It has become much clearer that forecast of China growth does hinge upon the sources of China Customs, through which the rapid expansion of its trade sector is recorded on. On the day of11 August, China Customs announced publicly that Chinese trade grew at 22.8% for the first 7 months this year, and the monthly value of trade has been over 100 billion consecutively since March of 2005.
Trade dependence
Indeed, China today shares nearly 70 % of its total GDP with the trade flow of the rest of the world. This is unusually phenomenal and something rarely seen in the past experiences of Japan and Western Germany during1950-70. As already puzzled by some economists a decade ago, China’s high trade dependence has invited much discussion and interpretation. Well, China should have prepared well its inner forces to propel the growth. But now China’s rapid growth is not so much driven by export boom of the East Asia type as it is overall trade-led, simply because Chinese market is much more open today than it was, for example, in Japan and South Korea.
Formally, economics students would argue that the modest (less 5% on average in the past decade) value of next export (or the balance of trade) should contribute little to China’s GDP as opposed to the overwhelming percentage of investment and consumption. Yes, even over $ 100 billion of trade surplus expected for this year, which is really high compared to past decade, is only less a tenth of China GDP. Why trade dependent?
Well, that depends on the way we understand the statistics. Though only net export rather than total trade is calculated into GDP under the expenditure approach, the volume and growth of total trade induce the huge growth of outputs in manufactures, services and public sector. And this induction effect has already been taken statistically into account by Chinese industrial ministries and so on. As one of emerging economies, China’s GDP should be better calculated through the summation of incremental change of its outputs in every sector, especially the industrial sectors and services. In fact, China has done a much better job of tracing the data in manufactures than in the service.
Growth Regime
China finally moved on to its style of growth regime about a decade ago as a inevitable product of a nexus of a series of big actions. They all came after the spring speech of then senior leader Deng Xiaoping, which was made informally on a tour to South in 1992. His speeches were actually laying a foundation for the build-up of consensus within the party for the tolerance for more openness of the economy. Among the reform initiatives then being implemented to a removal of trade controls and a 40% depreciation of the currency, RMB, in 1994, the introduction of a performance-based turnover system for local officials, and the adjustment of intergovernmental fiscal relations between the central and local governments in 1994 were extremely important tips to the formulization of the growth regime of China type.
The key to a better understanding of this growth regime is a nexus of opening-ups, decentralization and political cohesion through the party system. This combination has largely produced a unique incentive structure for both provincial and municipal governments to commit to a faster growth, a phenomenon I ever called ‘competing for growth’. Growth of GDP has since become the sole measure of so called political performance for local government leaderships, and to local officials, the priority of their jobs is to keep year-on-year growing of their economies. Given the persistent structural problem facing Chinese financial and industrial sectors, local officials clearly know that nothing is better than attracting existing foreign businesses to locate. So they bid for more FDIs to arrive in and they offer world class big deals: free access to labor, land and tax holidays.
In1980s, some of multinationals shifted their plants to China through setting up joint ventures with Chinese firms because they wanted to sell products to Chinese market which supposed to be huge in size. But most inflows of FDIs in the last decade chose China because they saw it would be foolish not to do ‘made in China’ in order to maintain competitiveness in the world. Within a decade, China became the second largest recipient of FDIs in the world only to the US.
It is FDI penetration that keeps China open further, and brings China into the globalization. With its unlimited supply of cheaper labor forces and appetizer for inflow of FDIs, China quickly integrates into the world economy, and it wakes the world! Frankly, China has definitely been benefiting from increasing inflow of FDIs and rising share in the world trading system. But at the same time, the quantitative growth of trade in China has created enormous opportunities and real values of wealth creation for both East Asia and for the US. Nobody denies this assertion. It helps Asian development and recovery, and it contributes a rising share to the global dynamics.
