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4.2 Comparative Institutional Analysis of China and India

4.2.1 Overview

The People's Republic of China was established in 1949 as a communist country under the leadership of Mao Tse-tung. Under the patronage of the then Soviet Union, a socialist state was created, but the Cultural Revolution, which lasted from 1966 to 1976, caused great turmoil. With the death of Mao Tse-tung in 1976, Deng Xiaoping took over the country's leadership, and in 1978, began implementing a policy of reform and opening up the nation that started the nation's economic development. Deng Xiaoping's economic policies enabled economic development by attracting foreign corporations, and in the 1990s, China implemented full-scale policies to further open the country's economy. As a result, direct foreign investment in China skyrocketed, and the number of Japanese companies investing in China grew rapidly. Currently, China is known as the “factory of the world,” and consumers throughout the world cannot live without Chinese-made products. Since the 1990s, China's economic growth has consistently been at a high level of around 10 %, and as we have seen in Chap. 1, the country's economy has surpassed Japan, making China an economic giant second only to the US.

On the other hand, the Republic of India gained independence from the British Empire in 1947, at which time it was established as a social democracy headed by Jawaharlal Nehru, who served as the country's first prime minister. Each state in India has an independent economic system, and taxes and regulations are extraordinarily complex. In 1980, the regulations were relaxed to allow partial participation of foreign capital, but the impact of that relaxation was very limited compared with China. Because of the lack of basic infrastructure such as roads and electricity, India has many handicaps as a manufacturing base. Yet, recently, the rapid growth of the IT service industry, primarily in software development and business process outsourcing (BPO), has greatly changed India's image internationally. While China is the “factory of the world,” India is the “world's software developer.” The size of the Indian economy in terms of GDP is

Fig. 4.1 Per capita GDP of China and India (Source: United Nations Statistics Division data)

still small, at about one-third the size of Japan's, but recent growth has been remarkable, and the country is predicted to be a giant market in the future.

Figure 4.1 shows the per capita GDP trends for China and India. The per capita GDP was about the same for both countries until 1990, but after that time, China's growth began to outstrip that of India. As of 2010, the per capita GDP was USD$4,400 for China versus India's USD$1,300, showing a huge gap. The source of this gap is thought to be the difference in policies for attracting foreign capital.

As shown in Fig. 4.2, direct foreign investment in China has been on an increasing trend since the 1990s. In contrast, for the most part, India had no visible direct foreign investment until about 2005, and only began to grow from 2006. Foreign investment growth in both countries declined in 2009 because of the financial crisis brought on by the Lehman Brothers' bankruptcy, but the cumulative total investment to date is still overwhelmingly large in China. Deng Xiaoping, who directed policies to open up China to the outside world, visited Wuhan, Shenzhen, Zhuhai, Shanghai, and other southern Chinese cities in 1992, personally witnessing the economic development of this economic zone made possible through the allowance of foreign investment, and confirmed the effect of an economic development model relying on attracting foreign capital. As a result, in his “southern tour speech,” Deng declared his intent to expand the reform that attracted foreign capital—which up to that point was restricted to certain regions —all over China. As a result, investments in China by foreign firms began in earnest.

Another turning point for direct investment in China came with their WTO membership in 2001. Until the 1990s, foreign investment in China was made at the

Fig. 4.2 Inward foreign direct investment of China and India (billions of dollars) (Source: ADB Key Indicators for Asia and the Pacific 2011 (August 2011))

