The Indian Economy Blog

August 27, 2005

How does China do it? Hint: Not free-market economics

Filed under: Growth,Politics,Regulatory reforms — Amitabh @ 11:55 am

Much as I am in sympathty with the generally libertarian outlook of this blog, I am not sure that a laisse-faire (free markets, enforce property rights etc.) gurantees quick economic growth. Take China and India. In China, the state is very actively involved in economic activity-from building infrastructure to an active industrial policy. Yes, inefficiencies abound as measured by private return on capital, but I would happily take ‘inefficient’ 10% growth over India’s ‘effeicient’ 7%. And there is no convergence in growth yet. Chinese per-capita GDP is twice that of India and growing faster than India. BTW, china has all the problems we bemoan in India – lack of property rights, inflexible labor rules and, of course, a worse financial system.

The difference mainly is that China invests a lot. China invests 40% of its GDP compared to 25% in India. Even though capital is better deployed in India, there is so much more to go around in China that it produces fatser growth. We can either be purists and wait for the private sector to build infrastructure. Or we can stomach some inefficiency and have the state build roads. ports, irrigation canals, power plants. Ultimately, raising capital-labor ratios is the best guarantee of growth and improved incomes.

6 Comments »

  1. [...] ies the difference Posted in Economics at 11:12 pm by Patrix Amitabh Arora has a solid reason to explain the difference i [...]

    Pingback by DesiPundit » Therein lies the difference — August 27, 2005 @ 11:13 pm

  2. More analysis on China’s economy

    Here are several recent newspaper articles and blog posts on China that are worth a look: * Will Hutton writes in Saturday’s Guardian on how China’s poorest will suffer if the self-defeating trade war on textile imports is allowed to continue. * Robe…

    Trackback by New Economist — August 28, 2005 @ 1:18 pm

  3. I am not an expert in the Chinese economy by any means but I could guess what the Chinese are doing right and the Indians are doing wrong. The Chinese, being socialist in nature, probably invest heavily in public goods. And they probably target the right public goods to invest in; i.e. the ones that give the best return on investment. They probably invest heavily in their cities and make them compatible with technological growth. That means having sufficient electical capacity for industry, enough sewage capacity for an expanding city population, etc.

    It seems to me that India underinvests in its cities and in other public goods (like railroad, roads, etc) that could be good compliments to production. In other words, China Inc. is just better at business than India Inc.

    But I would still bet that China will encounter some serious problems down the road.

    Comment by Michael H. — August 28, 2005 @ 4:38 pm

  4. The first lesson for India from China’s experience is to privatize and let market forces work more. China has sold several hundred thousand companies, of all sizes, in the last decade in order to get the state out of the market, while keeping ownership of several hundred bigger ones (which it will eventually have to sell). China also allows more competition, both domestically and from abroad, into most of its markets than does India. The lesson for India is to raise competition and to get government out of the business of producing things that the private sector can produce.

    The second lesson for India is to improve government spending, shifting from subsidies into investment. The private sector cannot provide public goods like rural roads or canals. The problem in India is that the government spends more on rural subsidies than on rural investment. The states spend more on electricity subsidies than on investment in the grid. China does not. That is the lesson for India, not to stop with liberalization but to complement more privatization with a redirection of public spending.

    Comment by Blue Sky — August 29, 2005 @ 10:27 am

  5. There’s an element of straw man here. India is nowhere close to being a laissez faire economy. You can’t compare two mixed economies and state that you’re unsure about laissez faire guaranteeing quick economic growth.

    So what is India doing wrong? Too much regulation and too little economic freedom. We’ve seen dramatic changes whenever economic freedom has increased. There’s a hell of a lot of data collected now for nearly 30 years, all around the world. Check out the Economic Freedom of the World: 2004 Annual Report

    This powerpoint presentation has a good intro. Especially look at the slides on Economic Freedom and Per Capita Income; Economic Freedom and Economic Growth; and Economic Freedom and the Income Level of the Poorest 10% of the Population.

    Freetheworld.com has the whole dataset for those wishing to delve deeper.

    Comment by Yazad — August 31, 2005 @ 5:53 am

  6. Yazad, this “economic freedom” ranking that CATO put together has Singapore ranked second so I am not sure how meaningful it could possibly be.

    Still, granting the list for the sake of argument, I’ve noticed that India enjoys more “economic freedom” than China which would seem to support Amitabh’s point.

    Comment by Walker — September 1, 2005 @ 9:26 pm

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