The unending escalation of trade tensions between the US and China has led to a disruption of long-established supply chains between the two countries. Firms exporting from China, both domestic and foreign, have begun to move to other countries in Asia. Indeed, by July this year, over 50 major global firms, from Nike to Nintendo and Panasonic, had indicated the possibility of their relocation, citing the risk of high tariffs and potential ineligibility for US procurement contracts as their primary motivations for a move.
In itself, these disruptions open up an opportunity for India to expand trade with the US and China—by filling in supply gaps. They also create the strategic possibility that India might attract firms exiting China to use India as an exporting base, thereby improving India’s manufacturing base, creating jobs and further expanding its trade, especially with the US.
In the first instance, one might be pessimistic about the possibility of India stepping in to close the supply gaps created by the US-China trade war. India’s top global exports are precious stones and jewellery, pharmaceuticals, metals, minerals, refined petroleum and textiles—product categories that account for roughly half of India’s exports and bear little resemblance to China’s export basket, which is dominated by machinery, office equipment and miscellaneous light manufactures.
However, the scale of Chinese exports (roughly 10 times India’s) implies that even small changes to some of China’s less significant exports may create opportunities of significant scale for countries such as India. For instance, Chinese textiles account for nearly 20% of US textile imports, while Indian exports account for only a little over 5%. Similarly, Chinese global machinery exports amount to nearly $1.2 trillion, while India’s are a paltry $27 billion. Indian machinery exports would increase by over 40%, were India to take over a mere 1% of Chinese machinery exports.
India’s prospects would be further enhanced if it were to attract manufacturers exiting China. While India has enjoyed an improvement in its “investment climate" and the “ease of doing business" rankings over the years, and while it has implemented significant liberalization of its foreign direct investment (FDI) rules, setting up manufacturing operations in India remains a daunting challenge for many would-be investors.
It is no surprise, then, that other countries, with more agile policy responses and more business-friendly environments, such as Vietnam, have been far more successful than India in attracting firms exiting China. Indeed, Vietnam’s exports to the US last year have risen by more than 40%—a truly remarkable increase—driven largely by firms that have relocated from China.
India’s aspirations in attracting foreign capital face another challenge. Given India’s relatively inhospitable environment, where the acquisition of land to set up large manufacturing operations remains hugely problematic and where infrastructure support remains less than ideal, the type of investment that India is likely to attract in the short run will be investment not of significant scale and not requiring much by way of either land or installed capital. In other words, the investments that are likely to flow to India, exiting China, will be characterized by low fixed costs and relative capital non-intensity—that is, relatively “footloose" investments.
The danger with footloose capital, somewhat akin to highly footloose portfolio investment, is that it may leave just as easily as it had arrived with even a small change in incentives either in India or abroad. Thus, should circumstances change between the US and China or in other potential host countries, such as Vietnam and Thailand, these investments may exit India as rapidly as they had entered. While we may count the incoming investments as benefits so long as they remain, on balance, India would surely prefer to attract more stable investments that generate output and job growth over a longer time horizon.
Avoiding the scenario where merely footloose capital fleeing the trade war migrates to India for an uncertain period and with uncertain benefits, and where instead, major capital-intensive manufacturing activities move to India permanently, requires a very substantial improvement in the basic factors that drive FDI. These include competitive labour costs, a tax and regulatory environment hospitable to business and easy and hassle-free access to all of the factors of production—land, labour, capital and other inputs such as raw material and intermediate inputs.
It is self-evident that India fares poorly in many of these areas at present—for instance, restrictive labour laws that make it hard to retrench workers once beyond a certain scale; the vagaries of the land acquisition process; an inadequate road, rail and seaport network, increasing costs of getting goods to market, especially foreign markets; and uncertainties in the taxation environment for foreign investment—all of which create a strong disincentive to invest.
It is clear that India faces a significant policy challenge. Finance minister Nirmala Sitharaman’s recent announcements offering improved trade facilitation—especially in dealing with paperwork relating to taxes, trade credits and so forth—are welcome improvements. However, they will only have a small impact if they are not accompanied by more substantial structural changes. Now is not the time for tinkering at the margins, but for bold moves to make India a serious player in global value chains. The finance minister’s recently announced corporate tax cuts represent the first bold economic move of the re-elected Narendra Modi government, and is very welcome. We need more of the same.
Vivek Dahejia and Pravin Krishna are, respectively, a Mint columnist and Chung Ju Yung Distinguished Professor of International Economics and Business at Johns Hopkins University
Prakhar Misra also contributed to this article. These are the authors’ personal views
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