trade-nov-dec2010

Feng Xingyuan

A

The Yin & Yang of free trade

Like Yin and Yang in Chinese science and philosophy defines every manifestation, so it defines trade relations between India and China. |8| India-China Chronicle  November-December 2010

lthough trade relations between India and China developed fast in recent years, trade protectionism and potential military strife constitute a threat to the peace and well-being of the two great nations. Free trade is a key to attain these two goals. And it starts with the inequality of the two nations.

Inequality as the foundation of social cooperation India and China have many things in common: both are mega-states in terms of population and economy; both are stars in out-performing other nations in terms of speedy economic growth; both are proud of their own long lasting civilizations; both suffered from colonization or semi-colonization

by Western powers, and thus are very sensitive of preserving their “national dignity.” Further, both countries are still poor in terms of per capita GDP the ranking of both in economic freedom is also lagging. In the 2010 Index of Economic Freedom of the Heritage Foundation, India is ranked No. 123, while China No. 140, after India.

At the same time, India and China are also quite different: India is the largest democracy in the world, while China is an authoritarian regime; India is based mainly on common law, while China adopted continental law; India is advanced in elite education, while China emphasizes more on general education and education for all; most educated Indians speak fluent English, even more fluent than some British and American native speakers, while most Chinese don’t have this advantage.

Although both nations are quite different, the cultural connections have had a long history. For instances, during the 1st Century AD, during the Han Dynasty, Buddhism was brought from India into China. It became popular after its adoption to Chinese culture and conditions later on, while it vanished in India, the very country of origin.

We can add up almost endless points to the list of similarities and differences between the two nations. In short, India and China are not equal in many fields. People might hate, discriminate or exclude each other just because they

feel that they are equal, or unequal or different. Equal men regard easily each other as rivals. Unequal men might not accept each other because they might not identify each other as own fellows.

However, just as Ludwig von Mises mentioned in his famous book >Human Action, it is precisely the inequality of men that generates social cooperation and civilization. In relation to the relationship between India and China, we have to base our discussions upon this insight, especially in current period in which trade between two countries grows fast, but vulnerable to the protectionism which can be easily imposed upon each other.

Protectionism as hindrance to bilateral trade and investments The economy of India is the eleventh largest economy in the world by nominal GDP and the fourth largest by purchasing power parity (PPP), while China is the world’s second largest economy after the United States by both nominal GDP and purchasing power parity.

According to IMF statistics, India and China made 5.05% and 12.56% of the World GDP in terms of purchasing power parity in 2009, respectively. Put India and China together, their GDP makes 17.6% of the World GDP. If adding up further the size of all the ASEAN countries (4.04%),

their economy makes 21.65%, which is larger than the share of the GDP size of the US (20.42%) and that of the EU (21.19%). However, the value of trade between India and China makes only 2% of the total trade value of China, while that between the ASEAN and China makes 9.7% of the total trade value of China.

Apparently, there exists a scissors gap between India-China trade and the ASEAN-China trade. One of the main reasons should be the trade barriers between India and China. No one is to blame. However, one can attain the improvement of the trade situation in terms of Pareto improvement which means an improvement that leaves everybody better off by reducing or even removing the trade barriers.

The consolidated GDP size of India and China makes 17.61% of the world GDP, while that of ASEAN and China 16.6%. Taking the ASEANChina trade level of 9.7% as a base, India-China trade can reach 10.2% (=17.61%*9.7%/16.6%), so 8.2% up in comparison to the current level if catching up a corresponding level by reducing trade barriers. In this regard, the India-China trade has a great potential.

Fortunately, trade relations between India and China improved rapidly during recent years in terms of trade volume (exports plus imports), which rose from 7.6 billion USD in 2003 to 43.4 billion USD in 2009, at an annual growth rate of 33.7%. However, it went up to 51.8 billion USD in 2008, highest in its history, at an annual growth rate of 46.8%. Apparently, the global financial crisis and protectionism on both sides affected to some degree this turn.

The above mentioned gap is to be traced back by and large to the trade barriers existing in both countries.

