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| India-Pakistan |
| The Microeconomic Rise of India |
| 2006-03-11 |
| By Yasheng Huang According to the World Economic Forum’s “Global Competitiveness Report (GCR) 2005-06,” released last September, China ranks 46th on the “Growth Competitiveness Index” and India 55th. It’s a pity that the GCR is often cited but seldom read. Beyond the table on overall rankings of country competitiveness, the report contains a wealth of valuable information and insights. In particular, a measure designed to capture the microeconomic foundation of economic growth, the business competitiveness index (BCI), adds significantly to the China-India comparison debate. China dominates India on almost every macroeconomic indicator. In the 2003-04 GCR, China was ranked at 25th place on the macroeconomic environment index, compared with India’s 52nd place. Newspaper headlines reveal the same story: China has had a faster GDP growth, and its per capita income is twice that of India. China’s exports have been growing faster and are substantially larger in terms of volume. It produces more steel, builds more roads, highways and skyscrapers faster than Indians can build slums. For foreign analysts, the most favored measure of economic success is the level of foreign direct investment (FDI). And almost every comparison of China and India will tell you that China attracts 10 times the amount of FDI as India. Looking at microeconomic indicators, however, a far more complicated picture emerges. In 2004, India ranked 30th in the BCI, far ahead of China’s 47th place ranking. On other components of microeconomic competitiveness—company operations and strategy, and quality of the national business environment—the Indians (30th and 32nd) were similarly ahead of the Chinese (39th and 47th). Yet perhaps the most stunning revelation is that since 1998—the first year this microeconomic ranking was produced—China’s standing has declined, whereas India’s has improved substantially. Despite a sharp increase in FDI amidst a growth rate of nearly 10% a year, China’s microeconomic foundations for growth since joining the WTO have deteriorated. India, in contrast, has quietly and solidly improved its microeconomic competitiveness. In terms of BCI, China was ahead of India by two places in 1998; in 2004, it was behind India by a yawning gap of 17 places. The most important thing to note in any China-India comparison is that there is a substantial difference between the macroeconomic measures and microeconomic measures of these two countries. China’s GDP growth is faster, as widely acknowledged, but its corporate performance has been very poor. The index of Shanghai Stock Exchange has declined by 50% since 2001. Based on Standard & Poor’s Compustat data for 346 top-listed companies in both countries, BusinessWeek calculated that the average Indian firm posted a 16.7% return on capital in 2004 versus 12.8% in China. This performance gap between Indian and Chinese firms has long persisted. According to a UBS report, during the 1998-2003 period, the average return on capital employed (ROCE) for an Indian firm was about 17%. For Chinese firms the figure was only 11%. If anything, these numbers may overstate Chinese performance. Many of the performance indicators do not take into account the fact that the cost of capital is heavily subsidized for state-owned firms in China. BusinessWeek quotes Chen Xiaoyue, president of Beijing National Accounting Institute, as saying that two-thirds of 1,300 listed Chinese firms fail to earn back their true cost of capital. This implies that return on capital might have been negative if capital were appropriately priced in China. This growing gap between macroeconomic and microeconomic performances has several serious implications. That India came from behind China provides the single best proof that India’s achievements are due to its longer history of capitalism. The fact is that China was significantly ahead of India in economic liberalization in the 1980s and for the first half of the 1990s. My view is that economic reforms began to stall in China since the late 1990s, but in India they have continually moved forward, however gingerly. The performance gap also raises some serious questions about the state of the Chinese economy. As Michael Porter of Harvard Business School, author of the microeconomic competitiveness study, pointed out: “Wealth is actually created in the microeconomic foundations of the economy.” GDP is an output measure, and the idea of economic growth is not so much to increase output but to create wealth. That the Chinese firms are making lower—and potentially negative—returns on their investments suggests that value is not being