Which will deliver the best returns - India or China?

A note from GaveKal Research has dispelled some of the myths that have sprung up about the economic performance of both India and China, says Martin Spring in his On Target newsletter. But which of the two will provide the best returns for investors?

Among the myths about the world's two very different emerging giants, China and India, is that China's lack of democracy has aided its economic growth while India's growth has been retarded by its democracy, GaveKal Research argues in a new study.

The chief difference between the two economies explaining China's outperformance is not their political systems but China's abundance of capital because of a savings rate much higher than India's (40 to 45 per cent compared to 25 per cent).

One reason has been agricultural reform in China that gave farmers ownership of land rights and freedom to sell produce on open markets. The resulting surpluses have been channelled into investment in manufacturing and a supportive infrastructure.

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By contrast, many regions of India have "retained a quasi-feudal land holding structure dominated by large landlords and populated by tenant farmers." Consequently, agricultural yields are far lower in India than in China.

Although India's underperformance is often attributed to the retarding effects of democracy, the real problem is the way its political system has been dominated by a post-colonial, educated elite whose principal aim has not been economic growth, but preservation of its own privileges.

"Economic policy focused on protecting existing owners of capital via the licence-and-permit Raj, which raised barriers to entry in many industries

"This deeply rooted attitude persists even in the supposedly new elite of India's modern knowledge economy an elite which, just like the old elite of the licence-and-permit Raj," is dominated by Brahmins and other high castes Upper-class Indians remain perfectly content with the existence of a servant class living in degraded conditions.

"The obstacles to economic growth in India are the low saving rate, a lack of infrastructure, and economic policies that discourage investment. Removing these obstacles is a function, not of the political system, but of the desire of the elite to make economic growth a high priority."

The GaveKal Research study also castigates the "myth that information technology will magically enable India to leapfrog the grubby industrial stage of development and proceed directly to a modern, high-income society on the basis of services.

"If India were leapfrogging, we would find that its services economy generates high levels of employment and income growth. In fact it does neither.

"The Indian services economy that everyone talks about employs somewhere between one and two million people, in a labour force that exceeds 600 million Indian policy has been heavily biased in favour of skill-intensive services, rather than labour-intensive services that would soak up excess rural labour."

It's a myth to believe that India's natural destiny lies in services, China's in manufacturing. In fact China's services sector has grown much more rapidly than India's and accounts for a bigger share of total employment. As China's bloated state-owned industries contracted, the workers they shed "found re-employment in labour-intensive services: driving taxis, waiting on tables in restaurants, working in shops."

Nevertheless, India is likely to continue delivering higher returns to portfolio investors than China for the next few years, says GaveKal Research, irrespective of the growth performance of either country. Among the reasons are a better legal environment and a vigorous private-enterprise sector that has produced world-class enterprises.

And you can find out more about how to invest in India by reading below...