'China Plus One' narrative sinks as Chinese share of global exports rises

Ever since the pandemic, India hoped to take a chunk out of the global export pie dominated by China, a strategy known as China Plus One. The idea stemmed from the anti-China rhetoric originating from the U.S. and our Chinese debt-laden countries around the world, coupled with the anticipated impact of the pandemic on China.

However, contrary to the rhetoric and the expectations China's share in global exports market has, in fact, increased by 1.7% in the last five years. From sub 14%, it has moved beyond 15.5%, says a recently published SBI Funds Management report.

The report also states that China's exports mix, over the past five years, has shifted away from consumer goods and has skewed more towards capital goods.

U.S. and Japan are the only two nations that succeeded in restricting 'Made in China' products in the past five years. Export from China to U.S. went down by 4.5%, while exports to Japan reduced by 0.5% between 2018 and 2022. The deficit was more than levelled by increase in exports from China to the rest of the world. During the same period, China's share of total exports to India went up by 1.1% while exports to Europe and Africa increased by 1.4% and 6.1%, respectively. Simultaneously, Chinese export to South America and Middle East increased by 3.6% and 2.5%, respectively.

Why gains to India were limited despite China Plus One policies?

The China Plus One strategy has not brought as much opportunities to India as the country was made to expect. While India was able to increase its export share in the U.S. market, the report observes that the opportunities may have stemmed due to the reduced industrial production in Germany and few other European countries. Probably the energy crisis brought on by the Russia-Ukraine war had worked favourably for Indian exporters to the US rather than the China Plus One policies, the report says.

China was already investing significant resources towards its industrial policy and increased its efforts after the COVID-19 pandemic to support its industries further. The Chinese government identified a few strategic sectors, specifically in the realm of new age industries, and went all out in terms of tax breaks, subsidies, preferential access to funding and state support to accelerate manufacturing sector investment and production.

As a share of GDP, China tops in industrial spending. It spends 1.73% of its GDP on Industrial activities while South Korea (0.67%), USA (0.39%), Japan (0.5%) and Germany (0.41%) are way below China's spend on industrial production.

The report suggests that the debate on industrial policy support and taxpayers subsidising 'rich' businesses is a must in a competitive era. In the current environment, if Indian manufacturers do not receive policy support, perhaps, Chinese manufacturing could overshadow India's production potential and leave India as a permanent import dependent and current account deficit nation. No nation is playing by the fair rule of comparative advantage, the report points out.

China officially launched its policy prioritisation of emerging industries in 2010. Within a decade, it has become one of the major players in myriad cutting-edge technologies such as green energy, 5G telecommunications, and manufacturing of various industrial equipment.

In 2018, Chinese policymakers charted out an agenda to focus on nine strategic emerging industries like the new age information technology that includes semiconductors, high end equipment manufacturing that includes solar panels, new energy, new energy vehicles, and biotechnology, to name a few. These are the industries that are knowledge and technology intensive and consume few material resources.

What China did to stay ahead?

Since 2018, China has reduced corporate income tax from 25% to 15% for its high-tech and new technology enterprises. Theoretically, to qualify for this status, a company must meet a whole bunch of criteria. However, two thirds of China's onshore-listed enterprises reported their statutory tax rate at 15% or below.

A full refund of VAT to exporters has been a policy in China since 1994. From 2022 onwards, a 200% pre-tax super deduction of R&D expenses is also granted to these strategic industries. Although this measure was introduced in 2018, the criteria got further relaxed to 200% in 2022. Depending on development stage and capex requirements, the qualifying industries also get a favourable treatment in their dividend payout policy, contrary to the general mandate for listed Chinese firms to pay dividend ranging from 20% to 80%.

Increased focus on Research and Development also forms a core part of the Chinese industrial strategy. In March 2021, in its work report from the National People's Congress (NPC) session, China set a target of increasing the annual R&D spending by more than 7% every year for next five years, as a part of its commitment to boosting technology and research. In 2022, the spending increased by 10%.

As a result of these measures, the manufacturing sector has taken the capex baton in China, enabling gross capital formation growth to match the overall growth in the economy even as real estate investment is on the decline. In 2022 and 2023, manufacturing sector fixed asset investment accounts for 50% of the incremental growth in China’s fixed asset investment while Utilities and Real Estate contributed just 9% and 27% respectively. During the 2010-20 period, Real Estate contributed a mammoth 34% in the incremental growth in China’s fixed investment while utilities and manufacturing contributed 7% and 46% respectively.  

Within the manufacturing sector, most of the incremental investment comes from electrical equipment and machinery, automobile, special purpose machinery and chemicals. These sectors capture the supply chain for electric vehicles, semiconductors and solar.

In the last 13 years, China’s PPI has grown at just 0.3% CAGR, significantly lower than other countries. For automobiles, and multiple machinery, the industry has seen a deflation.

China's industrial policies revolve around tax incentives, subsidies, and preferential access to funding. These factors work in combination with other state assistance to potentially improve the return on invested capital and make it more attractive for private investment, claims the report.