Things That India Can Learn From China

What is it that China has and India does not? “In China, there is a very clear set of objectives. They ask, “What are the binding constraints on our growth?” and focus on them. In India, when I ask a group of elites what the priorities for the 12th Five Year Plan are? Silence. And then a very long explanation about how we have to do all these things and have all these things running and maybe something will happen,” says Wendy Dobson, one of Canada’s leading economists. Dobson is the author of Gravity Shift: How Asia’s New Economic Powerhouse will Shape the Twenty-first Century and co-director of the Institute for International Business in the University of Toronto’s Rotman School of Management. Recently she had been interviewed by DNA Money. Excerpts from what she has said is given below with necessary modifications

Can you take us through how China, from being a communist economy, became what it is today? They are still a communist country, but they are probably more capitalist than the capitalist themselves.

Wild west capitalism. Essentially there was a demographic crisis. After the Cultural Revolution, production was very low because of all the disorder and the population was growing. They were outstripping the production. That was great trouble.

Den Xiaoping, to his credit, was curious as well as ambitious. He looked at what was going on in Korea, in Japan, in Taiwan. And said why are they doing better than us? That was part of the opening up to allow the diaspora to come in.

At the same time, experiments in which agricultural collectives were given to individual farmers to manage and they were allowed to pocket the proceeds from selling whatever they could produce over and above government quotas and taxes, were on. With the introduction of such incentives, production increased dramatically.

I have a picture on my wall of peasants in China in 1978 as Lushan, a hilltop town in Jiangxi province. On a sunlit street, a small group of peasants dressed in heavily patched blue shirts and trousers are engaged in intense discussion. At their feet are an assortment of produce and carrying baskets, and they hold simple scales with which to weigh the produce they have brought to trade. They have little scrips in their hand and they were exchanging produce fro promissory notes and using those notes to buy fertilizer or toothpaste. This was a market – hitherto banned since the founding of the People’s Republic of China in 1949. It just happened that the communist party boss in that province said, “Let this go on and see what happens.” He was promoted in one of the changes of leadership and he rolled out what became the change in arrangement that built on innovations.

So that is how it all started?

Yes. They realized that if we can do this in agriculture, let’s try this in industry as well. Hey set up special economic zones (SEZs) and found that yes, they are very attractive to foreign investors. And that one thing led to another. In the late 1990s, they realized that the state-owned production wasn’t working. They had a two-track system and basically concluded that the market system works better than the state-owned system. So they went through what was a very risky restructuring of the state-owned system. And the wheels almost came off. There were millions of people laid off as they closed down the small state-owned enterprises in rural areas. They closed the least efficient of these money-losing propositions; merged others into some of these huge state conglomerates that we see today. Those days, the state sector is only about 25% of industrial production. Non-state – private and hybrid sets of ownership – accounts for well over 75%.

What are the main reasons behind them being able to grow at such a fast rate?

It is the changes in institutions – from repressive ones where the government controlled everything to government withdrawing and freeing up large parts of the economy but keeping political control. The change in the use of land from agriculture to industrial areas, housing around the cities, huge investments in infrastructure, etc. at the same time, it was lubricated by huge capital inflows. There was also a transformation of industrial production to a very heavy emphasis on labour-intensive manufacturing. Those are the sources of growth.

China has allowed labour market flexibility where people can move even though there is a household registration system that denies them rights to social services when they move from the countryside to the city. There is a big debate going on right now that they have to remove that household responsibility system so that people can move freely like they in India. But beyond that, people can seek jobs at prevailing wages and employers can build up a labour force and adjust the labour forces if they need to. The flexibility in China’s labour markets has pulled tens of millions of people out of subsistence agriculture.

But there is a line that you cannot cross inter-bank China, everybody knows that. You don’t criticize the party. You don’t call for the downfall of the party or the public security people turn up and engage you one way or another. The party knows that it needs to create million jobs a year, preferably in the urban areas, moving people living in the rural areas of China into the urban areas or allowing villages and tows to grow into urban areas. That has led to all sorts of disturbances and protests because land is still owned by the state. So farmers have had to give it up without question and take whatever compensation is offered. But what’s interesting is Beijing is listening to them.

It is interesting that you mention the communist party. I was listening to a presentation made by an Indian bureaucrat five months back and he was trying to make a comparison between China and India on the infrastructure side. And he concluded by saying “India has democracy, China has everything else.” Would you agree with something like that?

