The Rise of India Depends on China

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There was a time when Wall Street analysts would downgrade a company if its CEO didn't have a China strategy. And for good reason: China had low-cost labor, a burgeoning manufacturing infrastructure, and favorable government policies and incentives.

But times change and China's attraction may not be quite as strong as it was 10 years ago. Perhaps its era as a manufacturing magnet is coming to an end.

There are a few reasons why this may happen. First, the growing contentious relationship between the US and China over trade issues and IP protection may lead to some form of bi-lateral protectionism.

Then there's the fact that China's manufacturing sector is maturing, labor costs are rising, and many technology companies are shifting their focus to product design and away from manufacturing services.

This week, China's Vice President Xi Jinping, the heir apparent to Premier Hu Jintao, is in the US, on a visit that may set the tone of relations between China and the West in the coming months. Indeed, the testiness of the relationship was reflected in comments made by Vice President Biden today that cooperation will only be mutually beneficial "if the game is fair."

There are other signs that China's role as the world's premier manufacturer may be challenged. A recent study published by Ernst & Young paints a picture of another emerging economy on the cusp of maybe becoming a manufacturing powerhouse: India.

"India is transitioning into the next phase of the growth cycle. Manufacturing will likely play a leading role in this growth trajectory," according to the E&Y report.

As Europe muddles through its sovereign debt crisis and US growth remains anemic, global OEMs are turning their attention to India because of its huge domestic consumer market and its low-cost and technically sophisticated workforce. A quarter of the 382 international executives E&Y surveyed believe that by 2020, India will be one of the top three destinations for manufacturing behind the US and China, displacing the UK.

Despite sluggish GDP growth last year, foreign direct investments in India increased 25 percent during the first 11 months of 2011 to $50.81 billion. Just over half of that came from the US, Germany, France, and the UK. Manufacturing accounted for 78 percent of the 864 investment projects and 61 percent of the 216,739 jobs created, according to E&Y. Almost 70 percent of respondents at companies that have a presence in India said they plan to increase or maintain their operations in 2012.

Within the manufacturing sector, the investments are concentrated in the industrial machinery, equipment and tools, and automotive sectors. In 2011, India's automotive sector alone created 40,000 jobs.

Over the long haul, though, investors are split as to whether India has what it takes to become a manufacturing innovation center where new products are developed. Besides software, India is not known for world-class technology.

Investors surveyed complained that the country's labs and research institutions need improving and are not well aligned with corporate product development departments. Adding to the challenges, India has a woefully inadequate infrastructure; domestic transportation and logistics management can be a nightmare, according to supply chain managers in the trenches. To top it off, the country has crippling government corruption and a lack of transparency that are roadblocks to the flow of capital in the future.

Some sectors such as automotive are confident these issues can be overcome, and India will become a center of innovation. Take, for example, Volkswagen. The company has aspirations to become the largest automaker in the world by 2018 and considers India a part of its world domination strategy. VW is investing $380 million in Indian operations by 2013 to ramp up capacity, launch new models, and invest in research.

Sure, India has a lot of work to do to attract investment and convince the world it has what it takes to become a center of innovation. But part of India's appeal depends on the impression that Xi Jinping makes during his visit and the changes he initiates when he takes the reins of power in China.