India-China: Economic Cooperation – Analysis

By Kandaswami Subramanian

Writing five years ago, in an IMF publication, on “India Economic Development and India-China Cooperation” Ambassador Nalin Surie was upbeat. He referred to the visits of Prime ministers of India and China in the years since 2002 and their resolve to improve the quality of relationship. As he explained, India and China are the two largest countries in the world and they are also the most populous countries and rapidly growing. Together they account for more than a third of the world’s population. As repeated estimates by research agencies and institutions showed, they will together become the largest market in the world and largest producers of a wide range of products and services. “As our cooperation increases, our common developmental efforts would benefit not only the two countries but the rest of Asia and the world as whole. This rapid and sustained development of one third of human kind would be hugely beneficial to the whole world and influence the future course of events. Has this come about?

The real question that has been haunting us since is whether the two are competitors or partners? A pragmatic view is that they are both with an acknowledgement that there is space for both the countries in a growing world. Prime Minister Dr. Manmohan has emphasized this view repeatedly. However, there are some who take the view that it could be a zero-sum game. Even so, there are strong grounds to believe that in the larger context of international developments and changes, narrow mechanistic zero-sum equations may not hold good. Much will depend on how international economic and political developments evolve, especially in the background of the continuing economic crisis. At times, China’s assertiveness and aggressive postures do disturb calm waters.

There was a view in the pre-crisis years that the world was wholly dependent on the advanced economies in the West and emerging economies had to rely on them on them to sustain their growth. This was a myth and has since been disproved by the financial crisis which erupted in August 2008 and has been wreaking havoc on global economies, especially in Europe. When the crisis broke out and the OECD countries had to engage in coordinated efforts to fight the crisis, they could not do it without taking the developing countries on board. G-7 lost its pre-eminence and G-20 was born. The G-20 continues to be a force notwithstanding its infirmities such as lacking institutional mechanism, lack of internal coherence and, in some ways, lack of legitimacy among developing countries in Africa and Latin America. It was during the early years of the crisis that ideas of developing countries getting ‘decoupled’ from developed countries were floated. These again were myths promoted in part by financial consultants like Goldman Sachs. As the crisis continued and emerging economies were affected in the second or third stages of the downswing when exports began to crash, employment shrink and capital flows behave with excessive volatility. Nowadays, the idea of emerging economies decoupled from the advanced economies is not mentioned in honourable circles.

What broadly seem to have happened are the loss of hegemony by the U.S. and a global shift of economic balance towards the south. BRICs, as an economic group, has emerged as a force even if it is fraught with internal conflicts and contradictions. Trade and economic relations between Brazil and China has taken phenomenal strides. Similar has been the rise of relations between China and South Africa. Trade between India and China has risen from a low level of around $3 billion in 2001-02 (Imports $2 billion=exports $1 billion) to $63 billion in 2010-11 (Imports $44 billion + exports $19 billion).

In all of these developments, it is the role of China that has dominated the global scenario. China’s rise has been a cause of concern to advanced countries, including the U.S. As one Task Force of the Council on Foreign Relations described, “Today, the geopolitical terrain is shifting again, altered by the emergence of China as a major power in a world dominated by the United States since the collapse of the Soviet Union. Despite the overall success of engagement in helping to shape China’s interests in ways desired by the U.S. government, US political support for engagement is under strain. As China’s economic and military power grows, there is considerable uncertainty about its future course. China’s development has raised concerns about the implications for America’s economic health, security and global political influence. Many Americans are not confident that China’s strategic interests are still compatible with those of the United States and argue that engagement does not sufficiently protect the United States against a China that could emerge as a threatening adversary in the future.” There have been continuing debates in the U.S. on China and views ranges from those who work for a modus vivendi with it like Zoellick to hawks on the extreme Republican fringes.

These fears began to grow as various disputes such as those relating to trade, WTO, Yuan rate, China’s modernization of its military, disputes over South China Sea, US’ arm supplies to Taiwan, etc. cropped up. On the U.S. side the currency manipulation has worked heavily on Senators and in spite of a decade of battling, the U.S. Treasury could not establish that China was manipulating its currency. The IMF which was set against China could not arrive at any finality and had to close the chapter. Rather, China, it seems, had played its cards deftly and allowed the Yuan to rise in line with the market. It did not succumb to the market as the U.S. wanted, but bowed to it after assessing its own national interest. It is interesting that in this Yuan debate, G-20 was on the side of China and did not point an accusing finger.

Taiwan is a sensitive issue for China and creates violent reactions in the Party and press. However, there is more noise and drama than action. There is a US law which permits supply of arms to Taiwan and this law was enacted with the Chinese approval. U.S. in its turn is aware of Chinese sensitivities and plays the cards in a measured way. It is more to placate the Taiwan lobby within the U.S. than as a measure of diplomatic affront. China knows this too well.

