The Future of Asian Trade and Growth : Economic Development with the Emergence of China [1 ed.] 9780203863282, 9780415368117

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The Future of Asian Trade and Growth

This book presents a comprehensive analysis of current trends of trade and economic growth in Asia, assessing how they are likely to develop in the future. It examines the evolving patterns of Asian economic development with the emergence of China, including since China’s accession to the World Trade Organization (WTO) in 2001. It is written by experts specializing in economic growth and regional and global trade/investment issues, alongside country specialists who have examined the development path of Asian economies. It discusses the significance of an export-oriented growth strategy on the Asian region, and the likely patterns of intra-regional specialization given China’s rise. The book examines the degree to which the remarkable growth of China is likely to affect other Asian countries in terms of global market share, and growth prospects. The book explores how the rise of intra-industry trade is affecting patterns of specialization in the region, and appraises the role of multinational corporations and foreign direct investment. Informed by the latest empirical economic thinking, this book is a rigorous examination of the influence of an emerging economic superpower, and the future for economic growth in Asia. Readers interested in the implications of the rise of China, the effect on the economic development path of the most successful developing nations of our time and the lessons to be heeded from China’s integration with the global economy will find this a thorough yet accessible account of the influence of an emerging economic superpower. Linda Yueh is Fellow in Economics at St Edmund Hall, University of Oxford. She is also an associate of the Centre for Economic Performance at the London School of Economics, UK.

Routledge Studies in the Growth Economies of Asia

1 The Changing Capital Markets of East Asia Edited by Ky Cao 2 Financial Reform in China Edited by On Kit Tam

10 Studies in the Economic History of the Pacific Rim Edited by Sally M. Miller, A. J. H. Latham and Dennis O. Flynn

3 Women and Industrialization in Asia Edited by Susan Horton

11 Workers and the State in New Order Indonesia Vedi R. Hadiz

4 Japan’s Trade Policy Action or reaction? Yumiko Mikanagi

12 The Japanese Foreign Exchange Market Beate Reszat

5 The Japanese Election System Three analaytical perspectives Junichiro Wada

13 Exchange Rate Policies in Emerging Asian Countries Edited by Stefan Collignon, Jean Pisani-Ferry and Yung Chul Park

6 The Economics of the Latecomers Catching-up, technology transfer and institutions in Germany, Japan and South Korea Jang-Sup Shin

14 Chinese Firms and Technology in the Reform Era Yizheng Shi

7 Industrialization in Malaysia Import substitution and infant industry performance Rokiah Alavi

15 Japanese Views on Economic Development Diverse paths to the market Kenichi Ohno and Izumi Ohno

8 Economic Development in Twentieth Century East Asia The international context Edited by Aiko Ikeo

16 Technological Capabilities and Export Success in Asia Edited by Dieter Ernst, Tom Ganiatsos and Lynn Mytelka

9 The Politics of Economic Development in Indonesia Contending perspectives Edited by Ian Chalmers and Vedi R. Hadiz

17 Trade and Investment in China The European experience Edited by Roger Strange, Jim Slater and Limin Wang

18 Technology and Innovation in Japan Policy and management for the 21st Century Edited by Martin Hemmert and Christian Oberländer 19 Trade Policy Issues in Asian Development Prema-chandra Athukorala 20 Economic Integration in the Asia Pacific Region Ippei Yamazawa 21 Japan’s War Economy Edited by Erich Pauer 22 Industrial Technology Development in Malaysia Industry and firm studies Edited by Jomo K. S., Greg Felker and Rajah Rasiah 23 Technology, Competitiveness and the State Malaysia’s industrial technology policies Edited by Jomo K. S. and Greg Felker 24 Corporatism and Korean Capitalism Edited by Dennis L. McNamara 25 Japanese Science Samuel Coleman 26 Capital and Labour in Japan The functions of two factor markets Toshiaki Tachibanaki and Atsuhiro Taki 27 Asia Pacific Dynamism 1550–2000 Edited by A. J. H. Latham and Heita Kawakatsu 28 The Political Economy of Development and Environment in Korea Jae-Yong Chung and Richard J Kirkby 29 Japanese Economics and Economists since 1945 Edited by Aiko Ikeo

30 China’s Entry into the World Trade Organisation Edited by Peter Drysdale and Ligang Song 31 Hong Kong as an International Financial Centre Emergence and development 1945–1965 Catherine R Schenk 32 Impediments to Trade in Services: Measurement and Policy Implication Edited by Christoper Findlay and Tony Warren 33 The Japanese Industrial Economy Late development and cultural causation Ian Inkster 34 China and the Long March to Global Trade The accession of China to the World Trade Organization Edited by Alan S. Alexandroff, Sylvia Ostry and Rafael Gomez 35 Capitalist Development and Economism in East Asia The rise of Hong Kong, Singapore, Taiwan, and South Korea Kui-Wai Li 36 Women and Work in Globalizing Asia Edited by Dong-Sook S. Gills and Nicola Piper 37 Financial Markets and Policies in East Asia Gordon de Brouwer 38 Developmentalism and Dependency in Southeast Asia The case of the automotive industry Jason P. Abbott 39 Law and Labour Market Regulation in East Asia Edited by Sean Cooney, Tim Lindsey, Richard Mitchell and Ying Zhu

40 The Economy of the Philippines Elites, inequalities and economic restructuring Peter Krinks

50 Ethnic Business Chinese capitalism in Southeast Asia Edited by Jomo K.S. and Brian C. Folk

41 China’s Third Economic Transformation The rise of the private economy Edited by Ross Garnaut and Ligang Song

51 Exchange Rate Regimes in East Asia Edited by Gordon de Brouwer and Masahiro Kawai

42 The Vietnamese Economy Awakening the dormant dragon Edited by Binh Tran-Nam and Chi Do Pham 43 Restructuring Korea Inc. Jang-Sup Shin and Ha-Joon Chang 44 Development and Structural Change in the Asia-Pacific Globalising miracles or end of a model? Edited by Martin Andersson and Christer Gunnarsson 45 State Collaboration and Development Strategies in China The case of the China-Singapore Suzhou Industrial Park (1992–2002) Alexius Pereira 46 Capital and Knowledge in Asia Changing power relations Edited by Heidi Dahles and Otto van den Muijzenberg 47 Southeast Asian Paper Tigers? From miracle to debacle and beyond Edited by Jomo K.S.

52 Financial Governance in East Asia Policy dialogue, surveillance and cooperation Edited by Gordon de Brouwer and Yunjong Wang 53 Designing Financial Systems in East Asia and Japan Edited by Joseph P.H. Fan, Masaharu Hanazaki and Juro Teranishi 54 State Competence and Economic Growth in Japan Yoshiro Miwa 55 Understanding Japanese Saving Does population aging matter? Robert Dekle 56 The Rise and Fall of the East Asian Growth System, 1951–2000 International competitiveness and rapid economic growth Xiaoming Huang 57 Service Industries and Asia-Pacific Cities New development trajectories Edited by P.W. Daniels, K.C. Ho and T.A. Hutton

48 Manufacturing Competitiveness in Asia How internationally competitive national firms and industries developed in East Asia Edited by Jomo K.S.

58 Unemployment in Asia Edited by John Benson and Ying Zhu

49 The Korean Economy at the Crossroads Edited by MoonJoong Tcha and Chung-Sok Suh

60 Japan’s Development Aid to China The long-running foreign policy of engagement Tsukasa Takamine

59 Risk Management and Innovation in Japan, Britain and the USA Edited by Ruth Taplin

61 Chinese Capitalism and the Modernist Vision Satyananda J. Gabriel 62 Japanese Telecommunications Edited by Ruth Taplin and Masako Wakui 63 East Asia, Globalization and the New Economy F. Gerard Adams 64 China as a World Factory Edited by Kevin Honglin Zhang 65 China’s State Owned Enterprise Reforms An industrial and CEO approach Juan Antonio Fernandez and Leila Fernandez-Stembridge 66 China and India A tale of two economies Dilip K. Das 67 Innovation and Business Partnering in Japan, Europe and the United States Edited by Ruth Taplin 68 Asian Informal Workers Global risks local protection Santosh Mehrotra and Mario Biggeri 69 The Rise of the Corporate Economy in Southeast Asia Rajeswary Ampalavanar Brown 70 The Singapore Economy An econometric perspective Tilak Abeyshinge and Keen Meng Choy 71 A Basket Currency for Asia Edited by Takatoshi Ito 72 Private Enterprises and China’s Economic Development Edited by Shuanglin Lin and Xiaodong Zhu 73 The Korean Developmental State From dirigisme to neo-liberalism Iain Pirie

74 Accelerating Japan’s Economic Growth Resolving Japan’s growth controversy Edited by F. Gerard Adams, Lawrence R. Klein, Yuzo Kumasaka and Akihiko Shinozaki 75 China’s Emergent Political Economy Capitalism in the dragon’s lair Edited by Christopher A. McNally 76 The Political Economy of the SARS Epidemic The impact on human resources in East Asia Grace O.M. Lee and Malcolm Warner 77 India’s Emerging Financial Market A flow of funds model Tomoe Moore 78 Outsourcing and Human Resource Management An international survey Edited by Ruth Taplin 79 Globalization, Labor Markets and Inequality in India Dipak Mazumdar and Sandip Sarkar 80 Globalization and the Indian Economy Roadmap to a convertible rupee Satyendra S. Nayak 81 Economic Cooperation between Singapore and India An alliance in the making Faizal Yahya 82 The United States and the Malaysian Economy Shakila Yacob 83 Banking Reform in Southeast Asia The region’s decisive decade Malcolm Cook 84 Trade Unions in Asia An economic and sociological analysis Edited by John Benson and Ying Zhu

85 Trade Liberalisation and Regional Disparity in Pakistan Muhammad Shoaib Butt and Jayatilleke S Bandara

89 Institutions for Economic Reform in Asia Edited by Philippa Dee

86 Financial Development and Economic Growth in Malaysia James Ang

90 Southeast Asia’s Credit Revolution From moneylenders to microfinance Aditya Goenka and David Henley

87 Intellectual Property and the New Japanese Global Economy Ruth Taplin

91 Economic Reform and Employment Relations in Vietnam Ngan Thuy Collins

88 Laggards and Leaders in Labour Market Reform Comparing Japan and Australia Edited by Jenny Corbett, Anne Daly, Hisakazu Matsushige and Dehne Taylor

92 The Future of Asian Trade and Growth Economic development with the emergence of China Edited by Linda Yueh

The Future of Asian Trade and Growth Economic development with the emergence of China

Edited by Linda Yueh

First published 2010 by Routledge 2 Park Square, Milton Park, Abingdon, Oxon, OX14 4RN Simultaneously published in the USA and Canada by Routledge 270 Madison Avenue, New York, NY 10016 Routledge is an imprint of the Taylor & Francis Group, an informa business This edition published in the Taylor & Francis e-Library, 2009. To purchase your own copy of this or any of Taylor & Francis or Routledge’s collection of thousands of eBooks please go to www.eBookstore.tandf.co.uk.

© 2010 Linda Yueh for selection and editorial matter; individual contributors their contribution All rights reserved. No part of this book may be reprinted or reproduced or utilized in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloging in Publication Data The future of Asian trade and growth : economic development with the emergence of China / edited by Linda Yueh. p. cm. – (Routledge studies in the growth economies of Asia) 1. China–Foreign economic relations. 2. Asia–Foreign economic relations. 3. China–Commerce. 4. Asia–Commerce. 5. China–Economic policy. 6. Asia–Economic policy. I. Yueh, Linda Y. (Linda Yi-Chuang) HF1604.F88 2010 382.095–dc22 2009024402 ISBN 0-203-86328-3 Master e-book ISBN

ISBN10: 0-415-36811-1 (hbk) ISBN10: 0-203-86328-3 (ebk) ISBN13: 978-0-415-36811-7 (hbk) ISBN13: 978-0-203-86328-2 (ebk)

Contents

List of tables List of figures List of contributors 1

Introduction

xii xvi xx 1

PART 1

The emergence of China 2

The China effect: how the emergence of China affects the global economy, export-led growth models and relations with the United States

7

9

L INDA YUE H

3

China’s trade policy post-WTO accession: focus on China–EU relations

33

FR E DR IK E R IXON, PAT R IC K MES S ER LI N , R A ZEEN S A LLY A N D JINGHUI W ANG

4

Vertical specialization and intra-industry trade in China (1992–2003)

75

XIN-QIAO PING

5

A computable general equilibrium model of foreign direct investment productivity spillovers in China Z IL IANG DE NG, ADAM B L AK E A N D R O D F A LV EY

91

x Contents 6

Domestic capital, sources of foreign direct investment, and national output in China

113

B USAKOR N C HANT ASASA W A T, K . C . F U N G , F R A N C I S N G , AND AL AN SIU

PART II

Impact on the rest of Asia

129

7

131

The role of China in Asia: engine, conduit or steamroller? JANE T . HAL T M AIE R , SHA G H I L A H MED , B R A H I MA C O U LI B A LY , R OSS KNIPPE NB E R G, SYL V A I N LED U C , MA R I O MA R A ZZI A N D B ETH ANNE W IL SON

8

Overcoming the middle income trap: the challenge for East Asian high performers

199

KE NIC HI OHNO

9

How ASEAN fits the Asian and China emerging trade paradigm

222

L INDA L OW

PART III

Case studies

251

10 The rise of China: new openings for Singapore?

253

HANS C . B L OM QVIST

11 In the shadow of China: integration and internationalization in Lao PDR

271

M AGNUS ANDE R SSON, AN D ER S EN G V A LL, A N D A R I K O K K O

12 Implications of the growth of China and India for the other Asian giant – Russia

295

E L E NA IANC HOVIC HINA, MA R O S I V A N I C , A N D W I LL MA R TI N

PART IV

Resultant global and regional trade patterns

319

13 Asian integration and the region’s long-term economic growth prospects

321

DOUGL AS H. B R OOKS, DA V I D R O LA N D - H O LS T, J EA N - P I ER R E VE R B IE ST , AND FAN Z HA I

Contents xi 14 China and the future of the Asian electronics trade

351

B YR ON GANGNE S AND AR I V A N A S S C H E

15 The evolution of product quality in trade between China and ASEAN

378

A. K. M . AZ HAR , R OB E R T J. R . ELLI O TT A N D J U N TI N G LI U

16 China and Southeast Asia in the new regional division of labour

406

PR E M A-C HANDR A AT HUKOR A LA

Index

432

Tables

2.1 2.2 2.3 2.4 2.5 3.1 3.2 3.3 3.4 3.5 3.6 3.7 3.8 3.9 3.10 4.1 4.2 5.1 5.2 5.3

Intra-industry trade as a percentage of total trade growth averaged over 5 years Ratio of merchandise trade to merchandise value-added (in percentages) Real price of primary products (2000 =100) Real average economic growth in Asia, 1971–2005 Population, openness, savings and investment for the ‘Asian tiger’ economies, 1960–1995 Bound and applied MFN tariffs World ranking in ease of doing business (2008) The enabling trade index (2008) Recently established or proposed RTAs/CEPAs by China (2000–2007) Leading partner countries of the EU27 in merchandise trade (excl. services) – (excluding intra-EU trade) Leading import and export countries of the EU27 merchandise trade 2007 (excluding intra-EU trade) Leading import and export countries of the EU27 services trade 2007 (excluding intra-EU trade) FDI inflow/outflow and inward and outward FDI stock EU27 in mln Euros EU member states and Chinese provinces GDP per capita (2005 US$ in PPP) Intra-EU trade and trade with China with the EU member states (EUMS) Vertical specialization in China’s total exports and its changes (1992–2003) The changes in vertical specialization in China’s exports to the U.S. (1992–2003) List of aggregated industries Shares of output and value-added of SOEs, FIEs, and private enterprises in each sector of MMU (%) Industry-level panel data

15 16 20 25 26 35 37 38 48 53 54 55 56 57 61 83 85 94 95 98

Tables xiii 5.4 Estimation of productivity 5.5 Estimation of productivity spillovers 5.6 FDI to China by sectors in 2003 ($ million) 5.7 Effects of FDI shocks to the benchmark economy 5.8 Impact of FDI inflow on enterprises of different ownerships (%) 5.9 Employees with employment history in foreign-invested firms 5.10 Impact of FDI shock on national output with and without spillovers 5.11 Impact (%) of FDI shocks on SOEs with spillovers 5.12 Impact (%) of FDI shocks on private enterprises with spillovers 6.1 Pooled 2SLS using FDI from USA 6.2 Pooled 2SLS using FDI from Japan 6.3 Pooled 2SLS using FDI from Hong Kong 6.4 Pooled 2SLS using FDI from Taiwan 6.5 Pooled 2SLS using FDI from Korea Republic 6.6 Random effects 2SLS using FDI from USA 6.7 Random effects 2SLS using FDI from Japan 6.8 Random effects 2SLS using FDI from Hong Kong 6.9 Random effects 2SLS using FDI from Taiwan 6.10 Random effects 2SLS using FDI from Korea Republic 7.1 Variance decomposition based on the estimated VAR 7.2 Share of parts and components in exports 7.3 Asian trade balances with the world 7.4 Asian trade balances with China versus rest of the world 7.5 Percentage of total regional exports to the world by technological category 7.6 Distribution of total exports to the world by technological category 7.7 Effect of competition from China on rest of region’s exports to the rest of the world, including Asia (per cent) 9.1 FTAs by status in ASEAN3 9.2 Tariff and rules of origin under US-Singapore FTA (USSFTA) commitments 9.3 Japan’s FTAs by status 9.4 FTA status by selected Asian countries, 2006 9.5 China’s FTAs by status 9.6 Business mobility regulations and standards in APEC Appendix Table 9.1 Cumulative CRTAs and FTAs by status and scope Appendix Table 9.2 FTAs notified to WTO by type of notification and FTAs not notified (as of end 2006) Appendix Table 9.3 Typology of FTAs Appendix Table 9.4 Bilateral FTAs by geographic area, WTO notification and status, 2000 (as of December 2006)

98 99 99 101 101 102 103 106 107 119 119 120 120 121 122 123 123 124 124 152 156 159 161 169 170 180 224 227 228 229 230 234 239 240 241

242

xiv Tables Appendix Table 9.5 Plurilateral FTAs by geographic area, WTO notification and status, 2000 (as of December 2006) 11.1 Commodity composition of trade, Lao PDR, 2000–6 (percent) 11.2 Country and industry distribution of approved FDI (percent) 11.3 Poverty incidence in Lao PDR 1992/93–2002/03, per region 11.4 Value of agricultural exports, Muang Sing district, 2001/1–2002/3 (million KIP) 11.5 Export licenses from Luang Namtha and Oudomxay in 2006/7 (9 months) 11.6 Average annual growth rates of per capita consumption 1997/98–2002/3 (percent) 12.1 Annual output, factor inputs, and population growth projections, 2005–20 (percent) 12.2 Changes in key economic indicators of the world economy as a result of global growth, 2005–20 (percent) 12.3 Changes in key economic indicators of Russia as a result of global growth, 2005–20 (percent) 12.4(a) Impact of China’s and India’s extra growth (relative to baseline, 2020) 12.4(b) Impact of China’s and India’s extra growth on trade (relative to baseline, 2020) 12.5 Impact of China’s and India’s extra growth on Russia (change in quantities in percent, relative to baseline, 2020) 12.6 Impact of China’s and India’s extra growth on Russia (change in prices in percent, relative to baseline, 2020) 12.7 Impact of China’s and India’s extra growth on Russia (change in values in millions of USD 2004, relative to baseline, 2020) 12.8 Decomposition of Russia’s welfare gains in the case of China’s and India’s extra growth 13.1 Asia’s growth and its sources, 2005–25 (%) 13.2 Baseline trade composition (percent change 2005–25) 13.3 Initial simulation experiments 13.4 Real aggregate income (percentage change from baseline in 2025) 13.5 Real exports (percentage change from baseline in 2025) 13.6 Aggregate terms of trade (percentage change from baseline in 2025) 13.7 Trade by development status 13.8 Asian regional trade linkages 14.1 Growth of electronics production, 1985–2005 14.2 Trade in electronics 14.3 Shares of China’s component imports, 2004 14.4 Chinese electronics processing trade, 2000

243 278 280 283 285 286 288 303 304 305 307 309 311 312

313 314 329 329 331 332 333 333 339 341 353 354 357 358

Tables xv 14.5 14.6 14.7 14.8 14.9 15.1 15.2 15.3 15.4 15.5 15.6 15.7 16.1 16.2 16.3 16.4 16.5 16.6

16.7

Patterns of East Asian electronics trade (percentages), 2004 Electronics trade specialization in East Asia, 2004 Electronics product categories Absolute and relative product sophistication indices Shares of countries’ electronics production by sophistication category (percentages) Summary of China’s trade in manufactures (SITC 5–8), 1994–2004 China–Malaysia manufacturing trade at the two-digit level (SITC 5–8), 1994–2004 China–Singapore manufacturing trade at the two-digit level (SITC 5–8), 1994–2004 China–Indonesia manufacturing trade at the two-digit level (SITC 5–8), 1994–2004 Product quality differences between China and Malaysian, Singaporean and Indonesian trade, 1994–2004 China–Malaysia trade in SITC 8 (miscellaneous manufactures), 1994–2004 The top ten MQ indices for five-digit SITC (5–8) categories, 1994–2004 Average annual compensation per worker in selected countries, circa 2000 Parts and components in world machinery trade, 1992/93 and 2004/05 (%) Southeast Asia’s parts and components trade: composition and world market share by major category, 2003/5 (%) China’s merchandise exports: composition, growth and world market share, 1992/3–2004/5 Share of parts and components in China’s machinery and transport equipment trade Direction of China’s trade in machinery and transport equipment: destination/source country composition and growth (%) Regression estimates of determinants of China’s imports of machinery and transport equipment, 1992–2004

361 362 365 365 366 383 384 386 388 396 398 400 409 411 413 416 417

418 423

Figures

2.1 2.2 2.3 2.4 2.5 2.6 2.7 2.8 2.9 2.10 2.11 2.12 2.13 3.1 3.2 3.3 3.4 4.1 4.2

4.3 4.4

5.1 5.2 5.3 5.4

Real GDP (in 2006 US$) Share of global GDP (PPP-adjusted), 1980–2008 Global market share of Asian exports, 1990 and 2000 China’s exports, 1992–2006 China’s imports, 1992–2006 Composition of China’s GDP, 1978–2006 Foreign direct investment to developing countries, 1990–2004 FDI into Asia, 1980–2006 Worldwide inflation, 1980–2008 China’s outward FDI, 1982–2006 Current account surplus, per cent of global GDP Gross domestic saving, per cent of GDP Foreign exchange reserves, per cent of GDP OECD FDI regulatory restrictiveness scores (1 = closed, 0 = open) Total trade (goods and services) in bln US$ (1980–2006) Inward FDI in bln US$ (1980–2006) A broader view of the EU–China trade deficit: the import side Vertical specialization trend in China’s total exports 1992–2003 Vertical specialization share of the value of imported intermediate products in China’s total value of exports by different countries The trend in vertical specialization in China’s exports to the U.S. (1992–2003) Vertical specialization share of the value of imported intermediate products by different countries in China’s exports to the U.S. (1992–2003) Consumption aggregation Disaggregation of output and value-added by ownership Impact of FDI shock on output with spillovers Impact of FDI shock on output: spillover premium

10 11 12 13 14 15 17 18 19 21 21 23 23 36 39 39 59 83

84 85

86 93 96 104 109

Figures xvii 7.1 Asia economies’ GDP, 1990 and 2006 7.2 Asia economies’ GDP (adjusted for PPP), 1990 and 2006 7.3 Goods exports from Asia, 1990–2005 7.4 Per cent of intra-regional trade in Asia, 1990–2005 7.5 Exports as a percentage of GDP 7.6 Contribution of net exports to GDP growth 7.7 Average annual rates of real GDP growth 7.8 Coefficients from growth regressions (Thailand, Malaysia, India) 7.9 Coefficients from growth regressions (Philippines, Indonesia) 7.10 Coefficients on growth regressions (Singapore, Taiwan, Hong Kong) 7.11 Coefficients on growth regressions (Korea, Japan) 7.12 Impulse responses using structural VAR (NIEs) 7.13 Impulse responses using structural VAR (ASEAN4) 7.14 Parts and components as a per cent of exports of manufactured goods, 2005 7.15 Parts and components as a per cent of imports of manufactured goods, 2005 7.16 Parts and components as a per cent of trade in manufactured goods, 2005 7.17 Revealed comparative advantage: Asia, China, Hong Kong, Taiwan, Japan, Korea 7.18 Revealed comparative advantage: Singapore, Malaysia, Philippines, Thailand, Indonesia, India 8.1 East Asia: governance and income 8.2 Different speed of catching up (percent of US real income) 8.3 Breaking the ‘glass ceiling’ in manufacturing 8.4 Sea transportation cost to Tokyo 8.5 Manufacturing ++ strategy of Malaysia 8.6 Modular versus integral manufacturing 8.7 Key relations in development policymaking 9.1 CRTAs from ASEAN’s perspective 9.2 Singapore’s FTA policy options 9.3 Singapore Inc + FTAs 10.1 China’s share of Singapore’s exports 10.2 China’s share of Singapore’s imports 10.3 Singapore’s trade intensity with China 10.4 Singapore’s outward FDI 10.5 China’s share of Singapore’s outward FDI stock 10.6 The structure of Singapore’s FDI 10.7 China’s FDI in Singapore, SGD million (stock as end-of-year) 11.1 Lao exports and imports 1993–2007 (million USD) 11.2 Country distribution of Lao exports 1997–2006 (percent) 11.3 Net inflows of FDI 1993–2007 (million USD)

134 135 136 141 143 143 144 145 146 147 148 149 151 158 158 159 176 177 200 201 204 209 210 211 214 237 237 238 260 260 261 263 264 265 266 274 277 279

xviii Figures 11.4 11.5 11.6 13.1 13.2 13.3 13.4 13.5 13.6 13.7 13.8 13.9 13.10 13.11 13.12 13.13 14.1 14.2 14.3 14.4 14.5 14.6 14.7 14.8 14.9 15.1 15.2 15.3 15.4 15.5

Lao exports to and imports from China (million USD) Growth incidence curve, northern Laos, 1997/98–2002/3 Growth incidence curve, southern Laos, 1997/98–2002/3 Demand is already leading supply regionally (intra-Asian import and export shares by country in 2003, %) Schematic view of Asian economies Asian trade shares (trade flows as a percent of total Asian trade, 2001) Summary of macro conditions, 2001 Real GDP growth by country/region (baseline, annualized percent change, 2005–25) Baseline changes in regional trade flows (percentage change from 2005 to 2025) Real aggregate income (percentage change from baseline in 2025) Total exports (percentage changes with respect to baseline in 2025) Terms of trade (percentage change from baseline in 2025) Asian import demand composition Regional trade flow levels (percentage change from baseline 2005 in 2025) Regional trade flow shares (percentage change from baseline 2005 in 2025) Asian regional public and private investment: an age of complementarity (Asian inbound aid and FDI, USD billions) East Asian electronics exports China’s electronics trade balance, 1987 China’s electronics trade balance, 2004 CTI relative to high-income OECD countries, country groupings NIEs’ upgrading trajectory ASEAN’s upgrading trajectory Shares of global production, EDP and office equipment Shares of global production, active and passive components China’s share in developing East Asia’s electronics exports The evolution of China’s imports and exports, 1994–2004 The evolution of trade for Singapore, Malaysia and Indonesia, 1994–2004 S indices for China–Malaysia bilateral trade SITC (5–8), 1994–2004 S indices for China–Singapore bilateral trade SITC (5–8), 1994–2004 S indices for China–Singapore bilateral trade SITC (5–8), 1994–2004

281 289 290 324 325 325 327 328 330 334 334 335 337 342 343 345 355 356 357 368 368 369 371 371 372 382 382 392 393 393

Figures xix 15.6 15.7 15.8 15.9 15.10

Product quality for China–Malaysia manufacturing trade in 1994 Product quality for China–Malaysia manufacturing trade in 2004 MQ indices for China–Malaysia manufacturing trade, 1994–2004 MQ indices for China–Singapore manufacturing trade, 1994–2004 MQ indices for China–Indonesia manufacturing trade, 1994–2004

394 395 397 399 399

Contributors

Shaghil Ahmed, Chief, Emerging Market Economies Section, Division of International Finance, Federal Reserve Board, USA. Magnus Andersson, Visiting Ph.D. student, Stockholm School of Economics, Sweden. Prema-chandra Athukorala, Professor, Division of Economics, Research School of Pacific and Asian Studies, Australian National University, Australia. A. K. M. Azhar, Associate Professor, Graduate School of Management, Universiti Putra, Malaysia. Adam Blake, Professor of Tourism Economics, Bournemouth University, UK. Hans C. Blomqvist, Professor of Economics, Swedish School of Economics and Business Administration, Sweden. Busakorn Chantasasawat, Programme Director, Kenan Institute Asia, Thailand. Brahima Coulibaly, Economist, Division of International Finance, Federal Reserve Board, USA. Ziliang Deng, Sessional Lecturer in Finance, Keele University, UK. Robert J. R. Elliott, Head of Department, University of Birmingham, UK. Anders Engvall, Ph.D. student, Stockholm School of Economics, Sweden. Fredrik Erixon, Co-Director, European Centre for International Political Economy (ECIPE), Belgium. Rod Falvey, Professor of International Economics, University of Nottingham, UK. K. C. Fung, Professor of Economics, University of California, Santa Cruz, USA. Byron Gangnes, Associate Professor of Economics, University of Hawai’i at Manoa, USA.

