Perceptions Drive Policy: India-China Reality

Introduction

      Perceptions drive policy.  This is also true of India’s China policy. What are Indian’s perceptions of China? Leaving aside the history of the border conflict, these perceptions are driven largely by knowledge of (or lack thereof) of the economic performance of the Chinese and Indian economies. I find that most Indians who take an interest in China, fall largely into two camps: One who think of China as a super achiever, the country equivalent of a superman. The people who fall into this group are generally either overawed or intimidated by China and have a defeatist attitude for India viz China.   The second camp is the opposite of the first one.  It is generally disparaging and dismissive of China’s achievements while exaggerating of India’s achievement and/or capabilities. By thinking that all we have do is have different govt., or change our objectives, or show the will, and we will grow fast and catch up in a jiffy. It sometimes verges on dangerous bravado.  In my view both these perceptions are equally problematic when it comes to defining India’s China policy. A foreign policy that furthers and promotes India’s interest must be based on a realistic appraisal of India’s position vis-à-vis China. This essay tries to present such an appraisal.

China: Superman or Iron Man?

     What are the arguments for the super-country view of China? China’s economy has averaged a growth rate of almost 10% per annum over a period of 30 years, the fastest and longest duration of sustained high growth rate seen in history.  In 2013 Chinese economy was 5 times the size of the Indian economy, in current US$ dollars, but equal in size of to the US economy in Purchasing Power parity terms.   Actually, China’s economy is about half the size of the US economy in current US$ terms but it is easy to fall into the practice of changing  metrics to suit ones argument.  This subtle exaggeration is also true of Western analysts who are pushing a G2 approach to US policy and the World order.

Good Luck & Good Governance?

      What are the kind of arguments on the other side?  China’s  per capita GDP in current US$ terms was about the same as India’s at the beginning of the 1990s. More precisely it was 0.84 of India’s US$ GDP in 1990 and 1.06 times India’s US$GDP in 1991. Even though China’s GDP was higher in 1990 (1.1x) and 1991 (1.4x), that was because of its larger population. This population differential is, however, projected by the UN, to end in 2025. The population differential and the consequent GDP differential have been around for several millennia, but should dis-appear in a decade.  Thereafter the game will be solely one of Per capita GDP. There is nothing inherently superior about the Chinese viz Indian’s that we can’t go back to the per capita GDP parity that prevailed in 1990-91, if we have the will and make the effort.  An important reason for the 9% average Per capita GDP growth of the Chinese economy since 1990 was the Geo-economic support that China got from the US, Europe and Japan, and which the Chinese Communist Party cleverly used to implement its (version of the) export led development model.  It did this by always telling foreigners what they wanted to hear (about free markets and private enterprise), while rigorously controlling & modulating the access of foreign analysts and experts to hard and soft data.

Reality of India viz China

   The reality is revealed by a careful appraisal of the real GDP of the two countries. The only way to compare the welfare of the people of different countries is in terms of their per capita GDP (income or consumption) in terms of Purchasing power parity(PPP). AS total GDP is population times per capita GDP(PcGdp) or PcGdp is derived from GDP by dividing it by population, GDP measured in purchasing power parity is also the logical way to compare the size of  GDP.  In 2013 India’s GdpPpp was 40% of China’s or inversely China’s GDP was 2.4 times that of India’s.  If China’s GDP was converted to USD in 2013 it would have got five times the US dollars that India would get from converting its 2013 GDP into USD.  However, if these dollars were used by the Chinese to convert into to Indian rupees, it would be able to buy in India real goods & services equal to 2.4 times the real Goods and Services it could have bought in China. Similarly if India used its entire 2013 GDP to convert into Chinese Renminbi in 2013 it could buy Goods and services in China equivalent to 40% of what it could have in India, double the 20% suggested by 2013 exchange rates.

Relative size

     That is one basic reality: China’s real economy is about 2.4 times that of India, or inversely India’s real economy is about 40% the size of China’s.  As China’s GDP at PPP was about the same as India’s in 1985, it took thirty years for China to open this gap.[1] During this period Chinas growth rate (9.9%) averaged 3.4% points more than the 6.5% average Indian GDP growth rate. As people some time confuse GDP with per capita GDP, the corresponding facts are as follows: China’s real per capita GDP, which was equal to India’s in 1992 (0.99) had become 2.2 times India’s per capita GDP (PPP) by 2013. The average growth rate of per capita GDP from 1990 to 2013 was 9% for China and 4.8% for India. It thus took, 25 years for a per capita growth difference of 4.2% per year to translate into a per capita income difference  of 2.2 times. 

       By way of benchmark, note that China’s GDP at PPP is now almost equal to that of USA, even though its Per Capita GDP at PPP (PcGdpPpp)  is only about 22% of US( because its population is 4.3 times).  India’s GDP is therefore also 40% of the US, while its per capita GDP is 10% of the US.

