A quarterly magazine of the IMF

June 2006, Volume 43, Number 2

Point of View

Creating a Globally Connected Asian Community

Raymond Lim

How the rise of China and India is paving the way for an integrated Asia

The center of gravity of the global economy is shifting toward China and India. With combined populations accounting for one-third of humankind and building on decades of sustained and rapid economic growth, China and India are poised to become the new economic powerhouses of the 21st century.

But the more important story of the new century is the rise not just of China and India, but of all Asia. Equally significant is the prospect that Asia's rise will lead not to an exclusive Asian or Pacific century to replace the Atlantic century, but a dynamic and globally connected Asian community spurring growth in the rest of the world through a network of trade and investment relationships.

This is a vision grounded in the reality of trends that are already taking place. Southeast Asian economies have recognized the rise of China and India and begun to collaborate and adapt to the new order of changing competitive advantages, global financial flows, and trade links. As these changes continue to spread through the world, non-Asian countries, too, will eventually have to restructure their economies, develop new competencies, and realign their growth strategies to not just cope with the rise of China and India but also to take advantage of it.

Asia on the rise

The signs heralding China and India's future dominance are clear. China's GDP has grown at an average of 9 percent a year for the past 25 years, and Chinese leaders set in 2005 a target of quadrupling it by 2020. If China succeeds, its economy will be second only to that of the United States. India's economy has also seen sustained annual growth rates averaging about 6 percent since 1980 and is expected to grow at about 8 percent a year for the next 10 years.

These high growth rates are the result of bold policy reforms that helped launch a wave of foreign direct investment (FDI). In China, following Deng Xiaoping's push toward a market-oriented economy since the 1980s, FDI increased from $3 billion a year in 1990 to $61 billion a year in 2004. In a similar trend—albeit one of different proportions—after India launched economic reforms in 1991, FDI increased from $133 million a year in 1991–92 to $4.7 billion a year in 2002–03.

Throughout history, the rise of new powers has changed the existing order and unsettled other powers. The rise of China and India is no different—it poses challenges for the rest of Asia and, indeed, the rest of the world. But the challenges are not insurmountable and contain within them opportunities for the other Asian countries—provided they take proactive steps to adjust to the new competitive landscape and to leverage off the "Chindia" growth phenomenon.

There is, of course, little doubt that Asian developing countries are facing intense competition from China and India in trade, manufacturing, services, and FDI. China, for instance, has been improving the efficiency of its regulatory and business environment since the 1990s and has developed a broad range of capabilities backed by heavy foreign investment. It now competes with Southeast Asian countries in low-cost, labor-intensive operations and in high-end manufacturing and research and development. India, for its part, has seen more liberalized trade policies lead to higher export competitiveness, particularly in its textile and information technology–related manufacturing sectors. Global producers ranging from Toyota to LG Electronics have established production bases in India. Not only will China and India continue to attract a large share of FDI and have a cost advantage over Southeast Asia, their much-larger domestic markets and pools of engineers and scientists also give them an edge in higher-value activities.

A growing body of evidence suggests, however, that the growth of China and India is not a zero-sum phenomenon for the rest of Asia. A study by Singapore's Institute of Policy Studies (Bhaskaran, 2005) showed that both China and Southeast Asia increased their share of global merchandise exports in 1990–2002 but that China's share did not in general come at the expense of Southeast Asia. More important, as China's trade surplus with the United States and its FDI inflows have increased, Southeast Asian economies have gained a larger share of global exports as they have increasingly become part of the supply chain of industrial components and raw materials that China needs for its export-led growth. As FDI flows to China and India, it also continues to flow to the Association of South East Asian Nations (ASEAN) region: from 2003 to 2004, FDI into ASEAN grew by 20.4 percent, surpassing flows into China (13.2 percent) and slightly below the amount going to India (27.9 percent). This win-win situation is not surprising given that production networks in Asia are highly integrated and characterized by disaggregated manufacturing across different locations and by a high level of trade in intermediate inputs.

China and India are not just factories churning out low-cost goods and services but are also rapidly growing markets in their own right, with a huge demand for consumer and capital goods produced in Asia and elsewhere. China in particular has become an important engine of growth for Asia. Its total trade, more than 50 percent of which was with Asia, nearly tripled between 2001 and 2005, reaching $1.42 trillion. Many Asian countries enjoy trade surpluses with China; China's imports from Asia totaled $440 billion in 2005, up by 20 percent, and accounted for 67 percent of China's total imports. As a result, China is now one of the largest trading partners of a growing number of ASEAN economies, such as Malaysia, Singapore, Thailand, and Vietnam. It has also been the largest trading partner of Japan and Korea since 2004; in fact, 2005 marked the seventh year in a row of increased trade with Japan, an all-time record of $189.3 billion. India, too, has been emerging as a growth engine, albeit from a much lower base. Trade between ASEAN and India increased sixfold between 1990 and 2004, to reach $18 billion, and Indian Prime Minister Manmohan Singh has set the target of doubling it to $30 billion by 2007.