request of the Chinese government authorities. However, China's WTO membership sent a message that the Chinese government would create an environment for investment that accorded with international rules, thereby reducing investment risks for foreign firms. In addition, the WTO membership paved way for deregulation such as the gradual elimination of foreign capital regulations in service industries like finance and distribution, which had a tremendous impact on direct investment. The Indian economic policy, on the other hand, still has marked remnants of protectionism for domestic industries, and investment risk is still a significant issue for foreign firms. When India gained its independence in 1947, Prime Minister Nehru implemented the concept of planned economy from the then Soviet Union, controlling the domestic economic activities through various regulations. These regulations were not only for foreign transactions but also for domestic operations, and the phrase “License Raj” (“Raj” is a term that means “rule” or “reign,” and was used during the period of British colonial rule) became a cynical phrase implying that Indian people were ruled by licenses rather than the British. The situation has significantly improved since then, but there are still many significant barriers to investment, such as labor laws to protect workers, business registrations, and a complex tax code. In addition, manufacturers are impacted by the lack of infrastructure such as roads and railways. On the flipside, IT services and software, which are not as affected by the lack of physical infrastructure, have seen a tremendous amount of investment, primarily from European and US firms. That said, India created special economic zones in 2005, developed industrial parks, and worked to lure foreign capital to its manufacturing industries. In addition, the government began relaxing foreign investment regulations since the early 2000s, resulting in direct domestic investment growing rapidly since 2006 (Table 4.1).

Table 4.1 Major politics and economics events in China and India




Bombay (Mumbai) Stock Exchange


Independence from British



Country was formed


15 million deaths due to starvation


Start of Cultural Revolution


End of Cultural Revolution


Liberalization of economy, aggressive implementation of direct domestic investment


Start of “One Child” policy

Deregulation policies focused on automotive industry


Decision to create economic zones in Shenzhen, Zhuhai, Shangtou, and Xiamen

First financial reform

Start of the “Contract Responsibility System”



Start of agriculture reforms; implementation of “Farmer Management Responsibility System”

Deregulation of consumer electronics and software sectors



Coastal cities opened to foreign investment; creation of economic technology development zones


Implementation of Management Responsibility System to split ownership and management of state-owned enterprises


Tiananmen Square incident


Shanghai Stock Exchange open

Economic rebuilding and deregulation of foreign investment


Gradual elimination of import licenses and lowering of tariff rates

Deregulation of foreign investment inflow

Liberalization of foreign exchange


Deng Xiaoping's Southern Tour Speech; support for economic reforms and policies for accelerated economic growth

Reform of commerce bank system

Deregulation of interest rate system

Decision on path toward “socialist market economy”

National Stock Exchange established

Authorization for foreign investors to trade shares of publicly traded Indian companies


Start of state-owned enterprise privatization

Removal of dual exchange rates


Table 4.1 (continued)




National Stock Exchange (NSE) open


Second financial reform

Implementation of foreign exchange system reforms (official RMB exchange rate devalued by 50 %, move to floating exchange rate system)

International trade surplus

WTO Membership


Implementation of Commerce Bank Law

Complete liberalization of interest rates and disposal of bad bank debt


Foreign banks to trade RMB (restricted to Shanghai's Pudong region)

July: Return of Hong Kong

September: Full implementation of stock system for state-owned corporations

October: Tariff reductions from 23 to 17 % on more than 4,800 products

Liberalization of foreign stock investment regulations


March: Acceptance of privately owned companies

November: Decision to develop western China

December: Return of Macao

Aggressive implementation of direct domestic investment


Acceptance of foreign majority ownerships outside of banking insurance, telecommunications, and private aviation. Most industries allowed 100 % foreign ownership


March: Beijing wins 2008 Olympics bid

December: WTO membership


Authorization for foreign investors to trade shares of publicly traded Chinese companies

Creation of economic zones


100 % foreign investment in real estate development allowed

Maximum percentage of foreign investment in financial and telecommunications industry firms raised to 74 %

Foreign investment approval process greatly simplified


Start of foreign stock investment liberalization

Source: Various

Japanese corporate investments into China and India are at USD$66.5 billion and USD$13.6 billion, respectively (till end of 2010), and investment in India is approaching to roughly one-fifth of Japan's investment in China. However, a closer examination reveals that Chinese investments cover a breadth of industries ranging from manufacturing industries such as automotive and electronics to retail and financial services. Indian investment, on the other hand, is primarily in the automotive industry.

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