The Rise of the Dragon

The following article was published in the weekly newsletter by Fin-X dated August 24, 2020.

Abstract: Amid the growing clamour of “Boycott China” across the world, this paper traces the phenomenal rise of the country to achieve its status as the “World’s Factory”. The paper also attempts to identify the key factors that competing nations looking to replace China as the “World’s Factory” need to focus on in order to replicate or surpass the level of success China achieved. The call for a boycott is tenable only in case of availability of a viable alternative and as the world tries to look beyond China, the seat of the “World’s Factory” is up for grabs to the one who is worthy…

Part-I

Take a walk in a shopping mall in India today and you would be able to see all the world’s top brands vying for your attention. The customer today has the option to choose from a wide range of brands, from domestic to international, in more or less any product she wishes to purchase. However, this was not always the case. Rewind a few decades and the same customer would not have the same set of brands to choose from. Her options across products would primarily be domestic brands. Foreign brands, be it a “Snickers”, an “Audi” or “XYZ” were just not available. This worked in favour of enhancing the value attached to the “NRI” tag as our “NRI” cousins would bring us foreign-branded gifts (toys, chocolates, cosmetics etc) from around the world much to our delight. But obviously every consumer must have wished for having an option to choose from these brands while purchasing a product rather than having to wait for his/her NRI cousin to visit India. And just as it is said that when many people wish for something, that wish comes true, so did this one. Over the decades, foreign brands have increasingly started appearing on the shelves of shops. The value attached to the “NRI” tag also started diminishing as achieving an “NRI” tag increasingly became easier. This, in simple terms, summarizes the benefits of “Globalization”.       

It is clear from the above instance that the consumer is better off as globalization seeps in providing her with more options to choose from. In fact, globalisation does have a significant positive impact on consumer surplus.     

As we can see from the above pictorial representation, globalisation does work towards maximizing consumer surplus. The consumer has a wider basket to choose from and at a cheaper price. But, on the other hand, producer surplus gets squeezed. In the world of globalization, the cheapest producer, the country with the lowest marginal cost, becomes the “World’s Factory”. Perhaps, this helps to explain the increasing rhetoric against the Dragon, “China”, and for “Localization”. Looking beyond China is necessary to mitigate concentration risk and future disruptions to supply chains but looking beyond may also entail higher costs.

Part-II

It is said that a picture is worth a thousand words and this chart is a perfect representation of how China’s exports to the world have grown over the years. Of particular note is its sharp increase in Exports to North America, Europe and ASEAN countries. China’s exports to North America was USD 35bn in 1997 and went up to USD 455bn in 2019. For Europe and ASEAN, the numbers stood at USD 29bn and USD 12bn respectively in 1997 eventually going up to USD 498bn and USD 360bn respectively in 2019.

The claim of China having assumed the role of the “World’s Factory” is further reinforced by looking at the country’s net exports. China’s net exports to North America have risen steadily through the years from USD 16bn in 1997 to USD 304bn in 2019. It comes as no wonder as to why the political establishment in USA is up in arms against China. Europe and ASEAN, on the other hand have been able to keep a check on net imports from China, with the number averaging around USD 110bn since 2011 for Europe and USD 60bn since 2012 for ASEAN. It is interesting to note that China’s trade with ASEAN was fairly balanced till 2011.

A raging topic in today’s geopolitical landscape is the hardening stance of USA and India towards China. After the escalations at Galwan Valley, the nationalistic fervour of the Indian populace has provided impetus to the actions of the Indian Government. The Indian Government banned 59 Chinese apps including the likes of much popular TikTok. The tension between USA and China is palpable with conflict points ranging from the Trade War to South China Sea. As the geopolitics plays out in the front, some rationale behind the countries’ moves could be guessed from the trade numbers. China’s net exports to USA and India stood at USD 296bn and USD 57bn respectively in 2019 up from USD 16bn for USA and close to nil for India in 1997. In an overall context, imports from China accounted for 17% for USA and 15% for India in 2019, up from 4% and 2% respectively in 1999. 

