A CASE FOR POLITICAL DETERMINISM: COMPARATIVE STUDY OF THE PUBLIC AND PRIVATE SECTORS IN CHINA AND INDIA

BY JACK ZHANG AND ADONICA BLACK

Abstract: SOEs, MNCs, and JVs have dominated the Chinese economic landscape since the FDI intensive Opening and Reform[1]. The Chinese party-state under the CCP has, until recently, favored FDI-driven growth, leveraging on the weakness of organized labor while holding on to a set of strategic enterprises. Deprived of state support and squeezed between domestic and multinational giants, few Chinese private enterprises can compete internationally. Indian economic reform began later and has proceeded haltingly. It has attracted a much smaller inflow of FDI than its Chinese counterpart. India’s democratic system retards the rate of reform and restricts labor law. While it is no match for China’s rate of growth at the macrolevel, India has managed to produce many more private enterprises that are competitive in the international market. A systematic comparison between the two countries reveals that their distinctive economic landscapes recapitulate fundamental differences in their political structures.

INTRODUCTION

In their influential 2003 Foreign Policy article, Yasheng Huang and Tarun Khanna made the bold proposition that India’s economy could overtake China’s in the long term because its bottom up approach of reform creates better micro level conditions than China’s top down approach of state-driven economic liberalization. Though controversial at the time, this proposition no longer seems far-fetched. In recent years, the two systems seem to be converging: India has been attracting more foreign direct investment (FDI), while China has been taking steps to encourage innovation in its private sector. China is trying to slow down its GDP growth even as India speeds up.[2] Even as the two Asian giants move to adopt each other’s best practices, the dissimilarities between their two systems become even more apparent.

The vast differences in Chinese and Indian economic landscapes may appear puzzling upon initial assessment. Both nations have undergone economic liberalization while having massive labor supply, planned economies, large bureaucracies, and a history of one party rule. Yet China has become the “world factory”, relying on FDI fueled export-driven growth for rapid GDP growth. On the other hand, India’s reform and growth has been more gradual; it has become the “world office”, developing a very competitive IT sector and a vibrant private sector. A systematic comparison of the two economies reveals that the differences are rooted in differences in their political systems.

The fundamental dissimilarities between the centralized authority of the CCP party-state in China and the multiparty democratic system in India explain much of the variation in respective state attitudes towards FDI, role of organized labor, and the balance of state-owned enterprises and the private sector.

CHINA

The State’s Role in Economic Control
The People’s Republic of China represents a developmental paradox.  Politically, it remains an authoritarian state, but, economically, it has embraced the free market. Under Deng Xiaoping’s leadership, the Chinese Communist Party (CCP) initiated process of reform and opening to unleash market forces in order to generate economic growth.  In the 1980s, collective farming gave way to a “responsibility system” which allowed farmers to profit from their surplus crops and special economic zones (SEZs) were established to encourage foreign investment. Beginning in the early 1990s, the CCP began the painful process of SOE restructuring, ending state price control policies and protectionist regulations that shielded China’s inefficient SOEs from market competition. However, the state has retained control of so-called strategic enterprises and dominates key sectors of the economy. In 2003, the state directly accounted for 38% of Chinese GDP[3] and employed 85 million people (Pei 2006).  To sufficiently understand Chinese economy, therefore, it is essential to recognize the central role the state plays in economic affairs (Gao 2009).

Economic Reform under One Party Rule
China dealt with the pressure to reform through a three-pronged effort: FDI liberalization, SOE restructuring, and private industry development. Since FDI liberalization, China has received more FDI than any other developing countries (Gallagher 2005). It attracted FDI through policies such as the creation of SEZs and the lowering of export tariffs. Though these policies were controversial at the time, the concentration of power within the CCP ensured their steady implementation. FDI has spurred capitalism and competition, incentivized development, and sparked political reform to transform China’s markets into globally competitive ones (Gallagher 2005). This foreign sector of investment also provided the experimental grounds to test the reactions to labor reforms and company restructuring (Gallagher 2005). This was done with no direct consequence to the state, specifically SOEs.  Finally, these FDI reforms prompted an ideological shift, transferring value from public ownership and control to value in national ownership.

