Can India Overtake China?
by Huang Yasheng & Tarun Khanna

Walk into any Wal-Mart and you will not be surprised to see the shelves sagging with Chinese-made goods—everything from shoes and garments to toys and electronics. But the ubiquitous “Made in China” label obscures an important point: Few of these products are made by indigenous Chinese companies. In fact, you would be hard-pressed to find a single homegrown Chinese firm that operates on a global scale and markets its own products abroad.

That is because China’s export-led manufacturing boom is largely a creation of foreign direct investment (FDI), which effectively serves as a substitute for domestic entrepreneurship. During the last 20 years, the Chinese economy has taken off, but few local firms have followed, leaving the country’s private sector with no world-class companies to rival the big multinationals.

India has not attracted anywhere near the amount of FDI that China has. In part, this disparity reflects the confidence international investors have in China’s prospects and their skepticism about India’s commitment to free-market reforms. But the FDI gap is also a tale of two diasporas. China has a large and wealthy diaspora that has long been eager to help the motherland, and its money has been warmly received. By contrast, the Indian diaspora was, at least until recently, resented for its success and much less willing to invest back home. New Delhi took a dim view of Indians who had gone abroad, and of foreign investment generally, and instead provided a more nurturing environment for domestic entrepreneurs.

In the process, India has managed to spawn a number of companies that now compete internationally with the best that Europe and the United States have to offer. Moreover, many of these firms are in the most cutting-edge, knowledge-based industries-software giants Infosys and Wipro and pharmaceutical and biotechnology powerhouses Ranbaxy and Dr. Reddy’s Labs, to name just a few. Last year, the Forbes 200, an annual ranking of the world’s best small companies, included 13 Indian firms but just four from mainland China.

India has also developed a much stronger infrastructure to support private enterprise. Its capital markets operate with greater efficiency and transparency than do China’s. Its legal system, while not without substantial flaws, is considerably more advanced.
China and India are the world’s next major powers. They also offer competing models of development. It has long been an article of faith that China is on the faster track, and the economic data bear this out. The “Hindu rate of growth”—a pejorative phrase referring to India’s inability to match its economic growth with its population growth-may be a thing of the past, but when it comes to gross domestic product (GDP) figures and other headline numbers, India is still no match for China.

However, the statistics tell only part of the story-the macroeconomic story. At the micro level, things look quite different. There, India displays every bit as much dynamism as China. Indeed, by relying primarily on organic growth, India is making fuller use of its resources and has chosen a path that may well deliver more sustainable progress than China’s FDI-driven approach. “Can India surpass China?” is no longer a silly question, and, if it turns out that India has indeed made the wiser bet, the implications-for China’s future growth and for how policy experts think about economic development generally-could be enormous.

The Stifling State
The fact that India is increasingly building from the ground up while China is still pursuing a top-down approach reflects their contrasting political systems: India is a democracy, and China is not. But the different strategies are also a function of history. China’s Communist Party came to power in 1949 intent on eradicating private ownership, which it quickly did. Although the country is now in its third decade of free-market reforms, it continues to struggle with the legacy of that period-witness the controversy surrounding the recent decision to officially allow capitalists to join the Communist Party.

India, on the other hand, developed a softer brand of socialism, Fabian socialism, which aimed not to destroy capitalism but merely to mitigate the social ills it caused. It was considered essential that the public sector occupy the economy’s “commanding heights,” to use a phrase coined by Russian revolutionary Vladimir Lenin but popularized by India’s first prime minister, Jawaharlal Nehru. However, that did not prevent entrepreneurship from flourishing where the long arm of the state could not reach.
Developments at the microeconomic level in China reflect these historical and ideological differences. China has been far bolder with external reforms but has imposed substantial legal and regulatory constraints on indigenous, private firms. In fact, only four years ago, domestic companies were finally granted the same constitutional protections that foreign businesses have enjoyed since the early 1980s. As of the late 1990s, according to the International Finance Corporation, more than two dozen industries, including some of the most important and lucrative sectors of the economy-banking, telecommunications, highways, and railroads-were still off-limits to private local companies.

These restrictions were designed not to keep Chinese entrepreneurs from competing with foreigners but to prevent private domestic businesses from challenging China’s state-owned enterprises (SOEs). Some progress has been made in reforming the bloated, inefficient SOEs during the last 20 years, but Beijing is still not willing to relinquish its control over the largest ones, such as China Telecom.
Instead, the government has ferociously protected them from competition. In the 1990s, numerous Chinese entrepreneurs tried, and failed, to circumvent the restrictions placed on their activities. Some registered their firms as nominal SOEs (all the capital came from private sources, and the companies were privately managed), only to find themselves ensnared in title disputes when financially strapped government agencies sought to seize their assets. More than a few promising businesses have been destroyed this way.

