Why Are China and India Growing So Fast? State Investment

Darley Shen / Reuters

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BEIJING -- The world's two fastest growing major economies are China and India.

Both countries demonstrate a common pattern of development different from that of the slowly growing West. Rapidly growing state investment plays a significant role in China and India's economic expansion, while private investment is either growing very slowly or declining. In contrast, the slowly growing Western economies rely on private investment with no rapid growth of state investment.

This economic reality is crucial for China's practical economic policy as the country seeks to achieve its goal of a "moderately prosperous society" by 2020 and a "high income economy" by World Bank standards shortly thereafter.

But the facts of this global economic trend are also crucial for economic theory and analysis. According to the dogmas of "neo-liberalism" and the "Washington Consensus," private investment is supposed to be "good" while state investment is supposed to be "bad." The facts show the exact opposite trend is occurring.

Rapidly rising state investment is associated with high economic growth.

Rapidly rising state investment is associated with high economic growth (China and India); over-reliance on private investment is associated with low growth (U.S., EU and Japan).

China and India's Rapid Growth

In 2015 China's per capita GDP growth was 6.4 percent and India's 6.3 percent based on World Bank data.

These are easily the fastest growth rates for any major economies. They also propel the most rapid rates of growth of household and total consumption. In particular, both China and India are growing far more rapidly than the Western economies -- in 2015 the EU's per capita was only 1.7 percent, the U.S. 1.6 percent, and Japan's 0.6 percent. Data for 2016 to date show the same pattern of rapid growth in China and India and slow growth in the U.S., EU and Japan.

Professor Zhu Tian from China Europe International Business School points out, referring to National Statistics Bureau data, that from January to June 2016, state-owned fixed-asset investment had grown by 23.5 percent over the same period last year, but private fixed asset investment growth had decelerated to 2.8 percent.

chart 1

Chinese state and private investment percent change year to year: 2011-2016 (CEIBS)

India, the other rapidly growing major economy, shows the same pattern as China. The analysis by Pranjul Bhandari, chief India economist of HSBC, in July noted that the year-on-year increase of India's state investment was 21 percent while private investment actually fell by 1.4 percent.

chart 2

Indian public versus private investment from 2010-2016 (CEIBS/HSBC)

In other words, the world's two fastest growing major economies, China and India, are both being driven by rapidly rising state investment, with private investment playing a less significant role.

Slow Growth in Western Economies

In contrast to China and India, Western economies are experiencing very slow growth. For Q1 of 2016, per capita GDP growth was 6.2 percent in China, 6.6 percent in India but only 1.6 percent in the EU, 1.3 percent in the U.S. and 0.2 percent in Japan. Q2 data of 2016 show continuation of the same growth rate in China while per capita growth in the U.S. fell to 0.4 percent, nearly one-fourteenth of China's rate.

chart 3

Year-to-year growth in per capita GDP 2015-2016 (IMF/OECD)

If we look at per capita GDP growth for world's major economies since 2007 -- the peak year of the last U.S. business cycle and the last year before the global financial crisis -- it is noteworthy that per capita GDP grew by 85 percent in China and 52 percent in India, but only by 3 percent in the U.S., and less than 2 percent in the EU and Japan.

chart 4

GDP per capita change 2007-2015 (IMF)

The vast growth outperformance by China and India compared to the Western economies is evident.

Low State Investment in the West

If China and India's pattern of high growth is associated with strong state investment, what, therefore, is causing the West to grow so slowly? The U.S., the best performing major Western economy, has published the most up-to-date data for state and private investment.

The chart below shows that the year-on-year growth of the U.S. private investment is as low as that of China and India, and has been steadily falling. In China and India, the low growth rate of private investment is offset by rapidly growing state investment of over 20 percent; whereas in the U.S., state investment only rose by 1.2 percent up to Q2 of 2016.

The U.S. has also released private and state investment data in inflation adjusted prices, which shows the same depressing trend -- private fixed investment in inflation adjusted prices rising 0.3 percent in the year before Q1 of 2016, and state investment rising 0.8 percent. But unlike China and India, the U.S. has not increased state investment to compensate for falling private investment.

chart 5

U.S. state and private fixed investment per quarter: 2011-2016 (NIPA)

Therefore, the correlation between rapid increase of state investment and fast economic growth in China and India, and slow increase of state investment and slow economic growth in the U.S., is factually clear.

The Role of State Investment

The logic is clear: the correlation between rapid growth of state investment and fast economic growth, as well as between reliance on private investment and low economic growth, is evident. It might occur to the reader that it is rapid economic growth in India and China that is leading to more state investment, not the other way around. Or low rates of investment in the U.S. because of its slower growth. This to me is implausible since state investment is directly under government control and not subject to diffuse market forces. Both the Chinese and Indian government have made clear that they have deliberately taken the decision to increase state investment in order to stimulate economic growth, while in the U.S. many are ideologically opposed to state investment.

