Ajit Ranade: It’s time to focus public spending on building human capital

livemint.com:

China’s extraordinary growth over three decades was fuelled by exports and domestic capital spending. At the peak, it enjoyed an 8% net export surplus consistently, which led to an accumulation of massive foreign exchange. On the other hand, its very high domestic savings rate was deployed to build infrastructure and expand industry.

These sometimes led to excesses which manifested, for instance, in the phenomenon of ‘ghost cities’ and the country’s current excess capacity for electric vehicles. But its export surpluses have continued unabated. Since much of its industry is state-owned, the profits accruing to capital were also a fiscal benefit, which were then generously invested in physical capital, leading to a high investment-to-GDP ratio.

There is a charge against China that its capital spending is wasteful, and returns on investment are inferior to world averages. On the other hand, India’s investment was comparatively frugal, but has had higher returns in terms of GDP growth. India is now poised to generate consistent high growth over multiple decades.

What is the optimal investment ratio for India and how can we achieve it? How much of China’s growth strategy can we emulate? There are many stark differences between the two in macroeconomic terms, even excluding the obvious political-economy factors, which are as follows. First, India has had a consistent trade deficit, which means that foreign capital is flowing in, adding to domestic investment. These inflows are just about 2-3% of GDP.

The rest has to come from domestic savings, which are much lower than in China. And that ratio has been falling, which is worrying. The second difference is in the large pre-emption of domestic savings by the state.