In view of the failure of global policy to engage China and uncertainty over China’s behaviour in future, it is time for India and the free world to reverse course and disengage with China. Having come this far, reversing course and disengaging with China will, of course, cause some economic pain as both India and the US have got used to availing ostensibly cheaper goods and services from China
India recently took some policy decisions to reduce or ban certain imports from China. This follows India’s earlier decision to abstain from the Regional Comprehensive Economic Partnership (RCEP). As may be recalled, the RCEP is a proposed free trade agreement (FTA) between the ten member States of the ASEAN and six of ASEAN’s FTA partners, which include both India and China (in addition to Australia, Japan, New Zealand, and South Korea).
India’s decision to abstain from the RCEP was apparently made on the ground that such an agreement would have effectively amounted to an FTA with China. Thus, the recent policy decisions appear to be the continuation of the earlier decision to abstain from the RCEP, though the recent hostilities on the border with China also have been a contributing factor for the policy decisions.
Proponents of free international trade argue that international trade benefits all trading countries and thereby improves their welfare. This premise is central to the rules and policies of the World Trade Organization (WTO). The WTO’s rules and policies, however, do not take into account important geopolitical implications of international trade, although international trade and geopolitics are inseparable.
For instance, China moved to restrict imports of several Australian products after Australia called for an independent investigation into the origins of the coronavirus pandemic last year. If the geopolitical implications of international trade are taken into account, then, as I argue below, international trade may not benefit all trading countries and the foundation on which WTO rules and policies are built is shaky.
Some important facts
In recent years, the trade deficit between India and China has been of the order of $55 billion a year and that between the US and China $350 billion a year. This means the trade deficit between India and China as a percentage of India’s GDP is even larger than that between the US and China as a percentage of the US GDP, as the US GDP is more than seven times of India’s GDP.
These staggering numbers are inconsistent with another premise of international trade which states that a trade imbalance of this magnitude cannot be sustained for long as the exchange rates and the wages or labour costs will adjust until the trade is in balance.
But this is not true in the case of China as the Chinese Government has complete control over both its labour market and exchange rate and has successfully prevented the value of its currency and workers’ wages from rising sufficiently which could have induced a balanced trade with both India and the US.
Instead, the trade deficits have been sustained and grown.
The exports from China consist mostly of goods that are considered low tech such as toys, firecrackers, and electrical fittings. These goods are imported from China mainly because they are ostensibly cheaper and not because they cannot be produced locally at reasonable cost. In other words, most goods imported from China are substitutes, not complements, for the goods produced locally.
China is also suspected of adopting predatory pricing policies. As a result, imports from China have led to the closure of many factories which used to manufacture these goods and have reduced employment in both India and the US.
Another important fact to note here is that China is ruled by a totalitarian government and is a large country, as it has the largest population and is the second largest economy. This makes China a unique country as there is no other country in the world which has both these traits: there are small countries ruled by totalitarian governments and there are large countries ruled by democratic governments, but there is no country, except China, which is both large and ruled by a totalitarian government.
Thus, China has large enough population under its control to man a large manufacturing sector as well as a big well-equipped armed force that can threaten its neighbours.
The policy instruments
In abstract terms, buying goods or services imported from China by an individual or a firm generates two opposing effects. On the one hand, it benefits the buyer individually because the goods or services is ostensibly cheaper than that produced locally, but, on the other hand, it imposes a social cost as it contributes (indirectly) to the budget to finance the Chinese armed forces which can threaten the independence of India. This social cost is hidden because it is not immediately apparent to the buyer.
More importantly, the market fails to factor in this social cost. As a result, goods or services imported from China may appear to be cheaper than it really is because the social cost is either hidden or not taken into account by the buyer. A branch of economics discusses policy instruments to correct such market failures and induce market prices that reflect the true cost of goods or services. One well-known policy instrument is to levy a tax on goods or services which is equal to its social cost.
