Monday, November 20, 2006

capital generation in india

20th nov 2006

dear professor vaidya

i am taking the liberty of posting this reply to your mail to my blog, as i think it demonstrates a startling fact: the enormous capital generation that goes on in india. you have shown how this is based on the thrift of the humble housewife, rather than some white guys sending money here.

i have been thinking of this from a different angle, namely the concept that india has *always* been an incredible generator of capital. of course this is why every barbarian from alexander the macedonian onwards to the europeans invaded india -- there was enormous wealth there.

it was only during the interregnum of 1757 to 1991 -- a very long 250 years, admittedly -- that this economic engine was brought to its knees. First, by thieving europeans, who simply stole the wealth through a variety of means. Second, by idiotic stalinist economists, who thought they could second-guess the million micro-decisions made by economically rational human beings.

once this straight-jacket was thrown off, there is enough capital generation to sustain double-digit growth. in other words, FDI is immaterial to india, unlike china, which i suggest subsists on large amounts of FDI, which may not be sustainable. (of course, they have built up a trillion dollars of reserves, but i also suspect the americans will do something to devalue the worth of this fairly soon, which suggests that it is time to exit the dollar. do you accept this hypothesis?).

anyway, you're absolutely right: the indian government has shown its utter incompetence at economics, it should confine itself to guarding the borders. alas, it has shown utter incompetence there as well. in fact, it may be the case that whatever the indian government touches, it destroys -- the 'bhasmasura syndrome', perhaps?

thanks
rajeev


On 11/20/06, Vaidyanathan R wrote:

For your information

 

Why the Indian housewife deserves paeans of praise

 

http://www.thehindubusinessline.com/2006/11/16/stories/2006111600500800.htm

 

R.Vaidyanathan

 

 

____________________________
R.Vaidyanathan
Professor of Finance & Control
Indian Institute of Management
Bannerghatta Road
Bangalore--560076
India

 


10 comments:

Prashant Rao said...

Rajeev,

Y'know I've heard that hypothesis a few times and I am puzzled a bit by the logic: Sure, by devaluing the dollar, the value of the moneys that the US has to return to China gets reduced but by the same token won't it reduce the value of all the money that people in the US themselves have? Which would imply a drastic reduction in the standard of living and trememdous inflation no? Wouldn't that be like one Siamese twin shooting himself in a shared limb to spite the other so to speak?

In other words what will be the effect on the US of a steep decline in the dollar? Will the net effect on the US be positive? What will this do to the dollar being the world's reserve currency? Any thoughts?

Prashant

someone said...

every barbarian from alexander the macedonian onwards to the europeans (emphasis mine)

Thanks for using that word. It's a fact, and we should say it as it is.

KapiDhwaja said...

OT: With all the Hindi-Chini Bhai-Bhai going on and the Chief Thug of China being feted around, we should look at what our true friends are doing for us...
Japan to make India 'special economic partner'

Ghost Writer said...

@ Prashanth
America is now fairly out of control as far it's own currency valuation is concerned. Truth is that the real exchange rate of the dollar will get decided where it usually does i.e. on whether there is a trade surplus for America or a Trade Deficit.
No amount of putting it off to a future date will prevent it. America is increasingly uncompetitive and loves to import cheap junk from China (thanks Wal Mart), without having the ability to sell anything to the Chinese in return; not just because American products are uncompetitive, but also Chinese slave wages ensure that Chinese cannot afford any American goods.

The only hope for America is to find a alternative to oil, which still accounts for 20% of all American imports. Only problem being that the Texas oil companies lobby will not let that happen!

chitrakut said...

There is a related article on the major contribution of Indian Housewives written by Gurumurty a while ago.

