Development Bank Research Bulletin

China and India: Who is hot in 2006? What do investment banks think?

Most investment banks have already released their forecast of GDP growth rates for India and China. Let’s see what they think about these two competitors’ prospects in 2006.
I find only three major investment banks that have released forecasts on both countries. They are Deutsche Bank, Citigroup, and Morgan Stanley.

Deutsche Bank always has no preference!
Deutsche Bank forecasts that China’s GDP will grow at 9% in year 2006, while India will grow at 6.9%. This creates a 2.1% growth gap. Both numbers are almost the same as the consensus in the market. This is not the first time; I have to mention that last year DB did the same thing. DB always agrees with the consensus view!

Citigroup loves Indian foods!
Citigroup however thinks the gap should be smaller. Citi predicts that China will grow at 8.7%, while India at 8.1%, which produces a merely 0.6% gap compared to DB’s 2.1%. I have to mention that Citi’s 8.1% forecast of India's year 2006 GDP growth is the highest among all major IBs. Their forecast of 7.5% for last year also was the highest. Citi does love Indian foods!

Morgan Stanley does not like Asian foods!
Interestingly, Morgan Stanly is very pessimistic about both India and China. Morgan Stanley thinks China will grow at only 7.8% while India at 6.6%. Among all major forecasters who have released numbers for China and India, Morgan Stanley’s forecast is the lowest. Last year MS also was the most pessimistic about the two countries, and missed the target by wide margin. They must have some private information and hard evidence backing their persistent opinion. I will try to find it out and share with readers in the next weeks.

Credit Suisse, Goldman Sachs, and BNP Paribas loves Chinese foods!
Finally, Credit Suisse, Goldman Sachs, and BNP Paribas are quite optimistic about China. They think China will grow at 10.1%, 9.6%, 9.5%, respectively, in year 2006.

Well, it is always to interesting to reexamine at the end of year 2006 how accurate their bets were. Please do remind me to do that.

Some reference readings on investment banks' views on China vs. India:

Morgan Stanley's Report: Indian and China: a special economic analysis
Deutsche Bank's Report:  China and India Chartbook: a visual essay

Why do the world’s richest always have better-looking children? The example of Mittal family

A widely-received explanation is that: the statistical odd of a rich man marrying an equally rich woman is slim; and for a woman from a poorer background to marry into a rich family, she is at least over-average in terms of looks. Thus their children will inevitably become better looking than their farther, thanks to their mother’s genes. Let me illustrate this with the example of Mittal family. The family head Lakshmi Mittal is the world’s third richest man, and the richest Indian.
Here is his picture:
   
And here are pictures of his son Aditya Mittal and daughter Vanisha Mittal. Apparently, they must have a very beautiful mother.

Below are pictures of Aditya Mittal with his wife and Vanisha Mittal with her husband. I am very sure Lakshimi’s future grandchildren will be even more good looking.

And don’t forget that Lakshmi Mittal’s initial wealth was inherited from his farther Mohan Lal Mittal, also a rich man; We can comfortably guess that Mohan Mittal could be much less good-looking than his son Lakshmi (although I am not able to find Mohan's photo through google).

Bottomline: It takes generation to improve the gene of a family!

+2000 years of Chinese trade surplus: a history lesson

“China, a vortex for the world's gold” is an intriguing article by Keith Bradsher (NY Times) on ancient history of Chinese trade surplus. Chinese reserves of foreign currency already exceed $800 billion, up from just under $4 billion in 1989. But it is nothing new if we travel back in time for 2000 years.

“Ancient Rome, for example, found that it had little except glass that China wanted to buy. Nearly 2,000 years ago, Pliny complained about the eastward flow of Roman gold along the Silk Road in exchange for Chinese silk.”

“...from A.D. 600 to 750, from 1000 to 1300 and from 1500 to 1800 - China again tended to run very large trade surpluses. By 1700, Europe was paying with silver for as much as four-fifths of its imports from China because China was interested in little that Europe manufactured.”