However, many policy-makers prefer an alternative policy instrument which is to impose quantitative restrictions, including a complete ban, on purchase of goods or services. The latter policy instrument, though not market friendly, is preferred because of its effectiveness whereas the former policy instrument, though market friendly, may not be much effective in controlling the demand for goods or services at the socially desirable level.
More importantly, the tax on imported goods or services may be neutralised by the exporting country by weakening its currency as a counter measure against the tax.
International trade and geopolitics
One would have expected the Chinese government to be more cooperative and sensitive to the concerns of its trade partners and show willingness to reduce the trade surpluses with them. Historically, international trade has often led to security alliances between trading partners and/or to balanced trade to ensure continuation of trade. But intriguingly the Chinese government has been insensitive to the concerns of India and the US against their huge trade deficits with China and has made light of the fact that China’s recent economic growth depends largely on the trade surpluses with these very countries. In fact, the Chinese government has been aggressive on the border with India and warned it, through an op-ed in its mouthpiece Global Times, of dire consequences if India aligns closely with the western democracies led by the US, as if India were not independent to choose its foreign policy or manage its international relations.
It is not India alone, the Chinese government has become openly aggressive against a number of other countries. It has claimed a large part of South China Sea contrary to the international law of the sea and brazenly rejected an unfavourable ruling by a UN tribunal.
The WTO and trade policy
At the time of its admission to the WTO in 2001, it was hoped that China will reduce its trade imbalance with the US. Many analysts also believed that engaging China in this way will help it to become liberal and drift towards a democratic system of governance. But exactly the opposite has happened: The US trade deficit with China, if anything, has grown bigger and the Chinese government, empowered by the trade surpluses with India and the US, has become even more authoritarian and assertive.
In view of the failure of global policy to engage China and uncertainty over China’s behaviour in future, it is time for India and the free world to reverse course and disengage with China. Having come this far, reversing course and disengaging with China will, of course, cause some economic pain as both India and the US have got used to availing ostensibly cheaper goods and services from China.
However, they do not really have a choice, as suffering some pain now is better than suffering more pain later which for India includes the possibility of losing independence to decide its foreign policy and manage its international relations.
India has already taken a policy decision to monitor and prevent predatory investments from China and barred China from the telecommunications sector for reasons of national security. It is also clear that India needs to impose a complete ban on imports of consumption or finished goods and services from China — and only from China so that the Indian firms still have to compete with firms from other countries — that can be produced locally at higher but reasonable cost.
However, allowing imports of some intermediate and capital goods, which are critical for India’s export sector, can be mutually beneficial for India and China, provided China agrees to import from India goods and services of equal value so that India has no trade deficit with China. Restricting trade with China in this way is likely to significantly affect China’s economy over time as India is a growing market. Furthermore, trade restrictions imposed by India can start a chain reaction worldwide as India’s recent ban on the Chinese-owned apps has. The total impact might be sufficient to unravel the threatening apparatus that China has built while riding high on its trade surpluses with India and the US.
In response to India’s recent policy decisions to restrict trade, China has been claiming discrimination and has been citing the WTO rules and policies. The present WTO rules and policies are not designed to distinguish between democratic and non-democratic countries and/or large and small countries. But as China’s uniqueness and aggression has demonstrated, it is time for the WTO to modify its rules and policies and start making a distinction between them as it does for instance between developed and developing countries.
The WTO rules should be flexible enough to allow every country the freedom to make whatever policies it considers necessary to balance its trade with a large country ruled by a totalitarian government, in view of the potential or actual threat such a country can pose to the country. The proposed formations of the Quad (a grouping of four democratic countries) and D-10 (a grouping of 10 democratic countries) are steps in the right direction. The countries within these groups may follow WTO trade rules when trading among themselves, but not necessarily when trading with a country ruled by a totalitarian government.
(The writer is a Professor at the University of Pittsburgh, USA)