The Chinese are coming, the Chinese are coming—and now the Indians, too. Alarms about the rapid emergence of two gigantic new competitors have begun to rattle the global motor vehicle industry. In just half a decade, China has grown from a modest market on par with Spain to the third-largest automotive market and fourth-largest auto producing country, with output trailing only the United States, Japan and Germany; in 2006 China is all but certain to surpass Japan as the second largest market for new motor vehicles. China has attracted tens of billions of dollars in direct foreign investment (DFI) each year, not least in motor vehicles. Virtually all of the world’s automobile assemblers and leading suppliers have invested in China, both to access the domestic market, and (in the case of parts firms, and potentially assemblers) to export. Assemblers and first-tier component firms in North America inform their suppliers that unless they match “the China price,” they will be dropped without a second thought. Just in the last year or so a similar buzz has begun to emerge about India, another giant country filled with smart engineers and inexpensive workers—many of whom, unlike most Chinese, are highly articulate in English. Nor is the sense of threat contained to automotive producers and labor unions in high-wage countries: to many in the developing world, China and India seem destined to emerge as fierce, even overwhelming competitors.
Despite the understandable concern expressed by headline writers and threatened firms and unions when the most populous countries on earth start growing at high speed and breaking into new markets, within the automobile industry skeptics are not hard to find. Huge populations and growing economies notwithstanding, China and India remain relatively small and unsophisticated players in the global industry, particularly in the crucial passenger car segment, their exports still only a fraction of those emanating from mid-sized players such as Mexico and Korea, much less global leaders Japan, Germany, France and the U.S. Their impact on other developing countries is even smaller and more indirect, since the large bulk of their exports aim at advanced markets such as Europe and North America. The value-added and technological sophistication of China and India remain limited, and many observers question whether either or both will be able to maintain the waves of reform necessary to sustain high-speed growth.
The alarmist and coolly skeptical views are not impossible to reconcile. China and India are already important economies, and they are likely to sustain vigorous growth, but from small bases. The global auto industry is gigantic and highly sophisticated, and China and India will continue to play modest roles for the next decade or more. They may come to exert a somewhat greater impact in certain regions and markets, such as small cars, vans and light trucks in the Asia-Pacific region, and labor-intensive parts throughout the world. But even in Asia, other factors will remain more important, such as the widespread opportunities created by the continued expansion of demand, bilateral and regional trading agreements, and the changing relative balance of power between established Western auto companies and the upcoming Japanese and Korean assemblers.
The policy implication is clear: particularly in the short run, there is little reason to devote excessive concern about China and India, and even less reason to turn toward protectionist measures that will grow steadily more counter-productive as the globalization of the auto industry continues. Firms and governments in less-developed Asian countries perhaps should think twice before competing directly with Chinese and Indian firms in those limited areas were they are beginning to make a concerted push. At the same, new opportunities for cooperation will emerge, both directly, as the division of labor in Asia proceeds, and indirectly, as other countries feed the extraordinary growth in China and India. The emergence of Chinese and Indian firms, particularly in small car segments, may also contribute, if initially only modestly, to the social problems attendant upon widespread motorization, including increased pressures on energy prices and greenhouse gas effects.
Between understandable concern and misleading hype: the sudden emergence of China and India
Over the past few years, an increasingly intense round of consolidation has squeezed the ranks of independent auto assemblers and drastically reduced the number of parts producers. Reorganization and consolidation, driven by increasingly powerful economies of scale and scope, are expected to continue, driven in part by the gradual displacement of Western assemblers and parts firms by more younger and more efficient Japanese and Korean firms. A Japanese auto expert in the consulting firm Accenture estimates that in the past 15 years mergers, bankruptcies, and exit have reduced the number of world auto parts firms by roughly 80 percent; over a slightly longer period almost as many assembly firms have disappeared (Misawa 2005: 66). Particularly in North America, with its relatively open markets and proximity to Asia, bankruptcies have spread even to such giant first-tier component manufacturers as Delphi and Dana. Industry observers agree that if General Motors (GM) and Ford are to avoid bankruptcy they will have to take much more drastic steps to cut excess capacity and improve the process of new product development; many doubt that they will be able to do so.
In this volatile and contentious environment, the entry of Chinese and Indian firms as new competitors understandably has raised great concerns (see e.g Detroit News December 5, 2004). Western suppliers report that their customers, desperate to reduce costs to compete with Toyota, Hyundai and other overseas rivals, demand that they match the “China price” by drastically cutting prices themselves, procuring materials from China, or investing in Chinese production (Business Week December 6, 2004). Billions of dollars in direct foreign investment in China, and more recently in India, have created impressive new capacities and raised the specter of excess capacity that may only be resolved through exports. Unlike their counterparts elsewhere, Chinese auto firms, sustained by rapid growth in demand, support from local governments, and capacity to develop niche markets of little interest to the multinationals, and lacking a developed institutional framework and political environment facilitating acquisitions and mergers, are not consolidating but still expanding in both numbers and capacity. And while most parts production in China, particularly for export, focuses on labor-intensive products such as wire harnesses or wheels, skills are rapidly increasing; with sufficient effort by multinational investors, virtually anything can be built in China. Assemblers and first tier suppliers can bargain down the price of components from smaller Western parts firms by threatening to source from China.
