Big trade deficit with China? Excellent!

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.

2 thoughts on “Big trade deficit with China? Excellent!

  • 2013.Jun.05 at 18:31

    Regarding large balance of trade between India China I wish to bring to your notice some hard facts.
    In China entire land is owned by the Chinese Government. Smaller companies get land and buildings on say 20 year lease. This reduces a huge burn on the balance sheet of the companies and this alone results in large capital productivity.
    When an Indian company approaches a bank for an industrial loan, banks need collateral – usually in the form of some immovable property. The loan given is just about 60 to 70% of the market value of the property at the time of loan disbursement. If in china land is owned by the government, by same token of banking norms, there is no question of any collateral. Bu then how do the banks protect themselves against the project going belly up in China? What happens in Indi- there are courts and litigations to drag on, and financial institutions do loose still. But getting loan itself will be tough, long drawn and can involve corruption – leading o escalating project costs, delays and lower profitability.
    Now let us look at the Coalgate issue. CAG pointed out that in India Government and hence the public lost huge sums of money due to adhoc coal mine allocations- which in turn were transferred by original allot tees to third parties. Hus middlemen – call them insider traders too- made huge sums for personal gains, duping the public exchequer. Coal price would anyway have gone up considering this land transfer. In China if land is owned by the Government always- then there e is no question of intermediate transfer. Then how do you think it will get reflected on cost of natural resources?
    Now let us look at banking interest rates on loans given to industries. Indian banks keep it above our own inflation rates. Indian inflation rate is a result of rampant corruption and various policies of the Government, black money etc etc. So if inflation rates are different in China and India- interest rates will also be different.
    Then in India- we have a set of traders who –wish to make quick and ft buck by importing cheap goods from China. So helplessly the Indian potential manufacturers sit watching Chinese goods being procured (do not call it dumped by Chinese. It is our own trader, greedy community) at prices below estimated material cost in India.
    Given above issues trade balance will widen. Government keeps watching helplessly Indian manufacturing sector fatter, Chinese goods seem to be t be flooding Indian foot paths and everywhere. It is sheer financial indiscipline, bad economics by Indian Government. Over and above this, Government of India i tries o bolster foreign exchange reserve by trying FDI in retail, in insurance begging foreign companies to come into aviation sector an d bring US Dollars.
    In USA- I understand that students get bank loans without collateral at about 3 % interest rates for education. USA had a sub-prime rate swallowing entire banking sector. That was a mistake and US Banks are trying t take corrective measures. So difference in banking policies can be a big hurdle for Indian industries to remain on-competitive globally.
    Who is going to teach economics to these stalwarts? Why is current account deficit going yo-yo?
    Do not always point issues at difference in labor productivity between India and China. Indian industries themselves need to understand why they are uncompetitive against Chinese and need to point out issues to GOI, RBI to provide corrective measures – it may be even in terms of tax differential or discounts for exports to such countries like China.
    Given so many issues pointed out above, whose responsibility is it to make Indian industries competitive globally? Is the world really flat? Does it play level playing field to all industries at all? Only after flattening the world- let us look at other issues like company management, labor productivity etc.

  • 2013.Jun.05 at 11:49

    Let me cite some example of Chinese cheap goods being available over the foot paths and toys etc. They have flooded Indian markets. Indian manufacturers are watching in awe- at amazing innovative and creative ideas in those cheap goods. Most of these cheap goods do not last for over a month or say 6 months. I will not call it dumping, but it is the gullible Indian traders who go to buy such cheap goods by containers loads and flood Indian markets on roads etc. Electronic bicycles which do not work for even a week are bought in container loads from china / Hong Kong, Taiwan etc. If India feels Chinese goods are not up to the quality- the source of supply remaining the same, the supply chain is changed.

    Now let us look at Government policies of liberalization in this context. This I would call financial indiscipline. Sitting in air-conditioned offices in the Government and taking policy decisions in the name of reforms and liberalization- this is what we get. Precious foreign exchange must be conserved to procure technology, and worthy products and services- but who is to define these.

    If foot path traders dominate- in the name of bread winners and entrepreneurship and if the country face gnawing current account deficit, fast weakening of Rupee – who is to blame? It is sheer financial indiscipline. I won’t even call this as widening trade gap or differential productivity. In another post I did mention about differential banking policies leading to differential capital productivity. Let us not even call it differential labor productivity. Indian manufacturer (like me for example) will not even think of manufacturing such dearth cheap product which will not even last for a week, any guarantees / warrantees – as his/her conscience pricks. But these traders in the name of making fast buck and greed bring all kinds of fancy articles just to please some for a short period. How different is this from giving open cheque to your children and spoiling them in the name of pocket money?

    Current account deficit of Rupee is going for a toss, totally uncontrolled. What kind of reforms are these. To balance such indiscipline, we try to bring in another trouble in the name of FDI in retail, insurance, infrastructure etc etc, What kind of reforms and how this economy is being driven unbridled manner? Who is responsible- fathers of our nations sitting in the hot seat of Parliament/ Government. Do we need such reforms at all? Is it necessary to give more time to UPA II to stay in power at all???


What do you think?