The Emergence of the Chinese and Indian Auto Industries

The auto industry encapsulates many of the themes of recent economic developments in China and India: constrictive protection has given way to liberalization and takeoff, and India has joined the chase, without closing ground on China. In both countries, reforms in the 1980s and especially the 1990s loosened restrictions on both demand and supply. The key breakthrough occurred almost simultaneously: in the early 1980s, the Indian government formed a joint venture with Suzuki, Japan’s minicar and motorcycle specialist; shortly thereafter, China finalized a joint venture in Shanghai with Germany’s Volkswagen (VW). At first, local buying power and technological capabilities limited output, but by the end of the 1990s, the combination of further liberalization and rising incomes led to a sudden expansion in demand and production (see Figure 3, Chinese motor vehicle production, 1991-2005)

Increasing success, in turn, gave the two countries confidence to accelerate liberalization. In 1993 India ended licensing of foreign automobile ventures, and in 2001 it lifted virtually all restrictions on direct foreign investment in the auto industry. Tariffs remained stiff, at over 100 percent on vehicles and just under 35 percent on parts, though preferential trade agreements with ASEAN, and particularly Thailand, led to some cuts in duties. China’s entry into the World Trade Organization (WTO) the same year led to a more gradual liberalization: tariffs on vehicles declined to 25 percent by mid-2006, while parts tariffs shrank to an average of 10 percent. Foreign auto companies gained the right to offer auto loans and to participate in car dealerships, though they were still restricted to no more than a 50 percent share in assembly operations, and a limit of two Chinese assembly partners (Noble, Ravenhill, and Doner 2005).

Indian passenger car production, barely over 200,000 units in 1993-94, doubled to just over a half-million units in 2000-01. In the next four years, it nearly doubled again, topping one million vehicles in 2004-05, and hitting 1.3 million vehicles in 2005-06 (including utility vehicles and MPVs; see Figure 4, India 1994-2005 Industry Statistics, updated for 2005-06 by Economic Times April 29, 2006). Exports increased even more quickly. Between 2000 and 2005, exports of assembled vehicles increased by a factor of six to reach 176,000 units, all but 40,000 of them passenger vehicles (Society of Indian Automobile Manufacturers, http://www.siamindia.com/scripts/export-trend.aspx, accessed May 4, 2006). Output of auto parts, which had grown somewhat more slowly in the 1990s, also doubled between 2000-01 and 2005-2006, reaching 10 billion dollars. Exports of auto parts, including those incorporated in assembled vehicles, also increased rapidly, hitting 1.8 billion dollars in 2005-06 (see Figure 5, ACMA, India Industry Statistics, Auto Component 05, updated for 2005-06 by Economic Times April 29, 2006).

Though it is often said that economic opening and reform began more than a decade earlier in China than in India (the end of 1978 vs. 1991), in fact Indian reform began in the early 1980s (Rodrik and Subramanian 2004), and as late as 2001, production of passenger cars in China only modestly surpassed that of India (607,000 units in China in 2001 vs. 513,000 in India in 2000-01; though production of trucks and busses already was higher in China). Then Chinese demand and output skyrocketed, hitting one million units in 2002 and two million in 2003. The much-remarked slow-down in output of motor vehicles hid the continued vigorous growth of passenger car production, which reached almost 2.8 million units in 2005, more than double the level in India. Despite continuing cuts in tariffs that started out lower than in India, imports of whole cars stagnated (163,000 units in 2005), while exports, led by a Honda transplant but including also new vehicles from independent Chinese firms, more than doubled in 2005 to 173,000 units, surpassing imports for the first time (People’s Daily, Japanese Internet edition, January 14, 2006). Exports of Chinese auto parts in 2004 totaled about 10 billion dollars (UN Comtrade data, from Noble, Ravenhill, and Doner 2005); in 2005 parts exports increased 75 percent (Jinyangwang March 10, 2006), to an order of magnitude greater than those of India (not including parts and components incorporated in exports of whole vehicles; recall the problems noted above in defining, measuring, and comparing parts production and exports).