A proprietary study conducted by McKinsey and the Associated Chambers of Commerce and Industry of India (summarized in PTI, April 18, 2005; Newsweek International November 28, 2005, and the Financial Times, December 1, 2005) estimates that by 2015 global auto production is likely to reach $1.9 trillion dollars, of which around $700 billion dollars will be produced in low cost countries. Exports from low cost countries look to increase to $375 billion dollars, more than quintuple the current level of about $65 billion. The study suggests that Indian production could expand from nine billion dollars currently to around forty billion dollars, of which 20-25 billion dollars would be exported—twenty to twenty-five times the current level of exports. Roughly half of the export growth would come from displacing production by other countries. Already, Suzuki and other foreign assemblers have begun to procure engines and other major parts from India for export to third markets (Nihon Keizai Shinbun, February 5, 2006).
As for China, its Ministry of Commerce has suggested that by 2015 Chinese firms could account for 10 percent of the global market, or 120 billion dollars in exports (Asia Pulse, April 1, 2005). As one press account notes, “GM imports only one-tenth of 1 percent of the parts used in its U.S. assembly plants from China […but…] expects to increase its auto part purchases from China 20-fold in six years--from $200 million in 2003 to $4 billion in 2009 (Detroit News April 7, 2005). Similar trends are observable at Delphi, Ford and other major assemblers and first-tier suppliers (U.S. - China Economic and Security Review Commission 2005: 30).
Similarly, while outsourcing of information technology and engineering has been relatively tentative in autos compared to the situation in many other industries, where it increasingly includes even small companies and early stages of product development by innovative start-ups in Silicon Valley, major increases have occurred recently. GM, Ford and leading suppliers such as Delphi and Bosch have opened research and development centers in China and India employing thousands of engineers and scientists, many of them with PhDs and years of the most sophisticated work experience. Most of their work supports development of the local market, but the investments, particularly in India, increasingly aim at true arms-length outsourcing as well. A study by the McKinsey Global Institute concludes that “In automotive engineering and R&D, 42 percent of total employment could possibly be offshored.” (cited in Kenney and Dossani 2005: 6).
Care must be taken in evaluating these numbers. The exact magnitude of trade in auto materials, parts and components is obscured by definitions that vary across and even within boundaries and double-counting difficult to avoid in accounting for the construction of a product integrating tens of thousands of parts and organized by tiers. Some studies include tires and car radios in the definition of auto parts, for example, while others do not. Similarly, some countries include the value of auto parts included in exports of built-up vehicles, while others do not. Long-term projections by consulting firms and government officials must also be viewed with reserve. Still, the universal expectation of rapidly expanding imports of good and services from developing countries led by China and India is clear.
Finally, Chinese and Indian firms have sharply stepped up the pace of their exports of vehicles to the developing world, and have begun assembly operations from Malaysia to Iran to Russia. Both have become net exporters of cars, have purchased controlling shares in South Korean auto makers (SUVs for China, commercial vehicles in the case of India), and have begun acquiring engineering and design capabilities in Europe and North America. Independent Chinese assemblers such as Chery and Geely, in particular, have initiated exports of small cars and commercial vehicles to Western Europe, and have announced bold plans to sell hundreds of thousands of units in Europe and North America within the next five years. Industry observers remain cautious about the exact timing, but increasingly incline toward the view that Chinese firms will succeed in exporting large numbers of vehicles in the foreseeable future (New York Times January 10, 2006; Automotive News November 1, 2005).
These bold new initiatives reflect long-term declines in the costs of transportation, telecommunications, and package software, and long-term increases in the capabilities of developing countries. They also signal the end of the old dichotomy in world auto production between efficient and innovative advanced countries and protected, inefficient enclaves in developing countries. With the expansion of trade and liberalization symbolized by the creation of the World Trade Organization (WTO), cozy enclaves are no longer viable. New export opportunities have opened up to countries and producers that can meet global competitive challenges, though production of many heavy, fragile, and labor-intensive items will remain viable in the developing world, and the shift toward “just-in-time” manufacturing will encourage investments in the assembly of many medium-intensity items on site.
