The Challenge of China and India

China and India are leading the way in the race for economic development, but their approaches are very different - what China is to manufacturing, India could well be to services. Together, they could usher in a broader and more powerful strain of globalisation that will put pressure on the developed world.

China's manufacturing-led impetus has been nothing short of astonishing. The industrial sector's share of Chinese gross domestic product rose from 41.6 per cent in 1990 to 52.3 per cent in 2003 - accounting for fully 54 per cent of the cumulative increase in the GDP over this 13-year period. The impetus that services have given to India's growth has been equally impressive. The services portion of Indian GDP increased from 40.6 per cent in 1990 to 50.8 per cent in 2003 - accounting for 62 per cent of the cumulative increase in the country's GDP.

But the strengths of China and India mask weaknesses in both economies. Industry's share of Indian GDP has been essentially stagnant at 27.2 per cent of GDP between 1990 and 2003. As a result, industrial activity has accounted for only 27 per cent of the cumulative increase in India's GDP over the past 13 years - literally half the contribution evident in China. At the same time, the services share of Chinese GDP rose from 31.3 per cent in 1990 to 33.1 per cent in 2003. Over the period, the expansion of China's services economy represented just 33 per cent of the cumulative increase in overall GDP - only a little more than half the contribution services made to Indian growth.

China has rewritten the classic script of manufacturing-led development. Four main factors have distinguished its industrialisation - a 43 per cent domestic savings rate, impressive progress in building infrastructure, surging foreign direct investment and a vast reservoir of hard-working, low-cost labour. By contrast, India's national savings rate is only 24 per cent; its infrastructure is in terrible shape; and its ability to attract foreign direct investment - which ran at only $4bn in 2003 - pales in comparison with the $53bn that poured into China in each of the last two years.

But these disadvantages have not stopped India. By opting for a services-led path, India has sidestepped the savings, infrastructure and FDI constraints that have long hobbled its manufacturing strategy. Its reliance on services plays, instead, to its greatest strengths: a well-educated workforce, information technology competency and English-language proficiency. The result has been a renaissance in IT-enabled services - software, business process outsourcing, multimedia, network management and systems integration - that has enabled India to fill the void left by chronic deficiencies in industrialisation.

China, on the other hand, is deficient in most private services - especially retailing, distribution and professional services such as accountancy, medicine, consultancy and the law. Exceptions in the services sector are telecommunications and air travel. Over the next five to 10 years, China's gap in services represents a huge opportunity. In the developed world, services account for at least 65 per cent of total economic activity - double China's current share. Expansion of a labour-intensive services sector could also fill an important employment need, as reforms of state-owned enterprises continue to eliminate 7m-9m jobs per year.

If China's manufacturing-led growth continues and India pulls off a rare services-led development strategy, the wealthy industrial world will face big new challenges. The theory of trade liberalisation and globalisation maintains that there is little to worry about. In the long run, the income workers make as producers should show up on the other side of the ledger as purchasing power for a new class of consumers, presenting opportunities to suppliers in the developed world.

The problem is that some of these basic assumptions are in serious question. In their simplest form, "open" economic models comprise two sectors - tradeables and non-tradeables. For rich, developed economies, the loss of market share in manufacturing to low-cost, developing nations is acceptable as long as there is a secure fallback to the non-tradeable services sector, which has long been shielded from international competition.

Yet now the knowledge-based content of the output of white-collar workers can be exported anywhere with a click of a mouse, the rules of the game have changed. Many services become tradeable, not only at the low end of the value chain - call-centre operators and data processors - but increasingly at the upper end where software programmers, engineers, accountants, lawyers, consultants and doctors work.

Services-driven development models, such as the one at work in India, broaden the global competitive playing field. As a result, new pressures are brought to bear on hiring and real wages in the developed world - pressures that are not inconsequential in shaping the jobless recoveries unfolding in high-cost wealthy nations. For those in the developed world, successful services- and manufacturing-based development models in heavily populated countries such as India and China - pose the toughest question of all: what about us?