Although the Indian economy seems to be more open than the Chinese, both are not sufficiently open. India’s exports to China stood at $ 11 billion while China’s exports to India were in excess of 27 billion USD in 2009. The trade gap is expected to be further widened and cross 20 billion USD in 2010. The sharp rise in the trade deficit with China was seen by the Indian government

November-December 2010  India-China Chronicle |9|

INFOCUS | INDIA-CHINA | TRADE

as a result from the trade barriers on the Chinese side. India proposed early this year a set of measures for increasing its exports to China, such as the removal of tariff and non-tariff barriers restricting import of power plant equipment from India and removal of restrictions on imports of basmati rice, fruits and vegetables, more imports of IT/ITES services from India, landing rights for Indian TV channels in China, and import of more Indian films, removal of procedural bottlenecks including time-consuming licensing procedures being faced by Indian drugs and pharmaceuticals etc. India threatened also with potential retaliatory measures if China fails to take adequate steps in

Learning from history and lessons from West Europe Relating to the mutual benefits of trade, there wasn’t lack of wisdom in ancient and modern time which both nations don’t seem to have learnt sufficiently. The ancient Chinese philosopher Mencius advocated the division of labour and the exchange between different trades. He saw the necessity of division of labour for good economic performance, or in terminology of modern economics, efficient resource allocation. Adam Smith’s classical economics is based on his analysis of the benefits from the barter and the exchange of one thing to another. In ancient Greek, the verb “katallassein”

vice versa. This applies also to the trade relationship between China and India.

The history of West Europe provides a good example of attaining peace and prosperity through competition and trade. It also seems that both India and China in general don’t learn sufficient from this part of human history.

The first lesson India and China can learn from Europe is thus peace through trade. Europe was a bloody place where World War I and II took place. However, the Marshall Plan and the European Community of Coal and Steel helped to bring the former rivals together, to concentrate on economic development and cooperation, and to make West Europe one of the

India and China have many things in common: both are mega-states in terms of population and economy; both are stars in out-performing other nations in terms of speedy economic growth; both are proud of their own long lasting civilizations. the following few months to reduce the deficit and move towards a more balanced trade ties. In July, 2010, the Indian government announced for so called “security” reason a list of embargo, which involved 26 companies, including 25 Chinese companies (such as Huawei, Lenovo, ZTE etc.) and an Israeli company Comverse.

This is a typical situation of a “prisoner’s dilemma” in which both sides chose the worst solutions by putting aside a win-win solution which should embody a reduction or removal of trade barriers on both sides, and more trade and investments with each other which implied more bilateral imports and exports.

or “katallattein” means not only “to exchange”, but also “to admit in the community” and “to change from enemy to friend.”

It seems that the Indian and Chinese in general perceive more of the negative side than the positive side of their economic relationships, which is understandable since the perception of negative side and that of positive side tend to be asymmetrical: People tend to perceive more strongly of the negative side than the positive side of the trade relations between the two nations. According to ancient Chinese philosophy, there are in everything elements of Yin (negative) and Yang (positive).

The Yin can be turned to Yang, and

|10| India-China Chronicle  November-December 2010

most peaceful places in the world. The rationale behind it is the so called functionalist perspective which is nothing else than the concept of “katallassein” – Trade brings about peace and prosperity. Germany was included within the European framework of economic integration, and the former rivals became partners in trade and politics.

Only the 1988 visit of Rajiv Gandhi to Beijing, under great domestic pressure and with enormous personal courage, marked the breakthrough of Indian-China diplomatic relations.

This move helped to secure to a great extent peace to both India and China and set a foundation for developing bilateral trade relations. But the bilateral

trade and investments are still limited.

In the current world, trade and foreign direct investments tend to turn relevant countries to a postmodern constellation of interwoven interests: There are you in me and me in you. In such a constellation, there will be no war of one nation against another, but wars of one nation against itself. For India and China, one should keep in mind that there are, and will be no excessive bilateral trade and investments.

In contradiction, there are too little trade and too few investments between the two great nations.

The second lesson India and China can learn from history of West Europe is related to the first lesson, however much more beyond it: Prosperity through trade, and trade through internal market. Around 60% of “foreign trade” takes place among the 15 old EU member states, thanks to the internal market in which the free movement of personal, goods, services and capital across borders of the member states is ensured.

What will India and China benefit from if there is an internal market among the two mega-states, and if it includes the ASEAN countries, Japan, Australia, South Korea, Taiwan, Hong Kong and more? It is possible since we now have good examples outside our region, but also good example such as ASEAN. And the ASEAN and the recent ASEAN-China Free Trade Zone set a good sound foundation for further developing and extending an internal market for the above mentioned countries. A larger free trade zone or a larger internal market can imply a 50%, 60% or even more of internalized “foreign trade” within the zone.