This bias against home-grown firms is widely acknowledged. A report issued in 2000 by the Chinese Academy of Social Sciences concluded that, “Because of long-standing prejudices and mistaken beliefs, private and individual enterprises have a lower political status and are discriminated against in numerous policies and regulations. The legal, policy, and market environment is unfair and inconsistent.”

Foreign investors have been among the biggest beneficiaries of the constraints placed on local private businesses. One indication of the large payoff they have reaped on the back of China’s phenomenal growth: In 1992, the income accruing to foreign investors with equity stakes in Chinese firms was only $5.3 billion; today it totals more than $22 billion. (This money does not necessarily leave the country; it is often reinvested in China.)

The Mogul as Hero
For democratic, postcolonial India, allowing foreign investors huge profits at the expense of indigenous firms is simply unfeasible. Recall, for instance, the controversy that erupted a decade ago when the Enron Corporation made a deal with the state of Maharashtra to build a $2.9 billion power plant there. The project proceeded, but only after several years of acrimonious debate over foreign investment and its role in India’s development.

While China has created obstacles for its entrepreneurs, India has been making life easier for local businesses. During the last decade, New Delhi has backed away from micromanaging the economy. True, privatization is proceeding at a glacial pace, but the government has ceded its monopoly over long-distance phone service; some tariffs have been cut; bureaucracy has been trimmed a bit; and a number of industries have been opened to private investment, including investment from abroad.

As a consequence, entrepreneurship and free enterprise are flourishing. A measure of the progress: In a recent survey of leading Asian companies by the Far Eastern Economic Review (FEER), India registered a higher average score than any other country in the region, including China (the survey polled over 2,500 executives and professionals in a dozen countries; respondents were asked to rate companies on a scale of one to seven for overall leadership performance). Indeed, only two Chinese firms had scores high enough to qualify for India’s top 10 list. Tellingly, all of the Indian firms were wholly private initiatives, while most of the Chinese companies had significant state involvement.

Some of the leading Indian firms are true start-ups, notably Infosys, which topped FEER’s survey. Others are offshoots of old-line companies. Sundaram Motors, for instance, a leading manufacturer of automotive components and a principal supplier to General Motors, is part of the T.V. Sundaram group, a century-old south Indian business group.

Not only is entrepreneurship thriving in India; entrepreneurs there have become folk heroes. Nehru would surely be appalled at the adulation the Indian public now showers on captains of industry. For instance, Narayana Murthy, the 56-year-old founder of Infosys, is often compared to Microsoft’s Bill Gates and has become a revered figure.
These success stories never would have happened if India lacked the infrastructure needed to support Murthy and other would-be moguls. But democracy, a tradition of entrepreneurship, and a decent legal system have given India the underpinnings necessary for free enterprise to flourish. Although India’s courts are notoriously inefficient, they at least comprise a functioning independent judiciary. Property rights are not fully secure, but the protection of private ownership is certainly far stronger than in China. The rule of law, a legacy of British rule, generally prevails.

These traditions and institutions have proved an excellent springboard for the emergence and evolution of India’s capital markets. Distortions are still commonplace, but the stock and bond markets generally allow firms with solid prospects and reputations to obtain the capital they need to grow. In a World Bank study published last year, only 52 percent of the Indian firms surveyed reported problems obtaining capital, versus 80 percent of the Chinese companies polled. As a result, the Indian firms relied much less on internally generated finances: Only 27 percent of their funding came through operating profits, versus 57 percent for the Chinese firms.

Corporate governance has improved dramatically, thanks in no small part to Murthy, who has made Infosys a paragon of honest accounting and an example for other firms. In a survey of 25 emerging market economies conducted in 2000 by Credit Lyonnais Securities Asia, India ranked sixth in corporate governance, China 19th. The advent of an investor class, coupled with the fact that capital providers, such as development banks, are themselves increasingly subject to market forces, has only bolstered the efficiency and credibility of India’s markets. Apart from providing the regulatory framework, the Indian government has taken a back seat to the private sector.