Please see:

http://www.newindpress.com/Column.asp?ID=IE620050329205627&P=old

It makes conclusions similar to Prof. Vaidyanathan.

chitrakut said...

from gurumurthys article I just posted above:

"Now see the stunning decay in women’s status in the relatively traditional Germany. Like in all West the German government provides doles till employment is offered to the unemployed. An unemployed German girl receiving the dole was stunned when told by the employment office to either join a brothel that had jobs to offer her or, if she declined to, become disentitled to her dole! Why? As Germany had legalised prostitution as an industry, a job in a brothel was as good any other employment for women in market economics!"

san said...

Read about how

Indian Carmakers to Market Hybrids in USA

KapiDhwaja said...

Below is Sardar Vallabhai Patel's letter(written in 1950) to pig-headed Nehru warning him about the dangers to India from China. Very few of India's current strategic thinkers have the kind of foresight and vision that Sardar Patel displayed more than half a century ago. A must read...

A Prophetic letter from Sardar Patel to Jawaharlal Nehru on arrogant China
11/17/2006 8:54:11 AM

(REF: "MAKER'S OF INDIA'S FOREIGN POLICY- RAJA RAM MOHUN ROY TO YASHWANT SINHA"- J.N. DIXIT)
NEW DELHI 7 November 1950
My Dear Jawaharlal,

Ever since my return from Ahmedabad and after the Cabinet meeting the same day which I had to attend at practically 15 minutes notice and for which I regret I was not able to read all the papers, I thought I should share with you what is passing through my mind.

I have carefully gone through the correspondence between the External Affairs Ministry and our Ambassador in Peking and through him the Chinese Government. I have tried to peruse this correspondence favourably(sic) to our Ambassador and the Chinese Government as possible, but I regret to say that neither of them comes out well as a result of this study, The Chinese Government has tried to delude us by professins of peaceful intentions.My own feeling is that at a crucial period they managed to instil into our Ambassador a false sense of confidence in their so called desire to settle the Tibetan problem by peaceful means.

There can be no doubt that during the period covered by this correspondence, the Chinese must have been concentrating for an onslaught on Tibet. The final action of the Chinese, in my judgement, is little short of perfidy. The tragedy of it is that the Tibetans put faith in us; they chose to be guided by us; and we have been unable to get them out of the meshes of Chinese diplomacy or Chinese malevolence. From the latest position, it appears that we shall not be able to rescue the Dalai Lama.

Our Ambassador has been at great pains to find an explanation or justification for Chinese policy and actions. As the External Affairs Ministry remarked in one of their telegrams, there was a lack of firmness and unnecessary apology in one or two representations that he made to the Chinese Government on our behalf.

It is impossible to imagine any sensible person believing in the so-called threat to China from Anglo-American diplomacy or strategy. This feeling, if genuinely entertained by the Chinese in spite of your direct approaches to them, indicates that even though we regard ourselves as friends of China,'THE CHINESE DO NOT REGARD US AS THEIR FRIENDS. With the Communist mentality of 'whoever is not with them being against them’, this is a significant pointer, of which we have to take due note.

During the last several months, outside the Russian camp, we have been practically alone in championing the cause of Chinese entry into the UNO and in securing from the Americans assurances on the question of Formosa. We have done everything we could to assuage Chinese feelings, to allay its apprehensions and to defend its legitimate claims in our discussions and correspondence with America and Britain and in the UNO.In spite of this, China is not convinced about our disinterestedness; it continues to regard us with suspicion and the whole psychology is one, at least outwardly, of scepticism, perhaps mixed with a little hostility.

I doubt if we can go any further than we have done already to convince China of our good intentions, friendliness and goodwill. In Peking we have an Ambassador who is eminently suitable for putting across the friendly point of view. Even he seems to have failed to convert the Chinese. Their last telegram to us is an act of gross discourtesy not only in the summary way it disposes of our protest against the entry of Chinese forces into Tibet but also in the wild insinuation that our attitude is determined by foreign influences. It looks as though it is not a friend speaking in that language but a "POTENTIAL ENEMY".

