Amidst rising political tensions between India and China, trade relations between the two countries have come under some pressure recently. India’s trade deficit with China, which stands at over $50 billion, has been projected by many on the Indian side as an economic evil that needs to be curbed by all means. To this end, they have demanded heavy tariffs and bans on Chinese imports. The trade deficit with China, in effect, is seen as a loss to India and a gain to the Chinese economy. So, naturally, steps to curb it are seen as justified.
Union Commerce and Industry Minister Nirmala Sitharaman, for instance, held talks with her Chinese counterpart earlier this month demanding greater access for Indian goods to the Chinese market. While the idea of unrestricted cross-border trade sounds great, the focus of her talks was on trimming the trade deficit rather than promoting free trade. Such fear of the trade deficit, however, makes very little economic sense. This is because, contrary to popular belief, the prevalence of a trade deficit, or a trade surplus for that matter, says nothing about whether a country benefits or loses out from trade. In fact, since free trade between countries happens on a voluntary basis, where individuals try to improve their lives, it is always beneficial to all sides. This is also the fundamental logic behind the overwhelming support for free trade among economists.
To make things simple, the balance of trade reflects how an economy earns its foreign exchange, and how it decides to spend it subsequently. Take the case of India’s trade deficit with China. India earns Chinese yuans primarily from Chinese investors who seek to invest in assets in the country. At the same time, India uses these yuans that it receives from Chinese investors mostly to purchase Chinese goods, rather than to invest them in Chinese assets. This preference among Indians for Chinese goods rather than assets, combined with Chinese preference for Indian assets rather than goods, is what causes India to suffer a trade deficit. If Indians had a greater preference for Chinese assets, and the Chinese had a greater preference for Indian goods, the situation would reverse and India would enjoy a trade surplus instead. The trade deficit is thus a mirror image of a capital surplus, which is formed by the relatively larger inflow of Chinese capital into India than vice versa.
As one can see, quite obviously, there is very little that is wrong with this state of affairs. A man who sells his assets to his fellow countrymen to purchase goods from them, for instance, would suffer a trade deficit and a capital surplus with the rest of the country. Very few would argue that the man suffers a loss from the trade, while the rest of country gains from it. The same logic holds true when it comes to trade between countries as well. It is high time irrational fears over trade with China, or any other country, are put to rest once and for all.
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