Comparing Economy Size Of India And China

Over the next twenty years, what is the likelihood that India will overtake China in terms of the size of its economy? Evaluate each economy using Khans economic rent analysis and one other analytical framework. Identity the factors driving economic growth in recent years and the social and political bases of these factors. Will they sustain themselves over the next several decades?

China and India are the two largest developing countries in the world and have both been experiencing rapid economic growth since the 1980s. With similar development strategies, the two economies have both insulated themselves from the world economy before eventually making the move to reform/liberalise (Srinivasan, 2002). Although, from similar economic backgrounds, the political environments of the two economies couldn’t be more different and could be argued as affecting particular drivers of economic growth. FDI levels are seen as an important determinant of both the growth and size of an economy and there are notable differences between the two and thus it is around this topic the analysis will focus (Wei, 2005). FDI has been shown to greatly contribute to China’s economic growth, in particular through a broad range of manufacturing activities. In comparison, India has attracted very little manufacturing FDI and instead any inward FDI has largely gone to services, electronic and computing industries (Huang and Khanna, 2003). This essay will argue that India is likely to overtake China in terms of the size of its economy in several decades and that India does not need to try to match Chinas levels of FDI due to the structure and composition of the economy, which reflect what it is, an international market niche (Balasubramanyam, Sapsford, 2007). In particular, the essay will begin by using Khans economic rents analysis to evaluate each economy before exploring the determinants of difference between China and India in market performance, including a look at the similarities and differences of both, and the advantages and disadvantages of investing in each in relation to the firm before drawing conclusions as to the future of these two emerging economies in the world market.

Rent is defined as “the portion of earnings in excess of the minimum amount needed to attract a worker to accept a particular job or a firm to enter a particular industry” (Milgrom and Roberts, 1992, p.269). The existence of rent in capital employed to a particular activity implies inefficiency in the processes of that activity however not in some cases where their existence is necessary. Rent may sometimes indeed be efficient and even essential in promoting economic growth and development. These complexities were not duly explored in older rents analysis’s such as: the competitive market model where no distinction was made between the minimum income that would be accepted (in terms of alternative comparison) and the minimum amount that would be realistically accepted before reciprocating with the goods service (Khan, 2000). Ultimately, previous models were unable to compare and explain the large differences in performance of countries.

Firstly, this essay will explore corruption as a rent and its consequential effect as a driver of economic growth. Corruption is defined as when “public officials break the law in pursuit of their private interest” (Khan, 2006 p.1), ultimately allowing the creation of rents. Several economists have stated a link between corruption and economic performance (Knack and Keefer, 1997) and this will be explored in the case of China and India. Often the powers given to public officials enable the ability or someone to bargain for bribes in “exchange for allocating rents to those who can pay for them” (Khan, 2006, p.5). The bribes in such a situation are illegal; however, the creation of such rents is seen as worth the risk, thus the incentive outweighs the risk. There are two drivers of corruption; the first is the need for a formal state so that the government can create legal rents, and secondly, is the formation of obstacles which results in people willing to pay money to access certain rents. Evidence suggests that corruption has a negative effect on society and in particular, China has a long history of corruption. Most recently, in 2000, Margolis noted that “corruption in china has rarely been worse or reached higher” (Margolis, 2000 p.1). Corruption in China is in many economists’ minds aiding the growth of such a large economy, and, due to its sheer size is difficult to regulate, however, measures are being taken to crack down on corruption due to increased tension between the state and the public. India reflects a similar story as with most developing nations that corruption is indeed widespread. However, corruption in India is lower than China and for many offers a more attractive host environment for international firms. India’s government have active responses to corruption and the results of such have seen India go down in rankings. Thus, using the rent of corruption, India’s economy could be said as being in a more politically stable mindset.

Furthermore, other rents as highlighted by Khan can be applied to provide a deeper analysis of both economies. Monopoly rents are dependent on the level of market competition and barriers to entry. Freedom of entry and exit would ensure no rents as if any player was gaining rents then other competitors would enter the fray thus driving down prices. Therefore net-social benefit would reach an optimal level, as would economic growth and efficiency. However, certain common phenomena such as economies of scale will always create the possibility for reduced cost structures and therefore a cost/price advantage for larger competitors who can resultantly monopolize markets and gain considerable rents. Although this is less prevalent in developing countries such as India and China with massive fragmentation of their markets due to disparity of consumer demographic types between geographic regions, it is more prevalent in China than in India since China have an emphasis on mass production thus supporting our conclusion. Conversely, the existence of natural resources rents signals efficiency and therefore their maximization would optimize net social benefit. This is because increased use and hence depletion of natural resources (for example: numbers of fish) would increase the difficulty and costs of tapping those resources. This would eventually reach a point where the cost is only exactly covered by the price due to the greater interest phenomena. Finally, rents based on transfers, in developed countries income from production is often lost through transfers, however, in developing countries these transfers can become the source of additional income and the basis for asset accumulation. As it is rarely the case that both parties in a transfer value the item equally the social welfare effect of this would be typically positive.

Schumpteranian rents are particularly salient as they regard the level of innovation within an economy, which has been pointed out by many scholars as a source of competitive advantage (Porter). Although innovations are economically beneficial they create rents for the entrepreneur who has created a massive competitive advantage. The optimal social benefit can therefore be reached through most rapid competitor innovation imitation. This is what would put India ahead of China as India has been shown to be seven years ahead of China in its ability to imitate new technologies (Huang and Khanna, 2003), and this is resultantly the main factor in the conclusion that can be made from the consultation of Khans economic rents analysis.

