The Growth Debate – China & India

The Growth Debate – China & India

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Written by Daniel Park

China and India are booming.  Superficially it is easy to be impressed.  We note that annual growth rates in Gross Domestic Product (GDP) have been sustained over the past few years at 8-10 per cent, sometimes even higher.  Analyses of China and India point to the major investment in education that is turning out many thousands of top-class engineers and scientists annually.  It seems that so many of our manufactured goods carry a “Made in China” label and that our call centre services are increasingly located in India.  The recent rises in energy and commodity prices are partly explained by the rapid growth in demand from China and India.  Moreover it seems to be assumed that this level of overall economic growth will continue indefinitely and that unless we in “The West” get involved in it, we will live to regret it.

This is, I believe, at best an incomplete perspective and at worst a dangerous one.

The two purposes of this White Paper are (i) to compare and contrast the high growth rates in the two countries and (ii) to assess the likely outcomes and impact.

The Nature Of Economic Growth

The first aspect of this is the significant difference in the nature and structure of growth in the two countries.  Growth measured in terms of GDP can be investment-driven and/or consumption driven.  In mature economies we can point to the balance between the two.  The majority of developed economies see investment at around 20-25% of GDP.  In the case of India, the investment share of GDP is slightly above average for the industrialised world. In China the position is very different, with investment accounting for over 40% of GDP sustained over the past 10 years or so.

The more relevant question in the case of China is as follows.  Given the high investment percentage within GDP growth, why is China not growing more quickly?  The key question in the case of India is different.  Given the major social and demographic changes that are being experienced, will India be able to manage the expansion of consumerism and retain a balanced structure of GDP growth without hampering investment in fixed capital formation and avoiding a growth in national, corporate and individual debt?

A substantial part of the answer to these questions is found by studying (a) the extensive versus the intensive pattern of economic development, to reach an understanding of what economists term “total factor productivity” and why it matters and (b) the tools and techniques available to government and industry/commerce to gain and sustain profitable growth at low risk.

“Extensive” Versus “Intensive” Patterns Of Growth

The extensive pattern of economic growth is based on continuously increasing resource inputs that are reflected in growing outputs allied to demand stimulation and demand management.

This works effectively, though not efficiently, (a) as long as resources are plentiful and (b) there is spare capacity throughout the productive system.  This type of growth has been described as a “ratchet” mechanism - if the top line goes up by 10 per cent, then everything contributing to it goes up by (at least) 10 per cent.

The essence of the intensive pattern of economic growth is that resource productivity increases along with growth in output and consumption and a greater rate - in other words there is a better than 1:1 relationship between growth in outputs compared with inputs.

This characterises developed economies throughout the world.  It is what drives greater efficiency in value-creating processes and, in modern times, greater production specialisation across national boundaries coupled with a high gross percentage of foreign trade (import and export) relative to GDP, even if the net trade balance does not alter much over time.

It was the “extensive” model of economic development that eventually finished off the Soviet Union despite belated attempts at macro- and micro-economic reform.   China still looks with horror on this rapid disintegration and has acted early enough to ensure that all but the most strategically sensitive industries are now to most intents and purposes private operations.  India has succeeded in abandoning its former addiction to Soviet-style planning early enough to avoid the worst damage. But there remains a massive deadweight of large-scale indigenous industry that is over-resourced, uncompetitive and sustained by the pressure of vested interests.  Merely changing the legal form from “state-owned” to “private” is nowhere near a solution.

There is, however, evidence that China is moving into a more intensive pattern of economic development, accelerated by a gradual move towards world prices for commodity inputs and other intermediate inputs together with market-based pricing allied to a market-rational internal cost of capital.  This is to ensure that high rates of economic growth can continue, driven increasingly by consumption relative to investment and based on more efficient resource utilisation.

What matters above all to a Western company is the quality of decisions made in respect of dealing with China and India as partners in increasingly global supply chains.

