -– a command-and-control system like China’s or a democratic system like India’s. Perhaps in the short-term—and, by that, I mean 30 years—democracy may impose an economic cost. If a Chinese provincial governor wants to build a highway from this city to that city, he or she can just look at the map and draw a straight line. If there are some villages along the way, well, they may be just a manageable implementation problem.

Not so in India. And so people ask all kinds of questions, and even if some of the questions are stupid, the political leaders can't ignore them. That slows down project execution. China grew at 10 percent a year for 30 years. Maybe it'll not be so easy for India to grow at 10 percent. But, despite democracy, can India grow at 8 or 9 percent for the next 20-30 years? I believe that the answer is “Yes.”

Now, if you take a longer -- say, 60-year -- time frame, then one could have a nice debate about which system may outshine the other even in terms of economic performance. China’s command-and-control system was very helpful in getting China to where it is today. But now China needs to innovate and the command-and-control system is proving to be a serious handicap. As a country, China spends about 9 times that of India on R&D. But by many solid measures of R&D output, India’s R&D output is about half that of China. So the productivity of R&D investment in China is pitifully small as compared to India.

The only explanation, I think, is the difference in political systems. In other words, the jury is still out on how the two economies will compare with each other in the second half of the 21st century.

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