Introduction agrees that time for adjustment was needed—say
June 5, 2019
Looking at the gross domestic product(GDP) growth rates of China and India for past few decades, we can consider both the economies as miracle economies of this century because they have also been unscathed by the recent global crisis.
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At constant international dollars, China’s per capita GDP was 19 per cent of the US level in 2007, as against 3.5 per cent in 1978; the figures were respectively 9 per cent and 5.8 per cent for India. China’s share rose from 0.92 per cent of the US level in 1970 to 1.63 per cent in 1980 and 13.8 per cent in 2006, while the figures for India were respectively 0.65 per cent, 0.68 per cent, and 2.02 per cent over the same years, in net output of manufacturing at constant international dollars. China’s percentage share in global exports of manufactures shot up from 0.8 in 1980 to 13.5 in 2009, and that of India from 0.5 and 1.3 (WTO database).
The industrial reforms of 1991 were some economist such as Joshi and Little, who in their book mentioned that since ‘a good deal of Indian industry, after 40 years of almost total protection and limited domestic competition was in poor shape in 1991 to survive international competition with only very limited protection’. They also agreed to the fact that in case of capital goods there was for some years ‘negative protection in some cases’, and that ‘everyone agrees that time for adjustment was needed—say seven years’.
It is evident that the reformers expected that an abrupt liberalization of imports would cause a collapse of many Indian industries, especially in capital goods. Imports across the board began to surge after a brief period of import compression. The import of capital goods saw a huge jump of about 50 percent more than in the pre-crisis year upto US$8.5 billion. Further, the import duties, as noted by the NMCC and others, remained over the years virtually nil for capital goods required for ‘mega projects’ across the sectors; the domestic player had to pay indirect taxes where as there was no countervailing duties on competing imports which further added to the insult. the compound average annual growth rate of all manufacturing was higher in the 1980s (7.6 per cent) than in the post-reform years, 1990-2009 (6.2 per cent); much steeper was the fall in that of capital goods, from 11.3 per cent to 5.4 per cent over the same years. The shock therapy was quite effective for capital goods with the growth rate plunging to 3.8 per cent during 1990-2000, but it recovered to 7.3 per cent over the next nine years (Reserve Bank of India RBI 2010). The deceleration in manufacturing growth happened because of various other factors apart from import liberalization. The reforms though predicted to acceleration in the labor intensive manufactures after 1991.
United Nations Industrial Development Organization (UNIDO) classifies all commodities into: (a) resource based (RB), (b) low technology (LT), (c) medium technology (MT), and (d) high technology (HT); the number of SITC three-digit products in these groups are respectively 68, 44, 72, and 17 (UNIDO 2009) From the UN Comtrade database, the percentage share of each group in India’s total export was calculated for 1990 and 2008. What is most remarkable is the sharp rise of the RB group from 35 per cent in 1990 to 47 per cent in 2008. The earlier policy of restricting the export of minerals and preserving them for future use in domestic manufacturing was gradually lifted after 1991; this led to large-scale environmental degradation and displacement, especially of the tribal population, and generated sociopolitical tensions. Equally remarkable was the precipitous fall in the share of labor-intensive LT goods from 47 per cent to 28 per cent in those years. However, the share of more capital-intensive MT group went up from 13 per cent in 1990 to 20 per cent in 2008. At the other end, the share of the HT group was quite small and stagnant at 4-5 per cent.
The table below shows that though India’s HT exports during 2000-9 rose impressively by a factor of 7, India remains a minor player with a share of less than 1 per cent of the total for six exporters.
Telecom manufacturing was heavily affected by the 1991 reforms which literally destroyed the domestic industry. A government-funded research and development(R) unit, C- DOT made remarkable progress in designing, developing, and commercializing a range of digital automatic exchanges within five years of its creation in 1984; the total outlay was just Rs 1,000 million, or a tiny fraction of the R costs incurred by MNCs. Further, the fixed cost per installed landline using C-DOT equipment was just onethird of that for imported equipment. After 1991, the government marginalized C-DOT, encouraged private players, domestic or foreign, and permitted duty-free import of equipment. The new policy became a huge success in terms of the number of subscriberbase, fixed line and mobile, which went up exponentially from 5 to 650 million during 1991-2010. Ther was an exponential increase in the revenue as which went upto US$30 billion. But the local production (mainly, peripherals like telephone sets) accounted for less than one-fifth. It is ironical that India’s major suppliers are Chinese SOEs that were entirely dependent on MNCs up to the mid-1990s. Since software plays a crucial role in manufacturing telecom equipment, and India is still well ahead of China in software development, the C-DOT and similar entities could, with appropriate state support, offer a stiff challenge.
