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Asia-Pacific Magazine
No. 2 May 1996
pp. 11-16.

India and China: Reforming Giants

by Ross Garnaut

A shared legacy

India and China entered the post-Imperialist era sharing the world's greatest development problems and most of the world's poor people. For the first three postwar decades, both succeeded in raising substantially average output and incomes, while neither was close to the developing world's top performers. Both succeeded in mobilising fairly high savings for investment--rather more deliberately and effectively in China although China's central planning system squandered much of the value of its investment. China grew faster on average than India, with massive swings in policy and performance with the vicissitudes of its centralised politics.

Alongside huge differences in state ideology and policymaking processes, there were many similarities in economic resources, structure and strategy between the two giants. Most basic was their shared abundance of labour relative to other resources necessary for development--land (or natural resources), and capital. This suggested the value of economic strategies focused on production of labour-intensive goods, exporting a proportion to support imports of the technology, capital goods and some natural resource-based products which were necessary for development.

Both India and China turned away from strategies based on exports of goods and services that used intensively their abundant labour and away from integration into an international economy. They both turned towards autarchy, and strong reliance on investment in heavy industry. The export shares of production in both fell markedly, against the world trend, and radically differently from the world's most successful developing countries. Along the way, both suppressed agriculture, holding relative prices of farm products well below world levels. These awkward outcomes required an effusion of regulation of all aspects of economic life. Bureaucratic decision, rather than value in a market, determined how resources were allocated amongst their many claimants.

It is not obvious at first glance why China and India would have come to adopt such similar economic strategy, so far removed from that suggested by their underdevelopment and resources.

China absorbed a development strategy that favoured autarchy, the domination of decision-making on resource allocation by a central bureaucracy, and the encouragement of heavy at the expense of light industry and agriculture, from Stalin, Lenin and Marx via the Soviet Union. The Soviet model and advice on its application were at hand when the Chinese Communist Party won power in Beijing without a settled approach to national economic policy. The internationally oriented and market-oriented alternatives were, at the same time, pushed beyond reach by the Korean War and the establishment of a version of the Cold War in East Asia.

India, too, was influenced by the Soviet model of central planning, especially after the South Asian variant of the Cold War saw India closely aligned with Moscow in strategic affairs from the mid-1960s. The die had already been cast in the very different setting of a parliamentary democracy, by Indian leaders' empathy with the postwar sympathy for `planning' in social democratic thinking in Europe (and the Antipodes), and in particular with British Fabian socialism.

Perhaps of more fundamental importance, India and China were big enough for ambitious dreams. Dreams of drawing their economies' needs from within their own wide boundaries. Dreams of quickly joining the rich and powerful countries of the North Atlantic in the breadth and sophistication of their industrial capacity. Their size suggested to their respective leaderships a capacity to support a large military backed by related industry; and their pride as large countries pressed for the realisation of this possibility. In all of this they were supported by ambivalence about inward-looking economic strategies in the West, before the lessons of experience elsewhere in East Asia had pointed to a more productive course.

The origins of reform

Central planning, purposeless regulation and protection can boost, or at least not greatly damage, measured and perceived economic development for a while. Some of the initial reforms by China's new communist government after 1949 spurred economic activity--notably the establishment of domestic peace after a century of more or less incessant disorder, the first land reforms and their effects on peasant incentives, and the provision of a range of public goods the earlier absence of which had held back production. Both economies seemed to perform well through the early and mid-1950s, and China better, as both demonstrated that it was possible to raise output per head and living standards in these huge and populous economies.

China went faster into an inward-looking strategy favouring heavy industry than India. There were weaker constraints on large, sudden policy shifts in China's Leninist political system than in India's rambling democracy. Encouraged unrealistically by the apparent success of early ventures into collectivisation and central planning, Mao Zedong launched the Great Leap Forward in the late 1950s to span quickly the gap between economic development and structure in China and in the world's most advanced economies. Steel and other heavy industries were big in the advanced economies, so they would be big soon in China. This lurch in economic strategy yielded an early harvest of tragedy, a legacy of bitterness within the Chinese leadership, and cast a shadow of policy instability and uncertainty through the chaos of the Cultural Revolution (1966-76) into the early years of the era of economic reform.

China seems to have had a greater impetus to growth than India--reflected in a higher savings rate when stability had been established, and higher and more widespread investment in education when political conditions were conducive to it.