Contributors xxi Jane Haltmaier, Adviser, Division of International Finance, Federal Reserve Board, USA. Elena Ianchovichina, Senior Economist, Economic Policy and Debt Department, World Bank, USA. Maros Ivanic, Consultant, Development Research Group, World Bank, USA. Ross Knippenberg, Research Assistant, Division of International Finance, Federal Reserve Board, USA. Ari Kokko, Professor, Copenhagen Business School, Denmark. Sylvain Leduc, Research Advisor, Division of International Finance, Federal Reserve Board, USA. Junting Liu, Lecturer, Department of Economics, Liaoning University, China. Linda Low, Head, Strategic Planning, Department of Planning and Economy, Abu Dhabi, United Arab Emirates and Adjunct Professor, United Arab Emirates University, College of Business and Economics. Mario Marazzi, Economist, Division of International Finance, Federal Reserve Board, USA. Will Martin, Lead Economist, International Trade Division, World Bank, USA. Patrick Messerlin, Professor of Economics, the Institut D’Etudes Politiques and Director of the Groupe Economie Mondiale, France. Francis Ng, Trade Economist, International Trade Team, Development Research Group, World Bank, USA. Kenichi Ohno, Professor, National Graduate Institute for Policy Studies, Tokyo, Japan. Xin-Qiao Ping, Professor of Economics, China Center for Economic Research (CCER) Peking University, China. David Roland-Holst, Adjunct Professor, Agricultural and Resource Economics, University of California at Berkeley, USA. Razeen Sally, Co-Director of the European Centre for International Political Economy (ECIPE), Belgium, and Senior Lecturer in International Political Economy, London School of Economics and Political Science, UK. Alan Siu, Associate Professor of Economics, University of Hong Kong, China. Ari Van Assche, Assistant Professor, Department of International Business, HEC Montréal, Canada. Jean-Pierre Verbiest, Country Director, Thailand, Asian Development Bank, the Philippines.

xxii Contributors Jinghui Wang, Ph.D. student, Groupe Economie Mondiale, Institut D’Etudes Politiques, France. Beth Anne Wilson, Chief, Advanced Foreign Economies Section, Division of International Finance, Federal Reserve Board, USA. Linda Yueh, Fellow in Economics, St Edmund Hall, University of Oxford, UK. Fan Zhai, Research Fellow, Asian Development Bank Institute, Japan.

1

Introduction

The rise of China and the effect on Asia The emergence of China in the global economy since the early 1990s has shaken up the existing economic order. Its rise has shifted world economic power to the East and away from the West. As such, it has also notably altered the Asian region with its reliance on exports for growth and its regional cross-border production chains that have dominated global consumer electronic goods markets. In some ways, the rise of China should not be surprising given the size of the country, which is the world’s most populous. China alone accounts for 20 per cent of the world’s population, 37 per cent together with India, while Asia accounts for half of the 6.5 billion people in the world. On the 30th anniversary of economic reform in 2009, China translated its population size into generating a sizeable economy, which is the third largest in the world after the United States and Japan. It is quickly nearing the size of Japan, due in part to its per capita income ranking 105th in the world according to the World Bank, giving it greater potential to grow quickly than richer nations. Nevertheless, being large and poor are not the sole or even main drivers of economic growth. There are numerous factors which have been important. Market-oriented reforms which gradually dismantled the centrally planned economy and openness to international trade and investment are two which propelled China’s transformation from a poor developing country to one of the few successful transition economies. The latter is the focus of this book. China’s rapid global integration has revamped the global economic structure, no less for its home region. Asia has been long regarded as an example of successful economic development, particularly the East Asian economies of South Korea, Singapore, Taiwan and Hong Kong, the first two of which have joined the ranks of rich countries. Their export-led strategy has served them well in driving growth since the 1960s but also poorly in terms of volatility as seen in the Asian financial crisis of the late 1990s. China’s opening was in part predicated on joining the regional production chains of manufactured goods which has characterized the export patterns of East Asia. The final markets are largely the United States and the European Union, but the supply chain is disaggregated within Asia where a part could be produced in China, largely finished in South Korea and exported from Japan. This is not to say that China’s

2 Introduction rise is entirely complementary as its exports also exert competitive pressure on its Asian neighbours and will cause shifts in specialization as wages rise in richer countries which will lead them to lose their comparative advantage vis-à-vis China and other southeast Asian nations. China’s population and large domestic market are also key factors in its growth. This is an issue that will also matter for its much smaller export-led neighbours. China’s attractiveness as a global destination for foreign direct investment (FDI) globally adds a further dimension to the development of the region. China’s rapid ascendancy to become one of the largest economies in the world also holds implications farther afield. Its exports and investments will impact the world economy, global trade patterns as well as regional trade in Asia. All of which will in turn affect its own growth prospects as trade and foreign investment influence its ability to sustain its hitherto strong growth rate. The future of Asian trade and its export-led growth model will undoubtedly hinge on these developments and comprise the core issue for this volume. This book views China’s emergence as fundamentally transforming the trade and growth patterns of the Asian region and thus also global trade and investment patterns. This thesis is explored empirically in several respects to establish those emerging patterns and shed light as to their likely developments in respect of Asia’s growth.

Structure and contents of the book The volume is in four parts. The first examines the emergence of China, focusing on its economic growth and external sector development in terms of international trade and foreign direct investment. China’s trade policies and its relations to the major economies of the United States and the European Union are investigated as well. The second part turns to explore the ways in which China has affected the Asian region, namely, whether China has been an engine or competitor and the challenges that it poses, including to the main regional trade group of ASEAN (Association of Southeast Asian Nations). In addition to the regional impact, the third part identifies three cases of affected countries ranging from a rich one such as Singapore to a poor country like Laos as well as a major emerging economy, Russia. The final component of the volume estimates the ways in which China’s opening has altered regional and global trade patterns, particularly in terms of the prospect for regional integration and high-end manufactured exports that have been a mainstay of East Asia. The resultant implications for the export-led growth model of Asia are explored throughout the volume. The main findings from the first part are that China’s emergence has been characterized by a high degree of global integration but still limited market opening. China’s trade and investment policies have significantly benefited its own growth and the development of its external sector is closely linked to the Asian region. The section starts off with a chapter by Yueh, who sets the scene of China’s emergence. She first details China’s growth and global integration in the past three decades. She then analyses the ‘China effect’ on the global economy

Introduction 3 and the avenues through which China has affected the global economic structure of the 1990s and 2000s and the indirect role that it played in the 2008 financial crisis. She concludes that China’s emergence and the global financial crisis raise issues pertinent to the export-led growth strategy of the Asian region as well as in respect of China’s relationship with the United States. The next two chapters turn to examine China’s trade policy and patterns, including its relations with the European Union by Erixon, Messerlin, Sally and Wang. They view China’s emergence in the world economy as making its trade stance more systematically important than even when it joined the World Trade Organization (WTO) in 2001, and that China–EU bilateral relations forms a major plank in the world trading system. They find that China has a mixed record on WTO implementation and that it has been passive in the latest Doha round of negotiations to expand trade liberalization. In contrast, China has been very active with preferential trade agreements (PTAs), setting off a ‘domino effect’ in East Asia. And, they conclude that unilateral liberalization – the driving force of external opening in the 1990s – has slowed down and identify the ways in which the EU–China trade relationship can be developed that would help smooth China’s global integration. Empirically, the next chapter by Ping finds that vertical specialization or intra-industry trade (which represents the presence of supply chains) rose from 14.2 per cent in 1992 to 22 per cent in 2003 of China’s exports. During the period 1992–2003, the value of imported intermediate goods and components from Japan, Korea and other East Asian countries accounted for about two-thirds of the increase in China’s exports to the world. About 75 per cent of the growth in China’s exports to the US is part of cross-border production chains linked to Japan, Korea and other East Asia countries, implying that China’s rapid increase in exports is linked to its integration into regional trade. The final two chapters in this section are by Blake, Deng and Falvey as well as Chantasasawat, Fung, Ng and Siu which assess the patterns of foreign direct investment in China. Blake, Deng and Falvey find evidence that decades of promoting foreign direct investment have resulted in improvements in China’s growth prospects. However, they find that the top five FDI recipient industries, which are electronic and electric products (11.9 per cent), textile industry (5.1 per cent), raw chemical materials and chemical products (4.9 per cent), garments and other fibre products (4.4 per cent) and transport equipment (4.4 per cent), may not receive the most benefit from FDI spillovers which generates positive externalities for Chinese enterprises that can foster productivity improvements. Nevertheless, China’s sizeable foreign investment inflows have led to productivity gains that have translated into a growth factor for its economy. Chantasasawat, Fung, Ng and Siu turn their focus to assess whether the origin of the inward FDI matters, and find that it does. Investment from the United States has the largest impact on China’s growth, followed by Hong Kong, Japan, Taiwan and South Korea. They also conclude that domestic investment is more important than FDI in driving national output. Together these chapters shed light

4 Introduction on the nature of trade and inward FDI in China and are able to point to the impact on its own growth as well as how China is linked to the wider global economy and specifically connected to the Asian region. China is evidently closely tied to its Asian trade and investment partners, with positive implications for its own continuing development. Part II concludes that China’s impact on the region has been largely favourable. Haltmaier, Ahmed, Coulibaly, Knippenberg, Leduc, Marazzi and Wilson find an increasing role of China as an independent source of growth in Asia. They also conclude that China plays an important and increasing role as a conduit for trade and investment. They show that China’s increasing presence in export markets has had a negative effect on exports of some products for some other Asian economies, but not for other products, including those of the important electronic high-technology industry. Ohno in the next chapter then examines how the nature of industrialization and export-led growth as well as the influence of China will affect the ability of Asian nations to join the ranks of rich countries as has South Korea. Concomitantly, the challenges faced by the second tier of countries such as Malaysia which have not grown as well as the early East Asian NIEs (Newly Industrializing Economies) such as Taiwan holds lessons for China as a late developer in the region. Ohno concludes that sustaining growth will require more than investing in infrastructure or liberalizing markets, but must also hinge on government leadership beyond the Washington Consensus and strong private sector dynamism, two factors that are not easily amenable to external manipulation. The final chapter in this part explores how ASEAN is affected by the emergence of China and the resultant changes in patterns of trade and investment in Asia. Low argues that the evolving Asian regional trade paradigm rests as much on small city-states like Singapore and Hong Kong, as the two entrepôt city-states play a crucial role in serving ASEAN and China, respectively. Part III focuses on three different cases. The effect of China’s emergence is explored for a rich (Singapore), a poor (Laos) and an emerging economy (Russia) in the region. Blomqvist starts off the section by examining the impact of the rise of China on Singapore. He argues that Singapore and Southeast Asia should view China’s growing markets and its potential as a production platform as opportunities. The growth of free trade agreements in the region also harkens to the start of greater regional integration. For rich countries like Singapore, China’s rapid upgrading in the technological level of its goods poses a challenge. Singapore’s best chance is probably to be agile and specialize in highend niche products and components, as well as services, where it has a comparative advantage. As a producer of high-end manufactures and sophisticated business services, there is every chance that the country can adapt itself successfully to the challenge of China, Blomqvist believes. Next, Kokko, Andersson and Engvall examine the impact of China on a poor country, Lao PDR. The huge Chinese market is within reach of many Lao producers and could potentially swallow any amount of exports from Laos, at the same time as Chinese exports pose a threat. They find that trade with China has

Introduction 5 contributed significantly to the economic development of Laos, but the Chinese footprint has looked different in different parts of the country. In the north, local markets are increasingly integrated with the Chinese market, and the low transaction costs for trade with China mean that the effects are widely dispersed across the regional economy. In the south, China is considered a distant trade partner that is mainly of interest for some sectors where Laos holds a strong comparative advantage. While the experience of northern Laos is probably hard to replicate elsewhere (except perhaps in some of the other less developed countries bordering China), the situation in southern Laos may be similar to that of many other developing countries. China is an important potential market for some commodities, but substantial investment is required to realize this potential and the benefits will not be distributed equally across the population. This section concludes with an analysis of large emerging economies, in the region, focused on Russia. Ianchovichina, Ivanic and Martin examine the joint effect of rapid growth of China and India on a third emerging economy, Russia. They find that Russia’s main benefit will derive from terms-of-trade improvements whereby higher energy prices will raise export prices relative to import costs. This is quite a different channel of effect than for many other developing countries which gain primarily through expanded trade with these emerging economies. However, the expansion of the energy sector and the contraction of manufacturing and services are a sign of a Dutch disease effect which will increase the importance of policies to encourage adaptation to the changing world environment. The final part of the book turns to explore the resultant patterns of regional and global trade from China’s rise. Roland-Holst, Verbiest and Fan likewise examine the effect of both China and India. They find that the economic emergence of the world’s two most populous countries is transforming the economic landscape of East and South Asia and contributing to fundamental shifts in global economic relations. While Asia’s traditional trade with the Western OECD (Organization for Economic Cooperation and Development) continues to expand and intensify, intra-Asian trade is accelerating as the most dynamic economies provide growth leverage for their neighbours. They argue that regional integration in Asia can accelerate growth and expand its basis, particularly for lower income countries in Asia. ASEAN has the most to gain from greater integration because it can emerge as a growth bridge between the larger economies of China and India. The next two chapters focus on two key aspects of regional trade: the evolution of electronics trade and product quality in Asia with the emergence of China. Gangnes and Van Assche find that China’s role as a key player in the global electronics industry has ignited concerns among its neighbours. But, they find that China’s effect on regional trade and production patterns is consistent with international production fragmentation in East Asia rather than as a competitor. They conclude that Japan and the NIEs have a more sophisticated electronics sector due to their specialization in high-sophistication components, while China and the better-performing ASEAN countries focus on mediumsophistication computer assembly. These latter countries, however, are upgrading their electronics industries more rapidly. Similarly, Azhar, Elliott and Liu find

6 Introduction that China’s rise has so far been a net benefit to the region and that trade is complementary between the production structures of these East Asian neighbours even if it has led to increased competition in foreign markets. It appears that due to the process of fragmentation, by each country specializing in different quality finished goods allows this group of countries to capture market share which leads to agglomeration effects, lower costs of production and finally higher regional growth. Their results also support the notion that while China may be crowding out the exports of consumer goods from Asian countries, this is more than compensated for by the increase in demand for intermediate inputs. The final chapter is by Athukorala, who examines the changes in the global pattern of trade with China’s rise. Analysing trade flows of China in conjunction with that of Asia, he finds clear evidence that network-related trade in components has strengthened Southeast Asia’s trade links with China, opening up new opportunities for the expansion of component production/assembly within vertically integrated global industries. However, these trade links with China have not lessoned the dependence of these Asian countries on the global economy; the dynamism of regional cross-border production networks depends inexorably on China’s trade in final goods with North America and the European Union.

Conclusion This volume analyses the impact of the emergence of China as the world’s secondlargest exporter and third-largest economy on the Asian region. It has presented a collection of papers that have examined this question in four different respects. China’s growth is indeed associated with a high degree of global and regional integration despite a mixed stance on opening and its emergence has been largely positive in affecting the development prospects of its neighbours. At the same time, its success has altered the calculus for Asia by raising numerous challenges, such as coping with China as a link in global production chains, as a competitor, and as a final market, with implications not only for trade but also the future economic development of Asia. Related issues such as greater regional integration in Asia and managing relations with the US and EU were explored. Also, case studies of Singapore, Laos and Russia provide an illustrative view of China’s likely impact on rich, poor, and other major emerging economies in the area. Finally, detailed analysis of regional and trade patterns, particularly in the electronics industry, shed light on the likely evolution of Asia’s exports and the export-oriented growth model. The future of Asian trade, and also growth, will be significantly tied to China, which has experienced remarkable growth in the past three decades. The evidence shows that China has been a complementary part of the Asian trade structure and also offers a potential final market. Trade and associated investment from Asia as well as rich countries have in turn been beneficial to China’s own growth. It thus appears increasingly the case that the future of Asia is closely linked to the future of China. Asia’s prospects in this century look more promising than ever before.

Part I

The emergence of China

2

The China effect How the emergence of China affects the global economy, export-led growth models and relations with the United States Linda Yueh

Introduction China is a developing country in the midst of transitioning to a market economy. Yet, it is emerging as a major force in the world economy, and increasingly has the impact of a developed country – one that accounts for over 20 per cent of the world’s population, more than four times the size of the United States and nearly three times that of the European Union. China’s size and integration with the world economy have contributed to altering the global inflationary environment; its currency has been a subject of contention; its exports have raised concerns for workers and firms in both developed and developing countries; its demand for energy and commodities has led to competition and conflict; it has rivalled the United States and the UK as a destination for foreign direct investment (FDI); and the effects of its own overseas investments have begun to be felt across the world, including its newly established sovereign wealth fund (CIC or China Investment Corporation). As a result, China has generated incremental growth in the global economy that has made its success and emergence significant for the welfare of other countries. The China effect hinges on two premises: its economic growth has occurred with significant global integration as both a part of global production chains and also as a final market for some exporting countries. In particular, China’s emergence will alter the global economic environment for its Asian neighbours as those economies have been largely fuelled by export-led growth. In the case of Japan, of export-led recovery, but for developing Asia, China’s rise will cause a re-examination of the export-led model of economic development that has served the region so well for most of the past half century. Its relations with the world’s largest economy and the predominant final market for the export-led growth model of Asia, the United States, will figure crucially. This Chapter will first examine China’s growth model and the extent of its resultant global integration. Then, the implications of China’s emergence will be analysed, particularly investigating the ‘China effect’, referring to the extent to

10 Linda Yueh which it influences international trade and investment, global demand and supply forces, and its contribution as a global growth driver. The third part of the chapter will draw out the subsequent indirect role of China in the global financial crisis and conclude with two sets of implications for Asia and its export-led model of growth as well as China’s evolving relations with the US hitherto the main engine of growth in the world economy.

China’s economic growth and global integration Since the process of economic liberalization began three decades ago in 1979, China’s economic performance has been remarkable. With an average growth rate of 9.4 per cent a year in real terms, GDP has increased some twelve-fold, while Chinese trade with the rest of the world has risen by a factor of 30. Figure 2.1 reveals the rapidity with which China has become the third-largest economy in the world. China’s per capita income at market exchange rates is less than $3,000, but estimates adjusted for the cost of living (that is, at ‘purchasing power parity’) are much higher due to its low cost of living. Figure 2.2 shows that when adjusted for PPP, China, since starting its re-integration with the global economy in 1979, has become more important in the global economy than all countries aside from the US, prompting the recognition that the US and China are the world’s ‘twin engines of growth’ (Dollar 2009). A startling aspect of China’s economy is its degree of openness to international trade. Total trade (exports plus imports) amounts to 75 per cent of China’s GDP, which compares with 37 per cent for the UK and just 20 per cent for the United States. China’s trade-to-GDP ratio is all the more remarkable given that one 16000

14000

US$ billions

12000

10000

8000

6000

4000

2000

0 1980

1982 China

1984

1986

France

1988

1990

Germany

Figure 2.1 Real GDP (in 2006 US$). Source: IMF.

1992 Italy

1994 Japan

1996

1998

2000

United Kingdom

2002

2004

United States

2006

2008

Canada

The China effect 11 30

25 USA

%

20

15 China Japan

10

Germany

5

France UK 0 1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

Figure 2.2 Share of global GDP (PPP-adjusted), 1980–2008. Source: IMF.

of the main determinants of this number is country size – large countries typically have low shares of trade in GDP (for example, the United States compared with the UK). One reason why China’s trade-to-GDP ratio is so large is the valuation of the denominator, which at market exchange rates understates the true size of the economy. But even allowing for this, the Chinese economy is open, reflecting its export-oriented growth strategy. China now accounts for around 8 per cent of world merchandise exports – a ratio that rivals those of the East Asian Newly Industrializing Countries (NICs) at the height of their export-led growth approach. This share was gained after only a decade of China’s ‘open door’ policy, which gained momentum after 1992. Although it was an integral part of China’s marketoriented reforms starting in 1978, opening to the world was not undertaken beyond a few coastal regions until the early 1990s. It marks the start of China’s global integration and the pace has been remarkable, as seen in Figure 2.3. The figure compares China’s market share in world manufactured exports in 1990 and 2000 to that of the NICs and the new generation of developing Asian economies vying for global market share. It shows not only all manufactured products, but also divides the goods into sub-categories: resource-based, low-technology, mediumtechnology, and high-technology.1 Manufactures account for the bulk of global merchandise trade, accounting for over 80 per cent of global trade, with primary and agricultural goods accounting for approximately even shares of the remainder. China’s rapid gains are evident across sectors and its dominance of nearly every sector of trade initially raised the spectre of competitive threats to the Asian region

12 Linda Yueh 14% 12% 10% 8% 6% 4% 2% 0% China 1990

South Korea 2000

Resource products

Singapore 1990

Low tech goods

Hong Kong 2000

Medium tech goods

Thailand 1990 High tech goods

Indonesia 2000 All manufactures

Figure 2.3 Global market share of Asian exports, 1990 and 2000. Source: UNCTAD. Notes: Resource based manufactures (resource based goods), excluding petroleum, comprise agricultural/forest based products and mineral based products, such as prepared meats and fruits, rubber, cement, glass, cut gems, etc. Low technology products (low tech goods) are textiles and fashion goods, such as textile fabrics, clothing, footwear, leather manufactures, pottery, furniture, jewellery, toys, and plastic products, among others. Medium technology products (medium tech goods) comprise automotive products and medium technology process industries, including vehicle parts, synthetic fibres, chemical and paints, fertilizers, plastics, iron, engines, industrial machinery, watches, ships, etc. High technology products (high tech goods) are electronic and sophisticated electrical products, such as telecommunications equipment, televisions, transistors, pharmaceuticals, cameras, etc.

but became more evident of complementarities in terms of intra-industry trade or regional production chains (Lall and Albaladejo 2004). In terms of market share of global trade in manufactured products, China has grown from having a mere 1.87 per cent to 4.70 per cent between 1990 and 2000 before joining the global trading community when it acceded to the World Trade Organization (WTO) in 2001. China has gained the most market share in low technology products for goods such as textiles and clothing. Also impressive has been its gain of export markets in medium and high technology goods as well as resource based goods. The rapid growth in market share of high technology goods such as semi-conductors, which has been the main engine of growth of the Asian Tigers, is particularly noteworthy. In the span of a decade, China grew from having 0.69 per cent of the world market, a percentage similar to the New Tigers (e.g., Thailand with 0.74 per cent), to 4.06 per cent in 2000, a market share that is threatening to the old Tigers. For instance, South Korea has a market share of 4.48 per cent and Taiwan holds 4.87 per cent, while Singapore has 5.88 per cent. Alone among the new Tigers, Malaysia has achieved a similar share of 3.75 per cent in 2000, although it started with a greater share in 1990 of 1.59 per cent of the market. This adds support to the ability of China to engage in the rapid technological upgrading of its manufactures as well as expand in its established labour-intensive products. It currently has a share of global trade that

The China effect 13 is comparable to that of the established Tigers, which have all lost or hardly gained market share in the 1990s. The four new Tigers of Malaysia, Thailand, Indonesia, and the Philippines began with less than 1 per cent of global trade in 1990 and have grown to account for more than 1 per cent in overall manufactures market share in 2000. However, this falls behind China, which started with a slightly larger share mainly in textiles at the start of the 1990s and has reached an impressive nearly 5 per cent of global market share in all manufactured exports by the end of that decade. Since 2000, China joined the World Trade Organization (WTO) and its market share has almost doubled. The large global market share of China leads to the belief that its economy is similar to the NICs in that it grows via exports. Although a portion of China’s growth strategy is indeed export-oriented, as evident in its ‘open door’ policy, the restrictions placed on international trade tell a different story. China’s policies centred on its Special Economic Zones (SEZs), export-processing zones initially located in the coastal provinces of Fujian and Guangdong and eventually spread into every province since the 1990s. These zones are geared at attracting foreign direct investment for the purpose of producing for export. Imports other than for export production were subject to punitive tariffs, such that an estimated half of all Chinese trade is processing trade (see Blanchard and Giavazzi 2006). This has the effect of limiting market access for foreign firms in China while benefiting from the competitive effects of international trade. Imports are likely to be as large as exports since many are intermediate goods used in the process of producing exports. The fast growth of imports alongside exports has meant that its current account surplus has not been sizeable over this period until the past few years. Figures 2.4 and 2.5 show the rapidity with which both exports and imports have risen since the early 1990s, but also the extent to which the goods traded are within the same

1,000,000

Other manufactures

900,000 Clothing & apparel accessories, textile, footwear

800,000 US$ thousands

700,000 600,000

Office, telecommn.& electrical equipment

500,000 400,000

Machinery & equipment

300,000 200,000

Primary mineral product

100,000

06

05

20

20

03

04 20

02

01

00

20

20

20

99

98

97

Figure 2.4 China’s exports, 1992–2006. Source: UNCTAD.

