To Infinity and Beyond?

A Crucial Juncture

It’s now 2012, and some are understandably more optimistic than others. An economic slump that began in 2007 remains Western policymakers’ biggest headache, in addition to near-total currency collapses and debt ceiling pantomimes. Developing countries, long schooled in the Western way to prosperity, should be forgiven for a little gloating. Yet while such countries as China and India bounced back faster than anyone after the global economic downturn, complacency is still something neither can afford. Their sustained growth is anything but assured.

This juncture is a crossroads for the world economy. The West’s economic growth in the latter part of the past century is historically unprecedented. Crucially, it made the transition from manufacturing-based growth driven by domestic demand to service-based growth and trade. In contrast, China and India were posting growth rates of only 3.8% and 5.8% in 1990, giving little indication of the boom to come.

The opening of the Indian economy to foreign investment (“delicensing”) and the development of a Chinese state-controlled capitalism led to a dramatic change in both countries’ economic statuses. China, now the world’s second largest economy has consistently posted growth figures of over 10%, and India is not far behind. Unlike the West, both countries have thrived on export-led economies. China is a global manufacturing powerhouse, while India has cornered the service market.

Relying almost exclusively on an export-led growth strategy does not yield long-term growth. The Economist recently highlighted an analysis of Asian growth by the Asian Development Bank (ADB). The study outlines two possible scenarios in 2050: the world’s economy could either be worth $191 trillion or $250 trillion, depending on whether or not China and India continue to rely on their current growth paradigm. The Economist concludes with a warning: if policymakers do not make the difficult but necessary decisions at this crossroads, the former number could quickly become our reality.

The $60 Trillion Question

What might these difficult decisions be? They are hardly problems that can be banished with a simple prescription. The only guarantor of prosperity is innovation and entrepreneurship. In a self-reinforcing upward spiral, innovation would lead to the vaunted domestic demand that would drive a post-industrial economy. The obvious impediment is the impossibility of creating entrepreneurs. At best, a government can provide fertile conditions for innovation and risk-taking.

Unfortunately, India and China have not taken this approach. In a 2001 paper, Stanford economists Debbie Liao and Philip Sohmen argue that the increasing trend towards Chinese entrepreneurship is still hampered by the lack of infrastructure and capital. In India’s case, the number of licenses required to start a business is daunting enough without the unsympathetic bankruptcy laws that would make even the most risk-friendly entrepreneur think twice. Innovation, in short, is blossoming in a small way despite government obstacles.

While better governance and accountability would go a long way to increase entrepreneurship, one of the most significant barriers to small business is an underdeveloped financial market. In the developed world, financial intermediation plays the important role of efficiently matching borrowers and lenders. When wealth is created in a country, it is invested in businesses that show promise. While some of them are doomed to fail, the ones that succeed become tomorrow’s giants. Efficient allocation of capital helps to ensure long-term prosperity.

By most standards, Asian capital markets are underdeveloped. This creates a divide between investors and businesses, where there should ideally be none. Creating better financial markets is easier said than done, but deregulation would at least create conditions fertile for investment banks and other financial institutions. India, in particular, can attribute its growth over the last twenty years to deregulation of industry, but its financial markets remain mired in licenses and red tape.

A New Kind of Growth

The way forward is not simple: it requires infrastructural changes, deregulation, better governance, and less corruption. Popular predictions of China overtaking the US economy by 2040, with India a close third, may yet prove to be true, but this will not mean much. Wealth can be created through manufacturing and exporting goods and services, but the crucial indicator of the countries’ growth is how much citizens benefit from growth. China ranks 94 in the world for GDP per capita, and India is an alarming 138. These rankings don’t speak of inclusive, domestically created wealth.

Despite the challenges and hurdles, a determined group of entrepreneurs have found a way to succeed. But if they are not given the opportunity to succeed in the future, the last twenty years will look like a flash in the pan.