In China, by contrast, bureaucrats remain the gatekeepers, tightly controlling capital allocation and severely restricting the ability of private companies to obtain stock market listings and access the money they need to grow. Indeed, Beijing has used the financial markets mainly as a way of keeping the SOEs afloat. These policies have produced enormous distortions while preventing China’s markets from gaining depth and maturity. (It is widely claimed that China’s stock markets have a total capitalization in excess of $400 billion, but factoring out non-tradeable shares owned by the government or by government-owned companies reduces the valuation to just around $150 billion.) Compounding the problem are poor corporate governance and the absence of an independent judiciary.

Dollars and Diasporas
If India has so clearly surpassed China at the grass-roots level, why isn’t India’s superiority reflected in the numbers? Why is the gap in GDP and other benchmarks still so wide? It is worth recalling that India’s economic reforms only began in earnest in 1991, more than a decade after China began liberalizing. In addition to the late start, India has had to make do with a national savings rate half that of China’s and 90 percent less FDI. Moreover, India is a sprawling, messy democracy riven by ethnic and religious tensions, and it has also had a longstanding, volatile dispute with Pakistan over Kashmir. China, on the other hand, has enjoyed two decades of relative tranquility; apart from Tiananmen Square, it has been able to focus almost exclusively on economic development.

That India’s annual growth rate is only around 20 percent lower than China’s is, then, a remarkable achievement. And, of course, whether the data for China are accurate is an open question. The speed with which India is catching up is due to its own efficient deployment of capital and China’s inefficiency, symbolized by all the money that has been frittered away on SOEs. And China’s misallocation of resources is likely to become a big drain on the economy in the years ahead.

In the early 1990s, when China was registering double-digit growth rates, Beijing invested massively in the state sector. Most of the investments were not commercially viable, leaving the banking sector with a huge number of nonperforming loans-possibly totaling as much as 50 percent of bank assets. At some point, the capitalization costs of these loans will have to be absorbed, either through write-downs (which means depositors bear the cost) or recapitalization of the banks by the government, which diverts money from other, more productive uses. This could well limit China’s future growth trajectory.

India’s banks may not be models of financial probity, but they have not made mistakes on nearly the same scale. According to a recent study by the management consulting firm Ernst & Young, about 15 percent of banking assets in India were nonperforming as of 2001. India’s economy is thus anchored on more solid footing.

The real issue, of course, isn’t where China and India are today but where they will be tomorrow. The answer will be determined in large measure by how well both countries utilize their resources, and on this score, India is doing a superior job. Is it pursuing a better road to development than China? We won’t know the answer for many years. However, some evidence indicates that India’s grassroots approach may indeed be wiser-and the evidence, ironically, comes from within China itself.

Consider the contrasting strategies of Jiangsu and Zhejiang, two coastal provinces that were at similar levels of economic development when China’s reforms began. Jiangsu has relied largely on FDI to fuel its growth. Zhejiang, by contrast, has placed heavier emphasis on indigenous entrepreneurs and organic development. During the last two decades, Zhejiang’s economy has grown at an annual rate of about 1 percent faster than Jiangsu’s. Twenty years ago, Zhejiang was the poorer of the two provinces; now it is unquestionably more prosperous.

India may soon have the best of both worlds: It looks poised to reap significantly more FDI in the coming years than it has attracted to date. After decades of keeping the Indian diaspora at arm’s length, New Delhi is now embracing it. In some circles, it used to be jokingly said that NRI, an acronym applied to members of the diaspora, stood for “not required Indians.” Now, the term is back to meaning just “nonresident Indian.” The change in attitude was officially signaled earlier this year when the government held a conference on the diaspora that a number of prominent NRIs attended.

China’s success in attracting FDI is partly a historical accident-it has a wealthy diaspora. During the 1990s, more than half of China’s FDI came from overseas Chinese sources. The money appears to have had at least one unintended consequence: The billions of dollars that came from Hong Kong, Macao, and Taiwan may have inadvertently helped Beijing postpone politically difficult internal reforms. For instance, because foreign investors were acquiring assets from loss-making SOEs, the government was able to drag its feet on privatization.

Until now, the Indian diaspora has accounted for less than 10 percent of the foreign money flowing to India. With the welcome mat now laid out, direct investment from nonresident Indians is likely to increase. And while the Indian diaspora may not be able to match the Chinese diaspora as “hard” capital goes, Indians abroad have substantially more intellectual capital to contribute, which could prove even more valuable.

The Indian diaspora has famously distinguished itself in knowledge-based industries, nowhere more so than in Silicon Valley. Now, India’s brightening prospects, as well as the changing attitude vis-à-vis those who have gone abroad, are luring many nonresident Indian engineers and scientists home and are enticing many expatriate business people to open their wallets. With the help of its diaspora, China has won the race to be the world’s factory. With the help of its diaspora, India could become the world’s technology lab.