created. Indeed, there is now evidence that the Chinese economy is less impressive in wealth creation compared to the Indian economy. The World Bank has just released a report that provides some measurements on wealth creation (based on 2000 data). China’s per capita income is about twice that of India, but by wealth measures, China is only 37.6% wealthier than India. China looks especially poor in the area of intangible capital—which is a function of education, rule of law and other intangible characteristics of an economic system. China has an intangible capital of $4,208 per capita as compared with India’s $3,738. Journalist Simon Long duly noted in a survey article in the Economist that China produced more, but India was more efficient in the long-run. Yet his conclusion seemed to proclaim: “But who cares?” This obsession with output measures—apparently shared by Brezhnev and Western observers alike—is extremely damaging. For one thing, this obsession overstates Chinese achievements and understates those of India. The outputs China produces are visible, especially in the form of skyscrapers in metropolises, but to appreciate Indian strengths one has to interact with Indian entrepreneurs and managers in order to understand their impressive visions and capabilities. Output obsession has also led to a wrong policy model. The idea that building skyscrapers, airports, highways and power stations is equivalent to economic growth has done the biggest damage to China’s microeconomic competitiveness. In China, this idea has led to massive and forcible seizures of land, the destruction of perfectly functional housing structures and a reduction of arable lands. These actions are terribly destructive in their economic effects, one of which is that the sense of property rights security—so fragilely maintained since the end of the Cultural Revolution—is undermined. The damage is especially extensive in rural China. My own research shows that rural entrepreneurship flourished in some of the poorest regions of China in the 1980s, but in the 1990s, financing became more difficult and, according to Chinese education researchers, rural basic education suffered. A country cannot stray from its microeconomic fundamentals forever. At some point, China’s macroeconomic performance will have to converge to a level compatible with its microeconomic conditions. Growth will slow down unless the Chinese leadership begins to proactively correct the deep institutional distortions in the Chinese economy by immediately banning all forcible land grabs and creating market-based land transactions, launching privatization programs, drastically improving both political and corporate governance and accountability, and opening up China’s financial sector to both domestic and foreign competition. Given China’s deep advantages in basic education, its formidable technical and scientific prowess, and its long and successful tradition of entrepreneurship, there is not a single good reason why China should lag behind India on microeconomic competitiveness. Mr. Huang is an associate professor in international management at the MIT Sloan School of Management and the author of Selling China (Cambridge, 2003). He is working on a book about the domestic private sector in China, entitled Capitalism with Chinese Characteristics. |
| Posted by:john |
| #25 phil_b: Zhang, I was specifically referring to FDI, which by definition can choose any country to enter. FDI should flow to where it generates the highest returns (discounting risk). We both agree that in the case of China it doesn't. So either economic theory is wrong or FDI flows to China for reasons other than return on capital in the normal timeframe of. I still maintain the comparison with the dotcom bubble applies. Actually, I wouldn't agree that FDI doesn't flow to where it achieves the highest return in China. It's not a mania. SC Johnson, Procter and Gamble and other consumer goods companies have plants in China not because they are blinded by a myth, but because they are competitive against Chinese manufacturers, who sell products for about the same prices as they do. A bottle of body wash (which the Chinese seem to prefer to bars of soap) sells like hot cakes despite its sticker price of 30RMB, half-a-day's pay in the wealthier cities. I can't imagine the average American paying $4 for a bar of soap. But the average Chinese will pay 30RMB for a bottle of body wash. The Chinese market is a gold mine for foreign companies currently, and is likely to become a much bigger factor in years to come. Why do foreign companies invest in China? Because of China's liberal investment policies, as well as its low costs. Goods from China are cheap because Chinese land and labor are cheap, and because China has fewer investment restrictions than countries like India, Korea and perhaps even Thailand. Returns on domestic Chinese investments are low because China is awash in capital, not because of inefficient allocation of capital. But foreigners make good money in China because the opportunity is large, and they invest only in those sectors where they can make money. |
