One Land, two planets

The boom - The economy will overtake that of the US by roughly 2050: along with China, India will do

Indian diplomats used to complain that their country was unfairly "hyphenated" with Pakistan: whenever one country was mentioned, the other invariably completed the sentence. That is still often the case, but nowadays India is just as frequently linked with China. This rarely provokes complaint. The reason for viewing India in this new light is straightforward: its economic growth rates are beginning to catch up with those of its giant neighbour to the north. Given that only India can be compared in terms of population to China - and will in fact overtake China to become the world's largest country by population some time in the lives of the next generation - the two giant neighbours belong in an economic category of their own.

Economic futurologists at the CIA, in the investment banks, at western universities and in the business press all agree that China and India will at some stage in the 21st century come to dominate the global economy. In Washington's various intelligence estimates, China will overtake the United States between 2030 and 2040, and India will overtake the US by roughly 2050, as measured in dollar terms. Measuring by purchasing power parity - the amount you can buy with your local currency: the rupee and the yen, in this case - India is already on the verge of overtaking Japan to become the third-largest economy in the world. China is already the second-largest. So, apparently, the future is easy to anticipate. It is only really on the speed with which the future will materialise that opinion starts to divide. Add or subtract a couple of points from India's annual growth rates and it could overtake the US as soon as 2050 or as late as 2090 (that it never will is, of course, a third scenario, should India avoid taking serious steps to check its HIV-Aids problem or, for that matter, if there was a nuclear war between India and Pakistan).

And yet, leaving aside the question of timing, there is little doubt that India's economic trajectory is improving and that its annual growth rate of at least 6 per cent, and probably much higher, is sustainable. Before 1991, when Manmohan Singh, India's then finance minister and now prime minister, began to dismantle the post-colonial "licence Raj" of minute state regulation of the economy, India was stuck in what was known as a Hindu rate of growth. Between 1947 and 1991 the country's average economic growth rate was about 3.5 per cent a year. This meant that, with population growth of almost 3 per cent a year, average incomes were improving by less than 1 per cent a year from a pitifully low base. Since 1991 annual population growth has fallen to below 2 per cent and economic growth has risen to more than 6 per cent. At these rates, average income levels will double roughly every 15 years - compared to every 60 or 70 years before 1991. Whatever your economic ideology, and however much you may disapprove of India's widening inequality of income distribution, it would require incredible acrobatics to argue that India's "neoliberal" phase since 1991 has been worse for the poor than what it replaced.

Yet the bold new India remains a terrible place to be poor, and there are many hundreds of millions of Indians who still fit that description. India is home to more people living in poverty than any other country in the world - roughly 300 million people still live on less than $1 a day, which is the World Bank's measure of absolute poverty. While the G8 focuses on Africa, almost a third of the world's poor live in India. India might be capturing an ever larger share of the world's software markets and its manufacturers making inroads into global export markets in pharmaceuticals and auto components, but at times it seems that the almost unimaginably large mass of Indians living in the villages might as well be on a different planet.

Judging by this measure, the economies of India and China (which has roughly 85 million living in absolute poverty) belong in different categories. The closer you look at the character of India's economic growth, the more you appreciate that India and China really ought - to borrow an even uglier phrase from India's foreign ministry - to be "de-hyphenated". The starting point is the source of economic growth. India's growth derives largely from its services sector. This includes the by now familiar boom story in the country's information technology, software, back-office processing and outsourcing sectors, which post effortless annual double-digit growth rates. But it also includes India's financial sector, medical services, the consumer industry, media, Bollywood and advertising, which are also expanding rapidly. Services now account for 55 per cent of India's gross domestic product, manufacturing for just 25 per cent.

China, by contrast, is powered by its manufacturing sector: Chinese companies - usually in joint ventures with foreign multi-nationals - make tangible things, such as toys, cars, garments and electronic goods, often of relatively low quality (although that is changing), and then export them to the rest of the world. To be sure, India has a growing manufacturing sector, and China has a growing services sector. But to a large extent the two economies are complementary: India exports services, China exports goods. The western consumer is far likelier to buy a Chinese-made shirt or DVD player than a physical product made in India. The processing of the consumer's bill of purchase, however, is highly likely to take place in an Indian back-office centre.

In terms of foreign-exchange earnings, India's services sector is serving the economy well, but in terms of employment generation, China's manufacturing story is by far the more attractive model. India has a workforce of 470 million people, of whom just one million are employed in software and other services outsourcing activities. Only seven million Indians are employed in the formal manufacturing sector, compared to more than 100 million Chinese. Western critics of outsourcing sometimes depict Indian call- centre employees as "cyber-coolies". Without doubt, many of the jobs are repetitive and sometimes even degrading - although that, too, is often exaggerated (contrary to conventional wisdom, most Indian call-centres do not give "accent neutralisation" training to their employees). In terms of economic status, however, these one million Indians are among the elite of the workforce, earning a multiple of what they could get in most other sectors (in call-centres, monthly wages of 9,000 rupees - £115 - and above are standard). They are part of India's new middle classes. By no stretch of the imagination could they be described as "exploited" or badly paid.

