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India Shining By: Vivek H. Dehejia
FrontPageMagazine.com | Wednesday, April 19, 2006


In their much-cited July/August 2003 Foreign Policy article, “Can India overtake China?”, economists Yasheng Huang and Tarun Khanna challenged an emerging orthodoxy by provocatively arguing that it could. While dismissed at the time by most analysts of the Asian scene, their argument is finding increasing adherents, as evidenced by the recent Asian Corporate Conference in Mumbai, organized by the Asia Society and the Wall Street Journal, and the Harvard Alumni Association’s New Delhi conference, both of which had sessions devoted to a comparison of growth prospects in India and China, in which the Huang-Khanna thesis was given much credence.

What are the sources of the conventional wisdom, and what accounts for its erosion? The conventional wisdom is spelled out easily enough. It is perhaps most succinctly summarized by Hugh Restall in the March 2006 issue of the Far Eastern Economic Review: “Authoritarian China excels at economic development because it can grasp the nettle of unpopular but necessary policies, while democratic India perpetually lags behind because its unwieldy system makes decisive action impossible.” Or, to put it more pithily, “In India everyone has a veto!”, as Arun Shourie, a minister in the previous government, complained of the slow pace of privatization of inefficient state-owned enterprises (or “disinvestment of sick public sector units”, in the Indian euphemism). This is an instance of a long-held view in development economics, that authoritarianism works better than democracy, at least in the early stages of modern economic development, because it better allows the state to mobilize the resources necessary for industrial take-off.

 

Casual empiricism would seem to accord with this conventional view. China has built an enviable infrastructure of roads, ports, airports, etc., and any visitor to Shanghai is immediately impressed by the modern superhighway, as good or better than any in the United States or Europe, that leads one from the glittering new airport to the gleaming skyscrapers of the special economic zones and downtown in a mere half-hour.

 

A visitor to Mumbai, by contrast, is confronted with a two-hour crawl from a creaky airport along traffic-congested, pothole-ridden roads that skirt some of the city’s worst shanty dwellings, until finally reaching the relative urbanity of the charmingly archaic colonial architecture of the city centre. The casual visitor might well be inclined to agree with Meghnad Desai’s dismissive claim that, while China may yet become a Great Power, India will be condemned to remain merely a Great Democracy.

 

Macroeconomic indicators seem to accord with this conventional view as well. Last year, China attracted nearly US$60 billion of foreign direct investment (FDI), India barely US$6 billion. Even recognizing that Chinese statistics are confounded by the problem of “round-tripping”, that is, investment flowing out of mainland China and returning as ostensible “foreign” investment to take advantage of preferential tax and regulatory treatment, and the fact that the majority of the “foreign” investment comes overseas Chinese from Hong Kong and Taiwan, making its definition as “foreign” questionable, a large gap remains. As many economists, rightly or wrongly, and foreign investors, rightly, take FDI as a summary indicator of economic progress, this would seem to provide further evidence in favour of the conventional view.

 

What, then, is the thrust of the Huang-Khanna-inspired contrarian view? Just that what is conventionally taken as signs of Chinese strength – high rates of FDI and domestic savings – are instead signs of weakness, of an economy with an inefficient financial system which cannot usefully canalize domestic savings into domestic entrepreneurship, and the consequent need to import capital and know-how from abroad.

 

Indeed, given the very high rates of investment, what is surprising is not how high the Chinese growth rate is, but rather how low it is! India, with inward investment a tenth of China, has achieved a growth rate in the range of 8 – 9 percent, whereas China has managed to squeeze only an extra percent or so of growth out of the cogs of the system – suggesting an incremental capital-output ratio (ICOR) inefficiently high in China compared to India.

 

A recent World Bank study reports an ICOR in China that has risen from 3.96 in the first half of the 1980s to 5.4 in the 2002. It would not be too much of an exaggeration to claim that China’s economic miracle is to have become a screwdriver-turning assembly economy for the developed world. The label “Made in China,” ubiquitous on the shelves of Western shopping malls, usually means “assembled in China from Western technology and capital by low-wage Chinese labour.”

 

Even more worrying for the long term is the inefficiency of the Chinese banking system, which is used to finance the soft budget constraints of state-owned enterprises. Even conservative, official estimates place the ratio of non-performing loans at about 25 percent of the total, but the true level is probably much higher, perhaps 40 percent or more. By any sensible standard of accounting, most Chinese banks are bankrupt. When these loans need to be recapitalized, the chickens may well come home to roost.

 

On the obverse side, the apparent weakness of India in attracting FDI reflects the strength of indigenous Indian entrepreneurship and the relative efficiency of the financial system, banks and the stock market alike. In India, growth is driven by domestic demand, and many of the new national champions, whether established business houses, such as the Tatas, or newcomers in the information technology field, such as Infosys, feature homegrown innovation and management.

 

Such is their success, in fact, that they are becoming internationally recognized brand names in their own right, and are growing through acquisitions abroad, including in the developed world. A trivial but telling example might be that the Pierre, New York’s premier hotel, is no longer the flagship of the Canadian Four Seasons group but, in fact, of Tata’s Taj Hotels group, whose own flagship, the Taj Mahal Palace Hotel in Mumbai, was built as a proud testament to indigenous entrepreneurship over a century ago in the colonial era.