Because these reforms to attract FDI happened before SOE restructuring, the SOEs complained of an unfair advantage enjoyed by multinational companies. SOEs could neither make autonomous decisions pertaining to worker retention and compensation nor could they escape the provision of social welfare provision requirements. The struggling SOEs were desperate for a way to motivate productivity and efficiency in performance.  Therefore, the central government implemented structural reforms of the SOEs that liberalized these processes, leaving the enterprises with more autonomy to be competitive with multinational corporations.  From 1979 to 1983, new features were implemented in the following ways: taxable profit (enterprises paying taxes rather than turning over all profits to the state) and loans for fiscal grants (turning government appropriations into loans to improve efficiency).  These changes were more efficient on two fronts – the government sinks less money into unprofitable ventures and the individual enterprises increase their profit intake, thereby providing an incentive for continued growth and success (Lin and Zhu 2001).

The establishment of the State-owned Assets Supervision and Administration Commission (SASAC), a specially commissioned group under the State Council charged with managing China’s SOEs, in 2003 marked a new phase of SOE reform. The founding of SASAC launched a process of redefining the relationship between the central government and the so-called “central enterprises” (zhongyang qiye), the key SOEs that have been selected by the government to form the basis from which China's future top global companies will be created. Central enterprises account for the bulk of SOE profits and around a quarter of SOE corporate investment (Mattlin 2007). The SASAC represents yet another way that the Chinese state, particularly the central government, exerts its power in the economic realm.

The Public and the Private Sector
According to the SASAC, there are 123 centrally owned companies within China. The centrality of China’s SOEs leaves a minor role for homegrown private companies. Strategic SOEs— such as telecommunications, electricity, and railroads—are particularly important to the CCP because they allow the party to have monopoly of power within the state. Additionally, SOE assets tied to these industries make up a large proportion within the Chinese market, making these ventures a very important factor:

The 2nd National Economic Census conducted in 2008 reveals that of all the 208 trillion RMB total assets of the secondary and tertiary sectors, 63 trillion, about 30%, was held by SOEs. …Meanwhile, in terms of enterprise number, there were 154,000 SOEs at the end of 2008, only accounting for 3.1% of the total enterprise number…SOEs control a substantial part of total enterprise assets in China, despite the fact that their total number is marginal.”(Xu 2010)

While China has continued to privatize non-profitable SOEs and has encouraged competition among SOEs through restructuring, SOEs remain central to the Chinese economy. Though SOEs account for an ever smaller portion of China’s industrial output, they have become increasingly concentrated in large, capital-intensive firms that are important to the state not only economically but also politically. Many of the executives of the SOEs are party members, and are appointed to their positions by the CCP through the tradition of nomenklatura [4]. The rotation of SOE executives and government officials through party politics creates perverse incentives to stifle private sector competition.

The precarious nature of one-party CCP rule meant that China has been far bolder with external reforms but has imposed substantial legal and regulatory constraints on indigenous, private firms. As Huang and Khanna’s study reveal that numerous Chinese entrepreneurs tried, and failed, to circumvent the restrictions placed on their activities to set up private firms. Some registered their firms as nominal SOEs (all the capital came from private sources, and the companies were privately managed), only to find themselves ensnared in title disputes when financially strapped government agencies sought to seize their assets (Huang and Khanna 2003). China faces competing priorities in its economic reform agenda; political pressures push the CCP must preserve certain SOEs, but economic pressures pull it down the path of private industry development. Though China’s political system has performed admirably in attracting FDI to fuel China’s economic reform, it has also inhibited the establishment of internationally competitive industries in the private sector.

INDIA

Consociational Politics
Unlike the centralized one-party state of China, multiparty pluralism and democratic elections characterize Indian politics. John Stuart Mill famously asserted that democracy is next to impossible in multiethnic societies and completely impossible in linguistically divided communities (Mill 1958). India flies in the face of this paradigm. Political scientists have puzzled over how India, with its deeply divided population, has managed to remain a majoritarian democracy since independence.

