Public rallies against imported Chinese goods are held quite regularly these days, across different parts of the country. India’s dependence on Chinese goods has only grown over the years. This can be made out from Figure 1, which plots India’s imports from China every quarter, for the last few years.
Figure 1 tells us very clearly that India’s imports from China have grown over the years. Having said that, it doesn’t make sense to look at imports in isolation given that India exports stuff to China as well. Hence, Figure 2 plots India’s trade deficit with China (i.e. the difference between our total imports from China and our total exports to it).
Figure 2 clearly shows that India’s trade deficit with China has grown over the years. This means that we import much more from China than we export to it. A major reason for this lies in the fact that most of the Indian firms are small in size. Take a look at Figure 3.
What does Figure 3 tell us? It tells us very clearly that close to 85 per cent of Indian manufacturing firms are small. They employ less than 50 workers. In case of China, only around 25 per cent of the manufacturing firms are small. Also, in case of China, more than 50 per cent of manufacturing firms are large i.e. they employ more than 200 workers. In the Indian case, around 10 per cent of the manufacturing firms are large. And India has very few middle-sized firms which employ anywhere between 50 to 200 workers.
Figure 3: Distribution of manufacturing workforce among small,
medium and large firms in India and China
Given this small size, Indian firms lack economy of scale, which is basically a proportionate fall in costs gained with increased production. Hence, Indian products are costlier than Chinese products. In a recent newsreport, Blooomberg quotes a small shopkeeper as saying: “India-made lights cost twice as much… Customers aren’t willing to pay that.”
The other factor that helps make Chinese imports cheaper is the huge fall in international shipping costs over the years. This is a point that Tim Harford makes in his new book 50 Things That Made the Modern Economy: “Goods can now be shipped reliably, swiftly and cheaply: rather than the $420 that a customer would have paid… to ship a tonne of goods across the Atlantic in 1954, you might now pay less than $50 a tonne.”
This has had a major impact on the way goods are manufactured and business in general is carried out. As Harford writes: “Manufacturers are less and less interested in positioning their factories close to their customers – or even their suppliers. What matters instead is finding a location where the workforce, the regulations, the tax regime and the going wage all help make production as efficient as possible. Workers in China enjoy new opportunities; in developed countries [and developing countries] they experience new threats to their jobs; and governments anywhere feel that they’re competing with governments everywhere to attract business investment. On top of it all, in a sense, is the consumer, who enjoys the greatest possible range of the cheapest possible products – toys, phones, clothes, anything [emphasis added].”
The point is that the Chinese factories operate on a very large scale and that makes their products cheaper than the ones being made in India. The fact that transportation costs are low, helps as well.
Those against Chinese products want this dominance of Chinese products on India to end. As Arun Ojha, national convener of Swadeshi Jagran Manch recently told Bloomberg: “Our youth are losing jobs and we are becoming traders of Chinese products.”
It is important to dissect Ojha’s statement. What he is essentially saying is that because Indians are buying Chinese products, Indian industry is shutting down and the Indian youth are losing jobs. So, what is the way out? The way out is that we stop buying Chinese products and start buying Indian ones. Will this help?
This is where things are no longer as straightforward as they seem. The straightforward interpretation here is that, as Indians stop buying Chinese goods and start buying Indian goods, Indian industry will flourish, and Indian youth will find jobs. Now only if it was as simple as that.
Henry Hazlitt discusses a similar situation in his brilliant book Economics in One Lesson, in the context of United Kingdom of Great Britain and United States of America. As he writes: “An American manufacturer of woollen sweaters… sells his sweaters for $30 each, but English manufacturers could sell their sweaters of the same quality for $25. A duty of $5, therefore, is needed to keep him in business. He is not thinking of himself, of course, but of the thousand men and women he employs, and of the people to whom their spending in turn gives employment. Throw them out of work, and you create unemployment and a fall in purchasing power, which would spread in ever-widening circle.”
An American manufacturer of sweaters can sell his sweaters for $ 30 per piece. At the same time, an English manufacturer can sell the same sweater for $25 per piece. Hence, the American manufacturer charges $5 or20 per cent more for the same product than the British one. Of course, if both the products are allowed into the American market, the consumer will buy the cheaper one. This would mean that the British manufacturer would flourish. In the process, the American manufacturer might have to shutdown and this would mean a loss of a huge number of jobs.
The American government would obviously be bothered about the American manufacturer and the American jobs. Given this, to ensure that the American manufacturer can compete, the American government needs to impose a duty of $5 on the British manufacturer. This will mean the British manufacturer will also sell sweaters for $30. In the process, the American manufacturer would be able to compete, and jobs would be saved.
This trouble with this argument, as convincing as it sounds, is that it does not take the point of view of the consumer buying the sweater into account. As Hazlitt puts it: “The fallacy comes from looking merely at this manufacturer and his employees, or merely at the American sweater industry. It comes from noticing only the results that are immediately seen, and neglecting the results that are not seen because they are prevented from coming into existence.”
If the consumer ends up paying $30 per sweater, he would be paying $5 more. This basically means that he would have $5 less to spend on other things. As Hazlitt writes: “Because the American consumer had to pay $5 more for the same quality of sweater he would have just that much less left over to buy anything else. He would have to reduce his expenditures by $5 somewhere else. In order that one industry might grow or come into existence, a hundred other industries would have to shrink. In order that 50,000 persons might be employed in a woollen sweater industry, 50,000 fewer persons would be employed elsewhere.”
If the British manufacturer was allowed a level playing field and sweaters continued to sell at $25 per piece, the American manufacturer would soon have to shutdown. The loss of these 50,000 jobs would be noticed. This would be the seen effect of letting the British sell in the American market.
If these jobs are to be protected, then even the British sweaters would have to sell at $30 per piece. This would leave the consumer with $5 less, which he could have spent on something else, otherwise. This lack of spending would impact other industries and jobs would be lost there. It’s just that the loss of these jobs would not be so visible as was the case with the American sweater industry. This is the unseen effect.
Now replace the United States with India and the United Kingdom with China in the above example, the entire logic remains the same. If Indians move towards buying more Indian goods than Chinese, they will end up paying more for those goods. This will leave them with less money to spend elsewhere. This would impact other industries, where jobs would be lost. It’s just that these job losses won’t be so obvious.
This is a rather obvious point that most people miss out on while analysing this issue. There is a certain opportunity cost of money. As Dan Ariely and Jeff Kreisler write in Dollars and Sense-Money Mishaps and How to Avoid Them: “The opportunity cost of money is that when we spend money on one thing, it’s money that we cannot spend on something else, neither right now nor anytime later.”
Given this, shutting out Chinese products is not going to create jobs in India. The only way jobs can be created is if Indian industry can compete with China. Right now, it doesn’t.
The column originally appeared in Equitymaster on Nov 27, 2017.