Key determinants of the different GDP growth rates in India and China

By John Ross

An earlier entry on this blog considered India and China’s efficiency of investment in terms of GDP growth. This analysis was carried out in terms of their relative Incremental Capital Output Ratios (ICOR) – the percentage of GDP which is invested to generate a unit increase in GDP. An advantage of using this measure is that many countries, including India, produce quarterly GDP figures which allow up to date calculation of results – valuable for practical current policy making. China does not issue quarterly data on the composition of GDP, which would allow up to date precise ICORs to be calculated, but it does issue figures for the shares of investment and consumption in quarterly GDP growth - which allows qualitative estimates to be made which can also be used as practical policy guides.

The results of such ICOR calculations for India and China are illustrated in Figure 1. As may be seen, if a five year moving average is taken to smooth out purely short term fluctuations, both India and China invest essentially the same percentage of GDP to generate a unit GDP growth – 3.7% of GDP invested to achieve 1% GDP growth. This efficiency of investment, from the point of view of GDP growth, is almost twice that of the US - for which a comparison is also shown in Figure 1. Both India and China's figure is highly efficient considered from the point of view of international historical comparisons of sustained periods of growth.

Among the conclusions which followed from this ICOR data, other things being equal, were that:

1. On the basis of India's previously achieved domestic savings rate, and a moderate balance of payments deficit of up to three percent of GDP, the data supports the view that India should over the medium term be able to achieve its goal of 10% annual GDP growth without unsustainable inflation or other uncontrollable  macro-economic imbalances. Therefore the inflationary pressures experienced by India at the beginning of 2010, while significant, should be containable except in the case of serious adverse international economic trends.

2. China's higher level of investment allows it to achieve 12% annual GDP growth without the development of unsustainable macro-economic imbalances. Therefore China's 11.9% year on year GDP growth achieved in the first quarter of 2010 was not surprising nor should it lead to unsustainable inflation or other uncontrollable imbalances - although significant further acceleration would be unsustainable. As with India such a conclusions applies in the absence of serious adverse international movements.

3. There is no evidence from such ICOR data that investment is used more efficiently in India than China. The efficiency of investment, from the point of view of GDP growth, is almost exactly the same in India and China and therefore, other things being equal, the relative rates of GDP growth in the two countries depends on their relative rates of investment.

Figure 1

ICOR and TFP studies

If an advantage of ICOR as a measure is that it is up to date, a disadvantage is that it does not capture the detailed data on investment and other sources of GDP growth that full Total Factor Productivity (TFP) studies do through use of growth accounting methods – ICOR is a less statistically precise measure of relevant trends. The problem of TFP studies, in contrast, is that they require far more detailed statistical information and are therefore typically not as up to date as ICOR comparisons.

Such a statistical trade off between recentness of data and precision is normal, but it means that it is valuable to make a comparison between ICOR and TFP studies. If TFP studies yield the same fundamental findings as ICOR indicators then this enhances the reliability of findings regarding the fundamental picture of GDP development and also increases the reliance that may be placed on ICOR calculations from a policy making perspective.

This article, therefore, examines the data on international comparative growth accounting and TFP studies provided in Khuong Vu’s ‘Determinants of Economic Growth over the Period 1995-2005’ and the updated data for Dale Jorgenson and Khuong Vu’s ‘Information Technology and the World Growth Resurgence’ which takes such studies from 1989 up to 2006 – the most recent published TFP data for India and China. Although both papers were written for another purpose, to analyse the role of ICT investment in economic growth, their authors have put in the public domain data which allows overall comparative calculations for India and China to be made. Naturally responsibility for the calculations and analysis based on that data is that of the present author, not of Jorgenson or Vu.

The overall picture

Before considering more detailed periods the growth accounting data for India and China for the ten year period 1995-2005 as a whole is analysed. As will be seen below the analysis of

shorter periods allows identification of detailed trends but does not alter the fundamental picture. Relevant data is set out in Table 1. 