Arend Lijphardt shed light on this puzzle by arguing that Indian democracy has demonstrated all the crucial elements of power sharing theory and represents a consociational system. (Lijphart 1996) A consociational system is characterized by (1) grand coalition governments that include representatives of all major linguistic and religious groups, (2) cultural autonomy of these groups, (3) proportionality in political representation, and (4) a minority veto with regard to vital minority rights (Lijphart 1996). Thus, though the Congress Party (and the Nehru-Gandhi family leadership) continues to dominate India’s political arena, the multi-party democratic process of Indian politics distinguishes it from the politics of one party rule under the CCP. Without having to win majority of popular votes in parliamentary elections, the Congress party has managed to remain in power consistently since independence by balancing the interests of various interest groups(Rudolph and Rudolph 1987). This illustrated that, although India’s associational life has proved too fragmented to agree or act on alternative national political doctrines that challenge Congress’s centrist consensus, Indian politics remain a dynamic and competitive multi-party system, characterized by high levels of social mobilization, a plethora of voluntary organizations, and conflicting sets of elite interests. This stands in stark contrast to the party-state politics of CCP-ruled China where there is a much more pronounced concentration of interest within the ranks of the CCP and no outside parties pose a viable threat to force the CPP to compromise its position.

Economic Reform under a Pluralistic Democracy
India’s democratic political order defined the process of economic reform just as one party rule shaped the development of China’s economic reform; logically, the two different political systems produced very different economic configurations. The Indian system necessitated compromise among divergent set of interests, this impeded and compromised the process of economic reforms. Indian politics is dominated by coalition building amongst interest groups with divergent interests whereas Chinese politics under the CCP has been very centralized. Democratic politics also empower labor unions in India and foster local protectionism which hinder the inflow of FDI; these are challenges China did not have to tackle when it initiated reform in the 1979.

India initiated reform much later than China; indeed, the impetus for large-scale economic reform might not have ever materialized if not for a moment of crisis. In 1991, the Balance of Payments Crisis dismantled the License Raj and allowed for private sector competition against state monopolies. However, India has taken the gradualist approach to economic reform, a process that appears piecemeal and haphazard to the casual observer. In contrast to China, India pursued a policy of divestment rather than privatization (Ahluwalia 2002). Disinvestment allowed the state to retain managerial control while mobilizing revenue for the budget. This policy had very limited success for disinvestment receipts were consistently below budget expectations (Ahluwalia 2002). Many economists have criticized the gradualist approach, complaining that the gradual process of privatization also increases the chances of favoritism to self interested and rent seeking politicians, bureaucrats, and labor unions (Ahluwalia 2002).

The Economic Landscape of Post-Reform India
The reforms of 1991 reduced the number of exclusive areas reserved for the public; by 2002, this list had been subsequently reduced to only three sectors: atomic energy, atomic minerals, and railway transport. Nevertheless, the fact that 246 enterprises remain in the ownership of India’s central government shows that reform has been slow. According to The Economist, “These companies employed almost 1.6m people in 2008 and accounted for 8.3% of the country’s GDP.”[5] It is well established that the state-owned and mixed sectors of the Indian economy are significantly inefficient as compared to the private sector (Bhagwati 1993; Majumdar 1998), but due to entrenched local interest, the Indian state has been unable to proceed efficiently with SOE privatization. Thus, while the number of loss-making SOEs has fallen from 110 to 53 between 2001 and 2008, the scale of the losses has crept up again in recent years. [6] As the number of state-owned companies has held steady, countless private outfits have grown up, encroaching on their turf and liberating their customers.

Yet, despite its efforts at reform and liberalization, India’s economy continues to lag behind that of China’s and faces significant challenges. Still, the success of the private sector is encouraged by the Indian government’s following projects: industrial de-licensing, protection of property rights, devaluation that had been implemented previously. This process has been slow, the central planners of economic reform are frustrated by local elites (Majumdar 1998). Small and medium scale companies still suffer from lack of finances and state barriers to expansion. Additionally the absence of a regulatory structure and infrastructure also hinder growth.

The modern Indian economy excels in the Information and Communications Technology (ICT) sector but lags behind China in manufacturing. Its economic landscape is shaped by local interests at the state level due to the legacy of licensing. A divergence in performance has taken place—firms in those states and sectors with the best institutions gaining, and those in the more tightly regulated states and sectors falling further behind.[7] The need for further institutional reforms is urgent, focusing on product and labor market regulations at the central and state levels.[8] However these reforms have been slow in coming due to India’s democratic politics, where the centrist Congress party consensus is increasingly challenged in recent years by political mobilization pressing for immediate and hard-to-fill demands, by the rise of religious fundamentalism and class/caste divisions, and the deinstitutionalization of the Congress party and state structure (Rudolph and Rudolph 1987).

