China is not the first economy to rise rapidly from the ranks of developing countries or to emerge from the ashes of war and internal strife to become an industrial power. In the aftermath of World War II, Japan and Germany (with the help of a large infusion of U.S. assistance) revived industries ravaged by defeat and destruction and managed to turn them into “miracle economies.” South Korea, Hong Kong, Taiwan, and Singapore emerged from Japanese occupation to become “tigers” or “little dragons” with high-growth economies and rapidly rising living standards. Taiwan managed to accommodate a major influx of mainlanders in 1949, while South Korea withstood war and insurgency to transform from an agrarian society into an industrial powerhouse. Both enjoyed generous U.S. help but were able to translate it into lasting progress. Thailand, Malaysia, Indonesia, the Philippines, and Vietnam were alternately hailed as “new generation tigers” destined to follow in the footsteps of South Korea, Taiwan, Singapore, and Hong Kong, although the Asian financial crisis and internal upheaval undermined their progress. Most recently, India has launched its first serious economic reforms and is now competing for the multinational investment it ejected in the 1970s.
Is there anything special about China, then? Is the country just one more link in this long chain of developing economies on their way up, receiving the baton from the little dragons only to pass it quickly onto the hand of the new kid on the block—Vietnam or perhaps India? And will China end up as a “paper tiger,” its imprint seemingly fizzling like that of a stagnating Japan or the little dragons following the Asian crisis? The question is not merely academic: If China is nothing more than another emerging economy on its way up, then its impact should be temporary, confined and, above all, predictable in form and path. This, in turn, will make it easy to draw lessons from the impact of China's predecessors, assess its competitiveness vis-à-vis its current counterparts, and above all, devise strategies and techniques to deal with the challenge.
The argument made in this book is that the rise of China in the early part of the twenty-first century is distinctive and has more in common with the rise of the United States in the twentieth century than with the advance of its Asian neighbors; the repercussions of its climb are equally monumental. The uniqueness of the Chinese ascent is rooted not only in China's enormous population base; after all, India also has passed the one billion mark. It's also not rooted in China's huge economy (Japan is still the world's number two economy in nominal dollars) or even its rapid growth (Japan and the four little dragons each enjoyed a higher growth rate at some point), although the combination of these factors is special to China. China's exceptionality is about a special legacy, different institutions, sky-high aspirations, and a one-of-a-kind combination of resources, capabilities, and bargaining power. China's uniqueness is also about timing. It is ascending during a dramatic acceleration in globalization, the emergence of powerful multilateral institutions such as the World Trade Organization (WTO), the most significant geo-political realignment since the fall of the Soviet Union, and increasing pressures associated with economic restructuring in major industrialized nations, especially the United States. This constellation of interdependent events has no direct precedent; it is also unlikely to be replicated elsewhere any time soon. It will force nations, firms, and individuals to question accepted assumptions, reject past analogies, and develop strategic responses that do not currently exist in their repertoire.
Consider this: China is the only Communist nation (admittedly with an increasingly open economy) to achieve rapid economic real growth over a sustainable time period. It's the only emerging economy with an authoritarian regime that seeks, but finds it increasingly difficult, to maintain tight control on individual freedoms and expression even as it frees ever-larger segments of economic activity. China is the only developing country that yearly pulls in an amount of foreign investment greater than that of all other developing economies combined, and that now attracts more international investment dollars than any other market, developed or developing.[1] China also receives technology transfer at a pace, scope, and depth never before seen in a developing country, especially one that is not considered a close ally of its benefactors. And, among all emerging economies in the past 50 years, China is by far the most ambitious in its goals and the most determined to fulfill them.
Understanding the experience of China's predecessors and counterparts at home and in international markets and assessing the efficacy of the responses it generated is important not only in judging China's uniqueness. The comparison is also vital for our ability to identify the benchmarks set by the Chinese government and the models and strategies it pursues in its continued development effort at home and in its expansion into foreign markets. This, in turn, will enable us to better grasp China's future impact on the rest of the world.
