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Why a 30 year loan is often better than a 15 year loan?

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As I am nearing my house purchase closing date, I am increasingly swayed by different data points to decide between two mortgage loan choices – a 15 year term and a 30 year term. In short, 15 year term offers lower interest rate, overall quicker growth in equity and less interest payment overall. On the other hand, a 30 year term offers more affordability and it is easier to manage since the monthly payments are significantly lower.

To compare these two term, I would lock the interest rates I have been quoted by one broker as 2.85% and 3.75% respectively. At the same time, I would lock the principal amount to be at 417,000$, above which the loan becomes “Jumbo” and calculations vary significantly. Now, assuming that you have affordability to pay either (i.e. can pay 15 year monthly payment from your income), I would like to discuss which one is the better option. If your affordability doesn’t help, I believe 15 year is a non-option.

First, I would like to calculate the payments and interests paid. The site taxprofessors helped me a lot in this. The net comes to something like this -

 Loan Term  Monthly Payment Interest  Months
15 year 2,849.74  95,952.77  180
 30 Year 1,931.20  278,226.65  360
 Diff  918.54  -182273.88  -180

At this point, it seems inevitable that you should go for a 15 year loan instead of a 30 year one. But I am already assuming that both 15 year and 30 year terms are equally affordable to you. So, you are left with 918.54$ extra at the end of each month. How about re-investing it into the loan in order to match the data “apples-to-apples”? That’s when principal prepayment comes into the equation. Now, if I use a principal prepayment of 918.54$ each month, we equate the first column in the above chart. The new terms are -

 Loan Term  Monthly Payment Interest  Months
15 year 2,849.74  95,952.77  180
 30 Year with Prepayment 2,849.74  141,197.12  196 (-164)
 Diff  0 (-918.54)  -45244.35  -16

So, on a 30 year term, you get to pay around 45,244$ more than your 15 year counterpart. Isn’t that still big? Not as big as you think if you consider the tax and inflationary savings. If you are in 25% tax bracket for next 15 years, you get to save ~11,000$ overall in the loan period. The actual calculations are a little more complicated and hence I am taking help of calxml.com mortgage tax savings calculator. Assuming a 25% tax bracket, let me compute the tax savings as mentioned by the website -

 Loan Term  Interest Months  Tax Savings
15 year  95,952.77  180  23,988
 30 Year with Prepayment  141,197.12  196 (-164)  51,477
 Diff -45244.35  -16  27489

Now the net tax-adjusted difference between the two loan terms becomes 17,755$ – even lower than what we were expecting. Of course this one assumes that one would be fully itemize the deductions. With a property tax, it’s often easier to claim itemized deductions (ahead of standard deductions currently @ 11,900 per married couple) in 30 year term than the 15 year counterpart. The scenario will require even more complicated table but the apparent tax gains due to 30 year loan should shorten because of that. On the other hand, you can always free to add more stuff on top of your itemized deductions in order to balance it towards 30 year term.

Moreover, the extra payment we make at the end of year 15 on wards for 16 more months in case of prepayment based 30 year term – is subjected to inflationary changes. The 2849.74$ per month I pay now will not be as “valuable” as it will be in 15 years because, prices of everything will go up and so would the salary. Considering historical data in USA, I see the value of 100$ in 1998 is now 141.28$, i.e. an inflation of 41.28%. Assuming the same to happen in next 15 years, the apparent 45,244$ gap will not be that intimidating. The inflation adjusted figure is only 32024$.

If we try to merge last two sections (mathematically wrong though, just to show you), we get a tax-inflation-adjusted figure of 12567$. If I remove all irregularities, I would probably get a value of $15,000 in current dollar value. So, the difference between 15 year and 30 year loan is basically $15,000 (i.e. 3.5% of the principal) !!

So, you are paying just 15,000$ more to get much more flexibility, i.e. lower the payments for a few years when your wife decides to get off from job and join a University course. You can always pay it back later and chances of getting foreclosed is much less. Also, you avoid a costly refinance if your income suddenly comes down or you lose your job.