China has proved itself as a competent player in the WTO and its team of trade lawyers have been playing the game according to rules. It is amazing that the maximum number of cases brought before the WTO panels are against China or from China. China is still treated as a “non-market” economy and is thus highly vulnerable to trade disputes. It has been fighting for the removal of that status with the US and EU for some years. In any case, the non-market status would end by 2016 under China’s WTO accession Treaty.

Sadly, disputes continue to fester and aggravate. As events unfold new developments and patterns crop up. Kissinger analysed the impact of growing conflicts between the U.S. and China and was uneasy about the postures of the U.S. and China. Many foreign policy analysts believe that the conflicts between the U.S. and China are real but they will not necessarily turn into war. On his part, Kissinger pleaded for a combination of “realism” and “idealism” in dealing with future relations with the Chinese to ensure the “best outcome.” He is not dreamy eyed about a Pacific Community or “a partnership” between Washington and Beijing. As he sees it, a more likely development is “co-evolution,” which means that “both countries pursue their domestic imperatives, cooperating where possible, and adjust their relations to minimize conflict.” This implies that two sides should “attempt to elevate familiar crisis discussions into a more comprehensive framework that eliminates the underlying causes of the tensions.”

There are issues of economic interdependence and changes in their relationships. The changes have come about partly in response to developments and mostly in the growing interaction between U.S. and China themselves which had become dominant powers. Economists like Niall Ferguson could coin pithy names like Chimerica to describe the newer relationship.

China which was isolated and shut out from the global trading system in the fifties and sixties has turned into the second most important power. Estimates of the IMF suggest that it would overtake the U.S. by 2016. As Arvind Subramanian puts it,[i] “When the presidents of China and the United States met last week in Washington, neither was likely to be aware that measured in terms of purchasing power, it is Hu Jintao, and not Barack Obama, who represented the world’s largest economy.”

This development was shocking to an average American who had looked upon China as a poor developing country. It was the US helping hand in the post Nixon years that helped the rise of the Chinese economy. China was transforming and emerging as a member of the international community. It could enter many international organizations including the WTO. It was the assurance of access to the U.S. market that created the massive export oriented economy. It was based on the new relationship with the U.S. It led to large flows of foreign investment, created export platforms, supply chains and these were truly the stuff of globalization.

The unique nature of China’s development was that it was not based wholly on the western capitalist model. It was described as “capitalism with Chinese characteristics.” China drew on its national savings and directed massive bank credit toward creation of infrastructure. This has given a tremendous of autonomy in pursuing policies and not subjecting itself to conditionalities of aid agencies. India was at the losing end due to its dependence on the Fund and the Bank. China’s astronomical investments in building infrastructure such as roads, bridges, airports, harbours, etc. have given it an advantage or led to the creation of what has been subsumed under China price. Manufacture in China began to command a premium of 30 to 40 percent when compared with any other location. Often it is said that this advantage is due to low wages. This is not correct. As the latest issue of the Economist [ii] (March 10-16, 2012) describes, “The old stereotypes about low-wage sweat shops are as out of date as Mao suits.”

This competitive advantage and the ‘hollowing’ of manufacturing in the U.S. gave rise to irrational fears. It is an area where economic interdependence instead of creating trust creates misgivings. As a Task Force report of the Council of Foreign Relations de3scribed, “China’s rapid economic development, accompanied by an enormous and growing trade surplus with the United States has become synonymous with the large challenge of globalization, especially the pressures created by competition with low-wage economies.” The fear of becoming or remaining a “declining power” could affect policies and global strategies. As one of the columnists of Financial Times explained, [iii] “America must manage its decline.” Even if American analysts and politicians deny the reality of their declining status, it influences their thinking and policies unknowingly.

It is interesting to study the changing patterns of production and trade patterns in Asia. One of the early papers of the World Bank [iv] narrated the situation well. As it said, China enlarged its share of intra-Asian trade from 1`3% in 1993 to about 22% in 2004. China has overtaken Japan as the major importer of Asian manufactured goods and has caught up with Japan as the major exporter of manufactured goods to the region.” It goes on to explain how foreign affiliates were the engines of China’s rise in international and Asian trade. By 2005, wholly owned affiliates were responsible for almost 40% of China’s exports and imports.

