August 30, 2011
China and India have become global economic powers. Even at the market exchange rate, China overtook Japan in 2010 as the world’s second largest economy. China’s trade and financial activities, India’s emergence as a technology and innovation hub and both countries’ commerce and investment interactions with other developing nations have been covered extensively in all forms of media.
China and India are both regarded as economic and political drivers of the international economy, particularly in the trade arena and in regards to global governance. Their economic engagement with developing countries and regions entails interactions in the areas of labour, human rights, international relations, security and environmental sustainability. The potential threats are mostly associated with trade and financial flows and with the social and political implications of China’s financial outflows.
Nevertheless, in the midst of the recent global economic crises, China and India’s demand for developing country goods proved to be a cushion to the declining flows of resources from advanced nations. China and India influence global economic and political dynamics and can provide alternative sources of development assistance for developing countries. They can also provide a number of potential lessons for other developing countries, three of which are highlighted in this article: absorption of surplus labour, raising of domestic and foreign investment and support for R&D. [Further lessons and more information on the role of China, India and other emerging economies, can be found on UNU-WIDER’s website: Southern Engines of Global Growth.]
Labour market peculiarities are key in understanding how economic growth has led to absorption of surplus labour in these economies — particularly in China. Here surplus labour from the traditional agricultural sector has shifted to the progressive industrial sector, thus promoting industrialization.
Characteristics of China’s labour market include an extensive rural-urban inequity, rapid rural-urban migration (despite various restrictions) and high and rising real wages in the formal sectors. In this respect, it has much in common with other emerging economies, such as South Africa. It is instructive however, to draw out the differences between China and South Africa, as this may hold some general lessons for the role of labour market dynamics in economic growth.
China, a labour-surplus economy, is rapidly experiencing a scarcity of labour. In contrast, South Africa — which historically has featured worker shortages — is increasingly suffering from a labour surplus in the form of open unemployment. South Africa’s labour market structure is affected both by the rural-urban migration as well as from inflows of foreign workers.
However, the standard Lewis model of economic development does not respond to the outlined cases (according to the Lewis model, a dual economy, formed by both capitalist and traditional sectors, exemplifies the typical economic development of developing countries): In neither China nor South Africa does the relative price mechanism operate. That is, changes in agricultural prices have been determined by government interventions and by other political economy influences, such as trade liberalization. In both countries there is a strong urban bias in terms of development policies and in the behaviour of formal sector wages, which are determined well above the market-clearing level.
Furthermore, China’s comparative advantage in labour-intensive activities — alongside the scaling-up of its production and export baskets — has iterated with an improvement in the investment climate. This is steep with a continuous, virtuous circle of growth. In contrast, South Africa’s relatively slow growth rate is associated both with its more mature economy, with resources other than unskilled labour being fully employed and with low investor confidence (on account, perhaps, of the social instability and crime that stems from high unemployment, high inequality and concern about the extent of labour protection).
South Africa’s comparative advantage in natural-resource-intensive activities — such as gold, diamonds, minerals — has not provided scope for the rapid expansion of exports and therefore the process of cumulative causation has not unfolded into higher growth. Despite competent macroeconomic policies, a strong entrepreneurial sector, sound infrastructure and buoyant prospects for world mineral markets, South Africa’s labour market trends, with their implication of rising numbers in poverty, pose a risk to the success of the economy as a whole.
The role of Foreign Direct Investment (FDI) in the Chinese economy is well-known. Emerging empirical evidence shows that FDI complements, rather than crowds out, domestic investment. Thus, foreign investment has not only helped in overcoming the shortage of capital, but also in stimulating economic growth through various spillover effects. Nevertheless, FDI may have brought some unwanted consequences such as increasing income and regional inequality, over reliance on exports, social stratification and little or declining capacity of labour absorption.
Accompanying FDI is the expansion of the private firms and multinational corporations (MNCs). Particularly, capital cities are attractive for firms to locate to. In India and China, labour-intensive firms tend not to locate in mid-sized or large cities as compared to smaller ones, due to higher wages, training and attrition costs.
Although labour regulations in China and India deter firms from locating in the larger cities, firms in the export sector prefer to be in large cities. Proximity to inputs within the city has a positive impact on firm location. These findings have important policy implications for urban governance, infrastructure, labour and environmental policies, which are key issues for growth and development.