By the 1970s, there was realisation in both China and India that economic performance was not all that it could be. Other economies, especially in East Asia, seen by Chinese and Indians as having poorer prospects, seemed to be doing better. This was affecting international standing and perceptions of security, and if there were no change in trend, the giants' relative positions might deteriorate to an extent that threatened the legitimacy of ruling élites. As Jagdish Bhagwati has said about India

The worst psychological state to be in is to have a superiority complex and an inferior status. This incongruity cried out to be fixed: reforms were increasingly seen to be the only answer.

Discomfort about the Bhagwatian incongruity came earlier in China, for several reasons. The disruption to economic processes through the Cultural Revolution (1966-76) increased the reality and perception of underperformance. It created a sense of political crisis and disillusionment with the established political framework that made radical economic reform possible--a possibility expanded by the death of Mao Zedong in 1976.

China's perception of its own underperformance was heightened by the success of near neighbours--Japan and Korea, and most pointedly the Chinese economies of Hong Kong and Taiwan which had commenced their swift movement to the average output levels and living standards of developed countries. Most telling of all, the ideological and political breach and clash with the Soviet Union liberated Chinese communist thought from the source of its original commitment to central planning, and the military clashes on the Heilongjiang in 1969 heightened awareness of the strategic consequences of continued economic underperformance.

China's Leninist political system allowed large and swift change in policy and strategy. After several years of incoherent policy, in December 1978 Deng Xiaoping succeeded in winning support in the Politburo for decisive commitment to open the Chinese economy to the outside world, and to accept a larger role for markets in domestic resource allocation. There was no blueprint for reform of economic strategy; the thinking of the Chinese leadership had not developed so far. But there was a clear sense of the direction of necessary change, and willingness to experiment with a wide range of new policies and institutional arrangements in that direction.

The Chinese economy responded dramatically to reform, particularly to the early reform steps in agriculture: the acceptance of the household rather than the people's commune as the basic unit of agricultural production; the acceptance of sale in markets for a large and expanding proportion of agricultural output; and, most powerfully of all in the early stages, the partial removal of the old suppression of agriculture, with the lifting of prices towards international levels.

The huge response of rural China to the reform incentives cemented political support for reform. Farm output and especially farm incomes grew prodigiously. A high proportion of the increase in income was saved; and the new policies allowed the savings to be reinvested profitably in rural areas in township and village industries, rapidly expanding off-farm employment and incomes.

There was large response, too, to the open policies, eased and magnified by participation of a large overseas Chinese business community, accustomed to linking abundant labour to world markets for labour-intensive products elsewhere in East Asia. The export trade share of GDP as conventionally measured has more than trebled in the reform period to over 20 percent; primary products were replaced by labour-intensive manufactures as the main exports; and, dramatically in the 1990s, direct foreign investment became an important source of capital formation and technological up-grading.

Output increased by around 9 percent per annum on average, and output per head at a rate that more than doubles average incomes each decade.

China's success emphasised its role as a natural rival for superior status and increased pressures for reform in India. There was also a strategic edge to the underlying competition with China: left uncorrected, the divergence between Chinese and Indian growth performance would lead eventually to a large shift in relative military weight.

Thus was the scene set for reform in India. The collapse of the former Soviet Union, and the economic model and the trade opportunities that it provided, were psychologically liberating. The immediate impetus was provided by the severe economic crisis in 1991--balance of payments weakness and stagnation in output that no longer seemed amenable to minor policy adjustment.

The reforms initiated in 1991 in India have been pursued more or less consistently through all the pressures of a Federal and democratic constitution. The lesser urgency of the background conditions and the different political framework have contributed to less radical and less decisive action on reform in India. But even in this, the similarities are at least as impressive as the differences: reform is gradual in both China and India, with both eschewing the `big bang' and the shock treatment that have sometimes been favoured by advisers to reforming governments in Eastern Europe and the CIS.

Starting points

It is important beyond the satisfaction of curiosity to understand the relative incomes of India and China now, and at the starting points of their reforms. Income levels at the starting point tell us a great deal about the likely evolution of comparative advantage, industrial structure and export and import specialisation in the process of opening to the international economy and of sustained strong growth. They can tell us a great deal about whether India and China are going to compete head to head in the same segments of world markets, or offer each other as many opportunities through complementarity as they block through direct competition in niches in the international markets for labour-intensive goods. Despite some inconsistency in data, a number of pieces of information seem to place China's per capita income at the commencement of its reforms in 1978 somewhere close to India's in the early 1990s, at the commencement of its own reforms.

