In recent years, China and India are often mentioned together when discussing the future. They contain the world’s two largest populations and are both developing rapidly. They are both set on a course to become world economic, political, and military powers. Recently, however, both The Economist and BusinessWeek have raised questions about India’s ability to keep up with China without major reforms. The 3 February 2007 cover of The Economist featured a startled Bengal tiger with its tail on fire and the headline “India Overheats,” while the 19 March 2007 cover of BusinessWeek featured an Indian elephant with a fracturing trunk and the headline “The Trouble with India” [click on image to enlarge]. What’s going on? The Economist starts with the good news [“India Overheats“]:

“The roar from Delhi is echoing across Asia. After peevish years cast as China’s underperforming neighbour, the huntress is now in hot pursuit. Over the past year the Indian economy has grown by an impressive 9.2%, not far behind China’s 10.4%. At some point this year India’s growth rate could even outpace China’s; and if you measure things by purchasing power parity, India should soon overtake Japan and become the third-biggest economy, behind only America and China. No wonder an increasing number of Indian businessmen, policymakers and economists are basking in the belief that their country is burning bright having at last broken free of its bureaucratic cage. An economy once famous for the ‘Hindu rate of growth,’ of 3% a year, was opened up by the reforms of the 1990s, many of them pushed through by the man who is now prime minister, Manmohan Singh. His government’s latest five-year plan assumes that India can sustain average growth of 9%. Who can doubt ‘Incredible India,’ to borrow the slogan of its tourism campaign?”

The question, of course, is rhetorical since both The Economist and BusinessWeek are expressing doubts about “Incredible India.” Continuing with The Economist:

“Fast growth is essential to pull millions of Indians out of poverty, so it is sad to pour cold water on this story. But that is precisely what is needed when there are so many alarming signs of overheating. Across India prices are rising fast, factories are at full capacity, loans are piling up. Yes, the economic reforms of the early 1990s spurred competition, forced firms to become more productive and boosted India’s trend—or sustainable—rate of growth. But the problem is that this new speed limit is almost certainly lower than the government’s one. Historic data would suggest a figure not much above 7%—well below China’s 9-10%. … Inflation has risen to 6-7% (compared with 2.8% in China); a record 99% of Indian firms report that they are operating above their optimal capacity; and credit is expanding at an annual rate of 30%, twice as fast as in China. Unlike China, India also has a widening current-account deficit—a classic sign of overheating, as domestic output fails to keep pace with surging demand. And if you are looking for a stockmarket bubble, Indian share prices have risen more than four-fold over the past four years, far more than in China. If something is not done, then a hard landing will become inevitable. The Reserve Bank of India has been too timid in cooling down domestic demand: although one interest rate was raised this week by a quarter point, the overall rise in rates over the past two and a half years has not even kept up with consumer-price inflation. But the main focus of the government’s attention should be on supply—and dismantling the many barriers that keep its speed limit below China’s.

The term that is liberally found throughout The Economist and BusinessWeek articles that best describes what is needed in India is “reform.”

“So far, reform in India has focused on setting its inventive private sector free from the world’s most fearsome bureaucracy. This has unleashed entrepreneurial talent, but more change is needed. Now is the time to tackle the public sector itself. Infrastructure, such as roads and power, and public services, such as education and drinking water, are woefully inadequate and limit growth. Even as the economy has been booming, many public services have worsened. It seems incongruous that somebody can own a mobile phone, yet has to waste hours queuing for drinking water. India’s top computer scientists are feted around the world, yet most children in rural areas lack the basic education needed to find more productive work. Around half of all Indian women are illiterate, compared with a ratio of around one in seven in China.”

Indian leaders are counting on the fact that scientific and technological advances will help them move people away from subsistence agriculture to more productive and better paying jobs. The theory is that these new jobs will help increase GDP, improve their people’s standard of living, increase savings, and make more money available for investment. Unfortunately, they are doing nothing to help prepare those they expect to move from rural to urban jobs. Education and skills training is sorely lacking, which makes the vision more of a hallucination. The situation isn’t hopeless, but it’s not rosy either. The Economist concludes:

“If these things can be tackled, India can indeed match China’s growth. Mr Singh remains a reformer, but his government relies on the support of the communist parties and, with today’s prosperity, there is no stomach to take them on. The worry is that today’s overheating will need to boil over before that mindset changes.”

Steve Hamm, writing for BusinessWeek, paints a very similar picture of India’s future [“The Trouble with India“]. He begins his story by painting a picture of what can be found in Bangalore, India’s version of Silicon Valley, and the high-tech office park called Electronics City. Inside the 6-foot cement walls of Electronics City, Hamm writes, is a high-tech, tranquil work environment. Outside those walls is a city with a crumbling infrastructure:

“With virtually no mass transit in Bangalore, Indian technology firm Infosys Technologies Ltd. spends $5 million a year on buses, minivans, and taxis to transport its 18,000 employees to and from Electronics City. And traffic jams mean workers can spend upwards of four hours commuting each day. ‘India has underinvested in infrastructure for 60 years, and we’re behind what we need by 10 to 12 years,’ says T.V. Mohandas Pai, director of human resources for Infosys.”

