The Emergence of the Chinese and Indian Automobile Industriesand Implications for other Developing Countries

Gregory W. NobleInstitute of Social Science

University of TokyoMay, 2006

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).

Skepticism: The Impact of China and India will be LimitedEven 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 ForcesUntil 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.

The Emergence of the Chinese and Indian Auto IndustriesThe 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 59th 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 athttp://www.gtz.de/de/dokumente/en_International_Fuel_Prices_2005.pdf). Recent policy pronouncements, notably the 11th 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.

The rise of the Chinese and Indian auto industries: Implications for other developing countries

It is easy enough to understand why workers and engineers in advanced countries are nervous about the muscular growth of China and India in recent years: imports from China have jumped, India looks to be repeating China’s success, and outsourcing from both countries, not least in automobiles, may well soar. Even if the overall gains from trade are positive, the costs of adjustment could be substantial for the workers involved. What about other developing countries, whose wage levels are much closer to those of China and India? Eichengreen and Wang’s (forthcoming 2006: 29-30) study of trading patterns from 1990 to 2003 shows that for poorer countries, crowding effects may overwhelm positive growth linkages, particularly in auto parts: “Countries specializing in the production and export of components, capital goods and raw materials feel positive effects from China’s growth, while countries specializing in the production of consumer goods feel negative effects. The pattern

of FDI spillovers is broadly similar…This positive response is shaped by proximity; in particular, Asian countries located close to China have a geographical and cost advantage when attempting to capitalize on these supply chain relationships. But this response also depends on industrial specialization and hence on past policy. For example, countries producing electronics, an industry that lends itself to production fragmentation, are better positioned than producers of motor vehicles, where for policy-related reasons, if not also because of technology, there is less scope for exploiting these international complementarities.”

The degree to which these results hold in the future will depend in significant measure on how quickly Chinese (and Indian) firms can move into markets now dominated by firms from advanced countries, and the speed with which outward FDI from China and India—virtually nonexistent in the period studied by Eichengreen and Wang—increases. Even in the short term, however, it is important to place these results in perspective: China (and India) remain small players in international trade, and other factors are much more important in determining the development of the auto industry in developing countries.

The developing economies most likely to face the brunt of intensified competition from China and India (and indeed liberalization of world auto markets more generally) are the four large economies of Southeast Asia; others include Pakistan and Taiwan. Yet with the partial exceptions of the Philippines and Pakistan, auto industries are flourishing in all of those countries, and in none of them is competition, whether direct or direct, from China and India a major concern. Economic growth has been respectable since the financial crisis, if not quite as rapid as before, or as fast as in China and India over the last decade. Growth rates in ASEAN generally have ranged from four to seven percent per year, with some pickup in 2003-2005, especially in industrial growth.

The most obviously flourishing case is Thailand, which threw open its doors to multinational investors and regional trade and developed plans to become “the Detroit of Asia” (back when that appellation seemed more propitious than it might today). After the

Asian financial crisis of 1997-98, Thailand seized on exports as the savior of its auto industry, and it has never looked back. Production of motor vehicles fell from 560,000 in 1996 to 158,000 in 1998, but by 2005, production is estimated to have reached 1.15 million units, of which about 450,000 units were exported (JAMA 2005); 2005 estimates from Asahi Shinbun January 12, 2006).

Traditionally, Thailand has specialized in small pickups, for which it is the second most important market and production location after the United States, but the proportion of passenger cars is gradually increasing, hitting one-third in 2004. The rise of the passenger car market could make Thailand somewhat more vulnerable to competition from China and India. Thailand’s auto industry has enjoyed an influx of direct foreign investment, mostly from Japan but also from GM and Ford of the US. Indeed, Thailand has no independent assemblers, and virtually all significant locally-owned parts firms have been acquired by foreign firms. In theory, those firms are more footloose than locally-owned firms, but in the current boom there is no likelihood of significant disinvestment. External tariffs on autos and parts remain high, but Thailand has entered into a dizzying array of free trade agreements, starting with ASEAN’s AFTA agreement, and including China, India, Australia and Japan.