The export oriented software industry was the only major Indian industry that emerged after 1991 and captured the global attention. The information technology revolution fueled this growth in USA, the presence of a large body of Indian expatriates occupying key managerial posts in that country, and the abundance of highly skilled workers in India earning a fraction of their American counterpart. Various tax incentives were provided by the Indian government which was in tune with the international practice; similar concessions were available to Indian exporters even before 1991.
The indian reformers deliberately claimed an ‘industrial policy’ with the overriding objective to ‘lock’ india into the global financial system by moving as fast as feasible towards the free cross-border flow of capital. Thus shortly after 1991, control on current account transactions was removed, and unlimited inflow of foreign portfolio capital with virtual exemption from all domestic taxes was solicited. The big firms started raising equity and debt funds in international capital markets, and Indians started investing abroads using domestic resources. This more or less free mobility of capital is of immense benefit for the large firms and rich individuals; however, whether India as a poor country could gain from such flows has been questioned by many mainstream economists. For a net inflow of capital, the current account has to be in deficit. The import surplus ballooned from $6 billion in 2000-1 to U$119 billion in 2008-9, or about 10 per cent of the GDP. The surge in India’s software exports and sizeable private transfers covered a large part of the trade deficit. There was still an almost persistent deficit in the current account. From 1990-1 to 2008-9, the cumulative current account deficit amounted to US$91.3 billion while the surplus on capital account was as high as US$337.9 billion, and foreign exchange reserves increased by US$248.9 billion. The corresponding figures (in US$ billion) for 2000-1 to 2008-9 were 47.6, 260.8, and 215.9 respectively .
China did not have a clear blueprint and hence had to proceed carefully with the reforms. It retained a number of policies from the Moist era and the polity had a grip of the state-party. The state kept with the goal of catching up with the capitalist countries and exercised enough control over economic transaction, domestic as well as foreign. FDIs and technology imports played important role in the process and encouragement was directed towards market forces in the ever-widening spheres, not as an end in itself, but as a tool of state policy. This basic feature of ‘socialism with Chinese characteristics’ contradicts the essence of neo-liberalism as formulated by Hayek or Milton Friedman, although some of Deng’s key ideas were indistinguishable from those of the latter.
China’s domestic savings which comprised of domestic investment and external accounts rarely went into the danger area in spite of the enormous appetite for the foreign capital. Being self-reliant on these two fundamentals, the state decided on the kind of foreign capital to be encouraged or barred. To promote exports and rapid modernization of domestic industries, FDI in export-oriented sectors was mollycoddled with income tax breaks and liberal imports of capital goods or intermediates. FDI had to face many restrictions when the government thought it would exploit the domestic market. Further, in each case to this day, the foreign investor must sign a prior contract with the state, specifying the foreign contribution (in the form of technology, capital goods, and cash), and the contract period (usually 30 years, but renewable) beyond which the investor would have no claim over the residual assets.
The foreign investor had to form a joint venture (JV) with Chinese SOE till the late 1990s. Major stake went to the Chinese SOE abd they played role in appointing the chairman. The foreign partner had to disclose full details of the technology and capital goods supplied, so that the Chinese could assimilate the know-how and know-why of the technology. Further, foreign exchange outflows (import of capital goods and raw materials, dividends, and so on) had to be balanced by exports either from the JV itself or from a ‘third party’ to be identified by the foreign investors.
The constraints mattered little for investors from the Chinese diaspora in Hong Kong, Macao, and elsewhere in Southeast Asia, as they set up low-technology, labour-intensive units for ‘processing exports’. The overwhelming bulk of FDI into China till the late 1990s came from these sources
Foreign investors (till the late 1990s) seeking to exploit China’s domestic market were irked by the restrictions mentioned earlier. Yet they came in droves to have a slice of the enormous market. Owing to the disclosure requirement, they rarely inducted the latest technologies. Still, they profited from China’s protected markets. Critics of the official policy lamented that the country lost precious foreign exchange, while the pace of modernization was slow. The same argument has been made with respect to other developing countries, and needs closer scrutiny.