The government is hoping that its entrepreneurial sector will spare the government from having to invest in infrastructure by opting to invest in infrastructure itself in order to improve the attractiveness of employment with rapidly growing companies. They recognize that investors are placing multibillion bets that Indian firms will succeed and they are hoping that they view infrastructure investment as a way of protecting investment dollars. That’s not likely to happen, at least in the amounts needed to fix the problem. Hamm writes:

“This economic boom is being built on the shakiest of foundations. Highways, modern bridges, world-class airports, reliable power, and clean water are in desperately short supply. And what’s already there is literally crumbling under the weight of progress. In December [2006], a bridge in eastern India collapsed, killing 34 passengers in a train rumbling underneath. Economic losses from congestion and poor roads alone are as high as $6 billion a year, says Gajendra Haldea, an adviser to the federal Planning Commission. For all its importance, the tech services sector employs just 1.6 million people, and it doesn’t rely on good roads and bridges to get its work done. India needs manufacturing to boom if it is to boost exports and create jobs for the 10 million young people who enter the workforce each year. Suddenly, good infrastructure matters a lot more. Yet industry is hobbled by overcrowded highways where speeds average just 20 miles per hour. Some ports rely on armies of laborers to unload cargo from trucks and lug it onto ships. Across the state of Maharashtra, major cities lose power one day a week to relieve pressure on the grid. In Pune, a city of 4.5 million, it’s lights out every Thursday—forcing factories to maintain expensive backup generators. Government officials were shocked last year when Intel Corp. chose Vietnam over India as the site for a new chip assembly plant. Although Intel declined to comment, industry insiders say the reason was largely the lack of reliable power and water in India. Add up this litany of woes and you understand why India’s exports total less than 1% of global trade, compared with 7% for China. Says Infosys Chairman N.R. Narayana Murthy: ‘If our infrastructure gets delayed, our economic development, job creation, and foreign investment get delayed. Our economic agenda gets delayed—if not derailed.’ The infrastructure deficit is so critical that it could prevent India from achieving the prosperity that finally seems to be within its grasp. Without reliable power and water and a modern transportation network, the chasm between India’s moneyed elite and its 800 million poor will continue to widen, potentially destabilizing the country. Jagdish N. Bhagwati, a professor at Columbia University, figures gross domestic product growth would run two percentage points higher if the country had decent roads, railways, and power.”

Hamm notes that transportation bottlenecks contribute to the overheating discussed earlier by The Economist. If India hopes to catch (let alone surpass China), it has to make significantly greater investments in infrastructure. Hamm indicates that China is still outspending India, which means that China is increasing the gap between the two countries.

“India today is about where China was a decade ago. Back then, China’s economy was shifting into overdrive, but its roads and power grid weren’t up to the task. So Beijing launched a massive upgrade initiative, building more than 25,000 miles of expressways that now crisscross the country and are as good as the best roads in the U.S. or Europe. India, by contrast, has just 3,700 miles of such highways. It’s no wonder that when foreign companies weigh putting new plants in China vs. India to produce global exports, China more often wins out. China’s lead in infrastructure is likely to grow, too. Beijing plows about 9% of its GDP into public works, compared with New Delhi’s 4%. And because of its authoritarian government, China gets faster results.”

America got most of its transcontinental infrastructure built by granting monopolies to various businesses. It then proceeded to break up those monopolies so that market forces could help run it. India has no such luxury and its political system is an anchor to its economic growth — or as Tom Barnett likes to say, “The engine can go no faster than the caboose.” Hamm says it’s not just the framework of government that is holding back India’s progress, it’s also corruption. He writes:

“Then there’s ‘leakage’—India’s euphemism for rampant corruption. Nearly all sectors of officialdom are riddled with graft, from neighborhood cops to district bureaucrats to state ministers. Indian truckers pay about $5 billion a year in bribes, according to the watchdog group Transparency International. Corruption delays infrastructure projects and raises costs for those that move ahead.”