More surprisingly, the Indonesian auto industry has also performed reasonably despite the devastation caused by the Asian financial crisis, and the relatively slow, consumption-based growth since then. Auto production collapsed from 389,000 units in 1997 to just 58,000 in 1998, but finally surpassed its pre-crisis peak in 2004 with production of 498,000 units (JAMA 2005; production data for 2005 are not yet available, but according to the Indonesian economics ministry, auto sales, the overwhelming bulk of which are accounted for by domestic assembly, increased by over 10 percent in 2005). Foreign investment, while much less robust than in Thailand, has increased to support the expansion of production. Foreign investment in the automotive sector in 2005 looked set to surpass 2004’s record of about USD 400 million dollars (Asia Pulse December 16, 2005). More surprisingly, foreign assemblers led by Toyota have begun to export significant numbers of vehicles from Indonesia

(66,000 units from January to September 2005; Asia Pulse October 20, 2005). Trade liberalization began in earnest after the financial crisis, and Indonesia has joined the 0-5 percent tariff regime of AFTA. Though the industry is largely limited to assembly and the skill base is not deep, Indonesia’s population of over two hundred million virtually assures the continuation of a significant auto industry.

Malaysia was not as badly affected by the Asian financial crisis as Indonesia, but recovery also was less dramatic, partly because the popping of the information technology bubble in 2001 hit electronics-dependent Malaysia hard: 2004 production of 472,000 units barely surpassed the previous peak of 457,000 units hit in 1997 (JAMA 2005; in 2005, sales increased 13 percent). The main problem in Malaysia is what to do with the national champion car companies Perodua (now controlled by Toyota affiliate Daihatsu) and especially state-controlled Proton, both of which are saddled by political interference and policies of ethnic preference and that have stymied the growth of a competitive parts industry. Long a symbol of Malaysia’s industrial ambitions, Proton cannot compete without heavy protection. Regional trade integration poses a grave threat to an independent Proton, which lacks the funds to develop new models. The signing of an FTA agreement with Japan in December 2005 provided an interim solution that sacrifices parts to save Proton. Malaysia agreed to eliminate immediately tariffs on parts kits imported from Japan, while keeping protection of larger cars until 2010 and cars with engines under two liters until 2015 (AFP, June 25, 2005; Kyodo News, December 14, 2005).The government has canvassed an array of potential partners (saviors) for Proton, but its unwillingness to relinquish majority control sank a deal with VW; talks continue with Peugeot and a variety of Chinese firms.

The Philippines was even less affected by the financial crisis than Malaysia, but it has never developed a significant assembly industry, producing only 110,000 motor vehicles on the cusp on the crisp in 1997, and just 45,000 in 2003 (Jidousha Nenkan 2004 nenban: 477). In recent years, it has used the lowering of tariffs within ASEAN to develop a comparative advantage in a few parts and components, including some simple auto electronics, and it actually exports much

more than Malaysia, with its large passenger car assembly industry. Both Toyota and Ford have made major investments, and Toyota exports transmissions, especially to its other assembly sites in ASEAN. In November, 2004, Japan and the Philippines signed a preliminary agreement on an FTA that would have progressively eliminated tariffs on automotive products by 2010. In the face of vehement objections from Ford and other Western auto firms that the agreement would have violated the understanding under which they had invested, negotiations between the Philippines and Japan stalled (Wall Street Journal, June 26, 2005; JETRO, December 27, 2005).

Through all these Southeast Asian cases run two few simple themes: First, strong growth in demand for autos (though not as strong as in China and India) has kept the regional auto industry growing and relatively optimistic despite the dislocations attendant upon liberalization. Second, China and India remain but a distant concern, greatly overshadowed by debates over regional integration and FTAs with Japan and other countries.

