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Financial Crisis May Worsen Poverty in China, India

Author: Jayshree Bajoria
November 20, 2008
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Introduction

By year's end, the impact of the global financial crisis of 2008 was starting to be felt in the developing world, with slowdowns expected in all emerging economies. These growth declines could have significant effects on the world's poorest populations. The World Bank estimates that a 1 percent decline in developing country growth rates traps an additional 20 million people in poverty. Concern centers on slowing growth in India and China, the world's two most populous nations and the largest contributors to reductions in global poverty in the last two decades, according to many academic studies. Reduced economic growth in both countries could reverse poverty alleviation efforts and even push more people into poverty, say some experts. The financial crisis has also likely made the achievement of the United Nations' Millenium Development Goals (MDGs) on poverty--to halve the proportion of people in extreme poverty by 2015--more difficult.

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The Poverty and Hunger Challenge

With an average annual growth rate of 10 percent, China has lifted over 600 million of its 1.3 billion citizens out of extreme poverty--those who earn less than $1 a day--since 1981. In the same time period, India's 6.2 percent average annual growth rate has brought an estimated 30 million out of its 1.1 billion people out of extreme poverty. But an estimated 100 million Chinese and more than 250 million Indians remained under the extreme poverty line in 2005, according to the latest World Bank poverty estimates (PDF). Roughly 470 million Chinese and 827 million Indians earned less than $2 a day, the median poverty line for all developing countries. Though some economists say World Bank figures understate the true extent of poverty, there is broad agreement that a slowdown in China and India will harm poverty alleviation goals. The administrator of the UN Development Program (UNDP), Kemal Dervis, warned in October 2008 that together with volatile food and fuel prices, "current global economic conditions threaten the gains that have been made to reduce poverty and advance development for large numbers of people."

The World Bank estimates that a 1 percent decline in developing country growth rates traps an additional 20 million people in poverty.

In the developing world as a whole, economists say that soaring food and fuel prices were already placing strain on the poor prior to the onset of the financial crisis. The UN World Food Program estimated in September 2008 that there are 850 million chronically hungry people in the world, a tally that could increase by 130 million this year (PDF). The World Bank estimates that the number of poor increased by at least 100 million as a result of the food and fuel crises. It argues that declines in food and fuel prices in late 2008 have not solved the problem. According to its November 2008 report, the poorest households were "forced to switch from more expensive to cheaper and less nutritional foodstuffs, or cut back on total caloric intake altogether, face weight loss and severe malnutrition."

The poor in India and China, like the rest of the world, have also been affected by the rise in fuel and food prices. For India the problem is especially vexing. The 2008 Global Hunger Index of the International Food Policy Research Institute says India already suffers from alarming levels of hunger, and is one of  three countries with the highest prevalence--more than 40 percent--of underweight children under five.

The Specter of Growing Inequality

The financial crisis could worsen the existing high levels of inequality in China and India, say experts. As this Backgrounder points out, despite unprecedented levels of economic growth in India and China, there is increasing geographic, sector-based, and income inequalities within each country. Benefits from growth have failed to trickle down to significant segments of each population, especially in rural areas. Biplove Choudhary of the UNDP's trade program says growth does not directly translate into poverty alleviation. Experts say gains from growth in India and China should be better channeled into areas that most uplift the rural poor, such as spending on health, education, and infrastructure.

Yet sharply tighter credit conditions and weaker growth are likely to cut into governments' abilities to invest to meet education, health, and gender goals, hitting the poor the hardest, says the World Bank. An October 2008 report on global income inequality by the International Labor Organization says income inequality, on the rise in most regions of the world, is expected to increase due to the global financial crisis.

China, with its current account surplus and nearly $2 trillion in foreign reserves, is better placed than India to continue long-term investments in infrastructure and social-welfare initiatives. In November 2008, the Wall Street Journal reported that as many as half of India's planned highway-improvement projects, valued at more than $6 billion, could be delayed as much as two years. India is especially hard-hit, it says, because it had expected private investment to fund around half of the more than $100 billion a year in planned infrastructure development.