With this background, we have to consider what new situation we are now faced with as a result of the disappearance of Tibet, as we knew it, and the Chinese expansion almost up to our gates. Throughout history, we have been seldom worried about our North-East frontier. The Himalayas have been regarded as an impregnable barrier against any threat from the North. We had a friendly Tibet, which gave us no trouble. The Chinese were divided. They had their own domestic problems and never bothered us about our frontiers.

In 1914,we entered into a convention with Tibet, which was not endorsed by the Chinese. We seem to have regarded Tibetan autonomy as extending to (an) independent treaty relationship.Presumably; all that we required was the Chinese counter-signature. The Chinese interpretation of suzerainty seems to be different. We can, therefore, safely assume that very soon they will disown all the stipulations which Tibet has entered into in the past. That throws all frontier and commercial settlements with Tibet, in accordance with which we had been functioning and acting during the last half a century, into the melting pot.

China is no longer divided. It is united and strong. All along the Himalayas in the North and North-East, we have on our side of the frontier a population not ethnologically or culturally different from Tibetans or Mongloids.The undefined state of the frontier and existence on our side of a population with affinities to Tibetans or Chinese has all the elements of potential trouble between China and us. Recent and bitter history also tells us that communism is no shield against imperialism, and that COMMUNISTS ARE AS GOOD OR AS BAD IMPERIALISTS AS ANY OTHER.

Chinese ambitions in this respect not only cover the Himalayan slopes on our side but also include important parts of Assam. They have their ambitions in Burma also. Burma has the added difficulty that it has no McMahan Line around which to build up even the semblance of an agreement. Chinese irrentism and communist imperialism are different from the expansionism or imperialism of the Western Powers. The former has an ideological cloak, WHICH MAKES IT TEN TIMES WORSE.

Racial, national or historical claims lie concealed in the guise of ideological expansion. The danger from the North and North-East,therefore,becomes both communist and imperialist. While our Western and North-Western threat to security is still as prominent as before, A NEW THREAT HAS DEVELOPED FROM THE NORTH AND NORTH-EAST.

Thus for the first time after centuries, India’s defence has to concentrate on two fronts simultaneously. Our defence measures have so far been based on calculations of superiority over Pakistan. We shall now have to reckon with communist China in the North and North-East, A COMMUNIST CHINA WHICH HAS DEFINITE AMBITIONS AND AIMS AND WHICH DOES NOT IN ANY WAY SEEM FRIENDLY TOWARDS US.

Let us also consider the political conditions on this potentially troublesome frontier. Our Northern or North-eastern approaches consist of Nepal, Bhutan, Sikkim, Darjeeling and tribal areas in Assam. They are weak from the point of view of communications. Continuous defensive lines do not exist. There is an almost unlimited scope for infiltration. Police protection is limited to a very small number of passes.There, too,our outposts do not seem to be fully manned. Our contact with these areas is by no means close and intimate.

The people inhabiting these portions have no established loyalty or devotion to India. Even the Darjeeling and Kali pong areas are not free from pro-Mongoloid prejudices. During the last three years, we have not been able to make any appreciable approaches to the Nagas and other hill tribes in Assam. European missionaries and other visitors have been in touch with them, but their influence was in no way friendly where Indians were considered. There was political ferment in Sikkim some time ago. It is quite possible that discontent is smouldering there.

Bhutan is comparatively quiet, but its affinity with Tibetans would be a handicap. Nepal has a weak oligarchic regime based almost entirely on force; it is in conflict with a turbulent element of the population, as well as with enlightened ideas of modern age. In these circumstances, to make people aware of the new danger, or to increase the defensive strength is a very difficult task indeed; and that difficulty can be got over only by enlightened firmness, strength and a clear line of policy.

I am sure the Chinese and their source of inspiration, Soviet Russia, would not miss any opportunity of exploiting these weak spots, partly in support of their ideology and partly their ambition. In my judgement, therefore, the situation is one in which we cannot afford to be either complacent or vacillating. We must have a clear idea of what we wish to achieve and the methods by which we should achieve it.Any lack of decisiveness in formulating our objectives or pursuing our policy to attain them is bound to weaken us and increase the threats.

