In 1950 both China and India were rebuilding their economies after a long period of war and unrest. Both independent, one communist and the other democratic. India was in much better shape, the largest economy in Asia, with a relatively sophisticated economic system. China went its own way, plunging into the chaotic and destructive Cultural Revolution and the Great Leap Forward.
By 1978, after the death of Mao, it was an economy going nowhere with a bloated population and great poverty. India had turned its back on its long history of capitalism and adopted a socialist economic model with state control. It grew only around 3.5% per year, with a population growing at 2.5% unable to tackle its challenges while it watched the miracle growth of Japan, Germany and South East India. With government control, increasing corruption and increasing civil dissatisfaction it too was going nowhere.
In 1978, China opened up, inviting foreign capital, promoting its coastal areas for investment, freeing agriculture from state control, introducing a one child policy and investing in infrastructure. Today, it is a $12.5 trillion economy, the second largest in the world and at $22.5 trillion in PPP, the largest economy. India opened up in 1991 after an economic crisis, grew impressively in dollar terms at 8.8% per annum and is today a $2.5 trillion economy, way behind China.
What are the lessons from China’s growth for India?
China first focused on investment in labour intensive industries to create jobs for its huge labour force, in textiles, garments, toys, light engineering and assembly, electronics, etc. It created special economic zones, whole districts next to the coast with different laws for business. The massive increase in employment created the resources from increased consumption and taxes to invest in infrastructure. It enabled the growth of large firms which could invest. Its banks lent freely to state owned enterprises too. China had a decentralised economic model, where the provinces made many economic decisions, granted incentives, marketed themselves and nurtured industries, with almost no red tape. The key target was job creation. China invested massively in skill development and in her universities. It created very many new cities, promoted urbanisation and benefited immensely.
China soon attracted over $1.5 trillion of FDI, becoming the factory of the world, the largest global importer and exporter and through mercantilist policies created a foreign currency kitty of over $4 trillion and managed its currency to keep its advantage. It used a sophisticated supply chain through Hong Kong to dominate global trade. It shifted over 400 m people from the land to the city and factories. It now boasts of some of the most sophisticated industries.
India incentivised capital intensive industries through its incentives and tax subsidies and discouraged job creation. Today industry pays an effective tax rate of 25% in corporate tax, while services sector pays 30%. It discriminated against large companies, reserving goods for the MSME. Its labour policies inhibit hiring and job creation. Labour intensive industries like garments suffer from excessive tax and regulations and over the last 25 years, India’s labour intensive industries declined globally, whereas it had all the resources to dominate the world.
India did not invest adequately in infrastructure—only 4.7% of GDP, where the need was 6.5%. China over invested at 8.7%, while it needed only 6.5%. As a result, India’s supply chain costs are at 14% of GDP, creating a high cost uncompetitive economy, while China is at 6%, creating a competitive low cost economy. The recent GST will remedy it somewhat, but huge investment in infrastructure is needed. India did not invest in her cities, discouraged urban planning, depriving her cities of autonomy and good governance, creating an urban crisis. It championed the romantic notion of rural villages, failing to understand that rapid urbanisation was the future.
The lessons for India are very clear.
Incentivise and increase investment in labour intensive industries to create more jobs. Remove restrictive labour regulations to increase job creation. Allow firms to grow faster in all areas by de-reserving goods for MSME and making them grow bigger. Reduce corporate taxes to 25% for all to increase internal generation of resources and reduce capital intensity by reducing depreciation rates. Incentivise job creation by special tax breaks. Increase investment in infrastructure to at least 6.5% of GDP, release investment resources by divestment in state owned mature infrastructure assets.
Improve productivity of ports, reduce power theft, improve speed on highways and in railways and reduce the cost of doing business by removing unnecessary regulations. Keep a level playing field between Indian business and FDI. Allow investment in education by the private sector to improve skills and human capital, grant full autonomy to the top 200 universities to increase innovation. Above all, invest in her cities including in new cities to promote rapid urbanisation, which could enable delivery of civic services to improve quality of life, give freedom to cities and towns to govern themselves and create new jobs.
China has many lessons for us. Their companies will dominate the world in future. India should learn from the Chinese success as it is the only country with a 1.3b+ population, which started off in 1950 with a similar economic and social structure and succeeded in dominating the world.
T.V. Mohandas Pai is Chairman, Aarin Capital Partners.