In this manuscript, we determine the sources of historic growth for the economies of India and China. Next, we estimate potential GDP growth for each country. The study concludes that India is more favorably positioned for long-term growth than China with a higher steady state growth rate. It is a large accumulation of capital or capital deepening, rather than improvement in the efficiency of capital that is driving the Chinese economy. Growth based on capital deepening as evident in China is not sustainable over time. Growth in India, in contrast, is very balanced as all major sources of growth (capital, labor and technology) contribute significantly to growth. Most positive for India was the fact that total factor productivity (TFP) growth in India was significantly higher than in China.
Putting it all together: Estimating Potential GDP
There are three approaches used to estimate potential GDP. First, the growth accounting equation is used to measure potential
output. Potential GDP (Y) is estimated using Equation 1 with trend estimates of labor (L) and capital (K) and a estimated as one
minus the labor share of GDP. The challenging task is estimating the growth rate of TFP (A), which, by definition, is a residual in
the growth accounting equation.