And history suggests that Chinese products will remain very cheap despite huge trade surplus and “appreciation” of money.

“A longstanding mystery for economic historians lies in how so much silver and gold flowed to China for centuries for the purchase of Chinese goods yet caused little inflation in China. Many of China's manufactured goods remained much cheaper than those from other countries until the early 1800s, despite the rapidly growing supply of silver in the Chinese economy. One theory is that Chinese output was expanding as fast as the supply of precious metal. Another is that the Chinese were saving the silver and gold, not spending it.”

British Empire worked out a way to maintaining a large long-term trade surplus with China by getting Chinese addicted to imported opium. In the twenty-first century, however, we have a better solution:  Chinese invest much of its foreign currency reserves in U.S. Treasury securities or mortgages on American homes.

On thing I am very sure: we should always try to learn from history. Let me tell you a story.

A famous historian, Niall Ferguson,  was talking to a mid-ranking official in the US Treasury about American plans for the post-war reconstruction of the Iraqi economy. She had just attended a meeting on precisely that subject. "So what kind of historical precedents have you been considering?" Prof. Ferguson asked. "The post-Communist economies of Eastern Europe," she replied. "We have quite a bit of experience we can draw on from the 1990s."

Well, she obvious is not aware that British used to invade Iraq more than 80 years ago.

"What happened in Iraq last week so closely resembles the events of 1920 that only a historical ignoramus could be surprised. It began in May, just after the announcement that Iraq would henceforth be a League of Nations "mandate" under British trusteeship. (Nota bene, if you think a handover to the UN would solve everything.) Anti-British demonstrations began in Baghdad mosques, spread to the Shi'ite holy centre of Karbala, swept on through Rumaytha and Samawa - where British forces were besieged - and reached as far as Kirkuk.Contrary to British expectations, Sunnis, Shi'ites and even Kurds acted together. "

Prof. Ferguson has to reach a conclusion in his op-ed "This Vietnam generation of Americans has not learnt the lessons of history" that:

"For many Americans - including the Democratic contender for the presidency, John Kerry - the only history relevant to American foreign policy is the history of the Vietnam War."

Chinese Dream: inequality of prosperity vs. equality of poverty

There are a lot of concerns about China’s income disparity between costal provinces and inland provinces. Let me show you why we shouldn’t worry TOO MUCH about it (we do need to worry about it though, and we definitely need to come up with solutions; but don’t’ worry too much or go against natural laws).

Some stylized facts for our readers:

50% of World's population and 67% of World's GDP are within 100 KM of an ocean or a river that is navigable as far as the sea. In Japan, 97% of population live within 100 KM of coast. In Europe, 89%, live within 100 KM of coast or ocean-navigable waterway. The ratio is 65% for the United States.

Thus it is natural that income disparity will always exist between costal region and inland of China, because you are naturally disadvantaged if you reside in inland areas.

You will certainly question me: why is the income disparity that huge in China then? Americans residing in inland are relatively poor but the gap is not as large as that is found in China.

The reason is population density. Starting more than 1,000 years ago, Chinese migrated westward and southward for new lands, and eventually the population density in these new-found lands becomes as high as where Chinese were originated. So long as the population density in inland region is higher than what its geography can support, you will have lower standard of living there; At least you have to try much harder.  American inland income level will go down substantially too if Mountains states have to support the same level of population density as in New England. There can only be several Las Vegas.

The only solution to this is migration of labor, as well as increase of accommodation capacity in already densely-populated costal area through better planning.  In Japan, the government does manage to increase population density in Tokyo bay area without compromising too much in environmental protections.

For the past twenty years, high geographic and social mobility in China has been a great weapon in combating poverty and social unrest. 

