Tuesday, April 12, 2005

China’s Socialist Market Economy and Hindi - Chini Bhai-Bhai!

The media the press, everybody is talking about an India-China Free Trade Agreement (FTA)! The discussion, however, reflects a confusion between the need for increasing India-China trade and improving economic relations and the usefulness of an FTA. In WTO parlance an FTA means zero duties on all goods (with few exceptions). Further an FTA does not include Services, FDI or the movement of persons, issues of vital interest to India that would normally be covered in a CECA.
An ICRIER working paper (No. 151) has shown that the highest un-exploited potential of India’s trade with any/all countries is with China. Her study shows that trade could be more than doubled. I am sure most scholars would agree with this assessment, even though precise estimates may differ. Normalisation of Trade between the two countries is highly desirable and perhaps even necessary.
To ensure that this potential is realised two countries must jointly identify the constraints and barriers to trade and take steps to remove them. These include rules and procedures and their application, transparency, information-language barrier. All other trade facilitation measures must be taken to make sure that the gap between potential and reality is closed. This does not require an FTA.
Prime facie the economic benefits of a bilateral FTA between India and any other country are not obvious. India till two years ago had the highest non-agricultural tariffs in the world. With the reduction of the peak rate to 15% we now have rates that may be in the top 1/5th or 1/4th . Tariffs on agricultural goods are much higher with few as high as 100%. Reduction of these rates to zero under an FTA could result in substantial Trade diversion and welfare loss. Thus as long as our tariff rates remain high the a priori presumption must be that an FTA with any country with lower tariffs is likely to result in economic losses not gains. Only hard evidence to the contrary should overcome this basic scepticism.
Building mutually beneficial economic relations between India and China requires a clear understanding of the Chinese economy. There is a tendency for people involved in China to find economic similarities even when they do not exist. Definitions are adapted to make it appear similar to a normal market economy. This is reflected for instance in the definition of “Private sector’ “non-state sector” State owned enterprises (SOE), Collective enterprises, Town & Village enterprises (TVE), listed companies, joint venture companies etc. The standard international definitions in which ownership (majority, minority, largest share etc), management control (e.g. power to appoint CEOs) are not used/ applied in defining the “private” and “public” sector. This obscures the true nature of the economy and of the development strategy.
A recent Working paper (No. 160, ICRIER, March 2005: www.icrier.org/wp160.pdf ) has given a stylised model of China’s economy. China’s basic Goal is National power through Growth maximisation. Employment generation, individual income growth and public welfare act as constraints (rather than secondary objectives) to the growth maximisation objective. The CPC network, a mix of centralised and decentralised systems, implements these objectives. Like most other developing countries, quality of governance in China is gradually deteriorating. This involuntary lack of control (e.g. on corruption) should not be confused with deliberate policy change by the State/CPC.
The strategy adopted to achieve the growth objectives has four important elements. The FDI-export policy is the most important and critical means for achieving this goal. China is now a part of the global supply chain for labour-intensive exports, and these are highly competitive. The reason is not however the productivity of Chinese labour in terms of output per man-hour. A critical subsidiary element of the FDI-export strategy was the abolition/suspension of minimum wage conditions, upper limits on working hours and rules against firing workers. Control of labour market (labour responsibility system) ensured the supply of workers who worked 100 hours a week, 52 weeks a year. Thus high productivity per person-year is due to more hours worked per week compared to normal market economies (35 to 48).
The second element is the social ownership of capital assets (100% till 1980) . The returns from these assets are used to raise national investment rates to very high levels, without creating disincentives and distortions through high tax rates. High infrastructure investment since 1997 is a manifestation of this. The third pillar is normal markets for most goods and services where the forces of demand and supply operate to set prices. This removes the worst feature of the Soviet system that played an important role in its collapse.
The fourth pillar is the control over banks and capital markets, which allows subsidisation of capital-intensive and skill intensive exports as well as FDI investment in hi-tech industry, indirectly through banks (govt department). The modus operandi is to give loans to State/CPC owned/controlled enterprises that supply inputs to the target companies. These loans are not expected to be repaid and therefore the use of the word NPA is a misnomer.
The result: Incredible rates of growth of 9.5% per annum for 25 years. Even if there is overestimation of 2% (scholars estimate 1% to 3%), 7.5% per annum is the highest in the world during this period (30% higher than India’s).
The Asian crises showed that some of the elements of this strategy are risky. The strategy is a bit like peddling furiously on a bicycle to keep from tipping over. Expectations of foreigners play a key role in FDI. Euphoria about China’s growth keeps FDI flowing. That in turn ensures very high growth of production. Given the low share of private income and consumption in GDP, excess capacity is created in many industries. This can only be utilised by pushing exports. Either unit values fall (e.g. textiles) or implicit subsidies have to be provided.
This picture of the Chinese economy suggests that the arguments for an FTA with China and the according of “Market economy” status to it are very weak. We should focus on normalisation of economic relations, settlement of the border issue and collaboration in areas where there are clear identity of interests (e.g. oil purchases) rather than jump from one extreme to the other. It is said that India-China Bhai-Bhai, became India-China Bye Bye, which in turn has become India-China Buy-Buy (over the last five years). Let us not restart the cycle by getting euphoric over words like “strategic partnership.” It is much better for both countries, as well as for the rest of Asia, if we jointly build a normal, realistic and well-rounded relationship that will last through the 21st century.

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