No other country comes up so often in discussions of the U.S.-China trade relationship as Japan. It is easy to see why: Both China and Japan are Asian nations that at one point were considered a national security threat to the United States (a familiar American sentiment about Japan in the early 1980s was that it won the military war with Japan but lost the subsequent economic battle), a suspicion that lingered even as geo-political realignment brought them closer to American interests. Both countries at one time were the number-one contributor to the American trade deficit, manipulated exchange rates to enhance competitiveness, flaunted intellectual property rights (albeit China on a much grander scale), and erected a litany of trade barriers restricting the importation of American goods. Both were accused of taking a free ride on U.S. open markets without opening their own. The similarities end there, however, as does the usefulness of the analogy. But first, some background.
In the 1970s, the U.S. media started carrying a growing number of stories: first on Japanese imports, and later on Japanese investments in the United States. Japanese complaints about being singled out (when was the last time you have read an article on British investments in America?) fell on deaf ears. Books describing the Japanese threat proliferated on bookstore shelves, just as utopian accounts of Japanese management were hitting the top of the best-sellers lists. High-profile purchases such as the Rockefeller Center, famous golf courses, and high-end Hawaiian hotels produced even more alarming accounts of a rising power that was bent on taking over the American economy. It did not help that many Japanese also bought into the belief that theirs was a system superior to any other. In the mind of many Americans and Japanese, the rise of Japan was inevitably linked to a decline of American civilization.
Nowhere was the Japanese threat more visible and threatening than in this most conspicuous symbol of the American economic might and way of life: the automobile. Japan, which designated automotive as a strategic industry already in the 1950s, restarted its car industry after the war by reverse engineering American models and taking advantage of orders from the American military in Korea. Less than two decades later, Japanese makers were already shipping product to the U.S.—first a few thousands units annually and, by the early 1970s, hundreds of thousands of cars per year. During all those years, U.S. car exports to Japan remained at the same dismal level of a few thousand cars annually. Japan's initial success in exporting cars to America was first attributed in the public's mind to the oil crisis of October 1973 (in reality, the crisis merely accelerated an export surge that was already in full swing), which enabled many to argue that the Japanese were merely lucky—they happened to have economy cars for sale just when the market needed them. When Japanese manufacturers extended their gains, another, not unfounded argument came about: Japan was not playing fair, artificially lowering the value of the yen to boost exports while erecting barriers to American exports. The same criticism was directed decades later toward China.
In the late 1970s and early 1980s, another explanation for Japan's success gained ground: perhaps Japan was simply producing higher-quality products at a more reasonable price, and to improve competitiveness, American firms needed to learn from Japan in such realms as quality control, productivity, and human resource management. The honeymoon with “Japanese management” was about to begin. U.S. business schools that until then did not want anything to do with Japan or any other Asian country began a period of enchantment with everything Japanese. Centers for Japanese business were established complete with teahouses and endowed positions, and Japan became a favorite topic of academic research. Scholars soon discovered that Japan had a tendency to defy Western thinking on such key issues as the relationship between exchange rates and trade, or, in the words of some economists of the time, that “Japan did not fit the model.”
It is hard to imagine that only 20 years ago Detroit auto workers publicly hacked a Toyota to show their disgust with Japanese imports, when today Toyota is becoming the third largest U.S. car maker, displacing Chrysler (now owned by Germany's Daimler), whose near death triggered much of the alarm about Japanese competition in the first place. Yet, it would be wrong to believe that the experience did not leave its marks on the American psyche and on the strategic repertoire of U.S. firms, the federal government, industrial unions, and other significant constituencies who are now drawing analogies from the Japanese experience to China. As misplaced as some of these analogies may be, they cast a long shadow over the interpretation of China's advance and the efficacy of the reaction to the challenge.
One supposed lesson from the Japanese challenge is that it has been exaggerated. After all, once-feared Japan later entered a prolonged period of painful economic stagnation and was forced to unload many of its more visible U.S. investments, often suffering big losses. The sale of the Japanese-owned Rockefeller Center back to U.S. interests just as the New York market was about to take off again reaffirmed the belief of many Americans that business acumen was on their side and there was no reason to worry about competition from Japan or any other country. The analogy implies that the Chinese threat is also overplayed, and the trade imbalances and dislocations it would bring are by nature temporary and would be resolved by market forces, if not by the rapid transformation of the U.S. into a service-based economy. This remains the prevalent view among economic observers.
