Date : 15/09/2023

Relevance – GS Paper 2 – International Relations

Keywords – Supply Chain, China plus one, FDI, FTA

Context –

Amid the efforts to cut dependence on China-centric global supply chains, countries such as Vietnam have grabbed the China+1 headlines more than India. However, the announcement at the G20 Leaders’ Summit on the landmark India-Middle East-Europe Economic Corridor (IMEC) has the potential to make India an Asian hub in global supply chains.

Prime Minister Narendra Modi’s visit to Washington DC in June showed that supply chains are at the center of the latest chapter in India-United States relations.

What is China Plus One strategy?

The term "China Plus One" strategy pertains to a business approach embraced primarily by multinational companies. This strategy involves diversifying their production and supply chain operations by incorporating an alternative manufacturing or sourcing location alongside China.

This strategy gained prominence in response to several factors, which encompass escalating costs within China, geopolitical instabilities, and the need to reduce risks linked to excessive dependence on a single production source.

The emergence of the China Plus One strategy can be attributed to several key factors:

• Cost Considerations: China's escalating labor and production costs have made it less economically viable for certain industries to maintain exclusive manufacturing operations within the country. As a result, companies in pursuit of cost-effective solutions often seek alternative locations with more competitive labor expenses.
• Risk Diversification: Heavy reliance on a solitary manufacturing location, particularly in a politically or economically unstable region like China, exposes businesses to a range of risks, including disruptions in the supply chain, trade disputes, and policy changes. Companies are motivated to diversify their production bases to mitigate such risks.
• Access to New Markets: Establishing manufacturing facilities in a different country can provide companies with enhanced access to local markets, potentially reducing trade barriers and tariffs. This strategic move can open up opportunities for market expansion.
• Proximity to Customers: Setting up production facilities closer to their target markets can help companies trim transportation costs and reduce lead times. This enables them to respond more effectively to customer demands and market fluctuations.
• Talent Pool and Innovation: Some businesses may opt to tap into the skilled labor force and technological capabilities of other countries to foster innovation and enhance product development.

In addition to these factors, there are also new challenges facing businesses. For instance, stringent data privacy regulations in China, which dictate how companies must handle data acquisition and retention, have led many global technology firms to either leave or scale down their operations in mainland China.

What are supply chains?

Supply chains, often referred to as global production networks, production fragmentation, or global value chains, involve strategically locating various stages of production such as design, manufacturing, assembly, marketing, and service activities in a cost-effective manner across different geographic locations.

Since the 1980s, global supply chains have emerged as the dominant model for industrial production, significantly shaping the course and character of globalization and regionalization. The transition from localized and regional production to a global supply chain model has occurred gradually over the past century.

Global supply chains are prevalent in a wide array of industries, spanning from simpler sectors like textiles, clothing, food processing, and consumer goods to more intricate ones such as automotive, aerospace, machinery, electronics, and pharmaceuticals.

Why are global supply chains moving from China?

Even prior to the outbreak of the Covid-19 pandemic, there was a noticeable trend among Western companies to reduce their heavy reliance on China as a primary sourcing market. This shift in sentiment was largely due to several factors. One significant reason was the migration of certain stages of production within Chinese supply chains, especially labor-intensive ones, to more cost-effective locations. This was partly driven by increasing labor costs in China and persistent bottlenecks in its supply chain infrastructure. Additionally, concerns among investors about potential heightened regulation of foreign firms operating in China contributed to this trend.

Recent data underscores the global risks associated with supply chains heavily concentrated in mainland China and Hong Kong. During the last quarter of 2022, exports from these two regions, which collectively make up 20% of global intermediate goods exports, witnessed significant declines of 15% and 27% year-on-year, respectively. Meanwhile, the United States, responsible for 8.1% of global intermediate goods exports, saw a 3% decrease in shipments, and Japan, accounting for 4% of the share, experienced a 13% decline.

These challenging conditions, combined with internal risks within China and the ongoing trade tensions between China and the United States, are compelling multinational corporations to reevaluate their global sourcing strategies.

It's worth noting that shifting supply chains is a costly endeavor. Establishing new manufacturing facilities requires substantial investments, and the hiring and training of a workforce can be complex and time-consuming. Nevertheless, considerations related to profitability are influencing a discernible trend of relocating production either to countries with favorable conditions or bringing it back to the United States.

Why is India being considered an attractive supply chain hub?

Foreign companies have been drawn to Southeast Asia due to factors like low labor costs, fiscal incentives, and improved logistics. Vietnam and Thailand have emerged as major beneficiaries of the shift in global supply chains. However, India also has the potential to complement China as an Asian manufacturing hub by capitalizing on technology transfers and creating value-added jobs.

