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China and India in the global economy

Article  in  Economic Systems · September 2010

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Jens Hölscher Enrico Marelli

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by Jens Hölscher * , Enrico Marelli * * and Marcello Signorelli ** *

1. Introduction

The decline and growth of the Chinese and Indian economies has a large influence on the

world economy. This influence can be positive, as it was the case in the last three decades, but also

negative like in past centuries. It is possible that in the aftermath of the recent economic crisis and

in the current gradual recovery, China and India could take over the role of global economic growth

engines. This phenomenon has attracted considerable research interest (see for example: Basu

2008, Chinn 2009 and Pritchett 2009).

China and India share many common elements: (i) geographically, not only they are placed

in the same continent, but are separated by a common border; (ii) demographically, both of them are

“giants”, with populations exceeding one billion; (iii) historically, both countries have rich and long

histories, considered as leaders in the world economy until the 19th Century. Also both countries

had similar developments in economic terms, although some important differences will be shown in

this article. Under their recent economic take-off, the two countries’ economic performances differ

in timing and intensities. The main difference between these countries relates to their different

political systems, however, this lies beyond the scope of this paper and so will not be addressed.

The purpose of this overview paper is to present the economic growth in China and India

over the last three decades with a specific focus on the integration of these countries into the global

economy.

Some stylized facts on economic growth in a long run perspective will be presented in

section 2. Section 3 will summarise the most significant institutional reforms and key structural
*
University of Brighton, email: [email protected],
**
University of Brescia, email: [email protected],
***
University of Perugia, email: [email protected]

1
features. Section 4 will present a descriptive analysis of selected aspects of economic growth. The

conclusions refer to aspects of the recent world economic crisis.

2. Some Stylized Facts: From Long-Run Decline to Recent “Miracle”

The economic decline and growth of China and India has been largely investigated

according to very different time-periods and comparative perspectives (e.g. Maddison 2007,

Srinivasan 2004 and 2006, Bosworth and Collins 2008). The long-run historical view highlights that

the two economies accounted just half of the world output from 1000 to 1820 1 , they declined to less

than 30% in 1870 and to less than 10% in 1950 and 1973 (Figure 1). That dramatic relative decline

was accompanied by: (i) a long period of relative growth in Western Europe (from 9% in 1000 to

18% in 1500, from 22-23% in 1700 and 1820 to 33% in 1870) followed by a relative decline (26%

in 1950 and 1973) and (ii) the relative growth of US (from 2% in 1820 to 27% in 1973). In the

long-run perspective the evolution in the relative weights of China and India - considered separately

- with respect to Western Europe, US and the World economy is particularly interesting (see Fig. 1).

Figure 1 - Relative Growth/Decline of China and India (1-2006)

60

50

40

30

20

10

0
1 1000 1500 1700 1820 1870 1950 1973 2001 2006
China/World India/World China+India/World
We ste rn Europe /World US/World Japan/World

Source: Maddison (2001) and update 2009

Note: The data refer to the % share of GDP of each country/region with respect to world GDP.

1
And even more in the first millennium.

2
 In the past three decades the high economic growth experienced by China and to a lesser

degree by India determined a fast increase in their weight in global output, from less then 10% to

over 20%. Since 1980 the Chinese and Indian GDP increased, respectively, at annual rates close to

10% and 6% respectively, while the economic growth in US and, especially, in Europe and Japan

were significantly lower. As shown in Figure 1, during the first half of the past decade, the GDP

weight of the "two giants" became again (for the first time after many decades) higher than that of

the US and of Western Europe. Also in coincidence with the recent global recession, China and

India had only a deceleration in their still positive growth rates rather than negative rates. As a

consequence the relative comparative “recovery” of the two giants has been continuing during the

global recession. 2 For the future, some studies have focused on the growth capabilities of the two

countries, highlighting in some cases the greater growth potential of India relative to China (e.g.

Srinivasan, 2006).

3. Institutional Change, Reforms and Opening of the Economies

Economic growth in China and India has been affected primarily by institutional change. It

cannot be ignored that both China and India experienced a gradual but significant “transition” (e.g.

Srinivasan 2004). Whilst recognising that there are a number of aspects of “transition”, in this

paper, we refer to the concept of “transition” just to “change in the economic system”, without

considering other important aspects, like the social and political evolutions.

