any Wal-Mart and you will not be surprised to see the shelves
sagging with Chinese-made goods—everything from shoes and
garments to toys and electronics. But the ubiquitous “Made
in China” label obscures an important point: Few of these
products are made by indigenous Chinese companies. In fact, you
would be hard-pressed to find a single homegrown Chinese firm
that operates on a global scale and markets its own products abroad.
That is because China’s export-led manufacturing boom is
largely a creation of foreign direct investment (FDI), which effectively
serves as a substitute for domestic entrepreneurship. During the
last 20 years, the Chinese economy has taken off, but few local
firms have followed, leaving the country’s private sector
with no world-class companies to rival the big multinationals.
India has not attracted anywhere near the amount of FDI that China
has. In part, this disparity reflects the confidence international
investors have in China’s prospects and their skepticism
about India’s commitment to free-market reforms. But the
FDI gap is also a tale of two diasporas. China has a large and
wealthy diaspora that has long been eager to help the motherland,
and its money has been warmly received. By contrast, the Indian
diaspora was, at least until recently, resented for its success
and much less willing to invest back home. New Delhi took a dim
view of Indians who had gone abroad, and of foreign investment
generally, and instead provided a more nurturing environment for
In the process, India has managed to spawn a number of companies
that now compete internationally with the best that Europe and
the United States have to offer. Moreover, many of these firms
are in the most cutting-edge, knowledge-based industries-software
giants Infosys and Wipro and pharmaceutical and biotechnology
powerhouses Ranbaxy and Dr. Reddy’s Labs, to name just a
few. Last year, the Forbes 200, an annual ranking of the world’s
best small companies, included 13 Indian firms but just four from
India has also developed a much stronger infrastructure to support
private enterprise. Its capital markets operate with greater efficiency
and transparency than do China’s. Its legal system, while
not without substantial flaws, is considerably more advanced.
China and India are the world’s next major powers. They
also offer competing models of development. It has long been an
article of faith that China is on the faster track, and the economic
data bear this out. The “Hindu rate of growth”—a
pejorative phrase referring to India’s inability to match
its economic growth with its population growth-may be a thing
of the past, but when it comes to gross domestic product (GDP)
figures and other headline numbers, India is still no match for
However, the statistics tell only part of the story-the macroeconomic
story. At the micro level, things look quite different. There,
India displays every bit as much dynamism as China. Indeed, by
relying primarily on organic growth, India is making fuller use
of its resources and has chosen a path that may well deliver more
sustainable progress than China’s FDI-driven approach. “Can
India surpass China?” is no longer a silly question, and,
if it turns out that India has indeed made the wiser bet, the
implications-for China’s future growth and for how policy
experts think about economic development generally-could be enormous.
The Stifling State
The fact that India is increasingly building from the ground up
while China is still pursuing a top-down approach reflects their
contrasting political systems: India is a democracy, and China
is not. But the different strategies are also a function of history.
China’s Communist Party came to power in 1949 intent on
eradicating private ownership, which it quickly did. Although
the country is now in its third decade of free-market reforms,
it continues to struggle with the legacy of that period-witness
the controversy surrounding the recent decision to officially
allow capitalists to join the Communist Party.
India, on the other hand, developed a softer brand of socialism,
Fabian socialism, which aimed not to destroy capitalism but merely
to mitigate the social ills it caused. It was considered essential
that the public sector occupy the economy’s “commanding
heights,” to use a phrase coined by Russian revolutionary
Vladimir Lenin but popularized by India’s first prime minister,
Jawaharlal Nehru. However, that did not prevent entrepreneurship
from flourishing where the long arm of the state could not reach.
Developments at the microeconomic level in China reflect these
historical and ideological differences. China has been far bolder
with external reforms but has imposed substantial legal and regulatory
constraints on indigenous, private firms. In fact, only four years
ago, domestic companies were finally granted the same constitutional
protections that foreign businesses have enjoyed since the early
1980s. As of the late 1990s, according to the International Finance
Corporation, more than two dozen industries, including some of
the most important and lucrative sectors of the economy-banking,
telecommunications, highways, and railroads-were still off-limits
to private local companies.
These restrictions were designed not to keep Chinese entrepreneurs
from competing with foreigners but to prevent private domestic
businesses from challenging China’s state-owned enterprises
(SOEs). Some progress has been made in reforming the bloated,
inefficient SOEs during the last 20 years, but Beijing is still
not willing to relinquish its control over the largest ones, such
as China Telecom.
Instead, the government has ferociously protected them from competition.
In the 1990s, numerous Chinese entrepreneurs tried, and failed,
to circumvent the restrictions placed on their activities. 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. More
than a few promising businesses have been destroyed this way.