Along with these external dangers, we shall now have to face serious internal problems as well.Hitherto,the Communist Party of India has found some difficulty in contacting communists abroad, or in getting supplies of arms, literature etc.from them. They had to contend with the difficult Burmese and Pakistan frontiers in the East or with the long seaboard. They shall now have a comparatively easy means of access to Chinese communists, and through them to other foreign communists. Infiltration of spies, fifth columnists and communists would now be easier.

The whole situation thus raises a number of problems on which we must come to an early decision so that we can, as I said earlier, formulate the objectives and methods of our policy.

It is also clear that the action will have to be fairly comprehensive, involving not only our defence strategy and state of preparations, but also problems of internal security. We shall also have to deal with administrative and political problems in the weak spots along the frontier to which I have already referred.

It is, of course, impossible for me to exhaustively set out all the problems. I have, however, given below some of the problems which, in my opinion, require early solutions, around which we have to build our administrative or military policy measures.

(a) A military and intelligence appreciation of the Chinese threat to India, both on the frontier and internal security.

(b) An examination of our military position and such re-disposition of forces as might be necessary, particularly with the idea of guarding important routes or areas which are likely to be the subject of dipute.

©An appraisement of the strength of our forces and, if necessary, reconsideration of our retrenchment plans for the Army in the light of these new threats.

(d)A long term consideration of our defence needs. My own feeling is that unless we assure our supplies of arms, ammunition and armour, we should be MAKING OUR DEFENCE POSITION PERPETUALLY WEAK and would not be able to stand up to the double threat of difficulties both from the West and Northwest, North and Northeast.

(e) The question of the Chinese entry into UNO.In view of the Chinese rebuff, and the method it has followed in dealing with Tibet, I doubt whether we can advocate its claims any longer. The UNO would probably threaten to virtually outlaw China in view of its active participation in the Korean War. We must determine our attitude on this question also.

(f) The political and administrative steps which we should take to strengthen our Northern and North-eastern frontiers. This would include the entire borderline. Nepal, Bhutan, Sikkim, Darjeeling and the tribal territory in Assam.

(g) Measures of internal security in the border areas, such as U.P, Bihar,Bengal and Assam.

(h)Improvements of our communications, road, rail, air and wireless in these areas and with the frontier outposts.

(i)Policing and intelligence of frontier outposts.

(j) The future of our mission at Lhasa and the trade posts at Gyangtse and Yatung and the forces we have in operation in Tibet to guard the trade routes.

(k) The policy in regard to the McMohan Line.

It is possible that a consideration of these matters may lead us into wider questions of our relationship with China, Russia, America, Britain and Burma.This, however would be of a general nature, though some may be important. For instance, we might have to consider whether we should not enter into closed association with Burma in order to strengthen the latter in its dealings with China.

I do not rule out the possibility that, before applying pressure on us, China may do the same to Burma. With Burma, the frontier is entirely undefined and the Chinese territorial claims are more substantial. In its present position, Burma might offer an easier problem for China and, therefore, might claim its first attention. I suggest that we meet early to have a general discussion on these problems and decide on such steps as we might think to be immediately necessary and direct quick examination of other problems with a view to taking early measures to deal with them.

Yours,
Vallabhai Patel.

( COMMENT: UNFORTUNATELY,A MONTH LATER THE 'SARDAR' PASSED AWAY.THAT WAS A TRAGEDY FOR INDIA.)

indianpatriot said...

Eventhough it is little bit of old news this article appeared Exactly 3 years back in Foreign policy. It questioned conventional wisdom of people that China is far ahead of India. That includes one blogger called SAN who made an outrageous claim that China's economy is 6 times the size of India and India should become a satellite of USA to get saved. Give me a break.
During 1987 Indian army cheif General Sundarji conducted an army excercise Oh near Arunachal Pradesh(Karat and fellow comrades call it Tawang part of China). Chineese army got so scared that in case of war India could have directly entered Lhasa and freed Tibet. Rajiv like his Grandfather chickened out. We need a leader who thinks India first and I think hopefully we will get it in next election whenever it is held sooner than later.