20

19

19

96

19

94

95

19

19

93

19

19

19

92

0

Primary agricultural product

14 Linda Yueh Other manufactures

800,000 700,000

Chemical and related products

US$ thousands

600,000 500,000

Office, telecomm.& electrical equipment

400,000 300,000 200,000

Metals and other minerals

100,000

Petroleum & gas Agricultural raw materials

19

92 19 93 19 94 19 95 19 96 19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 20 06

0

Figure 2.5 China’s imports, 1992–2006. Source: UNCTAD.

industrial classification. Although broad, the large proportion of the electronics trade is evident in both exports and imports. For instance, electrical and electronic equipment comprise 39 per cent of all China’s exports to Malaysia and also of 44 per cent of China’s imports from Malaysia. Electrical products and electronic equipment also comprise 33 per cent of China’s exports to, and 28 per cent of imports from, Singapore (Wang 2003). This is consistent with the predominance of East Asia cross-border production chains where the region accounts for around half of all global exports of electronic goods (Lall and Albaladejo 2004). The notable difference in the trade composition figures are that of clothing and textiles, which are not part of complex production chains, in exports, and the rising share of imports of energy and commodity products in imports. The former figure suggests China’s continued strength in low technology goods while the latter figure indicates its growing demand for commodities to fuel its re-industrialization and growing consumption. The domestic aggregate demand components that are driving the growth in imports of raw materials are evident in Figure 2.6, which shows the composition of GDP and the dominance of consumption and investment over net exports. The largest segments of the Chinese economy are investment followed by consumption in recent years; though, in the early part of the reform process, consumption accounted for nearly half of GDP with investment accounting for around 40 per cent. In either instance, domestic aggregate demand is sizeable, reflecting a large internal market alongside being a leading global trader. This is not dissimilar to Germany, with the United States being the other largest exporters in the world alongside having large domestic markets, particularly the latter. What is notable is the extent to which China’s trade is closely linked to that of its Asian neighbours and, through such cross-border production chains, is closely

The China effect 15 100% 80% 60% 40% 20% 0% −20%

1978

1981

Consumption

1984

1987

1990

1993

1996

Government Spending

1999

Investment

2002

2005

Net Exports

Figure 2.6 Composition of China’s GDP, 1978–2006. Source: China National Bureau of Statistics (NBS).

Table 2.1 Intra-industry trade as a percentage of total trade growth averaged over 5 years

East Asia South Asia

1986–1990 (%)

1991–1995 (%)

1996–2000 (%)

42.5 31.2

46.9 21.8

75.0 34.5

Source: IMF.

linked to global trade in manufactured goods. Intra-industry trade has grown significantly over the past decade, particularly in the second half of the 1990s. Intra-industry trade accounts for three-quarters of total trade growth from 1996 to 2000 in East Asia, rising rapidly from under 50 per cent in the previous decade. South Asia has seen increases as well in the degree of intra-industry trade. The prominence of multinational corporations plays a significant role in generating such trade as do existing large companies like those constituting chaebols or conglomerates in South Korea. Indeed, multinational corporations are important players in the export sectors of Asia’s developing nations. An estimated half of China’s manufactured exports are produced by foreign-invested firms. Granting tax and other concessions aimed at encouraging foreign investment characterizes the general growth strategy of industrializing Asian nations. A measure of the extent of vertical specialization in the form of production chains in cross-border trade is the ratio of merchandise trade to merchandise valueadded. Increasing numbers of parts and components that travel across borders for further processing would result in a higher trade-to-value added ratio. In spite of the difficulty of distinguishing final from intermediate goods, the rising ratios of total merchandise to value-added indicate the growing presence of cross-border

16 Linda Yueh Table 2.2 Ratio of merchandise trade to merchandise value-added (in percentages)

Asian region China Old Tigers: Taiwan, Singapore, Hong Kong, South Korea New Tigers (also Pakistan and Bangladesh): Malaysia, the Philippines, Thailand, Indonesia

1980

1990

2000

93.8 12.1 216.5

115.6 23.7 259.3

168.5 32.9 365.5

39.4

52.4

84.3

Source: IMF.

production chains in Asia. This evidence is also consistent with the exportoriented growth strategy undertaken by Asian nations. Local capacity building would be much slower than plugging into an existing global production chain of a multinational firm. When economies of scale and global production chains are considered, the needs of risk diversification and utilization of national capacities would predict rising intra-industry trade among the Asian nations. There is evidence of increasing economic integration in the region and China as part of regional production chains. This reflects China’s global integration as these chains produce manufactured goods which dominate large segments of global trade, particularly in the electronics industry. China appears to have benefited from adopting an export-led growth strategy similar to that of its neighbours, but under conditions which restrict market access that belies its open status.

‘The China effect’ Nevertheless, China’s economic growth model is one that has been outwardoriented and is characterized by a large degree of global integration. As a result, its emergence in the global economy is also associated with a range of effects on not just international trade but also the capital accounts of trading partners as well as other influences on global supply and demand factors. The China effect on the global economy can be broadly divided into four avenues: international trade, international capital flows (foreign direct investment and portfolio flows); global demand and supply of raw materials; and contribution to global incremental growth. China’s currency, the RMB or Yuan, would predominately figure in the first two effects which comprise the balance of payments. The impact of China on global demand for natural resources in particular would mean that even countries which did not trade with it will experience the effects of its rise as Chinese demand increases prices of energy and commodities that in turn increases supply side pressures in other economies regardless of whether they are linked directly to China. The same would apply to China’s role as a source of global economic growth, although its likely impact will differ from other major economies such as the United States due to its more circumspect opening.

The China effect 17 The contours of China’s international trade position have been explored in the previous section. The conclusions are that China’s trade patterns are not simply characterized by inter-industry trade whereby it sells socks and imports wine, for instance. Mirroring the rise of multinational corporations and offshoring, a significant proportion of China’s trade is processing trade or intra-industry trade whereby its exports and imports are part of regional and global production chains. This pattern is not limited to China alone, but reflects a shift in the global economic structure in the 1990s. China’s ‘open door’ policy took off in 1992, but it was concurrent with the outward orientation of India after its 1991 balance of payments crisis and the re-emergence of Eastern and Central Europe after the fall of Communism in the early 1990s. This re-emergence of these countries doubled the global labour force to some three billion people, leading to a fall in real wages, cheaper capital as the global capital-to-labour ratio halved, and the growth of offshoring as companies sought to take advantage of the cheaper production costs in these emerging economies. The rapid growth in FDI to developing countries since the 1990s can be seen in Figure 2.7. The increase in investment to Asia and the former Soviet Union states is notable in Figure 2.7, as is the much slower growth in FDI to Africa. Latin America experienced growth in foreign direct investment, which also reflects ICT and falling transport costs over the same period that facilitated offshoring and crossborder transactions. Focusing on developing Asia, Figure 2.8 shows that China’s attractiveness to FDI since the early 1990s which has propelled a growth in investment in the Asian region that surpasses the amounts invested even during the 1980s while the NICs were in the midst of their strong rates of growth. The dips

100 90 80

US$ billions

70 60

Sub-Saharan Africa Latin America & Caribbean East Asia & Pacific

50 40

Eastern Europe & Central Asia

30 20 10 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Figure 2.7 Foreign direct investment to developing countries, 1990–2004. Source: UNCTAD

18 Linda Yueh 90 80 70

US$ billions

60 50 40 30 20 10

China

84 19 85 19 86 19 87 19 88 19 89 19 90 19 91 19 92 19 93 19 94 19 95 19 96 19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 20 06

83

19

19

81 82 19

19

−10

19

80

0

Korea,Republic of

Singapore

Indonesia

Malaysia

Philippines

Thailand

Figure 2.8 FDI into Asia, 1980–2006. Source: UNCTAD

in FDI in Southeast Asia, in particular during the late 1990s, reflect the downturn associated with the Asian financial crisis. But, on the whole, the pattern reinforces the view that China’s emergence acts as a magnet for FDI into the region for production. As with all trade relationships, there will be those who gain and those who lose even if the overall economy benefits. Within countries, there will be a distributional shift of production and employment as some sectors expand and others shrink due to trade with China. The concerns over the distributional impact of China’s emergence are exacerbated by the effects of its currency. Thus, as China gained global market share and began to accumulate large trade surpluses, the clamour for liberalizing its currency rose in volume. At the country level, some countries will also gain and others lose from the integration of such a sizeable economy as China. The effect depends on whether a country is an importer of these goods, benefiting from the lower prices, or an exporter. Lower prices of many basic manufactures have been beneficial for high income countries that have already moved out of production in these sectors, and also for low income countries without such manufacturing capacity. However, there are also many products where China competes with other countries. For instance, Lall and Weiss (2005) find that 60–70 per cent of exports in some countries in Latin America (Costa Rica, El Salvador and Chile) are directly threatened by China’s rise due to a similar export product mix. Similar concerns arose in South Asia in countries such as Bangladesh and Sri Lanka when the Chinese textile and clothing trade grew in the aftermath of the abolishment of the worldwide quota system known as the Multi-Fibre Agreement (MFA) at the

The China effect 19 start of 2005, although bilateral restrictions have limited the impact of the MFA phase-out thus far. For developed countries, the impact of Chinese exports has been to lower the price of manufactured goods. In one-third of 151 industrial sectors disaggregated at the eight digit level, Kaplinsky (2006) finds that the prices of Chinese imports into the EU fell. Rogoff (2006) finds that China’s rapid global integration and remarkable growth have generated a favourable terms of trade (price of exports to imports) shock that produces lower than expected levels of inflation in the global economy. China, in other words, contributed to the lower prices, low inflation but strong growth environment of the past decade. Figure 2.9 shows the fall in worldwide inflation since the late 1990s, particularly since the early 2000s when China joined the WTO. This period was also characterized by strong economic growth, which has led the mild cycle to be termed the ‘Great Moderation’. There is, however, another side to the influence of China on global prices, which was evident as energy (oil and gas) prices rose along with commodity prices in the late 2000s. Whereas Chinese exports had a deflationary effect on the world economy, its re-industrialization and growing middle class have had the opposite effect through its rapidly growing demand for commodities. China is the world’s second largest consumer of oil after only the United States, according to the WTO. In 2004, with 4.4 per cent of the total world GDP, China consumed 30 per cent of iron ore, 31 per cent of coal, 27 per cent of steel, and 25 per cent of aluminum. Between 2000 and 2003, China’s share of the increase in global demand for aluminium, steel, nickel and copper was 76 per cent, 95 per cent, 99 per cent and 100 per cent, respectively (Kaplinsky 2006). China is undergoing a second industrialization to upgrade its old state-owned dominated capital stock which has led to fast growing demand for raw materials and energy. A 5.1 trillion RMB infrastructure investment project was also launched in 2006 that contributed to the real commodity boom peaking in the summer of 2008. Further, Chinese incomes, particularly those of urban residents, have risen alongside strong economic growth of some 10 per cent 140 120 100

%

80 60 40 20

19 80 19 81 19 82 19 83 19 84 19 85 19 86 19 87 19 88 19 89 19 90 19 91 19 92 19 93 19 94 19 95 19 96 19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08

0

−20

United States

East Asia

European Union

Figure 2.9 Worldwide inflation, 1980–2008.

World

Emerging and developing economies

20 Linda Yueh per annum since the late 1990s. This led to an increase in consumption demand for items such as cars. The growth of the urban middle class and massive amounts of investment, including in transportation infrastructure, heralded a period in the 2000s whereby Chinese demand outweighed the deflationary effect of its exports to drive up commodity prices worldwide. Increased consumption of meat at a time of other pressures on food production also led to a dramatic increase in food prices. Table 2.3 shows the growth in commodity prices since 2006. Although China is not solely responsible, it is a significant driver of incremental demand. One of the effects of such changes is to redistribute income between other countries in the world. Primary commodity exporters have experienced dramatic improvements in export earnings and in their terms of trade, paid for by importers of these commodities, largely in developed countries. In that sense, developed countries ‘lose’ from having to demand the same commodities as China. But, another set of winners from China’s emergence is those countries, particularly commodity exporters in Africa and Australia as well as Middle East oil producers, who sell to China’s domestic market. This last point also highlights the limitations of China as an engine of growth. Although Figure 2.10 shows how China has outpaced the growth of other comparable sized economies since 1980 and its role as one of the two engines of growth in the global economy is evident in Figure 2.2 as China has become more important than every economy but for the United States, it is not in a position to also serve as the world’s consumer, unlike the other engine. Its restrictive opening limits access into its domestic market and inhibits other countries from selling to China’s market in the same way as to the US. Instead, selective products, particularly energy and commodities, are imported while other goods and services are restricted. Those countries, and companies, who will benefit from China as an engine of growth will be those with access to its domestic market. Other beneficiaries of China’s emergence will be those regions where China sends its outward foreign direct investment. Beginning in 1982, China gradually invested small amounts overseas, averaging less than $2 billion per annum. Outward FDI increased dramatically in the 2000s when China began to permit overseas commercial investment, such as by firms like TCL which purchased France’s Thomson in 2003. Nevertheless, although there is not a detailed Table 2.3 Real price of primary products (2000 =100) Commodity

1960

1970

1980

1990

1995

2000

2006

2007

Oil (3 Spot Prices) Index Gold Metals Food

7 (12) 32 51

6 13 46 61

126 218 119 152

81 137 120 125

61 138 122 127

100 100 100 100

228 216 249 135

252 249 292 155

Source: IMF International Financial Statistics.

The China effect 21 20 18 16

US$ billions

14 12 10 8 6 4 2 0

1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

−2

Figure 2.10 China’s outward FDI, 1982–2006. Source: China NBS.

breakdown as to whether the investment is state-directed or commercial, the 2000s marked an acceleration in Chinese demand for energy and metals, as evident in its import figures. This demand drove greater state-led investments into resource-rich economies to secure raw materials. Therefore, Africa is the largest destination for Chinese overseas FDI. So long as Chinese demand continues to grow, countries in that region as well as others in the Middle East and Australasia will benefit from the capital outflows from an economy characterized by a savings rate that is around 50 per cent of GDP. China’s continued restrictions on its capital account limit portfolio flows. But, this does not mean that China does not affect global capital flows, particularly purchases of US treasuries. With an exchange rate that was originally pegged to the US dollar since its introduction onto global markets in the early 1990s and later to a trade-weighted basket of currencies in July 2005, China is an active investor in American and European government bonds. The record trade surpluses since 2005, moreover, resulted in impressive increases in China’s foreign exchange reserves which were around $2 trillion by 2009. This accumulation of reserves, far in excess of what might be needed to guard against a currency/financial crisis, led to China’s creation of a sovereign wealth fund (CIC or China Investment Corporation) as well as its use of other arms of the state such as the policy bank, the China Development Bank (CDB), to invest a portion of the reserves abroad. Coupled with the fixed exchange rate, China became an active investor worldwide. This, along with similar actions by other trade surplus countries in Asia and the Middle East, played an indirect role in the ensuing global financial crisis of 2008.

22 Linda Yueh

China and the global financial crisis Although it is certainly true that excessive risk-taking by financiers and inadequate regulatory supervision are to blame for the global financial crisis, macroeconomic forces should not be overlooked as a contributing factor. As a major player in the new global economic structure of the late 1990s and early 2000s, China had a part in the macroeconomic context which framed the disastrous financial crisis. The economic crisis of 2008 has its roots in the last recession. Ever since the US central bank used loose monetary policy to stave off a technical recession after the dot.com bubble burst in 2001, low interest rates were the norm for the next seven years in developed economies even as economic growth was strong. That is the usual use of monetary policy, but the fundamentally altered structure of the global economy of the 2000s made the outcome less than predictable. The mis-priced risk at the heart of the US sub-prime mortgage crisis is a result of low interest rates and excess liquidity. Credit was cheap and plentiful, which is peculiar in a country with a low rate of saving and a high level of consumer debt as well as highly leveraged firms. Normally, a savings deficit requiring borrowing to consume would increase the cost of borrowing on account of the low supply of funds. Moreover, such amounts of liquidity would usually lead to inflation. The reason for cheap and plentiful credit is linked to globalization and the global appetite for US debt, which kept down prices and the cost of borrowing. The US Federal Reserve then missed the signal that money was too cheap and lenders continued to seek borrowers, even if they were sub-prime ones. This strong demand for US treasuries stemmed from the trade surpluses in the Middle East (due to oil exports) and China and elsewhere in Asia (due to cheap manufactured goods). Figure 2.11 shows rapid increase in the current account surpluses of these countries which are largely matched by the gaping current account deficit of the United States since the late 1990s. When combined with

1.5 1 0.5

%

0 1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

−0.5 -1 −1.5 −2 United States

Euro area

Emerging Asia

Figure 2.11 Current account surplus, per cent of global GDP. Source: World Development Indicators, World Bank.

Oil exporters

2007

The China effect 23 50 40 30 20 10

1997

1998

1999

United States

2000

2001

Euro area

2002

2003

East-Asia

2004

2005

China

Figure 2.12 Gross domestic saving, per cent of GDP. Source: World Development Indicators, World Bank.

15 10 5 0 −5

1990

1992

1994

1996

1998

2000

China Latin-America Emerging Europe

2002

2004

2006

India Middle East Oil exporters

Figure 2.13 Foreign exchange reserves, per cent of GDP. Source: World Development Indicators, World Bank.

a high savings rate (Figure 2.12), particularly in Asia, large foreign exchange reserve holdings accumulated in their coffers (Figure 2.13). The fixed exchange rates operated by these countries also meant that purchases of US treasuries were necessary even if the American interest rate, and therefore returns, were low. From the figures, it is evident that European primary and external positions did not experience the same deterioration as the United States. However, measures undertaken in the 2000s in countries such as the UK opened the financial sector to raising funds from the US wholesale money markets instead of funding through deposits, spreading the liquidity across the developed world and leading to housing bubbles in Britain, Ireland, Spain, among others. Financial derivatives and securitized assets moved easily in globalized markets, which led to the prospect of systemic banking sector failure in Western Europe as well as in the United States for the first time since the Great Depression of the 1930s.

24 Linda Yueh With such global imbalances, one question must be why there was not a re-balancing when global savings/borrowing and trade surpluses/deficits were misaligned. The fixed exchange rate regimes of these emerging economies also forestalled a quick re-balancing of the global economy. When China, for instance, recorded trade surpluses which reached some 12 per cent of GDP, the RMB should experience irresistible pressure to appreciate. By so doing, goods purchased from China would have been more expensive for American consumers who will then buy less, thereby reducing the US trade deficit and concurrently causing the Chinese trade surplus to fall. This, however, did not happen, as the Chinese intervened to keep its currency in a managed band and instead used measures to raise reserve requirements in its banking sector, among other measures, to counteract the large increases in liquidity in its economy. This has not been entirely successful, as sterilization of the inflows was incomplete and China experienced the prospect of over-heating when investment, particularly in fixed assets and construction, grew rapidly and led to the prospect of an asset bubble. Fixed exchange rates are not the only reason. The US dollar has the status of being the reserve currency, demand for which does not fall purely on the basis of trade balances and capital flows. If that were the case, then the US’s ‘twin deficits’ (budget and trade) should have been unsustainable long before. Indeed, the US external deficit reflecting consumption based on borrowing from abroad was a phenomenon even before China’s significant opening to the world economy. Instead, the reserve currency effect meant that it was easier for the US to borrow since the demand for its currency is driven by factors in addition to its economic fundamentals. Moreover, it is not unusual for China or other developing countries to want stability in its currency and maintain competitiveness as they grow. Nevertheless, the so-called global imbalances meant that the West with low savings was importing savings from the (Far and Middle) East, and the appetite for the US dollar kept liquidity high and cheap (as well as interest rates low) in America. As European banks were able to draw on the US wholesale money market starting around 2000, the effects spread widely. The financial crisis followed, as financiers created ever more sophisticated instruments and sold them around the world. The global economy will need to be re-balanced. However, the process should proceed gradually. Western governments are indebted and likely to remain so as they fund bail-outs and stimulate their economies. These government bonds are likely to be bought by emerging economies with high rates of savings and external surpluses, such as China, while Western consumers and firms pay down their debts. Therefore, rather counter-intuitively, although global imbalances led to this crisis, they should be maintained throughout the recovery. Cutting off liquidity when the West is drawing upon it to fund their rescue efforts would likely lead to a long and painful period of global austerity. The recovery of the West and their markets is in the global interest, particularly China as the world’s second largest trader. Therefore, China has played an indirect role in the global financial crisis. Its actions, along with other major emerging economies, can also help in ameliorating

The China effect 25 the impact. The challenge, however, is the type of global leadership role that particularly China, along with other emerging economies, is willing to take on. Providing liquidity has been argued for, and otherwise easing of capital flows would help finance the recovery in a way that continues to preserve the Chinese exchange rate. Allowing greater convertibility and flexibility of the RMB, however, would also be helpful, particularly as it enables China to absorb the balance of payments shocks nominally through exchange rate movements instead of painful real adjustments such as a rise in unemployment as exports contract. This does not necessarily mean a floating currency, but a RMB that is more easily traded and moved within a band that allows China to navigate a middle path between stability and flexibility. Doing so is not just geared at aiding a US-led crisis, but to restore global economic and financial stability that has brought real prosperity to China and much of the developing world over the 2000s. Indeed, the real gains in the era of the ‘Great Moderation’ were not in the area of financial innovation but the strong growth in emerging economies that have both reduced poverty and begun to develop a middle class.

Implications for the export-led growth model The East Asian ‘miracle’ refers to the rapid growth of the NICs of South Korea, Taiwan, Singapore and Hong Kong from the mid 1960s that has highlighted the success of openness to trade in achieving economic growth. South Korea and Singapore have been propelled into the ranks of rich countries and become members of the OECD (Organization for Economic Cooperation and Development), a feat that has eluded most developing countries, including promising ones in Latin America during the post-war period. These old Asian ‘tiger economies’ were joined by new ones, as Southeast Asian nations adopted similar strategies of export-orientation. Table 2.4 shows the impressive real rate of economic growth for these eight economies over the past three decades. No model is without its flaws, and the capital account liberalization that was the counterpart to trade liberalization was a key factor in the Asian

Table 2.4 Real average economic growth in Asia, 1971–2005 Country

1971–80 (%)

1981–90 (%)

1991–2000 (%)

2001–2005 (%)

Hong Kong South Korea Singapore Taiwan Indonesia Malaysia The Philippines Thailand

9.4 7.3 8.8 9.3 7.9 7.9 5.9 6.9

6.5 8.7 7.5 8.0 6.4 6.0 1.8 7.9

4.6 6.2 7.6 6.5 4.4 7.2 3.1 4.6

4.3 4.5 4.0 3.2 4.7 4.5 4.5 5.0

Source: World Penn Tables.

26 Linda Yueh financial crisis that derailed these economies until the early 2000s. Nevertheless, growth rates even from 2001 to 2005 were high. Table 2.5 presents the growth indicators of population, openness, and savings/investment for the period 1960 to 1995 prior to the volatility of the Asian financial crisis. For countries that are the size of city-states (Singapore and Hong Kong) as well as large countries like Indonesia and the Philippines, the

Table 2.5 Population, openness, savings and investment for the ‘Asian tiger’ economies, 1960–1995 Country

Year

Population (thousands)

Openness (trade-to-GDP ratio)

Savings (% of GDP)

Investment (% of GDP)

Hong Kong

1960 1965 1970 1975 1980 1985 1990 1995 1960 1965 1970 1975 1980 1985 1990 1995 1960 1965 1970 1975 1980 1985 1990 1995 1960 1965 1970 1975 1980 1985 1990 1995 1960 1965 1970 1975

3064 3692 3942 4360 5039 5456 5704 6156 93996 104611 117537 132589 148303 163036 178232 193976 8140 9502 10853 12258 13763 15677 18201 20609 27561 32030 37540 43103 48317 54668 62598 70267 25252 28814 32241 35281

186.79 143.72 181.49 163.75 181.39 209.58 260.18 304.69 26.94 10.95 28.42 44.94 54.31 43.45 49.88 54.11 90.35 80.61 79.88 86.82 112.59 104.68 150.62 193.83 21.02 34.41 42.62 48.13 51.98 45.79 60.87 80.54 16.12 24.37 37.72 62.94

26.67 37.45 30.69 31.02 30.92 31.7 31.62 26.75 9.87 7.37 8.29 16.97 30.54 17.51 21.03 23.05 25.77 20.57 23.34 21.04 25.62 27.32 26.36 31.1 13.41 16.9 14.13 13.44 15.14 13.05 11.27 7.74 1.06 7.33 13.86 19.74

29.43 34.86 20.68 22.79 29.02 21.8 22.82 30.57 4.25 4.81 6.64 10.51 15.51 14.7 18.14 23.58 12.26 14.00 16.2 16.55 21.67 20.84 22.36 33.78 11.22 14.08 12.54 17.05 17.81 10.13 16.4 15.4 8.21 12.12 20.27 23.5

Indonesia

Malaysia

Philippines

South Korea

The China effect 27 Table 2.5 Cont’d Country

Singapore

Thailand

Taiwan

Year

Population (thousands)

1980 1985 1990 1995 1960 1965 1970 1975 1980 1985 1990 1995 1960 1965 1970 1975 1980 1985 1990 1995 1960 1965 1970 1975 1980 1985 1990 1995

38124 40806 42869 45093 1646 1887 2075 2263 2414 2736 3047 3526 26392 30641 35745 41359 46718 51146 55595 59401 11155 12928 14565 16001 17642 19136 20230 21214

Openness (trade-to-GDP ratio)

Savings (% of GDP)

Investment (% of GDP)

73.32 65.03 59.35 61.88 473.86 269.04 231.59 302.52 439.03 338.00 401.17 340.63 32.69 34.08 34.4 41.33 54.5 49.15 75.73 89.67 30.53 41.66 60.57 82.53 106.24 94.74 88.52 94.32

25.82 34.03 37.91 39.03 5.69 31.31 37.33 43.4 49.22 50.75 50.38 56.57 18.58 24.91 28.18 27.00 24.33 26.78 32.89 35.84 5.75 11.03 17.73 19.49 23.72 29.24 23.59 23.34

29.14 31.03 38.43 40.89 18.38 36.34 50.07 46.1 48.65 47.39 40.76 42.94 17.46 24.33 31.96 29.51 28.5 27.33 38.64 41.65 10.19 11.75 16.05 19.84 21.9 14.86 18.24 21.19

Source: World Penn Tables.

extent of openness to trade (measured as exports plus imports to GDP) is high and dwarfs China’s for the most part. At 75 per cent, China’s degree of openness is less than all of these countries with the exception of Indonesia, which at over 50 per cent of GDP is higher than even an open economy such as the UK. These economies are, of course, smaller which makes the trade-to-GDP ratio larger. But many of them trade a multiple of GDP, e.g., Singapore and Hong Kong at around 300 per cent or Malaysia at 200 per cent in 1995. The growth in trade through the 1960s to the 1990s coincides with their strong economic performance and the importance of openness in these economies underscores the export-led model of growth, evident particularly among the smaller sized countries but also apparent in the larger ones, such as Indonesia with some 200 million people. High savings and investment rates are also apparent through this period, such that these

28 Linda Yueh economies were both net savers and export-oriented – the pattern that China also followed in its ‘open door’ policy. However, significant ‘global imbalances’ did not arise with the growth of Asia during this period. By following the same strategy, China’s high savings and export-oriented development contributed to an imbalance in the global economy linked to cheap liquidity, though several other factors were also at play with the changes in the global economy in the early 1990s. Nevertheless, a key difference is that China is not a small open economy, but a large open economy whose integration in the world economy is more challenging insofar as such countries will affect global terms of trade. Small, open economies do not have the same effect, which can go some way toward understanding why China has had such a notable impact whilst otherwise pursuing the tried export-oriented strategy of its neighbours. For the Asian economies themselves, China poses an interesting challenge. China has become part of the East Asian regional production chain, serving as one part of the extensive cross-border links. However, despite China’s potential as a consumer market, it is not the main market for goods produced in the region. Rather, the final destination for such exports remains the United States and the European Union. Indeed, China’s own exports are largely destined for the EU and United States which are its largest trading partners, replacing Japan in 2004. This means that ‘de-coupling’ from US growth in particular is unlikely, as there is not an alternative market to sell to until China becomes wealthier and becomes more marketized such that its internal market can serve as more of an engine for the region. Due to the volatility that this reliance on exports entails (i.e. following the United States into recession), there is a case for reorienting to develop the domestic market. Aside from Singapore, which is a city-state, the other economies range in population from around 20 million in Malaysia and Taiwan to 45 million in South Korea and to 60–70 million in the Philippines and Thailand, the latter of which is on par with the size of the UK and Germany. Indonesia at some 200 million is not too far off the United States a decade ago. Hong Kong has become part of China, so its fate will be different, as would Singapore as it will not have the population to constitute its own market as a notable economic driver. Most of the other Asian economies, though, have populations that are on par with European nations and thus scope for developing domestic demand. The European single market and thus intra-European trade, which accounts for some three-quarters of all EU exports, helps the smaller as well as the larger nations. But, even without explicit economic integration, the growth of regional trade thus far suggests that should Asia develop its own domestic demand drivers then the region will benefit through spillovers via exports and imports (Winters et al. 2008). The push for regional free trade agreements such as ASEAN+3 (Association of Southeast Asian Nations2 plus China, South Korea and Japan) as well as ASEAN plus one of these nations being examples of greater trade linkages that are sought after in the region even without transforming into a single market such as the EU.