This bias against home-grown firms is widely acknowledged. A report
issued in 2000 by the Chinese Academy of Social Sciences concluded
that, “Because of long-standing prejudices and mistaken
beliefs, private and individual enterprises have a lower political
status and are discriminated against in numerous policies and
regulations. The legal, policy, and market environment is unfair
Foreign investors have been among the
biggest beneficiaries of the constraints placed on local private
businesses. One indication of the large payoff they have reaped
on the back of China’s phenomenal growth: In 1992, the income
accruing to foreign investors with equity stakes in Chinese firms
was only $5.3 billion; today it totals more than $22 billion.
(This money does not necessarily leave the country; it is often
reinvested in China.)
The Mogul as Hero
For democratic, postcolonial India, allowing foreign investors
huge profits at the expense of indigenous firms is simply unfeasible.
Recall, for instance, the controversy that erupted a decade ago
when the Enron Corporation made a deal with the state of Maharashtra
to build a $2.9 billion power plant there. The project proceeded,
but only after several years of acrimonious debate over foreign
investment and its role in India’s development.
While China has created obstacles for its entrepreneurs, India
has been making life easier for local businesses. During the last
decade, New Delhi has backed away from micromanaging the economy.
True, privatization is proceeding at a glacial pace, but the government
has ceded its monopoly over long-distance phone service; some
tariffs have been cut; bureaucracy has been trimmed a bit; and
a number of industries have been opened to private investment,
including investment from abroad.
As a consequence, entrepreneurship and free enterprise are flourishing.
A measure of the progress: In a recent survey of leading Asian
companies by the Far Eastern Economic Review (FEER), India registered
a higher average score than any other country in the region, including
China (the survey polled over 2,500 executives and professionals
in a dozen countries; respondents were asked to rate companies
on a scale of one to seven for overall leadership performance).
Indeed, only two Chinese firms had scores high enough to qualify
for India’s top 10 list. Tellingly, all of the Indian firms
were wholly private initiatives, while most of the Chinese companies
had significant state involvement.
Some of the leading Indian firms are true start-ups, notably Infosys,
which topped FEER’s survey. Others are offshoots of old-line
companies. Sundaram Motors, for instance, a leading manufacturer
of automotive components and a principal supplier to General Motors,
is part of the T.V. Sundaram group, a century-old south Indian
Not only is entrepreneurship thriving in India; entrepreneurs
there have become folk heroes. Nehru would surely be appalled
at the adulation the Indian public now showers on captains of
industry. For instance, Narayana Murthy, the 56-year-old founder
of Infosys, is often compared to Microsoft’s Bill Gates
and has become a revered figure.
These success stories never would have happened if India lacked
the infrastructure needed to support Murthy and other would-be
moguls. But democracy, a tradition of entrepreneurship, and a
decent legal system have given India the underpinnings necessary
for free enterprise to flourish. Although India’s courts
are notoriously inefficient, they at least comprise a functioning
independent judiciary. Property rights are not fully secure, but
the protection of private ownership is certainly far stronger
than in China. The rule of law, a legacy of British rule, generally
These traditions and institutions have proved an excellent springboard
for the emergence and evolution of India’s capital markets.
Distortions are still commonplace, but the stock and bond markets
generally allow firms with solid prospects and reputations to
obtain the capital they need to grow. In a World Bank study published
last year, only 52 percent of the Indian firms surveyed reported
problems obtaining capital, versus 80 percent of the Chinese companies
polled. As a result, the Indian firms relied much less on internally
generated finances: Only 27 percent of their funding came through
operating profits, versus 57 percent for the Chinese firms.
Corporate governance has improved dramatically, thanks in no small
part to Murthy, who has made Infosys a paragon of honest accounting
and an example for other firms. In a survey of 25 emerging market
economies conducted in 2000 by Credit Lyonnais Securities Asia,
India ranked sixth in corporate governance, China 19th. The advent
of an investor class, coupled with the fact that capital providers,
such as development banks, are themselves increasingly subject
to market forces, has only bolstered the efficiency and credibility
of India’s markets. Apart from providing the regulatory
framework, the Indian government has taken a back seat to the
In China, by contrast, bureaucrats remain the gatekeepers, tightly
controlling capital allocation and severely restricting the ability
of private companies to obtain stock market listings and access
the money they need to grow. Indeed, Beijing has used the financial
markets mainly as a way of keeping the SOEs afloat. These policies
have produced enormous distortions while preventing China’s
markets from gaining depth and maturity. (It is widely claimed
that China’s stock markets have a total capitalization in
excess of $400 billion, but factoring out non-tradeable shares
owned by the government or by government-owned companies reduces
the valuation to just around $150 billion.) Compounding the problem
are poor corporate governance and the absence of an independent
Dollars and Diasporas
If India has so clearly surpassed China at the grass-roots level,
why isn’t India’s superiority reflected in the numbers?
Why is the gap in GDP and other benchmarks still so wide? It is
worth recalling that India’s economic reforms only began
in earnest in 1991, more than a decade after China began liberalizing.