Let’s not forget the catch, the 15 year loan still gets you to add equity faster. So, if you are planning to sell your house off midway, expect to incur a loss, but again that loss is adjusted with tax and inflation. Let’s see it in the next table -

Loan Term  5 year principal 10 year principal  15 year principal
15 year  119,749.56 257,815.81 417000
 30 Year with Prepayment  101,892.32 224,761.94 372,927.71
 Pre-tax-inflation Diff  17857.24 33053.87 44072.29

I understand we all are different human beings and need to be treated differently. So, get to the tools and links I provided and get your calculations done. You can always comment on what you have found out for yourself.

Note – Another site that provides you with detailed data is this one.

Written by Diganta

February 26, 2013 at 11:52 pm

The Propaganda Legacy?

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There used to be a time when it was said that what Bengal thinks today, India thinks tomorrow. Post independence West Bengal was the first state to adopt computers. In fact, Indian Statistical Institute and Jadavpur University were the first institutes to offer a course in Computer Science way back in 1968. The same institute started country’s first computer center back in 1962.

Almost the same time West Bengal saw mass protests against computerization. The trade unions opposed introduction of computers at any cost. The power of trade unions grew massively in the following decades, resulting in an early death of any software industries in West Bengal. The propaganda created to uproot “computerization” lived in popular memory. IBM left India back in 1977 due to such policies.  (Read Luddite fallacies and know why it is wrong.)

Back in 1997, when I was to get into an university after my successful Joint Entrance campaign, I faced a dilemma. Given my rank, I would not have got into either of Computer Science or the Electronics in Jadavpur. But the rest of the options (including the NITs) were kind of open to me. I swayed between JU Mechanical, Bengal Engineering College (now Bengal Engineering and Science Univ or IIEST, Shibpore) Electronics or Computer Science. I asked for opinions from several people – teachers, servicemen and prospective students. Almost everyone asked me not to go for Computer studies. They thought I will run into trouble getting jobs as the field is “saturated” and there are no plan B options since Govt jobs don’t require Computer Engineers. Some others told me that Electronics field will have more research opportunities as it is the “mother” subject. A few said that Computer Science is not even an Engineering stream. I chose to study Computer Science after a few hiccups and that was probably one of the best thing happened to my life. 16 years later when I see careers of my friends and try to analyze the arguments, I don’t see any justification for any of them.

Not everyone is as lucky as I was. In WBJEE counselling (seat choice system), the seats for Electronics and Telecommunications (ETC) or Electrical Engineering (EE) get exhausted earlier due to higher demand from top ranked students. The arguments those drive the students away from Computer Science (CS) are probably still the same. However, in between, Indian Software industry grew exponentially. Let’s look at data from last year WBJEE counselling (2011) -

 University  CS Closing Rank  EE Closing Rank  ETC Closing Rank
 Jadavpur Univ  366  395  140
 Shibpore IIEST  1050  623  607
 Kalyani Engg College  2356  1684  1807

What’s the pan India trend? Let’s look at the data from IITs (2012) -

IIT CS Closing Rank EE Closing Rank ETC/EC Closing Rank
Bombay/Mumbai 75 91
Delhi 130 270
Guwahati 1367 2131 1973
Kanpur 280 590
Kharagpur 429 921 729
Madras/Chennai 240 539
Roorkee 961 1681 1293
BHU 1849 2799 2684

Now it clearly shows, Computer Science seats gets exhausted earlier than the other streams.

So, now the question becomes – why does West Bengal defy the trend? They will eventually compete in the same pan-Indian job market (which is again increasingly globalized) and preference to a particular subject should be almost global or at least pan-Indian. The fact that West Bengal defies the trend is amazing!

I believe the answer to this trend can be found in the propaganda legacy that were run in West Bengal against computerization. Computer is an “evil” and take jobs away from common people – was the notion and there were strong propaganda created to defend this. Along with that, inward-looking attitude among parents in West Bengal and lack of courage to take a bold decision matters as well. In a sense, West Bengal is stuck in 1970s and is not being able to adopt a new burgeoning India. The sooner we brake this trend-defiance, the better it is.

