Why India is flagging in China+1 sweepstakes
Earlier this month, Vietnam earned a distinctive stripe in its bid to be an Asian Tiger, that accolade of rapid economic development that Korea, Taiwan and China achieved over the past several decades. It was accused of currency manipulation by the US trade department, putting its booming exports in the sights of the Trump administration for possible retaliation.
September’s economic data for the country of 100 million also proved buoyant. Exports were up 18% year on year in September on the back of a 26% jump in computers/components exports and a 63% jump in machinery/accessories exports in the third quarter. More than half of Samsung’s smartphone production is from Vietnam.
Vietnam is well out in front in the global race to replace some of China’s export production. In fact, it is now grappling with the problems of success. While the outlook for the country is “particularly strong,” a banker based in Ho Chi Minh City says that the challenge now is ensuring its ports, roads and airports can keep up “with the next $100 billion in foreign direct investment (FDI). It’s a disciplined Communist economy with a high level of corruption, but they do execute (plans) very well”. Morgan Stanley’s emerging markets strategist Ruchir Sharma dubs it the next Asian Miracle and points out that FDI has averaged more than 6% of G.D.P. in Vietnam, the highest ratio in any emerging country.
Bill Stoops, Ho Chi Minh City-based chief investment officer of Dragon Capital, the largest listed equity investor in the country, says Vietnam’s export mix has changed dramatically. Ten years ago, it was skewed towards crude oil and agriculture; last year fish was the only non-manufacturing product in among its top ten exports.
“Also, about 65% of the country is still rural so there is an endless supply of people willing to move to cities. I am not concerned about Vietnam’s ability to accommodate more FDI,” said Stoops. Still, the labour market is tightening; unemployment dropped to 2.5% in September, in part because it is business as usual in Vietnam. Covid-19 in Vietnam has seemed akin to a seasonal flu: total cases since the pandemic began are about 1,100.
The past four weeks have provided evidence from India and Indonesia to Vietnam and Bangladesh that the race to supplement China’s role as the world’s factory has quickened dramatically. What was once referred to as the China + 1 strategy to managing global production a decade ago after the Chinese government forced up factory wages by double-digit levels is in vogue once again.
This time the driver is a desire to reduce dependence on China as companies want to guard against disruptions to supply chains after the experience early this year after China’s lockdown in response to the covid-19 pandemic as well as to find low-cost labour.
As a McKinsey Global Institute article on supply chain resilience recently observed, the threats to supply chains have become more frequent. Disruptions caused by 40 extreme weather events associated with climate change cost more than $1 billion each in 2019 alone. The tech war between China and the US adds another dimension of uncertainty.
For all these reasons, companies are seeking to diversify their production bases and Asia’s governments in turn are responding by seeking to make their countries more attractive to manufacturing investment. The Modi government’s pushing through Parliament of significant labour law reforms in late September was quickly matched by President Joko Widodo’s government’s changes to Indonesia’s stifling labour laws, passed by its Parliament about ten days later.
Last week, in preparation for losing its least-developed-country preferential trade privileges by 2024, Dhaka’s ministry of commerce was reported to be negotiating 17 preferential and free trade agreements, which have been critical to maintaining its huge lead over India in garment exports.
A recent Goldman Sachs survey found that for companies contemplating diversifying, Vietnam followed by India top the list as potential secondary production bases (see graphic). But, the survey also found that different assessments applied to different industries. In garments, for instance, Bangladesh is the prime beneficiary and Cambodia is on the ascendant.
Last week, the International Monetary Fund sparked a flurry of headlines by declaring that Bangladesh would momentarily surpass India’s per capita income in 2020. This reflects its success as a labour-intensive producer of garments, where its exports are double those of India’s, and also its performance on human development indicators.
To be sure, the Goldman report (“If not China, then Where”) cautions that the story of companies moving from China is more “nuanced” than headlines suggest. “Anecdotes of China manufacturing relocation can be misleading,” the report said, arguing that China’s superior ports and highways and well-educated workforce mean that companies in most industries will continue to locate the major part of their production there.
Goldman reports that in industries such as automobiles and auto components while some production is being started elsewhere, many companies are simultaneously expanding production in China because its large domestic market remains a huge draw.
The Indian response
This post Covid moment of seemingly large opportunities to draw manufacturing FDI away from China is on closer inspection riddled with legacy problems for those countries that have been slow to reform.