This is seen in the ramped-up manufacturing of iPhones in the country, early technology transfer in the product cycle of the technologically advanced Mercedes Benz EQS to India, and Foxconn Technology Group developing a chip-making fabrication plant in Gujarat. Manufacturing sectors in India such as automotives, pharmaceuticals, and electronics assembly are already sophisticated, and likely to emerge as winners in this race.

India's appeal to foreign investors is influenced by both geopolitical and economic factors. The World Trade Organization (WTO) ranks India as the fifth largest importer of intermediate goods in Q4 2022, with a 5% share. This suggests a changing perception of India's position in global supply chains since the pandemic.

The countries ahead of India in this ranking are China, the US, Germany, and Hong Kong. India has the potential to double its current 1.5% share of world exports of intermediate goods in the future.

India's service sector also holds promise, especially in information technology, back-office operations, financial and professional services, and transportation and logistics.

Since 2022, the Narendra Modi government has placed renewed emphasis on preferential trade through bilateral agreements with trading partners. Notable agreements include the UAE-India Comprehensive Economic Partnership Agreement (effective May 2022), progress in the Australia-India free trade agreement, and ongoing negotiations for UK-India and EU-India FTAs. These agreements are significant as they involve Western trading partners and signify deeper economic integration, moving beyond India's previous focus on goods trade in its FTAs.

What Should India do?

India can draw valuable lessons from China's experience in several key areas.

Firstly, to become an integral part of global supply chains, India should prioritize the attraction of export-oriented foreign direct investment (FDI). This can be achieved by maintaining a gradual approach to trade liberalization, encouraging an open-door policy for FDI in the manufacturing sector, and providing competitive fiscal incentives. Establishing modern special economic zones through public-private partnerships is crucial. Additionally, streamlining business processes through digitalization of tax, customs, and administrative functions, along with forging high-quality free trade agreements, is essential.

Secondly, Indian companies, both large and small, need strategic approaches to become active players in global supply chains. Large corporations naturally have advantages in terms of scale, access to foreign technology, and marketing capabilities. Conglomerates can distribute investments and costs among their various business units. Conversely, small and medium-sized enterprises can thrive by becoming industrial suppliers and subcontractors to larger exporters. Business strategies such as mergers, acquisitions, and alliances with multinational and prominent local firms make sense. Furthermore, investing in domestic technological capabilities to meet international standards in terms of price, quality, and delivery is crucial.

Thirdly, India should approach the idea of replicating China's state interventionist model with caution, as there is a risk of government failures and cronyism. It may be wise to engage with think tanks to gain insights into effective strategies. While wholesale adoption of China's industrial policy may not be advisable, certain elements could be relevant to India. These include targeting multinational corporations in emerging industrial sectors where India may have a comparative advantage and improving coordination between the central and state governments. Equally important is increasing investment in tertiary-level education in fields like science, technology, engineering, and mathematics to nurture skilled talent.

Is it possible for the South Asian region as a whole to benefit from this approach?

There is an important opportunity for India to play a pivotal role in advancing industrialization across South Asia, which could lead to greater regional stability, job creation, and reduced susceptibility to economic influences from China.

One promising avenue for spreading India's economic influence throughout the region is through market-driven spillover effects. This could be achieved by Indian businesses expanding their operations abroad, particularly in labor-intensive manufacturing sectors, thereby benefiting countries like Bangladesh and Sri Lanka.

India's vibrant startup ecosystem, availability of venture capital, and expertise in fintech could be leveraged to attract and collaborate with young entrepreneurs from other South Asian nations.

To facilitate this regional economic integration, the Indian government should contemplate two key policy initiatives. Firstly, it could expand the "Make in India" program into a broader "Make in South Asia" initiative. This could involve offering fiscal incentives to Indian manufacturers to invest and expand their operations in countries like Bangladesh and Sri Lanka, with a focus on sectors like food processing, textiles, apparel, and automotive manufacturing.

Secondly, India should explore the possibility of establishing comprehensive bilateral Free Trade Agreements (FTAs) with Bangladesh and enhancing the existing Indo-Sri Lanka FTA. These agreements would promote rules-based trade and investment within the region, facilitating the integration of these neighboring countries into supply chain activities centered around India as a key assembly hub. This integration could yield mutual benefits in terms of industrial development, increased income, and job opportunities.

By creating pathways for collaboration and economic growth within South Asia, India can position itself as an attractive partner for countries in the Global South. Furthermore, India's participation in emerging supply chains, particularly those involving the United States, could serve as a starting point for its global economic integration efforts, aligning with its "Neighborhood First" policy.

Conclusion

In the ever-evolving landscape of global supply chains, India has a unique opportunity to emerge as a key player. By fostering a conducive environment for foreign investment, nurturing domestic industries, and engaging in regional economic integration, India can not only enhance its own position but also contribute to the prosperity and stability of the entire South Asian region. With the right strategies and collaborations, India's journey in the global supply chain arena promises a brighter and more interconnected future for all.

Source – Indian Express