What China Can Learn from India

Yasheng Huang from the MIT Sloan School of Management says China could learn a thing or two from India about economic development. He believes India will outperform China in the next few decades unless "China embarks on bold institutional reforms":

China could learn from India’s slow and quiet rise, by Yasheng Huang, Financial Times: In an article published in 2003 called “Can India overtake China?” Tarun Khanna of Harvard Business School and I argued that India’s domestic corporate sector – strengthened by the country’s rule of law, its democratic processes and relatively healthy financial system – was a source of substantial competitive advantage over China. At that time, the notion that India might be more competitive than China was greeted with wide derision.

Two years later, India appears to have permanently broken out of its leisurely “Hindu rate of growth” ... and its performance is beginning to approach the east Asian level. ... More impressively, India is achieving this result with just half of China’s level of domestic investment in new factories and equipment, and only 10 per cent of China’s foreign direct investment. ...

Why, then, is India gaining strength? Economists and analysts have habitually derided India’s inability to attract FDI. This single-minded obsession with FDI is as strange as it is harmful. Academic studies have not produced convincing evidence that FDI is the best path to economic development compared with responsible economic policies, investment in education and sound legal and financial institutions.

An economic litmus test is not whether a country can attract a lot of FDI but whether it has a business environment that nurtures entrepreneurship, supports healthy competition and is relatively free of heavy handed political intervention. In this regard, India has done a better job than China. From India emerged a group of world-class companies... This did not happen by accident.

Although it has many flaws, India’s financial system did not discriminate against small private companies the way the Chinese financial system did. Infosys benefited from this system. ... It is unimaginable that a Chinese bank would lend to a Chinese equivalent of an Infosys. With few exceptions, the world-class manufacturing facilities for which China is famous are products of FDI, not of indigenous Chinese companies. ...

Pessimism about India has often been proved wrong. Take, for example, the view that India lacks Chinese-level infrastructure and therefore cannot compete with China. This is another “China myth” – that the country grew thanks largely to its heavy investment in infrastructure. ... China built its infrastructure after – rather than before – many years of economic growth and accumulation of financial resources. The “China miracle” happened not because it had glittering skyscrapers and modern highways but because bold economic liberalisation and institutional reforms – especially agricultural reforms in the early 1980s – created competition and nurtured private entrepreneurship.

For both China and India, there is a hidden downside in the obsession with building world-class infrastructure. As developing countries, if they invest more in infrastructure, they invest less in other things. Typically, basic education, especially in rural areas, falls victim to massive investment projects... China made a costly mistake in the 1990s: it created many world-class facilities, but badly under-invested in education. Chinese researchers reveal that a staggering percentage of rural children could not finish secondary education. India, meanwhile, has quietly but persistently improved its ­educational provisions, especially in the rural areas. For sustainable ­economic development, the quality and quantity of human capital will matter far more than those of physical capital. ...

Unless China embarks on bold institutional reforms, India may very well outperform it in the next 20 years. But, hopefully, the biggest beneficiary of the rise of India will be China itself. It will be forced to examine the imperfections of its own economic model ... China was light years ahead of India in economic liberalisation in the 1980s. Today it lags behind in critical aspects, such as reform that would permit more foreign investment and domestic private entry in the financial sector. The time to act is now.

Update - New Economist adds:

MIT's Yasheng Huang writes ... that China could learn from India's slow and quiet rise ... Huang's claims are, I think, exaggerated - India's poor infrastructure is a problem, and its education system has major shortcomings. Nonetheless, it is refreshing to read a piece these days that doesn't extoll the virtues of China, and which demonstrates that "pessimism about India has often been proved wrong"