These trends created optimism over the possibility of an Asian Union analogous to the European Union. It was assessed that more than half of Asia’s trade was with developing countries, especially intra-Asian. Intra-regional trade accounted for 51% of total Asian exports against 9.2% in 1990. However, these trends masked harsh realities. The intra-Asian trade was dominantly in the form of intermediates and semi-processed goods and took place within vertically integrated supply chains before shipment to western countries. China had turned into the manufacturing hub and a powerful magnet which attracted FDI. The attraction indeed was “China price.” As already explained, China price was not mainly due to low wages prevailing in China.

Alongside there were other developments. The U.S. was the pioneer in attempting to enter into bilateral or regional trade arrangements (RTAs). The RTAs are as much political in nature as economic. It was an attempt to bypass the WTO (Doha) negotiations which were stuck in disputes over agriculture subsidies and development issues. The US decided to bypass the WTO and capture trading opportunities with its political allies. RTAs introduced a host of other conditions which were anathema to the basic WTO arrangement such as labour standards, etc. Most countries in different regions of the world followed suit and this led to what Jagdish Bhagwati described as a “noodle bowl of RTAs.”

In the early years of its growth, China was averse to entering into regional trade arrangements. Over time, it realized the economic and strategic significance of these arrangements and began to court neighbouring countries. It served to augment its economic integration with Asia and, thereby, helped to extend its political influence. The integrated nature of Asian production with China as the hub facilitated these RTAs with several countries. It is estimated that there are 175 preferential trade agreements in force that include Asia-Pacific countries, and more are on the way with 20 awaiting implementation and 500 others under negotiation. The U.S. is excluded from all these RTAs. In the meantime ASEAN is on over drive. Since the beginning of 2010, ASEAN established FTA with China, Japan, South Korea and India and ASEAN-Australia-New Zealand FTA have also come into effect. Moreover, China-Korea and China-Japan bilateral FTA negotiations have also been taken up and China and South Korea were expected to begin formal negotiation in 2011. As several Congressional studies began to show, the U.S. was getting excluded from all these territories and arrangements. The U.S. faced the danger of being excluded from the economic cooperation in Asia. A study undertaken by Fred Bergsten of Peterson Institute for International Economics showed that if the East Asia Trade Area was established without the participation of the U.S., the U.S. would suffer a loss of at least US$25 billion every year and a job loss of 200,000. It was truly shocking to policymakers in the U.S. to realize that they had lost the dominance in Asia which they had built in the cold war years through U.S. investments, especially in outsourcing electronics manufacture, etc. The so-called East Asia Miracle described in the World Development Report 1958 unfolded under U.S. umbrella through the spreads of US corporations and with extra-ordinary customs duty concessions. Now the same U.S. is being excluded from Asia trade and this should have been quite galling to them. Now the efforts are to recapture the lost empire.

It is not surprising that the U.S. has stepped its strategy to promote the Trans Pacific Partnership (TPP) to counter these moves. There is a long history attached to TPP and there are several imponderables attached to its establishment and enlargement. But the U.S. will be unrelenting in its efforts to promote TPP without China. The idea seems to be to check China’s further rise and its integration with ASEAN or even to exclude it from Asian trade. Some analysts have argued that the U.S. can exclude China from Asian trade at its own peril. The policy is misconceived and will not work. More importantly, it may aggravate current rivalries and misgivings of some members vis-à-vis China and divide the Asian ranks. Given the current indication and the U.S. thrust, efforts will be made to induce India to become a member of the TPP in some form or other. It is possible that it would be linked to other arrangements and initiatives such as India US Civil Nuclear arrangement, agriculture and high tech dialogue, etc.

Many studies have suggested that the TPP may not take off in the coming years. It faces too many problems before the differences between members could be resolved. There is clear evidence that China looks upon TPP as an act of enmity and will frown upon other countries which become members of TPP. Official dailies such as China Daily have attacked the TPP strongly as an anti-China measure. If India wishes to maintain its current level of camaraderie with China, it should not show any interest in joining the TPP. It has to proceed with its current arrangements and/or ongoing negotiations with ASEAN countries or similarly situated RTAs.

India and China have concluded an arrangement under India-China Strategic Economic Dialogue (SED) which is analogous to what China has entered into with the U.S. in recent years. It was the result of a communique of India and China signed on December 16, 2010 when Chinese Premier Wen Jiabao visited India. The SED is a mechanism to deepen and elevate current levels of exchange and interaction. In its first meeting held in October 2011, the SED took up several thematic areas of high priority. It is now poised as an annual event on India-China diplomatic calendar. As one analyst put it, “India and China have demonstrated that they are capable of scaling up their level of engagement confidently, even as differences on issues such as the border, stapled visas, Tibet, the China-Pakistan equation and India-US partnership, suspicion over movement and activity in the South China sea and the Indian Ocean, remain.”