Thus, it appears that motor vehicles could begin to trace the trajectory of other industries such as textiles and electronics that have witnessed dramatic and disruptive increases in exports from a small number of highly competitive developing countries, led by China and now increasingly India as well. After the Asian financial crisis of 1997-98, direct foreign investment shifted from paralyzed Southeast Asia to relatively unaffected China. Less noticed at the time, Western firms such as General Electric (GE) began to outsource software production to India. Since China and India combine huge populations, rapid growth, and an unprecedented breadth and depth of engineering capabilities, other developing countries have reason to fear that they could lose out both in competition to export to third countries, and even in their home markets. Initial econometric analysis provides some backing for the notion that exports of other developing countries could suffer (Eichengreen and Wang, forthcoming 2006).
Even if China and India both continue to grow rapidly, exporting a wider range of parts and vehicles to a wider range of countries, their expansion may not make a major difference to the global industry. According to the WTO (2005: Table IV.66), world exports of automotive products in 2004 totaled $847 billion dollars, accounting for just under 10 percent of all global exports, with trade expanding at a blistering clip of 16 percent in both 2003 and 2004. While China was a significant (eighth largest) and swiftly growing exporter, less heralded countries such as Turkey and South Africa also expanded auto exports rapidly, and at just 0.7 percent of global automotive exports, China’s exports still trailed those of Mexico, Brazil and Turkey, and remained less than a fifth those of South Korea. India’s auto exports, in turn, totaled only about one-third of China’s (See Figure 1, WTO, Leading exporters and importers of automotive products, 2004, and Figure 2, WTO, Exports of automotive products of selected economies, 1990-04). Moreover, China’s automotive exports remained overwhelmingly dominated by sales of low-tech replacement items such as wheels, tires, batteries, and body parts for which the demands on quality and design integration were low. Despite improvements in domestic capabilities, the great bulk of design and technical skills remain in the hands of foreign firms; even in developing countries with strong engineering corps such as China and India, subsidiaries of foreign firms conduct most of the design and engineering (cf. Gilboy 2004).
Nor is the reliance on foreign design and technology likely to change in the near future. As Fujimoto (2003) emphasizes, while most electronic products, motorcycles, and even trucks have become highly modular, designing and assembling passenger vehicles demands a high degree of integration and intermeshing. Some movement toward greater use of modules notwithstanding, interfaces between most functional components in the auto industry remain resistant to standardization and commoditization. Changing a design to make a car more fuel-efficient, for example, is likely to require complex recalibration of other elements, such as crash-worthiness and noise insulation. As a result, the design of vehicles, particularly passenger cars, and the key components within them, remain firmly in the hands of a limited, and rapidly shrinking, number of global firms. Even Korea, with its highly successful assembly industry, has failed to create globally competitive component firms, and remains highly reliant on Western and Japanese suppliers. To be sure, the degree of integration may be subject to change (cf. Gereffi, et. al 2005), and some Chinese and Indian industry figures and academic researchers believe that developing countries can apply a relatively modular approach at the lower end of the market, where demands for seamless integration, precise road feel and noise control are less exacting, but it seems highly unlikely that any assemblers from the developing world can compete independently in the middle to upper ranges of the auto market within the next decade, if not longer.
The Emergence of China and India as Economic Forces
Until the 1990s, low incomes and pervasive protection and intervention by government constrained the economic development of China and India. Policy reforms, particularly greater openness of foreign investment, began in the 1980s and deepened in the 1990s. The effects of reform were particularly striking in the automobile industry, not least by increasing incomes and improving supporting industries and infrastructure.
The last two or three years have witnessed the emergence of a virtual cottage industry comparing and handicapping India and China, sparked in particular by a provocative article in Foreign Policy (Huang and Khanna 2003; see also Huang’s reaffirmation in Financial Times, January 23, 2006; Farrell, et al. 2004; Deutsche Bank Research 2005; Business Week, August 22, 2005). Vigorous debates notwithstanding, a rough consensus seems to have emerged. China has pulled ahead, with a per capital income roughly double that of India, largely because of its booming labor-intensive manufacturing, supported by superior physical infrastructure and, partly as a result, greater attractiveness to direct foreign investment. Despite India’s current weakness, it may well have better long-term prospects because of its superiority in software and soft infrastructure, including a democratic political system, an independent judiciary, better (if still imperfect) financial system, and two aces in the hole: widespread proficiency in English, and better-managed companies largely free of political interference and full of experienced project managers with extensive international experience. In the United States and Japan, the hopeful conviction that India is destined to surpass China pervades elite opinion and official government statements (see e.g. New York Times April 10, 2005; Washington Post June 9, 2005; Nikkei Bijinesu May 8, 2006: 26-50, esp. p. 43).
