China and India: openness, trade and effects on economic growth.

• Author: Marelli, Enrico
• Position: Report

1. Introduction

   In demographic terms, China and India are the two most important countries in the world and they are also rapidly becoming the leading powers in economic terms. Although the two countries have many common features, their recent economic takeoff differs in timing, intensity and key characteristics of the development processes. In a long-run perspective both countries have benefited from opening up to international trade and foreign relations, although they initiated liberalization policies only when their domestic economies were sufficiently strong to face foreign competition.

   Their integration in the global economy means that they are certainly affected by world economic developments, such as the last economic crisis. (4) On the other hand, the growth of China and India has a great influence on the world economy, not only in good times (as is well documented, for instance, by Srinivasan 2006) but also in bad times. In fact, the two Asian countries are helping to pull the world out of recession through their imports, despite persisting imbalances in specific trade relations (e.g. between China and the US). The short-run forecasts are also quite promising. (5)

   A first aim of this paper is to quantify and characterize the impact of trade on the economic growth of China and India by focusing on trade dynamics, degree of openness, FDI flows and specialisation patterns. A second aim is to econometrically estimate the links between openness and growth, for the two countries, in the last three decades.

   The structure of the paper is the following. In Section 2 we shall present some stylized facts--together with a partial review of the main literature--concerning the most significant institutional reforms, with particular reference to trade relations and their impact on economic growth. Section 3 presents a descriptive analysis of economic growth, opening of the economies and trade specialisation. In Section 4 an attempt is made to estimate econometric relations between economic growth and trade/openness (and other control variables). The conclusions highlight key results and policy implications.

2. Reforms, opening and recent economic growth in China and India

   China and India share some key common elements: geographically, they share the same continent and are separated by a common border; demographically, they are "giants", with populations exceeding one billion; historically, the two countries have a rich and long history, making them world leaders until the 19th Century. Their development is also similar in economic terms, although key differences are also clear (as will be shown later). The main difference is probably that the two countries have different political systems (with democracy being well rooted in India). (6)

   The economic development of China and India has been investigated largely according to very different time periods and comparative perspectives. (7) The long-run historical view highlights that the two economies accounted for nearly half of the world output from 1000 to 1820. Then, after a decline that started in the 19th century and an increasing gap--relative to Europe and the US in the first three quarters of the 20th century--the two countries have caught up considerably over the last three decades. (8) Since 1980 the Chinese and Indian GDP has increased at annual rates close to 10% and 6% respectively, while economic growth in the US and, especially, Europe and Japan has been significantly lower. Also during the global recession 2008-09, China and India showed only a deceleration in their positive growth rates, therefore the two giants continued to catch up also during the last crisis. (9)

   The investigation of the recent determinants of Chinese and Indian economic growth is quite complex and involves institutional, supply and demand factors. (10) We highlight here the main institutional changes and reforms, in particular leading to opening up of the two economies.

   First of all, it should be noted that "gradualism" is a common feature of Chinese and Indian transition (e.g. Srinivasan 2004) and it is one of the key differences with respect to the "great transformation"--characterised by high speed--that occurred in Eastern Europe in the early '90s. (11)

   In China the evolution from an inefficient planned economy began in 1978 and the long period of economic reforms can be divided into five periods (see Chiarlone and Amighini, 2007). In the period 1978-1984, a reform in the agricultural sector introduced a new form of collective firm and allowed distribution to households of the revenues deriving from production exceeding the planned level. This reform favoured an increase in the production and productivity of the primary sector. In the second period (1985-88), the reforms mainly concerned the industrial sector and consisted of prices and wages liberalisation, accompanied by the possibility of firms keeping the profits for self-financing. The increase in productivity and wages in this sector attracted labour force underemployed in the agricultural sector, contributing to the overall productivity growth. It was during this period that the "open door policy" started, thus supporting the beginning of integration of China in the world economy through both trade and FDI. Foreign firms were initially attracted by fiscal incentives in four "special economic areas" and later by international trade and FDI liberalisations in 14 large cities and coastal regions. The gradual openness and extension of strong incentives to FDI was, however, accompanied by persisting rigid conditions for admitting FDI. (12) In the third and fourth periods (1988-91 and 1992-97), reforms involved all economic sectors. (13) The last period, before the 2009 world recession and trade decline (1998-2008), was characterised by a growing openness of the Chinese economy, especially after 2001 with admission to the WTO.

   It should be noted that a crucial role in favouring the recent Chinese economic "miracle" is usually attributed to the increasing degree of trade openness, especially regarding exports, while the liberalisation of imports has been more gradual. In addition, huge FDI inflows, mainly attracted by much lower labour costs, probably engendered spillover effects and contributed to transformation of the production specialisation model.

   The Indian transition has also been "gradual", but quite different. First of all, the Indian institutional change and the reform policies began later, contributing to a significant delay in integration of this country in the global economy with respect to China. Some reforms, for example the partial liberalisation of imports (especially of intermediate and investment goods) were introduced in the 80s (14) and were followed by progressive privatisations, but it was only after 1992 that the institutional change and the reform policies gradually accelerated, including reforms of the fiscal system and the creation of "special economic zones". Secondly, in addition to persisting rigidities and weaknesses (15), the integration of India in the world economy is much less intense than that of China. (16)

   The "gradual" and partly different institutional change and reform policies that occurred in China and India in the last three decades produced a significant increase (especially in China) in the openness to international relations (trade (17) and FDI) of the two economies. (18) However, not only has the opening been gradual, but there are some limitations, e.g. in the case of FDI because of the obligation of local content requirements or favouring joint ventures, in order to develop domestic capabilities.

   The hypothesis that "openness" of the economy plays a positive role in economic growth has been largely analysed in the theoretical and empirical literature (e.g. Frankel and Romer, 1999; Bensidoun et al., 2009). Most empirical studies confirm the positive effects of "openness" on growth. The relationships between institutions, trade and growth are more complex and involve some econometric difficulties in estimating the relative long-term effects of the first two variables on growth: see Alcala and Ciccone (2001), Dollar and Kraay (2003). More specific studies have focused on the growth effects of production specialisations (19), economies of scale (e.g. Valli and Saccone, 2009) and comparative advantages, but also on the role of FDI in promoting technological and human capital improvements.

   It should be noted that during the last three decades, the huge increase in exports has been matched by a remarkable growth in imports. In any case, the value of net exports--although unstable--has been frequently positive, especially for China. This performance also has obvious macroeconomic consequences, for example the international allocation/investment of a part of the high (excessive) domestic savings and of a part of "sovereign funds" (deriving from high accumulation of foreign exchange reserves originated by positive balance of payments with fixed exchange rate). (20) The recent global financial and economic crisis can be partly attributed to these macroeconomic imbalances at world level.

   The recent economic situation--during and after the global crisis--is also a good example, on the one hand, of how the world economic cycle affects the economic performance of the two countries and, on the other, of the extent to which their growth can sustain global economic growth. As regards the first point, the IMF Report (2009) recognizes that the spillovers in Asia from the global crisis were unexpected in their size and speed of propagation, since the region had sound macroeconomic conditions. The reason lies precisely in Asia's exceptional integration in the global economy. (21) Moreover, because the 2009-10 world recovery was slight and uncertain, and the growth prospects for the immediate future are inadequate, both China and India need to rebalance growth from exports toward domestic...