If the feeling that Japan's threat was exaggerated took hold, it does not sit well with the facts. The U.S. trade imbalance with Japan that ballooned in the 1970s and 1980s may have stabilized in the 1990s but remains over $60 billion a year, second only to China's. The big three auto makers (treating Chrysler as a separate entity from its German parent) never recovered the market share they lost to the Japanese and are now fighting to defend their last turf of trucks and SUVs against relentless Japanese inroads often led by Made in the U.S.A. models. Employment in the industry is a fraction of that prior to the Japanese advance (although automation and chronic industry overcapacity have played a central role, too). In the meantime, Japanese consumers continue to frown upon American-made cars even as foreign investment in the Japanese automotive industry has grown substantially.
Vitally, the Japan experience exposes the inefficacy of many of the responses undertaken by American industry and unions to counter foreign competition. After all, the trade deficit with Japan persisted in the face of “voluntary” quotas, dramatic realignment in exchange rates, and continuous U.S. government pressure to pry open Japanese markets. The deficit also survived the establishment of U.S. transplants by the major Japanese manufacturers (together with their suppliers), who were supposed to export back to Japan (but rarely did), and a dramatic restructuring, including marked improvement in quality and productivity, by American makers. In fact, it now seems that the main factor curtailing the Japanese surplus has been the transfer of Japanese manufacturing capacity to China, which by and large shifted a portion of the deficit from one county to the other. Worse, it appears that some of the responses undertaken in the U.S. to fight the deficit with Japan may have backfired. For instance, limiting Japanese car imports in unit amounts as part of the quotas only accelerated their up market shift because this became the only way to augment export revenues. The shift culminated in the establishment of luxury divisions by Honda (Acura), Toyota (Lexus), and Nissan (Infiniti), which targeted the Cadillac and the Lincoln customer, along with German imports. Japanese firms have come full circle from low-cost producers to full-range competitors charging a premium for the perceived quality of their products. The U.S. manufacturing industry, on its part, discovered that the up market was not protected from Asian competition either.
Analogies are a useful lens through which to see the world, but as proven time and time again, they have their limitations. To be sure, China and Japan share a number of traits, starting with partial similarity in philosophy, religion, and institutions (such as Confucianism, although the philosophy did not become state orthodoxy in Japan until the late nineteenth century, precisely when the Chinese started to suspect it was detrimental to modernization). Both countries have been an enigma to Western observers, who oscillated between suspicion and an unadulterated admiration for their ancient civilizations and modern achievements. Both nations also have historical baggage: Japan as a member of the Axis during World War II (“remember Pearl Harbor” was often used as a slogan against Japanese imports) and China as a member of the Communist block (targeted by U.S. unions for its human right violations) during much of the cold war. Both Japan and China have had the misfortune of lacking development infrastructure, later reinterpreted as a boon because it enabled them to leapfrog countries with investment sunk in older technologies. Both have benefited from favorable geo-political circumstances: Japan was helped by the cold war, with many Japanese firms getting their first overseas orders from the American military in Korea, and with the U.S. reluctant to pressure a reliable ally in a largely hostile Asia with a Communist China and a Soviet-affiliated India. In the aftermath of September 11, China appears to play a role as a potential ally in the fight against terrorism and in containing North Korea.
Japan ran a coordinated industrial effort that gave priority to “strategic industries” while maintaining competition within each of those industries—something China would imitate later. In their foray into foreign markets, both Japan and China used an artificially weak currency to support exports; in fact, both continue to do so today. Both countries also have used trade barriers to block foreign—especially U.S. imports. Both benefited from a lingering perception that they were unlikely to become viable competitors with the possible exception of cheap, low-technology products. Then and now, this proved to be a serious mistake.
