Chronicle of a Death Foretold

    08-Sep-2020
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How China destroyed the global economic commons and the importance of the Indian resistance
 
-Pritam Banerjee 
 
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A large section of influential economists and opinion makers are uncomfortable by the growing economic resistance to China across the world. They feel that this represents an increasing tide of protectionism that will impede global trade and hamper the many advantages that free and open markets provide for global economic growth and development.
 
In making such an argument, they fail to realise that the resistance to China is actually a resistance to an unfair and predatory economic relationship that the Chinese state managed to impose on the world and got away with for close to three decades.
 
The question is why is that resistance suddenly growing in strength, and why are the Western economies much more concerned now compared to even a decade ago when they were more or less willing to ignore Chinese manipulation of global trade rules and unfair trade practices. While the COVID induced economic and geo-strategic dynamics to explain some part of it, there is much more to the story.
 
To understand the whole picture, one would need to step back to the early 1990s when the leadership of the G7 economies decided to allow the integration of a large one-party Communist State into the evolving post-Cold War global economic architecture largely defined by open markets and transparent rules to govern them.
 
One would also need to understand how the Chinese state was uniquely placed to undermine and abuse the advantages of a rules-based trading system to its advantage.
 
Enter the Dragon
 
The late 1980s and 1990s was a period of unbridled triumphalism for the US and their European allies. The Soviet Empire had first stumbled and then finally collapsed. The integration of China into the global economy was to signify the universal acceptance of a market-driven economic system committed to free trade. This was supposed to be the ‘end of history’ and all ideological conflict.
 
In the famous words of President Clinton, China’s integration into the global economy would be a ‘historic step towards continued prosperity in America, reform in China, and peace in the world’. This is an important quote precisely because it underlines the three naïve assumptions that drove the world’s leading powers at that time to shepherd China in as a full member of the global trading system.
 
The first assumption was that China would open its markets in a manner that allowed the US and indeed rest of the world to benefit from it sustainably. The second more erroneous assumption was that China would genuinely reform itself beyond the window-dressing required to earn this membership. The last assumption reflected that hackneyed liberal myth that countries that trade with each other do not go to war.
 
An OECD report published in 2019 highlighted how the Chinese state-subsidised production of aluminium by providing raw materials at a low price to manufacturers of aluminium products who are then able to dominate international markets. Another study by OECD also published in 2019 detailed pervasive trade-distorting support by the Chinese state to its semiconductor industry. Harvard economist Myrto Kalouptsidi has produced a detailed report on trade-distorting state support to the shipbuilding industry in China
 
In the years following China’s WTO accession in 2001, China’s exports started to grow exponentially. Many developing economies started to feel the impact as Chinese exports eliminated their firms from traditional export markets where they had earlier been competitive suppliers over decades, and even started to dominate their domestic markets. Warning signs about Chinese malpractices on trade and investment started to emerge. Complaints about the use of generous subsidies, intellectual property theft, counterfeiting, and use of non-tariff barriers to deny market access to imports into China was beginning to register. But the full spectrum of exploitation and abuse of a rules-based market economy was still not apparent to most observers.
 
An authoritarian regime had lulled everyone into the belief that every such act of violation of trade rules was an isolated case. That the instruments of accountability that acted as checks and balances in all the other large economies in the world, a free press and an independent judiciary that protected the rights of all economic entities, national and foreign, were absent in China, was not taken into consideration. China’s commitment to be a responsible member of a free and fair-trading system was being taken at face value.
 
How the West was Won
 
A peculiar alignment of interests was behind this benign neglect of increasingly apparent abuse of the trading system by the Chinese state. Through much of the 2000s, Chinese manufacturing was mostly focused on labour-intensive manufacturing and assembly and was not competing directly with the more advanced industrial products and activities that were of greater interest to the advanced industrialised economies. In short, despite popular belief, Chinese manufacturing was not stealing American or European jobs, with a few sectoral exceptions.
 
On the other hand, consumers in the EU, US and other wealthier countries were benefitting from a range of cheaper consumer goods. Western and Japanese MNCs were still dominating the supply-chains that linked Chinese manufacturing to the consumers in rich economies and were thus direct beneficiaries of this China-centric trade network.
 
