Chindia at a Crossroads

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The government's expenditure mix always tends to be an anchor for emerging economies like India. In the absence of a big infrastructure boost from the government, the corporate sector is also not pursuing a full-blown capital-expenditure cycle -- and both are critical for job creation. A major part of the foreign inflow of liquidity is used by households for funding their consumption expenditure on items such as cars, two-wheelers, etc. Indeed about two-thirds of the incremental bank-credit disbursement is to sectors other than industry and agriculture.

INVESTMENT LAGGING.

On the surface, these macro trends in India appear to be producing strong growth. But it is not sustainable. That's because, incrementally, India's consumption spending is being met through imports -- the trade deficit has been rising to new highs. More importantly, the cheap-money inflows from the global financial marketplace also appear to be ebbing. The Bombay stock market is down 20% in the last month alone.

Current macro policies that do not encourage investment in manufacturing create a weak investment-growth response. It leaves a large part of the resource pool, especially the working-age population, underutilized. There is clearly a need for a large increase in investment. This issue needs to be addressed urgently. India's young population is growing faster than any other country's -- some 42% of the country's population is under the age of 20, and they're bursting with unfulfilled aspirations and no means to achieve them legitimately.

Limited job opportunity means they may never realize their dreams. A large surplus is being added to the country's workforce each year. About 71 million people are likely to join the working-age population (15 to 64 years) over the next five years. This is even higher than the 44 million people being added in China during this period. In addition, the high unemployment level in India shows that the country cannot afford a weak investment environment and low job creation. According to government estimates about 20% of the population (220 million) lives below the poverty line, indicating the magnitude of the challenge that the huge numbers of unemployed represent.

MANUFACTURING FUTURE.

Although the strong growth in services outsourcing is a positive development, IT employs just 1 million, and that number will only double to 2 million by 2008. That's a drop in the bucket for a country of 1 billion. It is only an increased focus on education, China-style manufacturing (especially in the entrepreneurial small and midsize businesses), and infrastructure that will address this problem.

According to a study on employment by the Indian Planning Commission, 44% of workers in 1999-2000 were illiterate and a further 22.7% had schooling only up to primary level. Despite India's much-vaunted educated youth, what's in the pipeline does not inspire confidence. Only about 33.2% of the labor force had achieved schooling up to middle level (eight years of education) and above.

Even if we assume that all new additions to the workforce since 1999-2000 were educated to the middle level or above, the ratio would rise to only 39%. To accommodate the less educated, India will have to focus on manufacturing, especially because global trade opportunities are significantly higher in manufacturing. In 2005, total global exports of goods amounted to an estimated $10.4 trillion compared with $2.4 trillion in services. Also, the global market in IT and IT-enabled services outsourcing, which is more relevant for India, is minuscule.

CHINA PICTURE.

Workforce expansion and related unemployment concerns are challenges common to both China and India. However, the issue has so far evoked different responses from the two governments, particularly in the context of the management of public finances. While China is focused on infrastructure spending, lifting overall investment, and creating new productive jobs at a rapid pace, India is using its public finances to increase revenue expenses to pursue populist policies for supporting lower-income groups; the efficiency of this is questionable. If the Indian government were to increase its capital and development expenditure instead of running up unsustainably high revenue expenditure, the dependence on cyclical consumption drivers would be reduced.

Although China is better positioned on an overall basis compared with India, it is also facing a unique set of challenges. China's investments and export model have reached the other extreme. It needs to rebalance its growth model by increasing consumption. For that the government needs to redistribute wealth to households, reduce their insecurity from the rising costs of education and health, and ensure wage increase for its labor in line with productivity increases. China also needs to revamp its financial system, move to a flexible currency regime, and reform its institutional framework.

Both countries require political reform to lift them to the next level of economic development. While policymakers are increasingly aware of this need, they still have to demonstrate their willingness to tackle the issues head-on. If the two countries' governments manage to implement the prescribed measures, it will ensure stronger sustained growth for the two economies, lifting more and more people above the poverty line. More importantly, it will mean a world with less social-stability risks.

Chetan Ahya is executive director and India economist at JM Morgan Stanley (JM Financial Group, one of India's leading financial services groups, and Morgan Stanley). He joined JM Morgan Stanley in mid-2000 from BNP Prime Peregrine, where he was the India economist and strategist. Chetan earned a bachelor's degree in commerce and economics from the University of Bombay, a postgraduate diploma in economics and a master's degree in public policy and management from the University of London. He holds professional degrees of Associate Chartered Accountant and Associate Cost and Works Accountant.