Turbulence in two expanding Asian economies - China and India

A stock price board at a Beijing securities house. China needs to evolve to an economy not dependent on exports and low domestic wages. India must find other engines of modernization than new information technologies.
A stock price board at a Beijing securities house. China needs to evolve to an economy not dependent on exports and low domestic wages. India must find other engines of modernization than new information technologies. (ANDY WONG / Associated Press)
Posted: August 21, 2011

Jaswant Singh

is a former finance, foreign, and defense minister of India

India's democratic credentials do not impress Francis Fukuyama, who two decades ago prophesied the "end of history" as being a catalyst for the country's economic growth. Fukuyama, an American political scientist, finds excessive "patronage politics and fractiousness" in India - in stark contrast to China's speedier, though not necessarily cleaner, political system.

The reality is, however, somewhat different.

China's local governments have been accumulating mountains of debt to finance their construction binges, raising concerns about potential defaults. Premier Wen Jiabao himself recognizes the urgent need to address the country's inequitable growth, and thus to reduce the widening gaps between "rich and poor, cities and countryside."

Economist Nouriel Roubini predicts that China's economy will slow sometime between 2013 and 2015, when its fixed-asset investments of nearly 50 percent of GDP will demand social and monetary returns. Until now, says Roubini, who predicted the global financial crisis, China's export-led growth has depended on "making things that the rest of the world wants, at a price that no other country can match," a consequence of cheap labor and economies of scale. This cost advantage is diminishing fast.

India is facing severe difficulties as well. For example, outward investment by Indian companies is expanding fast. Some believe that this is a natural development for a rising power, but critics view outward investment as a reflection of the scarcity of opportunities at home.

Rising interest rates, high inflation, and policy gridlock amid a spate of government corruption scandals have impeded foreign and domestic investment, slowing economic growth to a level that is below its potential. An unpredictable regulatory environment, inadequate infrastructure, and a sluggish, monsoon-dependent agricultural sector add to the problems.

Clearly, economic turbulence is roiling both of Asia's major economies. Consider inflation. On July 6, the People's Bank of China raised its benchmark interest rate for the fifth time since October. This has generated apprehension about property markets, and fear that local governments could default on part of their staggering debt of $1.65 trillion.

In India, the government's failure to contain rising prices, pursue structural economic reforms vigorously, attract foreign direct investment, advance infrastructure development, manage expenditure, and avoid liquidity crunches underscores the many challenges it faces. Moreover, a continued standoff between the government and the opposition has weakened political effectiveness, further undermining growth prospects.

Indeed, India's core challenge remains political. With food prices rising sharply, the poor are being hit the hardest, fueling greater poverty, inequality, and resentment. But the same is true in China: Anti-inflation protests are now roiling both countries, owing mainly to rising energy, food, and raw-material prices, with food accounting for one-third of household spending in China and about 45 percent in India.

The fear now in both countries is that inflation shocks could turn into a self-reinforcing price spiral. As the IMF cautions, "Core inflation - excluding commodities - has risen from 2 percent to 3.75 percent, suggesting that inflation is broadening."

One reason that Indian prices are rising is that infrastructure growth remains sluggish. Progress on roads, railways, and power projects - all of which could prevent food from perishing prematurely, and energy and commodities from being unnecessarily wasted - is essential to stabilizing prices.

China, meanwhile, finds itself at a critical juncture. Its leadership will change next year - at a time when income inequality is on the march and the party lacks any consensus on how to stop it. In the absence of serious political reform, income inequality will widen as crony capitalism sinks its roots more deeply.

India and China both need a renewed commitment to structural reform to sustain economic growth. Cheap labor and monetary management will not do the trick on their own.

What both countries need are short-term corrections and long-term structural changes. China needs to prepare itself for an economy whose performance is not dependent on exports and low domestic wages. India must find other drivers of economic modernization than new information technologies. Workers in both countries are now demanding better living standards - a demand that even China's tightly controlled political system cannot ignore.

India needs to open up its economy further to take advantage of its rapid population growth and the changes in the structure of the global economy. It must recommit itself to feeding its population - attaining its stated objective of a "Second Green Revolution" in agriculture.

China and India have used very different political models to achieve their ambitious GDP-growth targets. Nonetheless, as their economies mature, both will need to embrace structural change - and to address the challenges of overdue political reforms.

This article was distributed

by Project Syndicate.

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