The Business Dimension

Though India has made well-publicised progress in technical and business education in the past twenty to thirty years, China has not held back.  Starting more recently, the level and pace of investment have been breathtaking.  However there are significant differences in the approach.  Whereas India has developed through its internal resources, China has undertaken rapid transfer of best practice and has adapted this quickly to the Chinese culture.  Additionally the spread of best practice has affected a very wide range of sectors of the economy.

The “Indian phenomenon” has been concentrated on engineering technology.  Hence we have seen the emergence of a very effective and internationally competitive software and I.T. community abound Bangalore, and it is often assumed that this is becoming typical of India.  It is not.  Much of Indian industry is still old-fashioned and, worse, it is stifled by a structure of bureaucratic management coupled with high levels of vertical integration that is over a century out-of-date.  Thank goodness labour costs remain low, because structures and management approaches are intrinsically uncompetitive in whole sectors of the economy.  Low labour cost is to a significant extent a compensator for systemic inefficiency, and the problem will come when labour rates begin to rise, as will naturally happen as the country becomes more developed.  Just as significant is the fact that the “Indian miracle” is manifest principally in product that can be delivered electronically rather than physical product.  It is in this latter type of product that the deadening impact of bureaucratic systems is found.  Any advantage of low cost for highly and non-so-highly skilled direct and indirect labour can quickly be outweighed by the transaction costs and delays incurred in operating through unresponsive, high-cost administrative systems.

Contrast China.  Theirs has been a much more holistic approach - an approach that fits so well with the philosophical and social traditions of the country.  What has happened here is that not only is there a major initiative in upgrading technical skills but also a set of programmes in transferring managerial systems and their associated competencies.  The Chinese have accepted that technology is only one dimension of international competitiveness, and that low labour cost is one more.  But these are effective only if the system as a whole meets best-in-class standards.  This does not always have to be “state-of-the-art”, but it should always be “state-of-the-market”.

Hence there has been a large-scale transfer of the best that the developed world has to offer.  Starting with the education of a top class of Chinese managers abroad - principally in the United States of America and Europe - and continuing with a similar programme of training trainers, one now finds replicas of top management development programmes in China ranging across many sectors of the economy.  Large-scale collaborative education and training ventures are found in all major Chinese centres.  This has rapidly resulted in the emergence of a new type of Chinese technocrat - (i) highly skilled in contemporary tools and techniques of logistics and supply chain management as well as in the basic technologies of product design, materials management, systems engineering, and in addition (ii) fully familiar with new concepts and practices in strategic management, international finance, global structures, partnerships/joint ventures.

The last skill mentioned above - partnership - is where the Chinese culture is particularly advantaged.  The Chinese have always been natural networkers: they networked for centuries and operated “extended” or “virtual” enterprises before we in the developed world claimed these as “advances” in management thinking!  Superimpose all this on to the modern structures of industry and commerce that are found in China’s new cities and special economic zones and the foundations of formidable competitiveness can be built provided that a more intensive approach to economic development can be achieved simultaneously.

It is misleading to think that there is some kind of “competition” between India and China as centres of outsourced activity.  Each will develop in its own way.  We need a note of caution in making assumptions based on well-publicised, but inherently superficial and partial, information claiming that the two growth rates are neck-and-neck and therefore there is a question of “who wins?”.

India will have to tackle the problem of bureaucracy - ask anyone who has operated there - and it will be a big issue as wage rates increase and eventually converge with world levels.  For its part China retains a huge and inefficient formerly state-owned sector of industry and commerce that is causing problems for the economy as a whole.  The best-publicised success stories come from the (atypical) new cities and special economic zones, which still constitute a minority of the total output economy but a major contributor of overall economic growth and added value.