 

Much more can be written in this vein, but I turn, instead, to the issue with which I began, that of autocracy vs. democracy in the process of economic development. The conventional wisdom would suggest that China’s autocratic state, in which the Chinese Communist Party holds a monopoly on political power, and in which liberties and freedoms are curtailed, can better marshal resources on the “long march” towards economic progress than India’s fractious, tortuous, and “argumentative” (to use Amartya Sen’s felicitous expression) democratic polity, in which “everyone has a veto” and is willing to exercise it. I leave it to scholars of China to decide whether, in fact, the Communist leadership is as monolithic and single-minded in its devotion to economic progress as this (admittedly caricatured) portrayal would suggest, but my inclination would be that it is not, as evidenced by the large number of public demonstrations against the government (about 75,000, officially reported last year), which surely causes the authorities in Beijing some considerable unease at the very least and might induce them to temper the fiery pace of economic reform if only in the interest of self-preservation.

 

The more interesting question: is democracy detrimental to economic growth in India? Many intelligent and perceptive observers, such as the writer Gurcharan Das, argue or concede that it is. Das even goes so far as to quantify the "democratic deficit” (to take a phrase out of context), by suggesting that the one percent or so difference in the growth rate between India and China, which keeps India just below double digit growth of aggregate income, is the “cost” of democracy in India.

 

I should hasten to add that he in no way takes this as an argument against democracy, just as the economic price that must be paid for democracy and liberty which have intrinsic value independent of economic growth. The Economist, typically, puts it most succinctly, in its much-cited comparative survey of March 5th, 2005: “A proudly democratic India that grows at 6% a year … should be congratulated for having succeeded better than a brutal anti-democratic China which grows at 10% a year.” (The actual gap is now only about a percent or so, but never mind.) Only the concluding “Amen” is missing from the homily.

 

This proposition is difficult to disagree with, but in my judgment it concedes too much. It is salutary to remember the classical liberal dictum best enunciated in the last century by Friedrich von Hayek and Milton Friedman, that economic freedom and political freedom are inextricably linked. Try to have the one without the other for very long and you do so at your peril. Cynics might sneer that this is yet another instance of the liberal fallacy (“that all good things go together”, in Jagdish Bhagwati’s witty turn of phrase), but the jury is as yet out on its importance in the Sino-Indian comparative context.

 

Certainly, it is difficult to see how the Communist Party will be able to maintain its iron grip on the levers of state power in China as it confronts the reality of a newly risen bourgeoisie. Leaving that aside, it is evident in the case of India that democracy, far from being a brake, is a lubricant that keeps the economic (and social) machine turning. Or, to further mix mechanical metaphors, democracy serves as a safety valve through which putative losers of reform can make their voices heard, obviating the need to take to the streets or subscribe to various religions, the only apparent acts of protest open to Chinese opponents of the regime (apart, of course, from exile or imprisonment).

 

Consider as a case study the 2004 general election in India. The economy was booming, and a confident Bharatiya Janata Party (BJP), which headed the National Democratic Alliance coalition, campaigned certain of victory with the triumphal election slogan, “India Shining”. Everyone, including the Indian National Congress Party, then in opposition, expected an easy re-election victory for the BJP. Even senior Congressmen sat the election out, so certain were they of the outcome.

 

Going against the grain, Jairam Ramesh, senior Congress Party political strategist, crafted an election strategy aimed at the rural masses who had been left out of the economic boom centred mainly in the major metropolitan areas. As charismatically delivered by Congress Party leader Sonia Gandhi, the campaign message, that economic growth must engage and embrace those who had been left out, largely the downtrodden and lower caste rural population, and not just further enrich the existing upper caste urban elite, struck a resonant chord. It is also struck a blindspot of the BJP, whose political base was mainly the very upper caste urban elite who were beneficiaries of the economic liberalization.

 

The election results were stunning, not least for the Congress: they were swept back into power, and the BJP were out. “India Shining” had badly backfired. The new coalition, called the United Progressive Alliance, headed by the Congress, embedded the winning campaign platform in the National Common Minimum Programme, authored by Jairam Ramesh, and overseen by a National Advisory Council that reported to the Prime Minister and the Union Cabinet.

 

In the two years since the Congress victory, economic reform, far from stalling, as some had feared, has been reinvigorated, and provided a broader political base, as it has attempted to economically enfranchise the heretofore neglected rural base of the economy, with a new emphasis on rural employment, investment in primary education and health, and an attempt to strike a balance between growth and equity that had, perhaps, been forgotten in the early heady days of economic liberalization. In the bargain, India is on track to maintain a growth rate of 8 percent, accelerating perhaps to 10 percent in the coming years as necessary investments in infrastructure begin to yield dividends.

This is, perforce, a narrative, as yet unfinished, rather than a clinching analytical argument, but such is the nature of social, including economic, phenomena, and it may yet be overturned by future events. But it does indicate that democracy, far from being a hindrance, is a handmaiden of economic development, at least in the Indian case. Ironically, India is shining after all.

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Vivek H. Dehejia is an Associate Professor of Economics at Carleton University in Ottawa, Canada, and a Research Fellow at CESifo in Munich, Germany.


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