By Vikram Nehru

Covid-19 is a dark cloud that has suddenly descended on humanity. But even the darkest clouds have silver linings. Indeed, the Chinese word for crisis, ‘weiji’, signifies danger as well as opportunity. The Black Death of Europe in the 1300s, pre-19th century cholera epidemics, and the Spanish flu pandemic in 1918-19 not only shook societies and economies, but also opened new pathways to change.

There is little doubt that the Covid-19 crisis will similarly change the world in profound ways, perhaps permanently. But with it will also come opportunity.

And all countries need to be alert to such opportunities so that some good can potentially be extracted from so much bad.

One of those changes will be a re-evaluation of the long and complex value-chains that have, over the last three decades, supported dramatic improvements in manufacturing efficiency and material standards across the world. These value-chains, financed enthusiastically by investors in advanced economies, have also allowed China to become the ‘factory of the world’.

Efficiency and profits shaped investment location decisions, not tail risks or black swan events. Competitiveness prevailed over resilience.

That imbalance has now been upturned. Firms now will be looking to diversify their sources of supply and demand. Some analysts have urged onshoring production. That is patently absurd. It would only concentrate risk, not diversify it. Firms need greater resilience, but without compromising competitiveness.

To achieve the right balance between the two, investors will be scouring the world for locations where strong States have shown themselves capable of managing black swan events effectively. The Covid-19 pandemic has made that tellingly transparent.

The strong ones dealt with the initial spread of the virus with effective social distancing and lockdown measures, and moved swiftly to mitigate the economic fallout.

Show of Strength
Strong does not necessarily mean authoritarian. Many States that showed their strength in recent weeks have been democratic — New Zealand, Australia, South Korea, Finland, Denmark, Germany, Japan, etc. Strong States possess capacity as well as legitimacy.

Capacity enables States to make informed decisions and then implement them. Legitimacy engenders trust in the State that, in turn, can leverage that capacity because people cooperate and follow orders willingly.

As it happens, strong States also supply other important public goods that international investors find valuable — infrastructure, macroeconomic and social stability, skilled labour, and relatively open trade policies. China fulfils most of the characteristics of a (very) strong State, but it lacks legitimacy. It fails another key test — it is considered an unreliable host country by most Western and Japanese investors because it has been known to use its economic power to pursue strategic goals seen as inimical to most democracies.

China’s willingness to use State power to acquire technological know how, sometimes illegally, hasn’t helped.

For foreign investors looking for alternative investment locations, that leaves very few countries that have strong governments also capable of replacing China as an important source of cheap, skilled labour. Arguably, India and Indonesia should top the list of candidates. They are large countries located near China. Moreover, India
has been unusually effective in dealing with the Covid-19 crisis so far.

It’s important that India is considered to share values and interests that align closely with those of Western democracies. It has impressive entrepreneurial talent, a large internal market and thriving private enterprises. Its analytic, financial and management services are world-class.

Its only drawback is its inherent suspicion of foreign investors, especially in manufacturing, and its protectionist trade policy.

According to an OECD index (bit.ly/2yOPeYo) covering 68 countries, India possesses the eighth most restrictive foreign direct investment (FDI) regime. A Property Rights Alliance trade barrier index calculated for 86 countries ranks India as having the most restrictive trade regime bar none.

Clearly, India needs a fundamental shift in its attitude toward trade and foreign investment if it is to figure in the emerging post-Covid-19 calculus of foreign investors. In the event it doesn’t, it will once again forgo an opportunity
to benefit from the expected post-Covid tsunami of firms that will choose to relocate away from China.

Indeed, ever since the global financial crisis, more than 50 global companies (Apple, Nintendo, Sharp, HP, Dell, etc) based in China were already shifting, or planning to shift, their production location to other countries. Most were motivated to relocate on account of rising unit labour costs, as rapid wage growth in China outpaced labour
productivity growth.

The US-China trade war accelerated the exodus. Japanese firms, which have a significant presence in China, had an added impetus.

The Ship Sails Soon
Companies propelled by these pre-Covid-19 push factors chose to relocate in Vietnam, followed by Cambodia, Malaysia and Mexico. Barely any chose to relocate to India.

The post-pandemic world will see a much larger exodus from China. Tokyo has already announced it will help Japanese firms diversify away from China either to Japan or to other Asian countries. Other advanced country governments are also likely to urge their investors to follow a similar strategy.

If India complements its State capabilities with more open trade and investment policies, it could be a major beneficiary of these supply chain realignments and its ‘Make in India’ strategy would get a jump-start. If it chooses, India could be a winner in a post Covid-19 world.

The writer is distinguished practitioner-in-residence, Johns Hopkins University School of Advanced International Studies, Washington DC, US