The China effect 29 This is not to suggest that openness is not good for economic growth or that export-led growth strategies should not be pursued, but rather that there is scope for developing the domestic economies of Asia after decades of strong growth on the back of exports. With the rapid growth of China and its potential as a market, it may be that the rest of Asia will simply find another final market destination. However, for countries that are not much smaller and indeed some are as large as European states, once economic development advances to a stage, then developing the domestic market can provide a more stable path for growth that integrates trade and openness to the world economy with a more balanced economic structure. For instance, pursuing exports by maintaining a cheap currency depresses domestic consumption as it makes imports more expensive and adversely affects standards of living within an export-led economy. A cheap currency also imports inflation, which was seen in Asia during commodity booms of the past few decades. In 2008, countries in Southeast Asia experienced double digit inflation as a result of global food price increases, for instance. How a country grows, therefore, is related to weighing the importance of different components of GDP and the balance between domestic and external drivers of growth. Another example is Japan. When a rich economy relies on exports and trade contracts due to the global economic crisis, then it too will experience a severe recession. In Japan’s case, it was one of the worst affected countries in the 2008 financial crisis. With China’s eventual maturation as a market, Asia might also have the potential of being more stable as a region. It might even contemplate mimicking the development of the EU which has knitted together large and small economies to their mutual benefit. For instance, in 1998, the big four economies made up around three-quarters of EU GDP (Germany at 25 per cent, France and the UK around 17 per cent each, and Italy at 14 per cent), while the rest of the EU countries constituted just around 27 per cent. Certainly, other challenges will arise, such as those experienced by the EU as it governs its single market. Relying exclusively on China will likely simply switch the focus from the US to one nearer to home without building up domestic demand alongside trade. As well as the export-led model has served the region, the volatility associated with relying on external demand and the fall in GDP that can follow from an external crisis, are among the reasons to argue for Asia to pursue openness in conjunction with developing its domestic markets. The export-led model of growth remains highly consistent with the notable gains accruing to countries as a result of globalization in the post-war period. How to modify that model to maintain stability in growth rates is the next challenge.

Conclusions: Relations with the United States Evident during the decade of the ‘Great Moderation’ and certainly so in the 2008 global financial crisis, China’s importance in the global economy is ever increasing. The China effect has altered not only the global economic structure, but also holds notable implications for its Asian neighbours and their export-led growth model.

30 Linda Yueh Its relationship with the United States, hitherto the leading economy in the world and likely to remain so for some time, is likewise changing. More so than ever as tensions flare over trade/investment and exchange rates, there is need to define a greater partnership between China and the United States in the way that the US and other major economies relate to each other, i.e., economic partners who coordinate and cooperate through various forums such as the G7 that encompasses the rich economies of the world (United States, Japan, Germany, United Kingdom, France, Italy, and Canada). The G7 meet regularly to discuss issues that affect the global economy. In the late 2000s, there has been a growing recognition that China was larger than most of the G7 and so meetings began to informally include the four large emerging economies of China, India, South Africa and Brazil. In this respect, the 2008 financial crisis has already reshaped the global economic power structure. The first international summit held to address the crisis in Washington DC in November 2008 was of the G20 group of major economies, and not just the G7. The G20 includes 19 of the 25 largest economies in the world plus the European Union: Argentina, Australia, Brazil, Canada, China, France, Germany, India, Indonesia, Italy, Japan, Mexico, Russia, Saudi Arabia, South Africa, South Korea, Turkey, United Kingdom, United States, and the EU. Spain is excluded except through its membership of the EU, while Thailand is also not a member singly or via another entity. There is no definitive forum for global economic coordination, but the trend is certainly shifting to include China and other large emerging economies in recognition of the shift in global economic weight. The G8 (G7 plus Russia) is rumoured to be considering expanding to the G8+5, so that it is the G8 plus China, India, Brazil, Mexico, and South Africa. Some have even argued for the Group of Two: the United States and China (Brzezinski 2009). The G20 has indeed become the forum to address global issues as declared by their summit in Pittsburgh in September 2009. These forums are often criticized for not producing concrete results, but they serve an important function in facilitating discussions about global economic problems. Globalization accelerating in the 1990s has led to more such forums, importantly between the United States and China in the semi-annual highlevel Strategic Economic Dialogues (SED) that involved several members of the Cabinet of both countries which was started under US Treasury Secretary Henry Paulson in the second Bush administration. The EU has followed suit, initiating its own high-level summits with China that also arranged for twice a year meetings. These summits serve a useful purpose as the relations between the two engines of the world economy are crucial, usually not only for them but for other countries as well. But, these informal meetings are not themselves enough to contend with the changed global economic structure. Rather, the United States and China are in a position to provide leadership to ensure that the international economic system is reformed to reflect the challenges of the global economy of the twenty-first century. These strictures can also serve to moderate US– China relations as international trade rules, for instance, can counter protectionist

The China effect 31 tendencies arising in either country. Protectionism in one of these countries of course affects many other economies, underscoring the importance of not only good bilateral but also multilateral efforts. In other words, the US–China relationship has global implications and should also operate on a multilateral basis. The scale of the economic crisis has already led to discussions of Bretton Woods II – a new international economic system that would supplant the original post-World War II institutions of the IMF and the World Bank. A relevant international economic system would be more beneficial than relying on forums that are useful in agreeing on cooperative measures. It would be in the interest of China, the United States and indeed all countries, to supervise international financial markets accordingly as well as agree to monitor the build-up of the next global imbalance which could result in devastating asset bubbles with widespread consequences. Participating as an active member of the G20 seeking to reform the Bretton Woods institutions would be beneficial not only to the global economy but to China’s own future. A new set of Bretton Woods institutions that identified these economic flows and assessed their consequences would help policymakers coordinate responses to try and lean against future asset bubbles. Indeed, the next one could be in emerging economies as cheap currencies and high levels of domestic savings fuel housing bubbles even as interest rate cuts to stimulate the West promote global liquidity searching for the next investment opportunity, which could be in Asia. Changing the shareholding in the World Bank and IMF as well as the constituents of other supra-national bodies such as the Bank for International Settlements (BIS, known as the central banks’ central bank) to better reflect shifting world economic power would allow for more representative policymaking and bring countries such as China on board to play a more active role in the governance of the global economy. Strengthening the coverage of the World Trade Organization would also restrain protectionist tendencies as well. Thus, a reformed international economic system could be a positive legacy of the 2008 financial crisis. Certainly, leading the reform of the international economic system to better reflect the changed global economic structure would be opportune and China and the US will be key to this process. No country is immune from a global economic crisis, particularly China with its high degree of global integration. Often criticized for the inward-looking nature of its economic policies, China is in a position to act to shape the governance of the global economy. Doing so would go a long way toward the position of China becoming an active stakeholder in the world economy as befits one half of the twin engines of growth alongside the United States.

Notes 1 The definitions of the sub-categories are listed in the notes to Figure 2.3. 2 ASEAN consists of Brunei, Cambodia, Indonesia, Lao PDR, Malaysia, Myanmar, the Philippines, Singapore, Thailand, and Vietnam.

32 Linda Yueh

References Blanchard, O. and Giavazzi, F. (2006) ‘Rebalancing growth in China: A three-handed approach’, China and the World Economy 14: 1–20. Brzezinski, Z. (2009) ‘The Group of Two that could change the world’, Financial Times, 13 January, 2009. Dollar, D. (2009) ‘Asian century or multi-polar century?’ in Natalia Dinello and Wang Shaoguang (eds), China, India and Beyond: Drivers and Limitations of Development. Cheltenham, UK: Edward Elgar. International Monetary Fund (IMF) (2002) World Economic Outlook, Washington, DC, September. Kaplinsky, R. (2006) ‘Revisiting the revisited terms of trade: Will China make a difference’ World Development 34: 981–5. Lall, S. and Albaladejo, M. (2004) ‘The competitive impact of China on manufactured exports by emerging economies in Asia’, World Development 32: 1441–66. Lall, S. and Weiss, J. (2005) ‘China’s competitive threat to Latin America: An analysis for 1990–2002’, Oxford Development Studies 33: 163–94. Rogoff, K. (2006) ‘Impact of globalization on monetary policy’, paper presented at the symposium sponsored by the Federal Reserve Bank of Kansas City on ‘The New Economic Geography: Effects and Policy Implications’, Jackson Hole, Wyoming, 24–26 August 2006. Wang, K. (2003) ‘China’s WTO accession and its trade with the Southeast-Asian nations’, University of Washington mimeo. Winters, A., Venables, A.J. and Yueh, L. (2008) ‘Economic integration in Asia: European perspectives’, in Masahisa Fujita, Satoru Kumagai and Koji Nishikimi (eds), Economic Integration in East Asia: Perspectives from Spatial and Neoclassical Economics. Cheltenham, UK and Northampton, MA, USA: Edward Elgar, pp. 143–72.

3

China’s trade policy post-WTO accession Focus on China–EU relations Fredrik Erixon, Patrick Messerlin, Razeen Sally and Jinghui Wang

Our purpose is twofold: first to interpret China’s overall trade policy since its accession to the World Trade Organization (WTO); and second to home in on China–EU relations. Both are not exactly minor topics. To state the obvious: China’s continued rise in the world economy makes its trade policy systemically even more important than it was at the time of WTO accession. And, perhaps less obvious, China–EU relations have rapidly become one of the major planks in the world trading system. Both aspects are thrown into sharper relief by the global financial crisis and economic downturn that started in 2008, with a concomitant upsurge in protectionist pressures. The first part of the chapter covers China’s trade policy in the round. It briefly summarizes policy trends leading up to WTO accession, as well as recent trade and foreign direct investment (FDI) patterns. Then it looks at China in the WTO: its record of implementing WTO commitments; its participation in the Doha Round; and in dispute settlement. The next section looks at China’s trade-related reforms outside the WTO, especially unilateral measures and preferential trade agreements (PTAs). The final section highlights challenges for China’s trade policy: in the context of domestic reforms; in the WTO; in PTAs; and in its two key bilateral relationships – with the USA and EU. The second part of the chapter focuses on China–EU relations. It summarizes bilateral trade and FDI patterns. Then it looks at macroeconomic issues, especially on the current account and exchange rates. The following section has a longer discussion of key trade-and-investment issues in bilateral relations, and concludes with recommendations for managing tensions, containing protectionism at both ends, and deepening commercial engagement.

1. China’s trade policy: trends post-WTO accession Trends up to WTO accession; trade and FDI patterns1 China’s ‘Reform’ and ‘Opening’ started in 1978. But its decisive external opening, and with it sweeping industrial and agricultural restructuring, belong more to

34 Fredrik Erixon et al. the post-Tiananmen phase, especially since 1994. China undertook enormous trade and FDI liberalization during the 1990s – before WTO accession in 2001 – followed by another big dose of liberalization in line with its WTO commitments. Its WTO commitments are very strong. They exceed those of other developing countries by a wide margin. This holds for disciplines on border and non-border restrictions in goods and services. In addition, there are detailed commitments on transparency procedures to make sure trade-related laws and regulations are implemented, backed up by administrative and judicial-review procedures to which individuals and firms are supposed to have recourse. It is important to note that the primary liberalization thrust, especially in the 1990s, was domestic and unilateral, coming from the Beijing leadership. The latter used WTO-accession negotiations as a strategic lever to consolidate and accelerate national reforms. China’s WTO commitments, and its participation in the WTO after accession, can be read as more the consequence than the cause of its sweeping unilateral reforms. Furthermore, Chinese unilateral liberalization followed in the footsteps of unilateral liberalization by the northeast and then the southeastAsian Tigers from the 1960s to the 1980s. This is how China inserted itself into regional and global manufacturing supply chains (e.g. in electronics, sport footwear, televisions and radio receivers, office equipment, electrical machinery, power and machine tools, cameras and watches and printing and publishing). That said, the momentum of further liberalization has slowed down in recent years (of which more later). The simple average tariff has come down from about 40 per cent in 1985 to about 9 per cent today. All China’s tariffs are bound in the WTO at very close to applied rates, with an overall bound tariff of 10 per cent. The maximum applied MFN tariff is 65 per cent. China’s weighted average tariff is about 5 per cent – low-ish by developing-country standards and the lowest among large developing countries (e.g. compared with other BRIICS – Brazil, Russia, India, Indonesia and South Africa) (Table 3.1). This is partly due to numerous duty exemptions and other measures to encourage exports. Trade liberalization also whittled down the impact of border non-tariff barriers (NTBs) to about 5 per cent on the eve of WTO accession. Trading rights have been fully liberalized; most quotas, licences, specific tendering arrangements and price controls have been removed; and there are strong disciplines on state trading enterprises, remaining subsidies and other NTBs. Overall, border barriers on goods trade have come down to southeast-Asian levels, and have been locked in by much stronger WTO commitments. China’s GATS commitments are very strong. On paper, the impact of WTO accession should be to cut services protection by half. In practice, China remains more protected in services than it is in goods trade. It is also generally more restrictive towards FDI. In terms of the OECD FDI Regulatory Restrictiveness Index, it is on a par with India and more restrictive than Russia and Brazil. Above-average levels of restrictiveness appear in key services sectors such as fixed telecomes, banking, air and maritime transport and electricity (Figure 3.1).

4.2 3.6 3.0 31.4 − 49.6 37.1 10.0 19.4 34.8 21.3 7.4

67.3 98.6

–

–

2005 2005 2005 2005 2005 2005 2005 2005 2005 –

100.0 100.0 99.7 100.0 0.0 73.8 96.6 100.0 96.3 76.2

3.0

3.7

1.7 3.3 2.3 12.6 11.5 15.9 6.4 9.2 8.8 9.4

3.7

6.3

7.9 2.8 8.4 7.9 10.7 24.4 7.2 8.8 5.4 9.0

3.1

4.1

2.7 3.2 3.3 12.3 11.4 17.0 6.5 9.2 8.5 12.3

2.0

1.2

2.0 1.6 2.5 7.1 9.6 14.5 6.0 4.9 5.4 6.1

3.7

5.0

6.7 6.1 8.1 27.7 17.9 15.5 8.7 19.1 21.3 17.8

Note for all countries except Russia: Rates are either partially or fully recorded applied rates. All other simple and weighted tariff rates are MFN rates.

0.0

0.8

9.0 5.9 2.7 0.0 16.0 3.5 0.0 0.0 1.0 0.9

Year Binding Simple Simple Simple Simple Weighted Share of lines Share of lines coverage mean bound mean tariff mean tariff mean tariff mean tariff with int. peaks with spec. rates (all goods) (all goods) (manufactures) (agriculture) (all products) (all products) (all products) (all products)

Source: World Bank (2005) http://siteresources.worldbank.org/INTRES/Resources/469232-1107449512766/WDI_table6_7_tariff_barriers.xls

EU US Japan Brazil Russia India Indonesia China South Africa Low and Middle Income Countries High Income Non-OECD High Income OECD

Country/ economy

Table 3.1 Bound and applied MFN tariffs

36 Fredrik Erixon et al. Index (0–1) 1.2 Russian Federation

Brazil

India

China

South Africa

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0.8

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Figure 3.1 OECD FDI regulatory restrictiveness scores (1 = closed, 0 = open). Source: Koyama and Golub (2006) OECD’S FDI Regulatory Restrictiveness Index: Revision and Extension to more Economies, Economic Department Working Papers No. 525, pp. 8–10, By Takeshi Koyama and Stephen Golub.

China ranks eighty-third overall in the World Bank’s Ease of Doing Business Index for 2008 – a low score, but a significant improvement over the past few years and clearly ahead of Russia, India, Brazil and Indonesia (Table 3.2). For ‘trading across borders’ it is way ahead of South Africa, Russia and India. It scores much better than the other BRIICS on the cost of importing and exporting. China also occupies forty-eighth position in the World Economic Forum’s new Enabling Trade Index, which combines indicators on market access, border administration, transport and commercial infrastructure and the business environment into an overall index that ranks 118 countries. It scores better than South Africa (59th), India (71st), Brazil (80th) and Russia (103rd). Ahead of China are OECD countries and more advanced emerging markets in eastern Europe, Latin America, east Asia and the Middle East (the non-OECD group being nearly all small, open economies) (Table 3.3). China has climbed up the world rankings for trade and FDI with lightning speed (Figures 3.2 and 3.3). It has displaced Japan as the world’s third largest trading nation, with 7 per cent of world trade by 2006 (7.7 per cent of goods trade and 3.5 per cent of services trade). This is streets ahead of the other BRIICS; and even ahead of India in world services trade. China’s trade-to-GDP ratio is 70 per cent – much higher than Brazil and India, and extraordinarily high for such a populous country. China has a 2.4 per cent share of global inward FDI stock, again ahead of the other BRIICS. It has been the second largest recipient of FDI in the world

3 12 1 4 2 5 125 120 122 129 83 32

6 64 10 15 1 16 127 65 121 171 151 47

Starting a business 26 39 2 20 2 7 108 180 136 80 176 48

Dealing with construction permits 1 17 1 20 14 10 121 101 89 157 111 102

Employing workers 12 51 16 74 3 43 111 49 105 107 30 87

Registering property 5 12 5 2 5 12 84 109 28 109 59 2

Getting credit 5 15 2 3 1 24 70 88 38 53 88 9

Protecting investors 46 112 5 3 12 13 145 134 169 116 132 23

Paying taxes 15 17 1 2 23 3 92 161 90 37 48 147

Trading across borders 6 21 14 1 11 29 100 18 180 140 18 82

Enforcing contracts

15 1 2 13 17 7 127 89 140 139 62 73

Closing a business

Note: The numbers correspond to each country’s aggregate ranking on the ease of doing business and on each of the ten topics that comprise the overall ranking.

Source: The World Bank Doing Business Databas: http://www.doingbusiness.org

US Japan Singapore Hong Kong New Zealand Denmark Brazil Russia India Indonesia China South Africa

Ease of doing business

Table 3.2 World ranking in ease of doing business (2008)

1 2 3 4 5 13 14 47 48 59 71 80 103

6.04 5.71 5.66 5.65 5.62 5.43 5.42 4.27 4.25 3.98 3.74 3.63 3.25

1 27 14 2 3 4 6 22 71 67 105 92 99

6.66 4.99 5.21 5.89 5.87 5.86 5.65 5.03 4.07 4.10 2.82 3.42 3.11

Score

Rank

Rank

Score

Market access

Overall rank

Source: The Global Enabling Trade Report 2008, pp. 12 and 13.

Hong-Kong Singapore Sweden Norway Canada Japan United States Indonesia China South Africa India Brazil Russia

Country/economy

Table 3.3 The enabling trade index (2008)

7 1 2 6 9 17 21 63 43 50 55 66 92

Rank 5.99 6.51 6.32 6.06 5.78 5.55 5.29 3.96 4.51 4.21 4.08 3.87 3.20

Score

Border administration

4 7 1 20 11 13 3 74 36 45 52 62 60

Rank 5.66 5.53 5.77 5.21 5.50 5.42 5.66 3.13 4.15 3.74 3.54 3.31 3.35

Score

Transport and communications infrastructre

2 3 14 10 16 35 25 32 77 99 58 96 114

Rank

5.84 5.82 5.35 5.45 5.33 4.90 5.08 4.97 4.28 3.87 4.53 3.91 3.35

Score

Business evironment

China’s trade policy 39

US$ billions 2,000 Brazil

1,800 1,600

Russia

1,400

India

1,200

Indonesia

1,000 China 800 South Africa

600 400 200 0

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006

Figure 3.2 Total trade (goods and services) in US$ billions (1980–2006). Source: World Development Indicators (WDI).

US$ billions 120.0 Brazil 100.0

80.0

Russia India Indonesia

60.0 China 40.0 South Africa 20.0

0.0 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 −20.0

Figure 3.3 Inward FDI in US$ billions (1980–2006). Source: UNCTAD World Investment Report (WIR): http://www.unctad.org/Templates/ Page.asp?intItemID=3277&lang=1.

40 Fredrik Erixon et al. since 2000. Inward FDI was US$ 69 billion in 2006. China’s outward FDI has also been increasing rapidly. It reached US$ 16 billion in 2006. China, unlike India, has successfully exploited comparative advantage in labour-intensive manufactures, and it has done so with a tight interlock between trade and FDI. China now accounts for close to 40 per cent of manufacturing exports from developing countries. Multinational enterprises (MNEs) account for almost 60 per cent of merchandize exports and imports. The fastest rates of export growth have been in finished consumer goods such as garments and toys, and in ICT products. In the latter category, as well as in assorted transport-and-machinery products, China has become the final-assembly point in east-Asian trade and FDI networks in parts and components, linked in turn to final export markets in the West. In contrast, services accounts for conspicuously low shares of China’s total trade and FDI. In sum, China has succeeded more than most developing countries, including the other BRIICS: first in generating very high rates of growth, and second in translating the latter into employment, poverty reduction and human-welfare improvement for a broad section of the population. High rates of saving and investment have driven this process, but trade and FDI have also been very important, especially in ramping up labour-intensive manufactured exports. China still has high regulatory barriers that waste resources, restrict internal trade and generally stifle domestic sources of growth. Tackling these barriers is the next big challenge. China in the WTO In the end-phase of China’s accession negotiations, many players and observers feared China might play sillybuggers once inside the WTO. Would it use the WTO as a foreign-policy football? Would it indulge in power plays and provocative rhetoric? Would it undermine multilateral rules? The answer to these questions is No. The strength of China’s unilateral reforms and WTO commitments, and its integration into the world economy, have made it keenly aware of its stake in well-functioning multilateral rules – more so compared with most other developing countries. China is a textbook example of how WTO accession works in tandem with national market-based reforms. It has become a strong WTO stakeholder, active in multilateral rule-enforcement and dispute settlement. For example, it has been very active in the WTO’s regular committees, particularly on core rules issues. Arguably, the embedding of China in the WTO has defused manifold international trade tensions that might otherwise have got out of hand; and it has smoothed China’s rapid integration into the world economy. Nevertheless, China’s record in the WTO has not been without controversy – not surprising given such a huge and complicated accession. Implementation of WTO commitments has been mixed. A raft of sensitive cases against China, mostly prosecuted by the USA, is working its way through dispute settlement. China has stayed conspicuously on the sidelines of the Doha Round. At the WTO

China’s trade policy 41 mini-ministerial meeting in July 2008, it was partly responsible for blocking an overall deal. Now we turn to these elements of China in the WTO in more detail. Implementation of WTO commitments2 On balance, China has been serious about implementing the bulk of its WTO commitments in timely fashion. That is true of phased tariff reductions, including the elimination of tariffs on goods covered by the Information Technology Agreement (ITA); phasing out import quotas, licences and other border NTBs; and expanding trading rights. The revised Foreign Trade Law, issued in April 2004, provides for trading rights to be granted automatically through a registration process for all domestic and foreign enterprises and individuals. This became effective six months before scheduled full liberalization required by China’s Protocol of Accession to the WTO. After pressure from the USA, tariff-rate quotas (TRQs) on protected agricultural products were expanded in line with WTO obligations. China has undertaken a huge programme of aligning national technical standards with international standards. In 2005 it reported that 1,416 national standards had been abolished as a result. It has also revised its laws to better protect intellectual property rights in line with the WTO’s Trade-Related Intellectual Property Rights (TRIPS) agreement. On the other hand, the USA, and to a lesser extent the EU, have led loud and vociferous complaints about China’s implementation record. Indeed, US complaints have increased and broadened in scope. To quote the US Trade Representative’s National Estimate on China’s trade barriers in 2008: In 2007, US industry began to focus less on the implementation of specific commitments that China made upon entering the WTO and more on China’s shortcomings in observing basic obligations of WTO membership, as well as on Chinese policies and practices that undermine previously implemented commitments. At the root of many of these problems is China’s continued pursuit of problematic industrial policies that rely on excessive government intervention in the market through an array of trade-distorting measures.3 To list some major complaints made by the US and other WTO members: Many WTO commitments are not uniformly applied in China. One example is uneven application of the WTO Customs Valuation agreement by customs officials at Chinese ports. Application of technical regulations, conformityassessment procedures and sanitary and phytosanitary (SPS) measures is arbitrary and inconsistent, with inadequate notification of new or revised measures under the terms of the WTO’s Technical Barriers to Trade (TBT) and SPS agreements. WTO notification of Chinese government subsidies was overdue and remains incomplete. IPR laws remain weakly enforced, particularly on copyright protection of a range of goods and services. There are substantial infringements of the Agreement on Trade-Related Investment Measures (TRIMS). China agreed not to make import and investment approval conditional on export-performance, local