The mix of vehicles produced in the two giants is also converging somewhat. Compact and sub-compact cars and small trucks and commercial vans have long ruled the roost in India. Incomes are lower and tariffs much steeper than in China, while mini-car maker Suzuki still accounts for a large, though shrinking, share of the market. In China, government officials and corporate managers long managed to have their work units (danwei) purchase cars on their behalf, often complete with chauffeur. Joint ventures with foreign automakers have focused on the more profitable middle and upper parts of the market. In the last couple of years, however, the compact and sub-compact segments have grown more prominent as households have come to account for a majority of purchasers, and new demand has begun to shift to less prosperous inland areas. Newly risen inexpensive domestic brands such as Chery (Qirui) and Geely (Jili) that minimize imports of costly foreign components, capital equipment and technology have both benefited from and contributed to the rise of smaller cars.

The economic and political environment is likely to accelerate the trend toward compact vehicles. Both China and especially India increasingly rely on imported oil, which analysts believe may stay expensive. The explosion of cars has raised concerns about air pollution, greenhouse gases, and congestion, causing the governments to shift policies to favor smaller cars. Both Indian and Chinese firms are beginning to design their own small cars, and it is likely that the vehicles and parts that the two countries export will increasingly concentrate on the compact segment.
Working to overcome possible obstacles to further growth of the auto industry

Firms and governments in China and India are acutely aware of the critiques raised by the skeptics noted above, and are striving to overcome the obstacles that currently keep local firms far behind, and dependent upon, the Western and Japanese leaders. The most obvious problem is product quality, which lags well behind ever-stiffer and more complex international standards for fit and finish, drivability, durability, safety, emissions, recycling and product liability. A careful comparative bench-marking study of the Chinese and Indian auto industries (Sutton 2004) suggests that assemblers and first-tier suppliers in both countries have been able, usually with the help of foreign parents or joint-venture partners, to improve quality and productivity remarkably effectively: global auto companies increasingly can produce world-class products in a wide range of developing countries, including China and India. Auto producers, however, are highly dependent on tiers of sub-contractors, and increasing quality in the smaller and less internationalized firms in the lower tiers is a far more difficult proposition. Nor are quality problems limited to individual parts. Even assemblers and first tier component manufacturers capable of churning out high-quality cars and parts for their Western partners face daunting hurdles when they try to design and integrate their own products. China’s Geely and Chery, for example, have found submitting their cars to Western crash tests a sobering experience, though they are relentlessly redesigning the models until they pass the tests.

Neither country seems to have carved out an unassailable lead in product quality. Sutton’s (2004) survey, one of the few studies directly comparing China and India, finds the leading firms in the two countries roughly equivalent. Balakrishnan et al. (2004) document the impressive progress made by India’s best auto firms, and note the large number of Deming prizes won by Indian firms. A closer examination suggests, however, that Deming prizes are an idiosyncratic indicator of quality. The Japan Union of Scientists and Engineers (JUSE) established the Deming awards in 1951and first awarded a prize to a foreign firm in 1989. From 1989 to 2000, foreign firms, including one Indian firm, won just four of the fifty application prizes awarded by JUSE. Then from 2001 to 2005 foreign firms earned 20 of 23 awards, suggesting that a structural transformation of the awards had occurred. Of the 20 foreign awards, 12 went to Indian firms, while Thai companies won the other 8 (compiled by author from data on the JUSE web site, http://www.juse.or.jp/e/deming/10_prizelist.html#02, accessed May 4, 2006) The large majority of the 20 foreign awards, in turn, went to firms from just two groups, both of them with intimate ties to Japan: the TVS group, former joint venture partner of Suzuki, in India, and in Thailand the Siam Cement group, which has numerous joint ventures and licensing agreements with Japanese companies (most of the remaining awards went to the Indian materials group Aditya Birla and its Thai subsidiaries). In 1997 the Suzuki affiliate Maruti Udyog first pushed its suppliers to apply for Deming awards, and helped initiate a program at the Confederation of Indian Industry. Coaching by aggressive and even abusive Japanese consultants has been a factor in most if not all of the winning firms (Saripalle 2005: 3-35; India Today, July 22, 1999).