This may well be just the beginning of the import growth story for China and India. According to A.T. Kearney's latest Global Retail Development Index (GRDI) released in April 2006, India was ranked top for the second year running as the most attractive market in the world for retailers, while Asia has surpassed Eastern Europe as the most attractive regional market in the world. Both China and India are still in the early stages of development, with much more scope for domestic consumption levels to rise. China's middle class, for example, is still relatively small at only 5 percent of the population of 1.3 billion and could increase by almost 10-fold over the next decade. India's middle class could expand from about 57 million now to about 160 million by the end of the decade.

The rise of China and India will redefine regional divisions of labor and trade and help the Southeast Asian economies take off on a new and higher growth trajectory. China and India will bring Asia into the center of the global economy.

The rise of China and India is helping Asia to not only grow but to become more integrated. Asian countries are working to create a cohesive Asian community that allows for both complementary growth and positive competition. The success of such an Asian community depends on three key factors.

• Growth in China and India must continue to catalyze economic integration in Asia;
• China and India must continue to adopt mutually beneficial developmental and foreign policies with respect to their Asian neighbors; and
• Other Asian countries must continue to reform and integrate their own economies and present themselves to China and India as valuable and viable partners.

Let us examine each of these in turn.

Economic integration in Asia. This is well under way, bolstered by an array of free trade agreements (FTAs) in Asia. Intra-Asian trade as a share of the region's total trade rose to more than 50 percent in 2004 from about 30 percent in 1980. In the past five years alone, it grew by 15 percent, on average, well above the average growth rate of 5 percent among the countries in the North American Free Trade Agreement and 9 percent within the European Union.

Besides trade, there is potential for further integration in financial markets and cross-border capital flows. Asia has the highest saving rate in the world (38 percent of GDP in 2004), and Asian official foreign reserves currently exceed $2 trillion. It has an estimated 2.3 million high-net-worth individuals compared with 2.7 million in the United States and 2.6 million in Europe, and their number is expected to grow by 7 percent a year. Although Asian investors have traditionally looked to Western markets for their investment and financial planning needs, their savings are increasingly being intermediated within Asia to be invested globally.

Although Asia has a high saving rate, its financing needs are equally high as it continues to grow rapidly. Across Asia, from Indonesia to India and China, there is a huge demand for funds to finance infrastructure projects. Private companies are also eager to raise funds to feed the growth of their businesses. To this end, greater integration of Asian financial markets and intermediation of funds within Asia will allow Asia to partially fund its own growth.

Regional policies of China and India. Mutual economic benefits and integration have been possible because China and India have chosen to pursue development strategies characterized by peace and partnership. They support the vision of a peaceful, progressive, and inclusive Asian community and have shown a willingness to engage and cooperate with regional neighbors, enhancing regional stability and cohesiveness.

China has repeatedly assured the region that it will stay on the path of peaceful development and is aware of the potential disruptions to its growth. It is actively engaging other nations to share the fruits of rising prosperity. China has, along with Japan and Korea, been working with ASEAN in the ASEAN+3 process. To help bolster the region against economic downturns, ASEAN+3 finance ministers launched the Chiang Mai Initiative—a system of bilateral and multilateral currency swap arrangements that will provide liquidity in the event of short-term financial crises—and the Asian Bond Market Initiative to link the economies through the creation of a pan-Asian bond market. At the broader level, Chinese leaders have also pledged to support general East Asian cooperation through such mechanisms as the Shanghai Cooperation Organization, the ASEAN Regional Forum, and the Asia-Pacific Economic Cooperation forum.

India has—since the early 1990s under former Prime Minister Narasimha Rao—embraced a "Look East" policy that encourages regional cooperation. As a direct result, India is today an important ASEAN dialogue partner and a member of the ASEAN Regional Forum, and, in December 2005, it became an inaugural member of the East Asia Summit (EAS). In fact, it was at the EAS that Prime Minister Manmohan Singh outlined his vision of an emerging Asian economic community. He also envisioned a Pan-Asian FTA that, together with the many other FTAs being negotiated in the region, will form the building blocks of this emerging Asian economic community.

China and India are also strengthening their bilateral relations. During Chinese Premier Wen Jiabao's visit to New Delhi in April 2005, the two countries pledged to resolve their long-standing border dispute and called for a doubling of trade (to $30 billion) by 2010. Although it is only natural that the two Asian giants will compete at some levels, such as foreign investment, energy sources, and regional influence, there is much room for cooperation and mutual emulation. China and India have signed a landmark memorandum of understanding to cooperate in the energy sector.