This supply-chain included export-oriented economies such as Thailand, Malaysia, and Taiwan that provided intermediate goods required for final production and assembly in China and saw their own exports buoyed by the exporting boom out of China.
 
Many proponents of free trade even went to the extent of defending Chinese export subsidies; however unfair they might be. Their logic was that if the Chinese state spends its own money to subsidise the consumption of people in other countries by making products artificially cheaper, it only made consumers in these importing countries better off.
 
This dominant narrative failed to register the increasing de-industrialisation in many large developing economies due to unfair trade practices by China. The export opportunities and associated economic growth and good jobs that could have come to other developing countries all ended up going to China. So while the consumers in the industrialised, rich countries gained from cheaper products and the Chinese state and the economic system it controlled got wealthier, the losers were in countries across Asia, Africa and Latin America who would have got a fair share of the pie had the much-touted ‘rules-based trading system’ really worked.
 
But the rules and institutional means of enforcement in the WTO were designed by economists and trade experts from the west or trained in the west. As such it was completely incapable of dealing with an all-encompassing authoritarian state like China.
 
Gaming the System
 
On the face of it, WTO agreements included institutional measures that would prevent member states from using subsidies and other measures to undermine genuine competition or practice predatory policies. But the problem was that governments have several ways by which they can provide support to their firms or subsidise them and it is extremely difficult to prove that such support has been provided as export subsidies that undermined fair competition in a rules-based trading system.
 
In most cases, the market itself played the role of regulator. In more open economies, internal competition among different firms for government support would balance the level of support the state can extend export-oriented firms vis-à-vis the demands of other sectors. Foreign participants in such markets could also challenge and lobby against any discriminatory government support that disadvantaged them. None of this was true for China.
 
The extensive prison system in China provides almost free labour for many industrial clusters. Independent observers have documented the use of Uyghurs prisoners from Xinjiang as slaves. Even when not using prisoners or slaves, the Chinese system ensured that the Chinese worker had very little rights for negotiating compensation, typically lived in dormitories within the factory premises and worked several hours over-time
 
But the biggest and most important differentiator between China and all other large economies in the world was that in China it was the state that controlled all factors of production in a manner unthinkable elsewhere. The Chinese state has gotten away by providing its industries with huge amounts of disguised state subsidies, including subsidised credit. Institutions like the WTO were not able to provide the institutional checks and measures since the Chinese economic system is unlike any other large economy in the world today. The Chinese state has the ability to directly or indirectly subsidise all of this factors-credit, labour, land, natural resources, and other inputs such as energy and water.
 
Moreover, these are not policies in the first place, but an extension of support by different levels of administration in the Chinese state to individual firms on a case by case basis. This complex web of subsidies and in-kind support makes it near impossible to use institutions like WTO to hold the Chinese state accountable for such non-market anti-competitive policies. Such multi-layer state support has allowed Chinese manufacturing to sustain over-capacity in production in a large number of sectors with a debilitating effect on manufacturers in other countries.
 
Several independent reports and studies have documented the multiple ways in which the Chinese state provides trade-distorting support to its firms. To provide a few illustrative examples, an OECD report published in 2019 highlighted how the Chinese state-subsidised production of aluminium by providing raw materials at a low price to manufacturers of aluminium products who are then able to dominate international markets. Another study by OECD also published in 2019 detailed pervasive trade-distorting support by the Chinese state to its semiconductor industry. Harvard economist Myrto Kalouptsidi has produced a detailed report on trade-distorting state support to the shipbuilding industry in China.
 
Firms that were seen as strategically important for capturing global market share were provided with cheap funds in the form of debt and equity serviced by state-owned investment firms and banks. State-owned enterprises provided raw materials such as coal or ores for highly subsidised prices or through long-term credit that requires very little up-front payment. Most of the land in China is state-owned and land for factories and warehouses were made available at nominal prices. Other important industrial inputs like electricity and water are also highly subsidised. The Chinese state could pick and choose winners based on this control of factors of production.
 