For nearly 500,000 foreign owned manufacturers in mainland, China is as much a hub of workshops as a market. Exports from China have since been accelerating at 3-4 times the growth of GDP for a decade long. China dominates many areas of world supply today from textiles to electronics and machinery. The most dynamic regions in eastern and coastal China are all modeled by the intense clusters of FDIs, and both the Pearl River Delta and Yangtz River Delta including Shanghai have since been a lead in terms of mounting inflow of FDIs and the growth of export processing.
In the past decade, the share of FDIs in the exports of most dynamic sectors including machinery and electronics has more than doubled or even tripled. FDIs account for over 80-90 % in the exports of PCs and related parts, other electronics and telecommunication equipments. Over 90 % of total growth of trade in China is due to the growth of processing trade, and this is the only source of trade surplus in current account of China. Of course, continuous inflow of FDIs provides China with a huge dollar reserves: over $700 billion in 2004!
Balanced Trade Growth with Imbalance of the US
It is a stylized fact that, though China has been accelerating its exports, its overall trade has been roughly in balance compared to Japan (1950-70s) and South Korea (1970-90s). This situation is of course very much due to the overwhelming share of processing trade in China.
But China runs a huge and climbing trade surplus with the US (about $162 billion as of 2004). In fact the US trade with the rest of the world is unbalanced by a deficit of $700 billion in total. Some economists blame it to Americans who save too little. Well, yes, Americans (including corporate sector) spend too much more than they save today. But that’s because borrowing is much cheaper. Then it turns back in to the question of currency market in the US. If there had been no inflow of money from abroad to accommodate the supply of currency, the rates should have been raised rapidly in the US, which should have slowed down the economy.
Here comes a cycle. America’s build up of current account deficit allows China and Asia to become big buyers in the US bond market, and foreign holdings of American debts in turn maintain the ability of Americans to spending more on imports, which makes the trade situation of the US not better off.
This circle suggests a dilemma not only facing the US, but facing global trading system. Globalization provides more opportunities for Asia to realize an export-driven growth under the quasi Breton Woods system of currency arrangement, and opens for global imbalance with the US. China rise as big player in Asia makes this imbalance so explicit and spot.
Look at the change of trade flow within East Asia. The trade between China and East Asian economies has more than tripled over the last decade. China has already surpassed the US as the largest trading partner for Korea. China is the second largest trading partner for Japan as well as for Taiwan. It is important to remember, however, that China registered a combined trade deficit of $126 billion with Japan, Korea, Taiwan and ASEAN in 2004. And it should be much clearer that, much of this deficit, especially those with Japan, Korea, Taiwan, is actually a product of a shift to China of East Asia trade surplus with the US, because the US overall trade deficit with East Asia has increased much slowly compared with China during the past decade.
So the economic rise of China obviously changes the flow of trade within East Asia, and this partly explains why many Americans refer to China as the chief culprit behind the increasing global imbalance. Such imbalance, as some analysts pointed out, is further fortified by an addition of sticky currency arrangement in Asia. The role of China as the hub and assembly point in the world production chain has produced enormous downward pressure on prices and profit margin in manufactures. Chinese currency peg to the dollar largely prevents China’s competitors in Asia, like Thailand and ASEAN, from allowing their own currencies to adjust, and such regional competition creates a tactics among Asian competitors to maintain a de facto dollar link.
Imbalanced Economic Growth of China
As one of global producers, the remarkable growth of China in the past decade has substantially changed the picture of global production chain, and is challenging the global trading system. And the world, the US for short, doesn’t get ready for China rise in the global economic system. Assuming China continues maintain its growth momentum in the next two decades as it does today, then the global system faces lot of challenges. But the fundamental question worth being raised is not as to whether we can avoid the global imbalance as such, but as to how serious the imbalance would be developing out.
Much of the growing concerns in the past few years over US imbalanced current account and fiscal budget focused on the dollar peg of Chinese currency, and Americans put lot of pressure on Beijing to make its currency float. China sees a stable exchange regime favorable to its current source of growth, and may definitely not want to make a big leap forward even after the decision of 2.1% revaluation which was finally came on 21 July. China also sees the transition to a flexible regime contingent on its alleviation of structural problems for which it is extremely difficult to set time table.