Not all Indian firms have taken the Deming route: the Tata group has aimed at America’s Baldridge Award (Domain-b.com, “Boom Time Bonanza” and “Deming Rush,” December 23, 2003). Similarly, Chinese firms tend to focus on total quality management rather than the Toyota-style “lean management” popular in the United States. Moreover, given the historic and geo-politic tensions between Japan and China, if Japanese quality consultants berated Chinese applicants the way they berate their Indian clients, riots would erupt. Thus, the domination of Deming awards by Indian rather than Chinese firms probably proves little other than a heightened willingness to submit to the Deming assessment process.

Moreover, despite the great strides made by Indian firms in recent years, other industry experts remain skeptical that India can compete with China in manufacturing quality (Financial Times November 29, 2005). Certainly, China’s extraordinary performance in exporting sophisticated electronic equipment suggests a formidable level of quality control in many Chinese plants. A survey by the Manufacturing Productivity Institute of over 400 Chinese manufacturers that have or are applying for ISO 9001 certification finds that they spend more on training and information technology, put more emphasis on innovation and achieve comparable or slightly higher rates of quality than the average American manufacturing firm (while interpreting survey results and making direct comparisons can be difficult, Chinese respondents reported slower turn-around times and much lower rates of worker empowerment, suggesting that they did not necessarily simply respond to the survey less honestly or more enthusiastically. Industry Week, November 1, 2004). Similarly, the Japanese managers of Guangzhou Honda’s export plant report that product quality is higher than in the comparable American facility (though slightly lower than in Japan; the level of imported parts also remains high, as it long did in the U.S. New York Times, June 25, 2005; Financial Express, April 29, 2006). At any rate, improvement in product quality in both countries has been impressively quick, so efforts at handicapping soon become dated.

A separate but related claim is that Indian firms are better managed. While the overall ranking of China in the Global Competitiveness Report 2005-2006 report cited above is a hair above that of India, on “company operations and strategy” Indian firms rank much higher (30) than Chinese firms (57). A KMPG International report (2005: 8) cites a Confederation of Indian Industry report as finding that the return on investment for Indian manufacturing firms is 19 percent vs. only 14 percent for Chinese firms. Similarly, Yasheng Huang (2006) notes that Chinese firms, especially private firms, report greater difficulty in obtaining capital, despite China’s extraordinary savings rate, and points to the superior ranking of leading Indian firms on a variety of surveys conducted by the international business press. KPMG and others (2005: 8) contend that while Chinese firms excel at mass production using standardized technologies, Indian firms have an advantage in parts requiring intensive inputs of engineering. This might give Indian firms an advantage in the auto industry, with its reliance on tacit skills, particularly in niche markets, such as sales to small developing countries. On the other hand, Balakrishnan et al. (2004) report disquieting evidence that Indian firms have had a difficult time translating superior product quality into superior economic performance. The top Indian firms may be better managed, and may have attained better product quality, but the range of competent firms is probably wider and deeper in China’s much larger and more rapidly growing industry.

