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Stephen Olson at Chinese Development Institute Conference

 

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(02/26/06) Clyde Prestowitz in the San Jose Mercury News

San Jose Mercury News

Copyright 2006 San Jose Mercury News

February 26, 2006

Bet on India for long term

By Clyde Prestowitz

Since this month's announcement of the trade deficit with China, Washington and Wall Street have been fretting over the $200 billion gap and the continuing transfer of even high-tech manufacturing to the Middle Kingdom. Amid the worrying, President Bush is preparing for a trip to Asia this week. But he'll be stopping short of Beijing, visiting the Asian behemoth that is sometimes considered an also-ran in the race for up-and-coming superpower: India. And he'll be following on the heels of Prime Minister Wen Jiabao of China and French President Jacques Chirac.

All three men are paying their respects for the same reason: Despite the world's laser focus on China's stunning rise, India, already a nuclear power, is not yet out of the race for economic leader. It may well overtake both the United States and China to become the world's largest economy within the next 45 years, a feat that could have a profound impact on everything from where the world's next new thing is invented to the balance of international power.

How profound? Well, big enough that in the midst of the war on terror President Bush is trying to reverse longstanding prohibitions on U.S. sales to India's nuclear development programs. His goal is to enlist New Delhi as a major new ally that can serve as a counterweight to China and Iran. Such an alliance would represent a major shift in America's foreign-policy calculus that had for decades favored Pakistan over India.

Of course, India won't displace China overnight. Although the GDPs of the two countries were roughly the same in 1990, China today is far ahead of India, with an economy that's twice as large and growing faster. But China has vulnerabilities over the long term, including some of the very factors that now appear to be making it super-competitive.

The same lack of the rule of law and due process that allows it to quickly bulldoze homes for skyscrapers, for example, has also led to corruption, rising inequality and social unrest. Conversely, India's apparent weaknesses -- a cumbersome democracy, lack of central planning and unrestrained population growth -- could be long-term advantages.

Export-led strategy

By now the China story is familiar. Using their power to mobilize and direct resources, China's authoritarian leaders have adopted a variation of the Japanese and Asian Tiger export-led growth strategy. Strong incentives have been created to produce national savings of more than 40 percent of GDP (U.S. savings are in the negative numbers), and the money has been guided into investment in massive public infrastructure projects and export-oriented manufacturing companies. Foreign investment has also been assiduously courted in "strategic" targeted industries.

Those investments, combined with inexpensive but hardworking and literate labor (China has virtually 100 percent literacy), have made China the global location of choice for production of everything from textiles to semiconductors. It passed the United States last year to become the world's biggest exporter of advanced technology products even as America was recording a $70 billion trade deficit in this category, which it has always dominated. Indeed, China's performance has been so impressive that Cisco CEO John Chambers has predicted that China will become the information-technology center of the world sometime between 2020 and 2040.

While nothing is forever, the International Monetary Fund believes that China, which has been growing at a 10 percent annual rate, can maintain at least 7 to 8 percent annual growth for the next 10 to 15 years. If so, it will surpass Japan to become the world's second-largest economy in 2016 and could be on a par with the United States by 2040. In fact, in terms of domestic purchasing power, China's economy could effectively be as large as America's by 2025. It is already the world's largest market for more than 100 products such as cell phones, cement and machine tools. According to the McKinsey Global Institute, all urban homes have at least one television set and a washing machine, while about 60 percent also have both mobile phones and air conditioners.

By any measure, that is an impressive record, and although India's economy is growing nicely at 6 to 7 percent annually, it will not be able to match China in the short to medium term. Nearly 40 percent of India's population is still illiterate. Its democratic system is not nearly as good as China's authoritarian system at mobilizing resources and quickly building massive public infrastructure such as highways. And at 25 percent of GDP, India's savings rate is only a little over half that of China's, while its rate of investment is less than half China's 50 percent of GDP. Only 40 percent of urban Indian households have a color television and about 20 percent have washing machines, while mobile phones and air conditioning are still available mostly to the wealthy.