Believe it or not, most of China’s middle class and new rich were born in inland countryside. They left their stifling hometown and headed for costal cities.  There are few opportunities in inland usually not because of high transport costs. It is more a culture thing, that inland people are relatively isolated and have less exchange with outsiders, as a result, through generation after generation’s cultural reinforcement, they become  less open-minded and less flexible, which is very bad in today’s commercial world.  Many inland Chinese who get successful in cities are unwilling to return because they really hate the gossiping and equalitarian culture back in their hometowns. Such culture really kills talented people.

Some leave by attending colleges in cities, thanks to the standardized college entrance exam which is probably the last area of the system that is not yet corrupted. Even the most totalitarian emperors in Chinese history dared not to abort or corrupt the exam system, because by doing so you are closing the route of social mobility and you are calling for grassroots uprisings.

Those who are less intelligent usually start  as laborers in construction sites in big cites, save some money, start small businesses, grow bigger. They are advantaged because they are more hard-working than those born in cities, and can take any pains in the process (what kind of pains and humiliations can be greater than returning to their hometowns without getting rich)

Whichever routes they take, they settle in cities, and within one generation of sacrifice they place their children on the same starting point as those who were born in cities. We talk about American dream, and this is Chinese dream!

We rarely notice such high social mobility in China because once these country folks settle in cities they blend with the other people and most of them are unwilling to reveal their original roots. Most of them deep down still feel inferior. 

This doesn’t matter though, so long as the system has provided paths for inland people to step up the social ladder.  It is the fact that most senior officials in all levels of government and businessmen in the Forbes list of richest Chinese were born in countryside.

World Bank’s “ World Development Report 2006: Equity and Development” calls for equality, but isn’t inequality of wealth through personal hardworking more beautiful than equality of poverty through government intervention.

World Bank president Jim Wolfonson realizes this too, and write down some important caveats in the introduction page in case the message of the book get mis-interpreted.

"The history of the twentieth century is littered with examples of disastrous policies which were promoted in the name of equity or equality, and the results of which were ruinous. No policy that pursues equity without respecting market-based individual incentives for prosperity is likely to succeed. The joint pursuit of equity and prosperity must therefore be cognizant of the primacy of individual freedoms, and of the role of markets in allocating resources"

It is more profitable to lend to “priority sector” in India?

According to a report in Indian Times, Chennai-headquartered Indian Bank is making very good profits in so-called “priority sector”(agriculture, backward areas, women-owned businesses, etc), to which other banks are willing to lend only when forced to by the government.  According to another report in Hindu Business Line,  many banks actually have to buy loans from public sector banks in order to meet the government-set target of priority sector lending.

Thus the news sounds too good for me to believe ( I checked my calendar and today is not April the First). The report doesn’t give details on how they manage to do it, but I think we definitely need to learn from them if it is true.

“At a time when most banks are fighting for market share in corporate/SME business, Chennai-headquartered Indian Bank is betting big on priority sector lending.  Against the mandated 40%, this bank’s priority sector portfolio accounts for 51% of its advances. “Our experience of lending to priority sector has been good. Non-performing assets (NPAs) in agriculture, for instance, account for less than 2% of that portfolio. The average net interest margin (NIM) is around 4% which is much higher than what we would get by lending to corporates,” says KC Chakrabarty, the bank’s CMD.”

How do they do it? If any readers know about articles about the experience of Indian Bank's lending to priority sector, please let me know. I'd like to look into it.

What determine turnovers of China’s provincial bosses? Evidence from historical data

It is widely believed that personnel decisions within China’s bureaucracy system are all based on connections, office politics, and dirty techniques. Serious examination of historic data reveals that the system is more sophisticated and meritocratic than it seems to be.

Professors Hongbin Li and Li-An Zhou at the Chinese University of Hong Kong study turnover data of top provincial chief in China between 1979 and 1996, and find that the likelihood of promotion of provincial leaders increases with their economic performance, while the likelihood of termination decreases with their economic performance.