A related problem affecting both product quality and corporate management is the quality of the Chinese and Indian workforces. Here again, there is a massive disparity between the high quality of the best workers and engineers, and the hundreds of millions of poorly educated workers. A careful comparison of four-year degrees in engineering, computer science and related disciplines found that in 2004 India graduated almost as many engineers as did the United States (112,000 vs. 137,000), while China produced more than three times as many as India (352,000) (ongoing research led by Gary Gereffi of Duke University, cited inThe News & Observer, December 13, 2005). In 2004, Chinese and Indians accounted for one-quarter of all foreign students in the United States (International Institute of Education, November 14, 2005, accessed at http://opendoors.iienetwork.org/page/71388/). In 2004, Chinese students accounted for a quarter of all American PhDs awarded to foreign students (both overall and in science and engineering), more than students from the next three countries combined, and more than three times the total awarded to students from India, the third largest country. Chinese science and engineering students also outnumber Indian students in Australia, Canada, the United Kingdom and overwhelmingly so in Japan, Germany and France (NORC 2005: Table 12, p. 52; NSB 2004: Table 11, Appendix Tables 2-40, 2-41, 2-43; Federal Ministry of Education and Research 2005: 10). Even more impressive has been the growth of PhD training in many Asian countries, led by China. Whereas conferral of PhD degrees in science and engineering at American universities remained essentially flat after the early 1990s at about 25,000 PhDs per year, in 2001, China awarded over 12,000 PhD degrees in science and engineering, five times the number awarded a decade earlier. Indian universities awarded over 10,000 degrees, up about a quarter (National Science Board 2004: Appendix Table 5-35).

Despite these highly impressive numbers, doubts remain about the adequacy of the work forces in both countries. Both have huge populations and have only recently (particularly in the case of China) begun to turn out large numbers of highly educated professionals, so stock is not as impressive as flow. Doubts also shadow the quality of instruction and research, particularly at the higher end. In quantitative comparisons of the world’s leading universities, China fares poorly and India worse (Yasmeen 2005). On the other hand, Kenney and Dossani (2005: 10) suggest that the gap in educational quality at the undergraduate level is only 10-20 percent. At any rate, in both cases, the perceived gap between the best and least well-educated portions of the population is huge. The consultancy McKinsey and Company reports that both countries face serious skills shortages; while China has expanded higher education more rapidly and is putting more resources into science, engineering, and English-language training, India retains a big lead in English competence, internationalization, and geographic flexibility. Even in India, however, employers report that the English level of the large majority of the population is inadequate to interact professionally with the rest of the world (McKinsey Quarterly 2005:4, China’s Looming Talent Shortage; 2005: Special Edition, Ensuring India’s Offshoring Future). Since the auto industry is a sophisticated and rising industry in India and China, its larger and better-placed firms, at least, should be able to attract ambitious and well-trained young employees. As India and especially China gain greater experience with developing their own models, many of the current weaknesses, such as lack of experience in product integration, should gradually dissipate. Nor does the auto industry require the kind of near-native competency in English and quasi-American accent required for success in the call centers that have powered India’s prominence in information technology. On balance, skill shortages are unlikely seriously to impede the progress of the Indian and Chinese auto industries.

A related issue is whether Chinese and Indian firms will be able to increase the level of design and research and development work. The Chinese government, in particular, has been intent on upgrading the capacities of local firms, and encouraging local subsidiaries of multinational firms to increase R&D capacities in China. The ratio of R&D to national income has risen sharply in recent years, reaching 1.35 percent in 2004 (English People’s Daily, March 1, 2005); total research expenditures in China, 60 percent from the corporate sector, are nearing those of Japan (roughly 80 percent of Japan’s level in 2003) and growing much more rapidly (NSF 2006: 19, Figure 0-6). The recent statistical analysis of Rodrik (2006) suggests that Chinese exports are far more skill and technology intensive than would be suggested by China’s per capita income. Between pressure from the government and from upstart domestic firms breaking into the lower parts of the market, Shanghai Automotive, First Auto Works, Chang’an and other Chinese automotive companies with foreign-dominated joint ventures have begun to turn their attention to developing brands and intellectual property independent of their foreign partners (Noble, Ravenhill, and Doner 2005). Local firms Geely and Great Wall, though still small, have built development centers with hundreds of engineers, and Geely claims to invest over 10 percent of revenues in R&D, an extraordinary figure for a automobile company simultaneously engaged in a massive expansion of production capacity (average R&D spending in the Chinese auto industry, including both assemblers and parts suppliers, was 1.4 percent of revenues in 2004. Zhongguo Qiche Gongye Nianjian 2005: 495; according to a survey by A.T. Kearney, in 2002 American suppliers averaged 2.5 percent, European suppliers 3.5 percent, and Asian suppliers 4 percent. Michigan Craintech, July 21, 2003). Chery claims to have 1,600 R&D workers (Toyota’s American branch has only 1,100), including 54 “sea turtles” (staff who have returned from study and/or work experience abroad) and 51 PhDs (Qirui presentation at innovation conference sponsored by Zhongguo Qiye Lianhehui [Cec-ceda], April 26, 2006). The independent auto companies have developed a dizzying area of new models and engines, initially with considerable help from European design boutiques and engineering consultancies such as Pininfarina and AVL, but increasingly on their own (Meiri Jingji Xinwen January 11, 2006).