Similarities notwithstanding, China and Japan differ in a number of key areas. One vital difference is size: Although the Japanese economy is larger than that of China's in nominal terms, the allure of a vast and rapidly growing Chinese market with pent-up demand for products and services translates into greater leverage with trade partners than Japan ever had. China's size gives it another advantage: While Japan moved in less than a generation from a low-cost manufacturer to a high-cost producer (and, unlike the U.S., it did not have immigration to cushion the transition), China has a vast, untapped hinterland with a huge supply of workers, which will permit it to move up the technology scale without sacrificing its present cost advantage for years to come. China will thus use its dominance in labor-intensive production to advance the knowledge-intensive industries of the future. In addition to having Hong Kong and Taiwan (and to some extent Singapore) as capital providers and knowledge catalysts, China has a vibrant overseas community that plays a major role in its development and globalization. Japan had none. China has the benefit of much larger foreign investment (which Japan rejected at the time for fear of foreign domination and as a threat to Japanese culture). China is also ready to open up its educational system, something Japan never did, and in addition to sending its students abroad, China is a host to many foreign students from Asia and the West. Plus, while Japan's World War defeat limited its future defense expenditure and deployment, China is a member of the Security Council and is becoming more involved in world affairs, participation it will later leverage for economic advantage.
China's potentially stronger impact is also anchored in the timing of its ascent. Its rise and challenge to its trading nations come at an earlier level of development than Japan's, driven by stronger internal pressures to provide employment (Japanese unemployment was low in the 1970s and 1980s) and relying on a much lower cost base. This means that, with a few exceptions, the Japanese strategy of transferring production to the U.S. is unlikely to be replicated at this time, which limits the prospects for employment absorption by implants. (Japanese auto transplants by and large avoided veterans of the U.S. industry but did hire other Americans.) Another difference between China and Japan is that the United States handled its trade conflicts with Japan on a bilateral basis, while conflicts with China are handled under the multilateral WTO regime. Given China's trade distribution (a huge surplus with the U.S., a moderate surplus with the European Union, and a deficit with Asia), continuous acrimony between the U.S. and the EU, and a rising conflict between developing and developed nations over farm subsidies, it would be difficult for the U.S. to garner support for policies limiting China's entry to its markets, especially since much of the world, according to Transparency International, views the U.S. as an unfair trader.
A crucial difference between Japan and China has to do with their capacity for innovation and propensity for entrepreneurial and international activities, all crucially important in today's global economy. Innovative capacity is not only a function of the number of scientists and engineers (although China is doing well on that measure as well), but is also a product of legacy factors. Historically, China has been an innovator, and Japan has been an imitator or an incremental improver, rarely producing radical innovations. The Japanese have often been critical of their education system as promoting rote learning and group conformity while stifling innovation. The Chinese education system suffered from some of the same ills, but not during its entire history. During many periods of its Imperial past, Chinese cities were host to residents of foreign nationality, religion, and culture. Now, with the help of foreign investors (never fully welcome in Japan), Chinese are building on that tradition.
Entrepreneurial activity has been limited in Japan, a result not only of lack of education for innovation, but also of low tolerance for uncertainty and prestige factors (the best graduates of Japan's universities sought government service or corporate employment), a nepotistic production and distribution network that kept outsiders at bay, and a lack of supporting infrastructure (such as venture capital firms). China, despite its legacy of bureaucratic control, tolerated entrepreneurial activity for much of its history. During Imperial times, some Chinese merchants accumulated vast sums of money, although the money often went into preparation for or the purchase of bureaucratic positions rather than to further economic activity. Some entrepreneurial activity survived into the mid 1950s and was gradually renewed from 1979 onward, which means that, unlike the Soviet Union, the reforming Chinese have had experienced entrepreneurs in their ranks. Finally, the overseas Chinese brought with them an enormous level of entrepreneurial ability and enthusiasm. As minorities barred from government and agricultural employment in their adopted countries, Chinese have founded flourishing businesses that have later invested in the “motherland.” In contrast, the largest group of Japanese descendents outside the U.S., in Brazil, has been more a source of menial labor for a society fearful of heterogeneity than a provider of investment, knowledge, and global contacts.