All of this paints a bleak picture, but the news is not all bad according to Hamm:

“Fortunately, after decades of underinvestment and political inertia, India’s political leadership has awakened to the magnitude of the infrastructure crisis. A handful of major projects have been completed; others are moving forward. Work on the Golden Quadrilateral—a $12 billion initiative spanning more than 3,000 miles of four- and six-lane expressways connecting Mumbai, Delhi, Kolkata, and Chennai—is due to be completed this year. The first phase of a new subway in New Delhi finished in late 2005 on budget and ahead of schedule. And new airports are under construction in Bangalore and Hyderabad, with more planned elsewhere. ‘We have to improve the quality of our infrastructure,’ Prime Minister Manmohan Singh told a gathering of tech industry leaders in Mumbai on Feb. 9. ‘It’s a priority of our government.’ Singh, in fact, is promising a Marshall Plan-scale effort. The government estimates public and private organizations will chip in $330 billion to $500 billion over the next five years for highways, power generation, ports, and airports. In addition, leading conglomerates have pledged to overhaul the retailing sector. That will require infrastructure upgrades along the entire food distribution chain, from farm fields to store shelves. Envisioning a brand-new India is the easy part; paying for it is another matter. By necessity, since the country’s public debt stands at 82% of GDP, the 11th-worst ranking in the world, much of the money for these new projects will have to come from private sources. Yet India captured only $8 billion in foreign direct investment last year, compared with China’s $63 billion. ‘Having grandiose plans isn’t enough,’ says Yale University economics professor T.N. Srinivasan.”

Hamm provides a litany of horror stories from companies operating in India that have had to deal with infrastructure problems. With the risk of losing foreign direct investment to other developing countries, one would think that politicians would pay more attention. The problem, Hamm reports, is that enlightened politicians generally pay a heavy price (their elected office) for investing in the future instead of the present.

“While the laws of supply and demand would argue that India’s infrastructure gap can be filled, that logic ignores the corrosive effect of the country’s politics. To gain the favor of voters, Indian politicians have long subsidized electricity and water for farmers, a policy that has discouraged private investment in those areas. That’s what wrecked the now-infamous Dabhol Power plant. In the late 1990s, Enron, GE, and Bechtel spent a total of $2.8 billion building a huge complex near Mumbai capable of producing more than 2,000 megawatts of electricity. But a government power authority set prices so low that it was uneconomical for Dabhol to operate, and the whole deal fell apart. … Politicians who refuse to play the game pay a steep price. N. Chandrababu Naidu, the former chief minister of the state of Andhra Pradesh, transformed the state capital of Hyderabad from a backwater into a high-tech destination by building new roads, widening others, and aggressively carving out land for factories and office parks. Google, IBM, Microsoft, and Motorola have all built R&D facilities there. His reward? Voters tossed him out of office two years ago. During his decade in power, Naidu didn’t do enough for rural areas, and his challenger promised to channel state funds into irrigation projects and electricity subsidies.”

Even when projects are set up to help rural areas, where most of the voters are found, corruption can undermine them. The government is using a Development-in-a-Box™-like approach to get a handle on corruption.

“None of the solutions to India’s infrastructure challenges are simple, but business leaders, some enlightened government officials, and even ordinary citizens are chipping in to make things better. The most potent weapon India’s reformers have against corruption is transparency. Last October a new right-to-information law went into effect requiring both central and state governments to divulge information about contracts, hiring, and expenditures to any citizen who requests it. The country is also putting to work its vaunted technology prowess to police the government. Officials in 200 districts are using software from Tata Consultancy Services Ltd. to help monitor a government program that offers every rural household a guarantee of 100 days of work per year. Most of this labor goes into public works. To minimize “‘eakage,’ the TCS software tracks every expenditure—and makes all of the information available real-time on a Web site accessible to anyone.”

Another Development-in-a-Box-like approach, public-private partnerships, is also being put to good use.

“A key to getting massive projects off the drawing boards is forming public-private partnerships where the government and companies share costs, risks, and rewards. In 2005, India passed a groundbreaking law permitting officials to tap such partnerships for infrastructure initiatives. Developers ante up most of the money, collect tolls or other usage fees, and eventually hand the facilities back to the government. The first project to take advantage of the new law is the $430 million international airport scheduled to open next year in Bangalore. The facility is designed to handle 11.5 million passengers per year—nearly double the capacity of the overburdened existing airport. It will be owned by a private company, which will turn it over to the Karnataka state government after 60 years. Global engineering and equipment giant Siemens is helping to build the facility, and Switzerland’s Unique Ltd. will manage it. These companies are also equity investors. The state had to contribute just 18% of the cost. Without such an arrangement, Karnataka wouldn’t be getting a new airport. A lot of India’s hopes rest on the airport deal’s success. If it proves the viability of public-private partnerships, more such ventures could come pouring in. A visit to the site instills confidence.”

In other words, there is a mixed picture in India. Proper investment in education will guarantee a bright and hardworking labor force that will be attractive to businesses. Proper public/private partnership investments in infrastructure will make India a more efficient place to do business. Proper investment in good governance and transparency will make India a beacon in Asia and the hope of billions of people now struggling in poverty.