The same could not be said of most of the remainder of India's workforce. Perhaps the best way of illustrating this is to compare the value of output of India's agricultural sector, on which two-thirds of India's 1.1 billion people depend for their survival, to that of its IT sector. India's agricultural output was roughly $150bn last year. India's IT sector produced almost $25bn, mostly in export earnings. India has almost 400 million farmers. In other words, India's one million IT employees earned roughly 65 times more per head than India's farmers. The phrase "productivity gap" is far too mild to describe the yawning gulf in output between rural and high-tech India. Another way of illustrating this gap is to compare India's scientific and technological accomplishments to its rural living conditions, particularly in northern India, where most of the country lives. India has developed both nuclear warheads - roughly a hundred of them - and the short- and medium-range missiles to deliver them. It also has one of the most impressive satellite systems of any developing country. China and India are competing, somewhat hubristically, to get a landing craft to the moon by 2010. It might be a dubious way of spending scarce resources, but India is quite capable of meeting its deadline. Meanwhile, the majority of India's women have to wait until after it gets dark before they answer the call of nature. Less than a third of Indian homes have an indoor toilet. Public toilets barely exist.

Some Indian economists are pinning their hopes on the country's growing manufacturing potential to lift India's masses out of poverty. Here again, however, India's successes so far have taken place in the capital-intensive industries, such as generic drugs making or the production of high-quality fashion garments, rather than at the labour-intensive end of the spectrum that China has virtually monopolised. In fact, India's manufacturing sector benefits from the same advantages as its IT sector - the availability of very highly educated English-speaking graduates, usually engineers, but also designers, accountants and other professions, at much lower wages than their counterparts in the west. Unlike China's manufacturing plants, Indian factories provide relatively few jobs for the unskilled and semi-skilled. Indeed, India's manufacturing growth over the past decade has come partly through shedding labour rather than adding to the payroll. Because of its absurdly strict labour laws, which make it virtually impossible for companies to fire anyone, which in turn deters them from hiring in the first place, this pattern seems unlikely to alter in the near future. Even in manufacturing, China and India are not so much competing with each other as providing complementary inputs: skilled Indian engineers are designing and making highly complex engine components, and Chinese shop-floor workers then assemble the car. Again, such activities earn India plenty of foreign exchange, but the money is being distributed to proportionately far fewer people than in China. One could say that China's rising tide lifts most of its boats (some of the boats are, naturally, bigger than others) but most of India's boats remain unseaworthy.

This brings us to a third stark difference between India and China: their agricultural sectors. China followed the classic sequence of development - it began with agricultural capitalism, then it moved to cheap manufacturing, now it is progressing up the value-added ladder, and finally, at some stage (one assumes), it will move to a stronger service economy. India, meanwhile, is progressing from the other end: its economy is scattered with islands of high-tech global excellence which are surrounded by a sea of semi-feudal rural darkness, sometimes literally, given that less than half of India's village households have an electricity connection. To be fair, India's farmers do produce more than they used to. But cereal output per hectare is still only half that of China, which in turn is far below the level of developed economies.

So what prevents India from modernising its agriculture or, for that matter, from creating more manufacturing jobs for the masses? Some people glibly blame India's economic inadequacies on its system of democracy. By embracing a full democratic franchise in 1947, when it had barely any industrial capacity and when only 16 per cent of its population was literate, India, they say, created all the pressures to redistribute the economic pie before it had even been baked. Yet this is too simplistic. India's worst economic decade was the 1970s, when Indira Gandhi, who was then prime minister, flirted with autocracy, suspending elections and the free media. The country's experience with authori- tarian rule helped to unleash a wave of separatist insurgencies from which the country is only now recovering. Clearly democracy is the price it must pay for maintaining the unity of what is probably the most diverse nation on earth. Those who advocate Chinese-style autocracy for India are unwittingly arguing for the country's disintegration.

A more persuasive argument is that India's inability to govern as decisively or reform as quickly as China can be attributed to its extraordinary diversity, which remains a fact regardless of the political regime. It is far harder to build the social trust necessary to take decisive and often painful action in an ethnically and religiously diverse society such as India than it is in a (comparatively) homogeneous one such as China. But Indians' very diversity also helps insulate them against some of the dangers of instability that might well be in store for the Chinese. As an American academic once observed, India is like a lorry with 12 wheels. If one tyre punctures, the lorry does not go off the road. China, meanwhile, has fewer wheels and so it can travel faster, but people rightly fear what might happen if one of its wheels flew off. In plainspeak, China's regime will flounder if it cannot maintain economic growth. For better or worse, India's democracy is what keeps India stable, even when growth rates are not as high as they could be.

And this brings us to the final and the most intriguing observation of what distinguishes India from China. When it comes to the most important reforms of all, it is China, not India, that seems to be frozen in the headlights. In order to continue to climb the economic ladder, China must create an independent judiciary and give much more social and political freedom to its people. India's legal and electoral systems are highly imperfect, but they have existed for decades and have entered the normal transactions of Indians' daily lives. Meanwhile, the economy is lifting many more people out of poverty than it used to, albeit at a much slower pace than it could. Readers, I hope, will forgive a parting cliche, but on a good day it is possible to imagine that the Indian tortoise is capable of overtaking the Chinese hare.

Edward Luce was the Financial Times's south Asia bureau chief until last year. His book, In Spite of the Gods: the strange rise of modern India, will be published in the UK later this year

This article first appeared in the 30 January 2006 issue of the New Statesman, A new sort of superpower