Competitiveness depends on (a) a multiplicity of factors and (b) the ability to fuse these factors into an effective whole in competing for customers with increasingly global perspective, requirements and choice.  It is not enough to have the best qualified technical people in the business available at relatively low cost if the business cannot achieve fast response times and quick decision-making.  The diffusion of “know-what” and “know-how” is so fast nowadays that any technical advantage, whether this be through superior knowledge or low labour cost, cannot be sustained for long.  What matters is the achievement of a holistically superior business model. It is my contention that on balance India, despite its problems of bureaucracy and structure, is for the moment a little ahead of China in this, despite China’s being culturally more suited to the model, as stated earlier.

Compare And Contrast

Government policies in China and India have been very different in terms of the approach to generating growth.  The difference illustrates the importance of the consumer sector in a modern economy.

China has directed the massive investment percentage of GDP into the creation of industrial capacity, aimed substantially at export markets.  It is therefore vulnerable to downturns in global markets, particularly in the USA.  Significantly since 2004 China has commenced a slow re-orientation towards strengthening consumption in the home market relative to investment.  The savings rate in China has been exceptionally high, and the level of credit in relation to GDP has been very low by world standards.  The level of consumption had fallen to 38% of GDP by the end of 2005, just about the lowest level of any major world economy.  Coupled with this we note that the excess capacity generated by the high level of investment relative to consumption has resulted in overcapacity, stagnating or reducing prices, growing levels of unsold inventory and pressures on profitability.  Excessive construction and the reluctance of the majority of the population to draw down on savings have prompted falling prices in the property sector.  One economist has recently calculated that if personal consumption in China as a percentage of GDP had remained at its 1990 level it would be 30 per cent above current levels - a more rational balance in relation to other GDP components (Lardy 2006).  There is sufficient spare capacity and inventory backlog in China to enable consumption to rise significantly without resulting in price inflation.

India has followed a different path.  The major point of difference has come about as a result of demographic change.  The size of India’s middle class has quadrupled to almost 250 million people over the past 15-20 years.  Overall population growth has slowed considerably, with large gains in per capita income.  India’s demographics are beginning to resemble those of the developed West - a move away from a high birth rate, overpopulation and predominant poverty towards smaller families and increased average income.  There still remains, of course, a major issue of poverty and poor education.  If, however, one looks at the economy as a whole, as the current generation of potential baby boomers matures and the consumer sector of the economy continues to prosper, spending power and modern consumer behaviour look set to “trickle down” through the economy for decades.  The big issue in all this is that India has relied considerably on a combination of growing domestic market demand and investment in knowledge-intensive industry and services, which has meant that India has been to a great extent insulated from global downturns affecting physical trade.  Personal consumption accounts for just over 60 per cent of Indian GDP, making it increasingly comparable with a fully-developed Western economy.  Thus it has been argued (for example Das 2006) that India’s “boom” is intrinsically more durable than China’s, noting that China’s population is likely to peak around 2030, whereas India’s will continue to grow, on current projections, till about 2065.

Impact On European Companies

Both areas should figure in the thinking of Western companies.  They will be a source of new opportunity and new competition.

Growth in the mature economies of North America and Europe will be increasingly difficult to find for the majority of Western companies.  Value migration will continue to be a phenomenon of 21st century economics.  This means that activities enjoying a comparative advantage in an Asian location will migrate there simply because (a) it is logical that they should and (b) it is becoming easier and less costly to manage such activities as a result of increasingly widespread availability of low-cost technologies of doing business.

If we think how many products and services we now buy from companies that did not even exist a generation ago and how many of these companies are based substantially (if not headquartered) in Asia or the Indian subcontinent, the magnitude of this issue becomes clear.  Whether this constitutes an opportunity or threat is something that is under the control of existing management teams.  The combination of the WTO (despite its sometimes difficult processes and experiences) and facilitating technologies (especially information technology) ensures that opportunity and threat will increase simultaneously.

India will continue to develop as a market for increasingly sophisticated consumer goods and technical services.  It will be a natural location for production of the former for the domestic market and the latter for global markets that can be served by web-based distribution.  China will continue to be an attractive location for manufacture and re-export into the Asian region and world markets.  This will not be restricted to basic specification goods with a high labour content: there are world-class operations in China producing to standards that are comparable with any in the USA, Japan and Europe.

