Stephen Roach: China -- Externally or Internally Driven?
April 2, 2003
While in Beijing recently, I caused a bit of a stir in discussing the sources of China's extraordinary economic growth. I depicted the vigor of the Chinese economy as being heavily dependent on exports -- an externally led growth dynamic that would put China center stage in feeling the stresses and strains of the global business cycle and globalization. I was criticized on this point -- by both Chinese and western analysts. They maintained that China's impressive growth could be traceable more to solid increases in domestic demand. This is obviously a key point in assessing the sustainability of Chinese economic growth, to say nothing of China's impact on the rest of Asia and the broader global economy. Who's right?
First of all, the numbers: I am on record as stating that fully 74% of China's GDP growth in 2002 is traceable to the growth in exports. Based on more recent data, this figure has actually been revised up to 77%. The data come from China's own national income and product accounts. In 2002, the level of exports accounted for "just" 26% of Chinese GDP. But exports increased from $266.1 billion in 2001 to $325.6 billion in 2002. That amounts to a $59.5 billion increase -- a 22.4% surge that accounts for fully 77.2% of China's $77.1 billion increase in nominal GDP in 2002. At the margin, there can be no mistaking China's export-led growth dynamic.
The critique comes from those who claim that I am only looking at half the story. Trade flows, after all, are a two-way street -- and imports should also be taken into consideration. Chinese import growth certainly did accelerate last year, surging by 21.2% in 2002 following an 8.2% rise in 2001. Nor was this a one-off development. Over the past five years, Chinese imports have effectively doubled. Imports, of course, are a reflection of China's "demand pull" on its trading partners. China actually ran outright trade deficits with Korea, Japan, and its ASEAN neighbors -- giving rise to the view that China has now become the growth engine of Asia. At a minimum, goes the argument, this solid growth in Chinese imports seems to dispel the notion that China is an externally driven economy.
Not so fast, in my view. First of all, Chinese exports still exceeded imports (the "trade balance") by some $30.4 billion in 2002. This trade surplus was fully 35% wider than the $22.5 billion surplus prevailing in 2001. While the external impetus as measured from the positive trade balance was a good deal smaller than that measured by the export side alone, that does not alter the basic thrust of an externally led impetus to Chinese economic growth. The more critical point bears on the mix of Chinese imports. According to our China expert, Andy Xie, purchases of foreign-made equipment have accounted for fully 55% of the growth in total Chinese imports since 1997; chemicals make up another 20% of the total growth in imports over the past five years, whereas purchases of foreign-produced fuels and related products account for another 13%. That means fully 88% of the cumulative growth in Chinese imports over the 1997-2002 interval can be tied either to capital formation or to the fuel or feedstocks of the industrial supply chain. That's why I have concluded that there's far more to China's spectacular success than a self-contained domestic demand story.
Yes, import growth doesn't occur without domestic demand. And many believe that China's strong growth in imports validates the notion that the Chinese economy now rests on an increasingly solid base of domestic demand. That may be technically correct. But it's a domestic demand that, in my view, is largely focused on the supply side of the Chinese growth equation -- namely the ramp-up in new capacity and infrastructure, in conjunction with the vigor of industrial production from existing capacity. China's import story also goes hand in hand with the dramatic emergence of an externally focused outsourcing production platform that is an obvious and important by-product of a massive surge of foreign direct investment (FDI). In 2002, FDI into China surged to a record $52.7 billion, making the Chinese economy the world's leading recipient of such flows. Moreover, this trend is continuing unabated: In the first two months of 2003, FDI hit $11 billion, running well above last year's record clip. In my view, China's FDI surge and its supply-oriented growth of imports go hand in hand -- both critical ingredients in the establishment of the world's newest manufacturing platform.
Consequently, as I see it, China's demand story today is much more about capital formation than private consumption. In the context of such a supply-driven growth dynamic, the Chinese consumer is the understandable laggard. Indeed, Chinese retail sales rose "only" 9.2% in the year-ending December 2002, about one percentage point short of the government's official growth target. This shortfall should not be surprising. As long as reforms in state-owned enterprises continue to result in the elimination of some 6-8 million jobs per year, the Chinese consumer will remain understandably hesitant. That will change at some point in time, as the reforms run their course and as the income generation of externally directed production provides support for private purchasing power. But that day is not yet at hand. Sure, there are some signs that Chinese consumers are beginning to stir -- witness last year's 30% surge in vehicle sales and an emerging retail culture in vibrant coastal areas such as Shenzhen and Shanghai. But those trends remain the exception, not the rule, in my view.
Why is this such an important issue? Two reasons come to mind. First, if Chinese export demand were to falter, the economy would be in serious trouble. In an increasingly weak global climate that seems like a perfectly legitimate risk to worry about. But fear not -- China's export comparisons actually accelerated sharply further to a 33% y-o-y comparison in the first two months of 2003. At work could well be the rapid growth of a cyclically resistant outsourcing dynamic. Deteriorating external demand conditions shouldn't make much of a difference to multinationals who are moving aggressively to integrate their new Chinese-based operations into global production platforms. Second, China's externally led growth dynamic is important because it has an increasingly powerful impact on the rest of the world. Last year, China accounted for only about 5% of the world's total manufactured exports but fully 29% of the growth in such trade. That means China's external impact on the rest of the world -- whether it's driven by exports of Chinese companies or outsourcing of foreign multi-nationals -- is undoubtedly several multiples of its share in the global economy. This has an important bearing on a host of critical global macro issues -- especially, currency considerations, the deflation debate, and the battle for market share in a soft global climate. China's global impact can no longer be denied.
There's nothing inherently wrong with an externally directed economic development strategy. Over the long sweep of economic history, this has been a key ingredient of the transition to prosperity. But as China now goes down this road, it does so with a scale that the world has never seen before. For that reason alone, China could also be the world's greatest beneficiary of globalization. And that underscores a potentially dark side of this story. If, in fact, globalization is now at risk, as I suspect (see my 26 March Special Economic Study, Globalization at Risk), it will be exceedingly difficult for an externally focused Chinese economy to remain unscathed.
morganstanley.com
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