42 Fredrik Erixon et al. content, foreign-exchange balancing and technology-transfer requirements. But officials continue to ‘encourage’ such measures without formally requiring them. This can amount to de facto requirements, especially as officials have substantial discretion in investment-approval procedures. It is also alleged that China is not living up to its WTO transparency obligations. Ministries and agencies responsible for drafting new or revised laws and regulations often do not circulate them for public comment – which is supposed to include foreign enterprises – and do not provide enough time for public comment before enactment. Finally, the USTR report notes that foreign enterprises remain sceptical about the adjudication of trade-related commercial disputes in designated Chinese forums, such as the China International Economic and Trade Arbitration Commission (CIETAC). Dispute settlement An indication of China’s serious commitment to the WTO has been its assiduous tracking of dispute settlement. Since its accession it has been a third party to sixty-two cases, in addition to being a complainant in two cases (US Steel Safeguards, and US Anti-Dumping and Countervailing Duties on Coated Paper) and a respondent in eleven cases.4 However, for the first five years of its WTO membership, China and other major players exercised mutual restraint in taking China-related cases to court. China viewed dispute settlement as a political-diplomatic mechanism to resolve differences through compromise and conciliation, before adversarial legal procedures kicked in. The USA, EU and others also generally refrained from testing China in court. In three cases – VAT-Integrated Circuits, EU-Coke Exports and AntiDumping Kraft Linerboards5 – China made major concessions and settled during the consultation phase, i.e. out of court (Gao 2005, 2007a, b). Mutual restraint seemed to end in about 2006. The USA launched a raft of cases against China. The first, on automotive parts, struck at China’s automotive industrial policy, which dates back to 2006. The latter includes provisions to encourage domestic production of auto parts. One measure stipulates that if the number or value of imported parts in an assembled vehicle exceeds specified thresholds, tariffs charged on imported parts should be equal to the tariff on completed automobiles (typically 25 per cent) rather than the tariff applicable to auto parts (typically 10 per cent). The complainants, the USA, EU and Canada, argued that this violates National Treatment and constitutes a prohibited local-content measure. Significantly, China chose not to settle the matter in consultations but to allow it to proceed to a formal adjudicatory panel (USTR 2008). The latter ruled against China, a decision confirmed by the WTO’s Appellate Body in late 2008. The USA followed up with four cases in 2007 and 2008. One case concerned Chinese subsidy programmes, e.g. income-tax exemptions and refunds, benefiting a wide range of locally manufactured goods. The USA argued that these measures discriminated against imports and imposed export-performance requirements, thus violating the WTO’s Subsidies and Countervailing Measures

China’s trade policy 43 and TRIMS agreements. The USA and China reached agreement on removing alleged prohibited subsidies during consultations. In addition, the USA filed a case relating to IPR enforcement in China; another, also IPR-related, on market-access restrictions on publications and audiovisual products such as films, DVDs, music, books and journals; and finally, one (filed jointly with the EU) on restrictions on financial-information services providers from dealing directly with Chinese clients (rather having to deal exclusively with Xinhua, the state news agency). The two IPR-related cases have gone to the panel stage, while the last case was settled in consultations in late 2008 (USTR 2008). These recent cases illustrate that China and its major trading partners have become more forceful in their use of dispute settlement. The USA has initiated cases that go to the heart of Chinese industrial policies and related domestic regulation. And China has become less wary of letting cases proceed to legal contest. On balance, this is healthy. China should be challenged in situations when it might well be in breach of its WTO obligations. At the same time, China should test the legal mechanics of WTO dispute settlement – to develop its traderelated legal capacity, defend its rights, and indeed to initiate cases when faced with infractions from its trading partners. Negotiations and participation in the Doha Round In stark contrast to its activism in implementing WTO obligations and in dispute settlement, China has been passive and a marginal player in the Doha Round – conspicuously so for the world’s leading developing country and third-largest trading nation. It seems to have made a decision to sit out this Round. Many motives have been ascribed to China’s quietism. The official rhetoric is that it needs time to digest new WTO obligations and generally acclimatize itself to WTO membership – but this is disingenuous after seven years in the club. More to the point, non-activism means that it has not stepped on developed and developing-country toes, and avoided extra pressure to further open its own markets through even stronger WTO commitments. But this has come at the cost of not forcefully pursuing its ‘offensive’ interests, particularly to open other markets for its manufactured exports, and secure stronger disciplines on AD duties and other ‘trade remedies’. To cynics who believe the Doha Round has always been a lost cause, Chinese wisdom and foresight might seem particularly acute. In terms of style, for much of the Round China differed markedly from most other developing countries, including the two other developing-country Big Beasts, India and Brazil. Unlike them, and indeed unlike the USA and EU, it eschewed polarizing rhetoric and confrontational posturing. It was especially careful not to antagonize the USA, but it was also sensitive to other developing countries’ fear of the Chinese export juggernaut. China’s overall negotiating position, in common with other Recently Acceded Members (RAMs), is that it is willing to contribute little or nothing beyond its WTO-accession commitments.6 There is a large gap between the RAMs’

44 Fredrik Erixon et al. strong WTO commitments and the weak commitments of most other developing countries. That is why the Doha mandate and subsequent negotiating texts have accorded special flexibility to the RAMs. China’s negotiating positions on specific issues have been mixed: offensive here, defensive there, and in-between here-and-there. That reflects a big, complicated country with a large spectrum of interests and preferences internally. In the non-agricultural market access (NAMA) negotiations, China’s interests are manifestly offensive: it wants greater access for its manufactured exports in both developed and developing countries. China has mixed positions on agriculture. Domestic sensitivities make it loath to commit to extra liberalization. On the offensive side, it needs lower developed and developing-country barriers to its growing labour-intensive agricultural exports. It has an interest in banning developed countries’ export subsidies and significantly reducing their tradedistorting domestic subsidies. Hence it joined the G20, led by India and Brazil. Its G20 participation, however, has been low key and non-belligerent. China is defensive in services. It has few export interests; and domestic sensitivities make it reluctant to concede stronger GATS commitments. However, as in goods, China is exceptional: in some cases its GATS commitments even exceed those of developed countries. One of China’s biggest priorities concerns anti-dumping. It has been active in the AD component of the rules negotiations and tabled proposals, mainly with a view to removing, or at least diluting, its non-market-economy status with some WTO members, notably the USA and EU. China had been flexible on Special and Differential Treatment (S&D) for developing countries, and on the Singapore issues (investment, competition, transparency in government procurement and trade facilitation). That said, China’s overall position seems to have hardened in the last couple of years. It has been impervious to US and EU demands to be more flexible with its defensive positions. Finally, during the WTO mini-ministerial in Geneva in July 2008, China emerged from the shadows. Led by its trade minister, Chen Denming, it formed part of the core group of six countries that tried to unblock deals in agriculture and industrial goods. Never before in the Round had it played such a role. But, within this core, it joined forces with India to defend a very generous ‘special safeguard mechanism’ to protect against agricultural imports, and resisted US pressure to lower its cotton tariffs (Beattie and Williams 2008). China belatedly played an up-front role in WTO negotiations, but it proved to be defensive rather than pragmatic and middle-of-the-road. That dovetails with a slowdown of liberalization at home and other defensive measures in China’s trade policy, especially since 2007. That is the subject of the next section. China’s trade-related reforms: unilateral measures and PTAs China’s mixed record in the WTO should be seen, above all, in the context of market reforms at home post-WTO accession. The overriding advantage of WTO accession is that it has locked in the sweeping unilateral reforms of the 1990s

China’s trade policy 45 and earlier, made China’s trade-and-investment regulations more transparent and predictable, and given China a long-term stake in multilateral rules. But faraway Geneva cannot drive reforms in Beijing. The national reform engine has slowed down, especially since 2007, and industrial-policy interventions have correspondingly increased. At the same time, China has been very active with PTAs, especially in its east-Asian neighbourhood. Now we turn to these two aspects of China’s trade policy in more detail. Unilateral reforms There has been paltry unilateral liberalization going beyond China’s WTO commitments. One example is the marginal opening of the highly protected securities sector, as a result of US pressure. But this is small beer. To a large extent, such liberalization slowdown is predictable. The Beijing leadership is more concerned with social stability in the wake of the massive social convulsions that have accompanied market reforms. Decision making is much more collegiate, cautious and incremental. This characterizes the leadership of Hu Jintao and Wen Jiabao – strikingly different from the bold, decisive strokes of Jiang Zemin and Zhu Rongji, and of Deng Xiaoping before them. On trade policy, national reforms and WTO-accession negotiations were highly centralized in MOFTEC (later MOFCOM), reporting directly to the State Council. After WTO accession, other regulatory agencies have got more involved. The government faces more lobbying – and resistance to further liberalization – from national regulatory agencies, state-owned enterprises (SOEs) and other ‘national champions’ in the private sector (or with hybrid forms of ownership), statesponsored trade associations, as well as provincial and municipal governments. Economic nationalism in government and the Communist Party is more influential than it was in the 1990s, though not quite in the driving seat. Finally, as China’s global economic clout has grown so quickly, so has the temptation to resort to more assertive mercantilism. That translates into unwillingness to open markets unilaterally, haggling hard over reciprocal concessions (especially with the USA), and stepping up industrial-policy interventions to promote favoured domestic sectors. None of the above is cause for wild alarm and panic: China is, to some degree, acquiring the ‘normal’ economic features and political pressures of a large, complex market economy. And its already deep integration into the world economy – much deeper than that of Japan, South Korea and Taiwan at an equivalent stage of development – constrains protectionist pressures and their distortive effects on international trade and investment. Still, these pressures need to be contained, especially with a global economic downturn and rising protectionism worldwide. Complacency is not the answer. Listed below are some major signs of industrial-policy intervention, as well as ‘unfinished business’ in external liberalization and related structural reforms.7 First, China’s already complex export regime has become considerably more restrictive. Export taxes, reduced VAT rebates on exports, export bans, licensing

46 Fredrik Erixon et al. and quotas are used to restrict exports of a growing number of goods – mainly raw materials and agricultural commodities. The objectives are various: defusing tensions with trade partners (e.g. over garments exports), reducing energy consumption, combating food inflation, and promoting downstream industries through cheaper inputs. Second, tax incentives, subsidies and price controls, as well as administrative ‘guidance’ on investment decisions, are used to favour domestic sectors over imports, especially where SOEs and assorted ‘national champions’ operate. This characterizes iron and steel, petrochemicals, automobiles and auto parts, forestry and paper, non-ferrous metals, telecommunications equipment, semiconductors and other science-and-technology sectors. Third, China has promoted unique national technical standards – some would say as a regulatory-protectionist device to compensate for falling border barriers. China-specific standards, at variance with international standards, can create high compliance costs for foreign enterprises. Notable examples are encryption for Wireless Local Area Networks (WLANs) and 3G mobile-phone standards. Foreign enterprises complain of lack of transparency in Chinese standard-setting bodies due to restricted membership, voting rights and information dissemination. This is exacerbated by standards set by different agencies at national and provincial levels. Foreign enterprises have similar complaints about Chinese conformityassessment bodies. They also complain about requirements to share commercially sensitive information and intellectual property when submitting samples and information for mandatory testing. Fourth, services barriers have come down more slowly than goods barriers, and perhaps more slowly than expected after WTO accession. High and discriminatory capital requirements discourage entry for foreign services providers in, for example, telecommunications, insurance and construction (though capital thresholds have been reduced in banking). Licensing procedures have become more transparent and regular, but problems remain, especially in financial services, telecommunications and express-delivery services. Equity and operating restrictions are prevalent in insurance, securities and telecoms, though not (at least formally) in banking. Telecoms is dominated by three SOEs, all with close links to the Ministry of Information Industries. No joint venture involving a foreign-invested enterprise has been licensed since WTO accession. Equity and severe operating restrictions apply to foreign Internet Services Providers (ISPs). Fifth, foreign-investment restrictions have been tightened. In November 2006, the National Development and Reform Commission (NDRC) announced a fiveyear plan for foreign investment. It stressed a shift from ‘quantity’ to ‘quality’, tighter tax supervision and restricted foreign acquisition of ‘dragon-head’ enterprises. This was soon followed by a government ‘guiding opinion’ identifying an enlarged list of ‘pillar’ and ‘backbone’ sectors in which further foreign investment in SOEs was to be prevented. New provisions on mergers and acquisitions also contained vague language on ‘national economic security’ and ‘critical industries’, perhaps intended to block foreign acquisitions. Foreign enterprises fear that the

China’s trade policy 47 new Antimonopoly Law, effective from August 2008, will be used to block mergers and acquisitions involving foreign-invested enterprises, and protect SOEs and other ‘national champions’. The Foreign Investment Catalogue, issued in 2007, suggests a more selective approach to foreign investment, targeting higher value-added sectors rather than basic manufacturing. It includes new restricted sectors such as biofuel production and soy crushing, and blanket prohibitions on foreign investment in movie production, news websites, audiovisual and Internet services. Another government ‘opinion’ calls for expanded domestic market share in industrial-machinery manufacturing sectors, which could presage difficulties for foreign investors seeking control of leading domestic firms. Finally, the government promotes domestic services sectors through foreigninvestment restrictions, notably in financial services and telecommunications. State promotion now extends to domestic private-equity and venture-capital funds. Sixth, government procurement explicitly discriminates in favour of domestic enterprises. China has applied to join the WTO’s Government Procurement Agreement (GPA), in line with its WTO-accession commitments, but negotiations have been predictably glacial. And seventh, energy sectors are largely insulated from global markets. Price controls apply to oil, natural gas, coal and electricity. Trade, investment and regulatory barriers protect SOEs in these sectors from international competition. PTAs China is the driving force for PTAs in Asia. By 2006, it had nine PTAs on the books and was considering negotiations with up to thirty other countries (Table 3.4). The China–ASEAN PTA, more than any other PTA initiative, is the one to watch in the region. It is the largest PTA ever negotiated, covering eleven diverse economies with a population of 1.7 billion. There has been progress in eliminating tariffs on trade in goods. However, little progress has been made on non-tariff barriers in goods, services (where a relatively weak agreement has been reached), investment and other issues. China has stronger ‘WTO-plus’ PTAs with Hong Kong and Macau (both admittedly special cases); a comprehensive PTA on goods with Chile; newly concluded PTAs with New Zealand and Singapore; and is negotiating PTAs with Australia, Iceland and EFTA. It has a partial-scope tariff agreement with Pakistan. It is also negotiating or thinking of negotiating rather weak PTAs elsewhere in the developing world, e.g. with Mercosur (Mercato del Sur – Market of the South) and the South African Customs Union (SACU). These are shallow – mostly preferential tariff reductions – on a limited range of products. China’s approach to PTAs is pragmatic and eclectic (Antkiewicz and Whalley, 2005). But it is mostly ‘trade light’. Even the China–ASEAN PTA is unlikely to create much extra trade and investment if it does not go substantially beyond tariff elimination in goods. China’s PTAs are driven more by ‘high politics’ (competition with Japan to establish leadership credentials in east Asia; securing privileged

48 Fredrik Erixon et al. Table 3.4 Recently established or proposed RTAs/CEPAs by China (2000–2007) Partner country

Type

Status

ASEAN Asia-Pacific Costa Rica ASEAN+3 ASEAN+6 New Zealand Australia Chile Gulf Cooperation Hong Kong Iceland India Japan–Korea Korea Macao Norway Pakistan Peru Singapore South Africa South African Customs Union Thailand Shanghai Cooperation Organization

CECA PTA FTA FTA FTA FTA FTA FTA FTA CEPA FTA RTA FTA FTA CEPA FTA FTA FTA FTA FTA CU/FTA FTA FTA

Under Implementation Under Implementation Proposed/Under consultation and study Proposed/Under consultation and study Proposed/Under consultation and study Signed FA signed/FTA Under Negotiation Under Implementation Under Negotiation Under Implementation FA signed/FTA Under Negotiation Proposed/Under consultation and study Proposed/Under consultation and study Proposed/Under consultation and study Under Implementation Proposed/Under consultation and study Under Implementation Proposed/Under consultation and study Under Negotiation Proposed/Under consultation and study Under Negotiation Under Implementation Proposed/Under consultation and study

Source: FTA database for Asia at the Asian Regional Integration Centre (ARIC), Asian Development Bank: www.aric.adb.org

influence in other regions) than by economic strategy. Foreign-policy ‘soft power’, i.e. diplomacy and relationship-building, is paramount. This reflects the emerging PTA pattern in Asia, and the established PTA pattern in other developing-country regions (Sally 2006). Politically sensitive sectors in goods and services are carved out, as are crucial areas where progress in the WTO is elusive (especially disciplines on AD duties and agricultural subsidies). Little progress is usually made in tackling domestic regulatory barriers (e.g. relating to investment, competition, government procurement, trade facilitation, crossborder labour movement and food-safety and technical standards). PTAs hardly go beyond WTO commitments, deliver little, if any, net liberalization and procompetitive regulatory reform, and get tied up in knots of restrictive, overlapping rules of origin (ROOs). In addition to bilateral PTAs, China is at the heart of regional-economicintegration initiatives in east Asia (Kawai and Wignaraja 2008). An ‘ASEAN Plus Three’ PTA (the ‘three’ being Japan, South Korea and China) has been touted, as has a three-way Northeast-Asian PTA (Japan, China and South Korea) and an ‘ASEAN Plus Six’ PTA that might include India, Australia and New Zealand. Visions of an East Asian Economic Community and even an Asian Economic Community have appeared on the horizon.

China’s trade policy 49 So far this talk is loose and empty. Regional players are speeding ahead with bilateral PTAs. The emerging pattern is of a patchwork of ‘hub-and-spoke’ PTAs, in a ‘noodle bowl’ of trade-restricting ROOs. This threatens to slow down and distort the advance of regional and global production networks. In particular, it could undermine the dense networks of east-Asian production-sharing and trade in manufacturing parts and components (‘fragmentation-based trade’, or what Richard Baldwin calls ‘Factory Asia’), which are in turn linked to final markets in Europe and North America (Athukorala 2006; Baldwin 2006). More generally, bitter nationalist rivalries – especially between China and Japan – and vast intercountry differences in economic structure, development, policies and institutions, will continue to stymie east-Asian and pan-Asian regional-integration efforts for a long time to come. China’s trade policy: challenges ahead China’s domestic climate for further trade-and-investment liberalization is clearly more inclement than it was before WTO accession; and there are signs of greater industrial-policy interventionism. These tendencies are reinforced by an external climate of liberalization slowdown, ‘reform fatigue’, Washington-Consensus scepticism, and, since 2008, increasing protectionism in response to worsening global economic conditions. It is important for China, and indeed for the rest of the world, not to go further in this direction. What China does, and what other major players do, are of course closely related. China’s immediate challenge is to play a strong supporting role in containing emerging global protectionism. Its maxim must be to ‘first do no harm’: by not retreating into further protectionism itself, it will send a powerful signal to others to follow its example. That means refraining from measures such as artificial currency depreciation, big export tax rebates, and additional inward-investment restrictions, import tariffs and export subsidies. This would be akin to China’s positive, system-supporting response to the Asian crisis a decade ago. Beyond that, China’s trade-policy challenges are twofold: to plug gaps in its implementation of WTO commitments; and to proceed with WTO-plus reforms. Both depend on restraining industrial-policy activism. That is easier said than done. Industrial-policy activists abound in Beijing and in provincial and municipal governments. In particular, sub-national officials enjoy considerable de facto autonomy, which they often use to restrict competition and protect well-connected incumbents. On WTO implementation, China needs to improve its enforcement of the TRIPS, TRIMS, SPS, TBT and SCM agreements, and have better WTO notification of its subsidies. Better enforcement of WTO agreements requires stronger restrictions on regulatory discretion at national and sub-national levels, especially on official ‘encouragement’ and ‘guidance’ of measures that are clearly incompatible with WTO obligations. More transparency is also needed, e.g. freely and promptly circulating draft laws and regulations to interested foreign enterprises, and allowing them sufficient time for comment. That said, limits

50 Fredrik Erixon et al. to regulatory discretion will prove very difficult in a country that still has not completed its journey from Plan to Market, and which has large, complex bureaucracies at national and sub-national levels. What about WTO-plus reforms? China could further reduce applied import tariffs, especially on industrial goods. It should reverse export controls on raw materials and agricultural commodities. But its more substantial – and politically tricky – challenge is to tackle high trade-related domestic regulatory barriers in goods, services and investment. Ideally, China would reduce measures to promote capital-intensive, SOEdominated sectors at the expense of imports; align national standards with international standards, alongside a more active role in international standards-setting bodies; restart services liberalization (by easing capitalization requirements, equity restrictions, and licensing and operating procedures); lower foreign-investment restrictions (by narrowing down lists of sectors in which foreign investment is banned or discouraged, and not applying antitrust provisions to block foreign transactions in favour of ‘national champions’); and gradually liberalize markets in government procurement and energy. All this is a tall order, even in good times. But it becomes especially problematic when anti-liberalization sentiment swells in response to worsening economic conditions. The first task is to prevent blatant protectionist backsliding. The next task is to prevent the escalation of selective industrial policies that distort international trade and investment. The subsequent task is to take liberalization and regulatory reform further, however gradually and patchily. China’s trade-policy reforms should also be seen in the context of necessary domestic reforms. Here the wishlist is long: revaluation of the Renminbi to something approaching market-determined levels; restructuring and privatization of SOEs and state-owned banks; financial-sector reform to deepen capital markets and turn savings into more productive investments; secure private property rights, including legal title to rural land; deregulation of internal trade to create a more integrated domestic market; market pricing for a range of inputs (land, water and other natural resources); and better provision of public services (health, education, pensions and social security). These are all reforms that would help ‘rebalance’ growth, making it less reliant on exports and capital-intensive, polluting production, and more reliant on services and domestic consumption. Externally, some of these policies would help reduce global macroeconomic imbalances and lower trade tensions.8 The common thread is that these policies would be competition-enhancing; they would lower transaction costs and improve the business climate. But that is precisely what WTO-plus reforms would do for international trade and investment. Both sets of reforms, domestic and external, would be mutually reinforcing: they would ease the costs of doing business and enable trade and investment – for domestic and international traders and investors. There are several tracks on which to pursue China’s trade-related reforms: the unilateral (domestic) track; in the WTO; in PTAs; and in key bilateral relationships, especially with the USA and EU. Consider each in turn.

China’s trade policy 51 First, the primary thrust of trade-related reform must be unilateral, i.e. outside trade negotiations, and hitched firmly to domestic reforms to improve the business climate. Put another way, trade policy should be embedded in domestic economic policy and its institutional framework rather than being driven by external negotiations and international institutions. Trade-related regulatory reforms are bundled up with domestic politics and economics; initiating and implementing them is overwhelmingly a domestic affair; and the scope for productive international negotiations and agreements is restricted. Chinese unilateral liberalization also has a vital external dimension. It is the biggest the world has ever seen, with the biggest spillover effect in Asia. China’s opening not only spurred southeast-Asian liberalization pre-Asian crisis; it probably helped prevent liberalization reversal post-Asian crisis. It has also encouraged east-Asian countries to further liberalize at the margin post-Asian crisis – for fear of losing trade and FDI to China. Not least, China has probably spurred Indian liberalization of import tariffs and FDI restrictions in some services sectors. Hence much depends on this Chinese engine for future trade and FDI reforms, elsewhere in Asia and beyond. It is vital it does not stall completely or go into reverse gear. And it is important that it revs up again. Second, China-induced unilateral liberalization is not a panacea. It does not lock in liberalization against future backtracking. Nor does it provide fair, stable and predictable rules for international commerce. That leaves room for reciprocal negotiations and international agreements, particularly in the WTO. The failure of the Doha Round (as of the time of writing) probably shows that future multilateral liberalization will be elusive and modest at best. Arguably, the best the WTO can hope for post-Doha is to lock in pre-existing unilateral liberalization through binding commitments, and gradually improve the functioning of multilateral rules. There should indeed be much stronger focus on safeguarding, updating and improving trade rules – in which China has such a substantial stake. This is more important for most WTO members than extra multilateral liberalization. China should be active in plurilateral ‘coalitions of the willing’ to make key market-access and rule-making decisions, and correspondingly take on stronger commitments than poorer, weaker and more recalcitrant developing countries. China, India and Brazil – the three developing-country Big Beasts in the WTO – should exercise co-leadership alongside the USA, EU and perhaps Japan (if the latter can get its act together). China’s helping hand will be indispensable – arguably more important than those of India and Brazil. PostDoha, it is vital that China moves to the WTO foreground and plays an active co-leadership role. Third, PTAs are generally trade-light; their noodle-bowl discriminatory patchwork causes complications for business and multilateral rules; and they are unlikely to spur regional and global integration. There should be much more caution with PTAs; and serious attempts made to minimize the damage from their discriminatory provisions. Again, China’s lead will be important. It needs to signal its intention to avoid gimmicky initiatives, clean up existing weak and dirty PTAs, and make them more compatible with multilateral rules.

52 Fredrik Erixon et al. Fourth, China’s key bilateral relationships, especially with the USA and EU, matter as much as what it does in the WTO and PTAs. These are, of course, twoway streets. The Beijing leadership is likely to arrest protectionist backsliding, and go farther with liberalization and structural reforms, if it enjoys friendly, give-and-take relations with major trading powers. This is probably necessary to overcome domestic opposition to change. Tub-thumping protectionism and belligerence by the USA and EU about issues such as the Chinese exchange rate and current-account surplus, and imports of garments and other labour-intensive exports, as well as on security-related issues, invite a Chinese backlash and make its leadership more defensive. That is a recipe for reform stoppage and reversal. Thus it behoves the USA in the first instance, and then the EU, to strengthen ‘constructive engagement’ with China across a broad range of economic and foreign-policy issues, while containing foreign-policy hawks and protectionist forces at home. This will, in turn, encourage Beijing to strengthen its key bilateral relationships and its participation in international institutions, contain aggressive nationalistic tendencies (especially directed at Taiwan and Japan), and, not least, step up economic reforms at home.9 This is the frame we use to view China–EU commercial relations. To this we now turn.

2. China–EU commercial relations We begin this second part of the chapter with trade and FDI patterns in the bilateral relationship. Then we discuss macroeconomic issues, notably the current account and exchange rates. Finally, we look at key trade-and-investment issues in bilateral relations. Trade and FDI patterns China is the EU’s second-largest trading partner. It is followed some distance behind by other Asian countries (see Table 3.5 for trade in goods). It is now the biggest source of EU goods imports, some way ahead of the USA and with 16 per cent of the EU market in 2007 (Table 3.6). The EU in turn is China’s biggest trading partner, ahead of the USA and Japan, and accounting for 20 per cent of Chinese exports. EU–China trade has been increasing by about 20 per cent per annum in recent years (17 per cent in 2007), and more than doubled between 2003 and 2007. Two-way trade in goods exceeded EUR 300 billion in 2007. EU goods exports to China were EUR 72.6 billion in 2007, an increase of 12 per cent on the previous year despite a 16 per cent appreciation of the RMB against the Euro in the same period. Chinese goods exports to the EU were EUR230 billion in 2007.10 EU–China services trade is very low compared with goods trade, and minuscule compared with EU–US services trade (Table 3.7). The USA is by far the EU’s biggest investment partner. EU FDI to the USA and US FDI to the EU dwarf other bilateral EU FDI stocks and flows.

1 2 3 4 5 6 7 8 9 10

2.661.077 441.731 302.643 232.339 169.410 121.560 119.850 99.424 64.156 55.644 53.797 131.809 1 2 3 4 5 6 7 8 9 12

Rank

Rank

Mio euro

2006

2007

2.510.656 444.201 258.603 213.125 159.316 122.014 117.622 91.686 63.626 46.989 44.914 125.880

Mio euro 1 2 3 4 5 6 7 8 10 11

Rank

2005

2.233.196 416.702 212.225 169.518 149.233 117.815 101.053 80.706 54.676 40.408 40.182 115.560

Mio euro 1 2 4 3 5 6 7 8 12 11

Rank

2004

Source: DG Trade Statistics, European Commission (http://ec.europa.eu/trade/issues/bilateral/dataxls.htm)/Eurostat.