Can India Overtake China?
Author: Yasheng Huang and Tarun Khanna
Publication: Foreign Policy
Date: July-August 2003
URL: http://www.foreignpolicy.com/story/story.php?storyID=13774
What's the fastest route to economic development? Welcome foreign direct investment (FDI), says China, and most policy experts agree. But a comparison with long-time laggard India suggests that FDI is not the only path to prosperity. Indeed, India's homegrown entrepreneurs may give it a long-term advantage over a China hamstrung by inefficient banks and capital markets.

Walk into any Wal-Mart and you won't be surprised to see the shelves sagging with Chinese-made goods-everything from shoes and garments to toys and electronics. But the ubiquitous "Made in China" label obscures an important point: Few of these products are made by indigenous Chinese companies. In fact, you would be hard-pressed to find a single homegrown Chinese firm that operates on a global scale and markets its own products abroad.

That is because China's export-led manufacturing boom is largely a creation of foreign direct investment (FDI), which effectively serves as a substitute for domestic entrepreneurship. During the last 20 years, the Chinese economy has taken off, but few local firms have followed, leaving the country's private sector with no world-class companies to rival the big multinationals.

India has not attracted anywhere near the amount of FDI that China has. In part, this disparity reflects the confidence international investors have in China's prospects and their skepticism about India's commitment to free-market reforms. But the FDI gap is also a tale of two diasporas. China has a large and wealthy diaspora that has long been eager to help the motherland, and its money has been warmly received. By contrast, the Indian diaspora was, at least until recently, resented for its success and much less willing to invest back home. New Delhi took a dim view of Indians who had gone abroad, and of foreign investment generally, and instead provided a more nurturing environment for domestic entrepreneurs.

In the process, India has managed to spawn a number of companies that now compete internationally with the best that Europe and the United States have to offer. Moreover, many of these firms are in the most cutting-edge, knowledge-based industries-software giants Infosys and Wipro and pharmaceutical and biotechnology powerhouses Ranbaxy and Dr. Reddy's Labs, to name just a few. Last year, the Forbes 200, an annual ranking of the world's best small companies, included 13 Indian firms but just four from mainland China.

India has also developed much stronger infrastructure to support private enterprise. Its capital markets operate with greater efficiency and transparency than do China's. Its legal system, while not without substantial flaws, is considerably more advanced.

China and India are the world's next major powers. They also offer competing models of development. It has long been an article of faith that China is on the faster track, and the economic data bear this out. The "Hindu rate of growth"-a pejorative phrase referring to India's inability to match its economic growth with its population growth-may be a thing of the past, but when it comes to gross domestic product (GDP) figures and other headline numbers, India is still no match for China.

However, the statistics tell only part of the story-the macroeconomic story. At the micro level, things look quite different. There, India displays every bit as much dynamism as China. Indeed, by relying primarily on organic growth, India is making fuller use of its resources and has chosen a path that may well deliver more sustainable progress than China's FDI-driven approach. "Can India surpass China?" is no longer a silly question, and, if it turns out that India has indeed made the wiser bet, the implications-for China's future growth and for how policy experts think about economic development generally-could be enormous.

THE STIFLING STATE

The fact that India is increasingly building from the ground up while China is still pursuing a top-down approach reflects their contrasting political systems: India is a democracy, and China is not. But the different strategies are also a function of history. China's Communist Party came to power in 1949 intent on eradicating private ownership, which it quickly did. Although the country is now in its third decade of free-market reforms, it continues to struggle with the legacy of that period-witness the controversy surrounding the recent decision to officially allow capitalists to join the Communist Party.