Data Source -

WB JEE – Jadavpur, BEC, Kalyani

IITs.

One can try out a few years and I have already eyeballed the data – it’s basically the same.

Jyoti Basu (CM of West Bengal) profile in Wiki talks about his “initial support of trade unions against the use of computers”.

The growth chart of Indian Software Industry -

Growth of Indian IT Sector - BusinessWeek

Growth of Indian IT Sector – BusinessWeek

Indian Software Exports - Univ of Manchester

Indian Software Exports – Univ of Manchester

Written by Diganta

February 16, 2013 at 12:54 pm

The Economy of British India – with Angus Maddison

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Angus Maddison is a world-renowned economic historian who is famous for his work on estimating the past GDPs of modern economies by different measures. I won’t go much details into his original work, but the pieces he wrote about Indian subcontinent are worth-reading. In this post, I will try to delve into his assessment of British rule in India (read the Mughal one also). Just to remind you, I am an Indian and Angus Maddison is a British national – so a difference in narratives (bias?) could be present in my write-up.

The Elitist British

The biggest change the British made in the social structure was to replace the warlord aristocracy by an efficient bureaucracy and army. In the first generation, British tried to Westernize India – introduced English education, tried out a few Social efforts and tried to modernize infrastructure. But soon they changed their course. Having failed to Westernize India, the British established themselves as a separate ruling  caste. They did not inter-marry, their kids grew up in separate schools and they socialized with separate clubs where “native” population was absent. Maddison compares -

“The British ruled India in much the same way as the Roman consuls had ruled in Africa 2,000 years earlier, and were very conscious of the Roman paradigm.

One of the positive sides of the whole thing was that the British never tried to settle down in India and remained low in number. This resulted in low taxation but Maddison described that it benefited the middle class and land-lords but not the bottom-of-the-pyramid peasants.

“There were only 31,000 British in India in 1805 … In 1911, there were 164,000 British … In 1931, there were 168,000. … The British had inherited the Moghul tax system which provided a land revenue equal to 15 per cent of national income, but by the end of the colonial period land tax was only 1 per cent of national income and the total tax burden was only 6 per cent. … Most of the benefits of the lower fiscal burden were felt by landlords, and were not passed on to the mass of the population. In urban areas new classes emerged  under British rule, i.e. industrial capitalists and a new bourgeoisie of bureaucrats, lawyers, doctors, teachers and journalists whose social position was due to education and training rather than heredity. In the princely states, the remnants of the Moghul aristocracy continued their extravagances – large palaces, harems, hordes of retainers, miniature armies, ceremonial elephants, tiger hunts, and stables full of Rolls Royces.”

The System of Exploitation

The main aim of British exploitation was to remit money to Britain. Again, as per Maddison, there were two phases of it. The British East India company had nothing but a short-term-profit-maker attitude while the British Kingdom had a long-term-rent-seeking approach. For example, Robert Clive, the East India Company General took quarter of a million pounds for himself as well as a jagir worth £27,000 a year. (worth mention comment from Maddison – British did not pillage on the scale of Nadir Shah, who probably took as much from India in one year as the East India Company did in the twenty years following the battle of Plassey.)

Comparatively, later on, the remittances became more smooth and systematic -

“the Viceroy received £25,000 a year, and governors £10,000. The starting salary in the engineering service was £420 a year or about sixty times the average income of the Indian labour force … Under the rule of the East India Company, official transfers to the UK rose gradually until they reached about £3.5 million in 18566, the year before the mutiny. In addition, there were private remittances … By the 1930s these home charges (i.e. remittances) were in the range of £40 to £50 million a year …  (also) About a third of the private profit remittances should therefore be treated as the profits of colonialism. “

Moreover, the Govt of India, which always ran fiscal surplus over the British Kingdom, ran into debts due to spurious reasons. Further, during the World Wars, Govt of India “gifted” (joke!!?) millions of pounds from its reserves to the British Govt. Maddison describes -

“In spite of its constant favourable balance of trade, India acquired substantial debts. By 1939 foreign assets in India amounted to $2.8 billion, of which about $1.5 billion was government bonded debt … (during World Wars) there were two ‘voluntary’ war gifts to the UK amounting to £150 million ($730 million). India also contributed one-and-a-quarter million troops, which were financed from the Indian budget.”

