The NEW Triad. Max P. Michaels

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1 The NEW Triad Max P. Michaels With $2.3 trillion in foreign trade and $12 trillion in cross-border investments, globalization is progressing just the way the architects of modern America envisaged it. The US led the integration of Europe and Japan to the global economy through effective implementation of the Marshall Plan; and the integration of Canada and Mexico through NAFTA. Max P. Michaels is the Managing Partner of CRYZTAL Capital based in New York. He has worked at McKinsey and Morgan Stanley in London and New York. His article entitled American Dilemma on Outsourcing to India (Economic Times, October 8, 2003) turned out to be prophetic, as the US Presidential election unfolded. He can be reached at America is now driving the globalization of India and China. The US has already formed a New Triad with these two countries creating large sources, and growing markets for goods, services and capital. It is an economic zone of a size, wealth, and potential heretofore unknown in the world, with a combined market of 2.66 billion people and estimated GDP of $20 trillion at purchasing power parity. It is already 2.5x the size of Europe in terms of buying power! The new triad has become a growth engine for the global economy. This triad can be characterized as a market-driven trading block, or a currency block. All three economies are growing in terms of GDP and productivity. All three have large production and consumer bases. US consumers have shaped the flows funded partly by the savings of the Chinese and Indian workers. If allowed to evolve without political interference, the prosperity of this economic zone will renew the global economy. India and China are both critical to America s continued economic success. Some trade and investment conditions are more favorable in China, most notably the stable policies and quality of infrastructure. Others, such as protection of property rights, and pools of professionals and entrepreneurs are stronger in India. China is more open on investments and India s currency policy is more market-based. October 2,

2 India and China together account for 18% of the global economy. They represent 14x the purchasing power, and 17x the population of Canada and Mexico. They offer large, growing markets for American goods, services and capital. Their savings support American consumers and businesses. America should work on expanding trade and investments with these fraternal Asian twins. Stimulating domestic demand and opening the services sector should be at the top of this agenda. October 2,

3 Trade within Triad It is interesting to note that all the countries in the triad are net suppliers to the US consumers, as evident from the trade surplus figures. Though China has the largest trade surplus ($110 Bn), Canada does the most trade with the US ($424 Bn). India has the smallest surplus ($11 Bn). Trade with the US and Canada has tripled since the implementation of NAFTA in 1994, with US accounting for 82% of the trade. Today Mexico is in the top ten in global ranking based on the size of the economy, accounting for 40% of the Latin American GDP; this represents the fastest integration of a developing nation to the global economy. In 2003 the US deficit with China jumped up by $21 Bn, but much of the expansion reflected goods that were previously exported to the US by Japan and Germany which now rely on China as an export platform. As the manufacturing industry has matured over the last twenty years, the low-growth markets in Japan and Europe have yielded market share to high-growth markets in China and India with their low-cost production and delivery centers. These low-cost imports are saving US consumers about $120 Bn per year. Chinese companies such as Haier Appliances, Julong Technologies, Konka and Legend Computers compete globally to deliver this value. Indian companies such as Tata Group, Infosys and Ranbaxy have also become key players in the global marketplace. Trade Potential China and India together represent 2.3 Bn people and a purchasing power of $9.4 Tn in purchasing power. India and China, with their huge workforces in the services and manufacturing sectors, represent not only cheap sources of labor, but also large consumer markets. China alone imports $187 Bn for internal consumption. China accounted for 23% of the world s purchases of TVs, 20% of mobile phones, 40% of cement, 31% of coal, 30% of iron ore, 27% of steel products, 25% of aluminum, and 7% of the world s total consumption of crude oil. In high-tech trade and services both China and India run a deficit with the US. US exports to both countries have tripled in the last decade, while it has been stagnant with Japan for several years now. Despite its strategic importance, American companies have been slow in committing resources to emerging markets like India and China. For instance, in India, Unilever has 10x the revenues of Procter & Gamble. In China, Ford and Walmart are far behind Volkswagen and Carrefour in market share. In order to maintain its global pre-eminence America needs to enhance its presence and influence with these two countries. Only 10% of the imports of China and India are from the US; though US represents 19% and 23% of their exports respectively. America needs to take market share away from the European and Japanese exporters to China and India, as these economies grow. October 2,

4 Together, these four countries represent 40% of the US trade. India and China account for only one-third of the US trade with Canada and Mexico. US imports from Canada is 15x the imports from India, and the trade deficit is 8x larger. Only 26% of the Indian economy is currently accounted by foreign trade. Trade can accelerate economic growth for India, as it happened in China, Canada and Mexico. October 2,

5 Direct Investment Potential The long-term impact of the new triad can be better understood, when we look at productionconsumption, trade-investments in tandem. FDI represents the expansion of American enterprise to foreign countries in production and investment. Being an insider is increasingly critical in markets like India and China. FDI accounted for nearly 15 percent of GDP in China during the nineties and reached 2.3 percent in India in The recent public policy debates have mostly focused on flow of goods and services, and the growing US trade deficit. However, the trade statistics miss out the impact of the crossborder flows of capital and economic ownership, and the resultant foreign affiliate sales of American corporations. US FDI stock is valued at $2.1 Tn, and the foreign affiliate sales are about $3 Tn. Simply put the affiliates of US multinationals such as Intel, GE and GM account for a significant part of America s wealth; these overseas operations sell 3x as much goods and services as they export from America. Many of these operations are more profitable. For instance, GM makes 15x the profits per car in China (the largest auto market in the world after the US and Japan). Though produced and sold outside America, the profits accrue to American shareholders. In fact, these reinvested profits contributed significantly to China s $57 Bn in foreign direct investments ($4 Bn for India) in In absolute terms, America s FDI stock in India ($10 Bn) is only a fraction of its stock in Canada ($200 Bn). There is a long way to go. Portfolio Investment Potential Trade statistics also ignore US trade in financial products and our portfolio investments abroad. According to the US balance sheet, US has sold $2.3 Tn in Government securities and $3.4 Tn in corporate securities. China with its $450 Bn in foreign exchange reserves has purchased over $200 billion in US treasuries; India holds over $80 billion in US securities. These foreign savings and investments have created a positive global dynamic for America. The foreign purchases of financial products help maintain low interest rates and mortgage rates. The strong dollar and the competition from imports make purchases more affordable. Yes, Americans buy GM s Buick for $24,000, when it is sold to the Chinese for $40,000! Over the next twenty years, China and India will evolve from production bases to consumption markets. As this structural transformation progresses, America needs to advance to an ownership society, that participates in this growth not only as consumers, but also as investors. The nation s foreign investments will play a significant role in this transition. Increased ownership of foreign assets will balance the impact of trade deficits, budget deficits and exchange rates on America s economic prosperity. American institutions and citizens need to invest more in India as well as China. The US portfolio investments in Indian and Chinese companies ($50 Bn) is a trickle in comparison to its $2.5 Tn in portfolio investments around the world. The investment potential is phenomenal! October 2,

6 China has attracted 16x the foreign direct investments in India. India lags far behind Canada and Mexico also in this regard. This will improve over the next 10 years, as India makes a concerted effort to improve its physical infrastructure, and refocuses on manufacturing. Indian capital markets have a small mindshare of the global investors. This will change dramatically over the next five years, as India delivers on the promise of services-led growth. This in turn will improve market valuations. October 2,