China or India: whose economic growth will prove more durable?

published 8 November 2006

Chances are good that you have found yourself in the following situation: You call your phone company or credit card bank to ask a question about your bill, and your call is taken by a friendly man with a distinct accent named 'John.'

After some short pleasantries, John walks you through your bill step-by-step - from a call centre halfway across the world in India.

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Despite the economic reforms of the past two decades, India's state sector still resembles the decrepit socialist experiment described above. Perhaps even worse, most of India's roads are in abysmal repair, and the traffic congestion in most cities is bad enough to make Los Angeles rush hour look appealing. Moreover, living conditions for large segments of India's population are appalling. The Financial Times reports that there is one toilet for every 1,500 people in some of the poorer parts of Mumbai (previously known as Bombay).

This new generation of young professionals is earning and spending at an unprecedented rate for India, and this trend will only continue as they progress through their life cycles - marrying, buying homes, and raising their children - spending ever more in the 'keeping up with the Jones's' tradition of Middle America. Even though the country is still in the early stages of its economic modernization, over the longer term India's prospects are brighter than those of China, South Korea and Taiwan. In the July/August 2006 edition of Foreign Affairs, Gurcharan Das published an insightful article titled 'The India Model' that explains how the country has taken a very different path from most of its contemporaries in Asia. It is one particular development - the emergence of a viable domestic consumer economy - that we find particularly appealing:

'The notable thing about India's rise is not that it is new, but that its path has been unique. Rather than adopting the classic Asian strategy - exporting labour- intensive, low-priced manufactured goods to the West - India has relied on its domestic market more than exports, consumption more than investment, services more than industry, and high-tech more than low-skilled manufacturing. This approach has meant that the Indian economy has been mostly insulated from global downturns, showing a degree of stability that is as impressive as the rate of its expansion.'

This is a crucial point; with most of the developed world facing an unprecedented demographic-induced recession or even depression after 2010, countries that have viable domestic consumer markets should fare much better than those that are focused on exporting to the West. This makes India's growth boom much more durable than that of, say, China. Das's article points out that personal consumption accounts for 64% of India's economy, compared to 58 percent for Europe, 55 percent for Japan, and 42 percent for China. As we have noted in the past, US consumption has hovered around the 70% mark for many years, proving that a country can grow and prosper with a consumption-driven economy.

In an economy dominated by services and information - like that of the US today and the one developing in India - savings and capital spending become less crucial to sustaining growth. China saves and then invests an enormous percentage of its GDP in building new manufacturing capacity, which puts China at a real risk for over-capacity and deflation in the event of downturn. India, in contrast, appears to be skipping the industrial phase of its development altogether and moving directly to services and information, thus looking much more 'American' than any other developing country.

India's demographics are slowly beginning to look more American. After decades of high birthrates and overpopulation, the country appears to be shifting away from the typical 'Third World' population distribution in which perpetually high birthrates ensure that the most productive members of society (primarily those aged 20 to 64) are a relatively small percentage of the population. The expense of raising this abundance of children (and the manpower taken out of the workforce to care for them) is an impediment to the development of a modern consumer economy, for better or worse.

Now, as more join the ranks of the middle class, Indian mothers are having fewer children, yet spending far more money on the ones they have, buying the basic consumer products that earlier generations simply had to do without. To see why this matters to the economy, think of it this way: profit margins are higher for store- bought disposable diapers than for home-made swaddling cloth. Add baby clothes, toys, and private piano lessons to the list of items purchased outside rather than produced at home, and it becomes obvious very quickly that a middle class lifestyle contributes far more to the economy than a traditional peasant one.

The levelling of the Indian birth rate is both an indication of the rise of the middle class as well as a contributing factor in its development. As India's birthrate continues to decline, the population distribution should start to look more and more like that of the US, circa 1964 (at the end of the American Baby Boom). Expect India to boom as its enormous young population begins to move through its Spending Wave over the next 40-50 years much like the American Baby Boomers of the post-war generation.

Despite the overwhelmingly bullish case for India over the coming decades, it is important to remember that India is still an underdeveloped country and is at a much different stage than many other countries labeled as 'developing,' such as South Korea or Taiwan. Per capita income is still pitifully low, on par with Iraq or Cuba, and India's government is certainly not immune from the occasional populist rash of anti-globalization sentiment.

It's unlikely that India would ever follow the example of, say, Venezuela, but there will definitely be setbacks that rattle investors. Even the United States, with its long tradition of free trade, has fallen into this trap recently, as the political grandstanding that killed the Dubai Ports deal in early 2006 made abundantly clear. Any political maneuvering in India or one of its major trading partners that undermines free trade could cause ugly - though most likely temporary - setbacks. India also has an unresolved conflict with Pakistan that could erupt into war at a moment's notice.

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