India and China's challenge in the current financial crisis

In an earlier post on this blog, 'China and the "third Asian financial crisis"', it was noted that while the present is a global financial crisis nevertheless in Asia it has a further aspect.

Asia has passed through two extremely severe financial crises in the last thirty five years which had long term consequences for the region and therefore for the world economy. The first, starting in 1973, was the financial and economic crisis in Japan which culminated in the creation of the bubble economy of the late 1980s and the collapse in asset prices, deflation and economic stagnation which followed after the bursting of this bubble in 1990. The second was the 1997 currency and devaluation crash in South East Asia - which drastically slowed the former South East Asian 'Tiger' economies of South Korea, Hong Kong, Taiwan etc.

Through this period of the previous Asian financial crises, however, India and China escaped any major long term consequences. Far from slowing, their economies accelerated over the historical period during which these crises took place.

These trends are shown in Figure 1 in comparing the four largest Asian economies - China, Japan, India, and South Korea. The divergence in performance between China and India on one side and Japan and South Korea on the other is evident.

As may be seen, at the beginning of this period, in 1970, Japan and South Korea had annual rates of growth, taking the average for the preceding five years, of over 10 per cent - comparable to China and India's today. However Japan and South Korea's economies then drastically decelerated - Japan's growth rate falling to an average of one per cent a year in the mid-1990s and two per cent a year in the most recent period. South Korea's growth rate fell to around four per cent a year up to the most recent figures available.

In contrast, over the same period, India's growth rate accelerated from four and a half per cent a year to approaching nine per cent a year. China's growth rate accelerated from four and a half per cent a year to over 10 per cent a year.

Figure 1

In order to illustrate this more clearly Figure 2 shows the change in the annual average rate of growth for these four economies in comparison to their 1970 growth rates - again the figures are shown as annual averages for the preceding five years in order to eliminate any purely short term fluctuations. Over the period concerned India's growth rate accelerated by four per cent a year and China's by six per cent a year while South Korea's economy decelerated by six per cent a year and Japan's by eight per cent a year.

Figure 2

This, therefore, is the challenge which confronts both India and China as they enter the third great Asian financial crisis. The economies of both South Korea and Japan were lastingly decelerated by the previous two financial crises. The reasons, in both cases, was due to a sharp decline in savings and investment rates.

The challenge facing both India and China is to avoid the fate of Japan and South Korea - to maintain their very high savings and investment rates and therefore simultaneously maintain their capacity for very high sustained economic growth. Given the very large size of their economies, in realistic Parity Purchasing Power (PPP) exchange rates India is the fourth largest economy in the world and China the second, the recovery of the world economy out of the current financial crisis will in very large part depend on how well they succeed in maintaining these economic growth rates.