Why is it so hard to replicate Chinese growth in India

On Social Media, there is a common refrain that India is unable to achieve the same speed of development as China. There is a comparison of how China built its Bullet train network vs the current plan of bullet train network in India. The other comparison is with regards to how China continues to dominate manufacturing and that India still lags behind on the same.

In this piece, I write on why it is unfair to compare a democratic country like India to China and why it is impossible in a democracy to achieve the rapidity of progress like China.

To start with, the content of threads are based on two wonderful books. “Trade wars are Class wars” by Michael Petitis and an older book — “Japan’s policy Trap”.

And secondly, I use economic concepts in the broader sense. I am not a trained economist and hence while I quote formulas and concepts, I do refer to them directionally rather than pedantically.

Now when I mention Democracy as a hindrance, most people will assume the bureaucratic hurdles, NGOs, environmental restrictions, Judicial interventions. Additionally, inability to pass land & labour reforms, farm laws are some of the other things that come to one’s mind.

But to me while these are important bottlenecks and need to be solved for, these are not the true cost of democracy. The real core of the issue is the allocation of resources between consumption and investment.

Let me first start with China and why it is so hard for countries to compete with China. China massively subsidises its manufacturing. There are multiple ways it does the same.

1. Direct transfer from common people to the manufacturers — When Land is forcefully acquired and provided to manufacturers at low rates.
2. Indirect transfer from common people to the manufacturers — By way of Hukou, suppress the wage power of labour.
3. Direct subsidies from the government to manufacturers — Export subsidy, Tax rebates, etc
4. Indirect subsidies from the government to manufacturers — Building Infrastructure and not charging the full cost/price. For eg: Building a new 10 lane highway where 4 lanes would suffice. Increasing port capacity 10X. All of these make its manufacturers competitive but the full price is not borne by them.

Chinese protesting against land acquisition

Now none of this is new knowledge and many people here are aware of the above facts. But what I would like to highlight is the quantum of the money that is transferred from common folks to the Industrial and Infrastructure sites.

It is the quantum of transfer that makes China achieve what it achieves whether in Infrastructure building or manufacturing/export prowess.

Let me start with a simple chart of % consumption as a share of GDP for China, India, France and Malaysia. As can be seen China has the lowest among all the nations here. And this is a comparison across peer groups of developed and developing nations.

So what does it indicate? It indicates that if China produces $100 of goods & services in a year, Chinese people consume only $54 of it. The rest is either used as investment (both public & private) or exported to be consumed by foreigners.

Now this is based on a simplified economic identity which states that a country’s GDP = C+I+G+X-M

Where C = Consumption, I = Private Investment, G = Government spend and X-M is the trade surplus.

And this makes intuitive sense right, if China says it produces 100 MT of steel in a year. Now this production is counted in China’s GDP. And this steel can be used broadly in only three ways

1. Steel is used for consumption — Household appliances, Cycles, Cars
2. Steel is used for investment — Building factories, roads, etc
3. Steel is used for exports — Export of any item that has steel in it

And if you take any good or service produced in a year, they will fall into the above three buckets. Let us take an extreme example of service like medical service

1. Consumption — Doctor taking care of patients
2. Investment — Doctor spending time on Incremental studies
3. Export — Doctor taking care of foreign patients

We can clearly see that if you look at the Investment (Gross Capital Formation) share of GDP for the same countries. You can clearly see that even in 2021, China’s gross capital formation was 1.7x of France, 1.9x of Malaysia and 1.3x of India.

So we can do a rough ballpark estimate of the amount of money that is transferred from ordinary households to Infrastructure and Export sectors. And that is the difference between the current share of consumption and the typical consumption that we would have seen in China’s development stage.

Taking 70% as that figure, the transfer of spending amounts to 70%-55% = 15% of China’s GDP. China’s GDP was $17.9 trillion in 2021. So 15% of that would translate to $2.7 trillion. That is the amount that is funded by average Chinese to build the vast bullet train network, the huge EV battery and Solar panel factories. That is nearly 85% of the total India’s 2021 GDP.

Now coming back to the initial point of this thread about India not doing similar to China. If we have to put India on such a track of double digit GDP growth, full throttled expansion of Bullet train network and manufacturing prowess similar to China. Then we need to do something similar.