India, on the other hand, developed a softer brand of socialism, Fabian socialism, which aimed not to destroy capitalism but merely to mitigate the social ills it caused. It was considered essential that the public sector occupy the economy's "commanding heights," to use a phrase coined by Russian revolutionary Vladimir Lenin but popularized by India's first prime minister, Jawaharlal Nehru. However, that did not prevent entrepreneurship from flourishing where the long arm of the state could not reach.

COMPETING GIANTS

Population (2002): China 1.28 billion; India 1.05 billion

Population Growth Rate percent (2002): China 0.87; India 1.51

Infant Mortality per 1,000 live births (2002): China 27; India 61

Average Annual Real GDP Growth Rate percent (1990-2000): China 9.6 : India 5.5

Foreign Direct Investment (2001): China $44.2 billion; India $3.4 billion

Population in Poverty (2002): China 10 percent; India 25 percent

Labor Force (1999): China 706 million; India 406 million

Fixed Lines and Mobile Phones per 1,000 people (2001): China 247.7; India 43.8

Size of Diaspora: China 55 million; India 20 million

Sources: CIA World Factbook 2002; The Economist Pocket World in Figures; World Development Indicators CD-ROM; Financial Times

Developments at the microeconomic level in China reflect these historical and ideological differences. China has been far bolder with external reforms but has imposed substantial legal and regulatory constraints on indigenous, private firms. In fact, only four years ago, domestic companies were finally granted the same constitutional protections that foreign businesses have enjoyed since the early 1980s. As of the late 1990s, according to the International Finance Corporation, more than two dozen industries, including some of the most important and lucrative sectors of the economy-banking, telecommunications, highways, and railroads-were still off-limits to private local companies.

These restrictions were designed not to keep Chinese entrepreneurs from competing with foreigners but to prevent private domestic businesses from challenging China's state-owned enterprises (SOEs). Some progress has been made in reforming the bloated, inefficient SOEs during the last 20 years, but Beijing is still not willing to relinquish its control over the largest ones, such as China Telecom.

Instead, the government has ferociously protected them from competition. In the 1990s, numerous Chinese entrepreneurs tried, and failed, to circumvent the restrictions placed on their activities. Some registered their firms as nominal SOEs (all the capital came from private sources, and the companies were privately managed), only to find themselves ensnared in title disputes when financially strapped government agencies sought to seize their assets. More than a few promising businesses have been destroyed this way.

This bias against homegrown firms is widely acknowledged. A report issued in 2000 by the Chinese Academy of Social Sciences concluded that, "Because of long-standing prejudices and mistaken beliefs, private and individual enterprises have a lower political status and are discriminated against in numerous policies and regulations. The legal, policy, and market environment is unfair and inconsistent."

Foreign investors have been among the biggest beneficiaries of the constraints placed on local private businesses. One indication of the large payoff they have reaped on the back of China's phenomenal growth: In 1992, the income accruing to foreign investors with equity stakes in Chinese firms was only $5.3 billion; today it totals more than $22 billion. (This money does not necessarily leave the country; it is often reinvested in China.)

THE MOGUL IS HERO

For democratic, postcolonial India, allowing foreign investors huge profits at the expense of indigenous firms is simply unfeasible. Recall, for instance, the controversy that erupted a decade ago when the Enron Corporation made a deal with the state of Maharashtra to build a $2.9 billion power plant there. The project proceeded, but only after several years of acrimonious debate over foreign investment and its role in India's development.

While China has created obstacles for its entrepreneurs, India has been making life easier for local businesses. During the last decade, New Delhi has backed away from micromanaging the economy. True, privatization is proceeding at a glacial pace, but the government has ceded its monopoly over long-distance phone service; some tariffs have been cut; bureaucracy has been trimmed a bit; and a number of industries have been opened to private investment, including investment from abroad.