 Where Maddison differs

Maddison differs quite a bit on the topic of Industry. He countered arguments of R.C. Dutt, R Palme Dutt and Nehru on de-industrialization (i.e. the decline of the old handicraft industry without the compensating advance of modern industry) of India with his set of facts. He accepted the facts that the Mughals did have a large industrial base and with British rule and policies it died. But added an important quote -

“Oversimplified explanations, which exaggerate the role of British commercial policy and ignore the role of changes in demand and technology, have been very common and have had some adverse impact on post-independence economic policy”

Maddison argued that the Mogul Indian industry were to produce luxury goods for aristocrats. But after British rule begun, the higher echelons of Indian society were flipped upside down. The British officers and native “copycat” Zaminders had little attraction on the traditional Indian handicrafts. Instead they developed taste of British merchandise. Furthermore, with social changes in Europe, there were a decline in demand of handicrafts overall (not only Indian but also other European ones as well).  Along with that, cheap and better quality textile from Britain occupied Indian market. Maddison agreed that the above incidents probably threw a lot of Indians out of job but he adds that the per-capita textile consumption doubled due to cheap British imports. He explains -

“the displacement effect on hand-loom weavers would have been smaller than at first appears. The hand-loom weavers who produced a third of output in 1940 would have been producing two-thirds if there had been no increase in per capita consumption.”

But he, in the end, agreed that India was the net loser on textile industry due to long term colonial effects -

“In time, India built up her own textile manufacturing industry which displaced British imports. India could probably have copied Lancashire’s technology more quickly if she had been allowed to impose a protective tariff in the way that was done in the USA and France in the first few decades of the nineteenth century, but the British imposed a policy of free trade. British imports entered India duty free, and when a small tariff was required for revenue purposes Lancashire pressure led to the imposition of a corresponding excise duty on Indian products to prevent them gaining a competitive advantage.  … If India had been politically independent, her tax structure would probably have been different. In the 1880s, Indian customs revenues were only 2.2 per cent of the trade turnover, i.e. the lowest ratio in any country. In Brazil, by contrast, import duties at that period were 21 per cent of trade turnover.”

So the fundamental issue was on the “free-trade” without preparedness but not the British policies.

In fact Maddison threw light into a few different aspects of Indian industries. Britain used India as their Asian export Hub and that resulted in Indian industrial gain.

“By the time of independence, large-scale factory industry in India employed less than 3 million people as compared with 12 1/4 million in small-scale industry and handicrafts, and a labour force of 160 million.56 This may appear meagre, but India’s per capita industrial output at independence was higher than elsewhere in Asia outside Japan, and more than half of India’s exports were manufactures.”

So, even though Indian industry was small, it was better off most of its Asian counterparts. However, the industry relied on mostly British skilled workers to fill in the upper ranks and that (along with protective policies) led to a demise of Indian industries post-Independence.

Conclusion

Overall, as per Maddison, British urban economy was better off the Moghul one. It was more productive, modern and focused on  entrepreneurship. On the other hand, the condition of villages worsened because of “extractive” Zaminders, population increase and reduced per-capita land availability. The book overall is a fascinating read and I will probably write up another post to follow up on my evaluations and criticisms of Angus Maddison.

The primary resource – Class Structure and Economic Growth: India & Pakistan since the Moghuls (1971) by Angus Maddison.

Written by Diganta

February 7, 2013 at 12:40 am

The Economy of Mughal India – with Angus Maddison

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I read a couple of chapters of Angus Maddison who described Indian economy and its pitfalls quite vividly. Angus Maddison is a world-renowned economic historian who is famous for his work on estimating the past GDPs of modern economies by different measures. I won’t go much details into his original work, but the pieces he wrote about Indian subcontinent are worth-reading.

