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Asia's Odd Couple: India and Japan Join Forces

December 14, 2015 Topic: Politics Region: Asia Tags: IndiaJapanChinaForeign PolicyNarendra Modi

Asia's Odd Couple: India and Japan Join Forces

India-Japan ties benefit the United States, even if they take place outside of Washington’s orbit.

To be sure, India can only go so far in its approach to Japan. Its long heritage of nonalignment and nationalism has left a powerful faction in New Delhi wary of Japanese ties, not the least because of Japan’s strong ties to the United States. The Indian government also worries about jeopardizing its economic relations with China. It may fret about the dependence implied by its large and growing bilateral trade deficit with China, but it also recognizes that it needs the trade. It is then testimony to the extent of security pressure on New Delhi, and the lure of a Japanese link, that despite such reservations it has made its defense positioning crystal clear by inviting Japan to participate in its Malabar naval exercises with the United States. In September, the first U.S.-India-Japan Trilateral Ministerial dialogue took place. Perhaps even more telling is India’s willingness to structure its security arrangements similarly to those of Japan and the United States, in particular with a high-level Security Consultative Committee in which Tokyo’s and New Delhi’s foreign and defense ministers meet at least annually to guide joint policy.

While prompted by security matters, this India-Japan embrace has gained strength by emphasizing the huge economic and financial benefits of closer ties. These lie in the remarkable complementarity of the two countries’ economies. Japan is capital rich, technologically advanced and has a highly trained (if expensive) workforce. India lacks the financial capital necessary for its own development, has an inexpensive, plentiful but poorly trained workforce and, despite some headlines, is technologically backward through most of its economy. Because each country is a mirror image of the other in every aspect of economics and investment, close economic relations should allow each to supplement the other’s weakness while leveraging its strength, to the benefit of growth prospects and wealth creation in both places.

Even a cursory review of comparative economic conditions makes these matters apparent. The relative distribution of occupations in particular speaks to radically different levels of development. In Japan, more than 70 percent of the population earns its living in services, more than 26 percent in industry and less than 3 percent in agriculture. In India, almost half the population works in agriculture, 20 percent in industry and only 31 percent in services. The average Indian worker has less than 5 percent of the productive equipment and technology at his or her disposal that the average Japanese worker has. The average wage in India is barely over one-eighth Japan’s. Literacy in Japan verges on 100 percent and the average worker has about ten years of formal education. Literacy in India is just 74 percent, and the average worker has barely over five years of formal schooling. Such circumstances suit each country for very different economic focuses, making the advantages of trade compelling.

Japan’s educational, technological and capital superiority suit it best for the production of high-value, sophisticated goods and services. Any effort to produce lower-value, labor-intensive products for itself wastes those advantages, while Japan’s high wage scale makes it uncompetitive anyway. Instead, Japan would do best to export part of its high-value products and import simpler, lower-value items. India’s economy is ideally suited to act as counterparty on both sides. Low-value, labor-intensive products minimize the handicap imposed by that economy’s lack of capital, its technological backwardness and the low levels of education and training generally in its workforce, while its plentiful, low-wage workforce actually gives India a competitive edge in this area. And indeed, this is the direction in which India’s economy has moved. An overwhelming share of India’s industrial workforce produces textiles and clothing, the quintessential labor-intensive, low-value products. Despite some headlines, only a small fraction of Indian exports are higher-tech goods and services, and even these, according to industry sources, lean toward the less sophisticated side of the scale. The Indian government acknowledges the situation, characterizing its own export strategy as aimed at employment for the unskilled and semiskilled.

Both countries gain in the exchange. It gives India a way to employ its plentiful youthful, if poorly trained, working population in the ways it can best compete, the only way it can produce effectively. The economy can then use the resulting income from the export of what it does well to buy the sophisticated products from Japan that it cannot produce for itself, at least not effectively. Since the exchange should also bring India access to the world’s best business and production practices as well as a flow of Japanese investments in support of trade, the arrangement will lay the foundations for the next steps in the country’s economic development.

