China and India push to compete with divergent approaches

The industrialized world has watched in awe as both China and India have undergone phenomenal growth in the last several years: China's rise igniting in the 1980s; India's a decade later.

A quarterly report from N.Y.-based consulting firm McKinsey & Co. —China

and India: the Race to Growth —says each country has traveled different economic growth paths, for reasons rooted in culture and infrastructure. Both also face differing hurdles that will influence their future course, in some cases, on an industry-by-industry basis.

China's growth is powered by massive state investment in infrastructure, centralized targeting of industries, and use of foreign investment and expertise for building manufacturing capacity, resulting in GDP growth of 9 percent in 2003. In that same year, China received $53 billion in foreign direct investment—8.2 percent of the world's total, and far more than any other country.

India, which suffers severe infrastructure problems—e.g., inadequate water and power—has nurtured entrepreneurial initiatives and excelled in creating world-class, knowledge-based industries in software, IT services, and pharmaceuticals. GDP climbed from 4.3 percent in 2002 to 8.3 percent in 2003, but foreign direct investment of $4.7 billion in 2003 is a fraction of its rival neighbor.

Where China encourages foreign investment, India remains more aloof. Where China has thrived based on hard infrastructure—roads, seaports, and power—India has taken advantage of softer intangibles, such as intellectual capital especially.

China set its course in the 1980s by state fiat, determined to do what was necessary to become a world economic power. It selectively targeted hard-asset industries that would serve as engines for growth. Lacking expertise, it was made easy for multinationals to invest and build what was needed.

Before 1980, as noted by McKinsey, there was no national Chinese economy. Everything was local, with no operating entity servicing beyond a few kilometers from headquarters. The central government removed provincial trade barriers and gave GDP targets to local officials, letting them invest where they expected to get the biggest bang for the buck competing against rival municipalities and provinces. This netted overlap, cyclical overcapacity, and price wars that were followed by shakeouts where the survivors emerged fit to bypass local government funding, and capable of competing internationally.

Bad debts on state-financed loans and inadequate regulation of capital markets remain serious obstacles to China's economic health. Steps are being taken to strengthen financial markets and impose tough reserve margins, risk-based loan assessment, and local management incentives in banking. While unevenly executed, growth in standards of living in China is a plus for it.

Where China has tried to intervene to strengthen its stock markets by fiat—largely unsuccessfully—India's entrepreneurial spirit in recent years has greatly improved the viability of its stock exchanges. India does not yet, however, drive growth to the same extent as China has during its centralized thrust toward modernization.

For these and other reasons, says McKinsey, India is likely to remain more viable in software and IT services, while China will dominate in consumer electronics. Automotive is a toss-up. In the end, high productivity, sound regulation, and the removal of competitive barriers will determine industry by industry which country will dominate in what sectors.