Can Modi really adopt, afford the Chinese model of development?
Narendra Modi has a strong mandate, so there is hope that he might get a few things done. But one thing is sure, following China’s example is neither possible nor desirable
According to a recent report, India's newly elected Prime Minister Narendra Modi, wants to emulate China in two ways. He wants to welcome foreign investment and build infrastructure. He apparently believes that both of these things would help India transform itself into “a globally competitive manufacturing hub”.
The question is whether Mr Modi can actually emulate China? To answer this question it is necessary to analyze exactly how China was able to achieve such success. The short answer is that China was able to use its financial and institutional systems to transfer wealth from households to investment. By increasing investment, especially in infrastructure, China was able to achieve incredible growth. The by-product was also jobs.
The result is that China built an extensive new infrastructure. The way they were able to transfer wealth into infrastructure investments is interesting. The Chinese, unlike Americans, Indians or Europeans, had very little choice in the places available to invest their money. Until quite recently, they were forced to save at one of the state owned banks. The amount of money the banks could pay on deposits was capped, as was the amount that the banks could charge for loans. This guaranteed large profits for banks and cheap loans for local governments and state owned industries. It also had the effect of imposing a very high financial repression tax on households.
Most people believe that the Chinese save because there is something inherent in their culture. I personally doubt this thesis. I believe that the Chinese save because the country has few safety nets. Anything, from healthcare to schools, require payments. The effect is that the Chinese, unlike the Europeans, cannot depend on the state for much. The only way they can protect themselves is to save.
The combination of the implicit tax and high savings meant that consumption was very low as a percentage of GDP. In contrast, investment was very high, especially by local governments, in infrastructure.
There is one problem with this model. It is unsustainable. Much of China's massive investment spending channelled to local governments and state owned industries has been wasted on projects with negative real returns. The credit growth necessary to continue this investment boom has reached levels almost twice the levels reached in the US, Japan, Korea and the UK before their meltdowns.
So the first question about whether India can follow the Chinese model is why would India want to? The second is whether it is possible? Probably not. India has a far more open economy and a convertible currency. Even China does not have a complete monopoly on its financial system. India never did.
Welcoming foreign investment into India would be an excellent idea. A large part of China’s export growth was built on foreign investment, but not necessarily because the Chinese wanted it. It was safe for the Communist Party to empower foreigners who could be expelled at any time than free local entrepreneurs. Even better, foreign investors brought with them advanced technology, which could be “liberated” and used by local companies. There was no need to consult anyone who might be put out of business by new entrants. The local Communist Party officials made decisions themselves. Generally foreign investors were only required to form partnerships if they wished to exploit local markets.
Allowing foreign investment into India has been a massive challenge. The most recent attempt at allowing foreigners into the retail sector met with formidable resistance. No doubt, allowing foreign investment into infrastructure projects would meet with similar problems.
Indian government officials are not the only power group in town. To allow foreign investors in would require approval from other groups, whose interests would be affected. The Indian government must also abide by the law, which does protect foreign intellectual property.
In the beginning one of the main attractions of China was the cheap labour. Any rules putting limits on how companies exploited that labour were not enforced. Now, Chinese labour has become relatively expensive and fairly restive.
China’s loss of a labour competitive advantage can be exploited by India, but only if it can reform its labour laws. It should follow the US model, which allows companies to dismiss workers without government approval. But the probability of Modi getting this through appears to be rather slim in my view.
This does not mean that Prime Minister Modi cannot do a lot to reform India. A technocrat’s dream reform agenda has been around for years, but goes nowhere. The main impediment has been the coalition governments and powerful states. Mr Modi has a strong mandate, so there is hope that he might get few things done. But one thing is sure, following China’s example is neither possible nor desirable.
(William Gamble is president of Emerging Market Strategies. An international lawyer and economist, he developed his theories beginning with his first-hand experience and business dealings in the Russia starting in 1993. Mr Gamble holds two graduate law degrees. He was educated at Institute D'Etudes Politique, Trinity College, University of Miami School of Law, and University of Virginia Darden Graduate School of Business Administration. He was a member of the bar in three states, over four different federal courts and speaks four languages.)
More in Moneylife
How Aadhaar linkage can destroy banks +11836 views
TODAY'S TOP STORIES
Can You depend on mainstream media to report economic scams?
What's your say?
What you said
Thanks for casting your votes! View Previous Polls