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China's trade power

By Prem Shankar Jha

One of the least satisfactory features of the Reserve Bank of India's mid-year review of the economy was its silence on India's unsatisfactory performance in exports. The report simply noted that the growth rate in this sector had come down from almost 20 per cent in 2002-03 to 10 per cent in the first half of the current year. It did not mention the fact that most of even this unremarkable growth had been achieved in the first three months and that in July and August the growth had declined to 5 and 4 per cent.

Perhaps the bounding foreign exchange reserves had made it complacent. But its complacency would have been dented somewhat had it compared India's performance with that of China. In October China recorded a $5.7 billion trade surplus. That was in a single month. Over the year China's exports have grown by 37 per cent. Before that India's 10 per cent looks decidedly anaemic and the 4-5 per cent in recent months looks catastrophic.

Mentioning China is not, of course in good taste, because it brings up all of Indian policymakers' allergies. Some are even likely to argue that China's exports are growing too fast. Washington has already made it clear that it thinks so. It has accused Beijing of deliberately holding down its exchange rate in order to increase its exports and said that this is causing a loss of jobs in the U.S. The Bush administration has even decided to impose quotas on the import of garments from China if it does not revalue its exchange rate or impose a voluntary restraint on its exports to the U.S. India, they may point out, cannot adopt such policies because its exchange rate is determined by market forces and is appreciating (the cause of the fall in the growth of exports) because of the decline in the value of the dollar.

A close look at China's and the U.S.' trade patterns, however, tells a completely different story. China's exports are growing explosively not because the Renminbi is undervalued deliberately, but because of its success in turning itself into an indispensable link in the global production chain. This becomes obvious the moment one looks closely at the pattern of Chinese and American imports and exports.

While China is running a growing trade surplus with the U.S. ($100 billion last year!) it is running large trade deficits with Japan, Taiwan and South Korea. How are these high wage countries able to run up trade surpluses with China when the U.S. is running a record trade deficit. The answer is 'outsourcing'. Once upon a time when labour was cheap in Japan, American firms outsourced a part or all of their manufacture to Japan. When wages rose in Japan, they went to South Korea and Taiwan.

But the Japanese did not want to lose their markets in the U.S. so they too went to Korea, Taiwan and elsewhere in Southeast Asia to keep down the cost of their exports. But then wages in Korea and Taiwan went up too, so Japan shifted its outsourcing to China. But the Koreans and Taiwanese do not want to lose markets either, so they are manufacturing or assembling products in China that they sell either to Japan for re-export or directly to the U.S. In the end everyone ends up in China because its labour is by far the cheapest.

What is taking place today is a transfer of production from other outsourcing centres to China's special economic zones, because of its success in making them welcoming places for foreign investment to come to. Proof that such a transfer lies at the root of the U.S.' burgeoning trade deficit with it is the fact that its deficit with Mexico, the main centre of outsourcing for U.S. industry in the past, has actually shrunk. The lesson for India is bitter, but it needs to be learned. China has succeeded where India has failed.

It has become an essential link in the global production chain for high value-added, hi-tech consumer products whereas India has failed. The reason is that China succeeded in creating an environment, with assured, worldclass infra- structure, free from the `transaction costs' imposed by endemic petty bureaucratic extortion that India failed to create.

Nor should Delhi be lulled into complacency by its software and back office operation exports. India owes its success here to one infrastructural advantage that China did not have — the familiarity of its educated classes with English. But that infrastructure was left to us by the British! And the Chinese are catching up.

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