Trade Balancing Act

By Liu Youfa

Since China and India established a strategic partnership in 2005， their bilateral economic and trade relations have seen rapid growth. Bilateral trade has increased at an annual speed of 40 percent， resulting in a record volume of $73.6 billion in 2011. However， the trade imbalance between the two countries has also increased over the years， reaching a record high of $53.2 billion in 2016. The trade defi cit has become a hot issue demanding the attention of both governments as well as analytical research.

Trade imbalance

An Indian proverb states that any flowing water can be traced back to its source， thus the trade imbalance between China and India has its root. The growing Indian trade deficit with China has been influenced by both international and domestic factors as well as political and economic factors. This is an inevitable consequence of globalization. It is an open secret that the essence of economic globalization has meant transnational corporations allocating factors of production and carrying out manufacturing and marketing activities around the world in an effort to maximize commercial revenues. They do this by capitalizing on their absolute advantage in technology， research and development（R&D;）， resources， production and marketing.

China has managed to attract foreign direct investment （FDI） of more than $1.7 trillion since the country started its economic reform and opening up 40 years ago. Now， more than 1 million FDI-related enterprises are registered and operating in the country， which has converted China into the “worlds factory.” This has greatly contributed to its economic and social development and transformed it into the largest trading nation and the second largest economy in the world. However， China has also been encountering major challenges， especially in the area of foreign trade.

In terms of economic development， globalization can easily lead to two direct results in affected countries. The first is the separation of the production， marketing and consumption of commodities on a global scale. Specifically， commodities can be designed in different countries， component parts can be manufactured in different places， and a product can be assembled and packaged in another country before being transported and marketed to different places around the world. Due to the fact that China is endowed with cheap but quality labor， as well as great market potential， the country has built up about 40 percent of global production capability in terms of daily and durable consumer goods. “Made in China”products have become a household brand around the world.

Consequently， transnational corporations have been producing the second effect： The diversion of trade fl ow between or among partner countries as well as the breaking off of trade volume and trade benefits. The over a million multilateral corporations operating globally have benefi ted from Chinas cheap labor and natural resources and have carried out commodities production and marketed their end-products in local markets across China and the world to maximize their revenues.

To illustrate， in 2013 one of my friends bought a Samsung mobile phone in Mumbai. When he opened the package， he realized that it was made in China. Samsung physically assembles phones in China， but the R&D;， trial production and construction of core components are all done at the parent company or supply chain partners in other countries. Only the downstream manufacturing， assembling and packaging are done in China. This friend spent about 50，000 rupees （$742） on his new cellphone， but the bulk of the money was spent on developing the intellectual property， microchips and the core components. Furthermore， Samsung realizes maximum revenues when marketing its products via its own network or special agents.

From the perspective of trade statistics， the aforementioned mobile phone originated in China according to traditional trade theory. The transaction is calculated exclusively as a Chinese export， which indirectly contributes to the growing Indian trade deficit with China. According to research findings， more than 60 percent of Chinas foreign trade is still carried out by FDI enterprises or exporters and importers from other countries， so the trade between China and India is essentially trade between many countries. Furthermore， the existing trade defi cit between China and India is actually a deficit between India and countries around the world. The misconception is caused by trade volume being calculated entirely as Chinas foreign trade.

This is an inevitable outcome of commodity trading based on different structures.“Misalignment of trade structures” is an important factor contributing to the growing trade imbalance between China and India. From the perspective of import and export structure， the commodities India sells to China are mostly primary industries， with minerals and agricultural products making up more than half. Meanwhile， Indian imports consist of mechanical products from China which make up 46.9 percent of the total； chemical products at 14.7 percent； metal products at 10.6 percent； and fi ber and textile products at 4.6 percent.

From the perspective of capital composition， Indias exports to China are mostly mineral resources and labor intensive products， while imports are mainly value-added industrial products followed by mineral and labor intensive products. Such a trade structure can easily result in a surplus in Chinas favor. Coincidentally， trade between China and the United States fi ts this same pattern.

This is due to different trade capabilities. Against the backdrop of globalization， sound economic and trade relations constitute the main engine powering healthy bilateral relations， of which trade relations naturally constitute the barometer. Since the two countries started their respective reform and opening up， their economies have merged onto the fast track of growth， with their consumer populations growing rapidly. However， China and India have different economic structures， different growth modalities， different industrial comparative advantages and different natural resources. Under market rules， expanding bilateral trade is bound to result in an increasing defi cit on one side.

Historically， bilateral trade grew slowly between the two countries in the 1960s and 70s. By 1989， bilateral trade stood at a meager $271 million， and by 2004， India still enjoyed a trade surplus of $1.74 billion. In 2006， however， Indias consistently growing trade defi cit with China began to emerge. In 2010， the defi cit ballooned to $20.01 billion and to $43.1 billion a year later. By 2016， the deficit with China reached a record high of$53.2 billion.

