The discontents of decoupling
Economic delinking with China makes no sense for India; investment, growth and public welfare will suffer
Two years ago, the United States accused China of using coercive methods to transfer technology from US firms to China, as also of outright theft of know-how. Soon, this quarrel morphed into an overall trade-cum-technology war, with escalating tariffs and political rhetoric at high decibel levels. Ever since, speculation has been rife that we are heading towards a “new normal” in global economic relations — where investment and trade links between the US and China are gradually “decoupled”. Other regions of the world have been drawn in, willingly or unwillingly, and the onset of Covid-19 has aggravated the already heated geo-political atmosphere. So, how should India position itself vis-àvis “decoupling” from China?
Decoupling means many things. To simplify greatly, we can examine it in two dimensions: Production/supply chains on the one hand, and markets/consumer demand on the other. Let us consider these different forms of decoupling, in ascending order of difficulty.
One painless way to decouple would be to shift any fresh investment planned in China to other destinations — e.g. if you have three factories there already, do not build a fourth. If this makes economic sense, it also follows good risk management practice. Japan — the earliest foreign investor in China — has been doing so quietly for a while, particularly of low value-added products where the Chinese market is saturated while production costs have risen. Hence, the shift of investment in garments, leather and toys, among other things, to destinations like Bangladesh, Cambodia and Myanmar (but not to India on any scale). A variant of this decoupling method is to uproot and relocate existing factories out of China. Naturally, this imposes heavy costs and is possible only in limited cases.
In neither instance does any “reshoring” necessarily follow — i.e. where the factory is set up instead in India. That requires other factors to come into play, such as local governance, transportation, logistics, skills and labour productivity. India needs a comprehensive and consistent set of reforms to create reshoring possibilities which produce the right employment consequences. Global investors look for quality, productivity, safety and sustainability; just a squeeze on labour wages or rights will not cut it, nor tax exemptions.
What about opting out of supply chains involving China? Today, about 28 per cent of global manufacturing is China-based, covering raw materials, intermediates and finished goods. Services come on top of that, all adding up to a big number. What does seem feasible is to identify and regulate key Chinese investment or inputs that have strategic or security implications. This list must necessarily be narrow and well-defined, or else we are opening the doors wide to protectionism. As the prime minister emphasised, “self-reliance” does not mean a return to economic autarky.
Does all this imply that China holds all the cards? Not so. When we look at the second type of decoupling — market/consumer-based — a different story emerges. The impact of Covid has stressed all economies: Even in China, with the pandemic under control, production is back to only around 86 per cent of pre-covid levels, so economic growth for the year may be zero. China is still highly dependent on its export markets, and a global depression looms ahead. Chinese investments abroad face bleak prospects: US interest rates are falling and could turn negative, and infrastructure investments in the Belt-and-road Initiative — always somewhat risky — now seem distinctly dodgy. So, investors and exporters in China should value comparatively stable polities where reasonable returns, large markets and long-term growth prospects are likely. India would certainly qualify here.
It is never a good idea to alienate your customers. Whilst most customers in India are price-sensitive, some are not. If their purchases are discretionary, satisfy emotional or non-essential needs, and where substitutes are not too pricy, these customers can be swayed by “sentiment” or current trends to avoid some Chinese products. That in turn might sway the political mood and thus affect even non-strategic Chinese investments. It is difficult to estimate the exact damage this might do to Chinese exports and/or investments in India. But one could ask the Chinese, when you are on the edge, why push your luck and risk both present and future?
The same logic works the other way. China’s growing consumer market and huge purchasing power will attract companies globally. In recent public pronouncements, China has indicated that it will enhance imports, with a view to ultimately balance its trade account. Even if that statement is an exaggeration, it should encourage Indian exporters, and makes reforms in our manufacturing environment even more urgent. Equally, we must carefully consider the revised offer to India by the Regional Comprehensive Economic Partnership countries, and negotiate a place in that group. With a looming global recession, this is no time for splendid isolation. We need to be part of vigorous trade and investment chains.
Ironically, there is one area where greater IndiaChina coupling might benefit both nations, and the world — the pharmaceuticals sector — where both countries are global players. This sector is one bright spot in an otherwise gloomy firmament. The present orthodoxy is that Indian formulations companies are over-dependent on imported Chinese drug intermediates (APIS) — a situation that cannot be quickly corrected. True, but so is the obverse: Chinese API producers too cannot easily replace India as a key market. Further, the entire world today is looking for large volumes of medicines at affordable prices — especially of a future Covid vaccine or medication. This should create enough common ground between Indian and Chinese companies to collaborate and advance their businesses in India, China and globally, while still bringing risk levels to more manageable proportions.
Finally, decoupling — except for the reservations stated earlier — makes no sense for India. Some industrialists might gain, but investment, public welfare and growth will suffer. Both nations would do well to insulate their economic relationship from the current downward turn in political relations — no easy task, but doable — while they work out a way forward.