Turning disadvantages into advantages There is a large degree of complementarities in the economies of India and China. India’s development is characterized through the reliance on consumption rather than investment, on domestic demand rather than exports, on service sector rather than manufacturing, on high-tech industries rather than labor-intensive lowtech industries. In contrast, China’s development is characterized through

her reliance on investment rather than consumption, on exports rather than domestic demand, on manufacturing rather than service, on labor-intensive low-tech industries rather than hightech industries. So the growth patterns of India and China are quite the opposite of each other.

If there is trade, it always implies the existence of relative advantages and mutual benefits. Otherwise the trade won’t take place. These relative advantages can involve absolute advantages, comparative advantages, and competitive advantages, or firstmover advantage, late-developing advantage, intra- and cross-industrial trade, and so on. What two nations

trary, we believe both of us are winners and strong.

have to do is to take advantage of their respective advantages in full scale.

Protectionism is often to protect the existing industrial structure and thus the backwardness and the weakness of the economy. It prolongs the existence of the disadvantages of their respective economy. The best way for getting out of such a “race to the bottom” game is to open the market and reinforce competition. This is the way we can turn our respective disadvantages into advantages. Both nations should have the courage to open the market, just because both have strong sentiments of “national dignity”: Each of us doesn’t believe that both of us are losers or the weak one. On the con-

by a large mass of analysts, been called the “Chinese Miracle.” Similarly, the remarkable economic success of India since the early 1990s was praised by some as the “Indian Miracle.” It is necessary to explain what happened to China in some detail.

China’s path of reform is basically characterized by gradual reform and opening-up. In particular, China recognized the spontaneous experiments with the rural household responsibility system and extended the system across China, and thus adopted the least resistance path at the beginning of reform.

China enforced selective stabilization of currency value till 1994 by adopting foreign exchange certificates which val-

Behind the “Indian miracle” and the “Chinese miracle” I would like to argue that both the economic success of India and China is to a large extent to be traced back to the formation and preservation of a competitive order which doesn’t function fully, but is still in shaping and improving and subjects to be deteriorated if we don’t take care of it cautiously.

The Chinese reform began more than 10 years earlier than the Indian reform. The rapid economic development and transformation of Chinese society over the past three decades has,

November-December 2010  India-China Chronicle |11|

INFOCUS | INDIA-CHINA | TRADE

ues was preserved by a fixed exchange rate in term of the US dollar, and by enforcing the Budget Law to prevent government’s borrowing from the Central Bank to cut the linkage of the borrowing to inflation. China gradually introduced private property rights which emerged spontaneously through their recognition and through “silent” privatization of most of the state owned and collective enterprises. China selectively adopted open market, first for foreign companies and capital, then for collective enterprises, or township and village enterprises (TVEs), and finally for the private sector. China didn’t enforce the reform of state owned enterprises in the beginning, but gradually introduced competition between

state owned enterprises and TVEs as newcomers and then that among SOEs, TVEs and private enterprises as newcomers. In this regard, China also gradually introduced to some degree freedom of contract and strengthened to some extent personal and corporate liability. Further, China ensured selectively the consistency and continuity of economic policy, especially for foreign direct investments (FDIs). The ban on the domestic sale of foreign capital involved enterprises which happened in India never happened in China.

Although this kind of step-by-step, selectively opening-up approach has been successful, it cannot be consid-

ered as the mystery and key point of the “Chinese Miracle.” Rather, it should be pointed out that it liberated the productive forces to some extent.

In economic terms, it improves the efficiency of resource allocation and expands the production frontier, but still limits further enhancement for resource allocation and thus further expansion of production frontier.

The above reform approaches, no matter they were of the nature of spontaneous order or piecemeal social engineering, rendered in general a higher degree of economic freedom and allowed market actors a larger free space of division of labour and knowledge.

Many reform approaches as mentioned above appear to be government-

led, but in practice it is due to factors both inside and outside of government control. At least until the mid-2003, the government had mainly chosen to quit from the economic sector to a certain extent, especially the competitive sector; removed a large number of restrictions, provided a policy and regulations environment that was beneficial for the development of industries and commerce and created and sustained, in most part of the competitive sector a relatively well functioning but still “ailing” competition order which has been favorable to performance competition and economic growth.

However, there is a certain distance,

|12| India-China Chronicle  November-December 2010

or even gap in quality between the poor competitive order which would relatively promote performance competition and one that would absolutely promote performance competition.

