By
CNBC
updated 3/30/2004 3:11:12 PM ET 2004-03-30T20:11:12

The North American Free Trade Agreement created a trading block made up of the U.S., Canada and Mexico, and the European Union has joined powerful countries like Germany, France and Italy. But imagine an economic block made up of 40 percent of the world’s population and the two fastest-growing economies. That's what you would have if India and China joined forces.

The India-China equation is a good deal more complicated than that, but the comparison is a natural one, especially for Western companies and investors wondering where to put their money. But while these two growing economic powers are natural allies, they are also historical rivals.

With more than than two billion people between them, India and China are the world’s two most populous countries.

“We’re talking about almost half the world population,” said Harvard Business School professor Tarun Khanna. “Not quite, but close.”

The two countries have common borders and common problems. They boast economic growth rates of between six and nine percent, making them natural competitors for foreign investment and trade.

“Both nations are full of very enterprising people who are willing to grow from nothing into something,” said Ratan Tata, who heads a family conglomerate that touches almost every commercial sector in India

They are also increasingly well-educated and politically ambitious.

“These are two countries that are both conscious of their ancient civilization and history, their ancient economic prowess, and are beginning to think they deserve more attention on the world stage,” said Khanna.

Unequal growth
A quarter century ago, India and China were on similar economic footing. They have grown remarkably, but not equally.

“India’s GDP is about $500 billion,” said Joelle Chassard, at the World Bank. “But if we compare with other countries, it will look very small. China’s GDP, for example, is two and a half times that of India.”

China has also far outpaced India in attracting foreign direct investment, which fuels growth.

“China’s just getting a huge volume of foreign investment, compared to India,” said Joydeep Mukherji, a credit analyst with Standard & Poor’s, and an expert on Asia. “The official numbers are about $50 billion a year. India on the other hand is around $4 billion or $5 billion a year, which is around one-tenth the foreign investment as China.”

That foreign investment has helped give China one of the fastest growth rates in recorded history. According to S&P’s Mukherji, China was able to lift 200 million of its people out of poverty during the 1990’s.

Growth also means more capital available for improvements in infrastructure, another area in which China leads and India languishes. But China still has its problems.

Mukherji sees a massive cloud of debt on the Chinese horizon, estimating that up to 45 percent of the total loans Chinese banks have made may go unpaid. India, meanwhile, has some formidable advantages.

India's democracy may be critical
The state’s high court is located here in Bangalore. There have been a number of key elements in India’s growth, but among the most critical is that it is a democracy with a well-established, independent judiciary.

“Where India is really a runaway success compared to China is on freedom of expression, democracy, the role of the media, just the vibrant role of the people to express themselves and think of things to do and be creative,” said Khanna. “And that of course is not unrelated to entrepreneurship.”

India’s democratic institutions make companies considering investment more comfortable there than in totalitarian or authoritarian countries. Normal business risks are tempered by the presence of independent courts, politicians, and a free-speaking media, all in a country where millions are fluent in English.

But foreign investors in India will still face a sometimes slow and well-entrenched bureaucracy.

“If you have a government with 24 parties in the coalition governing the country — you can’t get 24 people in your company to agree on something, try to get 24 parties to agree on a difficult political decision,” said Mukherji .

Both India and China desperately need foreign investment. For now, the balance of money for manufacturing is going to China, while India is getting more than its share of highly skilled, white collar work.

Their relationship may be marked by rivalry, but some foresee a day when the two could combine to form an economic juggernaut rivaling any in the west.

“A lot of people talk about India versus China,” said Shirish Sankhe at McKinsey & Co. “I would just like to turn that around and say it’s not India versus China, it’s India and China. I think there is enough potential and growth in the world as well as in the country that both countries can co-exist.”

© 2012 CNBC, Inc. All Rights Reserved

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