| Posted by: Zhang Fei 2006-03-11 23:55 |
| #24 Phil: Anecdotes are not data. Speaking of data - savings rates are much lower in India, and investment returns are higher. This should mean that India's population buys more stuff. Let's look at auto sales in 2004. Chinese consumers bought 5m cars in that year. India's number was 1m. This suggests one thing to me - the Chinese are under-reporting, not over-reporting growth rates. There's a rational reason for this - during the ideological era of the Great Leap forward, the incentive was to over-report, because the alternative - accurate reports about the dismal failures of collectivism - was being executed as a capitalist roader for sabotaging the Chairman's great plans.* Today, reporting high provincial growth rates means bigger demands from the central government for taxes, which are collected by the provinces (unlike in the US, where they are handed directly to the respective levels of government - city, county, state, federal). All of the provinces are sandbagging to evade central government demands for tax revenues. But doesn't lackadaisical reported economic performance pose a threat to the jobs of government officials? No - because (1) they get and keep their jobs not for performance reasons, but because of favors rendered to specific higher-ups and (2) high single-digit percentage growth is nothing to sniff at. And if they're fired, there's lots of favors they can call in - lots of ex-officials have turned successful private businessmen. Note that Deng Xiaoping had no official position immediately prior to becoming China's top leader - all he had were scads and scads of favors rendered while coming up through the ranks before becoming the commander of the Chinese military. But just prior to becoming China's top leader, he had been purged (dismissed) from his official positions for years. * Many provincial officials would have liked to report the correct (but dismal) numbers during the great disasters of that period. But they would have been shot, and new officials instituted to report the sparkling numbers the Great Helmsman (Mao) expected to see. So they provided falsely optimistic numbers, confiscated entire harvests for central government coffers and left tens of millions to starve. |
| Posted by: Zhang Fei 2006-03-11 23:44 |
| #23 Zhang, I was specifically referring to FDI, which by definition can choose any country to enter. FDI should flow to where it generates the highest returns (discounting risk). We both agree that in the case of China it doesn't. So either economic theory is wrong or FDI flows to China for reasons other than return on capital in the normal timeframe of. I still maintain the comparison with the dotcom bubble applies. |
| Posted by: phil_b 2006-03-11 23:32 |
| #22 Phil: I could mention Motorola's huge investment in semiconductor plants in China. The same semiconductor division that later went on to take a big nosedive. Anecdotes are not data. Actually, they are points of data. Motorola's semiconductor division was losing money and is an also-ran - that is why it was spun off. Enron's power plant division was perhaps the only money-making division at the company. So Motorola lost money in semiconductors in China - heck, it lost money in semiconductors worldwide. Enron made money with power plants, but lost money in India. Motorola has other investments in China - notably in cell-phones. It made huge amounts of money there, and is now reclaiming the top spot it once had in China - from Nokia. |
| Posted by: Zhang Fei 2006-03-11 22:59 |
| #21 Note that Enron walked away from a billion dollar power plant investment in India - that's $1b hard-earned simoleons it had to write off. Companies like Enron invest in India. Companies like Intel invest in China. I could mention Motorola's huge investment in semiconductor plants in China. The same semiconductor division that later went on to take a big nosedive. Anecdotes are not data. |
| Posted by: Phil 2006-03-11 22:31 |
| #20 On topic stuff here: http://p081.ezboard.com/fhinduunityfrm10.showMessage?topicID=37.topic |
| Posted by: Listen To Dogs 2006-03-11 22:30 |
