Long march ahead for China
AUG 22, 2001
Is China an economic juggernaut and a menace as it drains jobs and capital away from others in the neighbourhood? Analyst KWAN CHI HUNG offers a contrary view; he argues that it still has some way to go in the game of catch-up.
NOT too long ago, the whole world was concerned about the future of China. Political risks aside, people asked if China would be forced to devalue its currency amid financial turmoil in neighbouring countries; if it would default on its external debt; if its banking sector would collapse under the weight of its mountain of bad debt; and who would feed China.
This pessimism has suddenly turned into unreserved optimism over the past 12 months.
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Now the international media abounds with speculation that China is leap-frogging into the new economy without going through the cumbersome process of industrialisation, and that China will soon overtake Japan as Asia's No 1 economic power, if not the United States as the dominant global economy.
Some people even suggest that China should allow its currency to revalue to help Japan out of its recession.
In the absence of any significant improvement in China's economic fundamentals over the last year, it remains a mystery why this shift of sentiment has taken place.
The relative strength of the Chinese economy amid a global recession, China's accession to the World Trade Organisation (WTO) and the hosting of the 2008 Olympics in Beijing have certainly contributed to the euphoria.
But let us not forget that the Chinese economy is slowing down on the back of weaker export growth. WTO accession involves high costs in terms of rising bankruptcy and unemployment, and lower investment in industries that can no longer be protected by high tariffs.
ECONOMIC STRENGTH OVERESTIMATED
HOSTING the Olympic Games in Beijing would also divert investment funds from the national project of developing the country's western region.
Until a year ago, most people tended to underestimate China's economic power but, now, the pendulum has swung to the other extreme. An objective evaluation of China's economic strength should take into consideration the following factors.
Firstly, economic strength depends on the size of the Chinese economy, not its rate of growth.
Although China has been growing at an annual rate of almost 10 per cent over the past 20 years, its GDP is still only a quarter that of Japan's.
Although China's population is 10 times that of Japan, its per capita GDP, at less than US$1,000 (S$1,750), is only 2.5 per cent that of Japan's.
Although adjusting for the purchasing power of the Chinese currency multiplies China's GDP by four times, it does not change the fact that China is still a very poor country, with its global ranking in terms of per capita GDP improving only marginally - from 140 to 128 - by shifting to the purchasing-power parity measure, according to the World Bank.
Secondly, the booming coastal region represents only a fraction of the Chinese economy. Shanghai has a per capita GDP of US$3,000, which is about 10 times as high as that of the inland province of Guizhou.
It will take a long time for coastal China to catch up with the industrial countries and even longer for the rest of China to do the same. Major development indicators at the national level show that China still lags behind Japan by about 40 years.
Thirdly, China is heavily dependent on foreign investment, technology, and key parts and components.
Half of China's exports are composed of products made by foreign companies that bring in funds and technology. Even for local firms that involve no foreign ownership, a large percentage of their exports take the form of outward processing with foreign partners providing the funds, technology, product designs, key parts and components, and marketing channels.
Thus, for a US$1,000 laptop computer 'made in China', the 'value added' - mostly labour costs - that is truly indigenous Chinese would be a fraction of its price after discounting for the cost of imported parts and components, as well as interest, dividends and licensing fees paid to foreigners.
FLYING-GEESE MODEL OF INDUSTRIALISATION
THE spreading of the wave of industrialisation from Japan to the Asian newly-industrialised economies (NIEs) and then further on to Asean and China during the post-war period has been characterised as the 'flying-geese model'.
Countries specialise in the export of products in which they enjoy comparative advantage which commensurates with their levels of development and, at the same time, they seek to upgrade their industrial structures through augmenting their capital stock and technology.
Foreign direct investment from the more advanced countries to the less developed ones, through relocating industries from the former to the latter, plays a dominant role in sustaining this process.
With the onset of the Asian crisis, and contrasting growth performance between Japan and China in recent years, it has become fashionable to advocate that the rise of China, supported by the IT revolution, has rendered the flying-geese model irrelevant in describing the division of labour among Asian countries.
A closer look at the evolution of the trade structure of Asian countries over time, however, shows that the geese are still flying in an orderly manner.
It is certainly true that much progress has been made in China's industrialisation over the last 20 years. Manufactured goods now account for 90 per cent of total exports, up from 50 per cent in 1980.
Still, China's competitiveness in international markets is based mainly on the abundant supply of cheap labour, broadly in line with its level of economic development.
Chinese exports are dominated by labour-intensive products, such as textiles, and in product categories that are considered high-tech, China's main role is still in labour-intensive processes, such as assembling.
The current trade structure of China is similar to that of Taiwan in the early 1970s, one that is typical of a 'newly-industrialising country'.
