Dealing with China needs different reflexes

Illusions & Delusions

We have an awkward political relationship with China, yet our import dependence on it keeps growing. Our imports exceed $100 billion and are rising despite the government’s attempts to restrict them. We are also not able to maintain a steady policy stance toward China as a large section of our industry is heavily dependent on Chinese imports.

Visa restrictions placed earlier have been lifted. Not all are happy. The recent apprehensions of Tata Steel over steel imports, and the murmurs in the auto sector over duty relaxations on EV imports, are cases in point. We also face the challenge that although our economy is growing and we are a high consumer demand system, substantial new private sector manufacturing investment is not forthcoming, nor are our FDI levels rising above the mid-double digits. This, despite several investment support subsidy schemes. FDI into China continues to rise much faster despite all the talk of a ‘China +1 or 2’ strategy. We must reflect on how we also can gain industrial strength!

Our problem is that our reflexes are not in tune with the needs of the global trading environment. The management of the real sector -- the industrial ecosystem -- is not given due importance. We continue to assume that promoting trade and growth are goals in themselves, and the one is the sole means for the other. Undoubtedly, our 1991 experiment with trade liberalisation was a tremendous success. We experienced a boom both in GDP growth and a national sense of optimism.

Yet, our performance then was not an exception. The post-liberalisation period coincided with the dawn of the internet, a unipolar world and a WTO-governed trading order, much different from the Cold War blocs. The next two decades also witnessed record levels of output growth, especially in the Emerging Market Economies (EMEs). In 1990, the combined share of EMEs in global GDP was 20% at market exchange rates and 30.7% in PPP terms. These shares rose to 39.3% and 50.9%, respectively, with sharply reduced inflation. We rose with the tide.

However, now, times have changed. Scale is now vital. ‘Increasing return to scale’, as often pointed out by Paul Krugman and others, is the norm. Positive externalities are created as much by firm size as by clustering efficiencies, depending on the technological sophistication of the product in question.

The Chinese ecosystem and locational policies, post-Deng Xiaoping’s reforms, have been achieving this most effectively. Further, the Chinese macro-economic approach of sharply increasing industrial investment to handle any economic slowdown, regardless of cause, has assisted its rise to global dominance. China’s share of global manufacturing had touched 35% in pre-Covid times, but is currently estimated at around 38%, though global industrial output is itself still below pre-Covid levels. The strain of Chinese output increase is being felt elsewhere.

The primary reason why China has become so dominant is that its production is highly concentrated. Its manufacturing sector is organised in less than 400 large clusters (6 SEZs, 14 open coastal cities, 4 pilot ‘free trade areas’ ,114 national high-tech development parks, 164 national agricultural technology parks, and 85 national eco-industrial parks) which facilitate creation of scale economies.

In comparison, Indian manufacturing is spread over a much larger number (over 1,850) of smaller industrial estates/parks/SEZs, etc., reducing scale advantages. Our ecosystem is thus weakened. Chinese logistics costs are also consequently lower.

Alongside, despite its trade dominance, China’s economy is suffering from inadequate capacity utilisation of its existing assets. Illustratively, it has a total installed capacity of 1.17 billon tonnes of steel, which is more than double the combined capacities of US/EU and India, but operates at only 1.09 billon tonnes and consumes only 930 million tonnes, on account of its real estate crisis.

Likewise, more than 100 EV manufacturers are battling for survival in its domestic markets. The combination of ‘increasing returns to scale’ and substantial excess capacity makes China ferocious in the marketplace. Adding to the economic challenges is its political stance. Deng Xiaoping used to remark ‘Hide your strength, bide your time’, but Xi Jinping obviously feels that it is time to realise the ‘Chinese dream’. This may no longer involve win-win games.

So, what should we do? While we cannot ignore the hard realities of current trading necessities, we also need measures aimed to improve our industrial autonomy over a period of time. This would need creating our own ‘increasing returns to scale’ environment. This will need a particularly clear ‘locational policy’. We have always looked at manufacturing as a panacea for our jobs challenge and as a way of securing geographical equity and other developmental challenges. This fallacious thought process, especially when we are getting swamped by unfriendly competition, needs to be given up.

Manufacturing must be allowed to become globally competitive. This will need, among other things, effective clustering. Our existing successful industrial centres need to be further enlarged and strengthened by increasing the supply of essential public goods that support manufacturing. This would include co-locating educational institutions with industrially-focused areas to foster a more innovative ecosystem.

Another good starting point would be to pass the long-awaited ‘DESH bill’ and create an environment of policy stability. We could also think of further modernising our MSME definitions to bring them in line with our competitors. Ground realities are as important as good intentions.