World USA China Russia Switzerland Japan Norway Turkey South Korea India Brazil ASEAN – 6

EU imports + EU exports

1.980.462 394.869 177.068 129.983 137.213 118.101 86.074 72.865 48.601 33.523 35.884 110.918

Mio euro

Table 3.5 Leading partner countries of the EU27 in merchandise trade (excl. services) – (excluding intra-EU trade)

1 2 5 3 4 6 7 8 14 11

Rank

2003

1.804.482 385.406 147.693 107.869 130.471 113.365 78.685 58.109 42.451 28.636 31.509 104.016

Mio euro

2 1 3 5 4 8 11 16 18 20 23 34 40

100.0 16.6 11.4 8.7 6.4 4.6 2.4 2.1 1.5 1.1 0.9 0.7 0.4 0.4 5.0

1 2 3 4 5 8 9 15 24 26 32 39 40

2.661.077 441.731 302.643 232.339 169.410 121.560 64.156 55.644 38.959 29.307 24.477 18.165 11.390 9.512 131.809

1.423.025 180.621 230.945 143.314 76.736 77.867 39.367 26.200 18.362 17.938 16.601 12.745 7.796 5.555 78.996

Mio euro

Rank

% world

Rank

Mio euro

EU imports from

EU imports + exports

100.0 12.7 16.2 10.1 5.4 5.5 2.8 1.8 1.3 1.3 1.2 0.9 0.5 0.4 5.6

% world 1 4 3 2 6 12 9 18 25 32 37 46 43

Rank

1.238.052 261.111 71.698 89.025 92.675 43.693 24.788 29.444 20.597 11.369 7.876 5.421 3.594 3.957 52.814

Mio euro

EU exports to

Source: DG Trade Statistics, European Commission (http://ec.europa.eu/trade/issues/bilateral/dataxls.htm)/Eurostat.

World USA China Russia Switzerland Japan South Korea India Singapore Malaysia Thailand Indonesia Vietnam Philippines ASEAN − 6

Country

Table 3.6 Leading import and export countries of the EU27 merchandise trade 2007 (excluding intra-EU trade)

100.0 21.1 5.8 7.2 7.5 3.5 2.0 2.4 1.7 0.9 0.6 0.4 0.3 0.3 4.3

% world

China’s trade policy 55 Table 3.7 Leading import and export countries of the EU27 services trade 2007 (excluding intra-EU trade) Country EU imports + exports

EU imports from

EU exports to

Rank Bln euro % world Rank Bln euro % world Rank Bln euro % world World∗ USA 1 Japan 2 China 3

899.7 262.5 32.6 30.4

100.0 29.2 3.6 3.4

1 2 3

406.0 125.6 13.3 13.0

100.0 30.9 3.3 3.2

1 2 3

493.7 136.9 19.3 17.4

100.0 27.7 3.9 3.5

Source: DG Trade Statistics, European Commission (http://ec.europa.eu/trade/issues/bilateral/ dataxls.htm)/Eurostat. ∗

World is calculated excluding intra-EU trade

Outward and inward FDI with Asian countries follows far behind. EU FDI stock in China was EUR32.7 billion in 2006, representing 8 per cent of total FDI stock in China. EU FDI to China was EUR6 billion in 2006, compared with EUR2.1 billion of Chinese FDI to the EU (Table 3.8). A broad sense of China’s economic diversity is essential for an accurate assessment of the competitive pressures China will exert on the EU and the rest of the world economy, and of the opportunities China offers to EU and other exporters and investors, in the decades ahead. With 420 million people, the nine richest Chinese provinces are roughly as populous as the whole EU. With more than half China’s GDP, they already enjoy a GDP per capita of over US$ 9,000 in purchasing-power-parity (PPP) terms, making them as rich as or richer than fourteen EU member-states. For example, Shanghai is similar to Greece and Liaoning similar to Romania (Table 3.9). These basic facts suggest two conclusions. The nine provinces that account for 85–90 per cent of China’s current external trade and inward FDI are fast losing their comparative advantage based on low wages. That means that the competitive pressures they will exert on EU economies will be much less based on basic (or ‘cut-throat’) price competition. Their future growth will depend on the quality and variety of their products, and their capacity to innovate. Second, the population of these nine provinces is rapidly developing the taste for goods and services similar to those consumed in Europe. Trade and investment opportunities in China will no longer be limited to equipment goods and luxury consumer products. They will expand to ‘normal’ consumer goods, with a market size equivalent to Spain and Italy today (at current exchange rates), and another EU in the longer run. That said, the rise of Chinese average incomes hides huge differences between these nine provinces and others lagging behind (Messerlin and Wang 2008: 5–9). The current account and exchange rates11 From about mid-2007, the European Commission adopted a more confrontational tone in EU–China trade discussions. A major source of tension is the ballooning

−3654 3802 10849 4175 −13157 317 1991 5237 1936 1154 −1552 − 934 8284

953.716 3.568 12.659 247.764 99.264 7.581 3.197 40.041 2.723 153 −3.309 − 940 41.137

934.309 32.714 52.249 333.204 75.516 29.174 13.432 54.317 8.875 9.245 9.501 − 5.941 89.763

67.289 –116 2.777 18.849 −4.622 1.276 547 −2.026 431 32 400 − 154 −1.059

71.970 6.000 10.389 20.889 491 1.277 2.471 10.246 1.692 1.164 −2.047 − 812 12.101

75.624 2.198 .460 16.714 13.648 960 480 5.009 −244 10 −495 − −122 3.817

Outward stock

FDI inflow

Inward stock

FDI outflow

FDI inflow

Balance

2005

2006

31.292 6.241 9.596 74.442 11.920 5.006 2.452 −188 683 162 4.038 − 171 4.754

FDI outflow −35997 6357 6819 55593 16542 3730 1905 1838 252 130 3638 − 17 5813

Balance

874.540 1.112 12.315 240.110 82.701 6.143 2.517 28.173 1.729 114 −2.607 − 1.100 29.394

Inward stock

Source: DG Trade Statistics, European Commission (http://ec.europa.eu/trade/issues/bilateral/dataxls.htm) / Eurostat.

USA China Russia Switzerland Japan South Korea India Singapore Malaysia Thailand Indonesia Vietnam Philippines ASEAN

Country

Table 3.8 FDI inflow/outflow and inward and outward FDI stock EU27 in million Euros

850.366 28.171 33.277 310.806 90.161 28.873 11.142 48.752 7.961 8.665 10.890 − 4.844 82.838

Outward stock

451 13 15 80 − 1.841 2.407

11.522 518 261 16.588 8.156 1.420

FDI inflow

2004

15.496 3.868 6.013 −11.872 5.814 1.953 1.562 2.696 1.094 316 204 − 446 4.726

FDI outflow

3974 3350 5752 −28460 −2342 533 1562 2245 1081 301 124 − -1395 2319

Balance

842.190 1.811 5.762 233.457 89.211 5.498 680 17.711 1.661 189 403 − 1.034 22.222

Inward stock

815.787 22.465 21.615 250.399 79.463 20.582 9.074 45.847 8.074 7.964 7.115 − 4.288 75.261

Outward stock

70.014 38.058 34.724 34.108 33.626 32.077 31.995 31.580 30.496 30.469 29.644 27.750 27.270 25.520 24.473 23.004 20.410 20.281 20.006 17.014 16.654 15.881 14.085 13.573 13.218 9.374 9.353

Luxemburg Ireland Netherlands Austria Denmark Belgium Sweden UK Germany Finland France Italy Spain Greece Cyprus

Slovenia Malta

Czech Rep. Portugal Hungary Estonia Slovak Rep. Lithuania Poland Latvia Romania Bulgaria

EU27 and Asian countries

18.258 14.289 13.478 12.494 10.257 9.461 9.209 8.659 7.351

Zhejiang Guangdong Jiangsu Shandong Liaoning Fujian Nei Mongol Hebei

22.285

25.476

Tianjin

Beijing

Shanghai

13.735 12.015 9.844 7.704 7.267

Shanghai Beijing Tianjin Zhejiang Guangdong

Upper Middle Income

High Income

WB

Higher estimate GDP per cap [a]

Lower estimates GDP per cap [b]

Classification

Chinese provinces

Table 3.9 EU Member states and Chinese provinces GDP per capita (2005 US$ in PPP)

(Continued)

Mostly Developing Countries

Developed Countries

WTO

2.142 1.453 1.268

Vietnam

Cambodia Bangladesh

Heilongjiang Jilin Xinjiang Shanxi Hainan Henan Hubei Ningxia Qinghai Shaanxi Hunan Chongqing Jianxi Xizang Sichuan Guangxi Anhui Yunnan Gansu Guizhou

7.020 6.760 6.628 6.135 5.543 5.528 5.371 5.182 5.125 5.100 4.821 4.812 4.647 4.562 4.267 4.233 4.097 3.907 3.744 2.503 Jiangsu Shandong Liaoning Fujian Nei Mongol Hebei Heilongjiang Jilin Xinjiang Shanxi Hainan Henan Hubei Ningxia Qinghai Shaanxi Hunan Chongqing Jianxi Xizang Sichuan Guangxi Anhui Yunnan Gansu Guizhou

6.736 5.530 5.101 4.965 4.669 3.963 3.785 3.645 3.574 3.307 2.988 2.980 2.896 2.794 2.763 2.749 2.599 2.595 2.505 2.459 2.300 2.282 2.209 2.106 2.018 1.349 Low Income Income

Low Middle Income

WB

Higher estimate GDP per cap [a]

Lower estimates GDP per cap [b]

Classification

Chinese provinces

Least Developed Countries

WTO

Source and notes: [a] Based on previous PPP rates (WDI, World Bank, 2007). [b] Based on new (preliminary) PPP rates (2005 International comparison program: preliminary results, World Bank, 2007). [c] There is no official definition for ‘Developing Country’ in the WTO.

6.869

Thailand

EU27 and Asian countries

Table 3.9 Cont’d

China’s trade policy 59 EU’s trade deficit with China, which Commissioner Mandelson referred to as a ‘policy time bomb’. It rose from roughly EUR50 billion in 2001 to around EUR170 billion in 2006, a more than threefold increase. The EU trade deficit rise to around EUR169 billion in 2008, coming ever closer to the US trade deficit with China (US$256 billion in 2007). That does, however, mask one central difference between the US and EU current-account deficits: the EU’s overall deficit is negligible (around 0.5 per cent of EU-27 GDP), while the US equivalent is 5–6 per cent of US GDP. Economic analysis shows that trade deficits should concern macroeconomic policy-makers, not trade officials (Corden 2007a). In a nutshell, the trade balance of a country reflects its domestic savings–investment balance, those of its partners, and the macroeconomic policies influencing these balances (trade-policy instruments having little or no influence on domestic savings and investment decisions). EU trade officials’ fixation with the EU–China trade deficit is misplaced: Germany’s trade surplus, for instance, is even larger than China’s surplus. There are additional reasons for not being obsessed by the EU–China trade deficit. While the latter has increased, the EU’s trade deficit with the rest of the world has decreased – from EUR93 billion in 2000 to EUR66 billion in 2006. Many trading partners of the EU export to the EU via China rather than from their home countries. This is particularly the case for nine large trading partners with the EU: the USA, Japan, South Korea, Hong Kong, Indonesia, Malaysia, Singapore, Taiwan and Thailand. Figure 3.4 illustrates this evolution. Since 1999, there has been an increasing EU import share from China (the rising bottom curve), and a decreasing cumulated EU import share from the other nine advanced economies (the narrowing gap between the rising bottom curve and the declining top curve).12 Europe has thus imported more from China, but relatively less (in terms of import shares) from other Asian sources and the USA. The major difference between today and the 1980s and 1990s is that the EU global trade deficit is not spread over several Asian countries; rather it is concentrated on one of them – China.

Cumulated EU import shares (%)

60 50 40 30 20 10 0 1995 China

1999

2000

Hong Kong & Taiwan

2001

2002 South Korea

2003 Japan

2004

2005

Other Asia Pacific

Figure 3.4 A broader view of the EU–China trade deficit: the import side.

2006 USA

60 Fredrik Erixon et al. In short, the EU–China trade deficit is a reflection of the massive reshaping of global trade flows and production networks in the past decade, with China acting as an assembly hub where inputs from other countries are put together to be re-exported. Such ‘fragmentation trade’ (or ‘processing trade’) links dense east-Asian cross-border flows of parts and components to final markets in the West. That includes the intra-firm trade and global supply chains of EUbased companies (though this aspect is difficult to capture in conventional trade-data analysis). China has established comparative advantage in lowtech, labour-intensive finished goods such as garments and toys (classified as ‘miscellaneous manufactures’). But its final-assembly exports of products enmeshed in fragmentation trade (mostly ICT products bunched in the ‘machinery and transport equipment’ category) have been growing even faster (Athukorala and Hill 2008). The EU’s deficit in the latter category grew by more than EUR50 billion between 2000 and 2006. These trends are consonant with conventional trade theory. China is simply exploiting comparative advantage in unskilled and semi-skilled labour-intensive manufacturing, and following a standard path into the global division of labour. Hence the EU–China trade deficit is nothing to worry about. Lastly, it is profoundly misleading to focus on an overall ‘EU’ deficit. Few observers have noticed that, between 2000 and 2006, a majority of EU member states (16 countries, representing almost two-thirds of EU GDP and population) have had higher export growth rates to China than their import growth rates from China. This means that their export–import ratio with China is improving, sometimes substantially (see Table 3.10, columns 1 to 4). The new member states (the ‘EU-12’ line at the bottom of Table 3.10) have on average substantially improved their export–import ratios with China. And Eurozone members are equally divided between those with improving and worsening export–import ratios. Now turn to the exchange-rate issue. In late 2007, the EU broke its official silence on the appropriate exchange rate of the Chinese currency. Since then, EU officials have urged China to let the RMB appreciate against other currencies. Strong and mutually reinforcing economic and political reasons should induce EU not to go hurtling down this American route (with accusations of a ‘yuan fundamental misalignment’ and calls to declare China a ‘currency manipulator’). First, from a purely economic perspective, predicting the ‘right’ exchange rate is impossible. Economists disagree widely on the extent of the yuan’s underevaluation. Estimates run from zero to nearly 50 per cent. These diverging results are due to differences in the assumptions made and variables included, as has been shown carefully by two recent IMF studies (Dunaway and Li 2005; Dunaway et al. 2006). The inability to predict the ‘right’ exchange rate of a currency (particularly in an economy changing as fast as China’s) is the strongest argument for the use of the market as the best way to determine exchange rates.

Table 3.10 Intra-EU trade and trade with China with the EU member states (EUMS)

EU 27

Trade indicators EU 27 with China

Trade deficit % of GDP

Annual growth rate (2000–2006)

Export–import ratio

Trade with China

Intra-EU trade

Export [1]

2000 [3]

2006 [a] [5]

2005 [6]

Import [2]

Trade with China: EUMS with export growth rates than import growth rates 34.4 0.4 Latvia 133.0 Estonia 76.4 12.5 4.3 Malta 72.7 9.6 3.3 25.4 5.2 Slovakia 61.1 0.8 44.2 10.3 Cyprus 4.3 26.9 Hungary 55.3 Poland 33.6 15.6 7.1 Ireland 31.9 15.6 22.4 26.2 12.5 13.9 Portugal 26.7 2.2 Lithuania 39.9 23.2 12.7 10.7 Slovenia 24.7 15.7 4.4 Greece Czech Republic 28.1 22.9 9.5 15.3 11.7 42.0 France Germany 16.7 55.2 19.4 20.7 19.6 13.4 Spain

2006 [4] higher 10.5 63.6 50.0 23.6 3.9 14.3 17.1 49.5 27.7 4.1 18.4 6.8 12.2 50.8 63.3 14.1

Trade with China: EUMS with export growth rates smaller than import growth rates UK 12.3 12.6 17.0 16.7 Italy 15.7 16.9 33.9 31.8 15.6 29.7 26.6 Denmark 13.6 Belgium 13.9 16.8 33.4 28.6 20.0 23.6 12.8 10.8 Netherlands 14.0 19.9 69.6 51.5 Austria 13.2 109.9 57.5 Sweden 1.6 Finland 5.1 21.1 156.4 66.9 47.8 16.2 8.1 Bulgaria 31.5 Romania 11.0 44.7 49.2 10.0 Luxemburg 21.1 84.6 76.4 6.1 17.4 34.7 32.9 EU 27 16.3 EC 6 [b] 17.9 18.0 39.4 39.1 14.9 30.7 24.4 EC 9 [b] 10.6 EC 12 [b] 36.0 23.2 8.4 15.2 18.1 38.8 37.4 Eurozone 17.4 15.5 24.3 20.0 Non-Eurozone 11.8

−1.1 −1.1 −1.3 −1.5 −1.7 −4.2 −1.2 −0.6 −0.4 −2.7 −0.9 −0.9 −2.3 −0.5 −0.7 −1.2

−16.2 −11.8 −30.0 −0.5 −20.0 2.8 −2.3 12.2 −8.9 −9.2 −9.3 −9.3 3.1 −2.1 4.3 −3.6

−1.3 −0.9 −1.2 −2.4 −5.5 −0.5 −0.6 −0.6 −3.4 −2.0 −11.4 −1.2 −1.2 −1.2 −1.1 −2.0 −1.1

−3.1 −0.1 2.4 7.3 23.0 −4.4 −0.6 −0.1 − − 2.1 − 3.2 −2.6 [c] − 1.7 1.7 −2.0

Source: Eurostat, Trade Statistical Yearbook (2006), Eurostat Press Release (26 November 2007). Notes: [a] 2006 trade deficit in percentage of 2005 GDP. [b] EC 6: the founding EU member states’ EC 9 the nine EU member states having acceded before 1995; EC 12: the EU member states having acceded since 2004. [c] Excluding Bulgaria and Romania. Underlined EU member states are eurozone members in 2008.

62 Fredrik Erixon et al. Second, consistency between internal and external EU policy should make one wary of introducing currency matters into trade policy towards China. Within the EU, flexible and fixed (the Eurozone) exchange rates coexist. Almost all EU member states with a trade deficit with other EU member states have intraEU trade deficits larger than their trade deficits with China (see Table 3.10, columns 5 and 6). Moreover, out of the fifteen Eurozone members, nine have had a trade deficit since 1995, and five a quasi-permanent trade surplus (with only Italy shifting significantly from a trade surplus to a trade deficit during this period). Last, the yuan exchange rate is not the only – nor even the main – channel of corrections required to unwind global macroeconomic imbalances (Corden 2007b). It is in the interest of all countries, including the EU and the USA, that such corrections should be as smooth as possible. Deeper macroeconomic changes are needed, particularly an increase in the US saving rate, an increase in the Chinese spending rate and structural reforms in Europe. To summarize: it cannot be taken for granted that the RMB is systematically undervalued; the evidence is mixed and speculative. There is neither a case for being concerned about the bilateral trade deficit nor for forcing China to revalue its currency to address the matter. The structure of the EU–China trade balance is also a result of China’s macroeconomic policies. China has decided to run a big current-account surplus and accumulate vast foreign reserves, not least to compensate for and insure against underdeveloped capital markets at home. Yet China is now faced with domestic pressures that could – indeed should – lead to more incremental revaluation, or even to an eventual currency float. That would likely bring about a reduction in the trade surplus, provided revaluation was accompanied by measures to increase domestic investment opportunities for high domestic savings. Key trade-and-investment issues and the institutional framework for bilateral commercial relations The European Commission goes so far as to say that ‘China is the single most important challenge for EU trade policy’ (EU Commission 2006a). Yet the EU is avoiding a PTA with China, while it prioritizes negotiations with less important Asian trading partners (South Korea, ASEAN and India).13 As things stand, a serious EU–China PTA is not achievable for either side. China would ask for the following: recognition of market-economy status (MES); stronger disciplines on EU AD and safeguard measures; removal of peak tariffs on garments, leather goods and other manufactured exports; reduction of agricultural subsidies and tariffs to open markets for its expanding agricultural exports; and less trade-restrictive EU SPS and TBT measures. All these measures restrict China’s labour-intensive goods exports. PTA negotiations would put extra pressure on the EU to reduce or remove many of these barriers, which would expose inefficient EU producers to even greater Chinese competition. That is the main reason why the EU avoids a PTA with China.

China’s trade policy 63 What would EU exporters and investors gain from a PTA with China? A comprehensive, WTO-plus EU–China PTA would take over 90 per cent of Chinese tariffs down to zero (from a nominal average of 9 per cent); deliver GATS-plus commitments on services liberalization; remove foreign-ownership restrictions and secure better legal protection for EU investors; impose greater disciplines and transparency on all manner of domestic regulation (e.g. on administering subsidies, licences, safety standards, IPR and customs procedures); gain WTOplus commitments on government procurement, competition rules and trade facilitation; and extract commitments on core labour and environmental standards. As things stand, China is unlikely to make most of these concessions, just as the EU is unlikely to concede anything major to China, in high-pressure bilateral PTA negotiations. Besides, the trade-diversionary and system-fragmenting effects of a PTA between these two large powers might be considerable. Hence, now is not the time to launch an EU–China PTA initiative. Moreover, an EU–China PTA might not be a good idea at any time, now or in the future. But now is the time to strengthen and strongly institutionalize bilateral trade cooperation. Present arrangements are too soft. They should be hardened – without jumping onto the PTA bandwagon. Hitherto, the legal basis for bilateral relations has been the Trade and Cooperation Agreement of 1985. Since then there have been seven formal agreements and twenty-two sectoral and regulatory dialogues on a wide range of issues. The EU and China agreed to a ‘strategic partnership’ in 2003. In 2007, both sides agreed to start negotiations on a new Partnership and Cooperation Agreement (PCA), which would update and expand bilateral cooperation since 1985. The EU intends the PCA to cover political and economic issues, including its non-trade objectives on democracy, human rights, the rule of law, sustainable development, climate change and labour and environmental standards. Its tradeand-investment priorities for the PCA include: better enforcement of IPRs; mutual recognition of geographical indicators; WTO-plus commitments on services and investment; lower NTBs and subsidies; more transparent and open government procurement; improved norms and standards; and better functioning of the legal regime (EU Commission 2006a). An EU–China High Level Trade and Economic Dialogue Mechanism (HLTEDM)14 was launched in April 2008, in imitation of the US–China Strategic Economic Dialogue (SED). This attempted ‘hardening’ of bilateral economic relations is welcome. Granted, EU–China relations do not yet suffer from the shrill, China-bashing rhetoric found in the USA. But there are pressures on EU policy to head in a more confrontational direction. In-built EU protectionism against China, and Chinese protectionism and foot-dragging on reforms, can be mutually reinforcing. Hence the imperative to bolster the institutional framework for bilateral economic relations – to go beyond low-key, low-level, inconclusive regulatory dialogues and set-piece, photo-op annual summitry. This assumes added importance at a time of global economic crisis and rising protectionism. EU–China trade tensions are bound to get worse in this climate. They must be contained. What should be done?

64 Fredrik Erixon et al. Overcoming EU internal divisions The EU has to overcome internal divisions and zero-sum competition in its relations with China. The Big Three – Germany, the UK and France – prioritize their bilateral relations with China with competing and conflicting agendas, and often at the expense of the EU–China relationship (Barysch et al. 2005: 10–20). It is natural for China and EU member states to nurture country-to-country relationships through contacts at the level of national capitals. But EU member states – the Big Three in particular – must pull together and give more priority to collective EU–China relations. Trade policy, after all, is the one area of EU external policy that is highly centralized; and headline trade-policy issues concerning China can only be dealt with at the EU level. Avoiding trade and non-trade linkages The EU should refrain from linking trade to its all-embracing non-trade goals such as democracy, human rights, the environment, cultural diversity and sustainable development (which, like social justice, apple pie and mother’s milk, encompasses just about everything). These issues should be discussed on separate tracks. Linking them to bilateral trade issues makes the EU look politically correct and preachy, constantly pandering to its anti-market NGOs and other constituencies. It also gets Chinese backs up. Far better to deal with outstanding tensions and conflict in a contained, businesslike, problem-solving setting. An EU–China PCA will inevitably cover a sweeping terrain of trade and non-trade issues. But the HLTEDM – intended to be the primary forum for bilateral trade-and-investment discussions – should avoid trade and non-trade linkages. Designing and strengthening the EU–China high level trade and economic dialogue mechanism15 The EU–China HLTEDM cannot be a carbon copy of the US–China SED, for EU institutions differ so much from those in Washington. But it can learn useful lessons from the two-year track record of the SED. The latter meets bi-annually, and comprises cabinet officers who head relevant ministries and regulatory agencies (e.g. commerce, environment and agriculture ministries, central banks and financial and other regulators). It has been led by US Treasury Secretary Hank Paulson and his Chinese counterpart (formerly Vice-Premier Wu Yi, now her successor Zhang Dejiang). Discussions have covered, inter alia, trade and macroeconomic imbalances, IPRs, access to China’s financial-services and other services markets, bilateral environmental cooperation, regulatory transparency, a bilateral investment treaty and product-safety standards. The SED has delivered partial, piecemeal outcomes to open specific markets in China, especially in financial services and aviation. China has secured an explicit US statement to avoid protectionism and discriminatory treatment of Chinese investments in the USA. But these are not huge market-opening successes.

China’s trade policy 65 Indeed, it would be unrealistic to have such ambitions and expectations. Rather, the main advantage of the SED is its ‘damage-limitation’ function; and in this respect it has been quietly successful. On the US side, it has helped lower the temperature and moderate passions among protectionist China-bashers, whose chief outlet is the US Congress. Threatening Congressional initiatives, such as to declare China a ‘currency manipulator’ and slap on a retaliatory 27.5 per cent tariff, have not materialized. On the Chinese side, top policy-makers have become more sensitized to US concerns. On both sides, frank high-level discussions have raised mutual awareness of the depth of bilateral commercial engagement and the costs of protectionist reversal. Overall, the SED has provided a strategic mediumterm context for bilateral commercial relations, and enabled small-scale, low-key achievements. That is good enough. In this spirit, the EU–China HLTEDM should, above all, be used to avoid slip-sliding into tit-for-tat protectionism. That includes refraining from hostile rhetoric on both sides. The EU and its member states – especially member state governments inclined to China-bashing rhetoric and protectionism – need to be tied into a political process and a discussion agenda that present the costs and benefits of policy options with greater clarity. Europe needs much better awareness of the depth of bilateral commercial engagement, its actual and potential benefits, and the costs of protectionist measures against China. That is sorely lacking. The Chinese government needs to be tied into such a mechanism for exactly the same reasons. The EU side of the HLTEDM will be headed by the Commission, preferably led by the Trade Commissioner. But the Commission will require a mandate from the member states. This will be complicated, especially on non-border regulatory issues where competence is divided between the EU and the member states, and where the Internal Market remains far from integrated. Services and investment issues are the crux of the problem. For example, the EU has financial-services providers with a strong interest in securing the extra market access in China that their US-based counterparts have secured through the US–China SED. But the EU does not have a strong, centralized regime for financial services internally; and the Commission might not be able to offer Chinese banks and other financial-services providers the level of access to the EU market that it wants for EU counterparts in the Chinese market. The temptation for China would be to sign separate deals with 27 EU member states, given that relevant services and investment-related regulations still fall under national competence. That is already happening with bilateral investment treaties (BITs). Hence the importance for the EU and member states to create an internal process that is not too cumbersome, but which also secures substantial member state participation in the HLTED on issues of joint competence – especially on services and investment. In these areas the EU mandate will probably need to be stronger and more detailed than it is for multilateral negotiations and PTAs. Business input on bread-and-butter commercial issues is also vital. EU and Chinese firms with strong interests in each other’s markets should set up a bilateral Business Council similar to the US–China Business Council – preferably bypassing the

66 Fredrik Erixon et al. slow-moving, government-like bureaucracy of established business associations. The US–China Business Council keeps track of and feeds into the US–China SED and other bilateral policy discussions. It is crucial that serious thought goes into the design and content of the HLTED at the outset, if it is to achieve the goals set out above. If not, the danger is that it will degenerate into yet another empty talkfest that does not get into the nitty-gritty of pressing bilateral trade-and-investment issues. That is a bigger danger for the EU than it is for the USA, given the EU’s more complicated hybrid structure and division of competences on key policy issues. Trade-and-investment issues: shaping realistic reciprocal bargains16 The EU and China have no shortage of bilateral trade-and-investment conflicts to resolve; and this list may well get longer in the new global economic climate. Prioritizing issues for discussion and resolution will be important, especially in the HLTED. Here is our priority list: Chinese grievances about EU nonrecognition of MES and liberal use of trade remedies; EU grievances about China’s IPR enforcement, services and investment regulations, norms and standards; and China’s anxieties about the investments of its companies and sovereign wealth funds (SWFs) in the EU. There should be a way of crafting quid pro quos, a series of mutually beneficial bargains, across this priority list. That is the thrust of what follows. Market-economy status and trade remedies The EU does not recognize China as a market economy, even though it recognized Russia as such in 2002. Russia is not even a member of the WTO, and it is not obvious that its market-economy credentials are superior to China’s. According to China’s WTO-accession protocol, the EU and other WTO members are not obliged to give it MES until 2015. The EU’s argument against MES – that China does not meet four out of five set criteria17 – is specious. The criteria are vague and can be interpreted arbitrarily. One wonders, for example, how many EU firms would pass these tests. Granting China MES would only be right and proper. It would marginally increase disciplines on EU use of AD duties against Chinese exports – only marginally because the EU has shown flexibility in its use of non-MES as an AD weapon, and existing GATT Article VI disciplines on AD measures are very weak (even for countries with MES). It would eliminate the most outrageous procedural biases in AD cases against China; and it would reduce EU AD duties against Chinese exports from the present very-high average of 40 per cent. But far more important would be the symbolism of such a move. China feels acutely aggrieved by EU and US non-recognition of MES, despite its huge strides in the direction of the market, locked in by very strong WTO commitments. Its sense of natural justice has been offended. According China MES would, at a stroke, improve bilateral relations and probably make China more amenable to compromise on other issues.