Past decade sees a slow-down of structural adjustments for China’s inner sectors, mainly due to the political constraint. Banking system is still unhealthy and fragile, capital markets are dying. Growth of dynamic private sector is largely hurdled by its inability to invest in what governments still monopolized. Increasing regional disparity as well as urban-rural divide stagnate the consumption boom. This increases the existing dependence of economic growth on exports promotion and encouraging FDI-related investment.
An article in a recent edition of special issue of Business Week on China and India believes that Chinese “get ready for the next industrial leap. For years, China has been the cheap assembly shop for the world’s shoes, clothing, and microwave ovens. Now, it is laying the groundwork to become a global power in much more sophisticated, technology-intensive industries that also demand tons of capital. Billions of dollars are flowing into auto, steel, chemical, and high-tech electronics plants. Driving this massive spending push is voracious domestic demand for all manner of goods as well as a big shift by multinationals to manufacture in China. As a result, China is rapidly becoming more self-sufficient in key materials and components, and setting the stage to be a major exporter of high-end products.”
Well, it is fascinating to Chinese indeed. This conjecture seemly and implicitly suggests a need for the global trading system to make more room for rising China (if not including India or so). But at the same time we must bear in mind that China has enormous inner structural issues to overcome before making such export-led growth really sustainable.
The rapid investment-driven growth in the past decade has produced the pile-up of the excessive capacity, as evidenced by soaring non-performance loans in the banking sector and the zero growth of CPIs of a decade. Excessive capacity is both due to and a plus to the structural problem. Excessive capacity of production leads to price wars, squeezes the profitability for manufacturers, and activates asset sector, the real estate.
Delaying the structural reforms will slow down the economy eventually. Japanese experience in both 1980s and 1990s suggests a key lesson: the existence of structural problem contains the growth in the long run. China has similar problems. The investment-growth nexus in short run has helped create the monetary overhaul and threatened the macro stability, as manifested by recent overheats in the year of 2003-04. In this regard, China faces tremendous challenges in managing its macroeconomic stability under the export-led growth regime. Given the size and rising share of China-buy in global market, macro instability in China reinforces the fluctuation of global equilibrium prices of the basic commodities and raw materials.
But given the nature of this issue and political reality, however, China faces a dilemma between structural reforms and rapid growth in short run. Structural reforms call for fiscal consolidation and abrupt closure of and restructuring inefficient banking and state enterprises create short term downturn pressure on growth, and of course destabilize the society.
This may explain why there has been an increasing necessity for Chinese enterprises to go global in recent years. It is apparent that going global is increasingly being seen as an alternative to domestic structural complexity and becoming a rebalancing tactic strategy for Chinese in the next decade to participate in global economy. But this strategy will pay a price as Japan did twenty years ago. Going on an aggressive buying spree overseas upsets established international balances of interests, creates much more friction with the rest of the world, and hides the seriousness of structural problems.
So a strong argument would perhaps indeed be made for focus on the structural issues. One, this would allay some of the fears of the rest of the world for China rise; Secondly, this focus will win much of the applause from all the international business community who will smell the profit to be made in biding on contracts to improve the structural issues. Thus, rather than scaring these corporations and their rooted states, China will retain a very strong outside lobbying force and financing for its continued development. And, thirdly, in the end, China must effectively solve the structural obstacles before it can carry out its rapid growth into another decade or two. A truly secure and sustainable economic development in China has to build a large consumer driven base anyway, if it is ever to have some degree of independence operation in the world economy.
Undoubtedly, with China rise, the global imbalance as such can take longer time to change and to adjust collectively, simply because the US welcomes the economic rise of China and sees the growth in its interest. China needs and can continue its rapid growth with a careful manipulation of its domestic-based policies. Timely shifting focus to and working effectively with its serious structural problems in China satisfy both Chinese and global long term interests.
16 August, 2005
at UNU-WIDER in Helsinki
