China and India: Those two big outliers

The emergence of China and India on the world stage has aroused much interest. As in many other areas of (policy) economics, just how these countries “did it” and the lessons for other countries is something economists either do not know, do not agree on, or both. In the case of China, the literature seems to agree that capital accumulation, industrialisation, and export-led growth were key factors after 1979. Economists like Gregory Chow (1993) or World Bank chief economist Justin Lin, argue that, before 1979, Chinese central planning was a failure, economic performance was poor, and “haste made waste” (Lin 2010).i In the case of India, its poor performance during the 1960s and 1970s, referred to as “Hindu growth”, has often been attributed to, among other things, poor planning, and the license-permit Raj (Bhagwati and Desai 1970). Yet economists such as Bardhan (2006) and Nagaraj (2010) argue that infrastructure bottlenecks and demand–side constraints have been neglected in the discussion of India’s industrial performance. Built-up capability In two recent papers and using a data set covering almost 800 products (Felipe et al 2010a and 2010b), we examine the evolution of the export basket of the two countries. We argue that the capabilities that both China and India accumulated before reforms started are vital to understanding their growth later on. While we agree that planning led to mistakes, inefficiencies, and to the misallocation of resources in both countries, we argue that, given their income per capita, China’s and India’s export baskets are more sophisticated – as measured by the income content of the export basket – and diversified – as measured by the number of products exported with revealed comparative advantage – than might otherwise be expected. Both are far ahead of countries at similar levels of development. This could have been achieved only through planning, industrial policy, and sector targeting. The objective of the development strategies of both countries during the 1950s and 1960s was to achieve industrialisation. Both favoured the capital-intensive route, to a large extent as part of an import-substitution strategy that aimed at avoiding foreign dependence, although with significant differences between the two. The important point is that both countries developed a broad industrial base during the planning period that helped them accumulate capabilities that are now allowing them to grow (see Hidalgo 2009 and the footnote for further discussion).ii Export sophistication Figure 1 provides a cross-country comparison of the actual and the expected sophistication level of the export basket, given their income per capita. The sophistication level of the export basket (EXPY) of a country captures its ability to export products produced and exported by the rich countries, to the extent that, in general, rich countries’ exports embody higher productivity and wages (Hausmann et al. 2007). The level of sophistication of a country’s export basket is calculated as the weighted average of the sophistication of the products (PRODY) exported.iii Figure 1 shows that the export baskets of China and India are more sophisticated than their income levels might suggest. Figure 1. Export sophistication and GDP per capita

Diversification Diversification is measured by the absolute number of products that a country exports with revealed comparative advantage (RCA). We consider that a country has revealed comparative advantage in a product when this measure is greater than one.iv Hidalgo et al. (2007) argue that more diversified countries have greater capabilities. These allow a country to acquire comparative advantage in other products. Figure 2 shows that both China and India are positive outliers in the sense that their export baskets are more diversified than one would expect given their income levels. Figure 2. Diversification and GDP per capita, average 2001-2007

To gain further insights into the structures of China’s and India’s export baskets, we show in Tables 1 and 2 the number of products that both countries export with comparative advantage (i.e., RCA>1), according to Leamer’s (1984) classification, for the period 1960-2007.v We complement this information with Figures 3 and 4, which show the product spaces (Hidalgo et al. 2007) of the two countries in 1962 and in 2007. We mark in black the products that each country exported with RCA>1 in each year. A few things stand out: (i) In 1962 China exported with RCA>1 105 products, of which only 14 were “core” products.vi The bulk of the products China exported with RCA>1 were divided equally between tropical agriculture, animal products, cereals, labour intensive, and capital intensive products (excluding metals).vii By 1980, China was exporting 200 products with RCA>1, 39 of them in the core. By 2007, China exported 265 products with RCA, of which 106 were core commodities. India, on the other hand, exported a total of 71 products with RCA>1 in 1962, only 4 were in the core. In 1962, animal products, cereals, and capital intensive products (excluding metals) accounted for more than half of the products exported with RCA>1 (44 out of 71 products). By 1980, the number of products that India exported with RCA>1 had increased to 157, 25% of which were in core products. In 2007, out of 254 products exported with RCA>1, 84 were in the core. (ii) Over the period 1980-2007, China acquired RCA>1 in 67 core products (on a net basis). Table 1 shows that China lost RCA (where previously RCA was >1) in categories such as tropical agriculture, animal products, and cereals. The speed at which China acquired RCA>1 in the machinery category is outstanding, from 3 in 1980, to 22 in 1990, and to 60 in 2007. India acquired RCA>1 in an additional 97 products between 1980 and 2007. Of these 97 products, 46 were in the core (6 in metal products, 16 in machinery, and 24 in chemicals). (iii) The highest number of commodities that China exports with RCA>1 is in the labour-intensive category, followed by the machinery sector. In the case of India, on the other hand, the capital-intensive category tops the ranking of exports with RCA>1, followed by chemicals and labour-intensive. China acquired RCA>1 in 19 labour-intensive products between 1980 and 2007, while India acquired RCA>1 in only 6 products over the same period. (iv) In China, the majority of the machinery products (39 out of 60 in 2007) exported with RCA>1 are office and data processing, telecommunications, electrical, and photographic equipment. On the other hand, in India, the largest share of the machinery products (16 out of 28 in 2007) exported with RCA>1 is taken up by the power generating, machinery specialised for particular industries, metalworking, and general industrial categories. Table 1. China’s export diversification according to Leamer classification