So we need to spend more of our GDP into Infrastructure (Capex) or Exports rather than consuming ourselves. So let us take a target that we will restrict consumption to 60% from the current 70% share of GDP.

There are broadly two ways India can achieve this. Let me start with the more palatable option. We keep the consumption stagnant in dollar terms while significantly increasing the non consumption share of GDP.

So in 2022, India’s GDP was $3.7 trillion and 70% consumption translated to $2.6 trillion. So we keep that constant and increase the capex/investment share of GDP to 40%. That would translate to a Capex/Investment of $1.73 trillion taking the total GDP to $4.32 trillion. This would require a GDP growth of $0.62 trillion over the current GDP.

Now India’s GDP is growing organically at 7–8% given productivity gains from the past investments. So we would get $0.28 trillion from the same to meet this increment of $0.62. The question arises on how we get the remaining $0.34 trillion.

And for that we would need foreign investments. We would need an FDI of $340 billion in one year. That is 4X of FDI inflows in 2022 and nearly 10% of our GDP.

Let me illustrate why we would need foreign fund flows. As I mentioned earlier GDP represents the total output of Goods & Services. Now assume, we are producing 100 MT of steel.

Today 70 MT of steel is consumed by households in terms of Cars, utensils. And for simplicity’s sake, the remaining is used for building roads, factories. Now to increase the pace of road building, building trains, we will need more steel. Considering 40% target share (similar to China), would translate to 47MT steel. And we want to keep household consumption the same as before at 70MT. That means we need a total of 117MT of steel. But our production is only 100 MT. So the only way to cover the shortfall would be to import the remaining 17MT and for that we need foreign funding.

It is as simple as that, because to even increase steel production, we will need steel as we will need to build those steel factories.Now someone might argue that if we have unutilized capacity then the above will not be a challenge. To that my argument is that a) the above is an illustration and while one sector might have unutilized capacity other sectors might not and b) even if the economy as a whole is underutilised, that underutilization might be sufficient for a year or two. Gadkari’s Bharatmala program itself was enough to create price pressures on Steel and Cement. Imagine building 15 bullet train routes simultaneously.

The problem with this is that while foreign funding and money is plentiful. That is rational money. Gadkari can get foreign funding for roads but that will be based on the current performance. So given we have built 10,000 Kms of road this year, if we ask foreign funding for 15,000 kms of road next year, we might get interested investors.

But if Ashwini Vaishnav goes and says I am planning to build 15 bullet train routes and I need funding, no investor would be willing to fund the same.

Additionally foreign funding at this kind of scale has its risks and downsides. The volatility that such funding brings in can lead to crisis similar in nature to the Asian financial crisis in 1997.

So the only other option that India has is to cut consumption and divert the same to investments. So what would suppressing consumption entail? So we need to decrease consumption share from 70% to 60% and increase investment share from 30% to 40%. So we need a transfer of 10% of GDP or $370 billion dollars. Converting to current INR, that would be 31 Lakh Crores. That is nearly 70% of Central Budget

So India has to find ways to transfer 31 lakh crores from Indian consumers to Industrialists and Infrastructure building. How can that be done?

To begin with, India will have to cut all household subsidies and divert those subsidies to infrastructure building and PLI schemes. The major subsidies — food, fertiliser and petroleum — is estimated to be around Rs 3.75 lakh crore, which is 1.2% of the GDP for FY24.

And I will end my argument here itself. Because,we all know that the above is a non-starter. Even achieving this which accounts for 10% of the transfer needed is next to impossible. In a country where politicians take the easy way out of offering Freebies, we have an unrealistic expectation that Indian government will cancel every subsidy, and then on top transfer even more money from households to build China scale manufacturing and infrastructure.

To achieve a 10% transfer would entail, ending all household subsidies, increasing GST even further (as that reduces consumption automatically). Increasing tax on Petrol, Diesel and Cooking Gas. Increasing passenger railway fares to cross subsidise goods transport. Increasing electricity tariffs to households to subsidise Industries.As we can see each one the above step on its own is political suicide.

