April 2011

Although it had a a lower income level than India in 1980, China's 2006 per capita gross domestic product stood more than twice that of India's. This paper investigates the role of the business environment in explaining China's productivity advantage using firm-level survey data. The analysis finds that China has better infrastructure, more skilled workers, and more labor-hiring flexibility than India, but worse access to finance and a higher regulatory burden. Infrastructure appears to be a key constraint for India: it lags significantly behind China. Labor flexibility is also likely a major constraint for India, as evident in the predominance of small firms. Interestingly, regulatory uncertainty has adverse effects in India but not in China. The empirical analysis suggests that it is important to consider country-specific growth bottlenecks and the indirect effects of policy reforms.