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Will the peacock outdo the
panda?
By Chietigj Bajpaee
Lately there have been indications that
China is losing out to India in attracting foreign
capital. The Chinese Ministry of Commerce has
reported that foreign direct investment (FDI) for
the first five months of 2005 fell year on year
for the first time in five years. A number of
reasons have been cited for this, including a
global shift in investment from manufacturing
toward the service sector; structural faults in
China's stock market, banks, state-owned companies
and legal infrastructure; the Chinese government's
attempt to prevent the economy from overheating;
and a series of geopolitical and economic
frictions between China and some of its major
trading partners. In the medium term, China is
likely to bounce back with improvements in its
legal infrastructure and English-language skills.
However, in the longer run, India may outdo China,
given India's more sustainable development model,
and the geopolitical and security tensions between
China and its major trading and investment
partners.
Why the FDI
slowdown?
First, there are indications that
global FDI has shifted from manufacturing to
services. While China accounts for less than 3% of
the global trade in services, India's strong
English-language skills, progress in establishing
internationally recognized brands, and investing
in research and development have made it a hub for
investment in services. The Indian government is
also pushing ahead with the liberalization and
privatization of a number of sectors, such as
aviation, telecommunications and banking, and
committing to improve India's power and
transportation infrastructure. Having said that,
in terms of service investments, China may be
better placed to serve Chinese-speaking markets in
East and Southeast Asia.
Second, China's
economy is plagued by a number of structural
flaws. Intellectual property violations are
rampant; China's laws against piracy, copyright,
patent and trademark infringements, and its
enforcement and dispute resolution mechanisms, are
nowhere as developed as in India (although
admittedly, India's legal infrastructure is
plagued by inefficiencies and bureaucracy). While
China's growth rates have been among the highest
in Asia, its stock markets have been the most
poorly performing. While the Bombay Stock Exchange
Sensex index has risen 10% over the April-June
2005 period, Shanghai's stock exchange shed 8.5%
over the same period. The fact that the Chinese
government has attempted to unload undervalued
non-tradable shares, which comprise two-thirds of
China's market capitalization, has contributed to
this poor performance. Well-publicized instances
of corruption within Chinese state-owned companies
have also deterred investment. The high proportion
of non-performing loans in China's banks and the
collapse of China Aviation Oil (Singapore),
China's dominant jet fuel supplier, following
losses of US$554 million in derivatives trading,
have also highlighted the weak risk management
practices in Chinese companies. Furthermore, many
of the recent controversies in China's banking
system emerged just prior to plans to publicly
list them.
Third, in some cases the
Chinese government is attempting to intentionally
deter further investment to prevent the economy
from overheating. Attempts to contain inflationary
pressures by cooling the property bubble, lowering
fixed asset investment and slowing down certain
sectors, including steel and cement, by raising
interest rates, increasing reserve requirements
and mopping up excess liquidity with bond issues
have slowed investment into China. With China
having acquired $600 billion in foreign exchange
reserves (against India's $120 billion), there has
also been a shift from inward investment into
China to outward investment by China.
Lenovo's acquisition of IBM's personal computer
business, Haier's bid for US appliance maker
Maytag, and the bid by China National Offshore Oil
Corporation (CNOOC) for US energy company Unocal
illustrate this. Furthermore, as China's consumers
increase their purchasing power there is likely to
be a shift from investment-led growth to
consumption-led growth, making FDI a less
important engine of growth.
Finally,
inter-state disputes, extant or potential, may
have deterred some countries from investing in
China. With the US accusing China of fueling its
current account deficit, imposing safeguard quotas
on Chinese-made textiles and putting pressure on
China to revalue its currency, Sino-US relations
are cool. Sino-Japanese relations have hit an
all-time low following a wave of anti-Japanese
protests across more than a dozen cities in China
in April, which included attacks on Japanese shops
and a boycott of Japanese brands. The protests
were sparked by opposition to Japan's bid to gain
a permanent seat on the UN Security Council,
Japanese Prime Minister Kozumi's annual visits to
the Yasakuni Shrine, a territorial dispute over
the energy-rich East China Sea and Japan's
republication of a "New History" textbook
allegedly understating the brutality of the
Japanese military during World War II. These
events have already affected tourism between Japan
and China, and if tensions continue to escalate it
could cut into Sino-Japanese trade and investment.
Sino-Taiwanese relations have been on an
upswing in recent months, following direct charter
flights between Taiwan and the mainland during the
Lunar New Year period, the visits by KMT Chairman
Lien Chan and Peoples' First Party Chairman James
Soong to the mainland in May, and the current
visit by New Party Chairman Yok Mu-ming.
Nevertheless, relations could easily deteriorate
given the secessionist tendencies of the ruling
Democratic Progressive Party and Taiwanese
President Chen Shui Bian, and aggressive actions
by the mainland government such as its enactment
of the anti-secession law in March. Any souring of
Sino-Taiwanese political relations could easily
undermine economic, trade and investment
relations.