Chinese ‘private’ firms have representatives of the Communist party in their board who in many cases have substantive control on management decisions. There is thus a very little distinction between State-Owned Enterprises (SOEs) and private firms in the Chinese system. The entire Chinese manufacturing industry, whether public or nominally private, are essentially instruments of the Chinese state. This overwhelming control over factors of production and oversight of management decisions allows the Chinese state to use supply-chains dynamics to enforce their diktats in industries further downstream in the supply chain. A classic example that Indian industry is well aware of is the pharmaceuticals sector. The Chinese domination of the supply of APIs makes Indian pharmaceuticals vulnerable precisely because the Chinese state controls the decision making for all Chinese API suppliers in a manner that would be impossible in a market economy, and could cut off supplies to India through an internal fiat. The Chinese state does not need to use a formal export control order or explicit restriction that could be challenged in WTO.
 
Perhaps the least discussed advantage Chinese firms, including international contract manufacturers supplying to global MNCs derive from the absolutist control of the Chinese state is in the case of labour. The extensive prison system in China provides almost free labour for many industrial clusters. Independent observers have documented the use of Uyghurs prisoners from Xinjiang as slaves. Even when not using prisoners or slaves, the Chinese system ensured that the Chinese worker had very little rights for negotiating compensation, typically lived in dormitories within the factory premises and worked several hours over-time.
 
The Chinese hukou system that strictly manages domestic migration ensured that migrant workers in the industrial cluster were completely dependent on the state, and any protest could cost them their livelihood and access for their families to healthcare and education. While things are changing somewhat now, it is important to remember that for most of the 2000s and obedient workforce that worked long hours and accepted whatever raise they got without protest was implicitly used as one of the greatest ‘competitive’ strengths of Chinese manufacturing. Democratic countries that respect rights of the individual can hardly be expected to compete with a system that can effectively use disguised slavery and near serfdom as instruments of industrial policy.
 
Alibaba and the Forty (Million) Thieves
 
As China grew economically, the Chinese market and its billion consumers became the Alibaba’s cave, entrance to which would unlock all the riches for the firms that managed to tap it successfully. All they needed was the password that would open the cave’s door. But getting that password required compromises.
 
Setting up shop in the Chinese market required foreign firms to enter into Joint-Ventures (JV) with Chinese entities. In some cases, entering into such a JV was a mandatory requirement. But in most cases, foreign firms got a local partner because it was next to impossible to navigate the complexity of China’s regulatory landscape without having an influential Chinese partner to help. The local Chinese partner managed relationships with the provincial bosses of the Communist party in the region where the foreign investment would take place, as well as Central Ministries and departments in Beijing.
 
 
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Chinese local partners soon began to steal technology and reverse engineer products developed by western or Japanese MNCs. Such infringement was across the spectrum, from developing cheap counterfeits of branded products to stealing complex technology in sectors such as electronics, automobiles, and renewable energy-related engineering. With the rise of cross-border e-commerce led by the e-commerce giant Alibaba, consumers everywhere could purchase these cheap Chinese alternatives to western brands or buy their counterfeits
 
Foreign manufacturers and service providers were mandated or coerced into sourcing local intermediate goods or services. These local content requirements were mostly never formal or official. But it was made clear through local officials and other regulators that committing to such local sourcing was the only way to continue to do business. This opaque layer upon layer system of coercion to ensure that Chinese partners and suppliers got a significant share of the pie of any foreign business operation in China would have been impossible, and in many cases illegal under the laws in more democratic countries. But foreign investors, eager to get their foot in through the door of what was on its way to becoming to world’s largest consumer market did not care. They took care not to complain too much, in case the all-powerful Chinese state excommunicated them from the Chinese market and the opportunity it represented.
 
Chinese local partners soon began to steal technology and reverse engineer products developed by western or Japanese MNCs. Such infringement was across the spectrum, from developing cheap counterfeits of branded products to stealing complex technology in sectors such as electronics, automobiles, and renewable energy-related engineering. With the rise of cross-border e-commerce led by the e-commerce giant Alibaba, consumers everywhere could purchase these cheap Chinese alternatives to western brands or buy their counterfeits.
 
Alibaba took the lead in developing an e-commerce model using relatively cheap Postal parcel networks to deliver low-cost Chinese products to individual consumers anywhere in the world. Everything from lightbulbs to safety-pins was on offer. Use and throw consumerism in prosperous economies that put much relatively lower weight on quality, especially for consumer goods, helped this tidal wave of low-cost and low-quality Chinese goods to overwhelm global markets soon. Suppose one needed to change ones wall-paper every two years and smart-phone cover every four months why to bother about quality. The idea was to buy cheap to discard for something new and trendy in the next great online sale.
 