Part – III

It would be inaccurate to say that India has not benefitted from the globalization spree but as the charts depict, India’s numbers pale in comparison to those of China’s. India has not been able to capitalize on the opportunity presented by globalization to the extent China has. Although, India too has witnessed a steady increase in exports to USA and Europe. Exports to USA increased from USD 7bn to USD 59bn from 1997 to 2019 while for Europe the increase was from USD 9bn to USD 64bn during the same period. In the context of overall imports, imports from India accounted for 2.1% for USA and 2.6% for EU in 2019, up from 0.7% and 1.2% respectively in 1999. 

However, unlike China, India has not been able to position itself as a manufacturing hub. As a result, its imports too have continued to rise. A look at the net export numbers shows that India runs a deficit across most country-blocs except North America. In fact, the deficits have widened with time. India’s imports from Europe and ASEAN was negligible back in 1997 but has risen over time to USD 15bn and USD 22bn respectively. Not surprisingly, China has been able to consistently maintain a current account surplus while India suffers from chronic current account deficit. As we can see, the availability of foreign brands on the shelves of shops for us to choose from has come at a price, and the price is our dependence on foreign flows to fund our current account. India has, however, fared better on the services exports front.

Part-IV

China’s phenomenal rise to assume the mantle of the “World’s Factory” is not at all by chance. The country, to its credit, has been able to provide the perfect ecosystem necessary to position itself as a manufacturing hub. Reforms by China's late paramount leader, Deng Xiaoping, paved the way for the country to be able to achieve its potential. As of 2018, China had the largest share of global manufacturing output in the world at 28.4% compared to India’s 3.0%. 

Source: Statista

One of the biggest contributing factors behind the success of China has been the stability of its currency. The Renminbi had been pegged against the USD at 8.3 since 1994 and the peg held till 2005. Post mid-2005, the Renminbi appreciated by just more than 18% over the next three years to 6.8 due to international pressure from trading partners. The level of 6.8 held till 2010 after which, as can be observed from the chart below, it has averaged around 6.5 (should the Renminbi appreciate more? probably, yes! will it? now, that is a difficult question to answer!). The coefficient of variation (a measure of dispersion) for the Renminbi is around 4.4%. On the other hand, the Indian Rupee has always been on a depreciating trend in line with inflation and interest rate differential. Consequently, the coefficient of variation for the Indian Rupee stands at around 19.6%, almost 5x that of the Renminbi. The stability of the Renminbi has kept the hedging costs low for global manufacturers as global companies generally tend to borrow in the currency of their home country. Low hedging costs have ensured that currency does not play spoilsport in the overall cost of production.

Another significant factor contributing to the identity of China as a global manufacturing hub is availability of cheap labour. Manufacturing labour costs, as depicted in the chart below, are among the lowest in China and competitive to those of Indonesia, Vietnam, India and Philippines. Labour costs were comparable among the Asian nations in 2002 but as manufacturing activity started booming, labour costs for China started going up at a faster pace compared to other Asian nations; a trend that is visible in the numbers from 2015 and 2019. However, the increasing labour costs alone have not been enough to dethrone China from its reign as the “World’s Factory”. 

One more massive factor that has established China as the go-to manufacturing hub is its superior logistics compared to other low-cost neighbours. The triple combo of stable exchange rate, low manufacturing costs and superior logistics are the key ingredients that make China the perfect candidate for “World’s Factory”. China’s Logistics Performance Index (LPI) rank of 26 is the highest among developing economies, making it an ideal destination as a manufacturing hub. This compares against India’s LPI rank of 44. On the Global Competitiveness Index published by World Economic Forum, China ranks at 28, third amongst developing economies, compared to India’s rank of 68.

Part – V

As we draw towards the close of this paper, the time is opportune to put the entire discussion into a single frame. It is important to realize that the Indian consumer today is not the same Indian consumer of a few decades back. The Indian consumer today is habituated to having all global brands under one roof when she goes to a shopping mall. The pitch for localisation is tenable only when consumer surplus that has been taken for granted through the advent of globalisation is maintained. If India wants to pitch itself as a global manufacturing hub, becoming self-sufficient and competitive while serving the needs of the companies globally, it needs to focus on three critical pillars of i) a stable exchange rate through control of inflation and interest rates, ii) low marginal cost of production, and iii) robust infrastructure and logistics. The road ahead is long and difficult but the initiatives such as “Atmanirbhar Bharat” and “Make in India” are definitely steps in the right direction. We will end by invoking what we have been taught since childhood "Yad Bhavam Tad Bhavati", which translates into “As you think, So you become”.