With 40% of the world's population, China and India are significant in terms of size, but it has been their economies that have wielded the most influence on the global platform. By 2050, the Chinese economy is predicted to be the largest in the world, while India's could grow equal to that of the US. At Schroders' Annual Secular Market Forum, Martin Wolf, Chief Economics Commentator at Financial Times, and Jim O'Neill, Head of Economic Research at Goldman Sachs, led a lively debate when they presented their views on:

• China - the biggest success story to date;
• India - more of a potential success story;
• Factors that could support continued growth; and
• Possible problems for the countries to overcome

China - the dominant factor among BRIC economies

The continued progression of China's burgeoning economy has been the overriding story not only in terms of BRIC economies, but also the world. As Wolf highlighted, the growth strategy adopted by China has been largely similar to that of Japan and South Korea, in that it has been driven by export growth and industrialisation through high savings and investment. However, China has also been more open to trade and foreign direct investment.

Considering the supply-demand dynamic, cheap Chinese exports have contributed to today's disinflationary environment, but O'Neill points to the demand side as being at least as important. Since 2000, China's contribution to global demand has been equivalent to that of the Eurozone. Rising incomes have been closely linked to the migration of Chinese workers from rural farmland to the city. O'Neill suggests that this urbanisation is probably only halfway through its course. Wealth levels are improving, but still have a long way to go to catch up to other developed economies.

China is predicted to surpass Germany, possibly by the end of this year, as the third largest economy. By 2050, projections suggest that China should become the largest economy in the world. In other words, the economy could grow to more than five times the size it is today, a forecast which assumes a deceleration from the present growth rate of 9.6% per annum (2000-06).

Playing catch-up

The advancement of the Indian economy - contributing around the same to global GDP growth since 2000 as Russia - has been strong, but not quite as dramatic as that of China. India's growth strategy, however, is unique according to Wolf. It has been driven by the skill-intensive service sector rather than industrialisation. The focus has been on developing skills in its labour force, which of course has attracted outsourcing contracts from the West.

As he pointed out, the current surge in Asian economies (which began with Japan's rise) is the third significant transformation that we have seen since the industrial revolution. The first was the rise of the UK in the early 19th century. The second featured the US, Japan, Germany and Russia in the late 19th and early 20th centuries. In relative terms, however, China and India are still poor in terms of income per head. They, therefore, have enormous potential for further growth as they play ‘catch-up' to the rest of the large developed economies.

What is needed for this environment to continue

Productivity gains have thus far largely underpinned this economic growth and, in order for the pace of growth to be sustained O'Neill argues that both China and India need (1) sound, stable macroeconomic policies; (2) strong, stable political institutions; (3) openness; and (4) high and broad levels of education. In other words, he does not think that ‘miracle' conditions are required.

Potential problems

Some of the biggest problems facing China and India are political and policy constraints. Wolf sees fundamental difficulties in China trying to marry its communist party-state with the market. Sooner or later, one force will have to yield way, which is likely to cause some instability. China's economy depends on external technology - its manufacturers can replicate virtually anything, but they need input from outside the Chinese borders. India's problems are somewhat different from China's in that India already has a democracy. Instead, its problems are focused on a high amount of corruption, public spending waste and low investment in literacy, health and infrastructure. According to data from the World Bank, indicators of governance standards are much lower in China and India compared to the OECD average. Such factors include political stability, government effectiveness, regulatory quality and control of corruption.

Other obstacles that these economies will have to overcome include energy constraints. Consumption per person is currently very low in China and India, according to World Bank statistics. However, if the economies continue to expand strongly, as expected, policymakers need to make decisions on providing resources. While China has plenty of coal, it is a large importer of crude oil. One consequence is that the price of energy and oil will remain high, if not rise even higher, in the foreseeable future.

Another risk is that of protectionism, especially by the US administration. The Chinese government has been allowing the renminbi to appreciate gradually, but more needs to be done. China has a huge current account surplus and vast US dollar reserves (largely the counterpart to the US current account deficit). Questions to ask include how it will invest the surplus going forward and how will the government diversify its foreign exchange reserves.

Where does the story go now?

There are clearly a number of chapters left to the China and India stories. The potential for further rapid growth is still in place, but both speakers acknowledged some uncertainties. We could see a major shift towards the East in terms of economic, trade and possibly political power. As Wolf concluded, "the winners in the West will be those countries, companies and economic activities that are complementary to the rising 'giants' economies."

Download Jim O'Neill's presentation.

Download Martin Wolf's presentation.

Important information:

These notes are based on presentations by Martin Wolf, Chief Economics Commentator at Financial Times, and Jim O'Neill, Head of Economic Research at Goldman Sachs, dated 29 May 2007, and do not necessarily represent Schroder Investment Management's house view. Please note that these notes have been complied by Schroders staff and are not directly attributable to the speakers.

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