The rise of the Chinese and Indian auto industries: Implications for other developing countries

It is easy enough to understand why workers and engineers in advanced countries are nervous about the muscular growth of China and India in recent years: imports from China have jumped, India looks to be repeating China’s success, and outsourcing from both countries, not least in automobiles, may well soar. Even if the overall gains from trade are positive, the costs of adjustment could be substantial for the workers involved. What about other developing countries, whose wage levels are much closer to those of China and India? Eichengreen and Wang’s (forthcoming 2006: 29-30) study of trading patterns from 1990 to 2003 shows that for poorer countries, crowding effects may overwhelm positive growth linkages, particularly in auto parts: “Countries specializing in the production and export of components, capital goods and raw materials feel positive effects from China’s growth, while countries specializing in the production of consumer goods feel negative effects. The pattern of FDI spillovers is broadly similar…This positive response is shaped by proximity; in particular, Asian countries located close to China have a geographical and cost advantage when attempting to capitalize on these supply chain relationships. But this response also depends on industrial specialization and hence on past policy. For example, countries producing electronics, an industry that lends itself to production fragmentation, are better positioned than producers of motor vehicles, where for policy-related reasons, if not also because of technology, there is less scope for exploiting these international complementarities.”

The degree to which these results hold in the future will depend in significant measure on how quickly Chinese (and Indian) firms can move into markets now dominated by firms from advanced countries, and the speed with which outward FDI from China and India—virtually nonexistent in the period studied by Eichengreen and Wang—increases. Even in the short term, however, it is important to place these results in perspective: China (and India) remain small players in international trade, and other factors are much more important in determining the development of the auto industry in developing countries.

The developing economies most likely to face the brunt of intensified competition from China and India (and indeed liberalization of world auto markets more generally) are the four large economies of Southeast Asia; others include Pakistan and Taiwan. Yet with the partial exceptions of the Philippines and Pakistan, auto industries are flourishing in all of those countries, and in none of them is competition, whether direct or direct, from China and India a major concern. Economic growth has been respectable since the financial crisis, if not quite as rapid as before, or as fast as in China and India over the last decade. Growth rates in ASEAN generally have ranged from four to seven percent per year, with some pickup in 2003-2005, especially in industrial growth.

The most obviously flourishing case is Thailand, which threw open its doors to multinational investors and regional trade and developed plans to become “the Detroit of Asia” (back when that appellation seemed more propitious than it might today). After the Asian financial crisis of 1997-98, Thailand seized on exports as the savior of its auto industry, and it has never looked back. Production of motor vehicles fell from 560,000 in 1996 to 158,000 in 1998, but by 2005, production is estimated to have reached 1.15 million units, of which about 450,000 units were exported (JAMA 2005); 2005 estimates from Asahi Shinbun January 12, 2006).

Traditionally, Thailand has specialized in small pickups, for which it is the second most important market and production location after the United States, but the proportion of passenger cars is gradually increasing, hitting one-third in 2004. The rise of the passenger car market could make Thailand somewhat more vulnerable to competition from China and India. Thailand’s auto industry has enjoyed an influx of direct foreign investment, mostly from Japan but also from GM and Ford of the US. Indeed, Thailand has no independent assemblers, and virtually all significant locally-owned parts firms have been acquired by foreign firms. In theory, those firms are more footloose than locally-owned firms, but in the current boom there is no likelihood of significant disinvestment. External tariffs on autos and parts remain high, but Thailand has entered into a dizzying array of free trade agreements, starting with ASEAN’s AFTA agreement, and including China, India, Australia and Japan.

More surprisingly, the Indonesian auto industry has also performed reasonably despite the devastation caused by the Asian financial crisis, and the relatively slow, consumption-based growth since then. Auto production collapsed from 389,000 units in 1997 to just 58,000 in 1998, but finally surpassed its pre-crisis peak in 2004 with production of 498,000 units (JAMA 2005; production data for 2005 are not yet available, but according to the Indonesian economics ministry, auto sales, the overwhelming bulk of which are accounted for by domestic assembly, increased by over 10 percent in 2005). Foreign investment, while much less robust than in Thailand, has increased to support the expansion of production. Foreign investment in the automotive sector in 2005 looked set to surpass 2004’s record of about USD 400 million dollars (Asia Pulse December 16, 2005). More surprisingly, foreign assemblers led by Toyota have begun to export significant numbers of vehicles from Indonesia (66,000 units from January to September 2005; Asia Pulse October 20, 2005). Trade liberalization began in earnest after the financial crisis, and Indonesia has joined the 0-5 percent tariff regime of AFTA. Though the industry is largely limited to assembly and the skill base is not deep, Indonesia’s population of over two hundred million virtually assures the continuation of a significant auto industry.