Despite a gradually shrinking gap between the forerunners and latecomers in the process of economic development, Japan continues to lead the Asian economies in terms of income level as well as competitiveness in high-tech industries, with the Asian NIEs, the Asean countries and China - in this 'traditional' order - catching up.
Over the long term, the rise of China as an industrial power will be a major force shaping the economic landscape in Asia.
While higher-income countries are likely to benefit by exploiting their complementarity with China, lower-income countries will face keener competition from China in both trade and foreign direct investment.
The development of the Chinese economy can be characterised by export-led growth based on its vast labour resources.
China's industrialisation increases the supply of labour-intensive goods to international markets while raising the demand for capital-intensive goods, leading to a decline in the prices of the former relative to the latter.
This implies a worsening of China's terms of trade and an improvement in the terms of trade for the rest of the world.
Through this shift in relative prices, other economies are also able to benefit from the growth of the Chinese economy.
China's entry into the WTO, which is expected to promote the integration of China into the global economy according to comparative advantage, should have similar effects on relative prices.
Among countries in the rest of the world, however, a distinction should be made between winners and losers.
On the one hand, countries with trade structures complementary to that of China should gain because their import prices should fall relative to their export prices as China's terms of trade deteriorate.
Japan and the Asian NIEs, with levels of economic development far ahead of China, belong to this group.
On the other hand, the reverse is true for countries with trade structures similar to that of China, which include low-income Asean countries with per capita income levels similar to that of China.
The emergence of China as an attractive destination for investment has altered the flow of foreign direct investment in Asia.
Again, the distinction between countries competing with China and those complementary to it holds the key in separating the winners from the losers.
Higher-income countries rich in funds and technology are likely to benefit, while lower-income countries that compete with China for foreign capital may suffer.
Thus, Japan and the Asian NIEs can get high returns by investing in China, while the Asean countries may suffer a diversion of investment funds to China.
Led by Japanese companies and industries seeking measures to curb the influx of Chinese products, and politicians lobbying for a sharp reduction of official development assistance to China, more and more Japanese now look at China as a threat rather than a business opportunity.
This view, however, has been based on the wrong presumptions that China is already a developed country and that it has competitive trade relations with Japan.
In fact, the income gap between the two countries is still immense and the relations between the two countries are complementary to each other.
There is a clear division of labour between the two countries, with China specialising in labour-intensive products (and processes) and Japan concentrating on high-tech products.
Sure, the two countries do compete in certain sectors, but they make up a very small portion of their total exports.
As a rule, competition occurs in Japan's sunset industries, which Japan should discard without hesitation.
With no economic recovery in sight, more people blame Japan's prolonged recession on growing competition with China. There is no doubt that the rise in imports of cheap products from China is putting downward pressure on Japan's price level, but this is not necessarily bad for Japan.
Here, we need to distinguish between good deflation and bad deflation.
The former results from cheaper imports that reduce the costs of production of Japanese manufacturers, and is accompanied by an expansion of Japanese output.
The latter reflects a diversion of demand from Japanese products to Chinese products in both the Japanese market and international markets, which reduces Japan's domestic production.
The complementary relations between the two countries guarantee that the positive effect overrides the negative effect.
HOLLOWING OUT OF JAPANESE INDUSTRIES
THE rise of China is posing both challenges and opportunities for Japan. For many Japanese companies, China is a potential market and destination for investment.
For others, increasing imports from China have given rise to the need for industrial restructuring at home.
In sectors that compete with China, this may take the form of more bankruptcies and higher unemployment. This situation has led to growing fears of a 'hollowing out' of domestic industries and escalating trade friction between China and Japan.
Declining industries in Japan are unlikely to recover their competitiveness as a result of government protection.
Rather, Japan should seek a division of labour with its neighbours according to comparative advantage. This means promoting new growth areas through deregulation and investing in research and development at home, while, at the same time, relocating declining industries overseas.
The relocation of declining industries to China should not only help promote the country's economic development, but also free up resources for emerging industries at home.
The ultimate goal of the flying-geese model of economic development is the convergence of all nations in the region to the living standards enjoyed by industrial countries and the development of a horizontal division of labour among Asian nations.
The per capita GDP of the NIEs has already reached the standard of member countries of the Organisation for Economic Cooperation and Development, and the era of Japan being the only industrial country in Asia has ended.
But a lower relative position for Japan's economy does not necessarily mean an absolute decline in its standards of living.
Trade and direct investment are by no means zero-sum games, and it is possible for all the economies in the region to benefit by enlarging the size of the pie.
Indeed, the latest financial crisis in Asia vividly illustrated that it is in Japan's own national interest to be surrounded by affluent and peaceful countries rather than by poor and unstable ones.
The writer is a Senior Fellow with the Research Institute of Economy, Trade and Industry in Tokyo. He contributed this article to The Straits Times
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