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Posted by: Deepa Vasudevan on Wed, Feb 27th, 2019

Indian Economy: Why it is Set to Grow

China’s economy is slowing down. In 2018, China grew at 6.6%, the lowest rate since 1990[1]. In 2019, it is forecast to grow at an even lower 6.2%[2].  The slowdown does not look like a temporary bad patch; instead, China appears to be headed towards a structural transformation after more than two decades of 8% plus growth. Policymakers envision a “new normal” for China: with medium-to-high speed growth - driven by innovation, domestic consumption, and environmental improvement, rather than by investment and exports[3].  But even assuming that China grows by a moderate 5% -6% over the next five years, it will have a nominal per capita GDP of nearly USD14000, ten times the per capita GDP that India is expected to attain in that period. In fact, any comparison of India and China based on economic indicators shows the huge developmental gap between them- China’s economic miracle has pulled millions out of poverty, created massive infrastructure, and built world-class cities.

But as China eases into a slower growth phase, India is well-positioned to shift into the fast lane. We’ve been hearing for years that India will be the next China, but there seems, finally, a chance that it might happen. This optimism stems from three reasons. First, in terms of GDP per capita (PPP international dollars), the gap between India and China is narrowing fast[4]; and India’s per capita GDP (PPP) is expected to grow faster than China in the coming years (Pic 1).

 

Pic 1: Growth in per capita GDP (PPP)

Source: IMF WEO Database, estimates after 2017. This data uses GDP per capita PPP international dollars in constant prices. 

 

China is already a middle-income country, with a per capita GDP of over $16,000 (PPP international $); while India is a low-income emerging economy (GDP per capita PPP of $6925)[5]. China is well in the “middle-income trap” zone, while India is likely to enter the middle-income category only by the mid-2020s[6]. It has been observed that a country’s climb to middle-income level is faster and easier than the effort to jump into advanced-country income levels. Thus, India, which is still a low-income emerging economy, will be able to quickly upsize its per capita income given reasonable inputs of capital, labour skills, policy support, and assuming no sudden economic upsets. For China, the shift will be harder. It will have to improve labour productivity and push up technological progress, while keeping an eye on social unrest, global protectionism, and environmental concerns. The old formula of using state-owned companies to invest and grow incomes and output will not work anymore.

Second, China is a rapidly aging society. By 2050, one-third of China’s population will be over the age of 60, a steep rise from the current level of about 17%.[7] This has serious consequences for both the quantity and quality of labour. In contrast, India is in a demographic sweet spot. Its working age population will peak in the 2020s, and it will reap the growth benefits for a couple of decades after that. By 2020, the median age in India will be just 28, compared to 37 in China and the US, 45 in Western Europe, and 49 in Japan. India will have a large aspiring young population that will work, study, save, spend, and invest; all these activities will collectively boost growth and per capita income provided the demographic bulge is harnessed through education, skilling and jobs creation.

Finally, commitment to pro-growth and reform-oriented policies has become mandatory across political parties. The fact is that the country has moved towards greater openness and improved legal and institutional systems despite being governed by parties with widely different ideologies since 1991. This is a key component of India’s growth story, and may end up being the main reason for its people being able to achieve a better standard of living.

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[1] After the Tiananmen Square massacre in April 1989, China faced severe economic repercussions including decline in international investment flows and number of tourists, and decline in credit rating. The combined impact was a sharp fall in real GDP growth in 1989 and 1990. However, the economy rebounded in the 1990s. If we ignore 1989/90 as outliers, then the 2018 growth rate is the lowest since 1981! 

[2] IMF World Economic Outlook, Jan 2019

[3] President Xi Jinping used the term “new normal” in 2014 to describe the next phase of economic growth for China

[4] PPP stands for purchasing power parity. In comparing living standards of countries at different levels of development, it is better to use GDP per capita (PPP) as this adjusts for the differences in cost of living.

[5] In general, countries with GDP per capita (PPP international $) of $10,000 to 16,000 are considered to be middle income economies, between emerging and advanced countries.

[6] The growth slowdown experienced by middle income economies is known as a middle-income trap. Low-income economies grow rapidly for many years, but once they reach the middle incomes, all the low-hanging fruit of easy reforms and high return investments are already plucked and the country has to use innovation, highly-skilled workforce, or technology to sustain its growth rate. (Source: Eichengreen, Barry.,  Donghyun Park and Kwanho Shin: “Growth Slowdowns Redux: New Evidence on the Middle-Income Trap”, Working Paper 18673, National Bureau of Economic Research. Downloaded from  http://www.nber.org/papers/w18673

[7] Source: https://www.caixinglobal.com/2018-07-20/chart-chinas-aging-population-101306922.html

Prakash C Yalavatti on Thu, Feb 28th, 2019 12:18:46 pm

Very good content. Appreciative.

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