Smart Economics

THE WORLD IS IN conflict. Russia-Ukraine. Israel- Iran. China-US. China-Europe. China-Mexico. China- Indonesia. China-virtually any major economy. The first two are conventional wars. The damage to lives is evident. The rest are economic wars. The damage to livelihoods is not apparent but trade wars (which spill over to investment) don’t end well, especially for less prosperous countries and the poorest people. The international governance architecture is a proven failure, whether it’s the UN Security Council for conventional wars or the World Trade Organization (WTO) for trade wars. While the ongoing conventional conflicts, geographically contained thus far, do not suggest an imminent world war, the economic conflicts could spread damage across the globe.

Is there a reason for the rest of the world to be miffed at China’s economic policies? The answer is yes. For several years, even after it became a member of WTO at the turn of the century, China has used subsidies, sometimes in cash, often in kind, to support its domestic industries. It has done so either in direct contravention or clever avoidance of international rules and norms. It has also done so in the most non-transparent ways available.

Ironically, every country that is now trying to act against China’s unfair practices had turned a blind eye to them for long. The West did so for a mixture of political and economic reasons. The US had reached out to China in the 1970s as a counterweight to the then superpower Soviet Union. At the time, impoverished China was unlikely to be a threat to the US in the foreseeable future. The economic reasons were a lot stickier. Chinese manufactured goods kept prices low for consumers in the advanced economies. Western companies took advantage of China’s open policies towards foreign direct investment and greatly profited. It seemed a winning proposition for the West. Until it wasn’t.

Even emerging economies were caught on the wrong foot by China. India is a classic example. Our trade deficit with China at the time it joined WTO was under $1 billion a year. More than two decades later, it has risen to around $80 billion a year. Tellingly, India’s imports from China were mostly value-added manufactured goods while exports were largely raw materials. India’s half-baked reforms, which involved trade liberalisation but no factor market liberalisation, led to a deindustrialisation. Now, any serious reindustrialisation is simply not possible without dependence on China (for intermediary inputs and technology). Other emerging economies are worse off. Those who participated in China’s Belt and Road Initiative are heavily in debt. Others have either sold or leased their key assets, including natural resources, to China.

Everyone is now trying hard to disentangle themselves from China’s economic embrace. In doing so, they must take care not to damage each other. It is one thing to raise barriers against China. It is quite another to resort to protectionism across the board. Or to try and implement extensive industrial policies in what can only be described as a paradoxical response to China’s practices.

For the advanced economies, it is not going to be possible to “re-shore” every type of manufacturing activity. The economics will not work. Costs are too high and prices for consumers will be too high. Some highly strategic sectors, like fabrication of semiconductors, are already being offered incentives to re-shore but surely, light manufacturing (textiles, apparel, footwear, toys) low-tech manufacturing (metals, intermediate goods) or even mass manufacturing (of, say, automobiles) cannot be revived. Instead, it would be better to allow friendly countries to substitute for China as manufacturing bases while the advanced economies focus on high-tech sectors and upskilling their workforce. The West has followed this strategy before with Japan and South Korea after World War II. India ought to be a priority now.

For emerging economies, the temptation to lurch to generalised protection and a greater role for the state is even more risky, given limited state capacity. Most of these countries have failed to become rich because of too much state intervention. It makes more sense to stay open via regional trading agreements (which don’t include China) and to enact structural reforms to become more competitive.

The world needs to be smart in its economics in a very complex scenario.

China-IndonesiaChina-MexicoChina-US. China-EuropeChinese economyeconomistsIsrael-IranprotectionismRussia-Ukraine