These themes are supported by data on trade in auto parts (which in the case of the ASEAN 4 generally dwarf trade in assembled vehicles): Chinese and especially Indian exports to the big four ASEAN countries remain relatively limited in the context of overall ASEAN auto trade. ASEAN exports to major auto markets have not suffered any obvious crowding out by Chinese or Indian parts. Between 1996 and 2003, ASEAN exports to the major auto markets—the United States, the EU 15, and Japan--increased, in most cases substantially (the only exceptions are Philippine exports to the US and EU, which stagnated). Exports to China also increased substantially, but remained far below those of the other major markets. This pattern contrasts sharply with that of Korea, which grew much more dependent upon the Chinese market as sales of Hyundai and Kia vehicles assembled in China zoomed (see Figure 6, Exports of auto parts from South Korea and the four large ASEAN countries).

It is true that Chinese exports expanded rapidly in 2003 and 2004 (and 2005, though detailed data are not yet available), and in some cases China came to run an overwhelming surplus in auto parts with its Southeast Asian trade partners. In the context of the total

trade of ASEAN, however, the amounts remained modest. Using another data set that includes 2004 (but covers a narrower range of parts—those in the 784 industrial code covering general auto parts), we can see that while China came to run lopsided surpluses with Indonesia and Malaysia, the absolute amounts involved were quite modest at about 70 million dollars in Chinese exports to each of the countries, and accounted for only a tiny fraction of China’s expanding exports (see Figure 7, China’s trade in auto parts). Auto trade with Philippines remained minuscule. In the case of Thailand, Chinese exports expanded rapidly, but imports expanded even more quickly, and China’s one-time surplus turned into a bilateral deficit. Even in the case of these two burgeoning auto powers, however, trade remained extremely limited: in 2004, China imported about 49 million dollars of general auto parts from Thailand, and exported about 30 million dollars parts—only about 0.68 percent of China’s 4.4 billion dollars in exports of general auto parts.

Indian auto trade with the ASEAN four was even more limited (see Figure 8, Indian auto trade overview). At first glance this might seem surprising: India has a large, rapidly growing and highly protected market, from which its companies are aggressively exporting vehicles: in 2004, India exported passenger cars worth more than twice China’s car exports (727 million dollars vs. 317 million dollars), but where China imported 4.6 billion dollars worth of passenger cars, India imported just 7,500 cars, worth only 98 million dollars. India’s parts trade remains far more limited, however, and its vehicles mostly flow to Europe and developing country markets in which Japanese brands are less well established than in Southeast Asia. An examination of India’s trade in “other auto parts” in 2000 and 2004 shows an overwhelming reliance on imports from Japan, and limited trade with other countries. Malaysia showed surprising strength, but overall the numbers remained small. This could certainly change—Toyota announced that it would export 140,000 gear boxes from India to Southeast Asia in 2006, for example (Asia Pulse February 3, 2006) —but the base is small.

The one exception is the dramatic increase in parts trade with Thailand: only about a million dollars in goods passed each way in

2000, but by 2003 India imported 18 million dollars worth of parts from Thailand while exporting almost 7 million dollars worth. In October 2003 India signed free trade agreements with both Thailand and ASEAN as a whole, including an “early harvest” provision leading to rapid cuts in many auto parts tariffs. In 2004 “other auto parts” imports from Thailand shot up to 51 million, while exports more than doubled to 16 million dollars.