China and India have pursued radically different development strategies. India is not outperforming China overall, but it is doing better in certain key areas. That success may enable it to catch up with and perhaps even overtake China. Should that prove to be the case, it will not only demonstrate the importance of home-grown entrepreneurship to long-term economic development; it will also show the limits of the FDI-dependent approach China is pursuing.

Huang Yasheng is an associate professor at the Sloan School of Management at the Massachusetts Institute of Technology. Tarun Khanna is a professor at Harvard Business School. Reproduced with permission from FOREIGN POLICY #137 (July/August 2003) www.foreignpolicy.com

Copyright 2003 Carnegie Endowment for International Peace.
Copyright 2003, by China Now Magazine. All rights reserved.

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OK, this post has nothing to do with offshoring, China or Agile development methods, but I found this great motivational piece of writing on Elizabeth Gilbert’s WEB site. Gilbert is the author of the acclaimed best seller “Eat, Pray, Love”.

If you are considering blogging, read it. She describes how she became a successful writer.
Read her article here.

In addition, they are many good WEB sites and blogs on the basics of blogging. I like this one; it is clear, short and efficient. (Do not be repelled by the page’s title).

If you have some money to spend, you can hire a consultant in “digital image”. It costs but can save you a lot of time.

By all means, if you are procrastinating about blogging, go ahead, it is a wonderful thing to do. As for my personal experience, blogging has enabled me to reach out to people and opportunities I would not even have dreamed of.

Enjoy the writing!

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Another article on China: Gates conquers China or is it the other way around? says the title of the latest issue of Fortune. David Kirkpatrick’s article is well done, and it is definitely worth reading it.

The story explained how Microsoft was unsuccessful in China until they learned to play by the Chinese rules. Microsoft’s ability to understand local business practices paid huge dividends, and the tale has a happy ending: Microsoft is now everywhere in China, including on China President’s computer. Furthermore, Bill Gates and President Jintao Hu look like two college alumni.

Once again, “well done Microsoft!”

What were the Microsoft’s alternatives anyway? Pull out of China, or continue to have its technology pirated? I am not sure Microsoft’s shareholders would have liked any of these possibilities.

It seems to me that Microsoft has done the right thing, taking their objectives into account. They teamed up with the government to explain that their products come with an IP, and that it would altogether be beneficial for the government to start regularizing its situation, by accepting the payment plan they offered.

And last but not least since I suppose it was the primary objective of all this, Microsoft’s shareholders are happy.

I watched on Fortune’s WEB site the interview of Fitzpatrick where he talks about his article. Inevitably, the interviewer asks his opinion on Microsoft doing business with “an oppressive one-party country”. Fitzpatrick answers that he avoided in his article talking too much about US corporations compromising with Chinese officials when it comes to human rights.

Well, while I might understand the concept of boycotting a company or country, I am always wondering where to set the bar, who is to decide what is wrong and what is right, and why do we usually direct our critics on other countries when the USA should remain our primary focus.

Large corporations are in the business of making profit, at the expenses of ethics when needed, and that’s the real problem. We cannot ask a corporation to be ethical and at the same time to meet analyst’s expectations quarter after quarter.

Let’s make an example in the USA, and let’s choose a case where the number of casualties outpaces anything happening in China, due to human rights restrictions or pollution.

I found the following facts and figures on the American Sports Data Inc.’s WEB site. The National Center for Health statistics has been tracking America’s obesity problem for over four decades. The following statistics support the growing concern regarding the obesity problem in America:

• Between 1962 and the year 2000, the number of obese Americans grew from 13% to an alarming 31% of the population
• 63% of Americans are overweight with a Body Mass Index (BMI) in excess of 25.0
• 31% are obese with a BMI in excess of 30.0
• Childhood obesity in the United States has more than tripled in the past two decades
• According to the U.S. Surgeon General report obesity is responsible for 300,000 deaths every year.

While our various governments are prompt at blaming China for the absence of freedom, they let the (junk) food corporations sell hamburgers, sodas, etc. without taking any action, since these companies do not endanger our democracy nor hurt our freedoms, at least apparently.

Most large corporations will do anything it takes to please their shareholders. Need to give a list of names to the Chinese government to preserve a local market share? Here it is Mr. President. Need to poison American kids to sell more sodas? Have another drink with your multi-layered hamburger. The list goes on and on.

