Why banning trade with China will hurt India more

The Indian government has tried to respond to the border dispute with China by training its guns on trade. The idea resonating in Indian streets is that Indians should boycott Chinese goods and thus “teach China a lesson”.

Visuals of Indians breaking and burning their fully functional Chinese appliances such as TVs have been doing the rounds in social media. Union minister Ramdas Athawale has even demanded a ban on restaurants selling Chinese food even though these would be Indian restaurants, employing Indian chefs and using largely Indian agricultural produce to serve such Chinese dishes.

While one can understand the outrage that Indians feel when they hear about the brutal deaths of their soldiers, turning a border or defence dispute into a trade one is an ill-advised move.

There are several reasons.

1. Trade deficits are not necessarily bad

One of the main reasons why banning trade has been the first reaction is the notion that having a trade deficit is somehow a “bad” thing. The fact is altogether different. Trade deficits/surpluses are just accounting exercises and having a trade deficit against a country doesn’t make the domestic economy weaker or worse off.

For instance, if one looks at the top 25 countries with whom India trades, it has a trade surplus with the US, the UK and the Netherlands. But that doesn’t mean the Indian economy is stronger or better off than any of these three.

Similarly, it has a trade deficit with the other 22 of them (including China) — regardless of their size and geographic location. This list includes France, Germany, Nigeria, South Africa, UAE, Qatar, Russia, South Korea, Japan, Vietnam, Indonesia among others.

Yet, a trade deficit doesn’t necessarily mean that the Indian economy is worse off than South Africa’s. A trade deficit with China only means that Indians buy more Chinese products than what Chinese from India. But per se that is not a bad thing.

Why? Because it shows that Indian consumers — who made these purchase decisions individually and voluntarily — are now better off than what they would have been had they bought either, say, a Japanese or French or even an Indian alternative.

Essentially, it shows that Indian consumers, as well as the Chinese producers, gained through trading. It is this very process that generates the gains from trade. Both sides are better off than what they would have been without trade.

Of course, running persistent trade deficits across all countries raises two main issues.

One, does a country have the foreign exchange reserves to “buy” the imports. Today, India has more than $500 billion of forex — good enough to cover imports for 12 months.

Two, it also shows that India is not capable of producing for the needs of its own people in the most efficient manner.

At one level, no country is self-sufficient and that is why trade is such a fantastic idea. It allows countries to specialise in what they can do most efficiently and export that good while importing whatever some other country does more efficiently.

So while a persistent trade deficit merits the domestic government — the Indian government in this case — to put in place policies and create the infrastructure that raises competitiveness, it should not “force” or even “nudge” people to move away from trade because doing so will undermine efficiency and come at the cost of the consumer’s benefits.

2. Will hurt the Indian poor the most

More often than not, the poorest consumers are the worst-hit in a trade ban of this kind because they are the most price-sensitive. For instance, if Chinese ACs were replaced by either costlier Japanese ACs or less efficient Indian ones, richer Indians may still survive this ban — by buying the costlier option — but a number of poor, who could have otherwise afforded an AC, would either have to forgo buying one because it is now too costly (say a Japanese or European firm) or suffer (as a consumer) by buying a less efficient Indian one.

Similarly, the Chinese products that are in India are already paid for. By banning their sale or avoiding them, Indians will be hurting fellow Indian retailers. Again, this hit would be proportionately more on the poorest retailers because of their relative inability to cope with the unexpected losses.

3. Will punish Indian producers and exporters

Some may argue that trading with China hurts many Indian producers. This is true, but it is also true that trading hurts only the less efficient Indian producers while helping the more efficient Indian producers and businesses.

It is important to note that the list of Indian consumers of Chinese imports does not comprise just those who consume the final finished good from China; several businesses in India import intermediate goods and raw materials, which, in turn, are used to create final goods — both for the domestic Indian market as well as the global market (as Indian exports).

Contrary to popular belief an overwhelming proportion of Chinese imports are in the form of intermediate goods such as electrical machinery, nuclear reactors, fertilisers, optical and photographic measuring equipment organic chemicals etc. Such imports are used to produce final goods which are then either sold in India or exported.

A blanket ban on Chinese imports will hurt all these businesses at a time when they are already struggling to survive, apart from hitting India’s ability to produce finished goods.

To recap: Trade deficits are not necessarily bad; they improve the wellbeing of Indian consumers including producers and exporters. In any case, India has trade deficits with most countries so why single out China.

