Chanakyan

Wednesday, August 11, 2021

India’s trade dependence on China – Triumph of Group-think

This was published in the Times of India on 12th Aug 2021

The concept of Group Think was first introduced by the psychologist Irving Janis in 1971. He described it as a situation where “individuals tend to refrain from expressing doubts and judgments or disagreeing with the consensus”. While Group Think is widely prevalent in several social contexts, its presence in higher policy-making and inferences can have outsized impact. Perhaps the most well-known example of Groupthink in recorded history is the Bay of Pigs invasion. A CIA operation to overthrow the new revolutionary government of Fidel Castro in Cuba, it failed spectacularly – and became the showpiece evidence of how groups of smart people rush to consensus without fully analyzing the data.

India’s trade dependence on China falls in the same category – the overwhelming consensus in the commentariat is that there is a structural and large import-dependence, one that China can use as a geopolitical weapon in times of sharp political contestations. Headline numbers are trotted out in support – how imports from China have kept going up despite Government of India’s (GOI) Atmanirbhar campaign and backlash against Chinese goods post-Galwan. There is also a suggestion that China has been able to weaponize its trade surplus with India, using the surplus for enhanced military expenditure while making India “dependent” on Chinese imports for day to day economic life. Most of the hypotheses are in the realm of myths rather than facts.

Myth # 1 – India imports too much from China

China is the largest trading nation in the world – its trade volumes with all countries are very high. It is a function of both China’s size as an economy (at $14 trillion, the second largest in the world) as well as its manufacturing prowess. For India, China accounts for 15-16% of aggregate imports (20-21% of non-oil imports). This number is actually lower than many major economies in the world, and most major economies in Asia. US, Australia and Japan – fellow members of the Quad, have more than 20% of their imports originating from China.

India’s import concentration with China, while it went up sharply from 10% in 2010 to 16% in 2017, has stabilized at the latter levels now. For some of the more critical, truly strategic import categories, the trend has either reversed or there is energetic efforts underway to reduce dependencies.

Myth #2 – India is dependent on China for imports, creating strategic leverage

This is perhaps the most important hypothesis, meriting closest scrutiny. The largest components of Chinese imports are Heavy electricals and machinery, Power equipment and Organic chemicals. A few trends are quite clear from the chart below.

Source: Ministry of Commerce

In absolute terms, the largest category – Electrical and Electronics goods – are on their way down in absolute terms. The Production Linked Incentive (PLI) programmes rolled out over the last couple of years initially focused largely on this segment, and as capacities under the programme come on stream, the impact is likely to be felt even more. Above all, most of these areas are not “monopoly chokeholds”, ie, there are alternative sources of supply including domestic, albeit at higher prices.

The same holds true for the second largest category of imports – Power Equipment. Very similar to Electricals and Electronics, this is an area where China has built a price advantage over global (and Indian) suppliers over the years, and the current dominance is a function of that relative price advantage. A mix of tariff walls, PLI incentives and the US-sponsored global movement of supply chain diversification (popularly termed as China + 1 in trade circles) are creating insurance against China-enforced supply disruptions. Significantly again, China does not have a supply monopoly choke-hold here either – ergo, sourcing from elsewhere is a function of price rather than availability in many cases.

It is the third category – Organic Chemicals – where things are trickier. It includes Active Pharmaceutical Ingredients (API), the essential intermediate input for a vast majority of pharmaceuticals. China is a dominant global manufacturer of API, and this could represent a significant tricky dependence. Till about a decade back, India was self-sufficient in APIs, before much cheaper Chinese capacities drive most pharma companies towards imports. Good news is that there are no great technology hurdles in the segment, merely one of cost and capacity. Already, several Indian companies are investing heavily in the area. Over the next few years, the dependence on China will likely come down.

It is actually in a smaller (by absolute $ value) category, Rare Earth metals, that there are critical strategic issues. China is the source of a range of rare earth metals that are used in critical electronics, telecommunication and other hi-tech equipment. It isn’t an India-specific problem, the world is grappling with the same. The Chinese dominance in the area was sparked off by gradual US withdrawal from mining/processing of rare earth oxides and simultaeneous large investments by China. Already, a US-sponsored globally coordinated effort under President Biden’s diversification of supply chain initiative is underway. But this is likely to take time and careful handling by India.

Myth 3 – India’s strategic nirvana would be to cut down on consumer goods production

There is a general (most economist wisdom driven) hypothesis that too much of India’s China imports are to fuel elite consumer goods (like cars and mobile phones). India needs to wean off an economic model that fuels production of such import-intensive consumer goods. This is equivalent of cutting one’s nose to spite one’s face. Industries like automobiles, consumer electronics and mobile phones are not only clusters of large-scale manufacturing employment, they also provide enormous network benefits by spawning entire eco-systems of finance, supply-chain and other related services. They also engender manufacturing exports – small cars, eg, is a rare manufacturing export success story from India. India’s strategic vulnerabilities will rise (and not go lower) in case critical manufacturing bases are hollowed out in an attempt to curb imports. Imports from anywhere, China or otherwise, are not “bad”, and exports of anything is not tautologically “good”. Both are economic transactions with outcomes – the focus has to be on outcomes rather than inputs.

The China import issue, to a large extent, is a bogey. India’s vulnerabilities, as seen above, are far less than is popularly believed. India’s also part of the recent global instincts towards de-globalisation, which is actually nothing too different from redundancies in supply chains (which in turn is elementary risk management strategy, forgotten for too long). Our responses, therefore, need to be deliberate rather than paranoid, focused on key areas (like APIs and Rare Earth metals) rather than looking to up-end all benefits from liberalized trade that have accrued to India since the 1991 reforms. In a nutshell, Groupthink pitfalls need to be zealously avoided!