The exchange allows Japan to use its resources most effectively to generate the most income and wastes none on an uncompetitive effort at low-value, unsophisticated production. Japan gains still more because the kind of specialization permitted by trade helps it cope with its acute demographic pressures. Increasing longevity in Japan has produced a historically unprecedented overhang of dependent retirees, and years of low birth rates mean that Japan now faces a shrinking working-age population. By 2030, Japan will have less than two people of working age for each dependent retiree. However indirectly, those workers will need to produce enough for more than half a retiree each, in addition to their own material wants, those of their personal dependents and the economy’s investment needs. It is a pressured situation even for the most productive economy, one that makes it imperative for Japan to use its scarce labor as efficiently and effectively as possible.

It was with all these strengths, weaknesses and opportunities in mind that New Delhi and Tokyo in 2011 negotiated their Comprehensive Economic Partnership Agreement. It laid the groundwork for this beneficial exchange by reducing trade barriers, clarifying tax law and stipulating regulations on labor, investments and pensions—all measures that facilitate trade and encourage investment. From the start, the agreement recognized the direction in which economic circumstances would take trade, all but codifying the indicated division of production. It looks for India to export mostly petroleum products, iron ore, textiles, gems and jewelry, marine products, oils, meals, ferroalloys, generic chemicals and rare-earth minerals. All are simple, labor-intensive goods. The agreement expects Japan to export machinery, transportation equipment, finished iron and steel products, electronics, machine tools and organic as well as specialty chemicals. All are high-value, technology- and capital-intensive products.

To ensure that the relationship serves the next steps in India’s development, New Delhi has insisted that the agreement explicitly serve the country’s investment agenda. Consistent with the India Planning Commission’s goal to increase the economy’s gross capital formation to near 40 percent of gross domestic product by 2017, New Delhi negotiated Japanese commitments to invest heavily in India. Japan has acquiesced not only to create good will and promote the diplomatic-economic relationship it wants, but because these development efforts increase India’s attractiveness as a trading partner. Accordingly, Japan, on signing the agreement, promised to double its official development aid to India over the succeeding five years, with a special emphasis on India’s railways. To fulfill its obligation, Japan even made an exception for India when, in response to the 2011 tsunami, it cut off all other official aid. Within a short time after the agreement was signed, India qualified as the biggest recipient of Japanese aid. More recently, Japanese prime minister Shinzo Abe reaffirmed the investment commitment, pledging the equivalent of more than $30 billion in new private and public investment in India over the next five years, hinting in the process at the transfer of Japan’s Shinkansen bullet train technology. Indian prime minister Modi responded with a commitment to cut red tape in the country’s investment regulations and for the first time allowing 100 percent foreign ownership, even in railways, which New Delhi has long considered a strategic asset.

All this is clearly just the beginning, too. Until security concerns brought these two nations together, trade and investment remained underdeveloped, no doubt due to India’s powerful heritage of nonalignment and the lack of historical or linguistic ties between the countries or even much of an expat community of one living in the other. Even after the agreement was signed, each absorbed less than 3 percent of the other’s total exports. Though overseas investment by Japanese industry is massive by any standard and equals fully 25 percent of the Japanese economy, only 2 percent of this money flowed to India, less than what was directed at China, Thailand or South Korea. But now that security considerations have brought New Delhi and Tokyo together and revealed the economic and investment advantages, bilateral trade has exploded, growing by more than 15 percent a year during the last five years. Japan’s Bank for International Cooperation, after ignoring India for decades, ranks it as the number one long-term destination for Japanese investment, public and private.

There is a clear likelihood that the relationship between these two countries will grow. On the security front, it could become a major part of Washington’s effort against Chinese hegemony. In time, it could even substitute for direct U.S. efforts as a counterweight to China. For now, though, a strengthened Indian-Japanese relationship is a benefit to the United States, even if it is taking place increasingly outside of Washington’s orbit.