Sunday, 30 July 2006

Time to stop obsessing with China and FDI

MIT professor says potential for disruption of reforms is high


New Delhi

Is China vulnerable to an East Asian kind of crisis? It could, given the combination of high financial inefficiency and declining productivity. That was the combination in East Asia, right before the financial crisis, says Yasheng Huang, professor at the MITs Sloan Institute of Management.

Huang, who co-authored the definitive paper "Can India overtake China" along with Harvard Business Schools Tarun Khanna, was in India to deliver lectures on "Policy framework and development strategies: India and China" organised by the Confederation of Indian Industry.

Improvement in Chinas financial sector has been very modest compared with the Indian reforms in the 1990s. "The potential for disruption is and remains high. Though whether or not there will be an actual crisis will depend on other things we cant foresee," he warned, speaking to DNA Money.

Huang, who has been a trenchant critic of the development model followed by China in the 1990s, had one message for India: dont be obsessed with China or foreign direct investment (FDI). Ascribing Chinas success to its world-class infrastructure or its huge FDI inflows is an incorrect, misleading and harmful way of understanding the Chinese phenomenon, was Huangs simple point. "India is achieving 8% growth with 50% of Chinas investments and 10% of its FDI. To me this is a picture of more sustainable growth.

Chinas FDI inflows, Huang argues, reflect the systemic weaknesses in the economy. The financial system heavily supported the state-owned enterprises (SOEs) and actively discriminated against domestic private sector firms, which, then had no choice but to turn to foreign investors for equity capital.

A vibrant domestic private sector, Huang argues, can pull in high quality, technologically intensive FDI. Suppressing it, he warns, will bring in only low quality FDI, as it is in China. Huang questions the popular notion in India that FDI is needed to bring in technology. Korean firms, he points out, obtained technology by getting technical designs and information from the companies they supplied to, as also by exporting capital and acquiring firms in Silicon Valley and elsewhere. Much of Indian investments abroad too, he notes, are for acquiring technology, mentioning Ranbaxy as just one example.

Provinces like Zhejiang following an Indian growth model tend to get more technologically intensive FDI. They may have poor infrastructure but fairly liberal financial policies that support the domestic private sector. Zhejiang is home to a lot of the Indian IT firms. "India has the best of both worlds because it can get FDI as well as the benefits of domestic private sector growth."

Nor has Chinas growth to do with its huge infrastructure build up. The huge investments happened in the 1990s, his presentation showed, while the growth preceded it. China, in fact, may have over-invested in infrastructure, since the actual usage of expressways and some other hard infrastructure is very low. Not for him arguments that usage volumes will increase ten years down the line. "

Why? The volume is a function of growth and the growth is a function of education, health." Putting huge amounts of capital in physical infrastructure, will pull away resources from the health and education systems, which are equally, if not more, important for growth. Most business analysts underestimated India because they only looked at the lack of airports and hotels, he rued, ignoring its soft infrastructure. "Economic growth is a function of soft infrastructure, property rights and a relatively efficient financial system."

Though China is on a course correction of sorts, this, says Huang, is yet to show up in increased domestic consumption, another factor that economists like Morgan Stanleys Stephen Roach have identified as a factor behind Indias more sustainable growth. The government has started waiving rural education fees, reducing rural taxation. All this, Huang believes, will increase the consumption to GDP ratio over time.

Though attempts are being made to address the problem of lack of local entrepreneurship (which Huang and Khanna had identified as a major weakness in the Chinese growth model), Huang isnt sure the government is going about it in the right way.

"They think the lack of innovation is because of too much FDI. Its not because you have very liberal FDI policy. It is because you have very illiberal domestic investment policies." The government is beginning to look into the domestic business environment but not as drastically as Huang thinks they should.

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