TWN Info Service on WTO and Trade Issues (July10/02)
5 July 2010
Third World Network

China, East Asia need to rethink their growth strategies
Published in SUNS #6956 dated 1 July 2010

Geneva, 30 Jun (Kanaga Raja) -- China and other East Asian developing countries will require changes in economic policies and strategies that rely less on exports to the developed world, as their old growth strategies will no longer be able to serve them as before in light of the evolving global economic crisis.

This is the main conclusion of a new research paper by the South Centre titled "Export Dependence and Sustainability of Growth in China and the East Asian Production Network."

The paper is by Mr Yilmaz Akyuz, the Centre's Special Economic Advisor and Chief Economist.

According to the paper, the global crisis has exposed the high dependence of China and other East Asian developing countries on exports for their growth. This makes these countries economically vulnerable, as prospects for global economic recovery have become more gloomy recently, with growth likely to weaken considerably in Europe and with consumers in the United States reducing their high spending.

Using new methods of calculation, the paper finds that China has been much more dependent on exports for its growth than previously estimated. It is estimated that exports contribute about 50% of China's recent pre-crisis growth. This high export dependence makes China more vulnerable than normally perceived to the slowdown in the US and Europe. In the medium term, China will not be able to return to reliance on exports to maintain its pre-crisis growth of 10% or more, says the South Centre.

If its exports expand at the moderate rate of 10% a year (instead of the 24-30% in 2002-2006), its growth may barely reach 7%. Returning to a path of 10% growth requires raising domestic consumption much faster, says the paper, noting that in recent years, the share of consumption in GDP has gone down from 55% in late 1990s to 36% in 2008.

The paper makes several suggestions as to the way forward for China. One recommendation is that in view of bleak export prospects, a return to trend growth in China crucially depends on a sizeable increase in the share of household income in GDP and a corresponding decline in corporate profits, savings and investment. This calls for a higher share of wages in value-added and significantly greater government transfers to households, particularly in rural areas where incomes remain depressed.

There should also be greater public spending on social infrastructure in health, housing and education. These can be financed by dividend payments by state-owned enterprises.

A shift from export-led to consumption-led growth would also require significant industrial restructuring. An important part of Chinese exports are specific to foreign markets with little domestic demand. Adjustment in the production structure would depend primarily on reallocation of new investment and skills towards areas that need to expand to meet higher domestic consumption. In this process, state guidance of investment could no doubt play an important role.

The paper argues that the slowdown in global growth may impact other East Asian developing countries more seriously than China. This is because they are even more export dependent, and their exports not only to the developed countries but also to China will be affected, even if China continues its high growth. It notes that in Indonesia, Korea, Taiwan and Thailand, exports contributed over 60% to growth, compared to 40-50% in China. The export dependence of Malaysia, Singapore and Vietnam is even higher.

According to the paper, a key issue raised by the global economic crisis is the degree of dependence of growth in East Asian developing and emerging economies (DEEs) on exports, particularly to the US and the EU. Attention in this respect is often focussed on China as the centre of the East Asian production network and number one exporter, both in the region and globally.

The principal channel of transmission of the adverse impact of the crisis to Asian DEEs has been trade. As contraction started to take root in advanced economies, exports in Asia began to fall rapidly from the third quarter of 2008, with year-on-year (y-o-y) declines reaching double digit figures across the region, after growing at similar rates in previous years. This has pulled down growth, hitting particularly hard the leading exporters compared to countries with less impressive export performance, such as Indonesia and the Philippines. China could escape a collapse of growth thanks to a massive fiscal package and aggressive easing of monetary policy.

According to the paper, the sharp drop in exports and growth in Asia has raised questions over whether China and other DEEs linked to the East Asian production network could go back to rapid and sustained export-led growth as the world economy recovers from the crisis. The evidence suggests that in recent years the average import content of Chinese exports has been between 40% and 50%; that is, domestic value-added generated by exports is less than 60% of their gross value. In value-added terms, the share of exports in GDP is in the order of 20%.