China’s trade policy 67 Sadly, the EU lacks the internal consensus to go down this route. But it is time for state and non-state actors in the EU to make the case for MES and assemble the support to change EU policy. MES is just the tip of the iceberg. The EU cut its AD cases against other countries by a third between 2002 and 2006 compared with the 1995–2001 period. But it kept the number of AD cases against China constant up to 2006 (roughly six cases a year). In 2007, Chinese companies were involved in all six new EU AD investigations. In 2008, a number of new AD investigations of Chinese exports were opened. The number of AD cases per EUR billion of EU imports also shows substantial discrimination against China, with a figure for China twice as high as it is for the rest of the world. China remains the EU’s main AD target, with over forty cases in place (European Commission 2007). Furthermore, the EU has used another trade-defence instrument, safeguards, against Chinese exports. Safeguards against Chinese steel exports were used in 2002. In 2005, a second safeguard (under a specific provision of China’s WTO-accession protocol) was launched against a wide range of Chinese exports of textiles and clothing. Economic analysis shows clearly that, except for a tiny proportion (roughly 5 per cent of cases), trade-defence measures are plain protectionism. They rarely protect intended beneficiaries – workers and producers in import-competing industries – and delay inevitable adjustment. They harm consumers (households and firms) with higher prices. Moreover, they are based on an increasingly obsolete view of a modern industrial economy. The latter is now a complex production process fragmented among a large number of countries. Trade-defence measures equate industry to manufacturing alone, ignoring the crucial pre-manufacturing step (design and preparation of the physical manufacturing process) and postmanufacturing step (logistics, marketing, advertising, etc.). These two steps generate a lot of value-added in the importing country. For instance, even in labour-intensive products such as shoes, these two steps represent half to threequarters of European value-added in the shoe sector (Kommerskollegium 2007). In short, not only do AD and safeguard measures not protect the ‘old’ economy (the manufacturing step per se), but they might also hurt the ‘new’ economy (preand post-manufacturing steps). We draw the following policy conclusions. The EU should accord China MES. In addition, it should commit the necessary regulatory steps to discipline future use of trade remedies. That could include offering gradual dismantlement, ahead of the WTO’s 2014 deadline, of the ‘transitional product-specific safeguard mechanism’ in Article 16 of China’s WTO-accession protocol. In return, the EU should ask for the following Chinese concessions: better implementation of WTO commitments, e.g. on subsidies, IPRs and TRIMS; lower tariffs, e.g. on goods exempted from transitional safeguards; clarification and elimination of a core set of NTBs, such as some controversial norms and standards; and WTO-plus commitments to further open Chinese markets in investment and services. Recent history shows that trade remedies increase during global economic downturns. This has indeed happened in 2008 and 2009 and beyond. China will

68 Fredrik Erixon et al. be the prime target. Hence the importance of disciplining trade remedies as part of broader quid pro quo packages. The alternative is for rising trade tensions to lead to tit-for-tat protectionism. Intellectual property rights China’s enforcement of IPRs is still very problematic, as US and EU complaints testify. But it is unrealistic to expect a quick, across-the-board fix in such a continent-wide, fragmented economy. The EU position on IPRs in China should have more long-term considerations in mind. That would suggest a more restrained and selective agenda. The EU should pick its fights judiciously. EU policy should focus only on those issues where the net benefits from IPRs are crystal-clear, leaving others to private settlement and legal adjudication. Priority issues should be IPR enforcement in essential drugs, and big-ticket services and investments. This matters for a fairly broad range of producer and consumer interests in the EU, and indeed in China. Less important are pirated DVDs and geographical indicators (GIs). These affect only a very small knot of EU producers, but they still come at the top of the EU’s IPR priority list. Services and investment liberalization Both the EU and the USA have been pushing China to further open restricted markets in services and investment. This would require going beyond WTO commitments. Services and investment are intimately related, for US and EU firms are centrally interested in FDI in services sectors in China. Here they face high regulatory hurdles (Figure 3.1). The EU could target FDI opening in the most restricted sectors, e.g. electricity, banking, telecoms, air and sea transport. This would of course be in the interest of EU multinational enterprises in these sectors, but it would also benefit China. It would create domestic jobs, spur competition that would lead to product differentiation (thereby creating profitable opportunities for local enterprises), and stimulate and deepen domestic consumption (which would help ‘rebalance growth’ with less reliance on investment and exports). Hence there is a potential alignment of foreign and domestic interests, as has happened with FDI opening in services sectors in other emerging markets. This agenda will still face stiff opposition, especially from entrenched SOEs. The global financial crisis lends extra ammunition to such opposition. Market access in financial services is first in the line of fire. In China and elsewhere, politicians and regulators are adopting a harder defensive stance against the demon of financial liberalization, conveniently ignoring subtle distinctions between prudential controls and market access (i.e. removing barriers around inefficient domestic incumbents and exposing them to competition). And if trade-andinvestment protectionism gathers pace in financial services, the chances are that it will creep further into other politically sensitive services sectors such as telecommunications, retail and distribution, transport and professional services.

China’s trade policy 69 Chinese outward investment Overseas investments by Chinese enterprises have been growing significantly. SOEs such as CNOOC, PetroChina and Nanjing Auto have dominated foreign acquisitions; private firms with strong government links, notably Lenovo and Haier, have also been involved; and leading state-owned banks such as ICBC have taken minority stakes in big banks abroad. China now has its own SWFs, built on the back of swelling foreign-exchange reserves and with US$300 billion in combined assets. They have been investing in banks and private-equity groups abroad. Chinese SOEs are plagued with domestic distortions: subsidies, managed prices, politicized management and investment decisions, and so on. Not least, FDI and assorted domestic regulatory restrictions protect them from foreign competition. Hence they are easy targets for investment protectionism in host countries, as CNOOC found to its cost when it tried to make a big US acquisition. Investment-screening procedures of foreign SOEs have been tightened in the USA, with a similar trend in some EU member states, Canada, Australia – and even in China. Loose language in relevant legislation could open backdoors to protection of domestic enterprises from foreign enterprises. At the same time, there is considerable anxiety in the West about investments made by SWFs, with concomitant calls for tighter regulation. It is obviously in China’s interest to contain these pressures and keep the door to outward FDI as open as possible. The EU and China could agree to transparency standards for SOEs and SWFs, and establish joint procedures to deal with difficult cases. More fundamentally, China’s increasing investments abroad should make it more amenable to quid pro quos related to restraining protectionism at home – including FDI protectionism – and further opening its markets in investment and services. Norms and standards Among the Chinese regulatory barriers the EU highlights are subsidies, government procurement and norms and standards. It is difficult to handle subsidies in a bilateral setting: they are by nature non-preferential with respect to foreign markets and demand unilateral or multilateral solutions (or a combination of the two). Government procurement is also problematic due to the prominent role of sub-central authorities (e.g. EU member states and sub-national regions, Chinese provincial and municipal governments). Norms and standards are different. They are of bread-and-butter interest to business, and they should be a priority on a bilateral trade-and-investment agenda. This is of course a dense regulatory thicket ranging across several sectors. It should cover core SPS and TBT measures, such as food-safety and product-safety standards; and both sides should work on closer regulatory cooperation and joint procedures in areas of considerable friction (following the example of the

70 Fredrik Erixon et al. US–China SED on product-safety measures after exports of Chinese toys were found to be unsafe). Summary The EU and China should not overcrowd the HLTEDM, and by extension PCA negotiations, with a large wishlist. Rather they should select priority issues for careful scrutiny and discussion; issues that are amenable to mutually beneficial bargains. China wants MES and greater disciplines on trade remedies. It also wants an open door and legal protection for its increasing foreign investments. The EU wants better IPR enforcement, more open markets in services and investment, and more transparent, predictable norms and standards. These issues should form the basis for quid pro quos.

3. Conclusion The first part of this chapter covered broad Chinese trade-policy trends post WTO accession: implementation of WTO obligations; dispute settlement; participation in the Doha Round; PTAs; and unilateral measures. In sum: China has a mixed record on WTO implementation; a flurry of litigation has followed several years of diplomatic reconciliation in dispute settlement; and China has been passive in the Doha Round. In contrast, it has been very active with PTAs, setting off a ‘domino effect’ in east Asia. But its PTAs are ‘trade light’, driven more by foreign policy than commercial considerations. Finally, unilateral liberalization – the driving force of external opening in the 1990s – has slowed down. There has been little ‘WTO-plus’ liberalization, while measures of selective protection, especially related to foreign investment and industrial-policy targeting, have increased. Now, with a global economic downturn, the danger is that China – and many others – will engage in more serious protectionist backsliding. The short-term challenge for China is to contain protection at home. That will send positive signals to contain protectionism worldwide. Beyond that, China’s challenge is to stimulate further unilateral liberalization related to domestic structural reforms. That means tackling non-border, but still traderelated, regulatory barriers, especially in investment and services. Cleaning up PTAs and strengthening participation in the WTO are important auxiliary objectives. This should be seen in the context of further liberalizing the Chinese economy and ‘rebalancing growth’. The second half of the chapter focused on EU–China commercial relations. This has rapidly become one of the key bilateral relationships in the world economy. We covered patterns of bilateral trade and FDI; macroeconomic issues that are a source of trade friction, i.e. the bilateral deficit and the exchange rate; more micro marketaccess issues; and the institutional framework for EU–China relations. We argue that the EU is wrong to target the bilateral current-account deficit and the yuan exchange rate: this is based on (distinctly dodgy) do-it-yourself economics. But it has legitimate market-access complaints, especially on standards, subsidies, IPR,

China’s trade policy 71 investment and services – just as China has legitimate complaints about access to the EU market (concerning standards, contingent protection and the lack of marketeconomy status). We oppose a bilateral PTA as the means to tackle these issues. Its discriminatory effects would be potentially trade-diversionary and dangerously system-fragmenting. In any case, it is politically infeasible in the short term. Rather we advocate strengthened, more institutionalized bilateral regulatory cooperation through which these issues can be dealt with to mutual advantage. That brings the new EU–China High Level Trade and Economic Dialogue Mechanism into play. The latter’s objectives should be damage limitation, i.e. to contain protectionism at both ends, make incremental advances for reciprocal market access, and generally deepen ‘constructive engagement’. Specifically, we argue for a series of quid pro quos on the market-access issues mentioned above. If successful, stronger bilateral cooperation will help to contain global protectionist pressures. It would also be an important contribution to smoothening China’s further integration into the global economy – and into the international political system.

Notes 1 This section draws on Greene et al. (2006); Lardy (2002); Ianchovichina and Martin (2001); Mattoo (2003); Bhattasali, et al. (2004) and Athukorala and Hill (2008). 2 This section draws on WTO (2008) and USTR (2008). 3 USTR (2008): 1. 4 http://www.wto.org/english/tratop_e/dispu_e/dispu_by_country_e.htm 5 The issue in the first case was China’s attempt to promote the domestic semiconductor industry through VAT rebates for locally manufactured integrated circuits (ICs). Imported ICs, however, faced the full VAT rate. The USA argued that this constituted a local-content measure in violation of the TRIMS agreement. China withdrew the measure after consultations. In the second case, the EU contested Chinese controls on coke exports, which limited the supply and raised the price of coke imports to the EU. China largely repealed the measure after consultations. In the last case, the USA argued that Chinese imposition of anti-dumping (AD) duties on kraft linerboards did not follow procedures in conformity with WTO AD rules. China repealed the duties after consultations. 6 See ‘Proposal on flexible provisions for recently acceded members’, WT/MIN(03)W/8, September 4 2003, www.wto.org 7 The following draws on WTO (2008); USTR (2008); Paulson (2008). 8 From an American standpoint, Treasury Secretary Hank Paulson makes this case in a balanced and nuanced manner. See Paulson (2008). 9 This is the coda to Robert Zoellick’s much-publicized speech on US–China relations (Zoellick, 2005). It is also the underlying logic of the US–China Strategic Economic Dialogue, and now of its EU–China equivalent. 10 http://ec.europa.eu/trade/issues/bilateral/countries/china/index_en.htm 11 This section draws on Messerlin and Wang (2008): 10–14; and Freytag (2008). 12 Figure 3.4 excludes imports from OPEC members in order to leave aside oil imports as much as possible. 13 See European Commission (2006b) for its rationale for EU PTAs in Asia, and Sally (2007) for a critique. 14 It is unfortunate that both sides agreed to such a clumsy title, no doubt a combination of Brussels-speak and Chinese official jargon. It should be renamed – with a simpler, user-friendly title.

72 Fredrik Erixon et al. 15 This section draws on Dreyer and Erixon (2008). Also see Paulson (2008) on the record of the US–China SED. 16 This section relies primarily on Messerlin and Wang (2008): 9–10, 14–24. 17 The EU assesses the existence of a ‘market environment’ with five criteria: (1) Does the government influence the operations of firms? (2) Does the legacy of the command economy, in terms of public ownership, barter trade and so on, affect firms’ operations? (3) Do firms operate under an effective company law, and do they have effective accounting standards? (4) Do firms operate under an effective framework of bankruptcy regulation and property-rights protection? (5) Do firms convert currency at standard market rates?

References Antkiewicz, A. and Whalley, J. (2005) China’s new regional trade agreements, The World Economy, Vol. 28, No. 10, October. Athukorala, P. (2006) Product fragmentation and trade patterns in east Asia, Asian Economic Papers, Vol. 4, No. 3, pp. 1–27. Athukorala, P. and Hill, H. (2010) ‘Asian trade and investment: patterns and trends’, in Prema-chandra Athukorala (ed.), The Rise of Asia: Globalization and New Patterns of Trade and Investment, London: Routledge (forthcoming). Baldwin, R. (2006) Multilateralizing regionalism: spaghetti bowls as building blocs on the path to global free trade, The World Economy, Vol. 29, No. 11, pp. 1451–518. Barysch, K., Grant, C. and Leonard, M. (2005) Embracing the Dragon: The EU’s Partnership with China. Centre for European Reform, London. Beattie, A. and Williams, F. (2008) Doha trade negotiations end in failure after impasse on protection for farmers, Financial Times, July 30. Bhattasali, D., Shantong, L. and Martin, W. (2004) China’s Accession to the World Trade Organization, Policy Reform and Poverty Reduction. World Bank, Washington DC. Corden, M. (2007a) Those current-account imbalances: a sceptical view, The World Economy, Vol. 30, No. 3, March, pp. 363–82. Corden, M. (2007b) Exchange-rate policies and the global imbalances: thinking about China and the IMF, London: Bank of England (James Meade Centenary Conference), July. Dreyer, I. and Erixon, F. (2008) An EU–China trade dialogue: a new policy framework to contain deteriorating trade relations, ECIPE Policy Brief No. 3, 2008, European Centre for International Political Economy, Brussels, www.ecipe.org Dunaway, S. and Li, X. (2005) Estimating China’s ‘equilibrium’ real exchange rate, IMF: Washington DC, October, Working Paper WP/05/202. Dunaway, S. Leigh, L. and Li, X. (2006) How robust are estimates of equilibrium real exchange rates? The case of China, International Monetary Fund: Washington DC, October, Working Paper WP/06/220. European Commission (2006a) Accompanying COM(2006)631 final: Closer partners, growing responsibilities: a policy paper on EU–China trade and investment: competition and partnership, Brussels (Commission Working Document, COM(2006)632 final), www.trade.europa.eu/doclib/docs/2006/October/tradoc_130791.pdf European Commission (2006b) Global Europe: competing in the world: a contribution to the EU’s jobs and growth strategy, Brussels. Communication from the Commission to

China’s trade policy 73 the Council, the European Parliament and the Committee of the Regions (COM(2006)567 final; Staff Working Document SEC/2006/1230), October, www.trade.europa.eu/doclib/ docs/2006/October/tradoc_130370.pdf European Commission (2007) ‘Anti-dumping, anti-subsidy, safeguards.’ Statistics covering the full year 2007, Brussels (Interim Report 2007/12), www.trade.europa.eu/ doclib/docs/2007/April/tradoc_134456.pdf Freytag, A. (2008) That Chinese ‘juggernaut’ – should Europe really worry about its trade deficit with China? ECIPE Policy Brief No. 2, 2008, European Centre for International Political Economy, Brussels, www.ecipe.org Gao, H. (2005) Aggressive legalism: The East Asian experience and lessons for China, in Gao, H. and Lewis, D. (eds), China’s Participation in The WTO, Cameron May, London, pp. 315–51. Gao, H. (2007a) China’s Participation in the WTO: A Lawyer’s Perspective, Singapore Yearkbook of International Law, pp. 1–34. Gao, H. (2007b) Taming the dragon: China’s experience in the WTO dispute settlement system, Legal Issues of Economic Integration, Vol. 34, No. 4, pp. 369–92. Greene, M., Dihel, N., Kowalski, P. and Lippoldt, D. (2006) China’s trade and growth: impact on selected OECD countries, OECD Trade Policy Working Paper No. 44, 28 November, TD/TC/WP(2006)10/FINAL. Available at www.oecd.org/trade Ianchovichina, E. and Martin, W. (2001) Trade liberalization in China’s accession to the World Trade Organization, World Bank Policy Research Working Paper 2623, from www.worldbank.org Kawai, M. and Wignaraja, G. (2008) Regionalism as an engine of multilateralism: the case for a single east-Asian FTA, ADB Working Paper on Regional Economic Integration No. 14, February 1, Asian Development Bank Institute: Tokyo. Kommerskollegium (2007) Adding Value to the European Economy: How Anti-dumping Can Damage the Supply Chains of Globalised European Companies, Stockholm: Kommerscollegium. Koyama, T. and Golub, S. (2006) OECD’S FDI Regulatory Restrictiveness Index: Revision and Extension to more Economics, Economic Department Working Papers No. 525, pp. 8–10. Lardy, N. (2002) Integrating China into the Global Economy. Brookings Institute, Washington DC. Mattoo, A. (2003) China’s accession to the WTO: the services dimension, Journal of International Economic Law, Vol. 6, No. 2, pp. 299–339. Messerlin, P. and Wang, J. (2008) Redesigning the European Union’s trade-policy strategy towards China, Joint GEM-ECIPE Working Paper No. 4, available at www. ecipe.org Paulson, H. (2008) A strategic economic engagement: strengthening US-Chinese ties, Foreign Affairs, September/October. Sally, R. (2006) FTAs and the prospects for regional integration in Asia, ECIPE Working Paper 1, www.ecipe.org/publications/2006/WPno1_06_Sally.pdf Sally, R. (2007) Looking East: the European Union’s new FTA negotiations in Asia, Jan Tumlir Policy Essay No. 3, European Centre for International Political Economy, Brussels, www.ecipe.org United States Special Trade Representative (2008) National Trade Estimate Report on Foreign Trade Barriers: China, www.ustr.gov

74 Fredrik Erixon et al. World Trade Organization (2008) Trade Policy Review: China, www.wto.org Zoellick, R. (2005) Whither China: from membership to responsibility? Speech on US–China relations and remarks to the National Committee on US– China relations, New York, September 21, www.state.gov/s/d/former/zoellick/rem/ 53682.htm

4

Vertical specialization and intra-industry trade in China (1992–2003) Xin-Qiao Ping

1 Introduction The phenomenon ‘vertical specialization’ (VS) or ‘intra-industry trade’ (Balassa (1967) and Findlay (1978)) has been studied quite extensively by trade economists. It has also been labeled as ‘long-distance purchasing of services abroad’ (Bhagwati 1984)), ‘production delocalization’ (Leamer 1996), ‘disintegration of production in the global economy’ (Feenstra 1998), ‘outsourcing referred to a specific segment of the growing international trade in services’ (Bhagwati and Dehejia 1994), ‘fragmentation in production’ (Arndt and Kierzkowski 2001), ‘outsourcing in global economy’ (Grossman and Helpman 2002, 2004), ‘factor content of trade; intra-product specialization’ (Davis 1995; Davis and Weinstein 2000, 2001a, b). Many theoretical models of this persuasion focus on the impacts of increased vertical specialization on factor processes, production and trade patterns and welfare. Further, recently there has also been empirical documentation of measurements for the increase of vertical specialization. For example, Hummels et al. (2001) calculated the level of vertical specialization of ten OECD nations and their growth between 1970 and 1990. They also found out that growth in vertical specialization accounts for 30 per cent of the growth in these countries’ exports. However, all of this research comes from the viewpoint of developed economies, and, in all of these literatures the developed countries are regarded as the center of both the world economy and of world trade. It is also assumed that from this center some of the production stages have been ‘outsourced’ to developing countries. Although it is true that from a whole world production and trade processing perspective the developed countries represent both the designing center and final markets whilst the developing countries represent some stages of intermediate production, it is also true that most up-stream machines, intermediate components and materials imported from developed countries could be regarded as ‘outsourcing’ from the position of developing countries. In particular, in the total value of exports from developing countries to the developed countries, the value of these intermediate components or materials imported from developed countries might account for a high proportion of exports. This is, in fact, the phenomenon of ‘mutual outsourcing’. In the whole process of the worldwide vertical specialization, the developed countries are ‘outsourcing’

76 Xin-Qiao Ping some of their production stages to the developing countries, yet the developing countries are also ‘outsourcing’ some of their up-stream ‘designing and equipment building stages’ to the developed countries. Just as it is important to know how great the level of vertical specialization is in the exports of developed economy, it is similarly important to calculate the proportion of primary materials and intermediate components in the exports of the developing countries to the developed countries. To understand the rapid growth of VS in China’s exports in the past two decades, it is vital to consider three phenomena that have influenced both Chinese economic transformations and Chinese trade patterns with other nations. First, since the beginning of the 1990s, a joint venture seemed to be the most efficient company structure within China’s economy, whereas more recently this has been replaced by ‘wholly foreign-owned enterprises’. State-owned enterprises have gradually given way to private ones, which hasten technological, organizational and managerial improvements necessary to work with a market economy system. In order to promote a gradual transition, the Chinese government (the central government as well as local governments) instituted requirements for some strategic foreign industry partners connected to high-tech and engineer-to-order products. With a rapid increase of foreign direct investment (FDI) (US$64 billion in 2004), China has gradually transformed into an international sourcing hub. Many FDI companies adopt international sourcing to either legitimate or develop a foreign market outlet. They also explore international supply markets to import capital goods and intermediate components for their production within China, since some sources are of a specific high technology input unavailable in China, or only available under poorer conditions. At the same time, the Chinese government has granted tax incentives and instituted other policies to facilitate foreign investments. For example, under China’s VAT (value-added tax) system, the VAT on purchases of capital equipment by China’s domestic enterprises was not made exempt until the beginning of 2009, whereas for FDI companies, imported capital goods were exempt from VAT from the 1990s until today. These incentives have induced the exploration of international supply markets for FDI companies, particularly for the capital goods or intermediate goods produced by multinational companies’ homelands. The second reason for the growth of vertical specialization in China’s exports is China’s ascension to the World Trade Organization (WTO) in 2001. With the progressive reduction of international logistics costs, the integration of global information networks and the economic development of overseas countries, not only FDI companies in China but also China’s domestic enterprises (be they stateowned or private) are looking for international sourcing channels because of cost saving. As Nassimbeni and Sartor (2007) pointed out, there are at present mainly three types of international sourcing in China: imposed sourcing, intermediated sourcing by a third party at the purchasing-supply interface and direct sourcing. Although the exploration of international sourcing channels comes from the

Intra-industry trade in China 77 overall growth of China’s domestic markets, the comparative advantages of outside or international sourcing has also been noted by most export-oriented enterprises in China. Following entry to the WTO, the Chinese government has launched a series of further reforms to create logistic platforms aimed at making international transport easier as well as granting incentives and providing facilities to increase international sourcing. Now, even in labor-intensive industries like textiles, home furniture, footwear, toys and household appliances, China’s enterprises import various materials and intermediate goods from other countries to satisfy export demands. The third factor underlying the VS hike in China’s export is the intra-industry linkage between China and other East Asia countries, in particular, with Japan and Korea. The past two decades have witnessed the shifts of some industries (including electricity, footwear, mobile phones, toys and even the automobile) from Japan, Korea, Taiwan and other East Asian countries to China, principally due to the low cost of manpower in China. Up to now, the average labor cost (per hour) in manufactured industry is only about 6 per cent of that in Japan, and is about 20 per cent of that in Taiwan, Korea, Hong Kong and Singapore. In order to utilize this cost advantage, many multinational companies in Japan, Korea and Taiwan have shifted their production bases into China, whilst retaining their prior international sourcing and market outlets. As a result, the rapid growth of China’s exports (which increased by 22 per cent in 2003, and by 35 per cent in 2004) is closely related to a significant increase of vertical specialization to a level equivalent to Japan, Korea and other East Asian countries. As will be shown below, China’s VS level with Korea has increased by five times during the period 1992–2003, and the VS level with Japan has also increased by 66 per cent in the same period. The objectives of this chapter are to calculate the degree of vertical specialization in China’s exports to U.S. and to the whole world in the years between 1992 and 2003; reviewing evolutionary dynamics in China’s integration into the worldwide trade process; to identify the sourcing countries on which Chinese exports actually depend; and, to analyze the changes in China’s trade patterns that have taken place since the beginning of the 1990s. Using the method of Hummels et al. (2001) and a data set of Chinese exports in the period between 1992 and 2003, our calculation briefly shows that the vertical specialization level has risen from 14.2 per cent in 1992 to 22 per cent in 2003. The magnitude of the VS rise is much higher than the magnitude of the VS rise in Europe between 1970 and 1990. Second, our research identified important sourcing countries for China’s exports in the last decade. On average, between 1992 and 2003 the value of imported intermediate goods and imported components from Japan, Korea and other East Asian countries accounts for about two-thirds of the VS in China’s global exports. Third, our calculations review the evolutional dynamics of China’s exports to the United States (U.S.). Underlying the rapid growth of China’s trade surplus with the U.S. is the sourcing contribution from Japan and Korea: about 75 per cent of the VS rise in China’s exports to the U.S. come from Japan, Korea and other

78 Xin-Qiao Ping East Asian countries, implying that there exists some form of intra-industrial connection between China, and Japan plus Korea in China’s exports to the U.S. The chapter is organized as following: Section 2 will discuss the methods and data sets used in this research; the VS level and the dynamics of its evolution between 1992 and 2003 will be presented in Section 3; changes in the trade pattern of China with the U.S. and reasons for the rise in VS will be analyzed in Section 4; and finally, we will conclude this research and discuss some policy implications in Section 5.