It should be noted that “gradualism” is a common feature of both, the Chinese and the Indian

transition. This is one of the key differences with respect to the “great transformation” –

characterised by high speed – that occurred in Eastern Europe after the fall of Berlin wall in 1989 3 .

2
Considering Maddison's (2009) data - referring to year 2006 - together with more recent economic trends, it should be
noted that China’s GDP is now becoming higher than US’ (and already surpassed Western Europe).
3
As for some key features and consequences of the “speed of transition” in Eastern Europe, see for example Marelli and Signorelli
(2010).

3
 As for China, the evolution from an inefficient planned economy began in 1978 and the

trajectory of economic reforms can be distinguished in five periods. In the first period (1978-1984),

a reform in the agricultural sector (household responsibility system) introduced a new form of

collective firm (township and village enterprises) and permitted the direct distribution to

households of the revenues deriving from the part of production exceeding the planned level. As a

consequence, both agricultural production and productivity increased in this first period. During the

second period (1985-88), the reforms mainly occurred in the industrial sector, by liberalising prices

and wages, and permitting firms to keep the profits for self-financing. The growing productivity and

wages in this sector attracted labour force underemployed in the primary sector, contributing to the

overall productivity increase. It should be especially recalled that - during this period - the “open

door policy” started, thus supporting the beginning of integration of China in the world economy

through both trade and FDI. In particular, foreign firms were initially attracted by fiscal incentives

in four “special economic areas” and later by international trade and FDI liberalisations in 14 large

cities and coastal regions. However, the gradual openness and extension of strong incentives to FDI

was accompanied by (partial) persisting rigid conditions for admitting FDI. Throughout the third

and forth periods (1988-91 and 1992-97), economic reforms involved all sectors; the role of market

economy and private property was officially recognised at the Communist Party Congress in 1992,

by creating the condition for less gradual economic reforms. The more recent period (1998 -

present) has been characterised by a growing openness of the Chinese economy, especially post

admission in WTO (2001).

A crucial role in explaining Chinese economic growth is usually attributed to the increasing

degree of trade openness, especially regarding exports (while the liberalisation of imports has been

more gradual). This model of export-led growth supported by an undervalued currency was

successfully persued by West Germany in the 1950’s. In addition, huge FDI inflows, mainly

attracted by much lower unit-labour costs, probably favoured spill over effects and contributed to

the transformation of the model of productive specialisation.

4
 The “gradual transition” of India has been different to that of China in many aspects. In

particular, the Indian institutional change and the reform policies started later, contributing to a

significant delay in the integration in the global economy. Some reforms, for instance the partial

liberalisation of imports, especially of intermediate and investment goods, that began in 1976 with

the “open general licensing”, i.e. a list of products that could be imported without any license were

introduced in the 1980s and followed by progressive privatisations; but it was only after 1992 that

the institutional change and the reform policies gradually accelerated, including reforms of the

fiscal system and “special economic zones”. However, in addition to persisting rigidities and

weaknesses in the labour market, in the bureaucratic system, the infrastructure, the still high weight

of the public sector and small firms, the integration of India in the world economy is much less

intense with than China. It should also be recalled that India, in contrast to China, had a large

private sector even before the beginning of transition, although the market functioning was

conditioned by rigid state controls.

The “gradual” and partly different institutional change and reform policies in China and

India over the last three decades lead to a significant increase (especially in China) in the degree of

openness with regards to foreign trade and FDI of the two economies and their integration into the

world economy.

4. Structural Features of Development and Key Imbalances

One of the key explanations of per-capita GDP growth is usually related to the sectoral

reallocation of productive factors (labour and capital) from lower productivity sectors toward higher

productivity sectors. A complex and unstable relationship, with many feedbacks, exists between

degree of openness (export, import and FDI) and structural (sectoral) change. Moreover, in

transition economies the usual sectoral reallocation characterising economic development – from

agriculture to industry and services – is accompanied by a significant shift from the public to the

private sector.

