The Cost of Keeping Up With China

Comparisons between India and China are probably inevitable. The Asian neighbors both boast more than a billion citizens, and both enjoy giddy economic growth rates. Both are also touted as future superpowers, although China is a lot closer to that status than India. But the two nations are also very different: one's an autocratic one-party state; the other a flawed but functioning democracy. Those differences have a huge impact on the way the two countries are growing. In simple terms, if China's rulers want to build a new highway they do. In India, well, it's more complicated.

One such complication is the focus of an internal report of the ruling Congress party leaked to the Indian press last week. The alleged report, whose very existence is denied by Congress officials, contends that the government's policy on Special Economic Zones — India's version of investment enclaves that offer tax incentives, good infrastructure and other benefits — may cost the party votes in future elections.

At first glance the promotion of Special Economic Zones (SEZs) would seem unlikely to attract much controversy. Many developing countries have used such enclaves to encourage foreign investment and manufacturing growth. India was, in fact, the first country in Asia to demarcate a special economic enclave when it introduced an "export processing zone" in Gujarat in the mid 1960s. But in the past few years, the country has been playing catch-up with places such as China, which used SEZs to kick-start its own incredible economic expansion almost three decades ago. India attracts barely 10% of the foreign direct investment figure for China (although the two count investment in different ways), and wants to close the gap as rapidly as possible. Early last year, the Congress-led government passed a new SEZ law designed to speed up India's economy, in particular its manufacturing sector, by offering further incentives to prospective investors. Since then, hundreds of companies have applied to set up SEZs, with the government so far approving more than 200.

The problem is that many of the SEZs are on prime farming land. A few landowners are only too happy to sell up at a huge profit, but many poorer farmers and farm laborers are understandably opposed to having their livelihoods forcibly sold out from underneath them. Opposition to the SEZs is growing, and the consequences of that for the Congress, or any political party in India that hopes to win the rural vote — and given that a majority of Indians still live outside urban areas most parties do — could be particularly painful come polling day.

Although the Chinese authorities are mindful of the danger of a socially disruptive backlash by poor rural citizens, there are no national elections to worry about. "Voting is a much more immediate, more powerful threat," says Indian economic analyst Paranjoy Guha Thakurta. "And even when there's no election looming, Indians can put pressure on their representatives to have the bureaucrats transferred if they don't like them. In China you have a one-party state so that's a bit harder."

And it's not only farmers that India's politicians have to worry about. Opposition to the SEZs is coming even from free-market reformists. Most of India's newest investment zones are much smaller than China's and may not be economically viable in the long term. The tax breaks, which include a five-year holiday on profits tax and exemption from import and excise duty, are also much more generous than those in other countries. Critics of India's approach worry that its SEZs will not attract new investment but merely suck in investment already headed to India while hurting tax revenues. Also, India's Special Economic Zones have so far attracted mostly info-tech companies and not the employee-hungry manufacturers the country's unemployed had hoped for.

Perhaps stung by the mounting criticism, the Congress-led government this week decided to stop approving new SEZ applications until it can sort out some of the more contentious issues. There is talk that New Delhi will force any company operating in an SEZ to export at least half of its production. Whatever India's leaders do, you can be sure they will have one eye on public opinion, a handicap their Chinese counterparts rarely have to deal with.