Fear of an Asian challenge

The current rates of growth of India and China are a cause for concern in the rest of the world but the sustainability of their growth trajectories is debatable.

ACCORDING to statistics released recently, China continued to grow at a scorching 10.2 per cent during the first quarter of 2006, as compared with the corresponding period of the previous year. This has once again triggered the warning that the economy is "overheating", whatever that may mean. India closely follows China's performance, with its gross domestic product (GDP) growing at an annualised 7.6 per cent during the fourth quarter of 2005. These figures, while concealing much in terms of the distribution of that growth, keep alive the fears of the threat from these two Asian giants to growth in the rest of the world, including the developed countries. Unravelling the nature of that threat requires, however, clarity on the similarities and differences between the characteristics of growth in the two countries.

What is unquestionable is that in both cases greater integration with the world system in forms both traditional and new has played a role in triggering growth. Cross-border flows of goods, services, capital (fixed and portfolio) and labour are the means through which the process of growth is being sustained. Those flows, in turn, yield incomes and foreign exchange revenues that trigger demand and spur growth.

The role of integration as a support for growth partly comes through from the growing ratio of the exports of goods and services to GDP. In 1978, when China's reform began, that ratio was more or less the same in India and China, at around 6.5 per cent. Since then the figure has risen sharply in China, to touch 34 per cent in 2004, and much more slowly in India to just above 19 per cent.

Larger exports and/or a higher rate of expansion of exports can stimulate growth because of positive net exports or a trade surplus that serves as the demand stimulus and inducement to invest for an individual country. Even if it is not recording a large trade surplus, successful engagement in trade allows a country to dissociate the structure of domestic supplies from domestic production. This permits using the possibilities of transformation through trade to ensure availability of adequate quantities of commodities crucial to growth. Export revenues may be crucial in financing imports of specific commodities that are essential for consumption without running into balance of payments difficulties. Typical examples of such commodities are food, machinery and oil.

At the aggregate level, of course, it is only China that appears truly mercantilist, exporting more than it imports and accumulating wealth in the form of foreign reserves. In the year ending March 2006, China recorded a trade balance of $108 billion and a current account balance of $161 billion, taking its gold and foreign reserves to a record $875 billion. On the other hand, India recorded a trade deficit of close to $40 billion and a current account deficit of $13.3 billion. However, capital flows, especially portfolio capital flows into India's debt and equity markets, helped it keep reserves at $145 billion. In sum, the role of net exports as a trigger for growth appears to be true for China, but not so for India.

There is one more striking difference between India and China. In the case of China it is the export of goods that accounts for its trade success. In India's case its more limited gains come predominantly from services. Between 1985 and 1995, the ratio of goods exports to GDP rose from around 8 to 18 per cent in the case of China and from 4 to 9 per cent in the case of India. But after that, while the figure for China shot up to 26.7 per cent in 2003, it remained short of 10 per cent in the case of India. Relative to GDP, it is the growth in services exports that explains India's more moderate trade success. Add to this the important role of private transfers, or remittances from non-resident Indians and the relative resilience of the current account of India's balance of payments in the context of a rising oil import bill is explained.

The differential goods and services orientation of India and China is, as is to be expected, visible in GDP growth as well. Of the cumulative increase in GDP between 1990 and 2004, while 55 per cent was accounted for by manufacturing in the case of China, as much as 60 per cent was accounted for by services in the Indian case. It must be noted that not all of the growth in services in India is accounted for by software and IT-enabled services, the commonly quoted engines of growth. These still account for only around 4 per cent of GDP. Even among the "modern" services, areas directed at the home market like financial services seem to be as crucial.

The role of trade in facilitating growth in the countries explains in large part the perception that they threaten global growth, including that in countries of the Organisation for Economic Cooperation and Development (OECD). To boot, while China seems to be emerging as the manufacturing hub of the world, India is proving to be the global services hub. And each of these countries has an eye on the terrain occupied by the other. In the circumstance, evidence such as China's large trade surplus with the United States only strengthens perceptions of a major economic threat.

However, it must be noted that both countries - India more than China - are still small players in global production and global exports. Measured in terms of prices prevailing in 2000, China's share of world exports of goods and services was only 5.8 per cent in 2003 (up from 1.4 per cent in 1978), and India share was just 1 per cent (up from 0.4 per cent). In terms of constant price GDP, China accounted for 4.6 per cent of global GDP in 2003 and India for 1.6 per cent, both up from 0.9 per cent in 1978. Given the large sizes of the population in these countries, these numbers are still small. But their growth in China can be disconcerting.

Further, there are two other factors that need to be examined while assessing this threat. First, the growth of these countries also generates a growing domestic market that other countries can exploit. The transformed domestic marketplace, seen in terms of brand profiles, in both countries, does suggest that developed country firms are indeed benefiting from this market, even if based on production abroad. A figure of relevance here is the relative size of GDP in these countries, measured in terms of purchasing power parity (PPP) dollars, which is an indicator of the buying power of the Indian and Chinese populations. Measured in those terms, China accounts for 13 per cent of global GDP in 2003 and India for 6 per cent. This compares with 2.9 and 3.6 per cent respectively in 1978. Thus the rest of the world is benefiting from a growing market in these countries.

The second issue of importance is the sustainability of the high growth rates, supported with goods exports in China and services exports in India. Rapid increases in exports have in the past petered out in successful countries for a number of reasons. Principally, such growth runs up against supply constraints of different kinds, especially infrastructural constraints. China is partly able to deal with this because of its high ratio of investment to GDP. But signs of infrastructural bottlenecks are visible in India. High export growth soon results in increases in wage costs and/or exchange rate appreciation, which undermines export competitiveness. Thus there are considerable uncertainties surrounding the sustainability of the growth trajectories in these countries. But so long as they continue to grow at their current rates, the global fear of the challenge from Asia is unlikely to go away.