|
COPYRIGHT 2004 C.D. Howe Research Institute
In this issue ...
Canadians must respond creatively to China's emergence as a major economic force. Canadian manufacturers will have to face the painful possibility that they can be priced--or pushed--out of their main U.S. market by low-cost, China-based producers and Canadian policymakers should recognize that China may eventually suplant Canada as the largest trading partner of the United States. There is still time to develop public policies that take advantages of China's surging growth--but not much.
**********
China's emergence as an economic colossus has sparked enthusiasm about its role as a new locomotive of world growth and dismay at the potential for a train wreck. China joins Japan, Taiwan and South Korea as Asian countries that have staged economic revolutions in the last 50 years, industrializing rapidly and raising living standards dramatically. Though China's per capita income growth has not yet reached rates achieved by Japan in the 1960s, it has attained the levels of Taiwan and South Korea in the 1973-to-1990 period (Maddison 2001). Those economies were smaller entities, however, and their rapidly growing affluence and economic influence went relatively unnoticed for some time. By contrast, the sheer size of China's economy and the speed of its export-led industrialization will profoundly alter political and trading relations among countries around the world, all of which will have to adjust to that nation's success, as well as to possible political, economic and environmental setbacks.
During the past year, the press has trumpeted reports and testimony on the potential for a train wreck. U.S. voters and lawmakers expressed dismay during the presidential election year about unemployment, unfair import competition, an allegedly undervalued Chinese currency and, more recently, the dangers of the Chinese economy spiraling out of control. Analysis of each of these concerns illustrates the costs and benefits of adjusting to shifting comparative advantage and international macro-economic imbalances.
While Canada Sleeps
Why do the trade and employment issues, aired with such urgency in Mexico and the United States, not receive the same attention in Canada? I argue in this Commentary that Canadians currently benefit from China's growth because of the two countries' complementary economic structures. In the long term, though, the Canadian standard of living will depend on how the economy adjusts, as is the case with Canada's North American Free Trade Agreement (NAFTA) partners.
For that reason, the locomotive-train wreck analogy is directly relevant to Canadian business and public policy and to an analysis of what Canadians should do both to benefit from the locomotive and to be prepared for setbacks. If there was ever a time for Canada to have both a North American strategy (Dobson 2002), as well as a long-term non-North American strategy, it is now. This strategy, discussed in this paper, requires significant changes in our thinking about trade and investment in global value chains. It requires awareness that Canada could be priced out--or pushed out--of the U.S. market as a result of China's emergence as a low-cost producer. I discuss short-term issues of U.S. dollar depreciation, direct import competition in the Canadian market, and indirect import competition in the U.S. market, as well as a new possibility for which Canadian policymakers should begin to prepare--China supplanting Canada as the largest trading partner of the United States.
The Commentary begins with a brief overview of China's trade and investment position as a context for developing options for dealing with import competition from that country's exports to Canada and to its largest trading partner, the United States. It goes on to discuss China's monetary framework and currency choices and the implications for Canadian exporters of an appreciating domestic currency. The paper then evaluates the systemic risks posed by Chinese economic performance and concludes with the strategic considerations for Canada, as well as its NAFTA partners.
There has been an avalanche of analyses and opinions on the dramatic changes that characterize China's emergence since 1978 from a strife-torn, autarchic and isolated entity into one of the world's largest and most dynamic economies. Still, it is useful to recall some major elements of the story. Starting from almost no international economic flows, China is now one of the world's largest traders and it has been a top destination for foreign direct investment (FDI) in the past two years. Out of an industrial structure once dominated by state-owned enterprises (SOEs), China has struggled, not always successfully, to replace central control with market forces, while avoiding widespread bankruptcy and unemployment. China's economic transformation since 1978 is estimated to have lifted the incomes of about 100 million people above the absolute poverty level (World Bank 2000:12) and at least half of the labour force has moved out of agriculture since then. (1) Since 1990, China's economy has grown fourfold (Table 1). On a purchasing power parity basis, it ranks second in the world behind the United States. (2) Trade has grown from a mere 15 percent of gross domestic product (GDP) in 1980 to about 33 percent in 1990 and as much as 50 percent of the economy in 2002. The stock of FDI has grown more than 400 times since 1990 alone.
However, much remains to be done. Unequal growth rates in the coastal and urban areas threaten to leave millions of rural dwellers behind. Market institutions lag developments in the economy; without a fully developed legal framework, corruption is a critical problem. As well, Chinese governments, ever fearful of dramatic increases in unemployment, still support many loss-making SOEs, directing state-owned banks to buy their bonds, instead of subjecting them to hard budget constraints that would compel them to become profitable or to declare bankruptcy. The state-owned banks (and the asset-management companies originally created to take bad loans off their balance sheets) have huge debt overhangs that governments must address with injections of public capital.