4. Will barely hurt China

Still, some may argue that we want to single out China because it has killed our soldiers at the border and we will now punish it through trade.

Then the question is: Will banning trade hurt China?

The truth is the exact opposite. It will hurt India and Indian far more than it will hurt China.

Let’s look at the facts again. While China accounts for 5% of India’s exports and 14% of India’s imports — in US$ value terms — India’s imports from China (that is, China’s exports) are just 3% of China’s total exports. More importantly, China’s imports from India are less than 1% of its total imports.

The point is that if India and China stop trading then — on the face of it — China would lose only 3% of its exports and less than 1% of its imports, while India will lose 5% of its exports and 14% of its imports.

Moreover, if one takes the notion of not letting China profit from the Indian purchasing power strictly, then Indians should also avoid buying all products that use Chinese goods and labour. So, forget the several obvious Chinese brands and products, Indian consumers would have to go about figuring out if China gains any money from, say, the iPhones that are sold in India. Or if the steel used in a European gadget is Chinese or not.

The trouble is this is a near-impossible task not just because of China’s centrality in global trade and global value chains but also because even teams of bureaucrats will find it tough to map Chinese involvement in all our trade on a real-time basis.

On the whole, it is much easier for China to replace India than for India to replace China.

Here’s some food for thought: /What if Xi Jinping and the political establishment in China do the same thing to India? What if they decided to abruptly ban all trade and forbid all private investment via any route into India?/

Of course, India would survive, but at a huge cost to common Indians while depriving many Indian businesses (the start-ups with billion-dollar valuations) of Chinese funding.

Why? Because in the short to medium term, it would be both difficult and costly to replace Chinese products. Imagine diverting all our imports from China to Japan and Germany. We will only increase our total trade deficit.

If on the other hand, we decide to use Indian products, that too would cost us more — albeit just internally.

5. India will lose policy credibility

It has also been suggested that India should renege on existing contracts with China. Again, while in the short-term this may assuage hurt sentiments, it would be hugely detrimental for a country such as India which has been trying to attract foreign investment.

One of the first things an investor — especially foreign — tracks is the policy credibility and certainty. If policies can be changed overnight, if taxes can be slapped with retrospective effect, or if the government itself reneges on contracts, no investor will invest. Or, if they do, they will demand higher returns for the increased risk.

6. Raising tariffs is mutually assured destruction

It has also been argued that India should just slap higher import duties on Chinese goods. Others have suggested that India can allow primary and intermediate goods from China at zero duty, but apply prohibitive tariffs on final goods.

Even leaving aside the rules of the World Trade Organization that India would be violating, this is a poor strategy since others — not just China — can and most likely will reciprocate in the same way.

What will also go against India here is its relatively insignificant presence in global trade and value chains. In other words, it is relatively easy for the world to bypass India and carry on trading if India doesn’t play by the rules.

The Upshot:

The first thing to understand is that turning a border dispute into a trade war is unlikely to solve the border dispute. Worse, given India and China’s position in both global trade as well as relative to each other, this trade war will hurt India far more than China. Thirdly, such a shock — banning all trade with China — will be most poorly timed since the Indian economy is already at its weakest point ever — facing a sharp GDP contraction.

The surge of protectionism and anti-globalisation sentiment since the start of the Global Financial Crisis of 2008 is well known but it is also well established that trade leaves people better off.

Of course, not everyone. For instance, all inefficient domestic industries would want to be protected by higher tariffs in the name of economic nationalism. But, as explained above, this protection will come at the cost of domestic consumers.

Indeed, in the first four decades of India’s existence, it has tried — and miserably failed — making mantras like “self-reliance”, “import-substitution” and “protecting infant domestic industries” work.

India must try to aggressively acquire a higher share of global trade by raising its competitiveness. India now has an insignificant share in world trade. If it is not careful, much smaller countries will further chip away.

For instance, while in November 2019, India refused to join the Regional Comprehensive Economic Partnership (RCEP) — a Free Trade Agreement (FTA) in a region that is least affected by Covid and most likely to see trade volumes in the future — Vietnam signed an FTA with the European Union earlier this month. Indian exporters were already losing ground in the EU to Vietnam will now be adversely affected since most Vietnamese goods will enjoy zero import duties in the EU, thus making them more affordable for European consumers.