The paper also finds that the import content of consumption in China is quite low compared to more advanced economies. Around 60% of imports are used, directly and indirectly, for exports, less than 15% for consumption and some 20-25% for investment. "Thus, the Chinese economy appears to be significantly open to imports for exports and export-oriented investment, but not for domestic consumption."

Despite high import content of exports, one-third of growth of income in China in the years before the outbreak of the global crisis is estimated to have been due to exports because of their phenomenal growth of 25% per annum. This figure goes up to 40% if spillovers to domestic consumption (the multiplier) are accounted for and to 50% with knock-on effects on domestic investment.

These figures are significantly higher than the estimates of some 15% produced by conventional accounting based on net exports. It is estimated that a 10 percentage-point decline in the growth rate of exports would reduce Chinese GDP growth by at least 2 percentage points, including spillovers to domestic consumption, and by 2.5 percentage points including spillovers to both domestic consumption and investment.

A return by China to a trend income growth of some 10% per annum based on exports would require continued large gains in foreign markets. This would be problematic coming on top of existing trade imbalances and prospects of slow growth and high unemployment in major advanced economies. An aggressive export push by China could face stern resistance with attendant consequences for the stability of the international trading system, the paper cautions.

"If, on the other hand, China cuts growth of its exports to a more acceptable level, then, without a fundamental change in the pace and pattern of domestic demand, it may grow by no more than 7% - and even less if growth slowdown gives rise to increased financial difficulties and asset deflation," adds the paper.

When investment grows faster than consumption, firms would need to expand rapidly in foreign markets in order to fully utilize the production capacity thus created and maintain strong growth. China has been able to do this so far. However, if such an expansion is no longer feasible, the way out is to put consumption ahead of income and investment.

The paper finds that in China, the share of private consumption in GDP has been constantly falling since the late 1990s, from over 55% to some 36% in the past two years. A major cause of under-consumption in China is the low share of household income in GDP, as wage increases lagged behind productivity increases. As a result, the share of wages in GDP fell to about 40% at present from 50-55% in the 1990s.

According to the paper, export dependence in most other DEEs participating in the Sino-centric East Asian production network is no less than that in China. Although China has become the largest export market for an increasing number of these countries, an important part of Chinese imports from them is used for inputs into exports of consumer goods to the US and the EU. They are thus vulnerable to slower expansion of markets in the US and Europe not only directly, but also through China.

"Since Chinese exports are much more import intensive than its domestic consumption, a shift by China from export-led growth to consumption-led growth would imply significantly reduced imports from other East Asian DEEs."

According to the South Centre, China has come under criticism in the United States for having a large trade surplus with the US. The South Centre paper however points out that in reality, little of the gross surplus is retained in China. It finds that Chinese exports to the US are found to have greater import contents than its exports to the rest of the world in large part because a very high proportion of exports to the US - about 78% in 2002 - are processing exports.

In 2002, the foreign value-added content of exports to the US was around 63% compared to less than 50% for total Chinese exports. By contrast, US exports to China have very high domestic value-added content (around 87% in the same year) and very low foreign value-added content (13%).

As a result, while in gross value terms, the bilateral trade surplus of China with the US was estimated to be some $172 billion in 2005, in value-added terms (what is earned by the respective countries after deducting the import content of their exports), this figure comes down to less than $40 billion. In other words, China's exports to the US contain large amounts of value-added generated elsewhere, including in its Asian trading partners and even the US itself.

The paper stresses that a relatively important part of the domestic value-added generated by Chinese exports accrue to foreign firms. This is particularly the case for processing exports where foreign firms are dominant. It is estimated that of the total domestic value-added generated by Chinese exports in 2002 to the US, around two-thirds went to capital income, some 18% to labour and 14% to indirect taxes.

About 60% of these exports were by foreign firms, including firms from the US. Even if it is assumed that such firms shared only in the direct capital income, it can be estimated that an additional 7% of the value of total Chinese exports to the US went to foreign firms. As a result, income left in China was no more than 30% of total value of exports to the US.