Growth Differential

The second basic reality is that the difference in the growth rates of China and India has been narrowing during this period 1990 to 2013. Thus estimating and plotting the GDP “growth differential” and introducing a linear trend through it shows that the “growth differential” has declined by about 0.16 per cent point per year.   The per capita GDP growth differential has narrowed at the slightly slower rate of 0.15 per cent point per year. Those concerned about the new Indian data with base 2011, should be reassured that this narrowing trend was clear in the old data available up to 2013-14.  If we extend this data to include the forecast growth for 2015, we see a sharp narrowing of the GDP growth differential suggesting that the China’s growth trend will go below India’s from 2016 (actual GDP growth is virtually equal in 2014).

    Along with the GDP Gap, have been the narrowing of the gap is several ratios, known to be correlated to per capita GDP growth.  These include the Export/GDP, Import/GDP and FDI/GDP ratios. The faster growth of exports of goods and services, their imports and FDI, may in fact be driving the narrowing of the per capita GDP growth gap.

Appraisal & Projection

    A realistic appraisal of the relative position of India viz China and how we got there also provides a basis for projecting into the future.  Thus it took about 22 years for China’s real per capita GDP to become 2.2 times that of India’s with an average per capita GDP growth differential of around 4.2% per year.  Given relative population growth rates, it took about 28 years for China’s real GDP to become 2.4 times India’s with an average GDP growth differential of about 3.4% per year. If India’s average GDP growth averages about 3.4% points more than China’s, India’s GDP will take between 25 to 30 years to catch up to, and become equal to that of, China.   Thus for instance if India is able to accelerate growth to an average of 8.5%, while China’s growth slows to about  5%, it would take about 28 years to close the gap. This is however an optimistic projection from India’s perspective.

    A more realistic scenario would be for both Indian and Chinese growth rates to decline gradually, with Indian GDP growth averaging about 2.3% points higher than China over several decades. Based on this scenario, a realistic objective for Indian Growth and development would be to target an elimination of the GDP PPP gap with China by 2050.  Though this is a generational challenge it is far from impossible one.

   Adding a growth projection for USA to this scenario, suggests that the GDP at PPP of both India and China would in 2050 be about 2.5 times that of the USA, even though their per capita GdpPpp would still be 2/3^rd and 3/4^th (respectively) of the USA’s.

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A version of this note appeared in Economic Times Blogs under the title, “Perceptions Drive Policy” on May 19, 2015 at http://blogs.economictimes.indiatimes.com/PolicyAnalysis/relative-size-of-china-and-india/

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[1] Unless otherwise indicated, all data used is from the World Development Indicators data base of the World Bank. As pre-1990 GDP PPP data has been removed from the WDI, we use IMF data for GDP PPP for 1980-89.

Political Economy of Expectations & Performance Evaluation

      How do observers analyze the performance of the Modi Government, after completing one year in office? That depends on their expectations. An added complication this time is that expectations have changed sharply during the last two years. The evaluation of the Modi Government depends on whether the observer measures performance against his expectations one year ago or his expectations two years ago.  This note however discerns a pattern, that may help readers evaluate the evaluators and thus indirectly do a better job of evaluating the actual performance of the Modi Government.

     If we go back in time to the middle of 2013 (May-June), most observers of the economy and economic policy fell into two categories: Very negative and moderately positive. The first category(I) were extremely apprehensive about the future of the Indian polity and economy.  In political terms this group consisted primarily of anti-BJP, ant-Modi persuasion. The second category(II) were mildly positive, in the hope that any change from the previous dispensation would be in a positive direction, even though the change may be incremental and slow.  This group largely consisted of all those who were positive towards candidate Modi’s economic agenda or economic management style or both.

    By the middle of 2014, each of these groups had subdivided into two (A & B), depending on their political inclinations and attitudes to the NDA government. What is most interesting is that sub-groups IB and IIBs expectation converged after the formation of the NDA government in 2014, so that there were really three views/ sets of expectations in mid-2014. One part of the original negative group’s attitude changed little- they (IA) remained negative about the Modi Government’s performance, perhaps even a little more negative than before, expecting no improvement and giving no quarter.  The second sub-group in this category (IIB) went from negative expectations to Very high expectations of what the Modi Government should accomplish. This change took time to brew below the surface, but then changed suddenly on record.

      The original positive group (II) also separated into two sub-groups in mid -2014. One sub-group (IIA) remained positive but with a greater confidence and faith that the direction of the economy and economic policy would indeed be changed in positive direction.  It therefore began to sketch out a range policy & institutional reform possibilities that had a realistic chance of being adopted and implemented.  The second sub-group(IIB) was euphoric about the Lok Sabha majority attained by the NDA and its expectations, about what the Modi government could or would do, sky rocketed. Members of both this sub-group (IIB) and the other sub-group (IB) developed a must do agenda/reform lists based on long standing views, which each member of the group felt he had a right to expect from this government. Some of these ,verged on the miraculous when viewed in the light of harsh political reality and dynamics of the political economy of vested interests. 