| #19 John: Do you know what was behind these series of strikes against Japanese plants? Response to a Japanese minister suggesting that companies investing in China should hedge their bets and invest in India also. Karat - the leader of the CPI(M) Communist Party of India (Marxist) paid a visit to Beijing. When he returned (with his orders), the unions launched their attacks. A Honda Accord costs $30,000 in China (China charges a 20% tariff on the auto parts imported for assembly by Honda, but Chinese auto assembly wages are $2 per hour). Vs $40,000 in India. And $28,000 in the US. Not real surprising why profits for Tata are high - it's sitting behind high tariff barriers, as India's state-approved national champion. |
| Posted by: Zhang Fei 2006-03-11 22:25 |
| #18 India has all those things (which I don't actually understand) + Aishwarya Rai. It's just unfair! |
| Posted by: gromgoru 2006-03-11 22:24 |
| #17 Looking at the Tata page, there doesn't seem to be a model in the Accord category... http://cars.tatamotors.com/tatamotors/index.aspx |
| Posted by: john 2006-03-11 22:15 |
| #16 The imported Honda units are of course another story... the tariffs would apply.. I doubt Tata has a car in that category though... The Honda would compete against other brands |
| Posted by: john 2006-03-11 22:06 |
| #15 The Honda plant would be sourcing its parts locally so import tariffs would not apply. There are heavy excise duties on car purchases though.. |
| Posted by: john 2006-03-11 22:03 |
| #14 Note also that Honda lost US$30m in a single strike at its Indian operations. You don't get that kind of thing in China: Do you know what was behind these series of strikes against Japanese plants? Response to a Japanese minister suggesting that companies investing in China should hedge their bets and invest in India also. Karat - the leader of the CPI(M) Communist Party of India (Marxist) paid a visit to Beijing. When he returned (with his orders), the unions launched their attacks. |
| Posted by: john 2006-03-11 21:39 |
| #13 Mittal Steel. Mittal is a peculiar case hard to ategorize it as an Indian company - it is only now building a plant in India. A lot of top management is poached from the state owned Steel Authorty of India though... |
| Posted by: john 2006-03-11 21:35 |
| #12 John, a Honda Accord costs $40,000 in India. It costs about $28,000 at worst stateside. Tariffs are involved. Honda isn't competing on a level playing field with Tata. Note also that Honda lost US$30m in a single strike at its Indian operations. You don't get that kind of thing in China: Labor dispute at Honda Motor Co's motorcycle factory in India that developed into clashes between workers and police on Monday is hurting production, with the company incurring a loss of 3 bln yen to date, the Nihon Keizai Shimbun reported without citing sources. The dispute was triggered by the dismissal of four and the suspension of 50 employees for stopping production lines, with workers going on strike at the end of May, the business daily said. The average production units at the factory dropped to 400 motorcycles a day in June, although production has gradually recovered to 1,000 units, the Nikkei said. Honda Motorcycle and Scooter India Pvt, a wholly-owned subsidiary of Honda, account for 25 pct of Honda's global motorcycle output. Honda said the company is investigating the link between the labor dispute and the demonstration. |
| Posted by: Zhang Fei 2006-03-11 21:33 |
| #11 It seems Intel has announced investments of 1 billion in India Nokia has just opened a plant "Built up in 23 weeks, the plant commenced commercial production from January 2 this year and has already made over one million handsets. The facility currently has around 1100 employees." |
| Posted by: john 2006-03-11 21:31 |
| #10 like Bharat Forge, Reliance, Tata ...Mittal Steel. I don't think you can discount the experience some of these companies gain in the global market. |
| Posted by: Rafael 2006-03-11 21:29 |
| #9 err.. yes http://www.hondacarindia.com/about/honda_in_india.asp |
| Posted by: john 2006-03-11 21:22 |
| #8 john: Crushed? Some Indian companies are doing quite well in international competition - like Bharat Forge, Reliance, Tata No offence - but has foreign competition been allowed in their home markets? Has Honda been allowed to build a plant in India to compete with Tata? Gimme a break. |
| Posted by: Zhang Fei 2006-03-11 21:16 |
| #7 Crushed? Some Indian companies are doing quite well in international competition - like Bharat Forge, Reliance, Tata |
| Posted by: john 2006-03-11 21:09 |