"Therefore, the criticism that China enjoys extraordinarily high trade surpluses with the US is misplaced," said the South Centre.

Can China go back to export-led growth over the medium term as the world economy recovers from the current crisis, the paper asks, noting that a return to trend growth of some 10% per annum based on exports would mean continued increases in its penetration of markets abroad and its share in world trade. If growth in advanced economies which constitute the main markets of China remain sluggish, as suggested by most medium-term projections, the required increase in China's share in world markets will be even greater.

"A return to 'business as usual' with the US continuing to consume beyond its means and absorbing Chinese exports by issuing growing amounts of dollar liabilities is not a sustainable option - it is a recipe for deeper international monetary and financial instability."

An aggressive export push by China in the markets of advanced economies or other developing countries is likely to meet strong resistance, creating conflicts in the trading system. If, on the other hand, it cuts the rate of expansion of its exports to a more acceptable level, say to 10%, then, without a fundamental change in the pace and pattern of domestic demand, its growth may barely reach 7%, says the paper.

A solution to this dilemma could be to lower the foreign content of exports so as to enhance their contribution to growth. This would require technological upgrading and substitution of high-tech imported parts and components with domestic production and a shift from processing to non-processing exports. Such a transformation has been taking place in recent years, but there has been no significant decline in the average import content of exports, possibly because of increased vertical specialization in non-processing exports.

If the aim is to maintain pre-crisis growth rates of 10% or more, the solution is naturally to raise domestic consumption much faster than has been the case so far. The estimates suggest that for every 10 percentage points decline in export growth, private consumption would need to expand by at least an additional 5 percentage points in order to keep growth unchanged.

According to the paper, the East Asian DEEs in the Sino-centric production network are more vulnerable to a sustained slowdown in exports than China. The only exceptions are Indonesia and, to a lesser extent, the Philippines - the countries that have been relatively less affected by the fall-outs from the global crisis. China has become the largest export market for an increasing number of East Asian DEEs, notably Korea and Taiwan. However, an important part of Chinese imports from these economies is used for inputs into exports of final consumer goods to the US and the EU.

The indirect exposure of East Asian DEEs through China to a slowdown in exports to the US and the EU can thus be as important as and even more important than their direct exposure, the paper stresses. Estimates suggest that an important proportion of the value-added contained in China's exports to the US and EU is generated in East Asian DEEs supplying components, parts and other intermediate inputs to China. For every $100 worth of processing exports of China to the US and EU, about $35-$40 go to East Asian DEEs and $20-$25 to China.

Since processing exports constitute a very large share of Chinese exports to the US (close to 80%), and parts and components account for a large share of total exports of East Asian DEEs to China, a slowdown of Chinese exports to the US and EU can have a strong impact on East Asian DEEs, says the paper.

The DEEs in the Sino-centric East Asian production network are more vulnerable to a sustained slowdown of Asian exports to the US and the EU than China. Furthermore, while China is a major importer from East Asian DEEs, it is not a major market for them since an important part of Chinese imports are destined to exports to advanced economies rather than used internally. Domestic consumption and investment in China generate proportionately much less demand for imports from East Asian DEEs than its exports to the US and the EU.

Consequently, a shift by China from export-led to a consumption-led growth and a shift by the US in the opposite direction would result in a significant slowdown of their combined imports from DEEs, notably those closely participating in the East Asian production network. A $100 increase in Chinese consumption increases imports by less than $10, while a $100 decline in US consumption reduces imports by some $25.

"In other words, at its current pattern of domestic spending, the Chinese market is not a good substitute for the US and the EU markets for East Asian DEEs."

To become a regional locomotive, the paper concludes, China would need to raise not only domestic consumption, but also consumption of goods from the DEEs in the region. It can also play an important role in accelerating the growth of regional markets and promoting intra-regional trade by providing external financing to several Asian DEEs facing balance-of-payments constraints. +