As long as we do not redefine the role of shareholders, we cannot ask corporations to act ethically. It is and “either/or” situation, and possibly one of our biggest challenges for the first part of this century.

And to close on a funnier note, at the end of the article, it is said that Windows’ average price in China is of $ 7 compared to $ 100 to $ 200 in the developed countries. And Gates to comment, “Those figures will eventually converge.”

I hope they will converge to 7 dollars.

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Business Week recently published an interesting article on the “real cost of offshoring”.

A large part of the article focuses on demonstrating that the rapid growth of offshoring in our country has rendered some key economic indicators inaccurate.

I have to admit that I do not believe too much in these indicators anyway. In fact, I have long suspected them to be only technicalities that poorly reflect the real economic conditions; my opinion is not anew, it is just the old debate about the true meaning of statistics.

A sentence in the conclusion compelled me to write this post. It reads: (…) the rush of globalization has brought about a fundamental change in the US economy.

I would definitely have said: (…) the fundamental change in the US economy has created a rush of globalization.

And the difference is not marginal. We are NOT offshoring our jobs to China and India as a direct result of these countries’ attractiveness, but as a result of the economic models that have been used in the Western countries for the past 30 years.

The quest for an always higher profit yields to an ever-increasing dependency of the corporations to their shareholders, which yields in turn to have the most strategic decisions dictated by extremely short-term constraints, and has just accelerated the decline of the Industrial Age in the USA. Since corporations cannot rely only on increasing their sales to produce the high margins required by the stock market/shareholders/analysts, they need to keep cutting costs. There is no need to be a renowned analyst to observe the decline of the US manufacturing industry.

All of the above could only yield to massive manufacturing outsourcing and then business process outsourcing to Asia. China and India have never been in a position to force American and European corporations to offshore their manufacturing. How can we blame the local economies to have grabbed this golden opportunity?

Meanwhile we have let our education system and our values deteriorate. And numbers talk (statistics don’t!): China is now the largest producer of engineering graduates in the world, with some 600,000 coming out of its colleges and universities in 2005. India follows with over 450,000 engineering graduates in 2005, of which almost 30 per cent were computer engineers. Both India and China have over 2,000 colleges and Universities each. Compared to India and China, the United States produces only 70,000 engineering graduates every year. All of Western Europe produces just over 100,000.

We can (and must!) renovate our education system. That said, it would not produce any tangible result before another 10 to 15 years, so we are not even in a position to rapidly reverse the offshoring process.

Since we cannot reverse rapidly a situation we have created, what should we do?

And I would start by mentioning two things we should NOT do, as they would only backfire on us.

- We should not hope for China or India to collapse. I keep reading articles about pollution in China, political and social instability in India, etc. These things are certainly true, but we should hope that these issues will be addressed and resolved. First, because it is never good news when a country collapses, especially since we are so dependent from these two countries, and also because it does not help us improve our own situation

- We also do not want to ignore what is going on and just accuse the whistleblowers of “allegiance to the enemy”. The sooner we acknowledge the situation and act on it, the easier it will be to implement alternate solutions.

We have many reasons to be optimistic. We have a good country infrastructure, a wealthy economy, a democracy that lets people voice their opinion whenever they want, and a culture of entrepreneurship. We need to focus our energies in inventing the new jobs that the globalization is creating, and there is aplenty; the rise of China is creating opportunities in the tourism, food, greentech, and agriculture industries, to name a few.

I had a lunch a few days ago with a friend of mine, who retired to Mainland China after having spent most of his career in the Silicon Valley, as an investment banker. He asked me if I knew of Western companies interested in expanding into China, especially in the food and fashion areas. In cities like Beijing, Shanghai or Chengdu, a wealthy middle-class is now eager to buy goods from the Western countries. There are golden opportunities for American or European companies from all size. Yes, we can export to China, and we must do it.

In the IT outsourcing industry, we should consider hybrid models with development teams located not only in Asia, but also in the USA. Leading companies like TCS or Infosys have paved the way and have become global, creating jobs in most of the countries where they are doing business. At Venus Software, we are hiring not only in China, but also in the USA, in Japan, and soon in Western Europe.

It took us over twenty years to acknowledge the rise of China and India, since corporations were focused on increasing their profit at any rate and we the consumers on buying all sorts of goods (clothes, electronics, etc.) at low prices, since they were manufactured in developing countries. It should not take us another 20 years to realize that we must reorient our economies to adapt to the reality of globalization.

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