China’s reforms story: Lessons for India

The World bank released its Global Economic Prospect’s report on 10th January 2018. According to the report, India is expected to grow at 7.3% in 2018, and at 7.5% in 2019 and 2020. On the other hand, the report says that “Chinese growth is projected to edge down in 2018 to 6.4% percent as policies tighten, and average 6.3 % in 2019-20”. Since the last few years, India has been compared to China with the former purported to a be significant challenger to China’s influence in Asia, and perhaps the world politics by media pundits.

Let’s compare few vital numbers of both the economies:

What if I tell you that the Indian economy was at similar levels as China in 1978. India had a GDP of $135 billion, lagging not too behind China at $150 billion. However, China is currently a $11.2 trillion economy, five times bigger than India, which is at $2.3 trillion. So, what has led to this daunting gap between the two economies? The answer lies in understanding the Chinese vision and series of economic reforms undertaken over the last four decades to fulfil it.

Unfolding of the reforms story

The current phase of economic development in China was started in the year 1978 when Deng Xiaoping assumed power. The program of economic reforms, termed as “Socialism with Chinese characteristics” was carried out in two stages. The first stage, spanning over the 70s and 80s, involved decollectivization of agriculture, opening the country to FDI, and permission to entrepreneurs to start business. However, most of the industry remained state-owned. The second stage, in the late 80s and 90s, involved privatization of state-owned industry, lifting of price controls, protectionist policies, and regulations. The Chinese economy grew at approximately 10% each year for nearly three decades; an outstanding feat in itself.

China’s journey towards development started with agriculture…

During the pre-reform period, Chinese agricultural performance was extremely poor and food shortages were common. However, post 1978 agricultural output increased by 8.2% a year, compared with 2.7% in the pre-reform period, despite a decrease in the area of land used. Under the new policy, peasants were able to exercise formal control of their land as long as they sold a contracted portion of their crops to the government. Trade in agriculture was also liberalized and China became an exporter of food, a great contrast to its previous famines and shortages.

Today, China ranks first in worldwide farm output, primarily producing rice, wheat, potatoes, tomato, sorghum, peanuts, tea, millet, barley, cotton, oilseed and soybeans. Although accounting for only 10 percent of arable land worldwide, it produces food for 20 percent of the world’s population. This is despite the fact that agriculture sector’s share in GDP (see chart below) has fallen continuously over the last four decades.

Reforms which first began with the agriculture sector were later expanded to industrial sector

A dual-price system was introduced, in which state-owned industries were provided increased autonomy. By the 1990s, large-scale privatizations reduced the market share of both the township and village enterprises and state-owned enterprises and increased the private sector’s market share. The state sector’s share of industrial output dropped from 81% in 1980 to 15% in 2005. From virtually an industrial backwater in 1978, China is now the world’s biggest producer of concrete, steel, ships and textiles, and has the world’s largest automobile market.

Infrastructure is the backbone of a prosperous nation and China invested substantially to strengthen its own. China invested 8.5% of its GDP each year during the period 1992-2011– most of it on developing roads, power, and rail (see chart below). India spent 3.9% of its GDP on infrastructure during the same period. Today China boasts of the longest bridge in the world, Danyang–Kunshan Grand Bridge, spanning 165 km; longest high-speed rail network in the world, exceeding 25,000 km; and the biggest port in the world, the Shanghai port.

The service sector was also considerably liberalized after China joined the World Trade Organization

Foreign investment was allowed, while restrictions on retail, wholesale and distribution were withdrawn. Banking, financial services, insurance and telecommunications were also opened up to foreign investment. The service sector in China has increased from 24.6% in 1978 to more than 50% in 2016. China is aiming to get that number up to a 70-80%, the average for advanced countries.

Liberalization of economy with promotion of foreign direct investment greatly helped China in rapid development as it greatly increased quality, knowledge and standards, especially in heavy industry. During the last 20 years, there has been $2.9 trillion worth of FDI inflow in China, as compared to $404 billion in India. Also, the Chinese government focussed on export-oriented growth. Export as a % of GDP has increased from 14% in 1990 to nearly 36% in 2006. A major part of these exports has been high-technology exports – north of 25% of total exports.

The world’s factory – now a global force

Opening up of the nation to the world and adopting the institutions of a market economy has immensely benefited China. Today, China is considered to be the world’s factory with all kinds of goods, be it high technology goods like iPhones to children’s toys, being manufactured. Moreover, not just contract manufacturing for other countries’ products, China now has its own army of entrepreneurs who are beating the world’s behemoths in their own game. Amazon had to reluctantly accept defeat in China after having tried for years to turnaround its business started in 2004. Similarly, Uber had to retrace its steps from China in 2016 after pouring billions of dollars trying to snatch market share from the leader Didi Chuxing. Chinese companies like Alibaba and Tencent, having firmly established themselves in their domestic market, are making huge investments globally to compete in the world stage. The Chinese government is extending ample support to offer a conducive environment for entrepreneurship and innovation. China is quickly emerging as a hotbed for new technologies and areas such as Artificial Intelligence thanks to its talent, government support and venture capital funding.

