Half a century ago it would have been impossible to imagine a 21st century with China as the manufacturing hub of America and India as its back office. Yet, this has become the reality of the day resulting in the creation of the Chinese and the Indian economy that are intricately dependent on the US Economy. However there is a subtle difference in the manner in which both these economies have gotten married to the US Economy, a difference so real that it could alter the world’s perspective towards both of them. China planned it this way, as it always does; for India, it just happened to occur this way, as it always does.
The Indian Economy registered a 9.3% GDP growth in 2007 while China was winning accolades the world over as it registered 13% growth in the same period. Towards the end of 2007 the world saw a financial crisis comparable only to the crisis of 1927 that had triggered a decade long depression. Three years after the latest crisis, economists and central bankers are still using the adjective ‘subdued’ when referring to recovery.
Post the crisis, the Indian and Chinese economies have continued on their growth paths albeit in different trajectories. In 2008, 2009 and 2010 India grew at 6.8%, 8.0% and 8.6% while China has expanded by 9%, 9.1% and 10.3% respectively. For the year 2011 China is expected to grow at 8.7% while India will claim the crown of the fastest growing economy if the government’s estimates of 9% growth come true. Though the magnitude of growth in percentage points remains almost the same for both the economies, the fact to be noted is that India has returned to its pre-crisis growth rate of 9% whereas China will struggle to be above 9%, leave alone the lofty heights of 12-13% growth. And all this with the Indian government injecting only a minimal stimulus into the economy whereas China ‘adding the equivalent of India’s banking industry twice over’ in the same period.
The dominant component of GDP for India is the services and consumption sector whereas the dominant component for China, apart from investments, is the export oriented manufacturing sector. A major portion of Chinese exports land up on American soil, similarly a significant portion of India’s services and consumption growth is driven by that part of the working class that services the US Economy through our IT firms, BPO’s and call centers. Thus we can say that both the economies share their dependence on the American economy. However, to understand why India’s growth rate is at pre-crisis levels and China struggling way below it, we have to understand the segments of the American Economy that both these countries service. The Indian Economy mainly associates itself with the American business class by providing offshore services to American companies whereas the Chinese Economy mainly associates itself with the American consumer class by exporting cheap goods. In marketing parlance, the Indian Economy is B2B while the Chinese Economy is B2C.
To substantiate this theory further let us have a look at the consumer sentiment index published by Reuters in association with the University of Michigan. These numbers are widely monitored in the US financial circles because they bear a direct correlation to consumer spending and consumer confidence levels. During the peak of the boom cycle the average for 2007 stood at 85.5 and as Americans saw the crisis unfold the numbers dropped steeply to 63.7 in 2008 and then recovered to 66.2 and 71.9 in 2009 and 2010 respectively. The inability of these numbers to rise above or near to 2007 levels partially explains the inability of the Chinese economy to grow at pre-crisis levels.
So if the consumer is not spending, where is the money going? To answer this we would need to look at the personal savings rate published by the US Department of Commerce, Bureau of Economic Analysis. Being at 3.5% in January 2000 it dipped below 1% multiple times during the decade. Seeing the severity of the crisis the savings rate recovered to 1.3% in Jan 2008 and then climbed to 4.2% in Dec 2009 and 5.8% in Jan 2011. A saving of 5% of their disposable income by Americans means a cash of approximately $677 billion for the banks and the government and an immediate effect of this is a reduction of America’s dependence on China to finance its deficit.
A major advantage of the B2B association for India is that it lends a strong counter-cyclical force to the Indian economy. During an American recession consumer spending drops directly affecting Chinese exports, but at the same time American companies look to cut costs fuelling job growth in India. This explains why the Indian economy again appears to be moving to the 9% plus growth trajectory.
The real GDP for the US Economy contracted 2.6% for 2009 and is expected to expand at 2.8% in 2010. Unemployment numbers rose from an acceptable 5% to hit 10.1% in October 2009 and have consistently remained above 9% for the whole of 2010 with the Feb 2011 numbers coming in slightly lower at 8.9%. During the same period, US Corporate profits for March 2010 quarter were highest in 25 years. It is surprising to note that an economy actually swung from a 2.6% contraction to a 2.8% expansion without actually creating any jobs, infact, almost doubling the number of unemployed. At the same time record profits point to an increase in productivity or a high amount of cost cutting. There is a limit to the amount of productivity increase than can be achieved in such a short period of time and so the more logical reason could be cost cutting. And this cost cutting was achieved by outsourcing jobs to cheap and talented professionals in India.
The IT and BPO sector employs more than 2 million people in India which are high paying jobs compared to Indian middle class standards and provide for a large amount of disposable income. This money then gets spent on entertainment and leisure, trendy clothes, swanky phones, cars and bikes. A large number of these professionals are also required to migrate to cities other than their birth place, fuelling demand for rented homes. This explains the sky high property prices in Pune, Banglore, Mysore, Hyderabad, and Gurgaon, all home to IT and BPO employees. The net effect of the American dollar -showers is that it trickles down through the new economy employees to a large base of associated service providers triggering intense economic activity right upto the bottom layers of the population pyramid. According to NASSCOM the indirect jobs created by IT and BPO sectors stand at 8 million. All in all, this is substantial evidence of our services and consumption growth due to our B2B association with the American Economy.
Pre-crisis, the world was gung-ho about stratospheric Chinese numbers in every field but post-crisis the world has begun to pay attention to intangibles like democracy, free press, entrepreneurship and innovation. A B2B association with America is a similar intangible which shall stand good in the long haul.