Initially, some foreign firms apparently built R&D centers largely to satisfy the Chinese government, leading cheeky foreigners to dub them “PR &D” centers (Brandt, Rawski, and Sutton 2004: 27, fn. 38), but in recent years, GM, Delphi, and other foreign firms have engaged in a wave of expansion that suggests that they are serious about developing increasing local capacities (Walsh 2003; New York Times, September 13, 2004; Business Week March 29, 2006). A 2005 survey identified 130 foreign auto parts concerns with R&D facilities in China (Zhongguo Shangbao July 29, 2005). In 2006 Visteon (formerly the parts arm of Ford) announced that it would move its global headquarters for electronics to Shanghai, while GM shifted its global electronics procurement office there (Automotive News, February 27, 2006). Germany’s Bosch plans to expand its China research staff to 1,400 by 2010 (Automotive News, March 13, 2006). In March 2006, the American auto supplier Tenneco announced that an emission-control R&D center under construction in Shanghai would become one of its three most important research facilities worldwide. While the center initially would serve Tenneco's customers in China, CEO Mark Frissora bullishly proclaimed that "If we can expand this capacity faster and cheaper than in North America, we will engineer everything here…Our vision for this is it could become the core engineering center in the entire world…You can engineer basic products a lot cheaper here." (Automotive News March 13, 2006).

Nor is increasing R&D spending in China limited to modifying parts for global exports. Long-time market leader VW responded to a rapid loss in market share to new Japanese rivals such as Toyota and Honda and the rise of cheap Chinese brands by announcing plans to develop from scratch an inexpensive new model in China specially for the Chinese market; VW will attempt to cut costs by drastically increasing the use of Chinese parts and designs (Automotive News, January 9, 2006), and plans to boost exports from China to VW’s other plants. Similarly, GM has begun exploring the possibility of developing in China a very inexpensive commercial vehicle for export to other developing countries (Financial Times, January 11, 2006).

Some of the same trends can be seen in India. At the end of 1998, Tata Motors, a division of one of India’s leading conglomerates, introduced the Indica, the first indigenously designed passenger car in India. Tata’s major market is commercial vehicles, but it has become India’s second largest producer of passenger cars, and most active in pursuing independent development. Tata devotes about two percent of its venues to R&D (Tata Motors Sixtieth Annual Report 2004-2005: 6-7, 31). Market leader Maruti Udyog, in contrast, proclaims that it will become a regional Asian R&D for Suzuki, but it devotes only 0.48 percent of revenues to R&D (Maruti Udyog Limited, Annual Report 2004-2005: 23, 29-30). This compares to 5.0 percent at Nissan and 5.9 percent at Suzuki Motor (calculated from Suzuki Motor, Annual Report 2005: 2, 20). In 2002, number three producer Mahindra & Mahindra, longtime leader of the farm equipment sector, introduced the Scorpio, a multi-utility vehicle developed on its own, with help on the engine from the Austrian engine specialist AVL (The Hindu June 16, 2002). In 2006, it displayed an experimental hybrid vehicle. At 1.34 percent of revenues, however, M&M’s R&D spending remains modest (Mahindra & Mahindra 59^th Annual Report, 2004-2005: 15). Thus, while independent design efforts are increasing, they are less numerous and aggressive than in China.

