By Ganeshan Wignaraja
There is renewed interest in the Asian giants in the wake of sluggish growth in advanced industrial economies. Over the past decades China and India have become super-exporters and surpassed all other developing countries (Winters and Yusuf 2007; Bardhan 2010). Some are predicting that India’s trade and growth performance will soon outpace China’s. The reasons given for India’s expected rise compared with China tend to focus on its democratic political culture and more favourable demographics, both of which are viewed as being more conducive to sustaining rapid trade-led growth over the long-term. Amid such speculation, my recent research suggests that key factors – including market conditions, trade and investment policies, and supply-side factors – point to China continuing to outperform India for the next decade (Wignaraja 2011).
The giants rise in world trade
China and India have followed similarly impressive growth trajectories in recent decades. While China began to open its economy to market forces and foreign investment in 1978 – more than a decade before India – both countries have enjoyed years of rapid trade-led growth that has lifted millions out of poverty (Winters and Yusuf 2007). The two Asian giants’ exports increasingly comprise sophisticated manufactures and services, rather than simple labour-intensive products. Furthermore, in spite of the global financial crisis and worries about a double-dip recession, this year seems bright. Forecasts by the Asian Development Bank suggest that robust economic expansion is expected in both countries in 2011 – over 9% in China and 8% in India. If weak demand in industrial countries remains weak, slightly lower growth might occur in 2012.
China currently dominates world manufacturing export markets, while at the same time it is taking a larger global share of medium- and high-technology exports. In achieving its pre-eminent status, China benefited from favourable initial conditions including a large domestic market, low-cost productive labour, and the geographical advantage of its proximity to Japan, the previous engine of Asian growth. Even more importantly, China pursued a swift and coordinated economic liberalisation programme beginning in 1978 that served as a catalyst for subsequent decades of economic growth. This reform programme included:
- An open-door policy toward foreign direct investment (FDI),
- Promotion of technology transfer through FDI,
- Steady liberalisation of a controlled import regime,
- Export incentives, and
- A strategic approach to free trade agreements (FTAs) with neighbouring Asian economies.
By comparison, India’s economic liberalisation did not begin until 1991 – more than a decade later – and it focused more narrowly on easing restrictions on FDI and imports. In recent years India has accelerated reform of FDI entry regulations and import tariffs (Bardhan 2010). For instance, India’s simple average import tariffs reached 13% in 2009 compared with 10% for China. Nonetheless, as a result of China’s “first-mover” advantage and more comprehensive liberalisation programme, it has been able to achieve consistently higher trade growth than India for the past several decades and has a much larger export base than India.
From less than $10 billion in 1985, Chinese exports ballooned to $1.8 trillion in 2010, accounting for 11% of world exports (see Figure 1). Meanwhile, Indian exports, which were also less than $10 billion in 1985, have grown more modestly to $326 billion in 2010 and account for 2% of world exports. Over this same period, China’s share of world export manufactures jumped from 0.5% to 11%, while India’s share increased from 0.5% to around 2%.
Amid this boom, China has moved away from a heavy reliance on exports that are resource-based (eg food) and low-technology (eg textiles, garments, and footwear) exports to become a growing supplier of the world’s high-tech manufactures (eg electronic and electrical products, aircraft, precision instruments, and pharmaceuticals). In 2008, China accounted for 14.3% of the world’s high-tech exports, up from only 0.1% in 1985 (see Table 1). While China’s resource-based exports did comprise a larger share of the world market in 2008 than in 1985, rising from 0.8% to 3.5%, resource-based exports declined sharply as a percentage of China’s total manufacturing exports over this period, plunging from 38.9% to 8.5%. China has even made significant progress in the export of services, which has increased on average by 18.6% per year since 1985.
India’s manufactured exports have also increased since 1985, although not nearly as much in terms of global market share as China (less than 2% vs. 11%). On the other hand, Indian exports are increasingly led by more-sophisticated, skill-intensive services such as IT, business process outsourcing, and financial services (Kowalski 2010). In each of these areas, Indian exporters account for more than 4% of the global market, compared with China’s share of less than 2%.
Differing paths to reforms and regionalism
Firms operating in China today enjoy a more competitive business environment than their counterparts in India, with more market-friendly rules for business start-up, property registration, contract enforcement, and bankruptcy. For instance, China is ranked 79 on the World Bank’s Doing Business Index compared with 134 for India (see Table 2). Beginning in the 1970s, China attracted FDI into manufacturing to serve as the cornerstone of export-led growth. From the early 1990s onward, China attracted record levels of FDI, with inflows amounting to $54 billion a year during 1991-2010. Technology transfer accompanied FDI inflows while controlled liberalisation of protected industries led to increased efficiency and industrial restructuring. In recent years, Chinese outward investment into the region’s developing economies has become commonplace.