India vs China: Short-term
problems
None of these developments deny
the fact that India still has a long way to go to
catch up with China. In 2004, India attracted a
fraction of China's FDI - approximately $5 billion
- against China's $60 billion. This has been
partially fueled by China's overseas community
investing significantly more in China than
Non-Resident Indians (NRIs) did in India. India
still requires a number of structural reforms,
including addressing issues of corruption,
bureaucracy (in the form of the infamous "license
raj") and infrastructure improvements to its
electricity generation and transmission, and road,
rail and air networks. Furthermore, while the
government of Manmohan Singh has actively tried to
improve India's investment climate, it has been a
"two steps forward, one step back" process as the
government's leftist allies have attempted to
derail many reforms moves such as labor and the
privatization of state-owned industries.
Over the medium term, China is also likely
to catch up with India in the service sector as
legal infrastructure and management and
English-language skills improve in the mainland.
Furthermore, under its World Trade Organization
accession agreement, China will have to raise its
foreign ownership limits, which will attract
further investment. China's domestic banks will
face direct competition from foreign banks by the
end of 2006. Finally, with Sino-Indian trade
reaching $14 billion in 2004 and growing tourism
and other cross-border exchanges, growth and
development in either state is less likely to be a
zero-sum game. As both economies become
increasingly integrated, FDI in either is likely
to complement both.
China's long-term
disadvantages
Nevertheless, as long as
India and China vie for the much-needed foreign
investment, compete for oil and gas resources to
meet their growing energy needs, and China
continues to have cozy relations with Pakistan
while Indo-Pakistani relations remain frosty over
the Kashmir question, Sino-Indian economic
relations are likely to remain competitive rather
than complementary. In this case, China is likely
to "lose" out to India over the long run in terms
of its development model and ability to attract
foreign investment.
China has employed a
'top-down' development model, which relies on
foreign investment and the government creating
employment through massive infrastructure
projects. Meanwhile, India tends to rely on a
"bottom-up" development model based on grassroots
entrepreneurial skills, where government
intervention has often been a hindrance rather
than a help given state bureaucracy,
inefficiencies and corruption. India's model of
initiative and entrepreneurship is likely to be
more sustainable over the long run than China's
model of "spoon-feeding" the economy.
Furthermore, geopolitical factors are
working against China. If the US continues with
its goal of spreading democracy, Japan continues
on the path toward becoming a "normal" country
with an expanded military presence on the world
stage and Taiwan maintains its "separatist"
tendencies, China's relations with the US, Japan
and Taiwan are likely to deteriorate. The
mainland's ability to attract FDI is likely to
suffer over the long run given the fact that all
three are major trading and investment partners of
China. Furthermore, if the US were to pursue a
strategy of containing communist China by aligning
itself with democratic India, FDI could be
diverted from China to India. Meanwhile, India has
been improving relations with most of its major
trading partners; even Indo-Pakistani political,
economic and security relations have been showing
improvement over the past year.
Demography and democracy as Indian
advantages
The success of China's
one-child-per-family population control policy has
also, ironically, created a looming demographic
crisis; the country now has a rapidly aging
population and slower population growth rates
relative to India. Finally, China is likely to be
in a precarious position over the long run given
its need to ensure perpetual internal economic
stability and prosperity to deter questions of
political representation; future Chinese
governments might see a need to undertake some
painful reform measure, but find themselves too
politically weak to do it without endangering the
regime.
By contrast, in India, the stable,
predictable democratic process creates a safety
valve, and produces governments with the popular
mandate to reform when necessary. Recent political
developments in India showed this mechanism at
work: growing frustration with the BJP-led NDA
(National Democratic Alliance) government over
questions of income inequality and the rural-urban
divide led to a change of government to the
Congress-leftist alliance of the United
Progressive Alliance. In China no such safety
valve exists, resulting in the population airing
their grievances through a growing number of
sometimes violent public protests against the
government. Thus, while the current slowdown in
China's FDI is likely to be a short-term
phenomena, it may be an indication of things to
come.
Chietigj Bajpaee is a
Researcher for Civic Exchange, a Hong Kong-based
public-policy think-tank. He has been a researcher
for the London-based International Institute for
Strategic Studies and a Risk Analyst for a New
York-based risk management company. He has a
graduate degree in International Relations from
the London School of Economics and an
Undergraduate degree in Economics and Government
from Wesleyan and Oxford universities. His areas
of interest include energy security and political,
economic and security developments in the Asia
Pacific region. The views expressed here are his
own. He can be contacted at
c.bajpaee-alumni@lse.ac.uk.
(Copyright
2005 Asia Times Online Ltd. All rights reserved.
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