Why India lags behind China in Economic Development
Updated: May 2, 2022
Historical data of the three most successfully developed countries show that the Capital Accumulation Phase—that is during when countries accumulate much of the capital stock required to become wealthy—lasts roughly 35 years.
Consider the figure below showing the net domestic investment rates [(net domestic investment/GDP)*100] for Taiwan and South Korea over a long timeline of 53 years. We see that for the first 35-years of economic development, Taiwan from 1961 to 1995 and South Korea from 1963 to 1997, we see remarkably high investment rate figures.
Source: World Development Indicators Database, World Bank
Also consider their capital-income ratios [(capital stock acquired up until the end of an year from time immemorial/annual national income at the end of the year)*100].
The 35-year timeline above corresponds to the time when these North East Asian countries acquired/accumulated a lot of their existing capital stock. Here we have the historical capital-income ratios for Taiwan and South Korea in comparison to those of the same for four major early industrialized countries France, US, UK, Germany, France.
Source: For US, UK, France, GermanyAlvaredo Facundo, Anthony B Atkinson, Thomas Piketty, Emmanuel Saez, & Gabriel Zucman, The World Wealth and Income Database 2016, data retrieved from <WID - World Inequality Database>
Note: Data corresponds to West Germany for the period 1946 – 1990
Source: For South Korea and Taiwan:Author’s calculations based on National Accounts data; see Online Appendix at The General Theory of Rapid Economic Development
Capital-income ratio is a simple accounting notion that indicates a country’s aggregate net national wealth stock in market prices as a proportion of its annual national income also compiled in market prices at the end of a year.
For example, the ratio of aggregate wealth stock of the US measured at the end of 2007 at prevailing 2007 market prices and US national income for the year 2007 yields the figure 5.5 or 550%. This indicates that the national wealth of the US at the end of 2007 was five- and-a-half times the annual national income in that year.
Measuring wealth relative to national income is a much better way of gauging national wealth, or even its two components—private wealth and public wealth (another way of classifying wealth). The aggregate value of wealth stock on its own does not convey any meaning and does not capture the magnitude of the wealth stock.
Capital-income ratio is linked to savings rate and national income growth rate—a purely accounting construction—in the following manner. (see here how national income and GDP are related)
Capital-income ratio = s / g
The above equation is an accounting design that is true in the long term.
Savings rate and growth rate correspond to a year whereas capital-income ratio is an evolving year-to-year parameter by design. Every year new savings generated within the economy finances new capital investment, which adds to and increases the existing capital stock and by the end of the year when the much higher capital stock in aggregate is divided by that year’s national income, a new capital-income ratio is obtained.
That is if an economy maintains savings equivalent to 12 percent of national income every year and national income growth at 3 percent year-on-year, then its capital-income approaches 400% (12/3*100), or the capital stock builds up to four times the national income over the long run.
Similarly, if an economy, typical of the successful late-developed countries, maintains savings rate at 40% and grows its national income at 10 percent rate, then the capital-income approaches 400% (40/10*100) as well.
In practice, the savings rate and the growth rate does not remain high indefinitely. The higher rates come down, and capital-income stabilizes around those levels that were determined by the previously high magnitudes of savings rate and growth rate.
Simply, if an economy follows such a pattern of high savings rate and high growth rate of national income, the year-on-year capital-income ratio converges to the ratio s / g.
But what is the difference between those two scenarios? The higher savings rate (40%) and higher national income growth (10%) scenario pushes capital-income to levels (that being, 400%) faster than would the low savings rate (12%) and low national income growth (3%) scenario.
The first one is desirable for all late-developing countries, whereas the second scenario—wherein the norm is low rates—is what we observe in regards to all of the early- industrializers who built their wealth over a very long period.
We observe the low savings rate pattern observed among the four major early-industrializers in comparison to the high rates among the successfully late-industrializers Taiwan, South Korea and China.
Source: For US, UK, France, Germany
Alvaredo Facundo, Anthony B Atkinson, Thomas Piketty, Emmanuel Saez, & Gabriel Zucman, The World Wealth and Income Database 2016, data retrieved from <WID - World Inequality Database> Note: Data corresponds to West Germany for the period 1946 – 1990
Source: For South Korea and Taiwan:
Author’s calculations based on National Accounts data; see Online Appendix at The General Theory of Rapid Economic Development
In any given year, a higher investment rate is enabled by a higher savings rate, which then can produce higher GDP per capita growth and consequently a higher national income growth ‘g’. A low savings rate enables a low (3% - 5%) GDP per capita growth rates and a higher one enables a high (6% - 10%) GDP per capita growth rates. The question then arises is how exactly high savings rate can be achieved by India or any other developing country.
In order to grow fast, accumulate a lot of wealth rapidly, a developing country MUST post high savings rate. See the figure below showing how the relative lag India has with China in terms of GDP per capita growth rate over the timeline.
Source: World Development Indicators Database, World Bank
The lag India has with China in GDP per capita growth rate is explained by China’s premier savings rate and India’s lack thereof. See the figure below showing the savings rate of India and China over a 35-year timeline. We see that China’s savings rate is exorbitantly high. India’s savings rate also grew but not that much.
Source: Author’s calculations based on National Accounts data; see Online Appendix.
The extraordinary savings rate of China enabled the country to accumulate lot of unprecedented savings volume over the timeline. See the graph below showing Chinese savings rate (right-axis) and national income composition (consumption + savings) for each
year from 1989 to 2015.
As we can see, China not only increased its savings volume year-after-year—going from couple of billions to couple of trillions over a span of two decades, it also increased the proportion of national income it saved—going from less than 20% of national income in 1989 to about 40% in 2009. (all values in current prices). The Chinese posting a 40% savings rate in 2009 amounting to roughly USD 2 trillion is the stuff of extraordinary feats.
Source: Author’s calculations based on National Accounts data; see Online Appendix.
But can a country post high savings rate like China is a question economists have been struggling for some time. The piece The Chinese Saving Puzzle and the Life-Cycle Hypothesis by Nobel prize winning economist Franco Modigliani is trying to use his own theory to explain the Chinese savings puzzle and failing.
Consider some other works by professional economists trying to understand Chinese savings puzzle.
Why Are Saving Rates so High in China? (2011)
Why Is China’s Saving Rate So High? A Comparative Study of Cross-Country Panel Data (2010)
Counterintuitive facts regarding household saving in China: the saving glut (2018)
To summarize, what is lacking from India’s development story is high savings rate figures in the pattern achieved by China in the past 25-years (see figure 4 above). The higher India’s savings rate the larger will be India’s net domestic investment rate and the higher its growth rate will be. And if India’s maintains that pattern, the faster will also be its capital-income ratio.
