Saturday, September 04, 2004

Morgan Stanley honcho on India, China challenging the West

September 4.

The "giant sucking sound" redux? Where is Ross Perot when you need him?


The Challenge of China and India

Stephen Roach
The Financial Times, 31 August 2004

China and India are leading the way in the race for economic
development, but their approaches are very different - what China is
to manufacturing, India could well be to services. Together, they
could usher in a broader and more powerful strain of globalisation
that will put pressure on the developed world.

China's manufacturing-led impetus has been nothing short of
astonishing. The industrial sector's share of Chinese gross domestic
product rose from 41.6 per cent in 1990 to 52.3 per cent in 2003 -
accounting for fully 54 per cent of the cumulative increase in the GDP
over this 13-year period. The impetus that services have given to
India's growth has been equally impressive. The services portion of
Indian GDP increased from 40.6 per cent in 1990 to 50.8 per cent in
2003 - accounting for 62 per cent of the cumulative increase in the
country's GDP.

But the strengths of China and India mask weaknesses in both
economies. Industry's share of Indian GDP has been essentially
stagnant at 27.2 per cent of GDP between 1990 and 2003. As a result,
industrial activity has accounted for only 27 per cent of the
cumulative increase in India's GDP over the past 13 years - literally
half the contribution evident in China. At the same time, the services
share of Chinese GDP rose from 31.3 per cent in 1990 to 33.1 per cent
in 2003. Over the period, the expansion of China's services economy
represented just 33 per cent of the cumulative increase in overall GDP
- only a little more than half the contribution services made to
Indian growth.

China has rewritten the classic script of manufacturing-led
development. Four main factors have distinguished its
industrialisation - a 43 per cent domestic savings rate, impressive
progress in building infrastructure, surging foreign direct investment
and a vast reservoir of hard-working, low-cost labour. By contrast,
India's national savings rate is only 24 per cent; its infrastructure
is in terrible shape; and its ability to attract foreign direct
investment - which ran at only $4bn in 2003 - pales in comparison with
the $53bn that poured into China in each of the last two years.

But these disadvantages have not stopped India. By opting for a
services-led path, India has sidestepped the savings, infrastructure
and FDI constraints that have long hobbled its manufacturing strategy.
Its reliance on services plays, instead, to its greatest strengths: a
well-educated workforce, information technology competency and
English-language proficiency. The result has been a renaissance in
IT-enabled services - software, business process outsourcing,
multimedia, network management and systems integration - that has
enabled India to fill the void left by chronic deficiencies in

China, on the other hand, is deficient in most private services -
especially retailing, distribution and professional services such as
accountancy, medicine, consultancy and the law. Exceptions in the
services sector are telecommunications and air travel. Over the next
five to 10 years, China's gap in services represents a huge
opportunity. In the developed world, services account for at least 65
per cent of total economic activity - double China's current share.
Expansion of a labour-intensive services sector could also fill an
important employment need, as reforms of state-owned enterprises
continue to eliminate 7m-9m jobs per year.

If China's manufacturing-led growth continues and India pulls off a
rare services-led development strategy, the wealthy industrial world
will face big new challenges. The theory of trade liberalisation and
globalisation maintains that there is little to worry about. In the
long run, the income workers make as producers should show up on the
other side of the ledger as purchasing power for a new class of
consumers, presenting opportunities to suppliers in the developed

The problem is that some of these basic assumptions are in serious
question. In their simplest form, "open" economic models comprise two
sectors - tradeables and non-tradeables. For rich, developed
economies, the loss of market share in manufacturing to low-cost,
developing nations is acceptable as long as there is a secure fallback
to the non-tradeable services sector, which has long been shielded
from international competition.

Yet now the knowledge-based content of the output of white-collar
workers can be exported anywhere with a click of a mouse, the rules of
the game have changed. Many services become tradeable, not only at the
low end of the value chain - call-centre operators and data processors
- but increasingly at the upper end where software programmers,
engineers, accountants, lawyers, consultants and doctors work.

Services-driven development models, such as the one at work in India,
broaden the global competitive playing field. As a result, new
pressures are brought to bear on hiring and real wages in the
developed world - pressures that are not inconsequential in shaping
the jobless recoveries unfolding in high-cost wealthy nations. For
those in the developed world, successful services- and
manufacturing-based development models in heavily populated countries
such as India and China - pose the toughest question of all: what
about us?

The writer is Morgan Stanley's chief economist.

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