Obviously, the central government uses such institutionalized rule to promote desirable local economic outcomes. They also find that the central government always evaluates the average performance over the provincial boss’s whole tenure rather than the performance in the year when the decisions were made.

GDP-based promotions have the negative side. The fastest way to push up GDP is through public investment, while the last thing you need to care is pollution. This is exactly why the central government is recently emphasizing the so-called "Green GDP".

They published the findings in the Journal of Public Economics, a top journal in the field.

Political Turnover and Economic Performance: The Incentive Role of Personnel Control in China
Abstract: In this paper, we provide empirical evidence on the incentive role of personnel control in post-reform China. Employing the turnover data of top provincial leaders in China between 1979 and 1995, we find that the likelihood of promotion of provincial leaders increases with their economic performance, while the likelihood of termination decreases with their economic performance. This finding is robust to various sensitivity tests. We also find that the turnover of provincial leaders is more sensitive to their average performance over their tenure than to their annual performance. We interpret these empirical findings as evidence that China uses personnel control to induce desirable economic outcomes. Our study adds some basic evidence to a growing theoretical literature emphasizing the role of political incentives of government officials in promoting local economic growth.

Colonialism is good for colonies: empirical evidence

Is colonialism good or bad? Professors James Feyrer and Bruce Sacerdote at Dartmouth College put up some hard data to shed some new light on this debate. They collect meteorological (wind speed, direction, etc), historical, and socioeconomic data for a large cross-section of islands. Based on the data, they find that the number of years spent as a European colony and the density of settlement by Europeans is strongly positively related to the island's GDP per capita and negatively related to infant mortality.

They also show that colonizers’ cherry-picking (i.e. they chose better islands to settle) did not cause the results. Instead, wind direction and speed decides where Europeans settled first, which suggest that there is some positive causality betwween colonial rules and socioeconomic outcomes.

Another surprising result is that, French islands appear to outperform British, Spanish, Portuguese and Dutch islands. Well, that’s quite an achievement considering that French are not good sailors.

Is Colonialism Good For You? Evidence From A New Database of Islands
We use a newly assembled database of islands throughout the Atlantic, Pacific and Indian Oceans to ask whether colonial origins affect economic growth and health outcomes. The number of years spent as a European colony and the density of settlement by Europeans is strongly positively related to the island's GDP per capita and negatively related to infant mortality. We show that an island's discovery by Europeans and subsequent settlement is related to the prevailing wind patterns. We instrument for length and type of colonization using wind direction and speed. We argue that wind patterns which mattered a great deal during the age of sail do not have a direct effect on GDP today, but do affect GDP via their historical effects on colonization. Which European country does the colonization and settlement appears to be less important than length of time spent as a colony. French islands appear to outperform British, Spanish, Portuguese and Dutch islands.

Niall Ferguson in his column in the Telegraph, is more explicit about this in his article “Africa doesn’t need handouts; it needs honest governments”

“Nobody, least of all me, claims that British imperial rule was perfect. But most sub-Saharan governments since independence have managed to treat their populations significantly worse than the British did. For all its imperfections, the Colonial Civil Service was not corrupt. When money was sent to build railways or schools, British officials did not simply pocket it”

He further provides evidence that most of the aids sent to African countries after their independence were simply looted by the local elites.

“Between 1950 and 1995, Western countries gave away around $1 trillion (in 1985 prices) in aid to poorer countries....... much of the money that has poured into poor countries since the 1950s has simply leaked back out - often to bank accounts in Switzerland. One recent study of 30 sub-Saharan countries calculated that total capital export for 1970-96 was some $187 billion, which, when accrued interest is added, implies that Africa's ruling elites had private overseas assets equivalent to 145 per cent of the public debts their countries owed. The authors of that study conclude that "roughly 80 cents on every dollar borrowed by African countries flowed back [to the West] as capital flight in the same year".