Threats to Political and Social Stability

Falling employment and increasing poverty levels may precipitate political and social troubles in India and China. For more than two decades, China's Communist Party has used economic reforms as a source of legitimacy for its rule, even as it resists political freedoms and tries to rein in dissidents in the autonomous regions of Xinjiang and Tibet. But if a decline in growth slows the rate of economic reforms, it could threaten the party, say experts. CFR International Affairs Fellow Brian P. Klein writes in the Far Eastern Economic Review that social unrest could spike if China's annual growth rate falls below 8 percent, a level of growth inadequate to create the number of new jobs required.

A slowdown in exports contributed to the closing of at least 67,000 factories (NYT) across China in the first half of 2008, prompting laid-off workers to take to the streets in protest. Joshua Kurlantzick of the Carnegie Endowment for International Peace's China program writes in the New Republic that so far China has kept the labor protests separate from one another, preventing them from developing a common theme or a common leader. "But if China's downturn turns into an outright recession, the country could face its first serious threat to the regime," he warns.

"It's probably better to be a poor person in China than India" - Adam Segal, CFR senior fellow on China studies

According to the International Monetary Fund's (IMF) 2008 world economic outlook, China's gross domestic product (GDP) growth is expected to fall from 11.9 percent in 2007 to 9.3 percent in 2009. Adam Segal, CFR senior fellow for China studies, says the Chinese government's announcement of a $586 billion stimulus package in November 2008 shows how worried leaders are. "This is the first serious slowdown for China in thirty years," he says, adding that the government knows that to maintain social stability, it must keep generating employment for those migrating from rural to urban areas. In an October 2008 meeting with Singapore's prime minister, Chinese President Hu Jintao acknowledged the need for sustained economic reforms. He said the country will sustain its economic and social stability by "transforming the economic growth pattern, restructuring the economy, attaching more importance to agriculture, and taking regulatory measures."

In India, no one is going to be satisfied with a growth rate lower than what they have come to expect in the last ten years, says Arvind Subramanian, a senior fellow at the Peterson Institute for International Economics. The IMF projects India's growth will fall from 9.3 percent in 2007 to 6.9 percent in 2009. "Not meeting expectations poses a problem for policy," he says, adding that the government is sensitive to this and has already cut interest rates and pumped liquidity into its capital markets to sustain investment. But in India, the threat is different than the one faced by China, says Segal. India, a diverse, multiethnic, multifaith country, has always struggled with a degree of social instability as various minority groups seek redress against discrimination. Instability may rise as the country goes to the polls early next year and opposition groups try to take advantage of the financial crisis to highlight the government's deficiencies, say experts.

Stimulus and Questions Over Trade

Some economists say both China and India, with their relatively insulated financial sectors, are better positioned than many other developing economies for a quick recovery from the current crisis. The governments in both countries have responded with a slew of measures. India has undertaken a balancing act of easing the central bank's key lending rate to increase liquidity in the markets while moving to tighten monetary policy in other areas to stave off inflation. China, with its focus on economic growth, has announced several stimulus policies. The biggest by far is a $586-billion package slated for investment over the next two years in a number of sectors, including low-income housing, rural infrastructure, water, electricity, transportation, technological innovation, and earthquake reconstruction. Analysts see this as a step in the right direction.

China's top-down governance structure gives it a greater ability to mobilize resources and implement policies faster, says experts. CFR's Segal says "it's probably better to be a poor person in China than India" because of China's ability to spend on projects that could provide immediate relief to the poor. In India, taking steps through a democratic system makes the response time longer in such a crisis. India also lacks the ability China has to respond with direct cash transfers.

Some economists are worried about the impact on poverty reduction if the current financial crisis spurs protectionism, undermining free trade policies. In November 2008, the Indian government, in response to a fall in global commodity prices , imposed a 5 percent import duty (Bloomberg) on a range of iron and steel products, and slapped a 20 percent duty on crude soybean oil imports to protect domestic producers. India and China have also been called upon to agree to the World Trade Organization's Doha development agenda, dealing with a range of international trade reforms, including some in the agricultural sector. In July 2008, the seven-year negotiations reached a stalemate when India and China refused to compromise over measures to protect farmers in developing countries from greater liberalization of trade. But leaders attending the G-20 summit on the financial crisis in November 2008, which included India and China, promised to refrain from protectionist measures in the next year, and called for each country in the group to make "positive contributions" to a successful conclusion of the Doha round.

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