The resilience and attendant growth of both China and India, especially after the financial crisis, has been the subject of much attention. Both are enormously populous and by far the fastest growing major economies. And now after decades of inspirational double digit growth, China’s economy is showing signs of slowing to around 6 per cent and is likely to remain around this level till 2025. This growth, referred to as the ‘new normal’ is a far cry from the impressive record of expansion witnessed in China for over two decades. During the period of runaway growth, China served as an engine for global growth, a role that the United States had played for decades before the Chinese surge. The comparison is compelling but with one vital caveat.
The Chinese manufacturing burst beginning 1990s coincided with the most open phase in the history of the global economy along with contemporaneous development of trade in intermediate goods leading to the creation and entrenchment of regional and global value chains (GVC). It was no longer the conventional model between countries trading largely finished goods but an international division of labour based on comparative advantage at the level of components and tasks. Facilitating the Chinese export juggernaut was innovation in transportation in the form of containerization, which allowed components and also finished products to be shipped from one country to another at extremely competitive rates and at scale. The resultant emergence of China-centred GVCs in manufacturing was thus the coming of age of a new pattern of trade that involved location of design, assembly, marketing and service activities in the most efficient country. China became the world’s factory—its rapid industrialization enabled it to become the global manufacturing supply chain hub, assembling parts and components produced elsewhere.
Naturally all of this did not happen overnight and, on the other hand, we should not expect that China will indefinitely monopolise manufacturing exports. In the beginning, China’s foreign content or foreign value-added in exports increased because it was a cheaper and more efficient approach. As industrial upgrading occurred over time, there was steady rise in domestic value-added, indicating that more intermediate goods were being produced locally in China rather than being imported. Thus the share of domestic value-added content in gross exports rose over time to 82 per cent in 2015, up from 76 per cent in 2008. At the same time, China’s forward linkages (their exports for downstream processing) increased from 40 per cent in 2011 to 45 per cent in 2015. Inevitably, China emerged the world’s preeminent trading economy, with backward and forward linkages with almost all countries. Besides commodities, it largely imported parts and components from Australia, Africa, East and South East Asia among others and exported finished products inter alia to the United States and the EU.
Two developments prematurely arrested China’s linear march towards further cementing its dominant position as the supply chain hub in manufacturing. One was the global financial crisis of 2008-2009 and the other, the steady rise in protectionism since the crisis which finds ugly expression in the recent trade war with the United States. What the trade slowdown and the inward looking policies that swept the global economy soon after the crisis did was to provoke a rethink in China’s growth strategy. From being aggressively export- and investment-led, the new strategy focuses more on services and domestic consumption. This rebalancing as it is called would arguably have happened in any case because of the iron law of development. The law states that as countries grow and in China’s case with ferocious rapidity, labour costs are bound to rise. For more than a decade now, wages in the manufacturing sector in China have been rising and along with changing worker preferences away from factory work, the manufacturing sector has been seeking relocation to other cheaper destinations in Asia. Thus, a lot of Chinese FDI is moving to neighboring Asian economies (and not to India).
Thus, one could persuasively argue that the post-crisis protectionism and recent geopolitical considerations expedited China’s rebalancing that would have happened on its own later. Whatever the reason, trade disruption in China has large real and perceived effects that propagate through bilateral trade, regional supply chains and associated financial linkages. The reason these are large is because China is the leading trading partner for more than 120 countries and has strong and growing trade as well as investment linkages with almost all regions of the world. One estimate suggests that one per cent reduction in China’s growth could shave off 0.5 per cent in global GDP. The impact will be disproportionate on countries with stronger links with China, for instance smaller countries and those that have relied on China for commodity exports. Australia, for example, has already recognised that its economic fortunes have been inextricably linked with China in the past and there are considerable risks in sustaining this approach.
As a result, Australia is seeking to diversify away from China and has prepared a strategy document endorsed by their government that underlines a vision that India matters for it. It recommends that Australia should strive by 2035 to lift India into the inner circle of Australia’s strategic partnerships, and with people to people ties as close as any in Asia. It should be a matter of pride that we are being accorded priority ranking by a developed economy. Although Australia has long seen India as an important country, the relationship has not been enhanced in the manner being proposed now. Naturally Australia is governed by its own predicament and long term interest, and so should we. A lot of good could come if we are able to leverage the fact that India matters to Australia. But we are at a turning point where India ought to matter not just to Australia but to the world! In 10 to 15 years we should aspire to be where China finds itself today.
A slowdown in China has been classified as one of the top five risks facing the global economy along with increased protectionism and sluggish world trade growth. Several years ago, PM Modi had stated that India should seize the space being vacated by China to attract multinational corporations exploring alternative regional locations for labour-intensive segments of GVC manufacturing. The ‘Make in India’ initiative is a perfect foil for that ambition along with ongoing reforms in business climate and public infrastructure investment. Automation and the testy xenophobia sweeping the world make India’s position doubly challenging, but the stars, on balance are aligned in our favour. We could turn a major global risk into an opportunity as major economies look to India as a destination for exports, investment, financial returns and sourcing. The transformational Goods and Services Tax (GST) has set the tone for domestic integration, while improvements in transport infrastructure, better trade facilitation measures can build the momentum to integrate into regional and global value chains. But this is not pre-ordained. Difficult reform at home is necessary to demonstrate that India is indeed open to business. As the great Urdu poet had said:
maine mana ki kuch nahin ‘Ghalib’
muft haath aye to bura kya hai
(The author is Director and Chief Executive, Indian Council for Research on International Economic Relations (ICRIER), New Delhi. Views are personal)
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