No, I don’t. And as I write in the book, India has all the institutions that China does not. But they don’t work. India is in a sort of gridlock. At the very top, India has absolutely first-rate managers. But in China, there is a very clear set of objectives. They ask, “What are the binding constraints on our growth?” and focus on them. This is despite the fact that there are all sorts of vested interests in China. Like is the case dealing with rebalancing that they are talking about where they will rely less on export-led growth and more on domestic demand and imports. Now that is creeping along in incremental Indian fashion because there are vested interests. But everybody knows what the priorities are. In India, when I ask, as I did yesterday, of a group of elites what are the priorities for the 12th Five Year Plan, there’s silence. Silence. And then a very long explanation about how we have to do all these things and have all these things running and maybe something will happen.

That is a very interesting comparison.

An outsider looks at it and says; surely the labour market rigidities in India trap hundreds of millions in subsistence agriculture. If there is one lesson to learn, it’s focusing on that binding constraint in the way the Chinese did. I talked to Kaushik Basu who wrote Chater-2 of the Economic Survey where there are actually three paragraphs on labour market institutions. And when I read it, I asked people, who wrote such wonderful economic prose? They said it was Kaushik Basu. And when I met him, he said yes. But he said it was almost removed. And all he is saying is that we should have a debate in India. We should have discourse on this issue what to do about labour market reform. Nobody wants to talk about it because they will be labeled anti-poor. And if there is ever an anti-poor policy that I have seen, this is it.

Restrictive labour laws are not unique to India. They exist in Italy, and in Brazil, to some extent in South Africa. And they are anti-poor because they prevent demand from blossoming.

China till now has primarily been an export-driven economy for a while.

Not entirely. What drives growth in China? Investment in infrastructure and manufacturing capacity for exports. Consumption has been declining as a share of GDP because that investment and government spending on infrastructure mainly has been so dynamic. They have been investing almost 50% of their GDP. The reason for that is because capital is very cheap. Their financial system is basically run by the state council, the chief administrative authority. Interest rates are set by the state council. They have kept rates low for a very long time. And so capital has been cheap.

Energy has been cheap because it has been subsidized. Not unusual to China. Labour has been cheap. Land has been cheap, owned by the state, and all sorts of shenanigans have been used to bring land into industrial production. This is all unsustainable. This means manufacturers in China who run on razor-thin profit margins are going to look for other sites. And it’s a huge opportunity for India because you have got abundance of labour and, of course with the right policies. But in India there are 39,000 reasons, starting with labour laws, that can’t be changed because you will appear anti-poor.

This is from a recent column by the economist Bill Bonner. “There are about five times as many rivers in the US and five times as many cars…but China now has nearly as many bridges…three quarters as much road surface. But with easy credit, the connivance of local officials, and the blessing of the central government, it builds more.”

I agree.

I wouldn’t say that US is going to go broke. But I would say that they should be worrying about gradually declining interest in the dollar continuing to be the global reserve currency. As renminbi becomes more regionally used in Asia, if the Euro survives current stresses, we are gong to move into a world of several reserve currencies.

How long do you see this manufacturing-led growth continuing? I mean there are only so many numbers of bridges and roads that can be built. Or are they going the Japanese way, by building bridges to nowhere and so on……

There are all sorts of interest groups in the Liberal Democratic Party (LDP) which ruled Japan for 75 years before being booted out last year. There was an incentive system where, as long as construction companies were doing well, the election campaigns of LDP did well because they were financed by the firms who did the projects, the bridges to nowhere and so on.

In China, the local and municipal governments are well aware of that old saying about China – the mountains are high and the emperor is far away. So they are pursuing their own ambitions. They are evaluated every five years or so and get promoted or not according to what they did for growth. Lending has been directed with local governments having guaranteed loans for infrastructure. With lending almost doubling lat year, there will be all sorts of non-performing loans coming out that are guaranteed by local governments. So that again is a chicken that is going to come home to roost because eventually, it is a contingent liability at the Centre. And what will they do? That creates all sorts of incentives at the Centre to make reforms to raise the cost of capital because it has been too cheap and has been wasted.

China is largely a stimulus story. Their stimulus last year as a percentage of GDP was the biggest in the world, four times the size of the US……..

But they can afford it.

Absolutely. But keeping this background in mind, and the fact that interest rates have been low, credit has been easy and the bank lending has almost doubled in the last one year. Do you think that there is a bubble there?

I think it’s possible. But I’m not a forecaster with all the data at the fingertips to say, yes it is a bubble. The work I have done in the financial system I feel more comfortable saying there will be new crop of non-performing loans and like they were half a decade back. These loans will be shuffled back into asset management corporations and the government will inject capital into the banks again. They can afford to do it.

If there are three things India can learn from China what can those be according to you?

I am tempted to say labour market reform, labour market reform, and labour market reform. I would say in general, the return to my remarks about at the very top you have got equally competent and knowledgeable and dedicated political leadership and administrators, but in India, you have got a lack of focus and perhaps for the leadership if they are more focused to bring about some large changes in the binding constraints.

Do you see that happening?

No….But that’s one of the lessons to learn.