The New Horizon

A new world explored with a rational view

The Chinese Trade Story – Short Version

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In the wake of recession in Europe and downgrades by several rating agencies, Indian politicians and media are back to the drawing board to figure out what caused the debacle of last couple of years. Initially, it looked like a recession bypassing us and we are recession-proof. Later, the thought was that the effect would be temporary and probably caused by an international bubbles. Now, its more and more evident that recession has actually exposed Indian under-performance. A lot of the issues currently plaguing India is home-grown and the solutions can be achieved internally. But the media didn’t listen. Neither did the political leadership. So, with a new gun, they are targeting the trade deficit with China to be one of the main culprits. I can see politically things have started moving, both in terms of talks and actions.

Before I delve deeper into the issue, let me present the facts. The first point to note - Trade deficit between the neighbours widened to $40 billion last year. At $17.9 billion, India’s exports to China in 2011-12 were less than a third of the $57.55 billion worth of goods it imported from the country (source). The worrisome factor is – this has a trend. The trade gap is growing, even if we look at the post-recession trend alone. Overall, India is not in a good shape in terms of trade. The deficit is creating pressure on exchange rates and reserves. So, we get a culprit and it turns out to be our favorite – China.

Is it that easy? Probably not. Jyoti Rahman once explained how trade deficit with India might not be that bad for Bangladesh. In this case also, if I look deeper, I see the traces of hints from his writing. What caused this massive trade deficit and what keeps it growing – are the two prime questions I would try to answer at first. If one looks at this chart provided courtesy Wall Street Journal, you can easily identify the three major import items from China. They are (ranked) - Telecom equipment (e.g. ), Equipment for major projects (e.g. Power plant, Mining), Computer related accessories/parts (e.g. Computers, Hard Disks etc.). All these things are known as “Capital Goods”. In fact, overall Capital goods imports are estimated to have crossed $40 billion at present. They were $6.5 billion in 2003-04 (source). So, the growth in import from China is mainly coming from Capital Goods and not from toys (as people often complain).

Now that we have an answer that Capital Goods import from China is the major cause of Trade imbalance with China, we now question, is that a bad thing? To me, the answer is mixed but overall I am leaning towards the answer “No”. Let me explain why I am in favor of Capital Goods import from China.

Capital Goods import is considered to be a good sign for the economy in general. As explained in details in this article, a developing nation imports machinery (or other capital goods) and uses its cheap labor to make items worth of export. As the time proceeds, the country is able to produce more and more export-goods and eventually produce those capital goods close at home. This has happened in China too, as it is described in the figure below. In 1980s, it imported machinery from Japan and Germany to set up its factories where it produces garments/textile and consumer goods to be later exported to North America and Europe. After a while, Japanese and German companies invested in China to produce those machinery to compete rising labor cost close to home and China has eventually become a net exporter of Capital goods. At the same time, Japan and Germany moved to higher value added manufacturing industry (e.g. innovation, design) and China took their former place. Most of these capital goods tagged as “Made in China” are also designed in Japan/Taiwan/Germany.

Stages of China's trade structure

Stages of China’s trade structure

On the other hand, if one looks at growth rates of Chinese items exported to the rest of the world, one can easily verify that Telecom equipment, Electrical machinery and Office machines are three fastest growing export (that testifies the theory) sectors as of 2004. (source) So, it’s a natural thing in the growth cycle of a developing country and it’s better to get it sooner than later. But isn’t that hurting the competitiveness of Indian companies who build Capital goods also? That’s absolutely true but probably not a big deal. Imagine the early 1990s, when Indians started importing computer and related accessories from rest of the Asia. If Indian Govt decided to curb those and promoted domestic computer manufacturing industries, would we have seen such exponential growth in services export? Probably not. One advantage that India had was that they had no domestic manufacturer of Computers and no jobs were threatened because of cheap Computer import (Leftist brigade might still argue otherwise). There is no dispute that the third highest item in the list of imports from China (Computer and accessories) actually adds value to Indian services industry. The imports related to power plants and telecom are targeted towards another domestic problem – infrastructure.

However, Indian political delegates are talking to China in order to get more market access and remove restrictions. While this is not a bad ploy but the success of such ploy will definitely be limited. India should also push for greater market access in the developed world (such as EU-India FTA), where most of Indian exports should end up. After all, India will continue to have a huge labor advantage against the First world, but probably not against China. If India can fix their perennial infrastructure problem and obtain better access to developed world market, investments will start flowing. More investments are used for more capital goods import and more export of consumer goods and increase in jobs – just as the classical development paradigm suggests. So, the trade deficit with China is not as bad thing as the press suggests and we should probably rethink our perceptions about our constraints.

Additional Reads -

1. This old paper from Jong-Wha Lee argues why Capital goods import is good for long-run growth.

2. This paper from Veeramani relates Capital goods import with labor-productivity.

3. This paper suggests – “access to cheaper capital good imports not only had a positive effect on labor productivity growth for the entire sample period, but has become increasingly important in recent years.”

4. This paper concludes – “we find that for the period from 1980 to 1997, after controlling for trade liberalization, other reforms, and fundamentals, stock market liberalization are associated with a significant increase in imports of capital goods. Both our evidence and the literature’s further suggest that this can be attributed to the consequences of financial integration which allow access to funds and lower the cost of capital in an economy.”

WSJ published an article in the similar tune.

“India’s cabinet last month approved a 21% tariff on imports of power generation equipment into India. … But this is a profoundly short-sighted approach to the trade issue, which ignores what should be the far bigger concern of Indian policy makers—not the trade deficit with China, but the country’s overall infrastructure deficit. India’s chronic shortfall of electricity (witness last month’s blackouts), roads, airports and the like is a major constraint on growth. Imports from China are part of a solution to this problem, not a problem in their own right.

The vast majority of imports from China consist of capital goods such as electrical machinery, nuclear reactors, boilers, ships, boats and items for civil engineering projects. Consumer goods such as toys, footwear and the like account for less than 2% of imports from China. These capital goods tend to come at a lower cost (thanks to the so-called China price), and are made cheaper still by extremely advantageous financing offered by Chinese banks.”

Now Swaminathan Aiyar has come to my support.

“Why have falling import barriers now produced prosperity? Because this encourages specialisation in areas where India is competitive, and discourages wasteful investment in uncompetitive areas.”

Written by Diganta

August 14, 2012 at 11:21 pm

Posted in China, Economy, India, Thoughts

Tagged with ,

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