As in information technology, India’s major importance in the auto industry may come as a base for R&D by multinationals automakers and parts firms. General Motors is rapidly expanding its R&D center in India. Delphi recently announced that bankruptcy would not hinder its rapid expansion in Asia, and that it expected to have an R&D workforce of 800 in Bangalore by 2008 (Automonitor.co.in November 10, 2005). In late 2005 Germany’s Bosch, the largest auto parts firm in the world, opened in Bangalore its biggest research and development operation outside of Germany, and announced that it was scouting a location for a second facility of equal size. As with Delphi, the new centers will not be limited to supporting the Indian market: “Bosch India provides engineering and non-engineering services to the Bosch World such as electronic control unit development for automotive, industrial, consumer goods and building technology, as well as IT services, process consulting, mechanical engineering, IT design, shared services accounting, and translation/documentation.” (AsiaPulse January 11, 2006).

Most of the “research and development” by foreign firms discussed above involves modifying foreign products to fit local conditions. Similarly, much of the R&D by local firms involves increasing absorptive capacities to make it possible to license or reverse-engineer foreign technology or “co-develop” technology under the direction of foreigners. In these cases, a degree of increasing overseas R&D is not inconsistent with a continuing comparative advantage in R&D on the part of advanced countries. In the case of the auto industry in China and India, this probably accounts for the large bulk of reported R&D centers so far. More and more foreign MNCs, in autos as in other industries, however, are looking to China and India for specific competencies that they can use throughout their global operations. In the case of India, that means mostly software and information technology. For China, the primary area, at least for now, is auto electronics, which can piggyback on the extensive electronics manufacturing base in China, not all of which is labor-intensive assembly.

Moreover, the firms and governments involved are not just following markets. They are taking many steps to increase the attractiveness of local R&D. Ironically, the increasingly aggressive attitude of Western firms toward protecting intellectual property rights has created a sense of crisis, particularly in China, and a determination to propel “autonomous” (zizhu) development. Nor are Chinese firms sticking strictly to incremental innovation: they view technology breakthroughs such as hybrid cars or even fuel cells as a way of leap-frogging the deep knowledge accumulated by foreign companies in an industry still largely dominated by tacit information and incremental innovation (Noble, Ravenhill and Doner 2005; Noble, forthcoming). Just as world commerce consists not only (or even primarily) of the comparative-advantage based trade explained by the Heckscher-Ohlin theorem but of intra-industry trade among advanced countries with similar factor endowments, so too increasingly R&D will be distributed not so much on the basis of level of advancement (per capita GDP), but on an industry-specific basis, with countries specializing to a greater or lesser degree in the technologies relevant to specific industries. Of course, this is a long-term trend, and even in, say, auto electronics, the most cutting edge work is still being done in the US, Japan, or Europe. For the time being, a large gap is likely to continue to separate Western, Japanese and Korean auto firms, with their higher rates of R&D spending and greater commitment to radical innovation, but if current trends are any indication, that gap will narrow significantly long before China and India begin to approach the per-capita income levels of Korea, much less Japan and the West.

