Thursday, Nov. 10, 2011

The Case for India: Free to Succeed

If I have to endure another corporate executive blindly praising China and reflexively trashing India, I might actually gag. I'm often trapped in conversations with suits that follow the same, excruciating pattern. First, they swoon over China's stellar roadways and airports, the superior wisdom of Beijing's policy mandarins and the clinical efficiency of its authoritarian regime. Then they turn 180 degrees to rail against the feebleness of India's infrastructure, the ineptitude of New Delhi's bureaucrats and the convoluted course of Indian democratic politics. How, they ask, can India ever catch up?

When comparing India and China, most economists and business folk simply look at the wrong things. Beijing's bureaucrats may be better at building roads, but government dictates and human-rights abuses won't ensure the country's economic success. The past half-century of Asian economic history tells us that sustained development ultimately depends on entrepreneurship, a strong private sector, rule of law and political openness. India, not China, possesses these crucial building blocks of economic progress. And that is why India will overtake China as the world's premier emerging economy.

When I make this argument, I usually get bewildered stares — probably the same response you're having right now. Yes, I can see why many people believe India is stuck sucking fumes behind China's great industrial machine. The Indian economy hasn't been growing as quickly as China's, nor has its industry imprinted as deep a mark on the global economy. India has more than twice as many people trapped in desperate poverty, while its fractious democracy entangles policymaking in long-winded debates and ideological tussles unthinkable within China's autocratic government. Beijing and Shanghai are connected by high-speed trains; their thoroughfares are lined with modern office towers. In New Delhi and Mumbai, the dusty lanes remain lined with barefoot beggars and cluttered with soot-belching motorized rickshaws.

But to discover which nation will win out over the long haul, we need to dig past surface appearances, down into the guts of the two economies, to learn how they tick. China's economy appears lovely on the outside but is rotten at the core, like a brightly polished Ferrari with the innards of a Pinto. India's growth engine may occasionally get smeared with manure and lost in detours, but check under the hood, and you'll find it is much more powerful than it looks — more powerful, in fact, than China's.

Part of the reason is simple mathematics. Since the Chinese economy is more than three times the size of India's, the Middle Kingdom's growth rate will inevitably slow, allowing India to close the gap. For a developing economy, China is aging rapidly because of the distortions caused by its controversial one-child policy, giving India a demographic advantage in generating future growth. Much more important, and contrary to what many believe, India possesses a superior economic model to China's — sturdier, healthier and better equipped to maintain rapid progress over the long term.

That's because India's economy has balanced sources of growth. Strong domestic demand drives India's GDP, offering the economy protection from external shocks. China has no such cushion. Its economy is overly dependent on investment and exports. Economists believe China needs to encourage more domestic private consumption — to "rebalance" — to promote sustainable economic growth. In other words, China has to become more Indian. That became obvious during the Great Recession. India charged through the downturn because the resilient Indian consumer propelled the economy forward. When the financial crisis hit China, however, Beijing was forced to unleash a tsunami of government stimulus and credit from state-controlled banks to keep growth going. Even though the world's economists lauded the effectiveness of China's recession-fighting methods, these were, in fact, a sign of the economy's frailties.

Money Talks
Beijing's stimulus effort also exposed another Chinese weakness — a faulty, immature financial system. Though the state owns large chunks of the banking sectors in both countries, China's bureaucrats interfere much more intrusively in the credit decisions of its financial institutions, turning them into little more than arms of government policy. That makes Chinese banks more vulnerable and less efficient in allocating resources. Indian banks, on the other hand, are run on a more commercial basis. They have greater expertise in risk management and credit analysis, and as a result, they tend to lend money more intelligently and have stronger balance sheets. We cannot understate how important that is for India's future performance. "Indian banks are stronger [than China's]," explains Mark Young, head of Asian banks at rating agency Fitch in Singapore. "There is a clear link between the health of the banking sector and the capability to support economic growth."

India's corporate sector beats out China's too. Indian companies are more dynamic, better managed and financially sounder than Chinese enterprises. According to data crunched by investment bank CLSA, Indian firms outperform China's, with both wider profit margins and higher returns on equity. That's not about to change. Chinese corporations are not only burdened by more debt, they are adding debt at an alarming rate. Fitch figures that at the end of 2010, bank credit represented 139% of GDP in China compared with a mere 49% in India.

We can also make the case that India is more entrepreneurial than China. Indian firms like Infosys, Tata Consultancy Services and Wipro practically invented the entire offshore IT-services industry — a sector China is now attempting to copy. At their ever expanding campuses, these companies train and absorb thousands of new hires each year while extending their reach to every corner of the globe — management challenges Chinese executives would struggle to tackle. Arvind Subramanian, senior fellow at the Peterson Institute for International Economics in Washington, D.C., says the evidence can be found by evaluating how companies from China and India operate outside their home markets. Indian firms, he notes, not only invest more heavily overseas than China's (as a percentage of GDP), but they also tend to operate core manufacturing and service businesses in advanced economies. China, meanwhile, has focused outward investment on natural resources in Africa and other emerging economies. That, Subramanian contends, shows Indian managers can better compete head-to-head with the world's top CEOs in the most demanding markets.

Such management expertise will prove decisive as China and India lose their low-cost competitiveness. The only way either economy can keep growth roaring is to develop high-tech industries and innovative companies — a difficult leap that demands the type of smartly run companies India already has. It also requires democracy and civil liberties. By censoring the Internet, controlling the press and stifling debate, Beijing is suppressing the open exchange of information and risk-taking spirit necessary for entrepreneurial innovation. Indians, enjoying full freedom of expression and association, face no such hurdles. These basic rights in India, furthermore, are protected by an independent judiciary that can be trusted to uphold the rule of law — a crucial ingredient for economic progress.

Whether you believe India or China will own the future depends on whether you think the state or the market can generate the best economic results over the decades to come. True, China's government is more competent than India's. But can China's bureaucrats take the economy into the ranks of the most advanced? History tells us the answer is no. I dare you to name one example of an authoritarian, state-dominated economy that developed creative, innovative industries and world-beating companies. China faces that risk. On the other hand, we can make a long list of democratic, market-oriented economies with well-managed private companies that have excelled. There is every reason to believe India will be one of them.

So don't be fooled by Shanghai skyscrapers and Beijing propaganda, or misled by the chaos of Mumbai's streets and India's tendency for self-deprecation. China's state may give it an edge today. But India's private economy will give it the edge tomorrow.