Hamish McRae: Made in China, served in India: the clichés are changing but not the march of the East

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The Independent Online

China or India? Well of course it is not really either/or; it is both. But the practical question many business executives face is on which of those two giant markets to place the greater emphasis. To which country should they outsource manufacturing? Which, in the years to come, is likely to be the better market for their products and services? Less agreeably, which is more likely to steal their ideas or confiscate their assets? Tell just about anyone in the business community that you have visited both countries in recent months and the conversation swiftly turns to these questions.

China or India? Well of course it is not really either/or; it is both. But the practical question many business executives face is on which of those two giant markets to place the greater emphasis. To which country should they outsource manufacturing? Which, in the years to come, is likely to be the better market for their products and services? Less agreeably, which is more likely to steal their ideas or confiscate their assets? Tell just about anyone in the business community that you have visited both countries in recent months and the conversation swiftly turns to these questions.

There can be no definitive answers but that does not mean decisions can be delayed. Business has to do it now or risk some competitor gaining an advantage that can never be matched. In recent months, the mood of the business community towards these giants has shifted. A year or so ago, all attention was on China: it was the place to outsource, the place to set up a joint venture, the place in which to invest. An economy of 1.2 billion people growing at more than 8 per cent a year was just too big an opportunity to let pass.

It still is, but beside this focus on China has come an awareness of India. The other giant has been growing almost as quickly and will eventually become more populous. In recent years, since the reforms of the early 1990s, it has been growing at 6 to 7 per cent. It looks like being 7.2 per cent this year. That will be one percentage point lower than China but it is still very fast by developed world standards.

This raises a key point: just as China's economy is much more than a cheap supplier of manufactured goods, India's is much more than a cheap place for outsourcing. For several years, businesses have sought to outsource computer and other service industry functions to India, mostly successfully, sometimes not. I had a poor chap on the phone the other day from a Calcutta call centre, who tried to tell me I had won a holiday in Spain. I have no idea what he was supposed to be selling because the pitch was so absurd and it was unfair to waste his time. But it showed that outsourcing overseas has to be done with great care.

However, call centres comprise a tiny proportion of the Indian economy: far fewer than a million employees out of a workforce of 600 million. Add in computer support, accounting and all the various back-office tasks that have been outsourced to India and the total is still well below 10 million. So, yes, this business is an important driver of growth in some cities, most particularly Bangalore, and yes it is growing fast, but it is not the core of the economy. That remains agriculture, of course, but there is also the growing general industrial production. There have, for example, been large but little-noticed improvements in the motor components sector, which now exports to the rest of the region instead of just producing for the captive local market. Indeed, India now has a trade surplus with China.

There is a further point, which is where can businesses make money? China will remain a larger economy for the foreseeable future, having passed India in 1985 (first graph). It will also have a higher income per head, having passed India in 1992 (next one). But nothing is for ever. In about 10 years' time, India's growth rate is likely to exceed that of China, as China's workforce starts to shrink because of the one-child policy, while India's continues to expand. So while India will remain a smaller market (though huge in absolute terms) it is likely to become a more dynamic one than China.

Meanwhile, it is likely to be more profitable. Few Western firms seem to be making much profit in China. It produces cheap goods so there is money to be made by importing them. But within the country itself, the universal experience seems to be that it is hard to make money and harder to repatriate it.

That may change. In June, the Chinese authorities altered the regulations on foreign investment, which among other things should make it easier to get profits out. There have also been steps to try to improve the protection of intellectual property, though any investor transferring technology to China should be aware that the know-how is likely to be stolen. The experience of Volkswagen, which has a successful joint venture building cars there, is salutary. Near copies of its cars are made in a factory once owned by VW in Mexico, bought by the Chinese and rebuilt in China.

India, for its part, does a good line in onerous regulation so one should not be starry eyed about the ease of negotiating a path through its tax and red-tape environment. But that is supposedly getting much better and the practical experience of foreign companies seems to be that it is easier to make money there. Given the business-favourable climate under the new Prime Minister, the position seems likely to get better rather than worse.

That leads to a further issue: which country is more likely to deliver economic stability in the medium term? The very fact that China is growing faster means the risks of some kind of hiccup are all the greater. It does appear to have tamed its boom of recent months, a boom that seemed to be getting out of control, so fears of some sort of economic crash have receded. That is probably right. On the other hand, it is especially vulnerable to any downturn in the US economy and is more exposed than India to a sustained period of high energy prices. The threats in India are more those of a natural disaster (such as a poor monsoon) than a man-made one (like a banking crash). Both countries are vulnerable to any rise in protectionism in the US, with - from what they each say - a Kerry administration being more of a threat than another Bush one. But China may be more exposed than India if only because it has more to lose.

Investment and outsourcing decisions are usually industry-specific: if you want a radio made to your design, have it done in China; if you want your computer system managed, go to India; if you want to build a beer-canning plant, do it in China because it is a much bigger beer market. But the general message is that these two economies are too big to ignore - as markets, as suppliers and increasingly as competitors. How you make money - well, that is another matter.

A telling tax tale that is wagging the Euro dog

The tail does not wag the dog, or at least not as a rule. But there are signs that policies in the new EU member states will have an important impact on the "old" EU countries. A brief visit to Budapest last week demonstrated the evident success of the most advanced new members. The statistics may say that living standards are less than half those of Western Europe but the divergence looks much less when gauged by the clothes, cars and shop-windows, and it is narrowing fast.

Growing at Hungary's 4 to 5 per cent simply feels different to growing at 1.5 per cent, all that Germany manages even in a good year. You would expect economic convergence, with the central and eastern European countries being pulled towards the standards of western Europe. More surprising is that economic policies may be heading in the opposite direction.

One early example has been Austria cutting its corporate tax rates because of competition from Slovakia. As a result of low tax rates, companies have flocked there, with the effect that Slovakia will soon be the highest per capita car producer in the world. Now Hungary seems set to put pressure on its neighbours with personal tax reforms.

The new prime minister designate (he takes over in the next few weeks) plans to make radical reforms to the income tax system. This will be simplified into two rates, 18 per cent and 38 per cent. This is much lower than that of any of the established EU members. But this is not designed to hand money back to the rich: the greatest gainers will be middle-earners. Further, many tax deductions will be abolished with a tax on capital gains re-imposed (at 12.5 per cent) and higher taxes on rental and other income.

Viewed from the perspective of a British tax-payer, though, all this is pretty friendly, and viewed from any of Hungary's neighbours it is attractive indeed. But wait. The three Baltic states, Estonia, Latvia and Lithuania have gone further, cutting top personal tax rates to 26 per cent, 25 per cent and 33 per cent respectively, while Slovakia has a flat rate of 19 per cent.

It raises the basic question: how do the new - and relatively poor - member states manage to construct a less onerous tax regime than their more established neighbours? At a business tax level the tail is already wagging the dog. Next step: at a personal tax level too?

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