Some of the obstacles to the continued development of the auto industry stem from the wider environment, and require broader responses. India and China have some of the most crowded and polluted cities in the world, and they have begun working aggressively to tackle the social ills attendant upon mass motorization. Once relative laggards in pollution control, both have adopted versions of European emission standards. Major cities have taken the lead, and by 2010 both China and India plan to apply nationwide Euro-IV standards, the most stringent currently available (the European Union is expected to adopt the draft “Euro V” standards in 2008). Both have eliminated lead from automobile fuels. A more difficult problem is reducing sulfur from gasoline, where China in particular lags (Huizenga 2004). The Chinese government lowered the sulfur standard to that of the US in 2005, though soon after the US moved to a much stricter standard (http://www.greencarcongress.com/2005/01/sinopec_refinin.html). At any rate, sulfur in Chinese fuel will not affect exports. Already the new cars coming out of China and India are relatively clean, and by 2010 they will be at world levels; compared to water pollution and China’s many other severe environmental problems, auto emissions are amenable of relatively straightforward solutions, and the costs can easily be placed on car buyers. Similarly, the emphasis both Indian and Chinese automakers have placed on exporting to Europe means that their cars will soon routinely meet demanding international safety and recycling standards.

More difficult and even more pressing is increasing fuel efficiency. China and India have entered a period of massive motorization just as fuel prices have hit new highs (at least in nominal terms) and many experts think prices will spiral higher. Contrary to the usual arguments that India, as a democracy, finds it more difficult to take decisions that will arouse opposition from citizens, India has done a much better job of increasing fuel prices, perhaps because a higher degree of dependence on imported oil gives it little choice. Higher fuel prices no doubt help explain why small, energy-efficient cars are more common in India than in China. Fuel taxes are a rare case where opposition from China’s National People’s Congress (combined with squabbling by various units and levels of government over the distribution of revenues) has prevented the Chinese government from taking resolute action (Zhongguo Jingji Shibao May 7, 1999; Xinhua November 15, 2005; For time series data on China, India and other countries, see International Fuel Prices 2005, pp. 6, 35-36, accessed at

http://www.gtz.de/de/dokumente/en_International_Fuel_Prices_2005.pdf). Recent policy pronouncements, notably the 11^th Five Year Plan, however, suggest that the Chinese government has become alarmed about pollution, global warming, and especially energy, and is unlikely to give up on increasing fuel prices and taxes.

In the meantime, as a politically acceptable, second-best alternative, the Chinese government has introduced a new fuel efficiency standard for motor vehicles more demanding than that of the United States, and is likely to stiffen it further after 2008 (World Resources Institute 2004). The central government has also revised the sales tax on automobiles to favor smaller cars, and has ordered Chinese cities to stop using restrictions on small cars as a way to solve their traffic congestion problems; some cities have fought back by strictly implementing pollution control standards, which may deter an influx of older small cars, but in the long run will contribute more to improving emissions standards than to reducing the number of small cars (Renmin Ribao, January 10, 2006).

If India is ahead in raising fuel prices to reflect international prices, China has done far better in building infrastructure to accommodate both automobiles and mass transit, in large part because of the robust increases in tax revenues stemming from rapid growth and tax reform. China, which trailed India in road coverage until the 1990s, has engaged in a extraordinary project of highway construction that will ease congestion and encourage the continued growth of auto sales; China now possesses the second largest highway network in the world, and in a decade or so is likely to draw even with the United States. Of course, increasing the coverage of roads is a mixed blessing. Chinese cities, led by Beijing, in anticipation of holding the 2008 Olympics, are also expanding rail and subway lines at a frantic rate, and the central government is stressing the development of a comprehensive national bus network (Xinhua January 16, 23, 2006; Zhongguo Kechewang January 10, 2006). Particularly in rapidly growing second and third-tier cities that have not yet constructed significant mass transit systems, however, there is a great danger of creating land-use patterns irretrievably dependent on private cars, and thus expensive imported oil.

India has embarked on a significant highway expansion project as well. The “golden quadrilateral” highway linking India’s four largest cities is scheduled for completion this year (New York Times, December 4, 2005). Mass transit is also rapidly improving in Delhi, partly in preparation for the 2010 Commonwealth Games, and is making progress in several other major cities as well. Overall, however, India trails far behind China in highways, modern bus systems, and mass transit (The Hindu, January 17, 2006). Without further efforts, India faces the worst of both worlds: congestion that slows car growth but leaves commuters with few alternative means of transportation.