Cooperation has been possible even though, or maybe because, the two countries have adopted very different growth strategies. China, whose growth has been driven by manufacturing, has tapped into domestic savings and foreign investment to build an impressive infrastructure. India's progress, by contrast, owes much to private businesses. Although China currently seems to have the advantage over India in terms of the size of its economy and speed of growth, this difference can be attributed, in part, to China's 13-year head start in economic reforms. As India begins to capitalize on the improving skills of its workforce and advantages in age distribution (35 percent of its population is under the age of 15), the gap will probably narrow.

To their credit, neither country has played up these comparisons or differences for political gain; rather, they have tried to turn them into useful lessons. China, for example, is learning from India how to improve its performance in the information technology and services sector. In the same manner, India should learn from China's experience in building infrastructure and improving workers' skills if it wants to emulate China's success in manufacturing and in attracting FDI.

Viable partners across Asia. Asian countries have also come together to ensure that economic development in Asia is diverse and multiconnected, which will be more stable than a "hubs and spokes" configuration whereby every link revolves around either China or India. ASEAN, for example, has set the goal of forming an ASEAN economic community by 2020; when realized, this community will be a free trade zone and unified production base of 500 million people that can be a substantial economic entity alongside China and India. ASEAN countries are also looking to integrate their capital markets, such that the combined size will be comparable to the markets in India and China and thus relevant to global investors. An ASEAN index was launched in September last year, and plans are in place to create exchange-traded funds tied to a pool of ASEAN stocks.

Economic cooperation has gone beyond trade agreements to include financial crisis recovery plans and open political dialogue. In addition to the ASEAN+3 process, for example, ASEAN has annual summits with India, China, Japan, and Korea. ASEAN countries such as Malaysia and Brunei Darussalam are beginning to explore bilateral economic relations with other Asia-Pacific countries, such as Pakistan, Australia, and New Zealand.

As the web of bilateral and multilateral relations grows, the region will become more stable and cohesive. This will be the key to successfully managing and integrating the rising Asian tide that China and India have set in motion.

Becoming better connected

The emerging Asian community must not become an insular rival to other regions but a globally connected and engaged partner. China and India have already taken the lead in connecting the Asian community to the rest of the world. Apart from the heavy investments that U.S. multinational corporations have poured into China, or the increasing volume of international services being outsourced to Indian companies, the two countries have spread their links to almost every continent across the globe. The Australian, Latin American, and African mining industry booms, for example, owe their success largely to Chinese projects and Asia's huge demand for minerals and resources. India, in its quest for resources, has approached Russia, currently constructing a nuclear plant at Kudankulum in India's southern Tamil Nadu region; the plant, which will feature two reactors of 1,000 megawatts each, will be commissioned in 2008. As growing trade and economic partners of the EU, China and India also work with Europe on other fronts, such as Europe's satellite program.

Nor can other Asian economies afford to be closed and insular. ASEAN, for example, has been inspired to broaden its political engagement with dialogue partners. It held a commemorative summit with Australia and New Zealand in 2004 in Vientiane and a summit with Russia in December 2005 in Kuala Lumpur. Some Asian countries are casting their sights even farther; Singapore, for example, has developed close links with Middle Eastern countries, and even hosted the inaugural Asia–Middle East Dialogue in June 2005.

In addition to political linkages, Asian economies have continued to explore trade and economic linkages farther afield. Brunei and Singapore, for example, successfully engaged Chile and New Zealand to establish, in January 2006, a multilateral FTA known as the Trans-Pacific Strategic Economic Partnership. Singapore also has bilateral FTAs with the United States, Jordan, Panama, and the European Free Trade Area. Other Asian countries are also expanding the geographical reach of their bilateral FTA pursuits.

Asian economies are leveraging China and India's expanding global links and importance to establish their own relevance in global value chains. I have already described how ASEAN economies have tapped into a larger share of global trade by forming strategic regional production chains that link to Chinese manufacturing sectors. In addition to trade, Asian countries can take advantage of their geographical and, in some cases, cultural affinity to China and India. Singapore, for example, is positioning itself as an international market intelligence hub on India by setting up a network of public and private institutions that provide analysis and research about the subcontinent.

As Asia—led by China and India—reaches out to engage the world, it must and will ensure that its rise as a global economic powerhouse is not a threat to the security or prosperity of other nations and regions. China and India have chosen a development strategy based on peaceful partnership, laying the foundation for a harmonious, cohesive, and dynamic Asian community. As Asia connects to the world, there is every reason to hope that the same principle and structure of a community based on complementary growth and positive competition, held together by overlapping political and economic relationships, can serve as a model for the rest of the world. The Asian Century will be the Global Century.