      Not surprisingly both these sub-groups (IB & IIB) have, in mid-2015,  expressed severe disappointment in the performance of the Modi government. Both groups have written off the Modi Government (perhaps in different ways). The difference between the two is, that the dis-appointment of sub-group IB is tinged with  quiet satisfaction that its original expectations in 2013, that “no good can come from the rise of Modi”, may yet come true. In contrast sub-group IIB is genuinely dis-appointed with what they thought were easily achievable goals for a Govt. with a LS majority, unaware of forgetting that, a Rajya Sabha majority is needed to pass all legislation (except the budget and the finance bills). 

    Sub-group IIA which had mildly positive expectations in both 2013 and 2014,  continues to have such expectations of the Modi government. The Government’s performance balance sheet from its perspective has some good positive achievements, a smaller but still significant number of negatives (boo boos or slow progress) but is mildly positive on a net basis.  Members of this “realist” sub groups may differ on specifics of the positive & negative items and of the net benefits and impact, but they remain hopeful of steady progress on economic policy, institutional (governance) reforms and economic growth and welfare improvement.

 

India-China Growth Reversal & GDP Gap

Introduction

      The long anticipated deceleration in rate of the growth of China’s economy is under way. Even normally conservative World Bank and IMF, are confirming that China’s growth is slowing down and is likely to fall below 7%.  Even those analysts who had forecast a deceleration in China’s growth were unsure about when exactly the slowdown would start. The author had estimated in the 2000s that China’s growth would decelerate below 8 per cent, around the middle of the decade starting 2010.  The global financial crisis of 2008 sharply raised the probability that the slow down would occur within the following decade, despite risky efforts by China to prop up growth.

      In contrast India was forecast to achieve its potential growth rate of about 8 per cent, given its Export-import neutral growth model. The surprise in India’s case was the sharp slowdown from 2011-12, largely attributed to complacency and domestic policy mistakes. Despite these mistakes, however, India’s growth rate from 2002-03 to 2013-14 was among the ten highest in the world (using the old data series).  Though, the correction of these mistakes, may no longer be enough to restore growth to earlier levels, India can and must restore growth to the average rates achieved earlier. Again, this has been recognized by both the World Bank and the IMF.     These two developments taken together, imply that India trend growth rate is poised to  exceed that of China’s in the next few decades.

GDP Levels vs Growth rate

    This will start the long, slow process of closing the GDP gap with China, which was 1.4 times India’s real GDP in 2013.  There is a common tendency to confuse relative levels of GDP with growth rates, so it is important to understand that China’s real GDP, measured at Purchasing power parity in 2011 international dollars, is now 2.4 times that of India's GDP. China's GDP PPP was 1.1 times India's GDP PPP in 1990, with the two economies almost equal in size in the mid-1980s. During 1990 to 2013, China's growth averaged 9.9% per year, 3.4% points faster than India’s average GDP growth rate of 6.5%.  Even if the growth differential was inverted and China's GDP henceforth grows an average 3.4% points slower than India's GDP (say 5% - 8.4% = -3.4%),  it would take 30 years to eliminate the GDP gap, about the time it took to open it.

Previous Growth Forecasts

    The basic theory and empirics of growth, show that fast growing economies like Japan, S Korea, Singapore and Thailand, which grew fast when they were at low or middle income levels of per capita GDP, maintained growth at high levels for one to two decades and then slowed down as their per Capita GDP approached that of the (lower end) of the High Income economies.  The surprise in the case of China was that it maintained an average growth of almost 10% for thirty years, despite reaching middle income levels of per capita GDP about a decade ago.  Many analysts, whose predictions about China's growth slowdown had been proved wrong in the 1990s, became much more cautious thereafter. Those of us who were willing to take a reputational risk, have been proved right, as China’s economy slowed below 8% in 2012 and is now projected to slow below 7% by the multilateral institutions.

    The global financial crisis ensured that growth of World trade would slow sharply below the very high growth seen in the previous decade, aided by a correction of the bubble like growth seen just prior to the crisis.  This meant that China’s (net) export-investment model was no longer sustainable and would produce slower growth in the 2010s.  To delay this slowdown China pumped large amounts of credit into the economy, with the official Debt-Gdp ratio rising from 55.2% of GDP in 2008 to 88.1% in 2013, an average increase of 6.6% points of GDP per year. Analysts have estimated that the debt in the shadow banking system may have increased by an equivalent amount, with total debt rising to dangerously risky levels.  Based on historical experience of such debt bubbles, some analysts predict that this bubble is now likely to burst and reduce China’s growth rate to the 3% to 4% range. Analysts who have greater confidence in the ability of the Chinese Communist party to manage economic crisis, nevertheless predict a deceleration of the trend rate of growth to a range of 6% to 7%. A safe intermediate prediction is a gradual growth slow down to 5 to 6 per cent rate over the next 10 years.

