India will beat China – all in its own good time

Authoritarian regimes often yield strong short-term economic results, as seen in Germany in the 1930s, the Soviet Union in the 1950s, Brazil in the 1960s and China in the 1990s. Unencumbered by such things as property rights, legal recourse and public debate, the authoritarian regime can harness significant economic and political resources to achieve impressive industrial and economic feats.

Conversely, democratic regimes tend to be sloppy affairs with loud public discourse, a vocal press, stubborn land owners and a myriad of civil liberties. Far from being able to harness economic resources, the government often must act more as a regulator. The result is that there are very few grandiose government-sponsored projects. Instead, there are countless private-sector initiatives driven by the invisible hand of the market.

But while the authoritarian regime is envied by some, the fact is that, longer term, this type of socio-economic model has typically led to economic and social distortions.

That is the dilemma faced by China today. Since the 1980s, the government has focused on developing an export-driven economy supported by an artificially undervalued currency. Foreign direct investment was encouraged while domestic consumption was limited. Massive infrastructure projects were initiated, fuelled by a growing trade surplus, with cities sprouting up in the hinterlands like mythical phoenix. For years, the Chinese economy benefited from these policies with double-digit growth in gross domestic product, vast foreign currency reserves, and ever-increasing capital inflows.

But now the economic and social distortions have begun to appear with rising inflation rates, numerous asset bubbles, looming overcapacity and rampant institutionalised corruption. China's rulers find themselves in a quandary. If the government allows its currency to appreciate rapidly to reduce inflation, it will drive down exports and fuel unemployment. If it fails to quell inflation, social unrest will quickly unfold.

But while the hare runs into obstacles of its own design, the tortoise is looking well placed in the long endurance race for competitive advantage. In India there is an entrenched and vibrant democracy that will ultimately drive it to outperform China socially and economically. Messy, frustrating and more often than not agonisingly slow, India's democracy would seem chaotic at the surface. But if you look deeper, you will see why the tortoise will prevail. Let's take a look at two of the big advantages that India's democracy provides.

PROPERTY RIGHTS

As India becomes urbanised, many families will choose to sell or borrow against their land so that they can start businesses, buy apartments or provide education opportunities for their children. India is at the start of a gradual migration driven by the development of high-end manufacturing and other "sunrise" industries that will require a vast pool of skilled and semi-skilled labour. This migration will create an increasingly urban India that is expected to attract more than 200 million rural inhabitants to "secondary cities" by 2025.

This transition will facilitate the sale of land holdings by an estimated 30 million farmers and 170 million other individuals indirectly tied to the agricultural sector. These sales are expected to generate more than $1 trillion in capital by 2025. This capital will have a multiplier effect on the Indian economy that could exceed $3 trillion.

The development of mortgage-backed security and asset-backed security markets, driven by financial institutions like Citigroup, will create the liquidity required to free up this capital.

China, by contrast, has no rural property rights. The 750 million rural residents who lease land are at the mercy of local and regional government as to what compensation they will receive, if any, when they are forced from the land as a result of development, infrastructure improvements etc. Additionally, they have no right to borrow against their lease, and as such they have no assets. In fact, the Chinese government's official figures state that more than 200,000 hectares of rural land are taken from rural residents every year with little or no compensation. Between 1992 and 2005, according to some estimates, 20 million farmers were evicted from agriculture due to land acquisition, and between 1996 and 2005 more than 21 per cent of arable land in China was put to non-agriculture use.

The result has not been unexpected, with over 87,000 "mass incidents" (or riots) reported in 2005 – a 50 per cent increase from 2003. Many provincial governments in China have begun to use plain-clothes policemen to beat, intimidate or otherwise subdue any peasant that dares to oppose these land grabs. And, also as would be expected, the beneficiaries from these policies have been developers and corrupt government officials.

RULE OF LAW

This is a cornerstone of any modern society. India has a legal system that has been in place for well over 100 years. It is internationally respected and includes laws that protect intellectual as well as physical property.

The rule of law creates predictability and stability, allowing entrepreneurial behaviour to flourish. This is clearly evident in India, with more than 6,000 companies listed on the stock exchanges, compared to approximately 2,000 in China. More telling is that of these 6,000 listed groups in India, only 100 or so are state-owned. This stands in stark contrast to China, where more than 1,200 belong to the state.

Can there be any doubt where the next Microsoft or Intel will be created? Certainly not China.

More than 100 Indian companies that completed initial public offerings as mid-cap firms now have a market capitalisation of over $1bn (£500m). Companies such as Jet Airways, Bharti Tele-Ventures, Infosys, Reliance Communications, Tata Motors (which just acquired Jaguar), Wipro and Hindalco are becoming multinational competitors with globally recognised brands.

China also has numerous companies with a market capitalisation of more than $1bn, but most of these are state-owned behemoths recognised for their sheer size and not their nimbleness.

When the rule of law is seen by investors and foreign companies as something that is beyond question, it serves to facilitate additional investments in research and development. For instance, 150 of the top global companies now have research and development bases in India. Additionally, the US Food and Drug Administration has certified more companies in India than in any other country outside the US, a testament to the innovation fostered by free markets and the rule of law.

China, meanwhile, has a legal system that does little to protect intellectual and physical property rights; it has been ranked with Nigeria in this respect. Indeed, China's illegal copying of movies, music and software cost companies $2.2bn in sales in 2006, according to an estimate by lobby groups representing Microsoft, Walt Disney and Vivendi. This figure may in fact be understated as it does not include pirated products that have been shipped to overseas markets by government-controlled Chinese companies.

The rule of law, when applied evenly and justly in a democratic society, also helps to ensure that wealth accumulation does not favour individuals in political office or people connected to those in political office.

Democracy is a messy thing, especially when you have an electorate that exceeds 600 million motivated voters. However, it helps to ensure that individual liberties are respected and that the government is responsive and beholden to the will of the people – rich or poor. A democracy also ensures accountability through impartial courts that help enforce and protect such things as property rights, environmental rights, human rights and good governance.

India's democracy is far from perfect but it is also quite young, and as incomes rise and the populace becomes more informed, we can expect that India's state institutions will become more responsive and transparent.

And what about the hare? Consider this: a recent survey found that of the 20,000 richest men in China, more than 95 per cent were directly related to Communist Party officials. Where would you place your bet?

William Nobrega is founder of the Conrad Group, an emerging-markets strategic planning and M&A firm based in Miami. He is co-author of 'Riding the Indian Tiger'