China, in the early part of this year, deliberately stepped up its level of state investment in several areas -- particularly in infrastructure. By May the infrastructure investment action plan included 303 projects covering railways, highways, waterways, airports and urban rail transit, with 131 projects in 2016, 92 projects in 2017 and 80 projects in 2018.

india smart city

India's push to accommodate a booming urban population and attract investment rests in large part with dozens of "smart" cities like the one. (REUTERS/Amit Dave)

In late 2015-early 2016 China's economy had been slowing for some time, and the rapid build-up of state investment was not a stimulus package aimed at taking off growth pressure. As is well known, it was a deliberate measure to stabilize the economy and prevent a downturn. In India the Modi administration has appointed as its chief economic adviser a specialist on China's economy -- Arvind Subramanian, formerly of the Peterson Institute for International Economics and author of "Eclipse: Living in the Shadow of China's Economic Dominance." Immediately after assuming his position in October 2014, Subramanian made clear that he saw state investment as the key to India's growth. Subramanian was explicitly supported by India's Finance Minister Arun Jaitley. This was then supported by a series of reports by top Indian economic thinkers.

The reports concluded: "Public investment will be the main driver of growth ... At present, infrastructure spending is about 6 percent of the gross domestic product, which needs to be increased to 9 percent to make a (yearly) growth rate of 8 percent sustainable over a long term."

The rapid increase in India's state investment reflected in the data is therefore an entirely conscious and deliberate policy pursued by the Indian government -- the causal factor in the economic growth.

In the U.S., the idea of state investment often meets with skepticism and 'private' is perceived to be good.

However, in the U.S., the idea of state investment often meets with skepticism and "private" is perceived to be good. Significant state investment is not only rejected on ideological grounds, but is also structurally impractical due to the absence of a major state sector in its economy that is capable of delivering a rapid build-up of state investment.

Relation to the 'New Normal'

Turning to the interrelation of these trends with the "new normal" in China, it is well known that a key feature of the "new normal" is that growth for the foreseeable future period will be lower than the 9-10 percent annual growth rates seen for several decades after 1978 and which allowed the setting of an annual growth rate target of 8 percent. Part of the reason for this is the extremely slow growth of the international economy. This global "new normal" was accurately described by IMF Managing Director Christine Lagarde as the "new mediocre."

This slowdown in China is far less severe than in the advanced Western economies. Over the entire period 2007-2015 annual average per capita GDP growth in the U.S. was only 0.5 percent, in Japan 0.2 percent and in the EU 0.1 percent.

There is no doubt, as I have been arguing, as to the reason for this extremely slowing growth in the Western economies: It was due to the extremely low rate of growth of fixed investment. Indeed, by 2015 the level of fixed investment across the OECD countries, was still below its level in 2007!

chinese stock market

An investor observes screens at an exchange hall in Hangzhou, Zhejiang Province of China. (Getty)

The reason for this, as analyzed in the case of the U.S., was that state investment failed to rise rapidly in order to compensate for a stagnating or falling rate of growth of private investment. In contrast China and India, by rapidly raising state investment, were able to achieve far higher growth rates.

The role of state investment in both China's and the global "new normal" is therefore clear.

Conclusions

The facts on the growth patterns in the "new normal" of the global economy are clear.

  • The major economies with high growth rates of state investment (China, India) have high rates of economic growth.

  • The major economies with low growth rates of state investment, such as the U.S., have low rates of economic growth.
  • These trends also show why India has recently achieved growth acceleration and major economic success. India has broken away from the "Washington Consensus" of "state bad, private good" to use state investment as the driving force of its economic development. It is not by accident that India appointed a China specialist as its chief economic adviser and its state investment policies have moved towards China's pattern of development.

    These global facts have clear implications for China's economic policies and debates on it.

    • International comparisons show it is clearly correct for China to have undertaken a policy of increased and targeted state investment.

  • A policy relying purely on private investment is extremely unlikely to be successful as the experience of the U.S., Japan and EU confirms.
  • The global trends analyzed show clearly that state investment will have to play a key role in China's economic development in the current period.

    Global factual trends therefore show clearly that as President Xi Jinping rightly put it in an earlier economic discussion, for economic success China requires both the "invisible hand" and the "visible hand."

    This is counterposed to the "state bad, private good" dogma which as has been shown is doing great damage in the West.

    Economic success China requires both the 'invisible hand' and the 'visible hand.'

    Naturally, the global reality that state investment is a key factor in the present international "new normal" is anathema to advocates for the "Washington Consensus." It is for this reason that neoliberals dislike discussion of global economic facts and instead prefer utilization of stereotyped phrases unrelated to reality.

    China's economic policy is not about running a university class but about guiding the world's second-largest economy on which the fate of 1.3 billion people depends. The adoption by China of theoretically false economic positions such as "state bad, private good" would under all circumstances be damaging. Given the present global conditions, the damage would likely to be particularly rapid and severe.

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