India and China's developmental paths

Reams of literature have been written comparing India and China's divergent development paths. The latest addition is from W. Michael Cox and Richard Alm of the Dallas Fed, who argue with some interesting statistics and historical precedents that India's services-led strategy may be a better longer term bet than China's goods-dominated one. This line of arguement has become a popular one among many scholars and commentators, many of whom find it difficult to accept Chinese one-party dictatorship over India's vibrant multi-party democracy. But unfortunately, a deeper analysis and the challenge posed by the massive population numbers involved, means that such optimism may be misplaced.

China has followed the traditional route, becoming a center for low-wage manufacturing and exporting clothing, toys, electronics and other goods. India has emphasized services, using its large English-speaking labor force for call centers, data-processing operations and the like. The article has several interesting comparisons on the two development paths.

Factory output accounts for 48% of GDP in China but just 28% in India. The best indicator of the divergent growth paths is the fact that India's goods exports grew 11.4% annually from 1996 to 2006, while China's growth was 17.8%. In contrast, while Chinese service exports grew at 13.6%, India’s scorched through at 23.7%. In the past decade, India’s services sales have risen from 18% to 38% of all exports, topping the 30% of the US, the largest seller of services in the global marketplace. At the same time, China’s services sales have fallen from 13% to 8% of all exports, confirming that sales have risen faster for its goods than its services. Some of the interesting cross-country comparisons in the performance of the two models are shown below.









The authors are right that India has a competitive advantage in software and services, due to its pool of well educated, English speaking workforce. But it is plain wrong to invoke Heckscher-Ohlin theory and stretch the logic to describe them as India's abundant factor of production. The figures just do not bear them out - barely a million software jobs in a 450 million workforce, and just 18% of workforce in services against 60% in agriculture. Services cannot simply support the large numbers of unskilled and semi-skilled labour, who are the predominant share of the agriculture workforce.

The export success of software and high-skilled knowledge processing services in the last two decades and the high-profile enjoyed by this growth story across the world, have led to an illusion that the same can be replicated in other service sectors. This overlooks the crucial fact that the overwhelming majority of workforce are unskilled and illiterate, and can be employed in services that are inherently non-tradeable. The restrictions on global labour mobility only adds to the challenge. Further, the potential domestic demand for such services, while substantial, has its limitations.

Unlike in higher value added manufactured goods, the upstream in the services sector will be much more competitive. As Indian service exports move into the cutting-edge, it will have to compete in the established and financially strong service sector markets in the developed economies. The competition in such areas are likely to be intense and with service wages rising fast in India, our technology firms cannot hope to sustain the spectacular returns that they have enjoyed in the last two decades.

It is undoubtedly true that India's export success with technology and skill intensive services has allowed it to achieve a high level of services productivity for a nation at its stage of economic development. But whatever miracles services sector can potentially do to the Indian economy, the required numbers are just too huge to make any significant dent on the issue of poverty and development in India. Historical examples of small countries like Greece, Panama and Portugal are too irrelevant to be of any meaningful comparison for the Indian context.

There is no substitute to increasing its base in manufacturing. The authors rightly acknowledge that India would not have done too well in competing with China for export markets, given China's comparative advantage. But there is a silver lining in an extension of the "flying geese model", wherein the East Asian countries, starting with Japan, followed by South Korea, Malaysia, Thailand etc, successively moved up the manufacturing value chain, leaving their place to be taken over by those succeeding them. Similarly, as China moves up the manufacturing value chain and into more sophisticated goods, India has an excellent opportunity to take the vacated place down the value chain. This, along with a vibrant services sector, working out of its skin, provide interesting opportunities for India.

The emergence of numerous disruptive technologies have enabled the newer generations to leapfrog their predecessors in many sectors. The same cannot be extended to conclude that a services-led growth strategy can achieve economic development in India, bypassing the manufacturing and industrial sectors. Both theory, history and, in our case, the sheer weight of numbers militates against any such assumptions.