Domestic investment relies heavily on the proper functioning of the banking system, which has been considered the ‘weakest link’ in China. A key issue is whether the Chinese state commercial banks have reacted positively and successfully to ownership reforms and other challenges. ahead of the entry of foreign financial institutions. It is discovered that ownership reform and foreign competition have forced Chinese commercial banks to improve their performance, as their total factor productivity rose by 5.6 percent per annum during 1998 to 2005. However, much of the productivity gain was due to efficiency gains and not so much due to technological progress.
China and India’s export productivity and specialization patterns are in line with those of wealthier and more advanced economies. This empirical finding challenges the traditional assumption that knowledge creation is exclusively the domain of advanced economies. Drivers of such change include investment in knowledge and innovation activities and the growing link between high-tech companies and local research.
FDI and multinational enterprises’ investment in knowledge-creating activities, such as R&D, is concentrated in a few emerging countries. China and India are considered two of the top ten destinations for foreign R&D expansion. China has experienced the strongest growth in scientific research, surpassing any country, whether developed or developing. India has also built up prominent research records, with an extraordinary expansion of peer-reviewed studies in material sciences.
The exports of information, communication and technology (ICT) have been key in driving the Southern Engines’ economic success, mostly in China and India. Empirical analysis shows that Chinese exports have experienced rapid growth since the early 1990s; the country’s market share in both Japan and the US has risen sharply; most of the Chinese ICT exports are attributed to foreign firms; and the shrinking market shares on third markets (i.e., other Asian developing countries) may be the result of multinationals’ relocation rather than intensified competition from Chinese exports.
India’s experience reveals an unparalleled paradigm of the role of technological progress, and the transmission channels through which macroeconomic fundamentals can explain the country’s economic success, primarily by inducing changes in productivity. Changes in labour market antagonisms and investment market frictions (such as taxing labour income) did not play a significant role. The Indian experience in targeting productivity evokes that of other successful Asian economies such as Japan in a similar stage of development, or during the take off process.
China and India’s economic success has been largely interpreted as the result of thriving economic and political reforms. The unparalleled performance of China and India and their influence on the world economy, has been larger and faster than implied in earlier research.
However, the political economy view of such phenomena cannot be overlooked, particularly in the case of China. Therefore, it is pertinent to emphasize the role of the government in designing and implementing successful development policies and structural reforms.
First, a key lesson from China’s experience is the adoption of a pragmatic approach to economic reforms (which was the turning point in China’s economic development) and the adaptive capacity of the country’s economic agents to this process.
Second, industrial policy has been at the heart of development policies and strategies in developing countries, although not particularly so in India. As in the case of other strategies and economic reforms, this policy’s implementation produced varied outcomes, with different levels of success. Third, trade and the liberalization of commercial policies have played a primary role in the Southern Engines’ growth success.
The interface of trade liberalization and domestic reforms has contributed to their success, akin to developing and transition countries. Decentralization and privatization of state-owned enterprises is another area of policy accomplishment. Also, the formulation of economy-wide development strategies should be a balanced outcome of the government and private agent decisions and choices, reflecting at the same time the country’s evolving and comparative advantages. These policies and processes should also adjust to the continually changing global economy.
Needless to say, growth and development strategies are challenged by the multiplicity or non-uniqueness of institutional arrangements needed for reforms to succeed and to achieve desirable ends. Many generations of reforms have led an international agenda, but the lessons provided by the experiences of countries such as the ‘Asian Giants’ China and India, and other successful emerging economies — such as Brazil and South Africa — might prove to be more inspiring and generate more positive spillovers for other developing countries due to their autonomous and uncompromised nature.
The development approaches and growth paths of China and India (and other emerging countries), highlight the impact on the global distribution of wealth. Rapid growth has been a key driver behind poverty reduction and the expected convergence of per capita incomes at the national and international levels. This has prompted the growth of a rapidly emerging ‘global middle class’ — especially in China and India — defined as a group of people who can afford, and demand access to, the standards of living previously only accessible to those in advanced economies.
Notwithstanding these positive developments, fast growth may well exacerbate income distribution within countries. This should not be overlooked.
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This article was first published in UNU-WIDER Angle Newsletter in October, 2010.
This article is based on the UNU Policy Brief “The Global Impact of the Southern Engines of Growth: China, India, Brazil and South Africa”, that summarizes the finding of the WIDER Project on Southern Engines of Global Growth.