The following was written by my friend Vivek Kaul at Mumbai-based Equitymaster.com, the biggest independent investment research firm in India.
Fifty-five years ago, people living in India had higher average incomes than people in China. In 1962, India's average per capita income was $90, 29% higher than China's per capita income of $70. The story was the same in 1980 and in 1990. India's per capita income surpassed China's.
But then, Chinese per capita income took off, and India was left far behind. Twenty-five years later, in 2015, China's per capita income had grown to $7,820. This was 400% higher than India's $1,590.
And there's one big reason why China pulled so far ahead.
How Other Asian Economies Grew
Before we explain how China did it, it's important to understand how other Asian countries like Japan and South Korea went from being third-world countries to Asian economic powerhouses. These countries enjoyed high economic growth rates for a very long period of time.
And most of this growth came from exports.
Their export success is explained by Ryan Avent in his book The Wealth of Humans - Work and its Absence in the Twenty-First Century: "Success in exports markets once required economies to develop an entire suite of capabilities. To export electronics or cars, South Korea and Japan needed to build an entire, high-quality supply chain domestically; they needed lots of firms capable of designing and manufacturing components, and well-organized corporations capable of planning and coordinating the design, production and sale of complex goods."
Doing this took time. It started with building the supply chains needed to produce and export simple things like toys and radios. Then as capacity grew, companies in Japan and South Korea started producing and exporting more complicated products like cars, laptops and industrial machinery.
This is how they grew their economies. But China took a slightly different route.
China's Shortcut to Economic Growth
In 1980, China accounted for 1.3% of the global clothing and footwear export market. By 2007, this had grown to 37.6%. Meanwhile, India's share went from 1.4% (which was higher than China's in 1980) to only 3.2% by 2007, as shown below.
The story is the same for global merchandise exports. In 1993, China had a 2.4% share in global merchandise exports. Twenty years later, the number had grown to 11.5%. But, as noted in the following chart, India's share went from 0.5% in 1993 to just 1.7% by 2013.
China has left India well behind in the global export race. But China's export growth came during the supply-chain trade era. So, it was able to grow faster, and in a different way, than Japan or South Korea.
Avent explains: "Supply-chain trade changed everything. A California technology company could source component supplies from half a dozen Asian economics, have them all meet together in a Chinese port city for assembly, and then ship the finished package to consumers."
This meant that China did not have to build up its expertise and supply chains to build products that it could export. This shortened its time frame for exponential export growth.
Further to this, Avent notes: "A country like China could... immediately get into advanced electronics export game simply by tapping into global supply chains. Cheap labour and relatively small set of competencies were suddenly sufficient to participate in production of advanced goods. Trade swelled as international supply chains developed... And countries that found their way into supply chains enjoyed rapid growth."
The World Trade Report for 2013 commented: "A central feature of this... age of globalisation is the rise of multinational corporations and the explosion of foreign direct investment (FDI)...By 2009, it was estimated that there were 82,000 multinationals in operation, controlling more than 810,000 subsidiaries worldwide. Upwards of two-thirds of world trade now takes place within multinational companies or their suppliers -- underlining the growing importance of global supply chains."
China took advantage of the supply chain phenomenon to spur economic growth. But India missed out. The problem for India, and for China, is that the big gains from supply-chain trade have likely passed.
As a result, China needs to find a new economic growth model. And India's search for an economic growth model is likely to continue.
Mumbai-based Vivek Kaul is the editor of the Diary and The Vivek Kaul Letter, at India's leading independent investment research firm Equitymaster.com. You can sign up to receive his e-letter here.