1962 1965 1970 1975 1980 1985 1990 1995 2000 2005 2006 2007 Petroleum 0 1 1 1 5 3 2 1 2 1 2 1 Raw materials 9 8 7 10 13 11 15 14 16 11 11 11 Forest products 3 6 5 4 5 3 4 7 6 7 7 7 Tropical agriculture 15 23 25 23 20 17 15 15 15 10 10 8 Animal products 18 24 22 28 27 22 21 19 15 9 9 8 Cereals 13 20 24 21 21 31 27 14 16 9 8 8 Labour intensive 18 22 32 36 49 44 60 59 63 69 69 68 Capital intensive (exc. Metals) 15 14 16 21 21 32 37 35 36 47 47 48 Core Commodities

Metal products 6 7 10 9 14 10 17 16 18 20 21 26 Machinery 1 4 7 8 3 15 22 36 41 54 55 60 Chemicals 7 11 11 14 22 21 21 22 16 15 17 20 Total 105 140 160 175 200 209 241 238 244 252 256 265 Figure 3. Product Space, China: 1962 and 2007 a) 1962

b) 2007

Source: Hidalgo et al. (2007) and authors’ calculations Table 2. India’s export diversification according to Leamer classification

1962 1965 1970 1975 1980 1985 1990 1995 2000 2005 2006 2007 Petroleum 1 1 1 0 0 1 1 1 2 1 1 1 Raw materials 8 7 9 10 8 10 14 15 14 22 25 25 Forest products 0 2 2 2 2 2 1 2 2 2 2 2 Tropical agriculture 7 8 12 10 12 10 11 11 14 13 18 17 Animal products 13 11 13 11 15 14 8 9 13 13 14 14 Cereals 13 14 12 13 19 20 23 25 19 24 27 28 Labour intensive 7 7 12 32 30 28 29 34 37 39 37 36 Capital intensive (exc. Metals) 18 21 20 28 33 29 37 44 41 45 44 47 Core Commodities

Metal products 1 3 11 12 15 10 13 21 21 21 19 21 Machinery 1 2 4 9 12 17 14 12 14 22 23 28 Chemicals 2 3 6 9 11 11 27 28 37 30 34 35 Total 71 79 102 136 157 152 178 202 214 232 244 254 Figure 4. Product Space, India: 1962 and 2007 a) 1962

b) 2007

Source: Hidalgo et al. (2007) and authors’ calculations Giants without industrial policy? China and India are undergoing deep structural transformations. China has been able to do it by using manufacturing as its engine of growth and absorbing surplus labour from the rural areas. It has done it by both exploiting its comparative advantage in labour-intensive activities and by defying it. Without the latter, it would not have been able to establish a foothold in a wide number of core products. This was made possible under the planning system. While industrialisation on the scale seen in China has not yet taken place in India, the focus on heavy-machinery based industrialisation and emphasis on tertiary education has allowed it to build capabilities that, post-reforms, have led to its expansion into core activities. India’s failure lies in not being able to exploit its comparative advantage in the labour-intensive sectors, even after reforms. We do not claim that the policy framework in the two countries before reforms did not lead to misallocation of resources, shortages, and price distortions. Instead, we argue that industrial policies and targeting helped both countries accumulate critical capabilities in core sectors. Without these policies, and given their low per capita, the two would have shied away from those industries. Going forward, both China and India need to exploit their relatively strong position (see Felipe et al. 2010c) in the core sector, as well as in sectors of their comparative advantage. This does not mean a hands-off policy but rather support from the government to address the externalities associated with cost-discovery. Rodrik (2004) provides a broad outline of a modern industrial policy framework, one which entails private-public dialogue to uncover opportunities and obstacles to industrial growth. This paper represents the views of the authors and not necessarily those of the Asian Development Bank, its Executive Directors, or those of the countries that they represent. References

