How India's growth story differs from China's

Analysis of data on gross domestic product (GDP) — the value of all goods and services produced in a country's territory over a given period — usually looks at the income or ‘supply' side. This essentially refers to the composition of GDP in terms of individual sectors (agriculture, industry and services and, within these, sub-sectors such as manufacturing or construction) and their respective growth rates.

The market value of production in each sector (say, agriculture) translates into income for agents in that particular value chain (farmers, traders or truckers in this case).

But the other way of analysing GDP is to consider the expenditure or ‘demand' side. This factors in the total spending in a country — whether in the form of consumption by private households (C) and government (G) or as investment (I) in new plant and machinery by corporates.

In addition, there are goods and services produced domestically, but consumed outside the country (manifesting as exports or E), which have to be netted out from those produced overseas, but consumed within (manifesting as imports or M). The sum of all these expenditures (C+G+I+E-M) would add up to the value of what is produced in the country. In other words, its GDP.

The expenditure approach to GDP yields interesting insights into the workings of an economy. These include what are the drivers of its growth: Is it coming mainly from consumption or, alternatively, from demand for steel and cement due to building of new roads, airports and rail corridors? These, in turn, influence the very composition of GDP, besides the nature and sustainability of growth in that economy.

Two worlds

A useful way to understand the implications of the expenditure approach is through a comparison of India and China.

The Central Statistics Office's latest national income estimates for 2010-11 show the share of consumption in India's GDP at 68.7 per cent, of which 57.2 per cent was from C and 11.5 per cent from G. On the other hand, gross fixed capital formation or I accounted for 29.5 per cent, while E-M contributed minus 3.2 per cent (a result of the country's imports of goods and services, both for consumption as well as investment, exceeding its exports). The balance five per cent comprised inventories and assorted residual items.

It is quite the other way in China, where only 48 per cent of its GDP in 2009 — the latest year for which data is available — originated from consumption, including 35.1 per cent from C and 12.9 per cent from G.

The corresponding contribution of I stood as high as 45.4 per cent, with net exports (E-M) adding another 4.4 per cent, taking their combined share in GDP to almost half (against slightly over a quarter for India). The above numbers reveal two very different economies — one, that is significantly based on consumption and the other, that is largely investment and exports-driven.

The contrast becomes sharper if one looks at just private final consumption expenditure or C, where the relative ratio to GDP for India is more than 1.6 times that of China.

The Charts plot these ratios — including for G and I — for both countries over the last three decades. What emerges is a pattern, where the two economies have both recorded rising investment rates alongside a decline in the share of consumption.

The difference, though, is in the magnitudes. India's current investment rate is less than two-thirds of China — which explains why it produced some 67 million tonnes (mt) of crude steel and 220 mt of cement in 2010, compared with the latter's 627 mt and 1,800 mt.

Consume or Invest

China's economic model has basically involved suppression of consumption, especially in rural areas that account for hardly 24 per cent of private final consumption expenditure despite housing roughly 53 per cent of the population.

Sustained low wages (relative to productivity), financial repression (leading to households receiving, and firms benefiting from, below-equilibrium interest rates) and an undervalued currency (boosting profits from exports) have helped generate higher retained earnings for corporates to deploy into fixed investments.

These differences in the expenditure structure of GDP also show up in the way the two economies responded to the recent global meltdown. China saw its net exports-to-GDP ratio more than halve from 8.8 per cent between 2007 and 2009.

It offset this, however, by raising the investment rate from 39.1 per cent to 45.4 per cent.

India did otherwise by stimulating consumption through excise rate cuts and implementation of the Sixth Pay Commission's report, among other things. So, the overall consumption rate rose two percentage points, which effectively neutralised the decline in investment rate during this period.

The result: Neither of the two economies suffered the pangs of recession that others went through and are continuing to experience.

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