Volume 11 | Issue 3 | Year 2008

A rapid, technology-driven transformation is taking place within the global economy. India and China are playing decisive roles as emerging advanced technology superstates, defined as nations that will achieve great economic, technological, and financial status, that will become financially and politically powerful in international affairs, and that will inevitably strive to become military superpowers as well.
Both nations have populations of over one billion, annual gross domestic product (GDP) growth of 8 to 11 percent and export growth of 25 percent or more concentrated in manufactures and business services. Research and development (R&D) annual growth since 2000 has been 19 percent in China and 11 percent in India, compared with 4 percent in the United States, Europe, and Japan. Both are also engaged in rapid military modernization, driven by a deepening integration of defense and civilian advanced technology industries.

China is five to 10 years ahead of India in most respects, but India is ahead in a few areas and is closing the gap in others. Chinese exports are far larger for manufacturers, while India has the lead for business services. There is growing competition for foreign direct investment featuring large R&D components. Indian multinational companies, especially when including outward foreign direct investment, are ahead of Chinese companies not only for business services, but in the pharmaceutical, automotive, and steel sectors as well.

An advanced technology race between China and India is thus gathering momentum, and raises two basic questions: What are the likely courses ahead for the two nations, and how should the United States respond in order to maintain export competitiveness and long-standing leadership in technological innovation?

The short answer to the likely courses over the coming two to five years is that it is highly likely that India will continue its 8 to 10 percent annual growth, while China is equally likely to experience a “hard landing” adjustment from excessively export-oriented to more domestically-oriented growth, including slower growth for at least a couple of years.

Both nations face obstacles to continued high growth, but India is on a more balanced growth path, with growing momentum from private sector investment, including urgently needed infrastructure. The Indian economic reform process is slow and uneven because of opposition within the coalition government, but progress is being made, more by stealth than public pronouncement. For example, in 2006 a greatly liberalized law for special economic zones, essentially free trade zones, was quietly adopted, and by, 2007 40 such zones were already into production, accounting for $10 billion of exports.

China has had higher, 10 to 11 percent growth, but half or more of the growth has been accounted for by increased exports of manufactures and related investment. External and internal pressures to shift toward more domestically-oriented growth, including through a major revaluation of the yuan, are building, but the restructuring faces formidable obstacles. Personal consumption is extremely low, at 37 percent of GDP, the domestic banking system is dysfunctional, property rights and the rule of law are lacking, environmental degradation threatens economic well-being and health, and corruption pervades at all levels of economic activity.

Another dark cloud over the Chinese economy is the 2006 revised economic strategy of indigenous technological innovation, an economic nationalist approach designed to favor Chinese over foreign invested firms, particularly in advanced technology industries. Foreign firms, however, currently account for 58 percent of total Chinese exports and an amazing 88 percent of high technology exports. A substantial shift to economic nationalism could induce foreign companies to expand production elsewhere, including in India.

This highly differentiated outlook for India and China raises a number of far-reaching policy questions for the United States.

The United States needs a forceful and comprehensive policy response to the rapid rise of China and India to advanced technology superstate status. In the short to medium term, economic policy issues will dominate, while over the longer term foreign policy and national security issues will become more important.

The current economic policy context for the United States features a somewhat contradictory combination of very large and growing mutual gains from open trade and an international policy framework that has shifted out of balance to the detriment of U.S. technology leaders and the manufacturing and business services sectors more broadly. The policy response therefore needs to continue to encourage the mutual gains from free trade while righting the balance in the policy framework so that trade and investment flows are determined by competitive market forces rather than government manipulation.

The most important immediate economic policy challenge is exchange rate policy, which falls in the category of unfair government manipulation. The International Monetary Fund (IMF) proscribes currency manipulation to gain an unfair competitive advantage in trade, particularly through protracted, large-scale purchases of foreign exchange by central banks. China, together with some other Asian trading partners, is so manipulating their currencies on a historically unprecedented scale. The United States, together with Europe, Canada, and others suffering the adverse effects, should take decisive actions, within the IMF and the World Trade Organization, to phase out such mercantilist currency manipulation.

For trade policy, the mutual benefits of free trade should be pursued through further U.S. bilateral free trade agreements, especially across the Pacific so as to avoid an Asian preferential trade arrangement excluding the United States. Congressional approval of the U.S.-Korean FTA is critical for this path. The longer term objective should be to consolidate the many bilateral FTAs into a multilateral free trade agreement, at least for nonagricultural trade. The timing for this multilateral agreement will depend on when the two largest trading nations, the United States and China, see fit to have free trade with each other.

A supportive domestic economic policy agenda is also essential. In recent years, trading partners, especially China and India, have increased incentives to make their economies more investment friendly, while the United States, in a number of areas, has been moving in an investment unfriendly direction. Specific policy areas in need of change to strengthen U.S. export competitiveness and technological innovation include education, public support for basic R&D, energy, corporate taxation, and tort reform.

Longer term, the technology-driven transformation of the global economy is leading to fundamental change in the world economic and political orders. The new world order will center increasingly on the three existing or soon to be advanced technology superstates – the United States, China, and India – together with the European Union, an advanced technology superpower although not a state with a unified military and foreign policy.

These four advanced technology superpowers are also the economic hegemons – the dominant economic powers – within the advanced technology regions of North America, West Europe, East Asian, and South Asia. These four regions currently account for 70 percent of the global population, over 80 percent of global GDP and exports, 90 percent of global military expenditures, and 95 percent of global R&D. All of these percentages, except population, moreover, will rise further over the coming 10 years, principally as a result of exceptionally high economic growth in Asia, and in India and China most of all.

These momentous developments are leading to a new order of international relations, no longer defined in terms of East versus West or North versus South, but of leading edge advanced technology regions versus other less advanced regions. In terms of nation states, the new Asia-Pacific Triangle of the United States, China, and India will increasingly play a decisive role in the course of international events. And in this context there would be a world of difference,
or put another way, a very different world order of nations, if all three advanced technology superstates were democracies, based on the rule of law and individual freedom, rather than caught in the current political divide between the two largest democracies and the largest authoritarian state.

Ernest H. Preeg is Senior Fellow in Trade and Productivity for the Manufacturers Alliance/MAPI. He is author of the book, India and China: An Advanced Technology Race and How the United States Should Respond (Manufacturers Alliance/MAPI and Center for Strategic & International Studies/CSIS, March 2008, 315 pages). The book can be purchased at www.mapi.net ($17.95+S&H) or by calling Mary Pearson at 703-647-5139.

Previous articleInnovations That Could Change the Way You Manufacture:
Next articleIn the Fast Lane