In short, both Mughal and British empire were significantly “elitist” and “extractive“, i.e. from power to money – everything was in the hands of a few. Contrary to the widespread belief in India, the common mass lived a little above the sustainability level and were hit by periodic natural calamity and crop-failures. The system or the economy in general was built to grind the common people into de-facto slavery. In this blog-post, I will focus on the Mughal rule (read the British one also).

The Elitist Mughals

To start with the Mughal system, Maddison notes -

“India had a ruling class whose extravagant life-style surpassed that of the European aristocracy.It had an industrial sector producing luxury goods which Europe could not match, but this was achieved by subjecting the population to a high degree of exploitation. Living standards of ordinary people were lower than those of European peasants and their life expectation was shorter.”

To expose the elitism in Indian society, he notes that the major export items those India had at that time were “salt-peter (for gunpowder), indigo, sugar, opium and ginger” but the import items were nothing but silver, gold and other precious stones. This highlights that on the national level, India exported items produced by ordinary populace where they imported items for elites only. Maddison went on the compare the European standard of living with the Indian ones -

“In spite of India’s reputation as a cloth producer, Abul Fazl, the sixteenth-century chronicler of Akbar, makes reference to the lack of clothing in Bengal, ‘men and women for the  most part go naked wearing only a cloth about the loins’. Their loincloths were often of jute rather than cotton. In Orissa ‘the women cover only the lower part of the body and may make themselves coverings of the leaves of trees’. They also lacked the domestic linen and blankets, which European peasants of that period would have owned.”

So the common people perished where the wealthy had it all. While average Indians didn’t have cloth to wear on, the Indian muslin were famous in Europe and was noted for aristocracy.

The health condition of common people was equally bad. Indian population almost stagnated for about 2000 years -

“Kingsley Davis has suggested that mortality rates in India were high enough to offset the very high fertility rates, so that there was little increase in population in the 2,000 years preceding European rule.”

The System of Exploitation

There lies the hierarchy and Maddison got it correct. The Indian system worked through the caste hierarchy and the agro-income from the lowest strata of the society used to bubble up as taxes to the upper elites.

“The revenue of the Moghul state was derived largely from land tax which was about a third or more of gross crop production, i.e. a quarter or more of total agricultural output including fruits, vegetables and livestock products which were not so heavily taxed … Total revenue of the Moghul state and autonomous prince-lings and chiefs was probably about 15-18 per cent of national income. By European standards of the same period this was a very large tax burden”

Not only the taxes were high, the tax money were used mostly in “consumption expenditure of the ruling class”.  Maddison further notes that the Jagir system in India was not hereditary and the Jagirs were posted from place to place. So, he “had an incentive to squeeze village society close to subsistence”. The village society was very docile and governed by the rules of caste. That was the primary reason why India was smoothly ruled by outsiders for years as Indians were more concerned about their “karma” as per their “caste” and not to sidestep it for a larger or revolutionary role in the society. One notable absence, as per him, was that Indians rarely tried to take up sea-trade as part of their profession since “religious beliefs inhibited foreign travel and commercial development by Hindus”. Furthermore, caste stagnated the society to new ideas and technology unless they are imposed from the rulers -

“In spite of extensive contact with foreigners, India did not copy foreign technology either in shipping or navigation, or in artillery and military organization, and this is one of the reasons it was conquered by Europeans. “

On the other hand the revenues from this exploitation channels were put in to the “hoarding precious metals and jewels and “construction of palaces and tombs”. The total land-irrigation work undertaken was as little as 5% of the total fertile-land.

On the brighter side though, Maddison mentioned that religious institutes in India did not consume as much money as it did in Europe.

Conclusion

In summary, in spite of a few glitches (I would discuss those later), Maddison probably got to the closest to the reality. There are very few Indian scholarly articles that could now-a-days confirm that Indians on an average were richer than the Europeans or the Arabs at the same time. The perils of elitist economy would be felt sooner than anyone expected – during Industrial revolution. The major Indian produce – things such as muslin – were dependent on aristocrats to buy. In a world where mass-production was much more important than elite products – Indians were bound to lose the trade war. Moreover, the producer lived in perils and he had little incentive to innovate or take his production scheme to the next level. All things necessary to produce a failed state were gathering mass under the lavish Mughal aristocracy. The myth of rich Mughal India is thus just another myth.