This increase occasioned the only significant case of trade friction to erupt between China, India and Southeast Asia in the auto parts area—and the nervous party is not the ASEAN countries, but India, whose auto parts executives feared that high tariffs on steel and other imports handicapped them in competing against the relatively open and efficient markets in Thailand and potentially other ASEAN and Persian Gulf states with which India is negotiating FTAs. The Indian government pushed for stiff rules of origin and value-added requirements to prevent Japanese and Korean parts from slipping in via Southeast Asia, and continued to work on decreasing tariffs on inputs to allay the pain, but concern about lost revenues impeded rapid cuts (Hindu Business Line August 20, 2004, October 26, 2005; Dow Jones Newswire, October 21, 2005). Indian auto-related firms also petitioned the government for anti-dumping relief against imports of Thai and Chinese bus and truck tires (not treated as “auto parts” in the data given in this paper), and expressed concern about the turn-around in the trade balance with China in the first two-thirds of 2005, when imports from China suddenly doubled India’s exports to China (Rediff.com January 17, 2006; note that these are preliminary data, and not necessarily compatible with the UN Comtrade data used elsewhere in this paper; in 2005, China emerged as India’s largest source of imports and within two years is expected to surpass the United States as its largest trade partner. Reserve Bank of India, 2006). These incidents serve as reminders that trade patterns may change rapidly as the Chinese and Indian auto industries develop, but as of mid-2006, the most important finding remains the limited nature of Chinese and Indian auto trade, particularly in Southeast Asia, and the relatively smooth progress of gradual trade liberalization throughout the region.

The limited presence of China and India is even more evident in direct foreign investment. Globally, DFI is a crucial component of the auto industry. Thailand’s transformation into the “Detroit of Asia,” for example, has been accomplished almost entirely by foreign-owned firms, and Indonesia’s modest recent resurgence is attributable in good measure to Toyota’s takeover of the manufacturing assets of its former joint venture partners. And of course the auto sectors in India and especially China have received huge amounts of foreign investment. Outward foreign investment from China and India has been far more limited, though it is beginning to pick up pace. Chinese and Indian firms have begun to establish assembly operations in other developing countries, as seen in agreements reached in 2005 by Malaysia’s Alado/Information Gateway groups to assemble under license vehicles by the independent Chinese firms Chery, Geely, and Changan. Geely originally hoped to sell tens of thousands of units in Malaysia, where auto prices are much higher than in China, and also use Malaysia as a base for exports to other ASEAN countries at tariffs of 5 percent or less, as well as to other countries with right-hand drive, such as Australia, the UK and potentially India. In blithe defiance of WTO norms, the Malaysian government initially insisted that Alado export its entire production. In the end, Geely agreed to export 80 percent of output at USD $5,000-$6,000 per unit, with initial content of 40 percent (barely more than the cost of assembly), rising to 60 percent within a year. By agreeing to use idle assembly facilities, Geely assuaged the government’s concerns about excessive capacity, and reduced its own investments to virtually nothing (Diyi Caijing Ribao February 6, 2006; The Edge Daily, March 29, 2006). Among the possible partners for troubled national champion Proton are Chinese companies including Chery. According to one proposal, each country would assemble cars for the other, though whether Proton cars would be competitive in China remains to be seen (Financial Times, March 30, 2006; Reuters May 6, 2006).

The only prominent parts investment has not been from China or India to Southeast Asia, but from India to China. Bharat Forge, the world’s second largest forging company, announced that it would acquire the forging division of China’s largest auto conglomerate, First

Auto Works (Reuters December 8, 2005). These are small and unusual examples, however. Tata Motor has explored assembly investments in Thailand, but overall Tata and Bharat Forge are more interested in investing in Korea, Germany and possibly the United States, where they can acquire and develop the brands, skills, distribution channels and experience necessary to expand sales to advanced markets. The same is true of China, where industry leader Wanxiang, a maker of universal joints, has bought companies and established operations in North America, Australia, England, and Germany and expressed interest in investing in India, but has made no moves to enter Southeast Asia.

In many other areas, the presence of Chinese and Indian auto firms remains limited. Auto technology is still overwhelmingly dominated by Western, Japanese and (to a much lesser extent) Korean firms. The increasing focus of Indian and Chinese firms--and the Chinese and Indian operations of Western firms such as GM--on small, inexpensive cars and commercial vehicles may exert some mild downward pressure on prices, which could threaten some local producers, but also provide new opportunities for households and small businesses. On balance, though, the impact for good or ill remains limited.