Comparative Growth

   Based on World Bank, World Development Indicators data till 2013 (till which year India's GDP base 2004-5 was fully available), we can examine and compare the growth rates of China & India. A plot of these rates shows that the growth rate difference has been narrowing since 1990, due to a gradual deceleration of China and a stronger acceleration of India. Underlying this narrowing growth difference are variables that are drivers of or correlated with, GDP growth and productivity. These include FDI and exports, which are indicators of competitiveness and Imports which reflect openness.

     The difference between China and India’s FDI-GDP ratio has been on a declining trend, from about 3.5% of GDP in 1990 to a little over 2% of GDP in 2013. Underlying this is slow but steady progress in attracting technology and risk capital to India, with a milder decline in China’s attractiveness. China’s Export GDP ratio which was 8 per cent points higher than India’s in 1990, rose 10% points to an average of 18% during 2005 to 2007. It then narrowed rapidly to about 1% in 2013, indicating that India’s exports have held up to the global decline in world trade since 2008, much more effectively than China’s. The difference between China and India’s Import-GDP, which fluctuated around an average of 7.1% points between 1990 and 2007 declined dramatically to -5.2% by 2011-13, indicating that the Indian economy is now significantly more open than China’s.

Base Change Implications

       Analysis and forecasting of Indian growth has been confounded by the appearance of a new GDP series (2011 base) which has made some fundamental changes in methodology and data sources used.  As this new series provides less than three years of growth data it is impossible to estimate the underlying trend growth rate using this series.  After the mid-year 2014 budget I had written that “The measures taken in the budget will be sufficient to increase growth by about 1 per cent point over the last year’s 4.7% to 5.7%. Actualization of some of the measures indicated in the budget will however be necessary to raise growth to the 6.5 to 7% range in 2015-16.”  Given that the average growth rate as per the new data is about 1% point above that, using the new data, a projected growth rate of 7.5% to 8% is quite conservative. This seems to be the reasoning underling the World Bank’s and IMF’s  projections for India’s growth in 2015 and 2016.

      The CSO has however projected a growth rate of 7.4% for 2014-15 and a growth acceleration to 8% in 2015-16 would not be wildly optimistic.  As many observers have pointed out however, high frequency data, such as the Index of Industrial production for manufacturing, quarterly results for companies and tax revenues from excise and corporate income tax, do not appear consistent with these high growth levels. The author has argued in the policy paper, “Indian Growth Puzzle,” ( Policy Paper No. WsPP 3/2015, New Delhi, April 2015 ) that the global financial crisis (GFC) and the consequent global demand recession and excess capacity, have affected not only the export led Chinese economy, but also the globally competitive and connected corporate (GCC) sector of India. Post GFC, the GCC corporations will lag overall recovery, instead of leading it, as they did in 2002-3 to 2007-8. Thus all indicators connected with these companies, such as IIP, corporate profits, corporate & excise tax revenue would also lag the GDP recovery. The Indian Government needs to be aware of this issue and be prepared to manage central government expenditures subject to a slower recovery in tax revenues.

Conclusion

    Based on the theory and empirical evidence provided by high growth economies, some analysts had predicted since the 2000s, a slowing of the Chinese economy during the decade of the 2010s to rate of growth below that of the Indian (“China-India growth Projections” and other papers at https://sites.google.com/site/drarvindvirmani/growth).  By making the export-investment led strategy of development unviable, the global financial crises made this highly likely if not inevitable. It was also assumed in the forecasts that the Indian government would continue to carry out the minimum reforms necessary to maintain India’s growth rate at an average of the previous decade. Because of complacency and policy mistakes by the Indian Government between 2010 and 2012, the Indian economy, faltered seriously. The corrections introduced in the last two years, have restored some of the momentum.

    Sustained growth of 8 to 8.5% over the next few decades, however requires implementation of the reform agenda and continuing sensitivity to shocks that can derail growth, given that the World environment is far from conducive to sustained high growth.  If this is done we should expect to see India growing faster than China and beginning to close the wide gap that has opened between the per capita GDP of the two countries. This has implications for China and India's foreign policy towards each other, that need to be kept in mind. Given the wide Gap between the GDPs of the two countries, it is however, likely to take at least 30 years for India to eliminate the GDP gap with China.

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A version of this article appeared as the Lead article in The Hindu dated 29^th April 2015 under the banner. "Tracking Two Growth Stories" :

 http://www.thehindu.com/opinion/lead/india-and-china-tracking-two-growth-stories/article7151377.ece