Malaysia was not as badly affected by the Asian financial crisis as Indonesia, but recovery also was less dramatic, partly because the popping of the information technology bubble in 2001 hit electronics-dependent Malaysia hard: 2004 production of 472,000 units barely surpassed the previous peak of 457,000 units hit in 1997 (JAMA 2005; in 2005, sales increased 13 percent). The main problem in Malaysia is what to do with the national champion car companies Perodua (now controlled by Toyota affiliate Daihatsu) and especially state-controlled Proton, both of which are saddled by political interference and policies of ethnic preference and that have stymied the growth of a competitive parts industry. Long a symbol of Malaysia’s industrial ambitions, Proton cannot compete without heavy protection. Regional trade integration poses a grave threat to an independent Proton, which lacks the funds to develop new models. The signing of an FTA agreement with Japan in December 2005 provided an interim solution that sacrifices parts to save Proton. Malaysia agreed to eliminate immediately tariffs on parts kits imported from Japan, while keeping protection of larger cars until 2010 and cars with engines under two liters until 2015 (AFP, June 25, 2005; Kyodo News, December 14, 2005).The government has canvassed an array of potential partners (saviors) for Proton, but its unwillingness to relinquish majority control sank a deal with VW; talks continue with Peugeot and a variety of Chinese firms.

The Philippines was even less affected by the financial crisis than Malaysia, but it has never developed a significant assembly industry, producing only 110,000 motor vehicles on the cusp on the crisp in 1997, and just 45,000 in 2003 (Jidousha Nenkan 2004 nenban: 477). In recent years, it has used the lowering of tariffs within ASEAN to develop a comparative advantage in a few parts and components, including some simple auto electronics, and it actually exports much more than Malaysia, with its large passenger car assembly industry. Both Toyota and Ford have made major investments, and Toyota exports transmissions, especially to its other assembly sites in ASEAN. In November, 2004, Japan and the Philippines signed a preliminary agreement on an FTA that would have progressively eliminated tariffs on automotive products by 2010. In the face of vehement objections from Ford and other Western auto firms that the agreement would have violated the understanding under which they had invested, negotiations between the Philippines and Japan stalled (Wall Street Journal, June 26, 2005; JETRO, December 27, 2005).

Through all these Southeast Asian cases run two few simple themes: First, strong growth in demand for autos (though not as strong as in China and India) has kept the regional auto industry growing and relatively optimistic despite the dislocations attendant upon liberalization. Second, China and India remain but a distant concern, greatly overshadowed by debates over regional integration and FTAs with Japan and other countries.

These themes are supported by data on trade in auto parts (which in the case of the ASEAN 4 generally dwarf trade in assembled vehicles): Chinese and especially Indian exports to the big four ASEAN countries remain relatively limited in the context of overall ASEAN auto trade. ASEAN exports to major auto markets have not suffered any obvious crowding out by Chinese or Indian parts. Between 1996 and 2003, ASEAN exports to the major auto markets—the United States, the EU 15, and Japan--increased, in most cases substantially (the only exceptions are Philippine exports to the US and EU, which stagnated). Exports to China also increased substantially, but remained far below those of the other major markets. This pattern contrasts sharply with that of Korea, which grew much more dependent upon the Chinese market as sales of Hyundai and Kia vehicles assembled in China zoomed (see Figure 6, Exports of auto parts from South Korea and the four large ASEAN countries).

It is true that Chinese exports expanded rapidly in 2003 and 2004 (and 2005, though detailed data are not yet available), and in some cases China came to run an overwhelming surplus in auto parts with its Southeast Asian trade partners. In the context of the total trade of ASEAN, however, the amounts remained modest. Using another data set that includes 2004 (but covers a narrower range of parts—those in the 784 industrial code covering general auto parts), we can see that while China came to run lopsided surpluses with Indonesia and Malaysia, the absolute amounts involved were quite modest at about 70 million dollars in Chinese exports to each of the countries, and accounted for only a tiny fraction of China’s expanding exports (see Figure 7, China’s trade in auto parts). Auto trade with Philippines remained minuscule. In the case of Thailand, Chinese exports expanded rapidly, but imports expanded even more quickly, and China’s one-time surplus turned into a bilateral deficit. Even in the case of these two burgeoning auto powers, however, trade remained extremely limited: in 2004, China imported about 49 million dollars of general auto parts from Thailand, and exported about 30 million dollars parts—only about 0.68 percent of China’s 4.4 billion dollars in exports of general auto parts.

