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Business News/ Opinion / Columns/  Will the elephant overshadow the dragon?

Will the elephant overshadow the dragon?

The convergence hypothesis in economics suggests that the Indian economy should grow faster than the Chinese one till it reaches a level similar to China’s

India remains the only major economy to have democratized before it grew rapidly, whereas China proves the enigmatic exception to the rule that rapid economic developments ushers in democratization. Photo: Bloomberg Premium
India remains the only major economy to have democratized before it grew rapidly, whereas China proves the enigmatic exception to the rule that rapid economic developments ushers in democratization. Photo: Bloomberg

Now that the World Bank, the International Monetary Fund (IMF), and others have predicted that India’s growth rate will overtake China’s within the next year or two — or, indeed, already has, if one accepts the new methodology of measuring gross domestic product (GDP) in India — it’s an opportune moment to revisit an old but still very pertinent debate: can India actually overtake China?

First, though, for some basic economics: given that India’s economy is still a fraction of the size of China’s, it is entirely to be expected that Indian GDP growth will outpace China’s. The surprise, indeed, is that it has not happened sooner. The reason is what is known technically as the “diminishing marginal productivity" of capital, or, more loosely, diminishing returns to capital. In everyday language, this means that an increase in the capital stock creates more extra output when the capital stock is small, and that the additional output from each additional unit of capital declines as the capital stock increases.

This, in turn, generates what is known as the “convergence hypothesis" in the economics of growth: economies grow fastest when they are poor, and growth rates eventually taper down to a long run or “steady state" level as they get richer. If this property holds uniformly across economies, then, over time, economies starting at different initial levels of income will tend to converge to the same growth rate over time. A more refined version of this hypothesis — known as “conditional convergence" — adds the proviso that this convergence in growth rates must take account of — or, in statistical terms, be conditioned on — underlying structural differences (such as technology, preferences, and so forth) among economies.

The bottom line is that, through the lens of conventional growth economics, there is nothing surprising that India’s growth rate has caught up to, and has surpassed (or shortly will surpass), China’s, since India’s GDP is still much smaller than China’s.

Conventional it may be, but when the notion that India could overtake China was first mooted in the contemporary academic and policy discourse a little more than a decade ago, it aroused surprise, disagreement, and even derision. Following the lead of the late Samuel Huntington, a political scientist most famous in the public sphere for the “clash of civilizations" thesis, most scholars of political economy believed that India’s messy democracy could not match authoritarian China in mobilizing the resources necessary to grow rapidly. The economist Jagdish Bhagwati pithily captured this conventional view when he referred to the “cruel dilemma" between democracy and economic development. The Economist summed up well the conventional wisdom when they wrote in a leader: “A proudly democratic India that grows at 6% a year ... should be congratulated for having succeeded better than a brutal anti-democratic China which grows at 10% a year." (The Economist, March 5th, 2005).

The first important paper to challenge this orthodoxy was by economists Yasheng Huang and Tarun Khanna (“Can India Overtake China?", Foreign Policy, July 1, 2003 ). Their basic argument was that rapid growth in China was driven by foreign direct investment (FDI), which transferred little knowledge to the local economy, while growth in India was driven by domestic savings and entrepreneurship in knowledge-intensive sectors (both manufacturing and services). This, they argued, in the longer run, would prove to be more organic and sustainable than the screwdriver-turning manufacturing driven growth of China.

Shortly after Huang and Khanna, economist James Dean and I articulated a somewhat difference case for why India could overtake China. In a series of lectures in late 2004 and 2005 titled “The Elephant and the Dragon: A Tale of Two Countries", we challenged the conventional Huntingtonian view that Chinese style authoritarianism was better suited than Indian style democracy to delivering more rapid growth in the medium to longer run. In part, we drew on a nascent empirical political economy literature which showed that, on average, democracies do at least as well, if not better, than autocracies.

An important early article in this new strand of literature upon which we drew was by political scientists Joseph T. Siegle, Michael M. Weinstein, and Morton H. Halperin (“Why Democracies Excel", Foreign Affairs, September/October 2004 ). This has now blossomed into a veritable cottage industry of articles and books that use empirical methods to try to assess whether the conventional view that autocracies perform better than democracies on economic growth is actually true. The bottom line conclusion from this line of research is that there is no persuasive evidence in favour of the conventional view, and no iron law that says that democracies cannot do as well economically as democracies.

Dean and I also articulated a theoretical argument, harking back to an older literature in political economy most associated with pro-market, anti-socialist economists such as Ludwig von Mises, Friederich von Hayek, and Milton Friedman. The libertarian argument, that free markets and a free society are necessarily intertwined, was well summarized by Ralph Harris, when he said: “It wasn’t a theoretical thing; it was an active thing, that drive for democracy, for freedom. The argument always was that democracy is impossible without a free economy. (That) you need a free economy was a necessary though not a sufficient condition of democracy." (Harris was an original member of the Mont Pelerin Society, started by Hayek, and founded the Institute of Economic Affairs in London, which provided the intellectual support to Margaret Thatcher’s pro-market reforms during her tenure as British prime minister).

Interestingly, in a recent and much-publicized speech, “Democracy, Inclusion, and Prosperity" (20 February, 2015, Goa), Reserve Bank of India governor Raghuram Rajan gestured towards a similar argument, expanding on the work of political scientist Francis Fukuyama (himself a disciple of Huntington): “…free enterprise and the political freedom emanating from democratic accountability and rule of law can be mutually reinforcing so a free enterprise system should be thought of as the fourth pillar underpinning liberal market democracies."

The basic argument that Dean and I made was that, in the long run, the glaring discrepancy between an ever freer and more capitalistic economy, characterized by increasing wealth and economic opportunity, and a still repressive polity, characterized by a lack of political freedom, could lead to a political crisis in China. And, if a political crisis were to occur, which would be characterized by widespread social unrest and even violence, China’s growth miracle could quickly unravel.

By contrast, we argued that, in India, democracy provided a necessary “safety valve", through which putative losers from economic reform could make their voices heard, and that this would make the Indian path toward economic reform and more rapid economic growth more sustainable and less prone to political crisis or reversal. (Bhagwati had made a similar argument, also invoking the metaphor of a “safely valve", in a broad discussion of democracy and development, in “Democracy and Development: New Thinking on an old Question", Indian Economic Review, 1995).

In a sense, this libertarian inspired thesis — that a free market and a free society will tend to evolve together, and that it is difficult to have the one, without the other, for very long — has its own resonance in a strand of political economy literature most famously associated with the political sociologist Seymour Martin Lipset. Lipset, and others associated with modernization theory, argued that democracy in its modern form is an outgrowth of economic growth itself. As economies grow and a middle class is created, pressures for democratic reform will rise within a society, and lead to an eventual freeing up of the political system. This, indeed, matches the historical experience of all rapidly industrializing and growing economies, starting with Victorian Britain and going right up to the East Asian miracle economies.

Oddly enough, China and India are exceptions to this historical pattern, for different reasons. India remains the only major economy to have democratized before it grew rapidly, whereas China proves the enigmatic exception to the rule that rapid economic developments ushers in democratization.

With India now overtaking China — in terms of growth rate, although, of course, not of the level of GDP — a part of the hypothesis that Dean, I and others put forward a decade ago appears to have found a belated vindication. We shall have to wait and see if the obverse side of that hypothesis — an implosion in China, or a belated and disorderly democratization — will ever come to pass.

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Published: 05 Mar 2015, 01:32 PM IST
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