On a recent trip to London, UK, a friend of mine who is an Investment Banker stated that even though the Chinese economy is slowing down, the tapered growth is still quite meaningful to the entire world. His argument – at present, Chinese economy is so large that even if the growth were to slow down to 6 or 7%, it would still create a lot of demand worldwide. A few friends argued with him but, I believe those arguments were prompted more by Guinness than facts. On the way to my hotel, the discussions at the dinner table prompted me to analyze the growth of the Chinese economy and compare it with that of the Indian economy. As soon as I was back in my hotel room, I downloaded economic data from the World Bank database and started analyzing.
As I delved deeper into my analysis, a few things popped up that are worth mentioning. Firstly, in between 1991 and 2014, the Chinese economy has grown at an average rate of 10.1% as compared to 6.6% for the Indian economy. Also, in this span of 24 years, there have been 10 years when the GDP growth rate in China has exceeded 10% (see Chart A below). By contrast, in India, the GDP growth rate has exceeded 10% only once - in 2010. It is important to point out that in China the growth rates in excess of 10% have been in consecutive years – from 1992 to 1995 and from 2003 to 2007. Obviously, by all standards, this is a remarkable performance.
In addition, the GDP growth rates in China have been more predictable as compared to India. It is easy to prove this assertion solely on the basis of historical data. If we were to plot the current year’s GDP growth rate against the prior year’s GDP growth rates, we can see that in the case of China, the R-Squared is 0.37 whereas, for India the R-Squared is 0.05 (see Chart B). In statistical terms, the higher the R-Squared, the higher the predictability from one year to the next. Obviously, in the case of China, a higher R-squared means that the GDP growth rates in consecutive years are similar and not as volatile as is the case with India.
The effect of predictably high GDP growth rates has been that the Chinese economy has grown much faster than the Indian economy during the period 1991 to 2014. In 1991 the size of the Chinese economy was 1.63 times the Indian economy. In 2014, the Chinese economy is 3.3 times the Indian economy (see Chart C). Now here comes the interesting part – if the GDP growth rate in India accelerates to 10% per annum whereas that in China it slows down to 5% per annum, the Chinese economy will still be twice the size of the Indian economy 10 years later in 2025.
When talking of growth, it is important to look at the effect of Foreign Direct Investments in China and India. It’s a well-known fact that the policies of economic liberalization in both these countries have helped attract foreign capital which consequently has fueled growth. The question is – on a comparative basis, what is the quantum of FDI that these two countries have attracted. Well, the level of FDI in India pales as compared to that in China (see Chart D). Since 1995, there have been several years when the FDI in China has been ten times or more than that in India.
At last, the million dollar question is whether we can prove statistically that the difference in GDP growth between China and India is influenced by the difference in FDI. I took the difference in FDI between China and India in the prior year on the x-axis. The y-axis, represents the difference between China and India in the increase in GDP in the current year as compared to the prior year (see the formula for the Y-axis in Chart F below). As shown in Chart F, the scatterplot shows an upward trend. Also, a polynomial of second degree fits the data quite well with an R-squared of 0.77. In other words, we have proven that the increased GDP growth in China as compared to India is fueled by increased FDI inflows. The moral of the story – FDI is the fuel for growth in both these countries and the more you can attract FDI, the better it is for the economies.
As I delved deeper into my analysis, a few things popped up that are worth mentioning. Firstly, in between 1991 and 2014, the Chinese economy has grown at an average rate of 10.1% as compared to 6.6% for the Indian economy. Also, in this span of 24 years, there have been 10 years when the GDP growth rate in China has exceeded 10% (see Chart A below). By contrast, in India, the GDP growth rate has exceeded 10% only once - in 2010. It is important to point out that in China the growth rates in excess of 10% have been in consecutive years – from 1992 to 1995 and from 2003 to 2007. Obviously, by all standards, this is a remarkable performance.
Chart A: China & India - GDP Growth Rates (1991-2014), Data Source: World Bank
In addition, the GDP growth rates in China have been more predictable as compared to India. It is easy to prove this assertion solely on the basis of historical data. If we were to plot the current year’s GDP growth rate against the prior year’s GDP growth rates, we can see that in the case of China, the R-Squared is 0.37 whereas, for India the R-Squared is 0.05 (see Chart B). In statistical terms, the higher the R-Squared, the higher the predictability from one year to the next. Obviously, in the case of China, a higher R-squared means that the GDP growth rates in consecutive years are similar and not as volatile as is the case with India.
Chart B: Relationship between Current and Prior Year's GDP Growth Rates in China & India, Data Source: World Bank
The effect of predictably high GDP growth rates has been that the Chinese economy has grown much faster than the Indian economy during the period 1991 to 2014. In 1991 the size of the Chinese economy was 1.63 times the Indian economy. In 2014, the Chinese economy is 3.3 times the Indian economy (see Chart C). Now here comes the interesting part – if the GDP growth rate in India accelerates to 10% per annum whereas that in China it slows down to 5% per annum, the Chinese economy will still be twice the size of the Indian economy 10 years later in 2025.
Chart C: China & India - GDP in Constant 2005 US Dollars (1991-2014), Data Source: World Bank
When talking of growth, it is important to look at the effect of Foreign Direct Investments in China and India. It’s a well-known fact that the policies of economic liberalization in both these countries have helped attract foreign capital which consequently has fueled growth. The question is – on a comparative basis, what is the quantum of FDI that these two countries have attracted. Well, the level of FDI in India pales as compared to that in China (see Chart D). Since 1995, there have been several years when the FDI in China has been ten times or more than that in India.
Chart D: China & India - Foreign Direct Investment (1991-2013), Data Source: World Bank
We have looked at the GDP and GDP growth rates in the two
countries as well as the levels of FDI since 1991. What needs to be statistically
analyzed next is the relative impact of FDI on GDP growth. I tried to study the
relationship between increase in GDP in a given year (in other words the growth
in GDP) versus the FDI in previous year. The underlying assumption is that once
the investments are made, it takes at least a year for its impact on production
of goods and services. Also, in order to account for the difference in scale
between GDP and FDI, I used the log-log scale, i.e. both the x and y axes were transformed
to log scale. As you can see in Chart E, the relationship between increase in
GDP in a given year and FDI in previous year is quite strong for both countries
as evidenced by high R-squared values. Nonetheless, for China, the relationship
is stronger. Also, in the case of China, the slope of the line defining this relationship
is steeper as compared to India. This implies that for every unit of FDI
invested in China, the impact on GDP is higher when compared to India. One could draw a corollary that this also
means that for every unit of FDI in China, the revenue output is higher than in
India. This conclusion is quite significant because it easily explains why
between the two countries China is a natural destination for FDI.
Chart E: Relationship between FDI and GDP in China and India, Data Source: World Bank
At last, the million dollar question is whether we can prove statistically that the difference in GDP growth between China and India is influenced by the difference in FDI. I took the difference in FDI between China and India in the prior year on the x-axis. The y-axis, represents the difference between China and India in the increase in GDP in the current year as compared to the prior year (see the formula for the Y-axis in Chart F below). As shown in Chart F, the scatterplot shows an upward trend. Also, a polynomial of second degree fits the data quite well with an R-squared of 0.77. In other words, we have proven that the increased GDP growth in China as compared to India is fueled by increased FDI inflows. The moral of the story – FDI is the fuel for growth in both these countries and the more you can attract FDI, the better it is for the economies.
Chart F: Relationship showing increased amount of FDI fueling increased GDP growth