However successful China and India are in dealing with the domestic consequences of rapid motorization, two implications for the rest of the world are clear. First, the pressures of rising demand on oil prices are unlikely to abate. Second, exports of both vehicles and parts from China and India are likely to concentrate increasingly on small, clean, fuel-efficient and reasonably safe passenger cars and light commercial vehicles. Indeed, some experts believe that China and India may become leading users of clean small cars, pushing global development of new automotive technological technology and occasionally contributing to it themselves.

Finally, a challenge of special concern to the rest of the world is that untrammeled investment, particularly in China, is leading to excess capacity that will spill over to the rest of the world as Chinese companies dump excess cars and parts the minute domestic demand slows. The sum total of announced capacity investments in the auto industry, for example, could lead to capacity rivaling that of the United States in just a couple of years. The Chinese government emphatically shares this concern, not because it opposes inexpensive Chinese exports, but because it is concerned that opportunistic new firms and a glut of commodities could lead to a price war that impedes the efforts of established companies to increase the quality and sophistication of their products. Worse yet, it fears that underused factories could saddle China’s shaky banking system with unpaid loans, and plunge the economy into deflation. Historically, however, the Chinese government’s repeated calls on companies to merge and consolidate in to a few small groups have fallen on deaf ears, and the government has proven unwilling or unable to take the painful steps to prevent the emergence of excessive capacity in the auto industry. Foreign producers continue to pile in to China to grab a position in the still-maturing market before consumer preferences become fixed. Thus, despite the extraordinarily rapid increase in demand for automobiles, over the last couple of years, prices of Chinese cars, once far above world market prices, have steadily declined.

The National Development and Reform Commission has redoubled its efforts to shut down inefficient producers and discourage new investments in the automobile industry (see for example, the comments of NDRC Minister Ma Kai, Xinua via Asia Pulse, December 16, 2005). A number of would-be new entrants have pulled out of the industry for lack of support from the (government-controlled) banks (Asia Pulse, July 20, 2005). NDRC is unlikely to persist (much less succeed) in forcing consolidation around a few leading groups, but recent events suggest it may have a somewhat greater impact in shutting down the least competitive firms.

It is quite possible, however, that market mechanisms will serve to alleviate excess capacity even absent a credible exit threat, and on occasion the NDRC has also suggested that it will rely more on market mechanisms to reduce capacity (Shijie Jingji Baodao via Sina.com, January 6, 2006) Exuberant investments at the end of the 1990s and the turn of the century responded to an extraordinary burst in demand and a ballooning of profit rates. In the past two years, despite still strong growth in demand, profit rates in the auto industry have declined sharply, due both to excess capacity and spiraling costs of oil, steel and other inputs. In 2005, profitability in autos slid below the average for manufacturing industries for the first time (Shanghai Daily January 28, 2006). Already, some foreign firms are cutting back investments in the face of declining market share and sagging profitability. The most prominent case is Volkswagen. Long China’s market leader, it has lost a large chunk of market share to rapidly expanding Japanese and Korean rivals such as Hyundai, Honda, and Toyota. In response, it announced an “Olympic Program” that will scale back future capacity increases after 2008 (Auto Asia October 19, 2005).

Excess capacity remains a serious problem, as it is throughout the global auto industry, but it may be easier to respond to in China than in more advanced countries with stagnant or even declining markets or surging imports: since demand will continue to grow, reduction in future investments may be enough to whittle back the overhang of capacity without requiring the far more difficult task of forcing or allowing existing producers to shutter factories. Falling prices represent the effects not just of excess capacity but of rapid increases in the productivity of Chinese producers. Foreign producers will face an increasing competitive threat from China, but it is likely to stem from increases in real capabilities, not solely or even mainly desperate dumping to alleviate excess capacity.