The Chinese advantage in innovation, size, and timing suggests that as substantial as the Japanese impact has been, the Chinese impact is likely to be much bigger, more sustainable, and broader in terms of economic sectors. The initial impact will not be cushioned this time by foreign investment inflows to partially offset job losses, or by exchange rate realignment. Such alignment, as the Japan experience shows, will not make much of a difference anyway, and even less so in China where the government maintains a tighter grip and can met subsidies and other incentives as a way to compensate for exchange rate adjustment. Likewise, erecting barriers in the form of quotas may backfire by accelerating China's push into higher margin domains.
In the 1980s and 1990s, Japan slowly faded from U.S. media screens. Its foreign investment fell from a hiatus funded by low real interest rates, easy bank financing, and an asset price bubble. With the bursting of the Tokyo stock market in the late 1980s, Japanese firms had their bank loans recalled and unloaded U.S. assets often at fire sale prices. This signaled to Americans that the coast was clear: The Japanese threat had receded, its economy beginning a long period of stagnation. The American model had been vindicated again—or so it seemed. While growth and job creation resumed, the United States did not return to balanced trade in the twentieth century.
As Japan vanished from the American psyche, the void was filled by a second wave of Asian imports. The four “tigers” or “little dragons”—Taiwan, Hong Kong, South Korea, and Singapore—were initially regarded as “new Japans.” Indeed, while these four territories resented Japan for its brutal colonial and wartime record, they viewed it a model of Asian success worthy of emulation. Taking a page from Japan, these economies started by aggressively pursuing the labor-intensive, low-technology areas that Japan, with its higher cost structure, was forced to desert, but later turned up-market as a reaction to rising costs and Chinese competition. Today, the “tigers” are closely linked with the Greater China economy as investors and partners, and they are major contributors to the growth of intra-Asian trade. As a group, but also separately, the tigers remain major models that China closely follows as it charts its own course.
A British colony for a century and a half, Hong Kong served as the gateway to China for much of that time. In the 1960s and 1970s, Hong Kong was a thriving manufacturing base producing low cost goods, most of which did not compete directly with a Japan that was already climbing the technological ladder. Always reliant on its physical proximity but superior governance to China, Hong Kong has become more closely dependent on the mainland after the launch of the reforms, a closeness cemented in 1984 with the signing of the Joint Declaration, returning Hong Kong to Chinese rule in 1997. Feeling the heat from other tigers, as well as from newly industrialized bases in Malaysia and Indonesia and competition for its textile exports from lower cost bases, Hong Kong firms seized on the proximity and ethnic relations and shifted manufacturing operations to the Chinese mainland, initially in the adjacent South and later across China. This enabled the territory to develop a competitive advantage as an entrepreneurial and managerial junction rather than a manufacturing base. Today, there are many toy producers in Hong Kong, but not a single toy factory remains. The territory, competing with the mainland's urban centers (in particular Shanghai), is trying to reinvent itself as a financial and service center, a revealing challenge for those who see the future of the United States as a service hub.
At first sight, Hong Kong's experience bears little relevance to China. Small in size, “Westernized” on the surface, and a free market, Hong Kong does not cause the feeling of concern in the West that Japan or mainland China have elicited. However, Hong Kong has demonstrated important qualities that have been infused to the mainland and are becoming indigenous to it. These include experience in climbing the technological ladder (admittedly up to a point) via massive investment in higher education, a record of retaining knowledge capabilities while shifting production to cheaper locations, a strong entrepreneurial spirit, and the capability to develop and run not only small business, but also large, diversified global conglomerates, such as Hutchison Whampoa. With the blessing and support of the mainland authorities, Hong Kong has also shown that with massive reserves and steadfast determination, it is possible to defend an exchange rate peg in the face of ferocious attacks by speculators, who have managed to bring down such pegs in other countries. This does not bode well for American hopes to strengthen the yuan even if it were to be floated.