As a consequence, entrepreneurship and free enterprise are flourishing. A measure of the progress: In a recent survey of leading Asian companies by the Far Eastern Economic Review (FEER), India registered a higher average score than any other country in the region, including China (the survey polled over 2,500 executives and professionals in a dozen countries; respondents were asked to rate companies on a scale of one to seven for overall leadership performance). Indeed, only two Chinese firms had scores high enough to qualify for India's top 10 list. Tellingly, all of the Indian firms were wholly private initiatives, while most of the Chinese companies had significant state involvement.

Some of the leading Indian firms are true start-ups, notably Infosys, which topped FEER's survey. Others are offshoots of old-line companies. Sundaram Motors, for instance, a leading manufacturer of automotive components and a principal supplier to General Motors, is part of the T.V. Sundaram group, a century-old south Indian business group.

Not only is entrepreneurship thriving in India; entrepreneurs there have become folk heroes. Nehru would surely be appalled at the adulation the Indian public now showers on captains of industry. For instance, Narayana Murthy, the 56-year-old founder of Infosys, is often compared to Microsoft's Bill Gates and has become a revered figure.

These success stories never would have happened if India lacked the infrastructure needed to support Murthy and other would-be moguls. But democracy, a tradition of entrepreneurship, and a decent legal system have given India the underpinnings necessary for free enterprise to flourish. Although India's courts are notoriously inefficient, they at least comprise a functioning independent judiciary. Property rights are not fully secure, but the protection of private ownership is certainly far stronger than in China. The rule of law, a legacy of British rule, generally prevails.

These traditions and institutions have proved an excellent springboard for the emergence and evolution of India's capital markets. Distortions are still commonplace, but the stock and bond markets generally allow firms with solid prospects and reputations to obtain the capital they need to grow. In a World Bank study published last year, only 52 percent of the Indian firms surveyed reported problems obtaining capital, versus 80 percent of the Chinese companies polled. As a result, the Indian firms relied much less on internally generated finances: Only 27 percent of their funding came through operating profits, versus 57 percent for the Chinese firms.

Corporate governance has improved dramatically, thanks in no small part to Murthy, who has made Infosys a paragon of honest accounting and an example for other firms. In a survey of 25 emerging market economies conducted in 2000 by Credit Lyonnais Securities Asia, India ranked sixth in corporate governance, China 19th. The advent of an investor class, coupled with the fact that capital providers, such as development banks, are themselves increasingly subject to market forces, has only bolstered the efficiency and credibility of India's markets. Apart from providing the regulatory framework, the Indian government has taken a back seat to the private sector.

In China, by contrast, bureaucrats remain the gatekeepers, tightly controlling capital allocation and severely restricting the ability of private companies to obtain stock market listings and access the money they need to grow. Indeed, Beijing has used the financial markets mainly as a way of keeping the soes afloat. These policies have produced enormous distortions while preventing China's markets from gaining depth and maturity. (It is widely claimed that China's stock markets have a total capitalization in excess of $400 billion, but factoring out non-tradeable shares owned by the government or by government-owned companies reduces the valuation to just around $150 billion.) Compounding the problem are poor corporate governance and the absence of an independent judiciary.

DOLLARS AND DIASPORAS

If India has so clearly surpassed China at the grass-roots level, why isn't India's superiority reflected in the numbers? Why is the gap in GDP and other benchmarks still so wide? It is worth recalling that India's economic reforms only began in earnest in 1991, more than a decade after China began liberalizing. In addition to the late start, India has had to make do with a national savings rate half that of China's and 90 percent less FDI. Moreover, India is a sprawling, messy democracy riven by ethnic and religious tensions, and it has also had a longstanding, volatile dispute with Pakistan over Kashmir. China, on the other hand, has enjoyed two decades of relative tranquility; apart from Tiananmen Square, it has been able to focus almost exclusively on economic development.

That India's annual growth rate is only around 20 percent lower than China's is, then, a remarkable achievement. And, of course, whether the data for China are accurate is an open question. The speed with which India is catching up is due to its own efficient deployment of capital and China's inefficiency, symbolized by all the money that has been frittered away on SOEs. And China's misallocation of resources is likely to become a big drag on the economy in the years ahead.