The primary resource – Class Structure and Economic Growth: India & Pakistan since the Moghuls (1971) by Angus Maddison.

Written by Diganta

February 4, 2013 at 11:57 pm

IPL and Future of Cricket

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IPL is big.

IPL is big in terms of revenue, glamour, supporter-craze and of course in terms of cricketing excellence. The cricket crazy nation of India has probably never seen such a good domestic tournament so far – in any sports.

How popular is IPL? What percentage of popularity of cricket is actually driven by IPL? I started thinking about these questions after talking to grandfather of my kid’s mate. He’s Polish and lives in a village. But, IPL is one of his favorite sporting pass-time, apart from watching soccer. He’s still not so crazy about cricket but was able to tell me about KKR, Shahrukh Khan, Sunil Narine and what not. He enjoys the thrilling finish of T-20 games. But, to the contrary, he doesn’t watch normal ODI cricket.

IPL makes BCCI rich. Prior to IPL, majority(85% as of my latest knowledge) of revenues of all ICC tournaments were equally divided among the member nations. So, all countries were in a sense equal. IPL disrupted the same. They turned that equation upside down. Since IPL stands as Indian domestic league – BCCI pockets the profit from this tournament. That made BCCI one of the richest cricket boards.

That takes me to my first infographic that shows how IPL is climbing the ladder of popularity. Below is the search trend of two keywords – IPL and Cricket. The red one is cricket and the blue one is IPL.

IPL(blue) vs Cricket(red) interests

IPL(blue) vs Cricket(red) interests

Worldwide the interest around cricket is growing – but not at the same pace of that of IPL. IPL is a seasonal phenomenon and at its peak, it has overtaken interest on cricket in 2012.

If we concentrate only within India, we’ll see similar phenomenon replicated albeit IPL gaining more prominence compared to Cricket.

Interest on IPL(blue) vs Cricket (red)

Interest on IPL(blue) vs Cricket (red)

IPL is dominating cricket in India.

But don’t miss the point. The pinnacle of all these is the world cup winning moment of India. The IPL peak is hardly 60% of it. So, even though IPL slowly taking over cricketing phenomenon of India, the World Cup stays in its place.

IPL is most popular in West Bengal – probably justifying the recent success of KKR as a team.

Statewise search popularity of IPL

Statewise search popularity of IPL

I think its safe to comment that except a very few selected tournaments (such as World Cups), IPL is going to be the most popular cricket tournament in the coming decades. Whether it would enrich Indian cricket or not is a different question and I am not too hopeful on that right now. But the status of stature of IPL as a cricket tournament can only rise in coming future. Any opposition?

N.B. – Click on the images to visit the google trends for those keywords.

Written by Diganta

January 12, 2013 at 6:48 am

Posted in India, Stats, Thoughts, West Bengal

Tagged with , ,

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 ,

My Random Thoughts 1

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Subprime loans are back, this time to the auto industry!!

This happens only in Bangladesh, evicted JU VC gets most votes and possibly will be reinstated.

Why does India does so poorly in Olympics? Euronews correspondent thought out of the box and put the blame on academic minded parents, that’s interesting!!

After the aQuantive failure, Siegler reminds us of the bullet Microsoft dodged four years back. And see what was thought about it in that time.

Foxconn, the manufacturer of iPads, iPhones and tons of other smart devices, is starting to use robots in their newly proposed plants. The same might be replicated to Garments industry soon. Factory workers in India, China, Pakistan and Bangladesh face new competition?

India loses more manufacturing investment due to “labor unrest/rights” than due to lack of infrastructure, tax issues and problems in land acquisition. The recent Maruti incident is a mere manifestation of the same.

Written by Diganta

July 20, 2012 at 9:19 pm

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