Trade data are indeed disturbing as are the nature of bilateral (export/import) flows. India’s trade gap with China has gone up from about $1 billion in 2001-02 to $24 billion in 2010-11. China’s major exports to India includes electrical machinery and equipment ($11.8 billion); machinery and mechanical appliances ($7.7 billion); chemicals (($5 billion); project goods (($3.18 billion); fertilizers ($1.5 billion); ships and boats ($3.15 billion); vehicles ($733 million); medical equipment and accessories ($655 million) and gems and jewellery ($685 million). But India’s exports in 2010-11 continues to rely on raw materials such as ores, cotton, copper articles, iron and steel, chemicals and petroleum products. While China’s exports have been in high value added items India’s share has remained in raw material or low value added items. These trends have caused some concern to Indian authorities. Interestingly, Premier Wen said during his visit to New Delhi that India was the managerial support to China’s manufacturing role. This was taken as a compliment by some in India, especially those in the IT sector. Unfortunately, this is not a sustainable relation. Economic relations need to be more balanced and the service sector is not a dependable ally in the longer term as a lever of growth and development. The imbalance has to be redressed as early as possible.

Government has been working on several options to moderate the trade deficit and also the imbalance.. In the foreign trade policy announced in 2009 for the years 2009-14, the aim was to double India’s exports of goods and services share in global trade by 2020 through appropriate policy support. There are some joint working groups working on the ways by which the imbalance could be reduced. These till date on paper and are yet to show results.

The main reason is that India Inc. does not take bold initiatives to innovate and step up manufacturing of value added items. It seems to concentrate more on European and U.S. markets and spending its time and efforts and finances in trying to put through mergers and acquisitions in the western markets.. China remains an unknown territory with which many businessmen are not yet familiar. On the other hand, there is also a tendency on the part of some of our leading companies to piggy back on Chinese manufacturing facilities. Even leading electrical and machinery manufacturing companies are sourcing components and equipment from China and sell them in India with minor modifications. There is a fear of ‘cheap’ goods flooding Indian market which is irrational.

At the same time, there is heavy reliance on imports from China in major sectors like power equipment, telecom, electronics, etc. Indian companies are unable to match the competitive prices offered by Chinese companies. This has led to campaigns against them and resulted in demands for imposing tariffs as in the power equipment sector. WTO records indicate that over 50 per cent of anti-dumping investigations were filed by India against China. In the telecom sector it has created fears over ‘security ‘implications raised by Home Ministry officials. Some of these concerns may be genuine. However, in future, they should be discussed and resolved through the SED mechanism. They should not lead to loud public debates and denunciations by the media. They create bad blood and vitiate the trading relations. Precipitate action should also be avoided. The latest ban on cotton was another instance which has resulted in strong reactions from the Chinese side.

If the imbalance in trade ratios has to be redressed, it is a long haul. While on this subject, there is need to be cautious about Yuan credit being offered to Indian companies by China’s ICB. China has also decided to offer such credit to BRIC countries and this item is to come up for discussion in the forthcoming meeting in New Delhi in late March 2012.

China is keen to promote the role of Yuan as an international currency and to replace the role of US dollar as a reserve currency. This is a move which is in the larger interests of emerging economies and also the global economy as a whole. However, there is a risk that such credit/loan would create greater dependence on Chinese imports and skew the trade imbalance further. In a way, It may amount to a newer avatar of former colonial dependency. The attraction of India Inc. to tap cheap loans is well known. We should not encourage this trend. We may however tap these loan resources to fund investment in infrastructure projects to improve our productivity and competitiveness. India has to step up its infrastructure facilities and improve its productivity and logistics. China has a lot to teach on this. Its industrial “clusters” are imaginative and support the supply chain in a big way. In joint groups and studies, India and China can take up individual sectors or items and study how they their manufacture could be made suitable for Chinese consumers. Unless a sustained long term program is put through, there is a risk of continuing imbalance. It cannot be “business as usual.”

As visualized by Kissinger in his assessment of U.S. China relations in the coming decade, India should also be realistic and put in place ideas and schemes for “co-evolution” It is a long haul and requires patience. If this spirit of togetherness evaporates for any reason, it may result in unnecessary conflicts, trade disputes and cause immense damage. It will also be a test of China’s claim peaceful and harmonious rise in the world. It may be easier for Asians than for those across continents.

i Arvind Subramanian (2011), Is China already number one? New GDP Estimates, East Asia Forum, 2 March 2011.

ii Economist (2012), The end of cheap China, March 10-16 2012.

iii Gideon Rachman (2011), America must manage its decline, Financial Times, October 17, 2011.

iv Gillaume Gaullier, Francois Lemone and Deniz Unal Kesenci, The emergence of China and its Impact on Asian Trade, September 2006, World Bank.