Supply chains are at the center of the latest chapter in India-U.S. relations.
“When India and the U.S. work together on semiconductors and critical minerals, it helps the world in making supply chains more diverse, resilient and reliable,” Indian Prime Minister Narendra Modi said in his address to a joint session of the U.S. Congress last month.
The agreements on defense and critical technologies signed by Modi and U.S. President Joe Biden, as well as the e-commerce investments promised by Amazon.com, are indicative of how India is being considered by the U.S. as central to new supply chains and its inclusion in the shift of existing ones away from China.
Recent eye-catching investments in India for the production of Apple’s iPhone 14 and the Mercedes-Benz EQS electric luxury sedan suggest that supply chain pessimism about the country has started to fade since the pandemic.
India’s new attractiveness is linked to both geopolitical and economic factors.
The country is a key target of the Indo-Pacific Economic Framework launched by the Biden administration. The initiative seeks in part to decouple global supply chains from China and promote more global sourcing from trusted supplier economies.
Decoupling is already becoming visible in flows of capital and technology. Consider the delisting of Chinese companies from U.S. exchanges, or how American venture investment group Sequoia Capital has spun off its Chinese funds.
India’s large economy is poised to take advantage of this development. It is one of the world’s fastest-growing economies, with a low-cost, trainable workforce, a middle class with an estimated 250 million consumers and growing openness to trade and investment.
A similar scenario made China an attractive supply chain hub over time. But now China-centric global supply chains, which brought prosperity to East Asia, are being disrupted by multiple global shocks including geopolitical tensions, strike threats and weather-related disasters.
The global risks of supply chains concentrated in mainland China and Hong Kong are underlined by recent World Trade Organization data.
Exports from the two markets, which together represent 20% of world exports of intermediate goods, decreased 15% and 27% year-on-year, respectively, during the last quarter of 2022. Shipments from the U.S., which accounted for 8.1% of world exports of intermediate goods, fell 3% while those of Japan, with 4%, fell by 13%.
The downturn, coupled with rising labor costs in China and the country’s trade war with the U.S., is forcing multinational companies to rethink their global sourcing strategies.
It is costly to shift supply chains, and most multinationals cannot afford to undertake a wholesale relocation of production from China. Nonetheless, profitability considerations are influencing a trend of relocating production either to friendly countries or back to the U.S.
Southeast Asia has beckoned foreign companies with cheap wages, fiscal incentives and improved logistics. Vietnam and Thailand have been bigger winners in supply chain shifting than India so far.
But over time, India too can become a complementary Asian manufacturing hub to China by reaping gains from foreign technology transfers and creating value-adding jobs. Manufacturing sectors in India such as automotives, pharmaceuticals and electronics assembly are already sophisticated and likely to emerge as winners in this race.
The WTO ranked India as the world’s fifth-largest importer of intermediate goods in the fourth quarter of 2022 with a 5% share. In the coming years, India is likely to raise its 1.5% share of world exports of intermediate goods.
India’s service sector can also be a winner, including in information and communications technology, financial and professional services, and transport and logistics.
India can learn much from China’s experience.
First, the promotion of export-oriented foreign direct investment is key to participating in supply chains.
A gradual stance of trade liberalization dictates maintaining an open-door policy toward FDI in manufacturing and facilitating investment at a high level, with competitive fiscal incentives and the creation of modern special economic zones as public-private partnerships. The reduction of business hassles through digitalization of tax, customs and business administration and high-quality free trade deals will be essential.
Second, local companies need smart business strategies to join global supply chains. Big companies naturally have advantages in supply chains due to a larger scale of production, better access to foreign technology, and the ability to spend more on marketing.
Conglomerates can cross-subsidize investments and other costs among business units. Small and midsized enterprises therefore should work as industrial suppliers and subcontractors to large exporters.
Hence, business strategies like mergers, acquisitions and alliances with multinationals and large local business houses are all rational approaches in India. So is investment in domestic technological capabilities to achieve international standards of price, quality and delivery.
Third, industrial policy remains a controversial area and caution should be exercised before India attempts to copy China’s state interventionist template wholesale, as there is a significant risk of government failure and cronyism. It may be prudent to actively engage with think tanks to gain insights into what might work.
Nonetheless, some aspects of China’s industrial policy may be relevant to India, including better targeting of multinationals in new industrial activities in which there may be a potential comparative advantage and better coordination between the central government and state administrations. Equally important is upstream investment in tertiary-level education in science, technology, engineering and mathematics.
Finally, India should promote regional supply chains with its neighbors by scaling up the Make in India program into Make in South Asia. India can provide fiscal incentives to Indian manufacturers to spread into Bangladesh and Sri Lanka. Food processing, textiles and apparel, and the automotive sector might be candidates for this given India’s neighbors’ factor endowments and industrial experience.
To support regional rules-based trade and investment, India should prioritize a comprehensive free trade pact with Bangladesh and upgrade its existing one with Sri Lanka.
Unless India creates channels for South Asia, it has no offer for the Global South. The fresh supply chains opening up with the U.S. are a good place for India to start its global integration journey, Neighborhood First.
Dr. Ganeshan Wignaraja is Professorial Fellow for Economics & Trade at Gateway House.
This article was first published in Nikkei Asia.
The article draws on the author’s paper, The Great Supply Chain Shift from China to South Asia?, supported by Konrad Adenhauer Stiftung (KAS), Japan. You can download the PDF version of this paper here.