Secret behind the success

Vision aided by a strong communist government…

The most important factor that explains the success of China’s economic reforms is a six-letter word – Vision.  Deng Xiaoping set out an economic vision which seemed astonishing – a 70-year policy to transform China into an advanced economy. “We give ourselves 20 years,” Deng said then, “from 1981 to the end of the century, to quadruple our GNP and achieve comparative prosperity. By the middle of the next century we hope to reach the level of the moderately developed countries”. Although, Deng left for heavenly abode in 1997, successive leaders have kept the torch alight.

A strong communist Government, having complete power, created the necessary infrastructure for rapid development. Internal incentives were provided within the Government, in which officials presiding over areas of high economic growth were more likely to be promoted. Local and provincial governments in China were hungry for investment and competed to reduce regulations and barriers to investment to boost economic growth and the officials’ own careers. A government official’s performance was evaluated based on the GDP growth in his province. This led to high rates of investments, especially increases in capital invested per worker, which contributed to China’s superior economic performance.

Deng’s legacy carried forward by Xi Jinping…

The vision set out by Deng Xiaoping was carried forward by successive leadesrs. The present Chinese president Xi Jinping presented his 2050 vision for China: To become a top innovative nation by 2035 and a nation with global influence by 2050 (read – to become a global superpower by 2050). The Belt and Road Initiative and introduction of Petro-Yuan assets are some of the most important steps being taken by Xi in line with these targets.

The Belt and Road Initiative (also known as One Belt One Road initiative) is a major part of Xi’s strategy to push China to take larger role in global affairs with a China centred trading network. By various estimates, this project is one of the largest infrastructure and investment mega-projects in history, covering more than 68 countries, equivalent to 65% of the world’s population and 40% of the global GDP as of 2017.

The Belt and Road initiative (6 land corridors and the maritime silk route)

China rolled out a yuan-denominated oil contract on the Shanghai stock exchange in March 2018 – one that could presage a huge shift in global energy markets and advance China’s quest to play a bigger role in the global economy. China’s ultimate goal is to translate its growing economic might into levers of real influence that come with having a globally used currency like the dollar today or the pound sterling in decades past.

What does India need

India has been clocking an average growth rate of 6.6% since 1991, when the economic liberalization in India started, however, it is nowhere close to where it should be. However, some very strong economic reforms have been undertaken since the present Narendra Modi led government came into power. Introduction of Goods and Service Tax (GST) was the biggest reform undertaken by the government which is expected to augur well for the long term growth of the country. Also, the significant push to infrastructure being provided by the government is expected to boost economic development. Further, reforms such as increasing FDI limits in sectors such as railways, insurance, defence, and retail would help in globalization of the economy.

Although, the Indian Government has been taking various steps to step up economic growth, there are some inherent issues in the political and economic structure of India that obstruct decisive policy making.

Direction from the top

India needs a strong government that sets a clear vision for next several decades. The pitfall of a democratic country – government constantly on its toes to woo public to stay in power – has held back policy making since long. The present BJP Government does have a strong and visionary leader in Narendra Modi, however, public elections in every five years do not allow any government to plan decisively for the present term itself, leave alone next few decades. We need to ensure that our democratic structure does not hold us back from growing. Multi-decades targets should be set for the nation with each elected government obligated to achieve those targets.

Promote innovation, encourage entrepreneurship and protect local companies

The global market is extremely competitive with companies from all countries eying to gain market share globally. China provided sufficient protection to its in-house companies in terms of financial and political support to scale up and aggressively compete with foreign players. In India too, we need similar support from the Government to incentivise entrepreneurship and support in scaling up and be competitive. Government also needs to promote innovation and technological development in the country. India has been left behind in the race towards innovation and high-end technological development. For example, in Information Technology we have been stuck behind as an outsourcing hub, rather than evolving as an innovation and technology development hub. India’s skilled force, renowned in the world for its intelligence, has been lost to other countries due to brain drain. The Government needs to vigorously develop Innovation and Technology hubs in India, akin the Silicon Valley in US, and highly incentivise to allow for inward flow of foreign investments, new technologies, and retain highly skilled workforce.

Decentralized economic model with incentives for local development

Although, India does have a decentralized model for governance, local leaders are less bothered to develop their local provinces. Elected representatives are more concerned with filling up their own coffers rather than the development of their constituencies. India ranks 81st among the most corrupt countries in the world as per Corruption Perception Index (CPI) ranking released by Transparency International. India’s score of 40 (A score of zero indicates a “highly corrupt” nation while 100 indicates a “very clean” one) is same as countries like Ghana, Morocco, and Turkey. When the Indian public stops voting based on caste and religion and elect their leaders based on their contributions to local development, it would go a long way in creating a progressive economy.

 

This blog post is penned by Anurag Roonwal, Investment Advisor, Moneybee Investment Advisors Private Limited. For more information call on +91 22 4030 2052 or email on anurag@moneybeeadvisors.com

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