China is India’s largest trade partner. But India runs a large trade deficit of $29 billion with China. Prime Minister Manmohan Singh reportedly told his Chinese counterpart, Li Keqiang, at their recent meeting that this “needs to be addressed.” But as an economist he surely knows it is wrong to aim for balanced trade with each trading partner.
The beauty of international trade is that it enables every country to specialize in what it does best, export these specialties, and use the money to import what other do best. All countries end up specialising in what they do best, improving global productivity and reducing prices for everybody, a win-win situation.
India should export whatever it can to whichever destination is profitable at the best possible price. In turn, it should import whatever it needs from wherever at the best possible price. This implies that India should run a trade surplus with relatively uncompetitive countries (like Pakistan or Bangladesh), and run a trade deficit with highly competitive countries (like China or Germany).
The more competitive the trading partner, the more India should buy from it, and the bigger should be the bilateral trade deficit. China is the most competitive exporter of all, so India should run its biggest trade deficit with this country. Far from decrying this, we should view it as evidence that India is, very sensibly, getting its needs from the cheapest source. To see this in perspective, consider Indo-Pak trade. Pakistan has long erected trade barriers against Indian goods, importing many items at prices higher than what India offers. This hurts both Indian exporters and Pakistani consumers.
Pakistan has promised to soon liberalise trade with India. When this happens, India’s trade surplus with Pakistan will become even larger than it is today. That will be economically efficient, benefiting Pakistani consumers as well as Indian exporters. Yet many Pakistanis fret at the prospect, just as many Indians fret at their growing trade deficit with China. The fretting is unwarranted: large deficits in both cases are proof of sensible buying from the cheapest source.
Many Indians argue that China gives huge export subsidies that constitute unfair trade. Sorry, but no individual, corporation or country can become prosperous by selling its goods below cost. You can as a short-term measure subsidise some items here or there, but selling everything at a loss is economic suicide, and China is not suicidal. It does keep interest rates artificially low, and prevents its currency from appreciating. We can join the US in pressing for yuan appreciation. But that will affect the trade gap only slightly.
Where China gives excessive subsidies, Indian businessmen are quick to demand anti-dumping duties, and the government is quick to oblige. India has imposed more anti-dumping duties than any other country. Additional curbs have been placed on Chinese telecom equipment on security grounds.
The trade deficit however continues, suggesting that dumping is not the key issue. Rather, the deficit represents the gap in productivity between the two countries, especially in manufacturing.
Most people think that exports are desirable and should be maximized, while imports are undesirable and should be minimized. The very opposite is true. You typically export what you have a surplus of, and import what is locally scarce. What’s scarce is obviously more valuable than what you have in abundance. Seen in this light, the main benefit of trade is to end scarcities by importing what you don’t have. Exports are a secondary aim, required to pay for imports.
The pattern of Sino-Indian trade dismays many people. India exports mainly iron ore and other commodities. Its imports are almost entirely manufactured goods, especially machinery and telecom equipment. Some experts think commodities are somehow inferior to manufactures, and so bemoan the Sino-Indian pattern of trade. Now, manufactures often have more value added than commodities, yet somebody has to produce commodities too.
Specialising in commodities is not inferior. India’s biggest commodity producers are Ambani (oil, gas, petrochemicals, fibres), Tata (steel, soda ash, fertilizers, power) and Birla (aluminium, copper, cement, iron ore). Are Ambani, Tata and Birla inferior industrialists in inferior industries? No, they are India’s crème de la crème.
Both China and India still have far too many barriers to trade and investment, and these need lowering. Chinese non-tariff barriers are higher, and Indian negotiators must focus on this.
But their overall aim must not be to balance trade with China, or target a particular trade deficit. Rather, India should target improvements in its own productivity and competitiveness. Once that happens, its trade deficit with all countries (including China) will automatically fall. Lesson: target the productivity gap, not the trade gap.