Role of Labor Unions
Organized labor play a much more active role in the Indian economy than their Chinese counterparts. The number of unions grew considerably after independence; in the early 1990s, total membership rose to over 9 million. Many unions are affiliated with regional or national federations, the most important of which are the Indian National Trade Union Congress, the All-India Trade Union Congress, the Centre of Indian Trade Unions, the Indian Workers' Association, and the United Trade Union Congress (Heitzman 1995). Politicians have often been union leaders, and some analysts believe that strikes and other labor protests are carried out primarily to further the interests of political parties rather than to promote the interests of the work force (Heitzman 1995). Thus, labor unions also play a strong role in the reform the Indian economy. Organized labor is an important player in democratic coalition building; thus, they have a distorting influence in labor market regulation. It is only India’s organized sector that is subject to labor market regulation, and here employment has actually fallen. Unsurprisingly, private sector gains in India have arisen primarily in the unorganized and informal sectors of the economy, where productivity and wages are generally much lower than in the formal organized sector, where unions are entrenched.[9]

The Role of FDI
Due in part to the weakness of organized labor in China, foreign investment and foreign firms played a much greater role in China’s economic development than they did in India. As Huang Yasheng notes in Selling China, “foreign firms, either singly or as JVs with Chinese firms, have established a ubiquitous presence in China”(Huang 2003). The inflow of FDI has allowed the Chinese government to shift the political dynamic from a public vs. private sector issue to a Chinese vs. foreign issue, diverting attention from the painful process of SOE restructuring which resulted in massive job loss. In India, FDI has been a much less important part of export; today, FDI driven exports accounts for less than 10% of India’s total. Chinese domestic firms lack the political clout available to their Indian counterparts because of nondemocratic CCP one party rule; they could not protect themselves against competition from the influx of foreign firms. However, strong state control allowed China to develop more business-oriented, FDI-friendly policies than India, where regulations caused excess bureaucracy (Wei 2005). According to the World Bank Group, it takes 90 days to start a new business in India compared to 30 days in China (Wei 2005).

CONCLUSION
India and China, the largest developing countries in the world, garner a great deal of attention individually and in comparison.  The roles two governments play in private companies and state owned enterprises are very different mostly due to the political differences between the two countries. These differences have motivated fundamental changes in market participation, creating each distinctive economic landscape that reflects a political structure.  

The Chinese party-state under the CCP has historically favored SOEs and foreign MNCs over domestic enterprises. Deprived of state support and squeezed between domestic and multinational giants, China’s private sector has exhibited rapid growth (largely due to the weakness of organized labor) but few enterprises can compete internationally. On the contrary, India’s democratic system retards the rate of reform and restricts labor law. Indian economic reform began later and has proceeded haltingly, attracting a much smaller inflow of FDI than its Chinese counterpart. While it is no match for China’s rate of growth at the macro level, India has managed to produce more private enterprises that are competitive on the international market.

As time continues and policies change, the two states seem to be growing towards a point of convergence.  China began with great inflows of FDI and little additional investment in SOEs and local, private companies.  India saw a lack in FDI and developed very insular private corporations.  In recent years however, China is now more focused on encouraging research and development within its national corporations to further growth.  India is welcoming FDI as a way to improve many of the structural deficits it faces in furthering its development.  It remains to be seen what this second phase of reforms will do for either country politically and economically.

NOTES
[1] State-owned enterprises (SOEs), multinational corporations (MNCs), joint-ventures (JVs), foreign direct investment (FDI)

[2] China has set GDP growth target for 7-8% for next year in an effort to prevent its economy from overheating.

[3] By comparison, the state contributes about 5% of GDP in most East Asian countries and 7% in India.

[4] The practice whereby a small group of elites control key administrative positions in the state, typically through a Communist Party.

[5] "State-owned enterprises: Stakes and mistakes" The Economist, 2009

[6] Ibid.

[7] Economic Survey of India 2007, OECD Economics Department

[8] Ibid.

[9] Ibid.

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