Following the defeat of the Nationalists in the Chinese civil war, Chiang Kai-shek's forces retreated to the island of Taiwan where, with American help, they established a manufacturing-based economy consisting of mostly small, family-owned firms as well as some large state-owned large industrial enterprises. Like the mainland, Taiwan also started its foray into the global economy as a low-cost manufacturer but eventually moved up-market, sustaining labor-intensive activities by relocating to the mainland. It gradually developed technological capabilities that were rarely cutting edge but still provided advanced, specialized, niche capabilities and “value for money,” permitting the emergence of technology conglomerates such as Acer. Taiwan also successfully used agglomeration, which is now taken for granted by scholars and practitioners alike as an effective strategy for growing technical capabilities, co-locating multiple competitors and supporting industries in a successful bid to achieve global leadership in products like notebook computers. Taiwan is also the first ever democracy in a Chinese society—and a vibrant one at that. This example is sometimes cited as a future model for China, although the huge differences in size alter the order and stability equation that the People's Republic of China (PRC) utilizes as a justification for one-party rule; this and other factors suggest that those pinning their hope on China's democratization may be in for a disappointment.
Although Taiwan maintained a large trade surplus with the U.S. for many years, it did not come under much scrutiny. Much of this had to do with geo-politics. Until the formal recognition of the PRC as China's government in the late 1970s, Taiwan was viewed by the U.S. as the legitimate ruler of all of China and a bastion against the spread of Communism. Even after recognition of the PRC, U.S. support for Taiwan continued, and successive U.S. administrations remained fiercely opposed to the Chinese threat to take the island by force. Under those circumstances, the U.S. government was reluctant to pressure Taiwan on trade issues. Another factor that helped Taiwan (as well as Hong Kong and Singapore) avoid scrutiny and blame is that its exports consisted primarily of intermediate inputs incorporated into other products and often sold under other brand names. In contrast, Japan's exports relied heavily on end products, and its largest trade surplus was in the highly visible automotive category. The PRC enjoys similar benefits in areas like automotive components (with a China-made car in the U.S. market still years away), but it is keen on building global Made in China brands.
The third (predominantly) Chinese tiger, Singapore, is similar to Hong Kong in its small size, relatively free market, and entrepôt position (more with Southeast Asia). With the exception of occasional flare-ups about media censorship, the U.S. relationship with Singapore has been good, and trade has not been a major issue of contention. Singapore remains a center for high-tech manufacturing as it tries, like Hong Kong, to lure service providers and strengthen its position as a regional headquarters for multinationals. Singapore's relationship with China is close, underpinned by demographics (Singapore is almost 80 percent Chinese) and consummated via extensive foreign investment. In many ways, its economy is complementary to that of China, and the same may be said about its political and social system. Officially a democracy, the likelihood of regime change in Singapore appears to be extremely low, making it a potential model for the mainland in the future. There are other things the mainland regime likes about Singapore: In many ways, it is the ideal Confucian society, with patriarchal leadership, heavy socialization, emphasis on discipline, and overseen by a competent, prestigious, and highly compensated bureaucracy. The island nation even has Confucian academies and is probably as close as you get to a modern-era reincarnation of a Chinese empire ruled by an enlightened dynasty and a merit-based administration.
The only non-Chinese member of the tigers (although heavily influenced by Confucianism) is South Korea. Rising from the destruction of a long and abusive Japanese occupation, war, and internal strife, South Korea, whose GDP was similar to that of many African countries in the 1950s, turned itself within a relatively short time from an agrarian economy to an industrial powerhouse, even as it maintained a considerable defense expenditure, a feat that made it an enticing model in the eyes of the Chinese leadership, which remains the increasingly reluctant patron of North Korea.
South Korea's modernization charge was led by the chaebols, family-owned conglomerates that, with generous government support, grew to an enormous size and diversified into any imaginable activity. These conglomerates were responsible for the vast majority of Korean exports, with small and medium-size companies playing an important but largely supporting role. This has begun to change following the Asian financial crisis, which required bailout by the International Monetary Fund (IMF) and which exposed many of the vulnerabilities of the chaebol system, such as lack of transparency, weak governance, unchecked borrowing, and lack of strategic focus. Surprisingly, perhaps, China has not lost interest in the chaebols as a model for Chinese conglomerates, although it has certainly taken their weaknesses to heart. The ability of such chaebols as LG and Samsung to restructure and globalize convinced the Chinese leadership that they should continue to provide viable blueprints (albeit perhaps not under family ownership for now), except that China will try to leapfrog into more focused business groups. China also wants to learn from South Korea how to effectively use returning students to beef up its technological and managerial capabilities.