5
 In both China and India there occurred three decades of “institutional change”, the main

features of which have been the increasing share of private property and the private sector

(especially in China) as such, as well as price and wage liberalisations. This institutional change has

been a first, direct, channel promoting sectoral change, with a positive impact on GDP growth and

productivity dynamics. However, as previously recalled, the “gradual transition” of the two

economies differently affected the composition, level and dynamics of the “openness indicators”

(export, import and FDI): this can be considered a second, indirect, channel favouring sectoral

reallocation and increasing overall productivity.

Given the above relationships and the differences (i) in initial sectoral composition and (ii)

in the features of “gradual transition” in the two economies, the weight on GDP of industrial sector

was (persistently) far higher in China in comparison to India since 1980. This industrialisation also

led to a sharply rising demand for energy (Hölscher et al. 2008). India is more specialised in service

activities (including recently the advanced services) and also the agriculture’s economic weight is

still higher 4 (Figure 2). These differences in sectoral composition and reallocation can partly

explain the gap in per capita GDP growth of the two economies in the last three decades.

Figure 2 - Agriculture contribution to GDP (1980-2005/6)

40

30

20

10

0
1980 1990 2000 2005-6*
China India

Sources: DataStream, Note: * China 2005 and India 2006.

4
Agriculture’s weight in terms of employment is even higher: about half of total Indian employment is still in the agriculture sector
(it was 72% in 1970), thus testifying the backwardness and low productivity of this sector.

6
 These trends also have profound implications for “social sustainability”. A key structural

feature of the Chinese and Indian economies is related to the persistently huge disparities in

(individual and household) income/wealth distribution even within regions of the same country, e.g.

between rural and urban areas. The territorial and structural imbalances are combined with

macroeconomic disequilibria. For China it is evident that the international investment allows in part

for high domestic savings and of “sovereign funds” are mainly derived from high accumulation of

foreign exchange reserves originated by a current account surplus. This is the mirror image of

another imbalance in a different part of the world: in fact, until now, Chinese savings allowed the

financial sustainability of the huge and persistent US “twin deficits”. The financial sector in China

however is still underdeveloped, i.e. highly regulated and with the state as the majority shareholder.

The amount of ‘bad debts’ collateralised by a house price boom is simply unknown.

Figure 3 refers to the gross domestic product per capita since 1980. 5 Until the beginning of

the ‘90s GDP per capita was greater in India than in China, although the gap was quite small. Since

1993, China’s growth has been much faster, so in the final year per capita GDP in China was more

than double than in India.

Figure 3 - GDP per capita (PPP)

6000

5000

4000

3000

2000

1000

0
80

82

84

86

88

90

92

94

96

98

00

02

04

06

08
19

19

19

19

19

19

19

19

19

19

20

20

20

20

20

China India

Source: IMF statistics.

5
GDP based on purchasing-power-parity (PPP) per capita (current international dollar). Source: International Monetary Fund, World
Economic Outlook Database (on-line, April 2009).

7
5. Conclusions

In this review of the “miracle” of Chinese and Indian economic growth we have focussed on

the institutional reforms introduced in the last three decades and on the main structural features.

We have highlighted the positive growth effects of opening and integrating in the world

economy for both countries. On one hand, the extraordinary growth of these countries can sustain

global economic growth; on the other hand, world economic dynamics obviously affect their

economic performance. Therefore it is not clear, whether these growth rates will be sustainable in

an environment of a sluggish recovery from the crisis in Europe and the United States. Some

reorientation towards domestic development rather than export-led growth might be appropriate. In

addition to the continuation of important investment plans for infrastructures, housing, schools, etc.

also consumption should increase in the next years. Moreover, both giants have no institutions of a

welfare state or pension systems. In the absence of a welfare state, the propensity to save has been

extremely high, as is the only way for social protection. The expansion of public services and

transfers could be a way of reducing some inequalities in the development processes and, at the

same time, melting down the excessive currency reserves and reducing the global imbalances.

References

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From socialist Stagnation to Global Power, in: Journal of Economic Literature, Vol. XLVI,

396-406

Bosworth B., Collins S.M. (2008), “Accounting for Growth: Comparing China and India”, Journal

of Economic Perspectives, 22 (1), 45-66.

Chinn, M. D. (2009): Introduction – the Symposium on ‘China’s Impact on the Global Economy’,

in: Pacific Economic Review, 14, 3, 342-345

8
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