Indian auto trade with the ASEAN four was even more limited (see Figure 8, Indian auto trade overview). At first glance this might seem surprising: India has a large, rapidly growing and highly protected market, from which its companies are aggressively exporting vehicles: in 2004, India exported passenger cars worth more than twice China’s car exports (727 million dollars vs. 317 million dollars), but where China imported 4.6 billion dollars worth of passenger cars, India imported just 7,500 cars, worth only 98 million dollars. India’s parts trade remains far more limited, however, and its vehicles mostly flow to Europe and developing country markets in which Japanese brands are less well established than in Southeast Asia. An examination of India’s trade in “other auto parts” in 2000 and 2004 shows an overwhelming reliance on imports from Japan, and limited trade with other countries. Malaysia showed surprising strength, but overall the numbers remained small. This could certainly change—Toyota announced that it would export 140,000 gear boxes from India to Southeast Asia in 2006, for example (Asia Pulse February 3, 2006) —but the base is small.

The one exception is the dramatic increase in parts trade with Thailand: only about a million dollars in goods passed each way in 2000, but by 2003 India imported 18 million dollars worth of parts from Thailand while exporting almost 7 million dollars worth. In October 2003 India signed free trade agreements with both Thailand and ASEAN as a whole, including an “early harvest” provision leading to rapid cuts in many auto parts tariffs. In 2004 “other auto parts” imports from Thailand shot up to 51 million, while exports more than doubled to 16 million dollars.

This increase occasioned the only significant case of trade friction to erupt between China, India and Southeast Asia in the auto parts area—and the nervous party is not the ASEAN countries, but India, whose auto parts executives feared that high tariffs on steel and other imports handicapped them in competing against the relatively open and efficient markets in Thailand and potentially other ASEAN and Persian Gulf states with which India is negotiating FTAs. The Indian government pushed for stiff rules of origin and value-added requirements to prevent Japanese and Korean parts from slipping in via Southeast Asia, and continued to work on decreasing tariffs on inputs to allay the pain, but concern about lost revenues impeded rapid cuts (Hindu Business Line August 20, 2004, October 26, 2005; Dow Jones Newswire, October 21, 2005). Indian auto-related firms also petitioned the government for anti-dumping relief against imports of Thai and Chinese bus and truck tires (not treated as “auto parts” in the data given in this paper), and expressed concern about the turn-around in the trade balance with China in the first two-thirds of 2005, when imports from China suddenly doubled India’s exports to China (Rediff.com January 17, 2006; note that these are preliminary data, and not necessarily compatible with the UN Comtrade data used elsewhere in this paper; in 2005, China emerged as India’s largest source of imports and within two years is expected to surpass the United States as its largest trade partner. Reserve Bank of India, 2006). These incidents serve as reminders that trade patterns may change rapidly as the Chinese and Indian auto industries develop, but as of mid-2006, the most important finding remains the limited nature of Chinese and Indian auto trade, particularly in Southeast Asia, and the relatively smooth progress of gradual trade liberalization throughout the region.

The limited presence of China and India is even more evident in direct foreign investment. Globally, DFI is a crucial component of the auto industry. Thailand’s transformation into the “Detroit of Asia,” for example, has been accomplished almost entirely by foreign-owned firms, and Indonesia’s modest recent resurgence is attributable in good measure to Toyota’s takeover of the manufacturing assets of its former joint venture partners. And of course the auto sectors in India and especially China have received huge amounts of foreign investment. Outward foreign investment from China and India has been far more limited, though it is beginning to pick up pace. Chinese and Indian firms have begun to establish assembly operations in other developing countries, as seen in agreements reached in 2005 by Malaysia’s Alado/Information Gateway groups to assemble under license vehicles by the independent Chinese firms Chery, Geely, and Changan. Geely originally hoped to sell tens of thousands of units in Malaysia, where auto prices are much higher than in China, and also use Malaysia as a base for exports to other ASEAN countries at tariffs of 5 percent or less, as well as to other countries with right-hand drive, such as Australia, the UK and potentially India. In blithe defiance of WTO norms, the Malaysian government initially insisted that Alado export its entire production. In the end, Geely agreed to export 80 percent of output at USD $5,000-$6,000 per unit, with initial content of 40 percent (barely more than the cost of assembly), rising to 60 percent within a year. By agreeing to use idle assembly facilities, Geely assuaged the government’s concerns about excessive capacity, and reduced its own investments to virtually nothing (Diyi Caijing Ribao February 6, 2006; The Edge Daily, March 29, 2006). Among the possible partners for troubled national champion Proton are Chinese companies including Chery. According to one proposal, each country would assemble cars for the other, though whether Proton cars would be competitive in China remains to be seen (Financial Times, March 30, 2006; Reuters May 6, 2006).