Had China insisted on obtaining state-of-the-art technologies in the early 1980s, few MNCs would be interested, even if they became the sole owners with full control over the ventures. For, the market for such expensive products was quite small owing to the low income of the Chinese. Indeed, India’s Foreign Exchange and Regulation Act, 1973, put a 40 per cent cap on foreign equity, but relaxed it to 50 per cent or more, if a firm utilized ‘sophisticated’ technology not available in the country. At the end of the 1970s, only two or three out of hundreds of foreign firms fulfilled the requirement (Chandra 1994).
Conversely, could China in the early 1980s successfully absorb the latest technologies in different sectors? As noted earlier, the USSR in the 1970s had imported such technologies from the West in several industries. But these plants were like islands with no linkages to the rest of the economy, and could not be replicated by Soviet engineers. It should have been true a fortiori for China in the 1980s. On the other hand, the somewhat dated technologies of the JVs were fully assimilated by the Chinese personnel who set up new production facilities on their own with much lower imports than before. Moreover, through further development work, the Chinese kept production cost pegged at a low level. Technology diffusion spawned a large number of new domestic firms and intense competition among them as well as the JVs exerted a downward pressure on market prices, resulting in a rapid expansion in domestic sale and exports of low-cost manufactured goods.
Foreign invested enterprises (FIEs) do now play a leading role in China’s exports. In the figures below the values of their export and net export are shown and the share of FIEs in China’s manufacturing exports. On the FIE share, I have no data prior to 1991 when it was just 22 per cent; it improved gradually to 50 per cent in 2000, soared to a peak of 62 per cent in 2004, but came down to 58 per cent in 2008. On the other hand, their net foreign exchange earning was in the red till 1997, and became positive, though quite small, up to 2004.
Subsequently, the positive balance jumped from U$50 billion in 2005 to a massive US$171 billion in 2008. Still, their trade balance as a proportion of exports was just 22 per cent in 2008. The surge in FIE export from the late 1990s is related to China’s quest for high tech industries with the help of foreign capital and technology, and I shall discuss it shortly.
Another common perception is that the FIEs are mainly engaged in ‘processing trade’ in which local value added is small. Indeed, of FIE export in 1996, as much as 86 per cent consisted of processing export, according to the customs data; the percentage came down to 81 in 2000, and 73 in 2008 (UNCTAD 1996 and Invest in China, Investment Promotion, Agency of Ministry of Commerce, Beijing).
Data on processing export by all firms, including FIEs, are given in Figures 4.3 and 4.4. Such exports gathered momentum from the mid1980s, and consistently exceeded one-half of China’s manufacturing export from 1989, reaching a peak of nearly two-thirds in 1996. The share began to drop slowly thereafter, reaching barely 50 per cent in 2008. Net export was negative till 1988, and positive but small up to 1995. Over the years there was a significant improvement, and the ratio of net to total export rose to 44 per cent in 2008. The percentage is quite high compared to that for overall manufacturing exports from many countries, for example, South Korea. Viewing China’s processing export as a kind of entrepôt trade is outdated.
A detailed study for the Asian Development Bank by Geng Xiao (2004) put the percentage of round-trip to total FDI inflow at anywhere between 26 and 56 in the early 2000s. Next, China’s Central Bank reported that one-half of FDI into China in 2004-5 was owing to round-trips by domestic firms through Hong Kong and the Caribbean off shore centres to avail of tax-breaks (Hindu Business Line, 10 August 2005). In 2007, offshore locations like the Virgin Islands, Cayman Islands, and Samoan Islands became major sources of FDI, accounting for 28 per cent of the total of US$72 billion (SYC 2009); apparently, these were instances of round-tripping. Further, the current definition of ‘FIE’ includes any firm with a foreign equity of at least 10 per cent (Kennedy 2007). Hence a significant, though unknown, proportion of FIE exports and imports was on account of enterprises directly or indirectly controlled by the SOEs or other Chinese firms.