Table 1

Considering first the percentage structure of the determinants of GDP growth, the proportion of GDP growth accounted for by TFP increases was essentially similar in India and China – 43.0% for India and 46.6% for China. This illustrates, from a TFP angle, similarities in the two economies already clear from the ICOR data. The level of efficiency of investment in both India and China, as measured by ICOR data, was essentially the same. The proportion of their growth accounted for by TFP increases in India and China is also essentially the same.

Turning to absolute rates of growth, the annual rate of TFP increase in both India and China is high in terms of international comparisons. Of the 94 countries analysed by Vu, India ranked 15th and China 5th in terms of rate of TFP growth.(1) However this TFP comparison is complicated by the fact that many countries experiencing high TFP growth in this period were in Eastern Europe, where recovery from extremely severe economic decline in the early 1990s was taking place, and which is therefore likely to have temporarily raised their rates of TFP growth. Nine of the countries which ranked higher than India in TFP growth, and all countries that ranked higher than China, were in this latter category. If these East European countries are excluded then India ranked sixth and China first in terms of TFP growth. In either case TFP growth in India and China was high in terms of international comparison.

Pattern of inputs of capital and labour hours

If the percentage contribution to growth of TFP in India and China was similar, in contrast the mix of factor inputs differed significantly. For India 21.7% of GDP growth was due to increase in inputs of labour hours compared to only 9.0% for China. In contrast 44.4% of China’s growth was due to increased capital inputs compared to only 35.3% for India.

In comparative terms, therefore, India’s growth was based on a high level of labour inputs plus high TFP growth, whereas China’s was based on a high growth of capital inputs plus high TFP growth.

Absolute increases in factor inputs and TFP

This contrast in pattern becomes clearer if absolute numbers are considered rather than percentage contributions to growth. Over the period 1995-2005 China’s annual GDP growth was 2.5% a year higher than India’s - 8.7% per annum compared to 6.2%. This was accounted for by the fact that India’s lead over China in inputs of labour hours, of 1.3% per annum compared to 0.8% - an advantage of 0.6% after statistical rounding, was more than offset by China’s 1.4% a year advantage in TFP growth compared to India - 4.1% compared to 2.7%, and China’s lead in capital input growth of 3.9% compared to India's 2.2% - a higher level for China of 1.7% per annum.

These trends are charted in Figure 2 for percentage increases per annum in inputs and TFP and in Figure 3 for percentage of contribution of inputs and TFP to GDP growth.

Figure 2

Figure 3

The overall pattern

In the trends shown in Table 1 above it may be noted that the biggest gap between China and India is in terms of capital inputs. Of India's 2.5% slower GDP growth per annum than China 1.7% was accounted for by lower capital input and 1.4% by lower TFP growth - greater labour hours growth constituted an offsetting 0.6% growth advantage for India.

To further illustrate this Table 2 consolidates labour hours and TFP.This shows that India’s GDP growth in 1995-2005 was 71% that of China. However India’s combined growth of labour inputs and TFP growth was beginning to approach China’s at 83% of the latter's level. The greatest lag of India compared to China was in capital inputs – the growth of capital inputs in India was only 57% that of China.

This data, of course, confirms from another angle the conclusion of the ICOR analysis that the decisive lead of China over India in generating GDP growth is in terms of its greater capital input.

Table 2

Shorter periods

Turning to the analysis of shorter periods, and trends through time, comparative data for India and China for the periods 1989-1995, 1995-2000, and 2000-2006 are set out in Table 3.

Table 3

It may be seen that in each successive period the gap between India and China narrowed in terms of GDP growth - India’s GDP growth rate was 49% that of China in 1989-1995, 69% of China’s in 1995-2000, and 76% that of China in 2000-2006.

Turning to the reasons the gap between India and China narrowed, India maintained its lead in terms of growth of labour hours throughout – in successive periods India’s rate of growth of labour hours input compared to China's was 141%, 129%, and 158%.

India, in particular in the early part of this period, also very significantly narrowed the gap in terms of TFP growth, although the rate of narrowing slowed significantly in the later period – India’s rates of growth of TFP in the successive periods compared to China were 24%, 59%, and 65% respectively.