Surprisingly, even the auto industries of Pakistan and Taiwan, the economies most likely to be concerned about the rise of China and India, have remained relatively unaffected. If anything, the impact has been positive. Until recently, Pakistan has maintained a classic protected auto enclave, in which a swarm of assemblers produce a tiny number of vehicles in uneconomical batches behind high tariff walls. Since 2000 the government has gradually cut tariffs and promoted liberalization, and an increase in industrial and GDP growth has created greater confidence. Still, the auto industry (including Japanese investors, who account for 90 percent of assembly) remains ardently opposed to decreasing protection (The News International May 9, 2005; Dawn, January 15, 2006). In addition, Pakistan has not yet explicitly granted Most Favored National trading status to India, and despite India’s size and propinquity, it is not in Pakistan’s top 10 lists of export or import

partners (JETRO country data, in Japanese). China is a major source of imports, but imports of automotive products remain limited. On balance, though, the growth of China and India reinforces the sense that with proper reforms Pakistan, too, could develop an auto industry. Ironically, the extreme underdevelopment of the auto industry to date—in 2000-2001 Pakistan produced fewer than 40,000 cars to support a population of over 150 million (UNESCAP 2002: 86)—may well provide ammunition to the many critics of current policies, and help them overcome concerns about being overwhelmed by foreign automobile industries, among which China is still a minor player.

Similarly, the eruption of the Chinese auto industry has proved more boon than bane to Taiwan, which began a slow process of market opening for autos in 1986. Liberalization and the stagnation of the island’s car market at about 500,000 units per year pushed manufacturers to look outward for opportunities. Parts firms have succeeded in expanding exports of automotive components, mainly wheels, bumpers and other items for the aftermarket, despite the rise of competitors in the mainland, and indeed Taiwan parts firms also have established hundreds of subsidiaries in the mainland to produce lower-level, labor-intensive items. Taiwan’s leading assemblers, particularly the traditional champion Yulon (Yulong) and its sister company China Motors, have made significant investments, in conjunction with their Japanese partners, in southeast China. Along with Kuozui (Guorui), the local assembler of Toyota vehicles, they have also developed design centers specializing in the modification of Japanese cars for the Asian region, particularly mainland China. Political tensions notwithstanding, Taiwan’s auto firms not only have adapted smoothly to the rise of China but have pinned much of their strategy on China, and recently they have become interested in India as well.

CONCLUSIONHow much pressure are the newly risen Chinese and Indian

auto industries likely to exert on other developing countries, particularly in their immediate vicinity? The answer is something of a

paradox. On the one hand, the impact to date has been remarkably limited. Direct foreign investment from China and India to other developing countries has just started and barely rates a blip on the global radar, and trade flows have not been much greater. The one exception is Korea, whose growing dependence on the Chinese market does create some unease at home, but which has grown so robustly in North America and other world markets that concerns remain muted. Similarly, the only significant trade friction in the auto industry we have identified involves Thailand, the Korea of the 2000s, and the complainant is India, not Thailand. The Chinese and Indian auto industries remain distinctly junior players in a global industry firmly dominated by Japanese, Korean, and Western firms.

On the other hand, the growth in the Chinese auto industry, and more recently the Indian industry, truly has been remarkable, and the huge populations, low car penetration rates, and rapid growth of the two countries suggest that they may well grow into global powers. Exports, particularly from China, have shot up over the last couple of years, and appear to be on the cusp of a major expansion. Skeptics abound, of course, and they note that straight-line projection is hazardous to one’s predictive health. Doubts about China’s capacity to sustain growth and withstand its social, economic and ecological consequences are especially common. This study of the automobile industry suggests a different and rather more bullish interpretation, particularly when it comes to China. First, policy challenges are not limited to China (on India, cf. Kochhar et al. 2005), and at the moment China is far ahead not only in production (twice that of India), exports (more than ten times those of India), and physical infrastructure, but also in production of engineers and skilled workers. The top Indian firms may be better managed and more profitable, but the Chinese industry is broader, deeper and exposed to greater international competition. Moreover, as their similar scores on a number of international rankings of reviewed above suggest, India shares many of China’s problems, including inefficient banks, inadequate legal systems, and deep-seated inequality between urban coastal regions and rural heartlands. Second, despite these daunting policy challenges, a crucial psychological barrier has been passed in both

countries: a broad consensus has emerged that reform is necessary and possible, and that the growth payback from reform will be high. In both countries, that consensus has survived turnover of the national political leadership. Thus, while a series of obstacles looms, the skill, confidence and determination with which Chinese and Indian leaders are tackling them have also risen sharply.

