Decoupling from Chinese Manufacturing - An Assessment(GS 3 UPSC IAS Mains )

What is the issue?

The border clashes with China and the COVID-19 pandemic have reignited questions about India’s dependence on Chinese manufacturing.
In this context, here is a look into various economic and other factors for bringing in investments into India.

How dependent is India on Chinese manufacturing?

India’s imports from China in 2019-2020 reached $65 billion.
This is out of the $81 billion two-way trade.
Currently, India is exporting a lot of raw materials and intermediate products.
On the other hand, it is importing finished products from China.
It is also importing certain key intermediates such as active pharmaceutical ingredients from China.
Sectors - In terms of capital goods, Indian manufacturing is highly dependent on supplies from China.
This includes a wide variety of machineries, including electrical machinery, semiconductor driven machinery etc.
India also imports fertilizers from China.
Many limited value consumer goods, to a very large extent, have flooded the Indian market.
Whether these are actually required to be imported or not is itself not clear however.

What are the challenges in addressing the imports concern?

Alternatives - For a variety of reasons, India’s dependence on imports is localised.
In other words, there is no wide diversification of countries from which India is sourcing its imports.
E.g. Most of the critical medical supplies imported for frontline healthcare workers in the COVID-19 situation comes from China
This essentially means that apart from China, there are probably 3 or 4 countries on which India's dependence is increasing.
So it would be a difficult choice for India to get out of Chinese dependence and search for alternative partners.

Essentials - Concern arises not with imports that are not really a matter of choice but with those products that are crucial and essential.
E.g. the humidifiers, medical masks, liquid soap being utilised in the COVID-19 battle
For these and other such essentials, China remains the main source.

What should India's approach be?

India's approach has to go much deeper and has to develop sector specific strategies.
It should prioritise in terms of the areas in which it can, relatively, more easily move back away from the Chinese dependency.
India should now probably replicate what China did in the 1990s.
However, the global environment and global value chains are much different from how they were 30 years back when China was opening up.

How different are the global value chains now?

Policymakers suggest that India is set to become more open and that there is going to be more reliance on the global markets.
Unfortunately, that possibility is far from reality.
China's strategy in 1990s was a global market-driven industrialisation strategy, an export-driven strategy.
Global value chains are now in fact becoming more local.
Countries are depending more on their own economies rather than on global markets.
This is perhaps an impact of the great recession of 2008.
So China's strategy in 1990s may not work for India now.

What gives China its central place in global manufacturing?

China is so central to a very large number of global and regional supply chains.
One is because China offers the capacity to businesses to develop the supply chains by considerable lengths within itself.
Not just the geography, China also has a broad-base that it has developed over different sectors, and by and large in most products.
China’s biggest value comes as a final stage assembler and that's where China’s proficiency in value chains happens.
Importantly, alongside being an exporter of assembled final products, China has also become a major consumer for final products.
In the post COVID-19 situation, the businesses' emphasis is to make value chains shorter, resilient and durable, and locate them closer to the final demand markets.
In this context, undeniably, China is more advantaged.
China continues to remain a major source of the final demand market.
China's geography offers tremendous agglomeration advantages of moving back and forth across borders and integrated facilities.

So, is relocation possible?

Given the above factors, shifting supply chains physically out of the Chinese geography and it’s connected arms (such as Hong Kong and Taiwan) would be hard.
Whatever relocation was possible has already happened after the onset of the U.S-China trade war driven by tariffs.
So, seeing that kind of relocation is unlikely anymore.
Nevertheless, companies have moved out and are moving mainly to South-East Asia.
This offers scope for limited relocations, and India should see ways of attracting these.

Did Make in India succeed in this regard?

Make in India initiative was a good opportunity for India to get the manufacturing sector back on track.
But the country has not taken advantage of what it had actually planned for.
In the past 5 years, with Make in India programme in place, the dependency on China has actually gone up.
The Make in India strategy talked about FDI into manufacturing.
But data reveal that foreign investors had preferred service sectors.
And many of these sectors are those where India does not need any investment. E.g. IT services

What is to be done?

Despite being one of the most open economies and offering attractive terms to foreign investors, India has attracted little investments.
India should now analyse the gulf between FDI inflows into China and into India.
The policies should look at the wholesome picture to address the varied factors (Click here for Part II) that go into making 'attracting investments' work.

What are the key factors to attracting investments?