In relation to trade, China has noted the boost Korean exports received from the devaluation of the won during the Asian crisis, and the memory lingers as another reason to resist calls for strengthening the yuan. Another lesson China has drawn from the Korean experience is the importance of penetrating other developing markets—in particular in Asia—as a way of hedging against a trade backlash in the United States and other developed economies, and as part of a strategy to build a strong Asian market to match Europe and the Americas.
The Asian financial crisis, starting in Thailand in 1997 and quickly spreading to other Asian nations with a contagion effect of falling stock and asset prices, was a watershed in the region. Asian economies switched almost instantly from having the highest growth rates in the world to negative growth. The title “financial crisis” was somewhat of a misnomer; the crisis was as much about institutional and managerial failure, exposing weaknesses such as nepotism, corruption, lack of transparency, and weak governance. The crisis forced system changes across the region, although not to the extent foreseen by many Western observers.
The crisis also had a number of consequences for the U.S. perception of Asia, among them a misplaced vindication of the American business model, which was benefiting at the time from a prospering economy and a rising technology boom at home. This is one reason why the advancement of China was not being noticed at the time. China on its part interpreted its ability to withstand the crisis as a reminder that too high a dependence on the global economy was risky and that growth in global markets had to go hand in hand with continuous development in its domestic market. At the same time, it became apparent that Chinese firms, like their Asian counterparts, needed to continue to develop the skills that would make them competitive in a global economy.
Decades ago, India was mentioned together with China as two giants whose rise would shake the global economy. The forecast has been only half true so far. India stumbled time and time again, just when it seemed that it was finally getting serious about reform and about retreating from stifling government regulation and protectionism. More recently, India has been in the news again, this time with tales of economic restructuring, rapid growth, foreign outsourcing, and renewed interest on the part of foreign investors. India's successes, especially in software, have gained visibility, even a prediction that India will catch up with or overtake China.[2]
There are quite a few similarities between India and China. The two nations have enormous populations (roughly 1.3 billion in China and 1 billion in India) and a history as old and proud civilizations that have fallen on hard times and stagnation brought about by a centrally planned autarkic economy with correlates like rampant corruption. Both countries have a multi-million people strong Diaspora with the potential to assist in the country's development, the Chinese Diaspora with capital and business know-how, and the Indian with education, business experience, and advanced technological knowledge. Both nations have been working to liberate their economies from the shackles of socialist control, although ironically it is Communist China (which admittedly started earlier in this round) rather than democratic India that is far ahead in freeing its economy from planning rigidities and a regulatory maze. Both managed to attract some of the most lucrative investment of all—technology research and development—bringing about a debate in the U.S. as to whether this jeopardizes or facilitates U.S. technological leadership.
Several advantages of India are often cited. First, it has been a democracy for over 50 years. This is an advantage from a Western perspective that ties economic progress to democratization, although so far, the Chinese experience seems to challenge this belief. Because of its political structure, China is able to move quickly, whereas a democratic India often gets bogged down in political infighting. A second advantage of India cited is English, which is an official language in the country, while many Chinese are still struggling with it (although urban areas are making quick progress). Japan's example suggests, however, that command of English is helpful but not a prerequisite for entering global markets. So far, English has helped India in areas where the benefit of language ability is obvious, such as in call centers, as well as in software, where it's combined with strong engineering capability. A third advantage of India is a more sophisticated and relatively independent legal and financial system as well as greater transparency in governance. At least in the eyes of a foreign investor, transparency and separation of powers are admittedly a plus, although rampant corruption in both nations lowers the actual benefit accrued from it. In any event, this advantage has proven insufficient so far to redirect the flow of the investment dollars. Finally, India developed a middle class earlier than China, which is a benefit in terms of market potential and professional skills, but China is now catching up fast.