It needs to be noted here that selling counterfeits and protecting and promoting this industry despite protests from the original brand owners was also strategic. Flooding the market with counterfeits reduces the trust in the long-established brand, and consumers are less willing to pay a premium for quality if they are unsure about the authenticity of a product. This erosion of brand premium directly benefits the manufacturers of lower cost-lower quality alternatives-most of which were Chinese made.
 
Till the time China was primarily competing with other developing countries for low-end labour-intensive products, the western world was willing to turn a blind eye to its many violations of the rules of the international trading system. But over time, China started challenging market leaders in technology-intensive high-end sectors where western (and Japanese and Korean) brands had dominated for decades.
 

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In the early 2000s, Chinese manufacturers were stealing Kirloskar’s design and logo to produce and sell fake Kirloskar pumps in markets across Africa. But the harassment of an Indian manufacturer at the hands of Chinese industrial thieves did not matter to the world at large. But now something similar was happening to western tech firms. The enemy was at the west’s gates, and could no longer be ignored 
Even more ominously, China had effectively closed the gates of its digital economy to the western behemoths like Amazon, Google, Facebook and others, promoting local champions instead. For the west (and lesser extent Japan) it was this technological leadership of the digital economy and advanced industrial technologies that were the key to being able to sustain high-returns to their economy from the global value-chains in the years to come. This was now increasingly under threat from state-supported Chinese champions like Alibaba, Tencent and Huawei.
 
In the early 2000s, Chinese manufacturers were stealing Kirloskar’s design and logo to produce and sell fake Kirloskar pumps in markets across Africa. But the harassment of an Indian manufacturer at the hands of Chinese industrial thieves did not matter to the world at large. But now something similar was happening to western tech firms. The enemy was at the west’s gates, and could no longer be ignored.
 
Enemy at the (Western) Gates
 
It is perhaps convenient to portray President Trump as an uncouth, deal-making individual who was responsible for starting the trade war with China. But the truth is that President Trump simply decided to take the Chinese bull by its horns, preferring to call China’s bluff rather than try cautious economic diplomacy which was apparently not working.
 

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It is perhaps convenient to portray US President Trump as an uncouth, deal-making individual who was responsible for starting the trade war with China. But the truth is that President Trump simply decided to take the Chinese bull by its horns, preferring to call China’s bluff rather than try cautious economic diplomacy which was apparently not working 
In other words, everyone agreed that China was a violator of rules, protector and promoter of industrial thievery and espionage, and intended to use its burgeoning digital industry to try and dominate the global digital economy. But nobody knew how to stop this state-sponsored economic rampage. Schooled in old-world economic diplomacy that followed a set pattern of institutional responses, they found this tit-for-tat escalation overwhelming.
 
Many of these otherwise well-intentioned economists and policy-makers were unwilling to accept that the international trading system based on the Uruguay Round consensus that they had worked so hard to build and promote been a total failure when tested by a powerful state determined to do its bidding, rules be damned-i.e. China.
 
While President Trump fired the opening shot, the rest of the western world had also realised that the enemy was at the gates. Actions by EU member states like Germany and France, by the United Kingdom, Canada, and Japan all show a hardening stance. These actions range from restricting Huawei’s participation in digital infrastructure development, the arrest of Chinese entrepreneurs and engineers, and incentives to re-orient supply-chains away from China. These are but opening gambits of a new great game.
 
The socio-economic crisis precipitated by the COVID crisis and China’s increasingly aggressive geo-political stance has only added momentum to this conflict. The trajectory of this conflict is unpredictable. Some EU member states like Italy might end up as Chinese client states as their economies hollow out, and their champion firms and brands are acquired. Others like Australia would face severe economic consequences due to their dependence on the Chinese market for their raw material exports which drives their economy.
 