I think the original title of Ferguson’s article was  “Africa doesn’t need handouts; it needs Europeans governments”, and the editors of The Telegraph changed the title for political correctness reasons.

China in the eyes of fifty American MBA students

Americans, MBA students, China,  first-time visit... I guess these keywords already caught your attention, and out of question they provide perfect materials for blogging. As a matter of fact, now you can find them in EMBA China Blog 

During May, 2005,  students from the William and Mary College's Executive MBA class travelled to Beijing and Shanghai China for 12 days. After the trip, students started the EMBA China blog in which they posted their impressions and "take aways" from their visits with companies and government officials. These articles, mixing detailed experiences with personal analysis, are extremely interesting and some of them very insightful. Let's do a China trip without paying for the air fares!

Indian state-owned banks introduce performance-linked incentive packages for employees: the true story

According to a report in today’s Business Standard, India’s finance ministry decided on a reform plan to improve efficiency in state-owned banking sector. In the plan, not only the chairmen and executive directors but also ordinary employees are entitled to  performance-linked incentive packages.

“Heads of 29 public sector banks are set to get a performance-linked annual incentive package. Besides, all of them will get a lumpsum ex-gratia payment on retirement, depending on the number of years they put in as directors on bank boards.  Down the line, close to 800,000 employees in the public sector banking industry, too, will get incentives, based on their performance in five key areas.”

Five parameters are considered to determine the size of annual bonus,  which includes “credit growth, deposit mobilization, quality of assets, and recovery of non-performing assets.” (The report mentions only four parameters though).

I don’t think such design can help achieve the efficiency goal.

First of all, credit growth and deposit mobilization has nothing to do with efficiency; to the contrary, for India, faster credit growth and deposit mobilization  in state-owned banks actually reduce financial stability and crowd out efficient investment (as state-owned banks typically use the deposits to purchase government bonds instead of to invest in good projects).

Secondly, the “incentive” package is not linked to individuals’ performance but the performance of the whole bank. No employees will work hard to improve quality of assets or to recover non-performing loans, because (1) if he works hard, his colleagues in all branches across India can free-ride on the results as well (2) if he doesn’t work hard, he can still receive bonus pay so long as his colleagues work hard (3) knowing this, no one work hard.

There are restrictions on the total size of the incentive package: “The maximum amount a bank can pay to employees through this route will be capped at 1 per cent of a bank’s profit after tax (PAT).”  Nevertheless, no details are given regarding what fractions of this 1 per cent will be allocated to ordinary employees. Theoretically, all of them may be allocated to the CEO, which did happen in many corrupted countries when they introduced so-called “employee” incentive package. As a matter of fact, I also notice that: “Financial incentives given to chairmen and executive directors will be outside the cap (1 per cent of PAT) applicable to bank employees.”  Ha, I caught you!

I speculate that the plan is drawn up simply for the purpose of legally tunneling money from the state treasury to chairmen and executive directors of state-owned banks.

China Leadership Monitor : an authoritative source on current Chinese polices

For those who are interested in latest development in China’s foreign and domestic polices, I recommend to you this quarterly online magazine called "China Leadership Monitor", which is published by the Hoover Institute at Stanford University. Stanford has always been one of the centers of China studies, and the China Leadership Monitor has put together a very good team of China experts.

The Monitor’s analysis rests heavily on traditional China-watching methods of interpreting information in China's state-controlled media. Although the use of these methods has declined as opportunities to study China using other approaches have opened up in recent decades, their value in following politics among China's top leadership has not.

The editor is Professor H. Lyman Miller. From 1974-90, Miller worked in the CIA as a senior analyst in Chinese foreign policy and domestic politics, and branch and division chief, supervising analysis on China, North Korea, Indochina, and Soviet policy in East Asia. After quitting from CIA, he joined John Hopkins University as a professor, and currently he is a associate professor at Naval Postgraduate School. He speaks fluent Chinese.