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India could overtake China -- one day

With the right policies, the subcontinent might reach higher per head incomes than the Middle Kingdom

| China

India has now beaten China in terms of gross domestic product growth for three years in a row, with an estimated 7.5% for 2017 compared with 6.9%. And the outlook is for more of the same: The International Monetary Fund expects India to grow at 7.7% per year in 2018-2020 and China to grow at 6.3%.

What once may have seemed a blip is the new reality: With its much lower per capita income of $1,664 in 2016 (in market prices) compared with China's $8,129, India can look forward to faster growth for the foreseeable future assuming the rules of economic catch-up still hold.

But what should India do to give itself the best chance of fulfilling this potential? How likely is it that China could suffer an economic shock big enough to hold it back and to allow India to streak ahead? Does democracy give India some future advantages to support rapid growth or not? Or will China break with global precedent and show that a command economy can prosper even as it reaches the ranks of developed nations?

China grew much faster than India over several decades and is challenging the global dominance of Western industrial economies. Close proximity to industrialised Japan, early adoption of economic reforms to garner a first mover advantage in export-oriented foreign direct investment, a strong state role under the Chinese Communist Party and Confucian business ethics explains a lot of its success -- not least in outperforming India.

However, China has recently slowed with the population aging, wages rising and a looming middle-income trap. In response, President Xi Jinping has ended the one child policy to boost the birth rate, reforming inefficient stated-owned enterprises, promoting high technology and implementing the huge Belt and Road initiative, partly to remedy excess industrial capacity.

Meanwhile, India's growth is accelerating. Services -- fueled by growing middle-class consumption -- have flourished. Key states -- Andhra Pradesh, Maharashtra and Tamil Nadu -- are becoming manufacturing hubs and joining global supply chains.

Demographic dividend and reform

India is enjoying a demographic dividend in the form of an increasingly youthful population. Between 2000 and 2015, India's youth population -- those under 24 -- rose by 20 million whereas China's dropped by 80 million. A pick-up in India's reforms and increased FDI inflows have also benefited growth. Prime minister Narendra Modi's government has implemented a flurry of pro-growth measures since 2014 including investment climate reforms, a "Make in India" initiative , and fiscal reforms, and has boosted public sector accountability and increased public infrastructure investment. It has upset some parts of business with two other measures -- demonetizing large currency notes to fight corruption and introducing a general sales tax. But the economy is recovering from these shocks and the sales tax lays the basis for healthier future public finances.

To give itself the best chance of catching up with China's income per head, India should continue implementing market-oriented reforms. More investment is also needed in the knowledge sector for India become a technological innovator and an Asian technology hub, rather than an imitator of imported technologies.

India's increasingly youthful population is a blessing but it lacks important technical skills. In 2016, India had 2.6 million STEM (science, technology, engineering and mathematics) graduates while China had 4.7 million. Furthermore, India only invests 0.6% of its GDP on R&D compared with 2.1% for China. India's lagging R&D strategy gives insufficient focus on high technology industries of the future such as such artificial intelligence, robotics, biotechnology and aerospace. India's under-investment in the supply-side of growth is also visible in infrastructure gaps like unreliable electricity supply and obsolete railways. India spent 4.9% of its GDP per year during 1992-2013 on infrastructure compared with 8.6% in China.

To explore when India might overtake China, we projected long-run per capita income in the giants under reasonable assumptions about key variables like growth, inflation, exchange rates and population. We assume that China's growth would gradually decline from 6% in 2017-2025 to 5% in 2026-2035 and then to 4% after 2035. Meanwhile, from a lower economic base, India would grow faster at 8%, 7% and 6% in the three different sub-periods.

The projections suggest that India would eventually surpass China's GDP per capita around the middle of the 21st century.

Of course, such long-term projections are subject to many caveats, not least the chances of unexpected shocks. But China and India have in the past shown economic resilience following major economic upheavals such as the 1997 Asian financial crisis and the 2007 global financial crisis. Accordingly, our projection implicitly assumes that China will experience a soft landing as its economy naturally converges toward growth of Western industrial economies. As a relative latecomer to industrialization, India is playing a catch-up game with China but should also experience growth convergence, albeit over a longer time period.

Systemic risks

However, many risks lie ahead which could upset the two giants' development prospects. These include political uncertainty, trade protectionism, tighter global financial conditions and weak productivity growth. China's outlook is susceptible to systemic risks of a debt bubble in an overly state-controlled financial system, a trade war with the U.S. and a risk of a nuclear confrontation on the Korean Peninsula.

India's outlook could be dampened in the short-term by the transitory effects of demonetization, the implementation of the sales tax and subdued private investment. Longer-term, many business people complain the country is held back by its bureaucracy, its complex legal system, confusing land rights and powerful vested interests such as the farm lobby.

However, despite the difficulties, in ethnically, linguistically and religiously diverse India, democracy can aid rapid growth. Elected leaders can fall prey to vested interests. But those like Modi who rely on a broad support base are naturally incentivised to implement bold reforms which benefit the majority of the electorate. Elected leaders are also less tempted to engage in large-scale corruption and to tolerate bureaucratic inefficiency because they risk exposure.

Meanwhile in more homogeneous China, one-party autocracy has produced generally enlightened leaders who have in the past three decades imposed politically testing but vital reforms to enhance prosperity. Beijing created an attractive foreign direct investment regime and invested significantly in education and infrastructure. A poor person in China enjoys much better access to schooling and health care than a poor Indian.

But rising prosperity in China has felled demands for political freedoms and more property rights. The results of this pressure for democratization are unclear. Most other economies that went into industrialization under authoritarian rule later passed through a democratic transition, not least neighboring South Korea and Taiwan. If China avoids this change it will set a global precedent. If it does not, it could see disruptive changes that India's democracy, for all its shortcomings, will not have to go through.

Ganeshan Wignaraja, is chair of the global economy program at the Lakshman Kadirgamar Institute of International Relations and Strategic Studies, Sri Lanka. He is also a senior research associate at the Overseas Development Institute in London.

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