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21 Jan 2008

China and India: Implications for the EU Economy

Daniel Gros

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This paper provides background information on the likely challenges the rise of China and India will pose for the economy of the EU. The purpose is mainly descriptive, namely to spell out what kind of trading partner China and India will represent for the EU in the foreseeable future. A first observation is that India is several times smaller than China in economic terms. Moreover, because its investment rates in both human and physical capital are much lower than in China, its growth potential is likely to remain more limited.
China already now exports more manufacturing goods than all other emerging markets together. But its export structure is also evolving rapidly and has become rather similar to that of advanced economies like the EU. This ‘convergence’ is likely the result of a very rapid accumulation of human and especially physical capital. If current trends continue, China will have a capital/labour ratio similar to that of the EU by the end of the next decade. In terms of human capital, China has already caught up considerably, but further progress will be slowed down by its stable demographics and the still low enrolment ratio in tertiary education. In both areas, India lags China by several decades.
The rapid accumulation of capital suggests that the emergence of China will put adjustment pressures mainly on capital-intensive industries, not the traditional sectors, such as textiles. Another source of friction that is likely to emerge derives from the abundance of coal in China, resulting in a relatively carbon- and energy-intensive economy.