Trade and Investment
As China integrated into the world economy, one of its major foreign economic policy goals was to join the World Trade Organization (WTO). (3) Negotiations began in 1986 with the General Agreement on Tariffs and Trade, the WTO's predecessor. Since the WTO's founding in 1995, its rules of the road have been used as benchmarks to encourage domestic economic reforms. In 2001, 15 years after initiating its quest and after committing to further major reforms by 2007, China became a WTO member.
WTO membership, in signaling China's commitment to adopt international rules, reduced the perceived risks of producing there for many foreign investors. As a result, since 2000, China has surpassed the United States as the world's leading destination for FDI. It has also become the destination of choice for parts of the global production chains of manufacturers of electronics, telecommunications equipment, automotive products, and textiles and apparel, among others (Roach 2003). Other reasons for its magnetism are the size of its domestic market, its abundant quantities of low-cost, skilled labour and the evolution of the Special Economic Zones--where market forces were first experimentally introduced--into significant economic dusters that facilitate innovation and attract new investment, just as such dusters do in North America and Europe.
The recent flood of FDI (totaling $53 billion in 2002, but dropping back slightly in 2003) represents a stock adjustment by manufacturers responding to reduced uncertainty and risks of doing business in China. (4) The increase also reflects a survival strategy for foreign multinationals dealing with a strong U.S. dollar (before its subsequent weakening, however short-lived that may be) and intensifying competitive pressures in price-sensitive, commodity-related goods.
China has also become a significant location for the export processing link in global supply chains. Manufacturers produce components in other locations, before shipping them to China for processing into final goods that are then exported. Many of these operations are managed from yet another location. In the 1997-to-2002 period, processed exports accounted for 56 percent of China's total; the export share of foreign invested enterprises (FIEs)--both multinational affiliates and joint ventures between Chinese and foreign companies--was 48 percent in 2002 (Feenstra and Hanson 2003:37). Motorola and IBM alone accounted for nearly 1.5 percentage points of the total exports in 2000. U.S. and Japanese multinationals each accounted for nearly 2 percentage points; European Union companies for 1 percentage point, and South Korean and Taiwanese affiliates for less than 1 point each (UNCTAD 2002:165).
Clearly, China's trade has changed radically sInce 1980. It is now the world's sixth largest trading nation, accounting for a 4.3 percent share of global exports (just over a third of the U.S.'s dominant share of the total). Its exports to the United States had risen fourfold to more than a fifth of its total by 2001, while the U.S. share of China's imports had shrunk. Japan's shares of China's exports and imports have also declined. Most significantly, the export share of the East Asian economies, excluding Japan, has remained stable, while their share of China's imports has grown nearly seven times during this period (Table 2).
These trade patterns yield two significant developments. For one thing, China is integrating with its East Asian neighbours. For another, the changes are affecting the distribution of global employment, just as such a shift in comparative advantage would be expected to do. The advanced economies--not just the United States--are transferring low-value-added manufacturing jobs in exporting industries to China because these standard technology positions are most efficiently performed there by the relatively low-paid, though skilled, labour force. At the same time, while manufacturing jobs are vaporizing in the advanced economies, they are disappearing in China, as well. Indeed, one of the nightmares for Chinese authorities is that with capital readily available, it will be misallocated to labour-saving technologies in a labour-surplus economy, adding to the nation's unemployment pressures.
China's increased imports also contribute to its growing integration with its Asian neighbours. China's imports now account for 3.8 percent of the world total (still only about one fifth the U.S. share), though as Table 2 shows, there is a particular pattern to these imports in that more and more of them originate in East Asia, not in the United States or other major industrial nations. China's Asian neighbours produce many of the components that are shipped to China for assembly and later sale in North America and Europe.
In 2002, imports into China and Hong Kong from the rest of the region accounted for 16 percent of that area's total exports, while the United States and Japan accounted for 20 percent and 13 percent, respectively. Indeed, China has been running a trade deficit with the rest of the region. Not only that, one study of the local content of China's exports estimates that only 30 percent of all final goods exports is accounted for by domestic value added, compared with 20 percent for U.S. exports; the rest is content contributed elsewhere in the region (Xikang et al., 2001).
For OECD-country-based investors and exporters, the chance to market their products to 1.3 billion Chinese consumers has long been a magnet for FDI and export promotion initiatives. Yet hoped-for profits have often failed to materialize promptly, partly because China wants foreign investors to generate exports, not serve the domestic market. As well, China is still a poor country with per capita incomes far below those in the OECD countries. A significant middle class that demands western consumer imports is only beginning to emerge. (5)
China's Exchange Rate
One of the most controversial dimensions of Chinese economic dynamism is its monetary framework and exchange rate regime, under which the government has pegged the yuan to the U.S. dollar in a relatively narrow...
Read the full article for free courtesy of your local library.
|
Bookmark this article
Print this article
Link to this article
Email this article
Digg It!
Add to del.icio.us
RSS