The case for India catching up, or even overtaking China, is made in a recent Foreign Policy article.[3] In addition to citing India's legal, political, and governance advantages, the authors make two related overarching arguments: The first, that China's reliance on foreign investment is both proof of and reason for its underlying weaknesses, and second, that China, unlike India, has not developed world-class enterprises and lacks in entrepreneurial skills. Both arguments are misplaced. Foreign investment in China is a reflection of the country's attractiveness as a market and as an export platform. While foreign-invested enterprises are responsible for as much as half of China's exports, they also play a crucial role in upgrading the country's infrastructure and knowledge base, from which local players also benefit as joint venture partners, or via upgraded human resources and the emergence of supporting industries. Many of these local competitors are now giving the multinationals a run for their money in the Chinese market. The second argument about China lacking entrepreneurial skills is also entirely unfounded. A glimpse into Thailand, Malaysia, the Philippines, and other Asian countries reveals that the Chinese make up much of the entrepreneurial class there. Their involvement in the mainland together with that of entrepreneurs from Taiwan and Hong Kong serve as a model for the many indigenous mainland entrepreneurs we see today. Finally, the authors make the case that while India has world-class companies, such as Infosys and Wipro, China has none. Wrong again. Lenovo (formerly Legend) a home-grown manufacturer, has more than a quarter of the Chinese personal computer market, which is about four times Dell's market share. Haier, a leading appliance manufacturer, sells into international markets and now manufactures in the United States. In telecommunications, Huawei Technologies and UTStarcom, among others, are already forces to be reckoned with in developing markets and are beginning to be a factor in developed markets as well. This is without mentioning successful Greater China conglomerates such as Taiwan's Acer or Hong Kong's Hutchison Whampoa, which is one of the largest diversified conglomerates in the world.
Up to now, China's growth rate has been much higher than India's even over the last decade, when India has been reforming. China's growth pace is still higher today, although the gap has been narrowing. Foreign investment in India remains a fraction (less than 10 percent) of the Chinese figure, although it is likely to grow if investors, who have burned their fingers repeatedly in that market, are convinced that the changes this time are for real and that anti-foreign sentiments will not flare up again. While China has many weaknesses, it has made great strides in building its infrastructure and streamlining its regulations. In democratic India, the government continues to play an often-stifling role. Finally, China is globally competitive in a variety of industries, from textiles to appliances, while India is gaining in a narrow range—in particular software, back-office operations, and call centers. This makes India's presence felt in the outsourcing market but does not necessarily translate into a country-wide impact, which is a critical issue in a poverty-stricken nation.
All this is not to say that India will not eventually become a major global player or that it will not compete with China in global markets. To do so, India will have to overcome a number of hurdles. These include geo-politics—in particular its conflict with Pakistan over Kashmir (China has a problem with Taiwan, but it is largely of China's own making, which means that it can easily contain it), a history of broken promises that makes foreign investors nervous, and an underlying resentment of foreign investment, which China has already put behind it. (In addition to physical attacks against a Coca Cola bottling point, India has seen violent attacks and a smear campaign against U.S. fast food chains.) India will also have to liberalize its economy and fix its infrastructure, areas in which China has already made substantial progress. Finally, while India has a thriving overseas community, its Diaspora lacks capital and the will to massively invest in the country. Most importantly, India does not have a Taiwan and a Hong Kong to serve not only as models but also as economic launching points for reform. (For instance, the first economic zones opened for investment in China were in proximity to Hong Kong or Taiwan.)
For these reasons, India is unlikely to catch up with China any time soon, although it will affect certain knowledge-intensive sectors of the global economy—notably software—more than China. More importantly perhaps, India has strengths that are complementary to China, as the booming trade between the two countries suggests. India already provides competitively priced inputs (such as steel) to the fast growing Chinese economy, bolstering its capacity and cost structure. Down the road, India may also begin to absorb investment and growth from a more expensive China; however, the Chinese hinterland has such vast reservoirs of human capital that it can absorb rising costs in its eastern seaboard by way of employee migration, subcontracting, and the like before it would have to ship production to India, Vietnam, or other cheaper competitors. If and where this were to happen, it would hardly provide relief to those sectors who will bear the brunt of the Chinese impact in developed markets and in the other developing markets that are losing ground to China.