In addition to the late start, India has had to make do with a
national savings rate half that of China’s and 90 percent
less FDI. Moreover, India is a sprawling, messy democracy riven
by ethnic and religious tensions, and it has also had a longstanding,
volatile dispute with Pakistan over Kashmir. China, on the other
hand, has enjoyed two decades of relative tranquility; apart from
Tiananmen Square, it has been able to focus almost exclusively
on economic development.
That India’s annual growth rate is only around 20 percent
lower than China’s is, then, a remarkable achievement. And,
of course, whether the data for China are accurate is an open
question. The speed with which India is catching up is due to
its own efficient deployment of capital and China’s inefficiency,
symbolized by all the money that has been frittered away on SOEs.
And China’s misallocation of resources is likely to become
a big drain on the economy in the years ahead.
In the early 1990s, when China was registering double-digit growth
rates, Beijing invested massively in the state sector. Most of
the investments were not commercially viable, leaving the banking
sector with a huge number of nonperforming loans-possibly totaling
as much as 50 percent of bank assets. At some point, the capitalization
costs of these loans will have to be absorbed, either through
write-downs (which means depositors bear the cost) or recapitalization
of the banks by the government, which diverts money from other,
more productive uses. This could well limit China’s future
India’s banks may not be models of financial probity, but
they have not made mistakes on nearly the same scale. According
to a recent study by the management consulting firm Ernst &
Young, about 15 percent of banking assets in India were nonperforming
as of 2001. India’s economy is thus anchored on more solid
The real issue, of course, isn’t where China and India are
today but where they will be tomorrow. The answer will be determined
in large measure by how well both countries utilize their resources,
and on this score, India is doing a superior job. Is it pursuing
a better road to development than China? We won’t know the
answer for many years. However, some evidence indicates that India’s
grassroots approach may indeed be wiser-and the evidence, ironically,
comes from within China itself.
Consider the contrasting strategies of Jiangsu and Zhejiang, two
coastal provinces that were at similar levels of economic development
when China’s reforms began. Jiangsu has relied largely on
FDI to fuel its growth. Zhejiang, by contrast, has placed heavier
emphasis on indigenous entrepreneurs and organic development.
During the last two decades, Zhejiang’s economy has grown
at an annual rate of about 1 percent faster than Jiangsu’s.
Twenty years ago, Zhejiang was the poorer of the two provinces;
now it is unquestionably more prosperous.
India may soon have the best of both worlds: It looks poised to
reap significantly more FDI in the coming years than it has attracted
to date. After decades of keeping the Indian diaspora at arm’s
length, New Delhi is now embracing it. In some circles, it used
to be jokingly said that NRI, an acronym applied to members of
the diaspora, stood for “not required Indians.” Now,
the term is back to meaning just “nonresident Indian.”
The change in attitude was officially signaled earlier this year
when the government held a conference on the diaspora that a number
of prominent NRIs attended.
China’s success in attracting FDI is partly a historical
accident-it has a wealthy diaspora. During the 1990s, more than
half of China’s FDI came from overseas Chinese sources.
The money appears to have had at least one unintended consequence:
The billions of dollars that came from Hong Kong, Macao, and Taiwan
may have inadvertently helped Beijing postpone politically difficult
internal reforms. For instance, because foreign investors were
acquiring assets from loss-making SOEs, the government was able
to drag its feet on privatization.
Until now, the Indian diaspora has accounted for less than 10
percent of the foreign money flowing to India. With the welcome
mat now laid out, direct investment from nonresident Indians is
likely to increase. And while the Indian diaspora may not be able
to match the Chinese diaspora as “hard” capital goes,
Indians abroad have substantially more intellectual capital to
contribute, which could prove even more valuable.
The Indian diaspora has famously distinguished itself in knowledge-based
industries, nowhere more so than in Silicon Valley. Now, India’s
brightening prospects, as well as the changing attitude vis-à-vis
those who have gone abroad, are luring many nonresident Indian
engineers and scientists home and are enticing many expatriate
business people to open their wallets. With the help of its diaspora,
China has won the race to be the world’s factory. With the
help of its diaspora, India could become the world’s technology
China and India have pursued radically different development strategies.
India is not outperforming China overall, but it is doing better
in certain key areas. That success may enable it to catch up with
and perhaps even overtake China. Should that prove to be the case,
it will not only demonstrate the importance of home-grown entrepreneurship
to long-term economic development; it will also show the limits
of the FDI-dependent approach China is pursuing.
Huang Yasheng is an associate professor at the Sloan School of
Management at the Massachusetts Institute of Technology. Tarun
Khanna is a professor at Harvard Business School. Reproduced with
permission from FOREIGN POLICY #137 (July/August 2003) www.foreignpolicy.com
Copyright 2003 Carnegie Endowment for International