India was slower to adopt a comprehensive liberalisation framework and focused more narrowly on easing restrictions on foreign ownership in its first decade of reform that began in 1991. With the recent acceleration of reforms, FDI inflows increased, amounting to $9.5 billion a year in 1991-2010. Meanwhile, the two giants’ managed floating exchange-rate policies have been broadly similar as they both faced tariff reform gradually, seeking to use the exchange rate as a critical tool for encouraging exports. Both had success in the 2000s in maintaining a favourable real effective exchange rates for exports, although China’s stance provided better incentives for exporters.
China has been adept at using FTAs to deepen regional production networks, with increased competitiveness in export manufacturing as a result of a policy of trade openness that began in the 1970s. China has long pursued a strategy of using FTAs to link its economy with those of Hong Kong, China; Macao, China; and Taipei,China – with dividends that are being realised today. For example, while the Apple iPhone was developed in the US, its various components from suppliers around the world are assembled in a factory in Shenzen that is owned by a firm based in Taipei,China.
China is also integrating its economy with those in neighbouring Association of Southeast Asian Nations (ASEAN) through an FTA that has begun to reduce or eliminate tariffs on trade in goods (2005), trade in services (2007), and investment (date of implementation currently under negotiation). China seeks to benefit from free trade with ASEAN members by expanding its regional production networks to support additional export-led growth. And China now wants a Shanghai Cooperation Organization FTA to facilitate access to raw materials and energy supplies for its global factory.
India too has pursued the use of FTAs to expand trade regionally and globally. However, India’s initial FTA strategy focused on expanding South-South trade, possibly at the expense of maximising efficiency gains from free trade in general. More recently, India has moved toward expanding market access to major developed countries and East Asia. Indeed, with the prospect of slower growth in major industrial economies, closer India–East Asia economic relations can bring mutually beneficial gains and prosperity in the future.
While India’s working age population is expected to grow by an astonishing 136 million over the next 10 years, China will add a relatively modest 23 million new workers. India’s huge increase in the working-age population is perhaps a mixed blessing. India’s literacy rate of 63%, compared with a rate of 93% in China, suggests that the country may face an imbalance of low-skilled and high-skilled workers just as the knowledge sector of its economy is poised for continued rapid expansion. As Table 2 shows, China allocates significantly more resources than India to infrastructure and R&D, both key determinants of future trade and growth. Estimates by McKinsey, a consulting firm, suggest that just to keep pace with its rapidly growing urban population India will need to spend $1.2 trillion on urban infrastructure over the next 20 years, or eight times its current rate of spending.
Both Asian giants have a solid foundation for continued rapid economic growth. Growth in both countries will be driven by exports comprising increasing amounts of medium- and high-tech manufactures, as well as services. India has made great strides in reforms in recent years. Yet China’s economic policies, investment climate, and supply-side conditions remain more favourable than India’s. Accordingly, China’s trade will likely continue growing more rapidly than India’s in the decade ahead.
India has scope for closing the gap in trade performance with China by enhancing supply-side measures, such as investing in infrastructure, boosting literacy and skill creation, and fostering industrial R&D. Continuing with economic reforms and regionalism in both giants can also help sustain trade performance.
Many uncertainties and challenges lie ahead which will impinge on the giant’s trade. These include unexpected internal events, external demand shocks, protectionism, and macroeconomic issues, to name a few. How each giant tackles these issues will ultimately determine their growth and trade performance in the next decade.
Ganeshan Wignaraja is a Principal Economist at the Asian Development Bank’s Office of Regional Economic Integration. He also represents ADB on the WTO Director-General’s Advisory Group on Aid for Trade.
Bardhan, P (2010), Awakening the Giants: Feet of Clay, Princeton University Press.
Kowalski, P (2010), “China and India: A Tale of Two Trade Integration Approaches” in B Eichengreen, P Gupta and R Kumar (eds.), Emerging Giants: China and India in the World Economy, Oxford University Press.
Winters, A and S Yusuf (eds.) (2007), Dancing with the Giants: China, India and the Global Economy, World Bank.
Wignaraja, G (2011), “Economic Reforms, Regionalism and Exports: Comparing China and India”, East-West Center, Policy Studies No. 60.