Skills - Certainly, there are skill set problems in India.
Foreign investors get into the sectors where there are acknowledged skills. E.g. IT services
But there are no similar skill sets in manufacturing.
Infrastructure - Foreign investors are not to be seen as those who come to develop India.
They rather come to make profits, as apart of which development might happen.
So, when it comes to investments, besides having a good policy, there is a need for supportive infrastructure to make profits.
India lacks many of the advantages that China has locationally. E.g. ports
Productivity - There is a view that since the wage rates are low in India, investments are going to come here.
This may not work as expected.
It is actually productivity-linked wages that matter, and productivity in India is less encouraging.
Land - From 2005, after the special economic zones (SEZ) policy, the Government of India has gone and acquired land all over the place.
So land is not an issue per se now in India, to attract investments.
Red tapism - Red tapism is a constraint in business functioning.
Much needs to be done on ground in this regard despite the development in the ease of doing business rankings.
Labour reforms - Industries have been calling for labour reforms.
There are complaints that labour unions are too powerful in India and it should be easier to hire and fire workers.
But COVID-19-led condition has proved this wrong.
It is actually easy for industries in India to hire and fire.
The reverse migration made it apparent that labour policies are much flexible in India.
Nature of investments - Over the last 3-4 years, the kind of FDIs that India has seen, the big ticket FDIs especially, are essentially intending to acquire existing assets.
E.g. Walmart’s acquisition of a large stake in Flipkart, Facebook's in Reliance Jio
None of these was in the nature of a typical greenfield investment, which is capable of creating substantial jobs and other additional capacities.

Market - One thing India can probably offer unlike to the small degrees of many other countries in South-East Asia is a huge domestic market.

For instance, economies like Vietnam, Malaysia, Thailand, Cambodia or Bangladesh are all competing for a slice of the pie of the relocated supply chains.
These countries do not have the kind of a market that India has.
But they have the ability to provide access to other markets in a far more effective fashion.
E.g. Vietnam recently concluded a free trade agreement with the European Union, which will offer two advantages -
1. Some businesses from China can get relocated in Vietnam, taking advantage of the European market, and they can also export back to China.
2. Businesses will have the advantage of the greater ASEAN and Asia-Pacific region, which is basically following a strategy of scaling up markets if one’s domestic market is relatively small.
India should work to harness the strength of its dominant domestic market.

Utilising India's market potential is linked to the overall strategy of -
1. widening the manufacturing sector
2. allowing the manufacturing sector to absorb more labour, especially from agriculture
3. having a more resilient manufacturing sector, and thus reducing the dependence on countries like China

A strong manufacturing sector would bring down the unemployment rates and thereby address the issue of shrinking demand in domestic market.
A demand-filled market is what attracts both foreign investors and domestic investors.
Labour - The issues such as increasing wage rates and skilled labour becoming costly are there even in Vietnam.
But the point is to look at what kind of labour is wanted for what kind of operations.
There is a situation in India and across the region where skilled labour continues to be at a premium.
There will be a choice between countries and locations in terms of access to new labour.
Cultural elements - Another factor is that of a cultural commonness in business practices across the region, found in China, Japan, Korea, and large parts of South-East Asia.
There is also the emphasis on settling disputes through dialogues, emphasis on informal consultations.
This is opposed to terms of a more structured fashion found in India as well as in the West.
So, there also exists a cultural element to this entire question of supply chains and investments, and relocation, which India should not overlook.

How significant is RCEP in this context?

With concerns with the functioning of the WTO, various groups of countries have moved on to pursue regional and bilateral agreements.
The Asia Pacific has been a very active region in this regard.
India's joining in the RCEP (Regional Comprehensive Economic Partnership) has been delaying for long.
India's stated objective is to reduce dependency on China and work towards relocation of supply chains with like-minded countries like Japan, Korea, Vietnam, etc.
Now all these countries are members of RCEP as well.
Naturally, these are going to work on the same rules of origin that RCEP is going to give them.
In essence, India is trying to position itself as a hub and to relocate supply chains along with countries that are part of a completely different sub-regional trade understanding.
With such contradictory objectives in place, the RCEP gains a significant role.
India should go ahead and make its stance about engagements with the trade agreements clear.

How does the future look?

Given the trend in the last few years, India is seen to have gone more protectionist.
The average tariffs have actually gone up.
Likely, the tariff policy is going to be even more protectionist.
There are already calls for promoting domestic goods, shunning imported goods, and even products made by foreign companies.
This would mean India trying to take up the path of import substitution.
But, in reality, it is hard to bring in indigenisation in everything from air conditioners to furniture to leather products, etc.
So the right path ahead is for policies to be predictable and transparent so as to avoid these conflicting signals and instil confidence in investors and attract investments to keep the economy going.