The Chinese domestic market will, however, open gradually as its middle class grows as a proportion of the total population.  Many luxury goods are now sold in the Chinese domestic market.  Consumer tastes and preferences, especially amongst younger people, are visibly converging with the developed world.

Where Next For Western Companies?

There are two dimensions that Western business has to consider in the Chinese and Indian elements of internationalisation and globalisation - the deals and the learning.

Some Western companies have been demonstrably successful in developing a balance of trade and investment.  Central government has tended to stick too long to the “export trade” model in the hope that this will retain jobs and contribute to added value in the face of evidence that the trade-to-investment balance has already changed considerably.  Deals are being struck increasingly through investment relative to export trade.  Where such a strategy is implemented, the result is not job loss but the creation of more skilled jobs back in the home market and net increase in labour earnings at the level of the domestic economy whilst participating fully in the opportunities presented by globalisation.

What comes next is more challenging and critical for economic and business development.  How will Western companies build on the second dimension - the learning - that has been part of this process?

Unless a strong base of “intellectual capital” is maintained, the West will come under increasing pressure, especially in manufacturing, from countries such as China and India.  It is not a question of direct labour cost, since direct labour in most of modern manufacturing accounts for a relatively low percentage of total cost.  It is the inflation in general operating cost that is the bigger problem.

Quite simply, in an increasingly global business environment Western companies will achieve success only by moving up the value-add chain.  In other words, low-skill transactional-type jobs and activity will migrate Eastwards simply because this is a rational consequence of ever-opening economies, and at the same time there will be a compensating increase in the demand for higher-skill services that are used in the creative configuration and rapid re-configuration of such services - predominantly in designing and managing internationally competitive supply chains.  Such supply chains are not restricted to materials and products: they include, inter alia, information and finance.  It is through competency in the management of high-skill value-adding activity that the future of Western business is to be developed if our companies, large and small, are to compete successfully in the global economy.

China And India As Part Of Global Economic Shift

Globalisation presents us with threats and opportunities simultaneously, and the growth of China and India is a significant factor in this.  Partly through the influences of GATT/WTO and partly through advances in technology, primarily information technology, most organisations have easier access to markets than in the past.  This means inevitably that our own regional markets are also open to increased competition.

However, the concept of globalisation goes further than the product/market dimension.  It includes questions relating to fluid organisations, capital structure and value migration.  It relates increasingly to labour supply and deployment.  Whereas globalisation was defined customarily in relation to physical trade, it now relates to multiple factor mobility.  Globalisation is therefore about developing or sourcing a set of competencies that enable an organisation to contest any market it chooses and to derive competitive advantage from any combination of value-creating activities.  Success in the future for Western companies will depend on continuing to develop the core competencies and technologies required to design and manage multi-factor supply chains that will give access to the most attractive product and service markets.

Summary Remarks

Against this background B2B International has opened an office in Beijing, China.  It has two main business thrusts: (i) to undertake market research for Chinese companies on the China market and (ii) to undertake market research for non-Chinese companies looking to enter the market directly or via collaborative venture.  The concepts of marketing and consequently of market research are still in their infancy in China, but the speed with which Chinese companies and managers are taking on board the tools and techniques that we take for granted is truly astounding.  It is also part of the impact of globalisation on the market research business itself - we are finding that an increasing part of our market research work is concerned with markets for investment and opportunities for sourcing and operational collaboration as well as with opportunities for exporting products to China.

This white paper is not written to present India and China as some kind of “either/or” opportunity or threat.  Indeed the opportunities and constraints presented by each market have led to a sizeable and growing incidence of trade along with greater scientific and investment linkages between the two countries themselves.  Not least, the experience of India in its gradual move away from a Soviet-style development path is of considerable interest to policymakers in Beijing itself, and we should expect, and not be surprised by, the increasing linkages that are now opening up between the two very different countries.