Balassa, B (1965), “Trade Liberalization and Revealed Comparative Advantage”, Manchester School of Economics and Social Studies, 33: 99-123. Bardhan, P (2006), “Awakening Giants, Feet of Clay: A Comparative Assessment of the Rise of China and India”, Journal of South Asian Development, (1):1-17. Bhagwati, J and P Desai (1970), Planning for Industrialization, Oxford University Press. Chow, Gregory C (1993), “Capital Formation and Economic Growth in China”, Quarterly Journal of Economics, 108(August): 809-842. Feenstra, R, R Lipsey, H Deng, A Ma, and H Mo (2005), "World Trade Flows: 1962-2000", NBER Working Paper 11040, National Bureau of Economic Research, Cambridge, MA. Felipe, J, U Kumar, N Usui, and A Abdon (2010a), "Why has China succeeded? And why it will continue to do so", Asian Development Bank, Mimeograph. Forthcoming as working paper of the Levy Economics Institute of Bard College. Felipe, J, U Kumar, and A Abdon (2010b), “Exports, Capabilities, and Industrial Policy in India”, Asian Development Bank, Mimeograph. Forthcoming as working paper of the Levy Economics Institute of Bard College. Felipe, J, U Kumar, and A Abdon (2010c), "As you sow so shall you reap: from capabilities to opportunities", Asian Development Bank. Mimeograph. Forthcoming as working paper of the Levy Economics Institute of Bard College. Felipe, J and JSL McCombie (2010), “ Modeling Technological Progress and Investment in China: Some caveats”, Asian Development Bank, mimeograph. Hausmann, R, J Hwang, and D Rodrik (2007), "What you export matters", Journal of Economic Growth, 12(1):1-15. Hidalgo, C (2009), “The dynamics of economic complexity and the product space over a 42 year period”, Centre for International Development Working Paper No. 189, Harvard University, December. Hidalgo, C, B Klinger, AL Barabasi, and R Hausmann (2007), "The Product Space Conditions the Development of Nations", Science, 317:482-487. Leamer, E (1984), Sources of International Comparative Advantage: Theory and Evidence, MIT Press. Lin, J (2010), “China’s Miracle Demystified”, World Bank Blog, 15 March. Nagaraj, R (2010), “Industrial Performance, 1991-08: A Review”, IGIDR. mimeograph.

i Felipe and McCombie (2010) question the empirical evidence provided by Chow (1993). ii The Capability Theory (Hidalgo 2009) suggests that not all activities have the same consequences for a country’s growth prospects. A country’s ability to foray into new products depends on whether the set of existing capabilities necessary to produce these products can be easily redeployed for the production and export of new products. What are these capabilities? They are human and physical capital, the legal system, institutions, etc. that are needed to produce a product (hence, they are product-specific, not just a set of amorphous factor inputs); and at the firm level, they are the “know-how” or working practices held collectively by the group of individuals comprising the firm. iii Following Hausmann et al. (2007), we calculate the level of sophistication of a product (PRODY) as a weighted average of the GDP per capita of the countries exporting that product. Algebraically:

where xvalci is the value of country c’s export of commodity i and GDPpcc is country c’s per capita GDP. PRODY is measured in 2005 PPP $. PRODY is then used to compute EXPY as:

EXPY is measured in 2005 PPP $. We use highly disaggregated (SITC-Rev.2 4-digit level) trade data for the years 1962-2007. Data from 1962-2000 is from Feenstra et al. (2005). This data is extended to 2007 using the UNCOMTRADE Database. PRODY is calculated for 779 products. PRODY used is the average of the PRODY of each product in the years 2003-2005. GDP per capita (measured in 2005 PPP $) is from the World Development Indicators. iv Revealed comparative advantage (RCA) is the ratio of the export share of a given product in the country’s export basket to the same share at the world level We use the measure proposed by Balassa (1965), Algebraically:

A country c is said to have revealed comparative advantage in a commodity i if the above defined index, RCAci, is greater than 1. The index of revealed comparative advantage can be problematic, especially if used for comparison of different products. For example, a country very well endowed with a specific natural resource can have a RCA in the thousands. However, the highest RCA in automobiles is about 3.6. v These numbers are the net gain. It is the difference between the number of (new) products in which a country acquires revealed comparative advantage and the number of (old) products in which it loses revealed comparative advantage. vi Core products include metal products, machinery, and chemicals. These are, on average, more sophisticated than other products. vii Terminology for the sectors is as used by Leamer (1984).