India looks on as the East integrates

By Zorawar Daulet Singh

The agreement by the finance ministers of China, Japan, South Korea and the Association of Southeast Asian Nations (ASEAN+3) last week to create a US$120 billion regional reserve pool "to address short-term liquidity difficulties in the region and to supplement the existing international financial arrangements" must surely be another milestone in East Asian geoeconomics.

This, however, is not an unsurprising development but part of a trend to integration that has characterized the political economy of the region. India remains disconnected from this geoeconomic space. For too long, the country's look-East policy has been based on rhetorical aspirations rather than on immersing India into the commercial networks that have entwined the nations of East Asia.

The popular images that animate any discussion on East Asia, such as those concerning the North Korean nuclear question, the naval dimension and sea-lane security, and disputes in the South China Sea, tend to emphasize the latent, potential and ongoing conflicts in the region while crowding out any meaningful conversation on the question of economic interdependence. This is partly a result in India of a security bias within the security establishment whereby it tends to project India's perspectives on China onto other actors in the region. For the major part, however, this is because India's own economic linkages with the East are relatively perfunctory.

It is worth highlighting the underlying dynamic that enables interdependence to operate. While some analysts have opined that the economic impulse in the region has a life of its own, and security considerations have been subordinated by geoeconomics, such a perspective does not address the reality that East Asian actors have made a conscious political choice to stimulate commerce.

This is not to suggest that nations on China's periphery have somehow lost the plot and have adopted a benign attitude vis-a-vis China. China's neighbors are simply executing hedging strategies whereby their security under the American umbrella and the latter's substantial forward deployments in the Western Pacific has reassured them to enhance their economic linkages with China.

Ironically, the US has encouraged such engagement, and the extraordinary climb in Sino-US relations has only reinforced the impulse of China's neighbors to engage her. Thus, the situation of a muted security dilemma has paved the way for extensive interactions in the economic sphere.

The interdependence of East Asia cannot be understood without an appraisal of manufacturing supply chains, and China's role as a "conduit" in this process.

Over the past decade, production sharing has become more pronounced in the region. A number of electronic and machinery industries are now characterized by a vertical division of labor - the slicing up of the manufacturing process whereby each economy is specializing in a particular stage of the production sequence of a single product, which is eventually shipped out from Chinese ports to Western markets.

China has emerged as a central assembly point of imported high-technology components which are processed there by affiliates of multinational companies (MNCs), shipped out again for further processing, and sent back to China as organized components for final assembly.

This is reflected in the data. Over the past decade, the proportion of components in exports to China has increased by five times for Indonesia, 15 times for Thailand, 19 times for Malaysia, and 60 times for Philippines. Today, Japan, Taiwan and South Korea account for around 50% of China's component imports.

Foreign direct investment into China has played a vital role in restructuring intra-industry trade in the region. Japan has established 30,000 companies and joint ventures in China with an investment of US$60 billion. South Korea has 30,000 enterprises there with an investment of $35 billion. Singapore has invested $31 billion in 16,000 projects. Taiwanese firms are estimated to have invested $100 billion on the mainland. Taiwanese firms alone are responsible for 60% of China's information-technology hardware exports. From 1985 to 2007, MNCs in China increased their share of total trade from 10% to 60%, and currently 80% of the value of their exports is imported.

Clearly, what we view as "Chinese" exports is in reality part of a complex trade and investment web that spans across East Asia. This has three important implications:

First, China's manufacturing edifice must not be exaggerated since it is primarily the point of final assembly and shipment to Western markets. A lot of the sophisticated research and development and high-tech components that go into China's electronic exports continue to be manufactured in Japan, South Korea or Taiwan. To be sure, there has been a gradual relocation of some mid-value manufacturing to the mainland as China's advanced neighbors have moved up the value chain. But even here, MNCs (Japanese, South Korean, American) have led the way and continue to control major elements of the supply chain.

Second, for the most part (with the exception of a few labor intensive economies) the regional division of labor has largely been a positive-sum game. Thus, the popular notion of the Chinese hegemon overwhelming the Asian economic scene is empirically unjustified. Even more ironically, it may be noted that the US has been an important beneficiary in this division of labor. It is estimated that 60% of all imports into the US emanate from US subsidiaries or subcontracted firms operating in China. Thus, not only are US MNCs in East Asia playing a vital role in what is exported back home, the surpluses that China accumulates have been recycled into US government debt, making China into, as economist and columnist Paul Krugman has called it, a "T-bills republic"!

Third, the US trade deficit with China is in fact a de facto trade deficit with East Asia that bilateral statistics do not and cannot capture. Such a complex multilateral chain complicates attempts to impose economic costs on China, since protectionism against Chinese exports will inevitably penalize other East Asian producers, including US corporations themselves.

Clearly, the nuances in East Asian interdependence and the extensive economic involvement of the US must be appreciated if India is to craft a sensible look-east policy. A reliance on a stereotypical image of China and her neighbors has precluded India from economically immersing itself in the region.

Instead of overstating China's economic story, New Delhi should become better acquainted with the integration dynamic in East Asia, one that is already transforming political choices in the region. And the prerequisite for India's participation in regional supply networks will begin by constructing an ecosystem at home that encourages the allocation of resources toward labor-intensive manufacturing.