The only prominent parts investment has not been from China or India to Southeast Asia, but from India to China. Bharat Forge, the world’s second largest forging company, announced that it would acquire the forging division of China’s largest auto conglomerate, First Auto Works (Reuters December 8, 2005). These are small and unusual examples, however. Tata Motor has explored assembly investments in Thailand, but overall Tata and Bharat Forge are more interested in investing in Korea, Germany and possibly the United States, where they can acquire and develop the brands, skills, distribution channels and experience necessary to expand sales to advanced markets. The same is true of China, where industry leader Wanxiang, a maker of universal joints, has bought companies and established operations in North America, Australia, England, and Germany and expressed interest in investing in India, but has made no moves to enter Southeast Asia.

In many other areas, the presence of Chinese and Indian auto firms remains limited. Auto technology is still overwhelmingly dominated by Western, Japanese and (to a much lesser extent) Korean firms. The increasing focus of Indian and Chinese firms--and the Chinese and Indian operations of Western firms such as GM--on small, inexpensive cars and commercial vehicles may exert some mild downward pressure on prices, which could threaten some local producers, but also provide new opportunities for households and small businesses. On balance, though, the impact for good or ill remains limited.

Surprisingly, even the auto industries of Pakistan and Taiwan, the economies most likely to be concerned about the rise of China and India, have remained relatively unaffected. If anything, the impact has been positive. Until recently, Pakistan has maintained a classic protected auto enclave, in which a swarm of assemblers produce a tiny number of vehicles in uneconomical batches behind high tariff walls. Since 2000 the government has gradually cut tariffs and promoted liberalization, and an increase in industrial and GDP growth has created greater confidence. Still, the auto industry (including Japanese investors, who account for 90 percent of assembly) remains ardently opposed to decreasing protection (The News International May 9, 2005; Dawn, January 15, 2006). In addition, Pakistan has not yet explicitly granted Most Favored National trading status to India, and despite India’s size and propinquity, it is not in Pakistan’s top 10 lists of export or import partners (JETRO country data, in Japanese). China is a major source of imports, but imports of automotive products remain limited. On balance, though, the growth of China and India reinforces the sense that with proper reforms Pakistan, too, could develop an auto industry. Ironically, the extreme underdevelopment of the auto industry to date—in 2000-2001 Pakistan produced fewer than 40,000 cars to support a population of over 150 million (UNESCAP 2002: 86)—may well provide ammunition to the many critics of current policies, and help them overcome concerns about being overwhelmed by foreign automobile industries, among which China is still a minor player.

Similarly, the eruption of the Chinese auto industry has proved more boon than bane to Taiwan, which began a slow process of market opening for autos in 1986. Liberalization and the stagnation of the island’s car market at about 500,000 units per year pushed manufacturers to look outward for opportunities. Parts firms have succeeded in expanding exports of automotive components, mainly wheels, bumpers and other items for the aftermarket, despite the rise of competitors in the mainland, and indeed Taiwan parts firms also have established hundreds of subsidiaries in the mainland to produce lower-level, labor-intensive items. Taiwan’s leading assemblers, particularly the traditional champion Yulon (Yulong) and its sister company China Motors, have made significant investments, in conjunction with their Japanese partners, in southeast China. Along with Kuozui (Guorui), the local assembler of Toyota vehicles, they have also developed design centers specializing in the modification of Japanese cars for the Asian region, particularly mainland China. Political tensions notwithstanding, Taiwan’s auto firms not only have adapted smoothly to the rise of China but have pinned much of their strategy on China, and recently they have become interested in India as well.

How much pressure are the newly risen Chinese and Indian auto industries likely to exert on other developing countries, particularly in their immediate vicinity? The answer is something of a paradox. On the one hand, the impact to date has been remarkably limited. Direct foreign investment from China and India to other developing countries has just started and barely rates a blip on the global radar, and trade flows have not been much greater. The one exception is Korea, whose growing dependence on the Chinese market does create some unease at home, but which has grown so robustly in North America and other world markets that concerns remain muted. Similarly, the only significant trade friction in the auto industry we have identified involves Thailand, the Korea of the 2000s, and the complainant is India, not Thailand. The Chinese and Indian auto industries remain distinctly junior players in a global industry firmly dominated by Japanese, Korean, and Western firms.