This stylized contrast misses three important elements. First, the two countries share many similarities, not just in size of population and level of development, but weak institutions and reform trajectory. Of the 157 countries ranked in the Heritage Foundation/Wall Street Journal’s 2006 Index of Economic Freedom 2006, China ranks 111 and India 121. In the Global Competitiveness Report 2005-2006, published by Geneva’s World Economic Forum, China is 49th of 116 countries in “growth competitiveness,” followed by India at 50. Finally, in the World Bank’s survey Doing Business 2006: Creating Jobs, China comes in at 91 out of 155 countries, while India ranks 116. Even allowing for the inevitable imprecision of these surveys, the consistency with which the two countries are ranked close together, with China slightly ahead, is impressive.
Even some areas characterized by apparently yawning gaps turn out to be surprisingly similar, or at least somewhat convergent. By conventional measures, China has attracted far more direct foreign investment, a testament to the greater attractiveness of its market and the weakness of its domestic firms. The gap is significantly exaggerated, however, by the prevalence of “round-tripping” by mainland firms seeking to take advantage of tax and other benefits granted foreign investors, and by differences in definition and measurement. As a share of GDP, the gap in net foreign investment is not so great, particularly in recent years, as Chinese DFI has peaked while DFI to India has begun to surge (though exact measurement and comparison remain difficult) (OECD 2005: 13, 27; Mohan 2005). In a 2005 survey of multinational firms (released December 7, available at atkearney.com), India vaulted past the United States to trail only China as a preferred destination for direct foreign investment. Similarly, the contrast between China’s strength in manufacturing and India’s superiority in software has eroded somewhat recently: the rate of growth of Indian manufacturing and exports (particularly in autos) has accelerated, while China has surpassed India in total software output, though China’s software houses remain far smaller, less sophisticated, and less internationalized (Red Herring, September 5, 2005; A.T. Kearney 2004).
Second, notwithstanding these similarities, China is indisputably ahead of India in economic and social development (Asian Development Bank 2005) and continues to pull ahead. China’s gross and per capita national income are more than double those of India. China’s rates of savings and investments are nearly twice those of India, leading to significantly higher growth rates. Despite the acceleration of India’s growth rate, China has continued to grow even more rapidly, so the gap continues to expand. Tax revenues, historically a weak point in China, have surged in recent years, allowing China to spend far more on infrastructure while maintaining relatively sound government finances, and to cut tariffs, thus creating a more open and competitive economy. Between 1990 and 2002, China’s lead in secondary school attendance widened, while India’s advantage in tertiary education turned into a deficit. In 1990, 42 percent of Chinese girls and 55 percent of Chinese boys attended high school, compared to 33 percent of Indian girls and 55 percent of Indian boys. By 2002, the Chinese rates had risen to 69 and 71 percent, while the Indian rates were only 47 and 58 percent. Similarly, whereas twice as many Indians as Chinese attended tertiary institutions in 1990 (four percent of females and eight percent of males vs. two percent of females and four percent of males), by 2002, Chinese tertiary attendance surged to the lead (14 percent of females and 17 percent of males, vs. 10 percent of females and 14 percent of males in India). In 1988, almost twice as many Indians as Chinese published papers in leading international science and engineering journals; by 2001, the ratio had almost exactly reversed (National Science Board 2004: Appendix table 5-35; Zhou and Leydesdorff forthcoming 2006 ). In the latest year for which data are available (2002 for China, 2001 for India) R&D spending in China was more than four times greater than that of India (UNCTAD 2005: 105). Lacking adequate tax revenues, and committed to improving funding of primary and secondary education, the Indian government has found it difficult to maintain the quality and competitive position of Indian universities and research institutes (Yasmeen 2004).
Third, while observers routinely point out the numerous daunting obstacles threatening to slow down or even overthrow the Chinese juggernaut, the reality is that neither country will be able to sustain growth unless it continues to carry out difficult reforms. Both countries suffer from a high and rapidly increasing reliance on imported energy just as oil prices have skyrocketed. Both will need to continue reforming their banking systems. China’s one-child policy is leading to a rapidly aging yet still poor society lacking an adequate social safety net. A higher rate of population growth will keep India younger, but since the new entrants will hail disproportionately from the poorest and most rural parts of northern India, integrating them into an increasingly prosperous society will create a major challenge.
Fortunately, China and India are similar in another crucial way: the success of liberalization and reform over the last decade or two has convinced policymakers and public alike that further reform and growth are necessary and possible. A variety of public opinion polls show that Indians and Chinese (or at least the more easily surveyed urban residents in those countries) are the most optimistic peoples in all of Asia (Pew Global Attitudes Project 2005; Wang 2005). Short-sightedness and conflict over distributional issues, such as moving people off land slated for public works and industrial development, will not disappear, but technocrats and politicians in both countries now understand that the legitimacy of their rule increasingly depends on maintaining rapid economic growth.