In the early 1990s, when China was registering double-digit growth rates, Beijing invested massively in the state sector. Most of the investments were not commercially viable, leaving the banking sector with a huge number of nonperforming loans-possibly totaling as much as 50 percent of bank assets. At some point, the capitalization costs of these loans will have to be absorbed, either through write-downs (which means depositors bear the cost) or recapitalization of the banks by the government, which diverts money from other, more productive uses. This could well limit China's future growth trajectory.

India's banks may not be models of financial probity, but they have not made mistakes on nearly the same scale. According to a recent study by the management consulting firm Ernst & Young, about 15 percent of banking assets in India were nonperforming as of 2001. India's economy is thus anchored on more solid footing.

The real issue, of course, isn't where China and India are today but where they will be tomorrow. The answer will be determined in large measure by how well both countries utilize their resources, and on this score, India is doing a superior job. Is it pursuing a better road to development than China? We won't know the answer for many years. However, some evidence indicates that India's ground-up approach may indeed be wiser-and the evidence, ironically, comes from within China itself.

Consider the contrasting strategies of Jiangsu and Zhejiang, two coastal provinces that were at similar levels of economic development when China's reforms began. Jiangsu has relied largely on FDI to fuel its growth. Zhejiang, by contrast, has placed heavier emphasis on indigenous entrepreneurs and organic development. During the last two decades, Zhejiang's economy has grown at an annual rate of about 1 percent faster than Jiangsu's. Twenty years ago, Zhejiang was the poorer of the two provinces; now it is unquestionably more prosperous. India may soon have the best of both worlds: It looks poised to reap significantly more FDI in the coming years than it has attracted to date. After decades of keeping the Indian diaspora at arm's length, New Delhi is now embracing it. In some circles, it used to be jokingly said that nri, an acronym applied to members of the diaspora, stood for "not required Indians." Now, the term is back to meaning just "nonresident Indian." The change in attitude was officially signaled earlier this year when the government held a conference on the diaspora that a number of prominent nris attended.

China's success in attracting FDI is partly a historical accident-it has a wealthy diaspora. During the 1990s, more than half of China's FDI came from overseas Chinese sources. The money appears to have had at least one unintended consequence: The billions of dollars that came from Hong Kong, Macao, and Taiwan may have inadvertently helped Beijing postpone politically difficult internal reforms. For instance, because foreign investors were acquiring assets from loss-making soes, the government was able to drag its feet on privatization.

Until now, the Indian diaspora has accounted for less than 10 percent of the foreign money flowing to India. With the welcome mat now laid out, direct investment from nonresident Indians is likely to increase. And while the Indian diaspora may not be able to match the Chinese diaspora as "hard" capital goes, Indians abroad have substantially more intellectual capital to contribute, which could prove even more valuable.

The Indian diaspora has famously distinguished itself in knowledge-based industries, nowhere more so than in Silicon Valley. Now, India's brightening prospects, as well as the changing attitude vis-à-vis those who have gone abroad, are luring many nonresident Indian engineers and scientists home and are enticing many expatriate business people to open their wallets. With the help of its diaspora, China has won the race to be the world's factory. With the help of its diaspora, India could become the world's technology lab.

China and India have pursued radically different development strategies. India is not outperforming China overall, but it is doing better in certain key areas. That success may enable it to catch up with and perhaps even overtake China. Should that prove to be the case, it will not only demonstrate the importance of homegrown entrepreneurship to long-term economic development; it will also show the limits of the FDI-dependent approach China is pursuing.

Yasheng Huang is an associate professor at the Sloan School of Management at the Massachusetts Institute of Technology. Tarun Khanna is a professor at Harvard Business School.

Harish said...

Hei KapiDhwaja..
Thx a ton for posting that letter from Vallabhai Patel..
We can only dream of having such leaders in India..