The key players in this new great game would be those countries with very large domestic markets, domestic industrial depth, and having the human resources to develop or rapidly absorb technology. Besides the US and China, that list is limited to Japan, Germany, France, United Kingdom, Brazil and India. Three other players might also emerge as critical, Russia, South Korea and Vietnam. Amongst these countries, only India has the scale to match the US and China in the longer run. It is already the world’s third-largest economy in purchasing power terms, right behind China and the US.
 
Pushback: Why Indian resistance matters
 
Most analysts in the mainstream media have highlighted that India would feel a disproportionate share of the pain in de-coupling itself from Chinese-led supply-chains. This is true for short to medium term. Many Indian industries have become very dependent on Chinese intermediate goods to sustain their production lines. The Indian consumption economy has also gotten used to cheap Chinese imports.
 
But every major transformation produces some shocks to the system. If the goal of such a transformation is the revival of Indian manufacturing that has bore the brunt of unfair Chinese trade practices, then bearing the pain of this supply-chain disruption is necessary medicine essential for a healthy economic future.
 
But great amounts of care need to be taken on two aspects. First, to have a comprehensive plan to cushion the brunt of this disruption for industries that would be impacted by this de-coupling, including for the workers employed in such industries who might find themselves without livelihoods. This is easier said than done. Trade-related economic adjustment programs have been notoriously ineffective in most cases.
 
Second, the economic resistance to China must not become a free-for-all return to protectionism for Indian manufacturing. India must be willing to strategically and proactively engage with the rest of the world in trade and investment. It is only then that India would be able to grow a competitive manufacturing sector with deep ties to global value chains.
 
India has several things working in its favour to emerge successfully out of the short to medium-term economic challenges that it would face as it resists Chinese economic expansionism through unfair means.
 
It is a vast economy that has traditionally been much less dependent on export-led growth. The long-term prospects that the size of the Indian economy offers, especially in the Post-COVID geo-strategic equation where rest of the world is also trying to reduce dependence on China, would make it an attractive long-term investment bet for many investors.
 
There is also a clear indication that consumption patterns are changing globally. The buy cheap and throw-away consumer culture is giving way to need-based consumption and prioritising on quality. The income shock of the COVID crisis would be felt long-after, and these trends would go on to become mainstream consumer behaviour. This would mean a return to what was common in our parents and grandparents time. Consumers would buy products for the long-term and invest in their upkeep, repair and maintenance.
 
All of these activities, i.e. upkeep, repair, and maintenance mean a lot more of the value addition from a product is retained in the consumer economy as local entities, and their workers carry out these activities. Local customisation and automation of production through such technologies as 3D printing would also mean much more value-addition at the point of consumption. This essentially means that if you have a large consumer market, you start to capture much greater value-addition in your local economy. In other words, large consumer markets stand to gain much more from the value-chains of the future relative to what they do now. This works in favour of large consumer economies like India.
  
The economic resistance to China must not become a free-for-all return to protectionism for Indian manufacturing. India must be willing to strategically and proactively engage with the rest of the world in trade and investment. It is only then that India would be able to grow a competitive manufacturing sector with deep ties to global value chains 
 
As global production becomes more and more tech-driven, and technology itself becomes much more commoditised across many sectors, once again a large consumption economy like India stands to gain as it has much more leverage in being able to attract technology transfer. In addition, India’s relatively credible legal institutions and independent judicial system would inspire confidence in global technology rights holders to engage with Indian industry.
 
It also needs to be noted that very few countries have the absolute numbers of skilled personnel essential to successful technology adoption and innovation that India has. Human resource development trajectories indicate that China and India would have the largest pools of technically qualified human resources in the world in the near future. The newly announced National Education Policy (NEP) will help to ensure the depth, expanse, and quality of such human resources.
 
India is, therefore, the critical force-multiplier for sustaining a democratic and rules-based global order along with the US, Japan and major European economies like Germany, UK, and France. This makes India a key player in any resistance to China’s continued abuse of the international system to the detriment of others. This resistance is not against the Chinese people or the rich civilisational entity they represent but to China’s current political dispensation and its blatantly unfair and hegemonic designs. A sustainable global future needs China to be a part of the solution. But China and its regime must be forced to renegotiate the terms of participation in a rule-based global system and become a transparent and fair player. Indian leadership towards ensuring such a transition over the coming decade is going to be critical.
 
(The writer is Trade and Logistics expert)