But China has vulnerabilities that call into question the sustainability of its growth and even of its economic system over the next several decades. While they sound impressive, the high savings and investment rates are dangerously excessive. Japan and Korea, which had similar rates, wound up building excess capacity, wasting capital and eventually suffering from the huge costs of collapsing bubbles.

China is now wasting vast amounts of capital by building too many factories whose production will be far in excess of market demand with resultant financial losses. One measure of this is the fact that with double the investment, China's GDP is growing only a couple of percentage points faster than India's. This means its efficiency of capital use is only about half that of India's, which points to another weakness.

Capital wasted

China's banking and financial industry remains unsophisticated and subject to non-market government "guidance" that generates the excessive lending and non-performing loans that waste capital. And the proposed solutions to this problem only threaten to make it worse. As one top Hong Kong official recently told me, China's financial authorities think the solution to bad lending practices is to try to "unify thinking," coming up with bureaucratic directives on lending rather than letting interest rates and market forces do their work.

The authoritarian Chinese approach to growth has another drawback: the possibility that it will birth a backlash. I remember executives at Scott Paper Company, where I once worked, lauding former Philippines President Ferdinand Marcos for his ability to get things done. But they didn't see what was happening to real people in the Philippines and what those people would eventually do to Marcos.

China's leaders can move quickly because they don't have to worry about democratic procedures. But corruption is rampant with officials, for instance, arbitrarily seizing farmers' land for factory projects. Such actions helped ignite thousands of protest demonstrations last year. The difficulties that Google, Yahoo and Microsoft have experienced, as a result of their connection with China's Internet policing, are harbingers of the dangers that could lie ahead for foreign investors in China.

Finally, China's demographics are worrisome. In another 10 years, the one-child policy will begin to bite as China's population starts to age rapidly and, eventually, to shrink. At some point, the age pyramid will become sharply inverted, with too few young people trying to support too many seniors. If China doesn't run into problems sooner, this will be the ultimate barrier to its continued economic growth. In short, China will get old before it gets rich.

India, in contrast, enjoys many hidden, long-term advantages. Although its literacy rate is much lower than China's, its Indian Institutes of Technology rival MIT and are far better than such schools in China. It is estimated that only 10 percent of Chinese engineers have the skills required to work in a global company, while the comparable number for India is 25 percent. By one count, India's pool of well-qualified professional graduates will be twice as large as China's by 2008.

India's banking and financial institutions are well established and have long been lending on the basis of market-based analysis, which helps explain their more efficient use of capital. And although India's democratic system can be cumbersome and slow, it is stable. That makes investment less risky than in an opaque, authoritarian environment.

On top of this, English is the common language of Indians. This makes it easier for India to fit into an international business system whose lingua franca is English, as does the return in recent years of many skilled business people from the large Indian diaspora in America and Europe.

Another possible advantage is India's business culture. India's growth has been mostly a matter of the government deregulating and getting out of the way of aggressive, private-industry entrepreneurs, many of whom had experience in Silicon Valley. And these entrepreneurs have been focused on high tech and services.

As a result, India's growth has so far been based not on doing standard manufacturing less expensively, as China has done, but on developing innovative new services and high-tech products. In the long term, that entrepreneurial culture is likely to have more staying power and productivity. To be sure, India has its insularities and even hostilities toward business, a hangover from India's socialist past, but the new wave of development is changing these views quickly.

Young workforce

Finally, India's demographics are very favorable. Its population is still growing and will surpass China's around 2035. That, combined with steady growth, means India's GDP will probably surpass China's in the latter half of this century. Moreover, half of India's population is under the age of 25, which means that India will have no problem paying for elders' future health care and pension costs.

In sum, if you are a short-term investor, China is probably where you should put your money. But if you are in it for the long haul, you might want to bet on India. That certainly seems to be what George Bush is doing as he heads out this week to make nice with his newest international friend.

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