The demographic characteristics of China in 1975 pointed to a similar if somewhat richer country than India in 1990.

Table 1 Comparative demographic indicators for India and China

                                   India                      China                      
                               1975      1990          1975          1990          
Total fertility rate             5.7      3.8           2.8           2.1           
Population growth rate           2.2      2.0           1.8           1.3           
Crude death rate                15       11             5             7             
Life expectancy at birth        50       59            64            69            
Males                           ..       58.7          ..            68.4      
Females                         ..       59.3          ..            71.8      
Adult literacy rate             36       48            66            63       
Females                         ..       34            ..            62       

Per capita total consumption of food grain, including indirect consumption in meat, dairy products, alcohol and other foods, tends to rise with per capita income up to high income levels. Figure 1 graphs the relationship for a number of economies in South Asia, the Western Pacific and other major world regions. If we multiply China's official per capita income by three, both consume about the amounts of `grain equivalent' that one would expect from their per capita incomes. If anything, India is on the low and China on the high side of the trend line.

India's steel and natural fibre consumption is around what would be expected from India's per capita income - if anything, it is a bit lower than might be expected. China's per capita consumption of steel and natural fibre is around the level that would be expected for a country with three times its officially recorded income, or a bit higher still.

Both India and China consume considerably more energy than one would expect from their reported incomes (adjusted in the case of China). This reflects both economies' artificial encouragement of heavy industry with its intensive use of energy - characteristics that are removed only slowly through successful reform.

Comparison of India's with China's per capita output and living standards is not a simple matter, and a number of different cases could be made. It is a matter for further research. The balance of evidence currently available points to Indian income levels in the early 1990s being similar to those in China on the eve of reform in the late 1970s.

Comparison of India and China is further complicated by huge regional variations within both. This is not surprising, given their vast geographic extent, the poor quality and high cost of transport and communications - reinforced by official restrictions on mobility in China, and by ethnic, linguistic and religious difference in India. After making the major corrections required to Chinese income data, average incomes in the richest provinces of India exceed those in poor provinces of China.

Comparative advantage and export specialisation

On a world scale, both India and China have a large endowment of labour relative to both capital (including human capital) and natural resources. Their comparative advantage is in labour-intensive goods and services. This emerges in patterns of exports if protection and alternative forms of artificial support for other industries are removed.

India's population density is high on a world scale - 283 people per square kilometre compared with 41 in the world as a whole. It exceeds that of China (121 per square kilometre) by a wide margin. This suggests a somewhat stronger comparative advantage in natural resource-based products. It also suggests that India is likely to become a net importer of these goods at a relatively early stage of internationally oriented economic growth than China, and, that net imports are likely to be larger at higher levels of economic development.

But much more of the Indian land mass is economically arable than is that of China or the world as a whole. India's endowment of arable land per person (0.002 square kilometres) is very much larger than China (0.0008) with its vast arid and mountainous inland. An internationally oriented India is likely to remain a net importer of agricultural produce into much higher income levels than China, and to be a less intensive importer of agricultural produce at later stages of economic development.

Neither India nor China is an integrated economy with a more or less uniform ratio of population to natural resources and capital. Both have pockets of excellence, of real comparative advantage in technologically sophisticated production, based on parts of the education system and of capital-intensive industry that were once favoured artificially.

These simple facts carry some large implications. The removal of the suppression of agriculture by raising food prices to international levels, which was so important to enhancing growth in rural production and in cementing the political base for reform in China, can also provide powerful support for reform in India.

In China, where average food prices have reached international levels only over the past year, the extraordinary initial impulse that reform provided to increased agricultural output lasted for about six years. China became a net grain exporter briefly in the mid-1980s despite huge expansion of consumption with rising incomes. The levelling out of grain production after that, with output per person rarely and only modestly exceeding the 1984 peak, was accompanied by moderate growth in total agricultural output (around 4 per cent a year, compared with around 7 per cent a year in 1978-84). In the mid-1990s, continued rapid incomes growth has generated strong tendencies towards increased net imports of agricultural products.

India's larger per capita arable land endowment, and the similarity of its income levels now to those in China in the early years of reform, mean that effective internationalisation and reform of Indian agriculture is likely to have an even larger effect in raising farm incomes and output than in China. With successful internationalisation and reform, India is likely to become a substantial net exporter of agricultural produce, including grain, and to remain in this position for a considerable period. A lower propensity to consume food at a given income level (a difference in taste that includes lower meat consumption) may strengthen these tendencies in agricultural trade.