This essay will now move on to present the advantages of investing in both countries. The two emerging economies do share similarities which has lead to increased comparison, for example; both have large markets of one billion plus, and both have achieved high levels of growth in a short amount of time. On the basis of economic determinants China does better than India, but is this all that really matters? Chinas total and per capita GDP are higher and thus this makes it a more attractive location for market seeking FDI. Alongside this China reports higher levels of literacy compared to India, and thus is viewed as being able to provide a more skilled workforce and in turn this is attractive to efficiency seeking investors. However, there are advantages which cross between the two emerging economies. China has large natural resource endowments, in particular Chinas infrastructure makes it a more competitive place, particularly in richer parts of China on the coast. On the other hand, although China may have the advantage of natural resources and thus a greater potential for net social beneit in terms of natural resources rents (Khan, 2000), India is able to have an advantage over technical manpower in particular, in its skilled area of IT, India is able to provide the cheapest technically qualified manpower in the West however, a weakness arises in that India is yet to adopt a system of bulk production similar to China and therefore Chinas large domestic market with a system of mass production is attractive to multinationals.

Compared to China, India has become known for its heterogeneity, it is diverse in culture, religions and language. Although this may pose a problem for multinational firms, we now live in a world where firms are increasingly adapting to local environments and thus in order to be successful in the Indian market it is necessary to locally adapt. However saying this despite an emphasis on local culture many Indians are fluent in English and this greatly enables Indian firms to do business in the West, unlike many Chinese firms where often language barriers arise. The Indian market does hold great benefits to a firm willing to overcome any problems associated with heterogeneity and in particular, India could provide a niche market for international investors. As well as its highly skilled technological staff, India has a democratic political system and western style financial systems. As noted in an article in economic and political weekly, India’s financial systems are more developed than China and this provides an advantage for firms investing in India over China. India’s ability to attract R and D centres, also provides India with the capability of absorbing industry know how quicker than China, India is likely to become more technologically superior as it continues to absorb information from firms investing. Chinas economy in its very nature requires high levels of FDI due to labour intensive technologies and therefore is attracting knowledge along the lines of management styles.

In order to assess the strength of India, one particular aspect of Dunnings eclectic paradigm has been applied (Dunning, 1981). It is clear that China is the world’s global factory with high levels of FDI and an emphasis on manufacturing. However, to show that perhaps FDI figures are not the only economic factor such a theory will be applied to show other factors need to be considered and how such factors relate to India. Dunning (1988) related three factors to FDI, location, ownership and internationalisation factors. This essay will look at the first location factors to assess how they apply to India, such a theory may provide further understanding as to why, even though India has attracted considerably less FDI than China it is in good stead to compete and even overtake China in years to come. Dunning defined location-specific advantages as those advantages that a firm benefits from by choosing a particular location, as shown, India possesses communication facilities which enable it to effectively communicate with the rest of the world. In particular, many call centres are in India and thus many time constraints are being over come through 24hour international call centres. India is pioneering new technologies and it is shown to be 6-7 years ahead of China in terms of its superiority (Srinivasan, 2004). It is India’s IT sector which has outstripped China and the widespread of the English language has allowed Indian companies to deal with Western companies. Secondly, Indian government policies are also allowing foreign firms to benefit from lower levels of corporate tax. Thirdly, infrastructure in India is good, particularly in areas which are considered ‘technology hubs’, more specifically areas such as Bangalore in India which is often referred to as the Indian Silicon Valley, offer great location specific advantages. Bangalore, is an “organic phenomenon” (Huang and Khanna, 2003) and is based on knowledge, education, ambition and intangible assets. The advantage gained here comes from the concentration of computer software and IT industries and arises from a network of firms which allows each firm to benefit from ‘technological spillovers’ (Hill, 2009). This advantage is perhaps the most important advantage firms look to gain when investing in India.

According to the BRICS study, the world economy is set to show dramatic changes over the next fifty years. If we look at the data from this study we can predict the future activities of China and India in order to further conclude the likely future of these two economies. In the study it was predicted that both India and China will overtake the likes of America, Japan and Germany in terms of GDP. Ultimately, the study shows that both India and China will be key players in the economy come 2050. More specifically, India is shown to have the most potential to show the fastest growth over the next fifty years, more specifically it is predicted that as India is less reliant on exports it is less sensitive to changes in the world economy and due to its organic progression many economists are tipping India to overtake China in the long run. What is particularly interesting to note is that India is following a strategy of that seen in developed countries by investing in IT and services unlike most developing countries which follow China’s strategy by offering a manufacturing base complete with cheap labour.

In conclusion, the two emerging economies have very different strategies and this is reflected in the difference in their economic forecast. China has a strategy of labour intensive export led growth compared to India whom provides a more international niche, stepping away from the mass production market and moving towards providing a technologically superior nation focusing largely on IT and services. China has experienced great levels of growth and according to the predictions of the BRICS study is set to dominate the world economy by 2050. As it stands India is more technologically advanced Ultimately, however India holds great advantage over China as concluded in Khans analysis and referring to its developed private sector, stable democracy, and skilled workforce. As a final note as Huang and Khanna (2003 p.78) notes; “China may have won the race to be the world’s factory…with the help of its diaspora, India could become the world’s technology lab”.