China, free trade, imagined gains and real fallout

Illusions and delusions

Despite the improvement in our border stand-off, most policy observers recommend continued caution and trade restrictions while dealing with China on national security grounds. Deng Xiaoping remarked, ‘Hide your strength, bide your time’, they point out, but the current chief – Xi Jinping – obviously feels that it is time to realise the 100-year-old Chinese dream. However, also heard are voices that favour a liberalised trade relationship with China that can further boost our growth and employment prospects. What should our balanced response be?

An appropriate starting point would be to recognise that ideas revolving around benefits of trade arise from thought dynamics of ‘comparative advantage’. These have remained unchanged from the times of David Ricardo. He argued that nations benefit by focusing on producing goods where they have an edge, and importing those goods where other countries have an edge. He emphasised that even if a country is better at producing all goods, it will still benefit from producing only those goods where it has a ‘relative’ comparative advantage and importing those, where other countries have a ‘relative but not necessarily absolute comparative advantage’. The basic underlying assumption here is that countries function under conditions of “scarcity”’ and “diminishing returns to scale”. These pre-conditions, undeniably, held true for most part of the 20th century.

Till recently, large organisations were seen as relatively inefficient, compared to the smaller/nimbler firms. Further, they were not consciously promoted as part of a national industrial policy. However, matters have changed because of the revolutionary advances in transportation, computing technology and informatics witnessed in the last few decades. These advancements have created conditions where ‘increasing returns to scale’ are routinely experienced in multiple sectors, dependent on technological production. The most dramatic display of this was, ironically, seen in India in the 1980s and 1990s when Reliance, through sheer use of scale, demolished its competitors by undercutting them in prices while displaying continued growth in profitability.

The Chinese ecosystem, post-Deng Xiaoping reforms of economic decentralisation, is similarly displaying benefits from ‘increasing returns to scale’. The difference between India and China is that while the Reliance type companies are, in a sense, outliers in India, it is not so in China. There, individual cities promote and foster local champions. China, therefore, has over 150 solar cell manufacturers, 100 EV manufacturers, 90 robotic manufacturers, etc., all battling for survival in the domestic and export markets. All are global-sized or even larger. As a consequence, China now effectively dominates global manufacturing with a 38% share and an ever-rising trade surplus despite a variety of import curbs imposed by the US, EU and India.

Additionally, in sectors identified by the Chinese, the concept of ‘scarcity’ has been replaced by excessive ‘excess capacity’. Illustratively, it has a total installed capacity of 1.17 billion tonnes of steel, more than double the combined capacities of US, EU and India. It consumes only 930 million tonnes and needs to dump the rest in global markets. Similar is the situation in most other medium- and high-technology sectors. Notwithstanding this, to counter the policy-induced economic slowdown, China continues to increase investments in the manufacturing sector. A world where a major player is revealing ‘increasing returns to scale and excessive excess capacity’ is substantially different from a world where countries face ‘scarcity and diminishing returns to scale’.

Further, we tend to forget that ‘efficiency gains’ of trade happen by “reshuffling workers from less to more efficient producers.” This often implies closing down some jobs in some places. Similarly, discussions that only look at “winners” in poor countries and “losers” in rich countries tend to miss the point that the gains from trade are also usually unequally distributed, within both sets of countries. So, terms like ‘worker mobility’ often carry different images in different households, sectors and geographic regions. We need, therefore, to give more importance to voiced apprehensions of Tata Steel about steel imports or the murmurings in the auto sector regarding duty relaxations in imports of e-vehicles.

We also need to internalise that our 1991 experiment of economic liberalisation was a success partly because governance reforms had boosted entrepreneur sentiments and partly because this period coincided with the dawn of the internet, a unipolar world, and a WTO-governed trading order. Consequently, EMEs as a whole experienced rapid growth but because further governance reforms to truncate the long decision-making chains via effective economic decentralisation did not happen, we are not yet a major exporting nation. We rank a lowly 17th. Our trade deficit with China is over $85 billion.

Given all this, it is rather unlikely that liberalising China trade will create the imagined benefits for us as a society. It may instead weaken our economic prospects. Free trade theorists, therefore, need to be asked to revisit their assumptions.