Learning from China

At the World Economic Forum’s summer conference which is held — where else — but in China, Klaus Schwab, its president, announced that China would lead the world out of economic recession. This was not a pro forma obeisance to a host country: Schwab was being utterly sincere. One single statistic will tell us why. In the first eight months of 2009, China’s Yuan denominated; lending by China’s banks rose by 8.15 trillion ( $1.65 trillion). This is a rate of fiscal expansion that far outstrips even Obama’s in the US.

Sceptics may point out that all of this is not ‘new’ lending. Some increase would have taken place anyway to meet normal working capital needs. In fact  the National Bureau of Statistics itself pointed out that the increase in lending this year over the increase in the same period of 2008 is ‘only’ 5.04 trillion Yuan. But how much of the increase can one assume to be ‘normal’ when a country is in the grip of recession, exports have fallen by a quarter, profits have nosedived, and slackening domestic demand has pushed down the wholesale price index by 7.1 per cent?
No, let us not fool ourselves. At least three quarters of it, possibly all of it, is a product of China’s fiscal stimulus package. And, as was mentioned in an earlier column, unlike the UPA government’s fiscal stimulus package in india, the lion’s share in China is going into investment, ie building the future, and not into consumption, which alleviates stress in the present. Proof of this is the phenomenal rise in its urban fixed assets in the past eight months.

Such an explosive rate of growth of investment is neither economically nor politically sustainable. It is being financed by a carte blanche to China’s 80,000-plus cadre-manned investment agencies to borrow whatever they want from the state-owned banks with little or no thought about its economic viability. No country, least of all India, should follow China’s example blindly. But that does not mean that we cannot learn a great deal from the way in which it has happened.
The secret of the new Chinese ‘miracle’ is the way in which the planning of investment has become decentralised in a highly centralised state. The first part, the decentralisation, took place over a three year period at the beginning of the reforms, roughly between 1980 and 1983 when Beijing wound down centralised planning and allowed much of the power to invest to slip into the hands of the local governments.
Following a near-decade of anarchy during which a race to invest, between the Central and local governments, pushed investment up by as much as a third in several of the years, Beijing began reigning in the local governments through a succession of taxation and banking reforms, the first of which occurred in 1994.
However, these reforms were only partially successful. Having developed an appetite for investment, the party cadres that man China’s local governments continue to dream up projects first and look for ways, fair or foul, of financing them.

Economy unleashed
When the global recession hit China all that Beijing had to do was release the brakes on borrowing from the banks that it had imposed in order to curb the uncontrolled boom of the previous six years. Within six weeks of announcing its 4 trillion Yuan fiscal stimulus plan, the State Reform and Development Commission was inundated with 25 trillion Yuan worth of project proposals.
India represents the opposite paradox, for it is a democratic state with a bottom-up political structure in which economic power — specifically the power to sanction investment — still remains concentrated largely at the very top. In the heyday of the mixed economy, despite the fact that industry was a state subject, New Delhi exercised complete control over non-agricultural investment. But after 1991, when it progressively wound up its own planned fixed investment, it did not transfer the power to sanction such investment to the state governments. This left a vacuum that no one has been able to fill.

The vacuum occurred in the infrastructure. While the Centre all but ceased to invest it nevertheless retained the power to sanction such investment. Left out in the cold, the states found themselves having to do the dirty work of acquiring the land and raising tariffs on essential services. More and more are balking at doing so.
Today if 95 per cent of the Indian stimulus package has gone into consumption (while 91 per cent of China’s has gone into investment) it is not because the UPA government is indulging in populism, but because there is little else that it can do. For over the last 18 years the Centre has forgotten how to invest.

If there is anything that India needs to learn from China, it is the benefits that will accrue from transferring the final power to  sanction investment completely (subject to infrastructure clearances) to the state governments and to retain direct sanctioning powers only for inter-state projects. The competition this will unleash between them will not be unlike the race to invest between the Central and local governments in China and will have many of the same beneficial results.
Unlike China, India will not face the peril of over-investment, because unlike China the bulk of the investment will be made by the private sector. India also has a professionally run banking system intent on making profit, a well developed and regulated money market and an exceptionally able and vigilant Central Bank. This reform will also make it possible for the Central government and the planning commission to focus on building the infrastructure of backward states so that they don’t get left behind, and providing expert advice to the state governments as they come to grips with their new responsibilities.