Policy Innovations Digital Magazine (2006-2016): Commentary: Democracy as Economic Strategy

With financial markets in the United States and Europe in turmoil, and China threatening to upend the dollar by attenuating Beijing's U.S. Treasury assets in its foreign exchange portfolio, investors are looking to minimize their risk. Does China's mercantilist dictatorship offer a better future than India's messy democracy?

During the Cold War, China and India were excluded in large part from international markets in which the United States, Western Europe, and Japan competed for limited demand. To counter overproduction and rectify trade imbalances, these three powers frequently resorted to managed trade regimes and imperfect international financial policy coordination.

But the Cold War is over, and China and India and other once-excluded economies are now integrated into international markets and supply chains. This transformation has resulted in the sustained expansion of global demand, inspired by a marriage of management skills and technologies from the advanced economies with abundant cheap labor in the emerging economies. China has enjoyed a successful economic take-off in this era without the need for domestic accumulation of capital and indigenous manufacturing technologies.

After 25 years of economic reforms, however, China is suffering from serious economic dislocations and an income disparity ratio of about 30 to 1 between the top and the bottom ten percent. Similar income gaps also exist between China's coastal and hinterland provinces, between urban and rural populations, and between the urban middle class and migrant laborers in cities. Prosperous enclaves of urban growth rely on a seemingly endless supply of cheap labor from rural areas in which about 60 percent of China's 1.3 billion people still live. 100 million to 150 million rural laborers float between villages and cities, subsisting on part-time, low-paying jobs.

China's income imbalances are exacerbated by a residence registration system that distinguishes between rural and urban householders, defining two de facto classes. This system once successfully managed rural-to-urban migration and avoided the slum formation typical of urbanization in the developing world. But China's booming cities exert an irresistible pull on the peasants who seek a share of the current prosperity. Furthermore, these migrants are increasingly resentful because, without urban household registrations, their access to municipal education, health, unemployment, and social services is denied.

India also has its own burden of vast rural populations that are unemployed, underemployed, or marginally employed. India's rural poor, 70 percent of its total population, account for a mere 17 percent of GDP. India's industries are adrift amid intense global manufacturing competition, due in part to the country's inferior socioeconomic infrastructure that holds little appeal for foreign direct investors.

Certainly, New Delhi is building a solid base in the information technology sector. Some Indian leaders even dream of leapfrogging the capital-intensive industrialization stage and moving directly to a knowledge-intensive service economy. In reality, however, India's IT sector still faces serious shortages of skilled software engineers for its own work, and thus is unable to effectively absorb and train armies of unskilled rural laborers for basic industrial tasks, much less educate them in complex information technologies. A leapfrog approach might create modern service-focused IT enclaves yet not generate much spillover in the broader rural economy.

India's legal and regulatory systems also discourage large-scale migration from the rural to urban sectors and favor those already employed, the urban middle class. New Delhi's political establishment has a strong relationship with urban organized labor. India's "labor aristocracy" is keen on preserving its vested interests at the expense of urban unorganized labor, wage earners in informal sectors, and rural laborers. Income redistribution isn't on India's policy agenda.

Neither Beijing nor New Delhi seem able to manage the potential for instability that results from the deepening structural imbalances in growth and wealth distribution. China's cities soon will be unable to accommodate the pressures from the floating migrant populace. India's problem is worsening, but at a much slower rate.

The bottom line is that China's political system lacks the built-in democratic processes needed to defuse such systemic stresses. Instead, the urban middle class is likely to allow itself to be co-opted by the authoritarian communist regime rather than push for the creation of a new democratic polity that would demand income transfers to the poor. The communist regime may endure for an extended period, but it flirts with a sudden implosion that would have a catastrophic impact on regional stability.

India's democratic process has a built-in capacity to rectify similar structural imbalances. Even the bottom castes make their voices heard in domestic politics and policymaking. In India's democractic context, its middle class is less able to reject fair reallocation of wealth and socioeconomic opportunities that benefit the rural poor majority.

Democracy is a crucial element of economic development that India enjoys, and China's stability will not be sustainable in the long term without it.