These trends in the car and car parts sector present a startling contrast to developments in textiles and electronics assembly, where Chinese firms have grabbed market share from other developing countries and established a dominant position in the world economy, especially since the elimination (in principle, at least) of quotas on textile exports. Industrial characteristics account for most of the difference. The auto sector is far larger—the single largest industry in the international trading system—and much of it is skilled-labor and capital intensive. The tacit and incremental character of technological innovation in autos militates against the rapid entry of new competitors seen in electronics, while the numerous incentives for local production (transport costs; differences in tastes, taxes, and regulations; just-in-time production systems; after-service care), make it difficult for auto makers and even many parts firms to rely solely on exports. Thus it is not surprising that even the dramatic expansion of market demand and production capacities in China and India as yet has exerted only a modest influence on the world industry. Perhaps more surprising, even that limited impact has been felt far more deeply in the United States and Western Europe, where worries about outsourcing and cheap imported parts run deep, than in the developing countries near China and India.

If the impact of China and India has been modest to date and is unlikely in the short-to-medium term to increase greatly, there is even less cause than usual for other developing countries to resort to protection or to slow the pace of liberalization. Nor is there any particular need to worry about the quality of Chinese and Indian vehicles and parts: heightened concerns about pollution and energy efficiency are pushing both countries to approach world frontiers in emissions controls and fuel efficiency, and the recent move to expand exports to Europe will force Chinese and Indian firms to meet

advanced standards of crash resistance and recyclability. To be sure, the push of Chinese and Indian producers into

surrounding regions could have some minor and indirect effects, not least the upward pressure on prices of raw materials, with complex implications for various developing countries, depending on their resource bases. The increasing concentration of China and India on compact cars and commercial vehicles could significantly depress prices of those vehicles in the developing countries to which they are initially being exported, with consequences both positive (access to lower cost inputs for poor households and small local businesses) and negative (heightened competition for local firms, increasing congestion). The impact of even this mixed blessing, however, is likely to be small. Perhaps more important is the learning effect: other developing countries can see how once stifled economies have come alive in both China and India. They can also learn some specifics—the importance of developing appropriate credit systems and legal criteria for repossession of vehicles to prevent the expansion of the auto industry from leading to an eruption of dud loans, as it has in China, or the need to price petrol realistically and develop mass transit before private automobiles become ubiquitous and entrenched. But most of all, for the next few years, at least, they can stop worrying about the still modest influx of Chinese and Indian cars and parts, and focus on more fundamental issues of economic management.

Figure One: Leading auto parts export and import countries

Source: World Trade Organization (WTO), International Trade Statistics, 2005

Figure Two: Auto parts exports of selected economies

Source: World Trade Organization (WTO), International Trade

Statistics, 2005

Figure Three: Chinese production of motor vehicles, 1991-2005

Figure Four: Indian production of passenger cars, 1994-2005

Source: Automotive Component Manufacturers Association of India (ACMA), Industry Statistics, 2005 (vehicle industry)

Figure Five: Indian auto parts production

Source: Automotive Component Manufacturers Association of India (ACMA), Industry Statistics, 2005 (auto component industry)

Figure Six: Exports of auto parts from South Korea and four large ASEAN countries

Source: UN Comtrade data

Figure Seven: China’s trade in auto parts

Source: UN Comtrade data

Figure Eight: Indian auto trade overview

Source: UN Comtrade data

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