The area where the decrease of the gap between India and China was much slower was in capital inputs. India’s inputs of capital were, in the successive periods, 59%, 58%, and 65% those of China’s.

These trends are illustrated in Figure 4

Figure 4

To summarise the above data, in each period India maintained its lead over China in terms of labour hours, there was substantially narrowing of India’s gap compared to China in terms of TFP growth, but there was only a relatively small narrowing of the gap in terms of capital inputs. Aggregating, India’s combined input of labour hours plus TFP growth rose from 45% of China’s in 1989-1995 to 85% in 2000-2006 – that is India was almost eliminating the gap with China. However India’s capital inputs only rose from 59% to 65% of those of China.

It is clear from this data that the slower rate of growth of India’s GDP compared to China’s is due to both a lower rate of growth of TFP and a lower rate of growth of TFP. However whereas India has made significant progress in narrowing the gap of its rate of growth of TFP compared to China it has not made notable progress in narrowing the gap in terms of capital inputs - this is directly related to the higher rate of growth of investment in China compared to India, and the higher percentage of investment in GDP in China. .

Conclusion

A number of clear conclusions follow from the above analysis

1. The ICOR analysis and the TFP analysis are clearly in line - enhancing confidence in the findings and that an accurate economic picture is being given. The ICOR analysis finds that the efficiency of use of investment in India and China, from the point of view of GDP growth, is essentially the same. The TFP study confirms the ICOR data that the primary reason for the higher rate of growth of GDP in China compared to India remains the higher rate of growth of investment. 

2. The TFP studies confirm the ICOR one that there is no evidence that India uses its resources more efficiently than China. The TFP study is more negative in this regard than the ICOR analysis. The ICOR study showed that China and India used investment equally efficiently from the point of view of GDP growth – 3.7% of GDP being invested for each 1% GDP growth. However the TFP studies show that by 2006 the rate of growth of TFP in India was significantly lower than in China – slightly less than two thirds of China's level. The claims in certain sections of the Indian media that India uses its resources more efficiently than China is therefore statistically unfounded.

3. Statistically, if India were to close the gap with China in terms of rate of growth of TFP this still would not lead to India’s GDP growing as rapidly as China’s. Taking the most recent period in the studies above, 2000-2006, if India’s rate of growth of TFP were assumed to be the same as China’s, and its lead in input of labour hours was assumed to remain the same, then India’s GDP would only grow at 91% the rate of China’s. India’s rate of growth of TFP would have to be 20% above that of China’s, other things remaining equal, for its GDP growth rate to equal China’s. As in 2006 India’s rate of growth of TFP was 64% that of China's this would imply that India’s rate of growth of TFP would almost have to double, other things remaining equal, for it to equal China’s GDP growth.

To assess whether it is possible for India to achieve the same rate of GDP growth as China only on the basis of an increase in the rate of growth of India's TFP it may be noted that in the most recent period above, 2000-2006, it would require, other things being equal, India’s annual rate of growth of TFP to be 4.84% for its GDP growth to equal China’s – an 87% increase. Leaving aside specific conditions already noted in of Eastern Europe only two small countries, Chad and Trinidad and Tobago, achieved such a rate of growth of TFP in 2000-2006 of the 122 studied by Jorgenson and Vu. The first was recovering from civil war and the second is an oil and gas producing state with a population of only slightly over one million. In the entire period 1989-2006 only one other country, Lebanon, apart from China achieved a 4.84% per annum increase in TFP – also during recovery from civil war. It is therefore implausible that India can achieve the same rate of GDP growth as China purely on the basis of productivity increases without an increase in the rate of growth of capital inputs.

To achieve the same rate of growth of GDP as China India would have to increase the rate of growth of capital inputs and therefore of the level of investment in the economy. Strategies which rely on India achieving the same rate of GDP growth as China without increasing its level of investment are statistically unrealistic.

* * *This article originally appeared on the blog Key Trends in Globalisation on 02 May 2010.

Notes

(1) Vu analysed a series of other countries for which data did not separate labour quality and TFP growth. As the current article examines the difference between labour growth and TFP these countries have been excluded from comparisons in the present study.