This occurs as a result of different trade policies. China and India are the two most populous countries in the world， and both are nurturing a growing middle class with great potential for consumption. China and India are the worlds second and fi fth largest economies， respectively， with different industrial advantages that could translate into ideal two-way trade. Theoretically， the two countries could export their products with different comparative advantages to complement their distinct economic development stages， and realize tangible trade benefits according to the healthy road map for developing countries in their early stages. Such a strategy expedites industrialization and ensures advantages for being a latecomer to the fi eld of economic growth.

However， both governments have periodically implemented policies to limit the import or export of certain commodities in various industries， which put the breaks on a smooth two-way trade fl ow and exacerbates the growing imbalance.

This is an inevitable symptom of insufficient two-way investment. Against the backdrop of globalization， trade and investment are the two wheels driving healthy bilateral relations. When bilateral trade grows to a certain stage， two-way investment should naturally follow， creating a complementary situation. Since the end of the Cold War， both economies have grown rapidly， and both have formulated comparative advantages in various industries， which should serve as new steam for the development of economic and trade relations. However， the ideal scenario has yet to play out between China and India.

Statistics show that over the past 10 years， Chinas comprehensive economic power has grown faster， and Chinese capital can now be found all over the world， with a volume of more than $1.4 trillion. Of that total， less than 1 percent has been invested in India. Meanwhile， India has accumulated industrial advantages in IT， software and pharmaceutical industries but has incorporated its advantages into the production chains of developed countries in North America and Europe. It has not transformed them into the boosters for its national manufacturing sector nor allowed them to supply investment in China. Apparently， the“misalignment of endowment of natural re- sources” has become a major causal factor of the worsening imbalance in bilateral trade.

The situation is overblown in statistics modalities， where national statistics are known to be prone to human errors. It is common consensus that an average discrepancy between 5 and 10 percent can be found in foreign trade tallies. In general， bulk manufacturing commodities are relatively easy to tally so therefore lead to fewer discrepancies. But commodities carried by retail traders can more easily slip past the customs statistics of both countries.

According to Chinese Ministry of Commerce statistics， several thousand Indian traders have been carrying out regular trading activities at the Yiwu Commodities Fair in Zhejiang Province， on Chinas east coast， which could tip the trade imbalance between the two countries. It is noteworthy that services trade has been playing a more important role in international trade， an area where India has a clear upper hand over China， but an area that is not included in statistics related to bilateral trade.

Potential measures

Understandably， a growing trade deficit is a hot-button issue for any government or social sector and a major economic issue to be addressed by partner countries. Nevertheless， against the backdrop of globalization， trade between any two countries can seldom achieve and maintain absolute balance. The issue of a trade defi cit gradually emerges and requires concerted policy measures by the relevant countries to resolve the matter in an incremental and dynamic way.

Policy dialogue and coordination needs to be stepped up. China and India have different national situations and different economic structures. Further trade growth warrants more frequent high-level exchanges to enable the national leaders to gain top-notch vision and dispense political guidance. Heads of state must meet regularly to carry out agreements reached and transform political decisions into operational policy measures.

Trade needs to be expanded. Both China and India should tap into the potential of existing commodities trade while exploring new areas of trade and new tradable products and services. The two governments need to provide companies and individuals with timely market information and facilitate conditions for market access， reducing policy barriers.

Two-way investment needs to be actively promoted. The two governments should expedite negotiations to form a bilateral investment treaty， which would provide a more solid legal foundation for two-way trade. In addition， it would allow for a readjustment of relevant policies to provide support to various enterprises that seek to establish joint ventures or carry out joint production. The two governments should also work to provide comprehensive services， promote coordinated industrial development， expand tradable areas， promote value-added trade， increase jobs for the people of both countries， and promote third-country trade to help balance bilateral trade in a comprehensive way.

Industrial cooperation must be steadily promoted. A good place to start is carrying out orderly dialogue on industrial policies to align with the national strategies and fiveyear plans of both countries. Both should promote further cooperation in infrastructure， which will help provide India with the steam to revitalize its manufacturing sector with hardware and software support. Based on Chinas manufacturing capabilities and Indias technology capabilities， the two countries should carry out effective industrial cooperation in agreed industries to give full play to the comparative advantages of both sides， promote investment in third countries， jointly explore third markets and realize the benefi ts of developmental cooperation.

Joint research and development must be expedited. Policymakers should give full play to summit dialogues to identify areas for R&D; and establish relevant institutions. They should select competent enterprises and institutions to carry out such activities and identify R&D; areas related to the agreed industries. Jointly establishing a fund for agreed areas of R&D; will provide financial support for relevant projects. Setting up industry-related research centers will facilitate conditions to transform standards of joint-venture products into global standards and elevate the positions of China and India in global division chains.

Cooperation in human resource development should be expedited. Within the realm of the Internet and information highway， no country can realize economic development without the sound support of human capital and an ideal division of labor and industrial cooperation. Competition will eventually become focused on areas such as human resources. The two countries should further strengthen cooperation in culture and education to provide sustainable and effective support in human resources to accompany further growth of bilateral economic and trade relations.