I recently shared a thread on the infrastructure that could have been built from the latest Karnataka government’s Freebies. That itself is enough to match China’s pace of construction in Karnataka State. And that is the problem. Politicians like will see the Rs. 10 Lakh crores Capex budget by the current central government and think of the various Freebies that they could dole out instead. Maybe sharing the amount with 20 crore households by announcing a yearly direct income of Rs. 50,000.

And this is the difficulty India has to face. A promise of Rs. 50,000 will enthuse voters as we saw in the Karnataka election against the promise of Infrastructure that will take years to build and provide the benefits. Otherwise, BJP should have swept the old mysore region where the latest Bengaluru mysore expressway was built.

Today, the infrastructure vote bank is too miniscule to influence. And that is the challenge that India faces. That is why it is hard to build like China.

Now some of the folks on the left who neither understand economics nor mathematics might say that there is a third way. Tax the rich. Just take away the wealth of Adani and Ambani and we can build Chinese style infrastructure and manufacturing.

But in reality, it is just taking from one pocket to another. Ambani has invested his wealth in building infrastructure (4G & 5G) and manufacturing (Giga factories to be built). So the government taking over and doing the same will not increase investment in the best case. Worse, like any rational investor, Ambanis would try to move their wealth out of India before the government took over and the government would end up with less investments than what would have happened originally.

So taxing or appropriating from the rich will not power the double digit GDP growth nor the rapid infra building of China. Redistribution of wealth might actually increase consumption which is the opposite of what we want to achieve in terms of competing with China.

And then there is an additional argument that like China, India should run very large domestic debts to build Infrastructure. Yes, there is a lot of domestic debt in the Chinese economy but taking a lot of domestic debt without suppressing consumption leads to run away inflation. The only Chinese could build huge infra with a lot of debt but kept inflation stable through suppressed consumption.In the steel example, it will lead to demand chasing the limited steel which will result in increased prices.

In UPA2, congress did try to do something similar with huge expansion in capacity, debt but without adequately suppressing consumption and we saw how quickly India started seeing double digit inflation.

No, sadly the burden of this has to be borne majorly by the poor. The reason is that consumption’s share of the rich’s income is smaller as compared to an ordinary poor household. An ordinary household would nearly consume 100% of income but even with their extravagant lifestyle, it will be hard for billionaires to spend 100% of income.

A major share of poor households’ income might just go into Grocery bills but it will be very hard for Ambani’s annual income to solely go into the grocery income even if one assumes truffles and other excotic mushrooms.

The rich and the middle class already save (which translates to investments). To gain Chinese style of reduction in consumption, the poor have to bear a relatively higher burden.

Now ideally cutting consumption need not necessarily mean cutting income. For the rich and the middle class, there are ways the government can incentivize them to save more (thus cutting their consumption) without affecting their income. The tax breaks for 80C are prime examples. But for the poor who live month to month, income is more than not equal to consumption. It would be hard to cut consumption without cutting income.

I would like to call out that I don’t pass any judgement on the poor who are incentivized by the Freebies. It is hard for anyone who is living month to month to pass off an incremental income and vote for a 6 lane highway near their house.

Just like in our personal life, we need to defer current consumption for future investments, nations must too and just like how it is harder for poorer families to save and invest, it is similarly hard for nations with a lot of poor.

And therein lies the true cost of the Chinese development model or rather East Asian development model. Each and every nation that followed this model took this approach of repressed consumption to drive infrastructure and manufacturing investments. From Japan to South Korea to Taiwan.

And except in the case of Japan, all of these countries were under dictatorships. Japan is an outlier but Japanese consumption was already suppressed due to wartime needs during WW2 and in combination with a sense of mission, it was easier to keep that way and kick start the Japanese miracle.

But, to do so in a democracy is really really hard. I don’t think there is any democratic example of where the same was achieved. It needs people and ordinary voters to willingly sacrifice the immediate benefits in return for increased future gains. It needs a sense of purpose and vision that is singularly hard to achieve across the nation.

So I end this thread with a request to those who criticise India for not achieving rapid infrastructure and manufacturing growth similar to China. It is unfair and unrealistic. Please appreciate what is being achieved currently. It takes a lot of political will to stake 10 Lakh crore of roads & railways rather than gifting Rs. 50,000 to 20 crores households every year. And that in itself is an achievement that needs to be valued and fought for.