On the other hand, the growth in the Chinese auto industry, and more recently the Indian industry, truly has been remarkable, and the huge populations, low car penetration rates, and rapid growth of the two countries suggest that they may well grow into global powers. Exports, particularly from China, have shot up over the last couple of years, and appear to be on the cusp of a major expansion. Skeptics abound, of course, and they note that straight-line projection is hazardous to one’s predictive health. Doubts about China’s capacity to sustain growth and withstand its social, economic and ecological consequences are especially common. This study of the automobile industry suggests a different and rather more bullish interpretation, particularly when it comes to China. First, policy challenges are not limited to China (on India, cf. Kochhar et al. 2005), and at the moment China is far ahead not only in production (twice that of India), exports (more than ten times those of India), and physical infrastructure, but also in production of engineers and skilled workers. The top Indian firms may be better managed and more profitable, but the Chinese industry is broader, deeper and exposed to greater international competition. Moreover, as their similar scores on a number of international rankings of reviewed above suggest, India shares many of China’s problems, including inefficient banks, inadequate legal systems, and deep-seated inequality between urban coastal regions and rural heartlands. Second, despite these daunting policy challenges, a crucial psychological barrier has been passed in both countries: a broad consensus has emerged that reform is necessary and possible, and that the growth payback from reform will be high. In both countries, that consensus has survived turnover of the national political leadership. Thus, while a series of obstacles looms, the skill, confidence and determination with which Chinese and Indian leaders are tackling them have also risen sharply.

These trends in the car and car parts sector present a startling contrast to developments in textiles and electronics assembly, where Chinese firms have grabbed market share from other developing countries and established a dominant position in the world economy, especially since the elimination (in principle, at least) of quotas on textile exports. Industrial characteristics account for most of the difference. The auto sector is far larger—the single largest industry in the international trading system—and much of it is skilled-labor and capital intensive. The tacit and incremental character of technological innovation in autos militates against the rapid entry of new competitors seen in electronics, while the numerous incentives for local production (transport costs; differences in tastes, taxes, and regulations; just-in-time production systems; after-service care), make it difficult for auto makers and even many parts firms to rely solely on exports. Thus it is not surprising that even the dramatic expansion of market demand and production capacities in China and India as yet has exerted only a modest influence on the world industry. Perhaps more surprising, even that limited impact has been felt far more deeply in the United States and Western Europe, where worries about outsourcing and cheap imported parts run deep, than in the developing countries near China and India.

If the impact of China and India has been modest to date and is unlikely in the short-to-medium term to increase greatly, there is even less cause than usual for other developing countries to resort to protection or to slow the pace of liberalization. Nor is there any particular need to worry about the quality of Chinese and Indian vehicles and parts: heightened concerns about pollution and energy efficiency are pushing both countries to approach world frontiers in emissions controls and fuel efficiency, and the recent move to expand exports to Europe will force Chinese and Indian firms to meet advanced standards of crash resistance and recyclability.

To be sure, the push of Chinese and Indian producers into surrounding regions could have some minor and indirect effects, not least the upward pressure on prices of raw materials, with complex implications for various developing countries, depending on their resource bases. The increasing concentration of China and India on compact cars and commercial vehicles could significantly depress prices of those vehicles in the developing countries to which they are initially being exported, with consequences both positive (access to lower cost inputs for poor households and small local businesses) and negative (heightened competition for local firms, increasing congestion). The impact of even this mixed blessing, however, is likely to be small. Perhaps more important is the learning effect: other developing countries can see how once stifled economies have come alive in both China and India. They can also learn some specifics—the importance of developing appropriate credit systems and legal criteria for repossession of vehicles to prevent the expansion of the auto industry from leading to an eruption of dud loans, as it has in China, or the need to price petrol realistically and develop mass transit before private automobiles become ubiquitous and entrenched. But most of all, for the next few years, at least, they can stop worrying about the still modest influx of Chinese and Indian cars and parts, and focus on more fundamental issues of economic management.

Figure One: Leading auto parts export and import countries

Source: World Trade Organization (WTO), International Trade Statistics, 2005
Figure Two: Auto parts exports of selected economies

Source: World Trade Organization (WTO), International Trade Statistics, 2005
Figure Three: Chinese production of motor vehicles, 1991-2005

Figure Four: Indian production of passenger cars, 1994-2005

Figure Five: Indian auto parts production Source: Automotive Component Manufacturers Association of India (ACMA), Industry Statistics, 2005 (auto component industry)

Figure Six: Exports of auto parts from South Korea and four large ASEAN countries

Figure Seven: China’s trade in auto parts

Source: UN Comtrade data

Figure Eight: Indian auto trade overview

Source: UN Comtrade data


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