The risk is that countries such as India and Indonesia could fail to get on the springboard of export-led growth that has propelled Vietnam and Bangladesh despite the pandemic while struggling to compete directly with Chinese workers’ higher productivity levels, its first world roads and ports and the subsidies to manufacturers.
But India has succeeded spectacularly in the recent past. As a recent paper by Ashoka University’s Arvind Subramanian and Soumitro Chatterjee underlines, India was itself among the fastest growing export-led economies for about two decades from the mid 1990s. But its performance in labour-intensive exports is well below potential. A notional calculation in their paper (published in The Indian Express) of the opportunities lost to countries such as Vietnam, Cambodia and Bangladesh shows that India is “defying the comparative advantage” of having the world’s largest youthful workforce.
As the tragic migration back to villages by tens of millions showed in late March after India abruptly went into lockdown, the jobs held by much of India’s labour force remain tenuous in the extreme.
Still, the Modi government appears determined to catch up. Its labour reforms should help create an environment for small companies to grow into mid-sized ones as they allow for easier hiring of contract workers and allow firms of up to 300 employees to lay off workers without seeking government permission. It has created a single-window clearance for new investments, according to a report in Business Standard. It also created a productivity linked incentive scheme to draw mobile phone and component manufacturers to India.
In late September, three of Apple’s largest contract manufacturers were reported to be investing almost $1 billion in India in the next five years to take advantage of the government’s production-linked scheme that offers companies cash for up to 4% to 6% of an increase in sales of locally-made smartphones over the levels they reached in 2019-20.
The hope is that this will lead to India becoming an export base for smartphone manufacture. (Tariffs on assembling mobile phones have increased by 20% in successive moves since the Modi government took power.) But the complex scheme is also a way to compensate companies for subsidies that are no longer allowed by the World Trade Organisation.
As the Ministry of Electronics and Information Technology website explains with admirable candour, “The domestic electronics hardware manufacturing sector faces lack of a level playing field vis-à-vis competing nations. The sector suffers disability of around 8.5% to 11% on account of lack of adequate infrastructure, domestic supply chain and logistics; high cost of finance; inadequate availability of quality power; limited design capabilities and focus on R&D by the industry; and inadequacies in skill development.”
Same old story
Muddled logic also underpins the pledge to build a self-reliant India and India’s trade policy in general. As Subramanian and Chatterjee point out, since 2014, there have been 3,200 tariff increases on most-favored-nation imports; the average tariff has jumped from 13% to nearly 18%.
Speaking to me for a Mint Long Story in August, mid-sized exporter after exporter in industries ranging from apparel to furniture complained of the effects of higher tariffs and non tariff barriers on imported inputs they needed to compete overseas.
Since then, the drop in imports coming into India because of additional customs scrutiny on countries of origin has increased the compliance burden on our small and midsize businesses, and, coupled with the drop in demand for imports because the economy has slowed down, has led to a shortage of shipping containers for export shipments.
Japan, Korea and Taiwan used industrial policy to manage economic development 50 years ago as did Nehruvian India, but the problem with India’s renewed love affair with import substitution is that supply chains are much more international than before, and Indian exporters’ competitors in Vietnam and Bangladesh are not similarly handicapped.
Trade in intermediate goods to keep supply chains humming have tripled since 2000 to $10 trillion, according to McKinsey. Mobile phones and computer components in north Asia often cross borders 20 to 30 times before the finished product is finally shipped to retailers overseas. Indian customs officials are already notorious; a rallying cry such as self-reliant India will be used to harass small and midsize exporters in particular.
India’s main weakness as it enters the race to profit from the opportunities to be the + 1 to China in global manufacturing is that economic policy has long played second fiddle to the distractions of politics and been undermined by a socialist bureaucracy. Bangladesh’s politics have often been toxic as well but the government responds energetically to the needs of the garment industry, creating the equivalent of a hotline between Bangladesh’s garment manufacturers’ industry body and the commerce ministry.
In Vietnam, Stoops similarly characterises the Communist leadership’s approach to economic development as pragmatic. The government focused on primary and secondary education and healthcare while building up its industrial base. Says Stoops: “The Communist government has a policy-planner consensus approach.”
Vietnam’s manufactured exports increased 25% last year to reach $304 billion. India, with 12 times its population, saw its exports decline slightly to $323bn while Guangdong, China’s most industrialised province with 113 million people, boasted 2019 exports of $444 billion. The challenge for India is that its competitors paradoxically have both the purposefulness of the tortoise and the speed of a hare.