For example, till now, China has been using state power to depress private property rights in “important industries” as emphasized by government, i.e., the banking sector, securities sector, and other service sectors.

In contrast, the emergence of Germany’s “Economic Miracle” is related to the establishment and preserving of a competitive order which would absolutely impel performance competition in its early stage of social market economy. West Germany stressed the maintenance of private property rights since the establishing of the state. The thought of a competitive order in Germany stemmed from the Freiburg School, which is the most important source for the early stage of the social market economy in Germany. The other two sources are Christian and Socialist ideology. Eucken, founder of the Freiburg School, asserts that the establishment of a competitive order is the only road leading to prosperity.

And the principles that constitute the competitive order are: the primacy of monetary policy (stability of currency value), private property rights, open market, free contract, liability (Haftung) and the consistency and continuity of economic policy. The market economy and competition order has laid a direct institutional foundation for Germany’s “economic miracle.”

The competition order of China, which has still much deficiency, could be seen as an unintended approximation to or imitation of the competition order of the early German social market economy - a benchmark that would completely promote performance competition. Nevertheless, the poor competition order of China has still provided a space for bringing into play the entrepreneurship in large scale.

Similar as in China, India’s economy was once heavily dependent on agriculture. It evolved under social democratic-based policies from 1947 to 1991. The economy was characterized at that time by extensive regulation, protectionism, public ownership,

pervasive corruption and slow growth. Economic reforms in 1991 dramatically altered economic policy to privatize state-owned enterprises and to promote competition and investment.

Since 1991, with continuing economic liberalization, India moved towards a market-based economy. The focus has since changed from one based on selfsufficiency to one based on services and trade with other countries. A revival of economic reforms and better economic policy in the 2000s accelerated India’s economic growth rate. In recent years, Indian cities have continued to deregulate their business and economy. India’s economy has expanded in recent years into the industry and services. By 2008, India

which is characterized by preserving a certain degree of economic freedom in combination with political suppression. However, the above analysis shows there is a learning of “Western Model” behind the “Chinese Model”, which is implied that the “Chinese Model” is rather an illusion or a misinterpretation.

For productive forces to become fully liberated, China has to abandon the particularistic and selective approach to reform: It has to base a set of rules and procedures to better preserve currency value, protect property rights which implies reform of SOEs, open the market, enforce freedom of contract, enhance personal and corporate liability, and implement

As related to trade, it is utmost important to reduce trade barriers of any kind. A triple track path toward trade liberalization can be established and enforced: First, push forward trade liberalization in the WTO framework; Second, promote regional economic integration and the formation of an internal market between India and China, or substantialize it by expanding the ASEAN-China Free Trade Zone to India (however, one should avoid to build a protectionist front consisting of “ins” against “outs”); Third, proclaim unilateral trade liberalization in one’s own country.

Philosopher Immanuel Kant once argued that peace can neither be inaugurated nor secured without a general

a fair and consistent economic policy.

This step implies that China has to launch an essential political reform that President Hu Jintao and Premier Wen Jiabao proclaimed in Shenzhen respectively. Without political reform, it is less certain that China will attain a distinctly high per capita GDP. In contrast to China, India, as the world’s largest democracy, doesn’t have the necessity of a political reform as an obstacle that China is facing. It is also uncertain that whether the Party and the government in China really enforces political reform. In this regard, China’s future is still dismal while India’s future is brilliant and promising.

agreement between nations. He thus believed that a particular kind of league, which might call a “pacific federation” (foedus pacificaum), is required.

This applies to India-China space, the South and East Asian Region, or even the Asian-Pacific Region. 

According to ancient Chinese philosophy, there are in everything elements of Yin (negative) and Yang (positive). The Yin can be turned to Yang, and vice versa. This applies also to the trade relationship between China and India. had established itself as the world’s second-fastest growing economy.

In comparison with the history of the “Indian Miracle” and that of “Chinese Miracle”, India and China have approximated or simulated, intended or unintended, the competition order elaborated by Eucken and enforced in Germany and the US. Actually, there is no escape from this path for any country in the world if it seeks to become prosperous and developed.

Working Together for a Better Future Recently, there was a hot debate on the so called “Chinese Model”

Feng Xingyuan is Deputy Director of Unirule Institute of Economics and Professor of Economics of Chinese Academy of Social Sciences. Email: xingyuanfeng@gmail.com.

November-December 2010  India-China Chronicle |13|