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Crouching Tiger, Hidden Dragon

The reports of the death of globalization have been greatly exaggerated, if investing trends in venture capital qualify as a compass for the future. According to a survey released June 10 by the U.S.-based National Venture Capital Association, half of the venture capitalists said they would increase investments in China and other Asian countries over the next three years, while 43% of those surveyed said they would invest more in India. (see the survey here)

Just 17% said North America would see more VC investment. A large number of VCs also expect an upswing in venture fund backers, usually financial institutions and wealthy individuals, coming from abroad. The overarching trend is clearly towards global investing.

Perhaps reflecting how the rest of the world views Asia, the survey has interesting choice architecture: India has been given a separate standing, while China and the rest of Asia are lumped together. It could have been the other way round, but isn’t. Putting aside compelling arguments derived from history and culture, the distinction also reflects the different economic growth models adopted by India on one side and the Asian tigers and China on the other.

Since Deng Xiaoping ushered in socialism with Chinese characteristics, Asia’s dragon has established itself as the epicenter of global manufacturing, winning accolades for its efficient factories and seamless infrastructure. In the 1980s, the rise and dominance of Japan was conventional wisdom, and China didn’t really dominate the public discourse. The Chinese state, rather than the citizenry, has catalyzed this transformation, driven by massive public investment.

India’s development has been more organic, with entrepreneurs usually growing their businesses despite the government rather than because of it. The founder-CEO of a leading India-based power equipment manufacturer once recounted to me how the government hindered his business and powerful bureaucrats extracted rents every step of the way, from the stage where the product left the factory in trucks to the point where it was loaded into containers at ports. The process made a business manager a “pehelwan” or a strong wrestler able to deal with any eventuality, he said. In China, he added, the government assists rather than hinders enterprise.

Indian entrepreneurs have to beat their competitors and deal with a government that is not the most enterprise-friendly. In an almost Hayekian way, some of India’s self-created barriers to entrepreneurship have made Indians entrepreneurs that much more hardy and competitive, mirroring the aspirational urge of India’s people.

Besides offering a large labor force of English-speaking people and a democratic system, India is also far more capital efficient than China. Since the early 1990s, India has invested about 25% of GDP and obtained an average GDP growth rate of about 6%, while China has invested over 50% of GDP and obtained an average growth rate of 9%.

India is a better capital allocator, requiring four units of capital to generate one unit of output, while China consumes about 5 units of capital to generate 1 unit of output. As economist Niranjan Rajadhyaksha puts it, capital efficiency is the reason why India has “few good roads but many world-class companies.”

For investors, return on invested capital is the metric to watch, and India widely outperforms China on this metric. To make itself an even more attractive investment destination, India has also started taking steps to reform higher education, a key ingredient to drive economic growth through technology and innovation.

China has invested relentlessly in education over the last three decades, and the seed for change was sown by Deng Xiaoping himself, who resumed in 1977 the Gao Kao entrance examination system suspended by Chairman Mao. University student enrollment has grown nearly 50% and the number of universities has doubled since 2002. In the meantime, India has only succeeded in creating special interest groups competing for admission into premier colleges based on identity rather than merit, and starved its citizens of world-class universities to the point that more Indian youth study abroad than any other nation.

Education Minister Kapil Sibal has spoken at length on re-organizing the higher-education institutional framework at all levels and reducing government control on education. He sounds like he means business.

From purely a development standpoint, India needs more investment from abroad in the form of both foreign direct investment and venture capital than China does. Global investors are eager, and Indian entrepreneurs have demonstrated that they are a cut above the rest. It’s now up to the state to ensure that it doesn’t fritter away the merit of the Indian entrepreneur.

The crouching tiger might spring a surprise.

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