Everybody is talking about an India-China Free Trade Agreement(FTA). The discussion reflects a confusion between the need for increasing India-China trade, improving economic ties and the usefulness of an FTA. In WTO parlance, an FTA means zero duties on all goods. Further, an FTA does not include Services, FDI, or the movement of persons — vital issues for India.

An ICRIER paper has shown that the highest un-exploited potential of India’s trade with any/all countries is with China and that it could be more than doubled. Normalising trade between the two countries , therefore, is highly desirable. To ensure that this potential is realised, India and China must jointly identify barriers to trade and move to remove them. This means putting procedures in place, ensuring transparency and overcoming the information/language barrier. This does not require an FTA.

Prime facie, the economic benefits of a bilateral India-China FTA are not obvious. India, until two years ago, had the world’s highest non-agricultural tarriffs. With the reduction of the peak rate to 15 per cent, we now have rates that may be in the top 1/5th or 1/4th. Tarriffs on agricultural goods are much higher, a few as high as 100 per cent. Lowering these rates to zero under an FTA could result in substantial trade diversion and welfare loss. Thus, as long as our tariff rates remain high, the a priori presumption must be that an FTA with any country with lower tariffs is likely to result in economic losses not gains.

Building mutually beneficial India-China economic relations requires a clear understanding of China’s economy. Some analysts have a tendency to find economic similarities even when they do not exist. Definitions are adapted to make it appear similar to a normal market economy. This is reflected, for instance, in the Chinese definition of private sector, non-state sector, state owned enterprises, collective enterprises, town & village enterprises, listed companies, joint venture companies. The standard international definitions in which ownership (majority, minority, largest share, etc), management control (eg, power to appoint CEOs) are not used in defining the ‘private’ and ‘public’ sector. This obscures the true nature of the economy. China’s basic goal is national power through growth maximisation. Individual income growth, employment generation, and public welfare act as constraints (rather than secondary objectives) to the growth maximisation objective. The CPC network, a mix of centralised and decentralised systems, implements these objectives. Like most developing countries, China’s quality of governance is deteriorating. This involuntary lack of control (eg, on corruption) should not be confused with a deliberate policy change by the state/CPC.

The strategy adopted to achieve the growth objectives has four important elements. The FDI-export policy is the most important and critical means for achieving this goal. China is now a part of the global supply chain for labour-intensive exports, and these are highly competitive. The reason for this, however, is the productivity of Chinese labour in terms of output per man-hour. A critical subsidiary element of the FDI-export strategy was the abolition/suspension of minimum wage conditions, upper limits on working hours and rules against firing workers. Control of the labour market (labour responsibility system) ensured the supply of workers who worked 100 hours a week, 52 weeks a year. Thus high productivity per person-year is due to more hours worked per week compared to normal market economies (35 to 48).

The second element is the social ownership of capital assets (100 per cent till 1980). The returns from these are used to raise national investment rates to very high levels, without creating disincentives and distortions through high tax rates. High infrastructure investment since ’97 is a manifestation of this. The third pillar is normal markets for most goods and services, where the forces of demand and supply operate to set prices. This removes the worst feature of the Soviet system that played an important role in its collapse. The fourth pillar is the control over banks and capital markets, which allows subsidisation of capital-intensive and skill intensive exports as well as FDI investment in hi-tech industry, indirectly through banks. The modus operandi is to give loans to state/CPC owned/controlled enterprises that supply inputs to the target companies. These loans are not expected to be repaid and therefore the use of the word NPA is a misnomer. The result: incredible rates of growth of 9.5 per cent per annum for 25 years. Even if there is overestimation here of 2 per cent — a growth rate of 7.5 per cent per annum is the highest in the world during this period (30 per cent higher than India’s).

The Asian crisis showed that some elements of this strategy are risky. The strategy is a bit like peddling furiously on a bicycle to keep from tipping over. The expectations of foreigners play a key role in FDI. Euphoria over China’s growth keeps FDI flowing. That, in turn, ensures a very high growth of production. Given the low share of private income and consumption in GDP, excess capacity is created in many industries. This can only be utilised by pushing exports. Either unit values fall (for instance in textiles) or implicit subsidies have to be provided. This picture of the Chinese economy suggests that the arguments for an FTA with China and the according of ‘market economy’ status to it are very weak. We should focus on normalising economic relations, settlement of the border issue and collaboration in areas where there is a clear identity of interests (eg, oil purchases), rather than jumping from one extreme to the other.

It is said that ‘India-China Bhai-Bhai’, became ‘India-China Bye Bye’, which in turn has now become ‘India-China Buy-Buy’. Let us not restart the cycle by getting euphoric over words like ‘strategic partnership’. It is better for both countries, as well as for Asia, if we jointly build a normal, realistic and well-rounded relationship that will last through the 21st century.