| #6 phil_b: The reason is that the investors believe that sometime in the future the payback (from investing in China) will warrant the poor returns they are currently recieving. "We can't afford not to be there, even if we aren't making any money from being there." If this sounds reminiscent of the Internet bubble, its because the thinking is the same. Will it end in a similar bust? I'd say the chnaces are a lot higher than many think. The Internet bubble involved handing out free goods and services in return for mouse-clicks. The China phenomenon is part of a well-trodden path first explored by other East Asian countries. In fact, many of the major foreign investors in China are the ex-tiger economies - they are there because it is cheaper to manufacture in China. Japan used to manufacture in Southeast Asia. As did Korea. As did Taiwan. As did a host of American and European companies. They have moved some of their facilities to China. The Internet, in contrast, was pure hype. Advertising revenues will pay companies to hand out free goods and services. Consumers will start spending a much bigger chunk of their household income on telecom-related services. By contrast, the China story isn't even particularly Chinese - it's a story of manufacturing being moved to a poor country because of it opens up its economy. In effect, it's a rerun of what the tiger economies experienced in the 70's, 80's and 90's, except China has a deeper pool of cheap labor. India hasn't opened up its economy. That's why the profit margins of domestic firms is high. Once foreign companies are allowed in, Indian companies are going to get crushed, and returns will plummet, as they have for Chinese firms. |
| Posted by: Zhang Fei 2006-03-11 21:03 |
| #5 phil_b: The key metric is the return on capital. Return on capital has been very high in India even before the recent opening of its economy. It's when return on capital starts to head south that we will know that India's economy has truly opened up. Efficient use of capital doesn't mean returns are high - it means that capital is allocated where returns are the highest - it's a relative kind of thing. Returns in China are low because the Chinese savings rate is high, meaning capital is cheap and domestic competition is therefore ferocious. Returns in India are low because the Indian savings rate is low, meaning capital is expensive and domestic competition is therefore tame. The treatment of foreign investors in India is also atrocious - this is why most of them avoid India despite over a decade of hype. Note that Enron walked away from a billion dollar power plant investment in India - that's $1b hard-earned simoleons it had to write off. Companies like Enron invest in India. Companies like Intel invest in China. |
| Posted by: Zhang Fei 2006-03-11 20:51 |
| #4 The key metric is the return on capital. Investors have been pouring money into China despite the fact, they aren't getting the return they could get elsewhere. The reason is that the investors believe that sometime in the future the payback (from investing in China) will warrant the poor returns they are currently recieving. "We can't afford not to be there, even if we aren't making any money from being there." If this sounds reminiscent of the Internet bubble, its because the thinking is the same. Will it end in a similar bust? I'd say the chnaces are a lot higher than many think. |
| Posted by: phil_b 2006-03-11 20:42 |
| #3 Article: According to a UBS report, during the 1998-2003 period, the average return on capital employed (ROCE) for an Indian firm was about 17%. For Chinese firms the figure was only 11%. The writer uses these number to suggest that Chinese state subsidies promote the inefficient use of capital. However, another reason for the lower returns might be that it is more difficult to start up a company in India, and easier to start one up in China. Competition could simply be more brutal in China. Note that there is lots of foreign investment in China. This means a lot of foreign firms are producing for the Chinese market, reducing returns for Chinese firms. There is little foreign direct investment in India, which means little competition for India firms producing the same thing. Could this be why Indian firms are making more money? The one thing Yasheng Huang doesn't seem to understand is that companies in closed economies are hugely profitable. This is because the state makes it difficult for competitors to enter their markets. In closed economies, it's the *people* who make no money. |
| Posted by: Zhang Fei 2006-03-11 20:34 |
| #2 China's already facing a worker shortage for their industries at current wages. As soon as they try to mimic the model of running factories in less well-developed countries they are going to come smack up against their lack of management structures, accountability measures and incentives. I just hope they do it slowly so that WalMart has time to source elsewhere. ;-) |
| Posted by: lotp 2006-03-11 19:50 |
| #1 Interesting. Much of the same irrationality displayed in the Great Leap Forward. |
| Posted by: Nimble Spemble 2006-03-11 19:45 |