Thursday, July 1, 2021

Covid19 - Atmanirbhar Bharat a serendipitous policy response to a protectionist world

This was published in The Times of India on 1st July 2021

In March 2020, Rabbi Jonathan Sacks, the former Chief Rabbi of the United Kingdom, provocatively said that Covid19 is “the nearest we have to a revelation, even to atheists. We’ve been coasting along for more than half a century…and all of a sudden we are facing the fragility and the vulnerability of the human situation”. More than a year hence, the metaphor rings true. Even the most affluent have been starkly, brutally made to come face to face with human fallibility and mortality. That has been the Black Swan. Several of the outcomes facing the world today, however, are white(r) swans – increasing inequality, higher trade barriers, increasing geopolitical tensions.

Indian economy, already cratering on growth even before the rolling lockdowns started in March 2020, is confronting the same challenges both internally and in its external engagement. Growth had touched a multi-decade low of 4% even without the impact of the virus. Traditional growth drivers had sputtered down, and the country was looking for new imagination and ideas. A big traditional driver of growth that has been morphing itself fundamentally is open-ness of the Western world to free trade.

The growth of Asia post second world war has been a stunning success story of free trade. Or perhaps more accurately, a success of the model where the West (primarily the US) traded one-way market open-ness for political support (against the USSR) – the grand bargain of the 20^th century with Asia. Non-reciprocal access to the large consumer markets of the West was a “one-two” punch for Asia – it protected domestic industry from larger, more efficient western firms and incentivized the latter to set up bases in Asia to export back to the West. Japan, the Tiger economies of East Asia and China have all been beneficiaries of this grand bargain. India had been rather late to this party, having decided on a “non aligned” political stance for much of the 20^th century on one hand; and focusing on an internally-focused, import-substituting industrial architecture on the second. Post liberalization, India too jumped on the same global trade bandwagon, and the trend-break growth of the last thirty years has a lot to do with India’s global engagement. Most spectacularly in the areas of Information Technology outsourcing.

The free trade consensus, however, has been fraying at the edges for quite some time. Triggered partially by China’s increasingly polemical politics, protectionism has grown in its political seductiveness in the US. Much before the pandemic, President Donald Trump’s MAGA campaign at its policy-core raised trade barriers and tariff levels, mostly against China (and a few small ones against India too). Coming out of the pandemic, the strategy has not met the full measure of its advertised objectives. Prior to Covid19, while exports from China to the US came down a tad, it only seemed to mean a shift in trade chains – from China to other countries in East Asia. Firms, including Chinese firms, relocated from mainland China to Vietnam, Thailand and Taiwan. As a result, aggregate US trade deficit has only grown since 2016. The new Biden administration has now finessed the strategy further, via the Securing Supply Chain review exercise, released earlier this month. In a range of key areas – from pharmaceuticals to semiconductors – the US government would now look to build redundancies and sacrifice efficiencies in the process. The redundancies are meant to be built, putatively, around more onshore production and/or those based in “trusted partner” countries.

For good measure, China too, with less fanfare, rolled out its own version of self-sufficiency last year. Confusingly christened Dual Circulation, it identified “internal circulation” - the domestic cycle of production, distribution, and consumption – as the main pillar for its development. “External circulation” – trade and commerce – is expected to play a supportive role only. Details and sketchy and scarce, but it smells, walks and quacks more like a duck (read, greater trade protection) than not.

Last but not least, there is a growing tide of anti-immigration sentiments in the West. It has always been tough for India to trade the area of its comparative advantage – labour, for its area of comparative disadvantage – capital (and market access). Its gotten a whole lot tougher now.

India’s Atmanirbhar Bharat programme provides a somewhat serendipitous potential policy response to the current global group think. Post 1991 reforms, India’s policy framework has generally opted to favour increase in overall cost efficiencies of the economy and attract capital in areas of relative competitive advantage. As a result, whole swathes of manufacturing, where Chinese imports provide cheaper and more efficient alternatives to domestic consumers and industrial users, Indian manufacturing simply does not exist. This is true even for sectors that have no great technology barriers. As a result, India’s biggest trade deficit is not in the area of hydrocarbons (which is usually the most closely monitored variable), but in manufactured goods.

Source: ASKWA Research

As can be seen in the table, manufactured goods represent the biggest deficit hole in India’s trade account. Much of the manufacturing lines don’t need ponderous “reform” measures, nor are they hostage to proprietary technology access. Recently, during the first flush of the pandemic, India realized the strategic weaponization potential of some of these manufacturing lines. Active Pharmaceuticals Ingredients (API), eg, a key pharmaceutical intermediate, had shifted almost wholesale to China (from India even 10-15 years back). A potential choking of API supplies could potentially jeopardize several key and life saving drugs in the country. Similar, even if somewhat less dramatic, strategic potential lies in other areas like electronics, rare earths and semiconductors. The government’s Performance Linked Incentive (PLI) programme – now rolled out across multiple sectors – has sought to specifically target these sources of strategic vulnerabilities.

In short, despite a lot of initial flak, Atmanirbhar Bharat seems to be in lock-step with the global fashion. China’s rise, no longer considered benign by anyone around the world, has had literally bloody repercussions for India. The old compact of the West, around free trade and non-reciprocal trade access is breaking down. Like rest of the world, India too needs to craft a new paradigm.

With trade being intermeshed a lot more with politics, and focus firmly pivoting on trade as a club rather than a global commons (as represented by WTO principles), opportunities and threats have arisen in equal measure. India’s praxis as a leading democracy, member of the Quad and potential bulwark to China opens trade club opportunities. The easy status quo of non-reciprocity with the West, however, is gone. It’s a more complex world, one which is a bit more dog-eat-dog rather than what End of History would have assumed.