China slowdown presents India an opportunity to shine Editorial 20th Feb’19 LiveMint
Middle income trap:
- Many countries that have succeeded in moving out of mass poverty (through rapid economic growth) have struggled in their effort to move to mass prosperity.
- Research by economists showed that the most common point when inertia sets in (that is per capita income levels stagnate), is when average incomes are either around $11,000 or $15,000 a year.
- This is the famous middle income trap.
- Fewer countries emerge from it than enter it.
Reasons for this:
- Initial growth is input intensive:
- Economic growth in the initial phases is predominantly driven by the use of more inputs (labour, capital etc.).
- The labour force is growing. Investment rates are high.
- At a certain stage, productivity growth is required to leap to the next phase of development:
- After the initial growth phase, the need for productivity growth kicks in.
- The transition from one phase to the other—from using more inputs to using them more productively—is not an easy one.
- Most countries find this transition difficult:
- Economies such as South Africa and Brazil have not, for decades, been able to get out of this “middle income trap”.
- The countries of East Asia also painfully realised this in 1997.
China has arrived at that point:
- China has entered challenging territory of “middle income trap”.
- The International Monetary Fund (IMF) estimates that average incomes in China will be $10,098 this year.
Inputs peaked and now looking for productivity growth:
- The Chinese labour force seems to have peaked. The investment rate is already unsustainably high.
- China is now struggling with the challenge of finding ways to switch the economic growth model from input intensity to productivity growth.
China’s efforts to get out of the middle income trap has led to financial stress:
- China has responded to its challenges of productivity through stimulus measures.
- The credit booms directed by the government have raised the risk of a financial meltdown.
- The true fiscal deficit, which includes subnational borrowing as well as money raised off balance sheet (many local governments in China raise debt without showing it on balance sheet in order to avoid lending limits imposed by central government), is perhaps close to 10% of Chinese GDP.
- Most of this is connected to the challenge of changing the growth model to escape the middle income trap.
China’s worries ahead:
- The ruling Chinese Communist Party fears that any economic collapse will lead to a political collapse of the sort the Soviet Union saw in 1991.
- It is also worried about the sort of financial meltdown that many Asian countries saw in 1997.
- Another fear is a long stagnation (very low growth rates) like the one Japan encountered after its financial bubble burst in 1989, at the very end of its economic miracle.
But China can still come out of the middle income trap:
- Economists have been forecasting the collapse of China for two decades but that has not happened so far.
- China to its credit has seen the most spectacular economic boom in human history as well as the most astonishing development story ever.
- So the possibility that China will extricate itself from the middle income trap should not be dismissed.
Can India catch up with China while it slows down?
China’s economic status built through very high growth rate for a long time:
- In the two decades before its structural slowdown began in 2013, China expanded its economy at double digits in nine years while it grew in excess of 9% for another six years.
- China has on average been growing around two percentage points faster than India since the early 1990s.
India grew fast only for a few years:
- India had one year of double digit growth and three years of 9%-plus growth in the same period.
- As a result, China moved ahead very rapidly.
India lags behind China is many ways:
- Gap in living standards:
- The Indian average income in 2019 is broadly similar to the Chinese average income in 2006. This means is that India is now 13 years behind China in terms of living standards.
- There is a similar gap when it comes to the size of the economy (GDP).
- Gap in global strategic heft:
- China’s economic power gives it enormous strategic heft which it uses aggressively.
- Indian economy needs to grow fast for a long time to achieve similar status.
- Gap in social development:
- There is a large gap between India and China for social development indicators such as health and education.
Now India has a chance to close the gap:
- With China slowing down, India has a chance to close the gap on China.
- India has been growing faster than China in the past couple of years, and has taken over as the fastest growing major economy in the world.
- That is likely to continue as the Chinese economy continues to lose momentum.
Depends on policy choices:
- However, whether the income gap can be closed, or at least narrowed, depends on whether India can improve its economic trajectory even while China slows down.
- A lot depends on the respective policy responses in the two countries.
- It depends on whether China can come up with policies to change its growth model without a financial shock.
- It depends on whether India can accelerate its growth rate over the next two decades.
- The China slowdown is an opportunity for India to close the gap.
- The first condition for that will be policy reforms to sustain higher economic growth.
GS Paper II: International Relations