It is not certain that the lifting of food prices to international levels and the associated lift in output and income would provide as large a boost to non-farm rural economic activity in India as in China. The dynamism of non-farm rural industry has contributed considerably to China's extraordinary overall growth performance in the reform period. Part of this dynamism may depend on phenomena that are characteristically Chinese: particular patterns of informal organisation and exchange; and elements of Chinese family structure applied to business enterprise. In wondering whether non-farm rural output could make a similar contribution in India, however, it is salutary to recall that this element of the success of Chinese reform took the Chinese authorities by surprise. If the institutional conditions existed for a similar response in India, the underlying economics of Indian agriculture would make it even more powerful.

China's longer progress in rapid economic growth spurred by internationally oriented reform leaves India, on average, with comparative advantage in the simplest, most labour-intensive manufactured goods. China, on average, is one and a half or two decades up the ladder of capital-intensity and technological sophistication in export specialisation.

Regional economic diversity makes this pattern more complex. The most dynamic Chinese provinces are rapidly graduating from comparative advantage in labour-intensive production. The frontier of internationally oriented growth based on exports of labour-intensive products is shifting into the Chinese inland, which is now competing in international markets with newly export-oriented production from the highest income parts of India. The success of these regions will open a path for the beginnings of internationalisation in the mass of India.

Meanwhile, the pockets of internationally competitive manufacturing with greater technological sophistication will promote an element of economically efficient diversification in both India and China. Capital-intensive as a proportion of total manufactured exports are about as important in the export structure of India (32 per cent) as China (34 per cent). That the proportion of labour-intensive goods in exports is so low in India, despite its earlier stage of economic development, is an indication that policy reform so far has not done as much in India to bring industrial and trade patterns in line with underlying economic realities.

As internationally oriented growth proceeds, capital-intensive and technologically sophisticated goods and services will eventually contribute a higher proportion of internationally competitive production. The pockets of internationally competitive capital-intensive production that have been created by history in both countries will provide a base in both for rapid diversification of exports out of labour-intensive products as labour becomes less abundant in later stages of the development process.

The evolution of Chinese comparative advantage and export specialisation out of manufactured goods will be accelerated by distinctive demographic features, including distinctive differences from India. China's fertility rate is unusually low for its average income level - even for its adjusted income level. This is associated with the low annual population growth rate of 1.3 per cent, compared with India's 2.0 per cent. China (1.24 billion) has a substantially larger population than India (0.93 billion), but already China's population of children under the age of 10 years has fallen below India's.

If these divergent tendencies in fertility and population growth continue, the labour force of India will come to exceed that of China in the early decades of next century. China's relative abundance of labour will diminish more quickly than if it was experiencing a more normally paced demographic transition. This will further improve the international environment for internationally oriented economic growth in India for the longer period in which its comparative advantage remains strongly in labour-intensive manufactures.

Competitors or complements

It is commonly said that India and China are natural economic competitors, that success for one in the world markets, will reduce opportunities for the other, and even that the world is not big enough for export-oriented growth to succeed in both at the same time. Our closer look has suggested the contrary - that India's reform and internationalisation has been positively supported by reform in China. Indian reform was helped first by success in China through the spur to action provided by the success of a rival, and by the example that internationally oriented growth in a big country was possible. And it will continue to be supported by the more advanced state of economic development in China, by structural change out of labour-intensive exports in the more advanced, coastal region of China, and by the dramatic demographic transition in China - all of which mean that China will be losing competitiveness in world markets for labour-intensive manufactures in time for India to step into its place.

Further reading:

• Asian Market Economies: Challenges of a Changing International Environment;
• Australia and the Northeast Asian Ascendancy;
• (with Peter Drysdale) Asia Pacific Regionalism: Readings in International Economic Relations;
• (with Peter Drysdale) Sustaining Export-Oriented Development;
• ASEAN in a Chaninging Pacific and World Economy;
• (with Kym Anderson) Australian Protectionism: Extent, CAuses and Effects;
• (with Liu Guoguang) Economic reform and Internationalisation: China in the Pacific Region;
• (with Christopher Findlay) The Political Economy of Manufacturing Protection: Experience of ASEAN and Australia.

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