2 Methodology and the data set 2.1 The method Based on the method desribed by Hummels et al. (2001), we calculate the vertical specialization (VS) levels and its trend between 1992 and 2003 in China’s exports both to the world as well as to the U.S. 2.1.1 Measurement of VS in export Assume there are n sectors in economy, let MIi be the value of intermediate goods in the imports of sector i, let Yi be output value of sector i, and Xi be export of sector i, following Hummels et al. (2001), we get: 

VSi =

MIi Yi





Xi · Xi = Yi

 · MIi

(1)

It should be noticed that here MIi represents  the value of intermediate goods in the import of sector i, meaning that MIi = nj=1 MIji . MIji is an intermediate good in the import of sector i from sector j in the other countries. Usually, however, there exists only aggregate imports of specific goods in data sets. value of intermediate goods imported by sector i   For example, the aggregate is nl=1 MIil , rather than nj=1 MIji . Here, l is a foreign country instead of a sector. Thus, the equation (1) should be revised, and the imports should be sorted by the country they were derived from (such as imports from Japan, Korea, other East Asian countries and the U.S.). In order to calculate the VS level of China’s exports to the U.S. and to the world, we define the aggregate VS of China as the following:   

 Xi   VSi  i VSi Xi · Xi VS VS i i  VS in Export ≡ =  = = i X X Xi i Xi i Xi

(2)

Intra-industry trade in China 79 Substituting the definition of VSi in equation (1) into (2) gives:  VSi VS in total export = i X ⎛ ⎞   n n n 1 MIi 1 Xi ⎝ I ⎠ · Xi = = Mji Yi X Yi X i=1

=

=

1 X

i=1

n

n

i=1 j =1

j =1

Xi I M Yi ji

(3)

n n 1 Xj I M X Yj ij j =1 i=1

MI

Let aij = Yjij represents the value of imported good from sector i to produce one unit output of sector j, then (3) could be rewritten as VS in total export: ⎛

a11 . . . 1 ⎜ .. . . = (1, 1, · · · , 1) ⎝ . . X an1 · · ·

⎞⎛ ⎞ a1n X1 .. ⎟ ⎜ .. ⎟ = 1 uAM X V . ⎠⎝ . ⎠ X Xn ann

⎛

where u = (1, 1, · · · , 1), AM

a11 . . . ⎜ .. . . =⎝ . .

⎞ a1n .. ⎟ is an n × n imported coefficient . ⎠

an1 · · · ann matrix, and is a n × 1 export vector. If we use the complete coefficient matrix of I-O table, then VS in total export =

−1 1 M uA I − AD XV X

where ⎛

b11 . . . ⎜ .. . . D A =⎝ . .

⎞ b1n .. ⎟ . ⎠

bn1 · · · bnn

is the domestically exhaustive coefficient matrix, and value of intermediate good produced by sector j for product DijI of domestic sector i bij = = Yj Yj

(4)

80 Xin-Qiao Ping Further, given that A D + AM = A. Thus we can find out the AM from the direct exhaustive matrix of the I-O table. For this to be analyzed, first we should analyze the data set on MIji , i.e. the imported intermediate goods by sector i in China. 2.1.2 Determination of MIji The unique source for us to find out the data set about the value of intermediate goods is the Input-Output (I-O) table. Consider the China I-O table in 1997. Before proceeding, as is customary in this sort of analysis, it must be verified that the value of intermediate goods is included in the direct exhaustive matrix. It is confirmed from the research result by Wang et al. (2000) that the imported intermediate goods had already been taken into account in the I-O table (1997) provided by China to GTAP. In addition, we assume that: (i) The ratio of some imported intermediate good to the total value of that corresponding input good is the same for all the domestic sectors, implying that the ratio of imported intermediate good to output is determined only by the input-output coefficient. (ii) For a specific sector, if its output could be divided into intermediate and final parts, then we also assume that the ratio of imported parts to domestic parts in the intermediate good is equal to the ratio of imported part to domestic part in the final good. This is exactly the method used by Wang et al. (2000) to separate imports into intermediate goods and final goods. In other words, if we let CiM and CiD represent the imported part and the domestic part in the final goods produced by sector i respectively, and let IiM and IiD be the imported part and the domestic part in the intermediate good used by sector i respectively, then the assumption (ii) implies that CiM IiM = . CiD IiD Therefore, it could be derived that, IiM IiM + CiM CiM = = CiD IiD IiD + CiD Then, IiM IiD + IiM

(5) =

IiM + CiM IiD + CiD + IiM + CiM

Intra-industry trade in China 81 This means that, in sector i, the ratio of imported intermediate goods to total intermediate goods (the sum of imported and domestic intermediate goods) is equal to the ratio of total imports (the sum of imported intermediate goods and imported consumption goods) to the algebraic summation of total gross output value and imported consumption goods minus exports. There are two approaches to define VS: the first one is the equation (1). This is the definition for the value of VS, measuring how much of the intermediate goods in exports come from imported intermediate goods. The other way is equation (2), (3) and (4), with equation (4) as a basis for calculation for VS. However, with the second approach, VS comes out as a weighted average of the VS proportions of each industry. In this chapter, we follow the second approach, since this approach is better for showing the changes in trade and production structures, and also, showing the interdependence of China’s exports with imported intermediate goods country by country. 2.2 The data set There are two data sources available for our calculation of VS in China’s exports: (1) China’s input-output tables (1992, 1997 and 2000); (2) The annual data set on China’s trade (for the years 1992 to 2003), which comes from the United Nations Statistics Division-Commodity Trade Statistics Database (COMTRADE). Among these input-output tables, the 1992 table includes data of 119 threedigit industries and of 33 two-digit industries respectively, and the 1997 table covers 124 three-digit industries, whereas the 2000 table consisted of only 40 two-digit industries. For consistency, we have merged all three-digit industries into 40 two-digit sectors. Based on the data sources from the input-output tables, the ratio of equation (5) becomes computable: (total import)/(total output–export). We then calculate this ratio on each two-digit sector. Multiplying matrix A in the input-output table with above ratio vector, we get the matrix of AM . Note that for different foreign sourcing countries, the matrix of AM must be different, as the ‘total imports’ in equation (5) are sorted by different sourcing countries. The trade data from COMTRADE covers the information about four-digit industry specific export from China. In order to combine these trade data with China’s input-output tables, we have added four-digit sector specific export information into a two-digit one. 2.3 The calculation process For calculation of equation (1) and equation (3), it requires for matrix A, AM and AD at each year between 1992 and 2002. And also, we need not only the information about AM for the total national import, but also the information about AM sorted by sourcing countries as well. However, only the input-output tables in 1992, 1997 and 2000 are available at hand, thus, there are only three matrixes of A (i.e. the direct exhausting matrix), respectively for 1992, 1997 and 2000. We assume that

82 Xin-Qiao Ping the matrix A is invariant during 1992–96, 1997–99, 2000–3, so that we use the matrix A in 1992 to substitute for those in 1993–96, the matrix A in 1997 for those in 1998 and in 1999 and matrix in 2000 for those in 2001–3. How can we calculate the ratio of equation (5)? Import and export information for each year is provided by COMTRADE (2000). The information about the denomination in equation (5) is based on the formula (the total value of products consumed as well as productively used = total value of output + import − output). This information is available in the Chinese Statistics Yearbook and on COMTRADE. Using the series of A matrixes and the import ratio vector (in equation (5)) at each year (1992 through to 2003), we are able to get out the series of AM (1992 through to 2003). Based on AM at each year, it is feasible to calculate the matrix of AD . With the export vector at each year, the vertical specialization (VS) ratios can now be calculated. As the information regarding exports and imports in COMTRADE is country specific, it is now feasible for us to sort each sector’s imports by sourcing countries. In this way, the proportion of import from each foreign state in each sector’s total import can be calculated. It is then possible to compute the imported country specific matrix AM . Using vectors of export to the whole world as well as to the U.S., we can calculate the equations (1), (2), (3) and (4), to bring out: (i) The VS level of China’s global exports year by year (1992 to 2003), and the contribution for VS rise from the main sourcing countries. (ii) The VS level of China’s export to the U.S. year by year (1992 to 2003), and the contribution for VS rise from the main sourcing countries.

3 The vertical specialization (VS) level and its evolutionary dynamics in China’s total export (1992 to 2003) 3.1 The general trend of VS in the period 1992 to 2003 As mentioned before, VS represents the proportion of the value of imported intermediate goods and components in total exports. Thus, it also shows the relative weight of the value of domestic production in total exports. The results of our calculations are presented in Table 4.1 and Figure 4.1. It is obvious from column 2 of Table 4.1 that the VS share in total exports grew significantly between the initial year (1992) and final year (2003) of the sample years. VS rose from 14 per cent in 1992 to 22 per cent in 2003 in China’s total exports, meaning that the VS rose about 50 per cent in the sampled twelve years. Compared with VS rises in Australia, Canada, France and the U.S. (where on average the VS rose from 16.2 per cent in the earlier 1970s to 19.8 per cent at the beginning of the 1990s) the increase of VS was around 25 per cent. Thus, compared to the countries examined in Hummaels et al. (2001), the VS share in China’s exports has risen at a faster rate, reflecting the higher degree of opening of China’s economy and its integration to the world.

Intra-industry trade in China 83 Table 4.1 Vertical specialization in China’s total export and its changes (1992–2003) Year

Total

Japan

Korea

Japan and Korea

U.S.

East Asia Union

East Asia Union +Japan and Korea

Other countries

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

0.1422 0.1436 0.1458 0.1483 0.1496 0.1519 0.1555 0.1521 0.2017 0.2047 0.2103 0.2182

0.0229 0.0288 0.0306 0.0329 0.0317 0.0329 0.0317 0.0289 0.0379 0.0356 0.0363 0.0380

0.0057 0.0096 0.0123 0.0145 0.0163 0.0184 0.0189 0.0167 0.0221 0.0209 0.0228 0.0265

0.0287 0.0384 0.0429 0.0474 0.0480 0.0513 0.0506 0.0456 0.0600 0.0565 0.0591 0.0646

0.0139 0.0136 0.0150 0.0155 0.0156 0.0152 0.0166 0.0155 0.0206 0.0224 0.0186 0.0166

0.0072 0.0077 0.0089 0.0100 0.0109 0.0128 0.0144 0.0131 0.0207 0.0205 0.0221 0.0247

0.0358 0.0461 0.0518 0.0574 0.0589 0.0641 0.0650 0.0587 0.0807 0.0770 0.0812 0.0893

0.0925 0.0839 0.0790 0.0754 0.0751 0.0726 0.0739 0.0779 0.1003 0.1054 0.1105 0.1124

0.2500 0.2000 0.1500 0.1000 0.0500 0.0000 1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

Figure 4.1 Vertical specialization trend in China’s total exports (1992–2003).

It can be seen in Figure 4.1 that the VS ratio in China’s exports grew relatively slowly in the 1990s, and was even declining during the East Asian financial crisis (during 1998 and 1999). The rapid growth of VS happened after 1999, probably due to the industrial restructuring and intra-industry shifts from Korea, Japan and other East Asia countries to China. Since 2001, the VS growth trend has been stable, implying greater exploration of international sourcing by Chinese enterprises after China’s entrance into the WTO. 3.2 Decomposition of VS and identification of sourcing countries In answering the question of which countries are the main sourcing basis for VS growth in China’s export, we also decompose VS share by each main import source.

84 Xin-Qiao Ping Table 4.1 and Figure 4.2 document the results of decomposition. It can be seen from column 6 of Table 4.1 that the VS share of U.S. in China’s export did not significantly increase between 1992 and 2003, while the VS share of the East Asia countries and regions in China’s total export grew rapidly from 0.0358 in 1992 to 0.0893 in 2003, an almost three-fold increase. Among East Asian countries, the VS share from Japan has increased about 66 per cent during this period, and in particular, the VS share from Korea has increased by five times in the same sampled period! If we compare the decomposed structure of VS in 1992 with that in 2003, it is very clear that the weight of VS share from East Asia in China’s exports has increased considerably. In 1992, the weight of VS share from the East Asia in China’s total VS was only around 25 per cent, while in the year of 2003, this weight has been increased to 41 per cent! In conclusion, in the total 7.6 per cent points increase of VS share (from 0.1422 in 1992 to 0.2182 in 2003) in China’s exports, about two-thirds (around 5 percentage points) can be attributed to the growth of VS shares of Korea, Japan and other East Asia countries or regions in China’s exports. Among this 5 percentage point rise, 1.5 percentage points come from Japan, 2 percentage points come from Korea, and 1.7 percentage points come from other East Asian countries. Therefore, the rise of VS share in China’s export appears to come mainly from imported intermediate goods and components from East Asia.

4 VS share in China’s exports to the U.S. (1992 to 2003) The initial motivation of this research was to seek intra-industry connections in the rapid growth of China’s export to the U.S. in the last decade. Employing a similar method and the same data sets as those used in Section 3, we can subsequently start calculating the VS in China’s exports to the U.S.

0.12 0.10 0.08 0.06 0.04 0.02 0.00 1992

1993

1994

1995

Japan

1996 Korea

1997

1998

USA

1999 ASEAN

2000

2001

2002

2003

Others

Figure 4.2 Vertical specialization share of the value of imported intermediate products in China’s total value of exports by different countries.

Intra-industry trade in China 85 4.1 The general trend of VS in China’s exports to the U.S. (1992 to 2003) Table 4.2 and Figure 4.3 provide evidence about the general trend of VS in China’s exports to the U.S. Briefly glancing at them, the trend appears similar to that in Table 4.1 and Figure 4.1, as the VS share of China’s export to the U.S. has increased by 8 per cent (from 0.1477 in 1992 to 0.2294 in 2003). This indicates that the trend of vertical specialization or intra-industrial connection in China’s exports to the U.S. is of a similar nature to the trend of China’s total global exports. However, after examining Table 4.2 and Figure 4.3, there appear at least three features of note in the VS variation in China’s exports to the U.S. First, comparing Table 4.1 with Table 4.2 (and also comparing Figure 4.3 with Figure 4.1), it is clear that in each year from 1992 to 2003, the VS share in China’s Table 4.2 The changes in vertical specialization in China’s exports to the U.S. (1992–2003) Year

Total

Japan

Korea

Japan and Korea

U.S.

East Asia Union

East Asia with Japan and Korea

Others

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

0.1477 0.1552 0.1561 0.1573 0.1580 0.1601 0.1622 0.1635 0.2130 0.2135 0.2181 0.2294

0.0232 0.0315 0.0337 0.0355 0.0342 0.0358 0.0338 0.0338 0.0401 0.0370 0.0375 0.0402

0.0062 0.0107 0.0132 0.0155 0.0174 0.0193 0.0193 0.0189 0.0228 0.0216 0.0236 0.0280

0.0294 0.0422 0.0469 0.0510 0.0516 0.0550 0.0530 0.0526 0.0628 0.0586 0.0611 0.0681

0.0142 0.0147 0.0162 0.0166 0.0167 0.0166 0.0180 0.0190 0.0227 0.0239 0.0198 0.0178

0.0072 0.0077 0.0090 0.0103 0.0113 0.0135 0.0155 0.0142 0.0229 0.0218 0.0234 0.0266

0.0366 0.0499 0.0559 0.0613 0.0628 0.0686 0.0685 0.0668 0.0857 0.0804 0.0845 0.0947

0.0969 0.0906 0.0840 0.0793 0.0785 0.0749 0.0757 0.0777 0.1046 0.1091 0.1138 0.1168

0.25 0.20 0.15 0.10 0.05 0.00 1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

Figure 4.3 The trend in vertical specialization in China’s exports to the U.S. (1992–2003).

86 Xin-Qiao Ping exports to the U.S. is always higher than that of the VS share in China’s total global exports. This is evidence that there exist somewhat closer intra-industrial relations in China’s exports to the U.S. than those in China’s overall trade pattern. Second, the rise in VS has stopped at times during the sample years (1992 to 2003). Even during the East Asian financial crisis (1997 to 1998), the VS share in China’s exports to the U.S. grew continuously, as opposed to the VS trend of China’s total exports where the VS rising trend was interrupted during the East Asian financial crisis. Third, the effect of WTO entry on the VS share of China’s exports to the U.S. manifested itself later than it did on the VS share of China’s global exports. Table 4.1 shows that the VS share of China’s total exports rose from 0.2047 in 2001 to 0.2103 in 2002. This 1 percentage point jump occurred immediately after China’s entrance into the WTO in 2001. However, Table 4.2 shows that the 1 percentage point jump in the VS share of China’s exports to the U.S. happened between 2002 and 2003. We argue there is a one-year lag in the intraindustrial adjustment process between China’s external trade with other countries and China’s exports to the U.S. 4.2 Decomposition of VS and identification of sourcing countries in China’s exports to the U.S. The results from a decomposition of VS in China’s exports to the U.S. are shown in Table 4.2 and Figure 4.4. We again see the differences in vertical intensity across different countries that account for the total VS share in China’s exports to the U.S. The cross-country decompositions deliver three lessons.

0.14 0.12 0.10 0.08 0.06 0.04 0.02 0.00 1992

1993

1994 Japan

1995

1996 Korea

1997

1998

U.S

1999 ASEAN

2000

2001

2002

2003

Other countries

Figure 4.4 Vertical specialization share of the value of imported intermediate products by different countries in China’s exports to the U.S. (1992–2003).

Intra-industry trade in China 87 First, in the VS share of China’s exports to the U.S., the level of vertical specialization between China and the U.S. is lower. The VS share from the U.S. itself was 0.0142 in 1992 and 0.0178 in 2003 – not only far lower than comparative countries, but also almost invariant over the time our sample covers. Thus, the reasons for the rapid increase of VS share in China’s trade with the U.S. as well as the rapid growth of China’s exports to the U.S. might lie outside of the intra-industry dependence between China and the U.S. Second, in the growth of the VS share in China’s export to the U.S. in the period 1992 to 2003, the contribution of input sourcing from countries classified as ‘Others’ (see the last column of Table 4.2) was slight. The contribution from ‘Others’ has risen only 2 percentage points (from 0.0969 in 1992 to 0.1168 in 2003) accounting for only about a quarter of the total growth in VS in the exports to the U.S. from China. Please note, by the word ‘others’, we mean all countries in the world except for East Asia and the U.S. Therefore, our decomposition estimation of VS provides evidence that the main reason for the rapid growth of China’s exports to the U.S. in the 1990s and after the turn of the new century did not come from the intra-industry connections of China’s economy with European countries, nor with other North American states. Finally, in answering to the question where the rise of VS share in China’s export to the U.S. has come from, we look at Table 4.2 again. Our decomposition estimation tells us that the contribution of East Asian countries accounts for about 75 per cent of the whole rise (6 percentage points out of 8 percentage points) in VS share over the sample years (1992 to 2003). Among these 6 percentage points of the VS rise, 2 percentage points could be attributed to Japan, another 2 percentage points to Korea, and the other 2 percentage points have come from other countries of the East Asia Union. Examining the decomposed structure of VS share in 2003, it can be seen that Japan was the largest sourcing country for the VS share of China’s exports to the U.S., accounting for 0.04 of the whole 0.2294 VS share that year. Similarly, Korea’s contribution to China’s VS in exports to the U.S. was over half that of Japan; and the rest of the East Asian countries’ contributions to that VS share as a whole was about the same size as that of Korea’s.

5 Conclusion Much attention has been focused on the extent of China’s integration with world trade processes and evolutionary dynamics as measured by the growing vertical specialization (VS) share of China’s exports during the 1990s and at the turn of the century. In this research, we have not simply added up all the OEM related exports and regarded them as the measure for vertical specialization. Instead, based on China’s input-output tables (for the years 1992, 1997 and 2000) and data from COMTRADE (2000), we calculated and identified the intra-industry connections in a vertical trade chain in China’s exports (both globally as well to the U.S. in particular) during a very important stage of China’s economic reform and opening process (the period between 1992 and 2003). Our primary measure of vertical specialization, VS, is the imported input content (intermediate

88 Xin-Qiao Ping products and components) of China’s exports and is similar to that used by Hummaels et al. (2001). However, our deposition estimation is different from that by Hummaels et al. We decompose China’s VS by different countries, instead of by different industries, with the goal of identifying the sourcing countries and isolating some characteristics of China’s trade patterns. Our evidence indicates that the VS share of China’s global exports has risen from around 0.14 in 1992 to 0.22 in 2003, meaning the VS share grew by more than 50 per cent in this relatively short period. Compared with the 30 per cent growth of VS share in 14 OECD countries between 1970 and 1990, it is clear that the vertical specialization process has proceeded at a faster rate in China’s industrialization. Moreover, the VS share in China’s exports to the U.S. was even higher than that in China’s overall exports between 1992 and 2003. The VS share grew by 1 percentage point each year during this sample period, indicating that the intra-industry connection or intra-industry trade relationship underlying China’s external trade with the U.S. might be deeper than that with the other countries. The effect of China’s entrance into the WTO on the transformation of China’s international trade pattern has also been reviewed, and it was shown that more than two-thirds of VS growth in China’s export occurred at the turn of the new century. However, as shown by our decomposition estimations, the rapid growth of VS share in China’s exports between 1992 and 2003 might not reflect the strength in inter-industry connections between China and the U.S. or Europe. Rather, the VS growth in China might have been driven by the intra-industry trade between China on one side, and Japan, Korea and other East Asian countries on the other side. Our calculations discovered that the increase in the imported products and components from Japan and Korea might account for half of the whole VS growth in China’s exports not to only the U.S. but to the whole world as well. On the other hand, the country specific decomposition tells us that the VS share contributed by the U.S. to China’s VS was almost invariant between 1992 and 2003. Thus, our conclusion is that some intra-industry connection between China and Japan, Korea and other East Asian countries underlies the rapid growth of China’s exports and its rising VS share. In this way, China’s exports reflect somewhat indirect trade from East Asia to the U.S. and other Western countries. We report our estimations with some hesitation. A lack of all of the inputoutput tables each year between 1992 and 2003 constrained us from bringing out all of the values for AM . Thus, in the calculation and identification of VS, our assumption that the Matrix of A was invariant in the periods 1992–96, 1997–99 and 2000–3 is incorrect – our sources for input-output tables are only from those years, 1992, 1997 and 2000. This inadequacy has already been reflected in our estimated results: in all the VS share trend curves in all of the figures in this chapter there are jumps in the years of 1997 and 2000. However, employing the previous year’s input-output table in calculating the matrix of AM at the current year would only underestimate the VS share and its rising trend. Therefore, we would prefer our estimation results to be conservative, and argue that the rising

Intra-industry trade in China 89 trend of VS share in China’s exports and its heavy dependence on East Asia should be believable.

Acknowledgements The author thanks the China National Development and Reform Committee and the Government of Beijing (for the funding of co-construction of Beida, ‘Western Economics’) for financial support. Special thanks for excellent research assistance to Hao Chaoyan, Mao Liang, Li HuaSong, Zhang Lu and Hu Xiangting.

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5

A computable general equilibrium model of foreign direct investment productivity spillovers in China Ziliang Deng, Adam Blake and Rod Falvey

1 Introduction FDI plays an increasingly significant role in the global economic system, especially for the emerging economies. During the three decades of ‘reform and opening-up’ policy implementation, China has become an attractive FDI destination because of its enormous labour supply and low labour cost, relatively stable political and economic environment, and pro-FDI policies. As a result, FDI inflows to China increased dramatically from US$0.9 billion in 1983 to US$74.8 billion in 2007. Since 1993, China has been the largest FDI recipient among the developing countries. Productivity spillover effect is arguably one of the most important aspects of FDI. The productivity spillovers are economic externalities which the presence of FDI brings to the host country’s domestic firms. These spillovers take place through four channels, namely, backward and forward input-output linkages (Javorcik 2004; Markusen and Venables 1999; Pack and Saggi 2001; Girma and Gong 2008); exports of multinational affiliates (Aitken et al. 1997; Clerides et al. 1998; Greenaway et al. 2004), and demonstration effects (Findlay 1978; Koizumi and Kopecky 1977; Wang and Blomström 1992). To pursue the benefit of FDI productivity spillovers, many developing countries adopt preferential FDI policies characterized by ‘swapping domestic market access for advanced foreign technology and productivity’ (Long 2005). In exploring the spillover effects of FDI, there has been rich emerging literature, both theoretical and empirical, on the FDI productivity spillover channels and effects since the 1990s. However, it is still debated in the literature on how to quantitatively measure FDI productivity spillovers as an economy-wide and cross-industry phenomenon rather than a region- and sector-specific one. This question is what this chapter will address. This research combines computable general equilibrium (CGE) modelling and econometric techniques to quantify FDI productivity spillovers in the context of the Chinese economy. The remainder of the chapter is organized as follows: the next section introduces the computable general equilibrium model constructed here, data used, econometric models employed to estimate the spillover parameters, and the

92 Ziliang Deng et al. spillover parameters estimated from the econometric model. Section 3 compares the impacts of FDI shocks with and without productivity spillovers. Section 4 concludes.

2 Methodology and data 2.1 CGE modelling framework The research on the productivity spillover effects of FDI is conducted in a CGE framework which involves estimating key FDI productivity spillover coefficients with econometric analysis and then implementing simulations of FDI shocks to evaluate the overall impact of productivity spillovers. This static, single-country CGE model contains ninety-three industrial sectors (i.e. mining, manufacturing and utilities, in short ‘MMU’) and eight non-industrial sectors (i.e. agriculture and services). The CGE model is aimed at providing a comprehensive measure of the productivity spillover effects of FDI by scrutinizing four spillover channels, with a focus on the MMU sectors. In this model, the representative consumer has a nested consumption structure, each nesting level of which can be represented by a CES function, as shown by Figure 5.1. The lowest level (level 4) aggregates the commodity across firms in the same industry with the same ownership, e.g. the products of stated-owned enterprises in the textile industry. There are three ownerships in each industry, namely foreigninvested enterprises (‘FIE’), state-owned enterprises (‘SOE’) and private ones (‘Private’). The second lowest level (level 3) is an Armington aggregation over domestically produced commodities and imported commodities. Commodities are further aggregated across the three ownerships at level 2. At the right panel of Figure 5.1, eight sectors in agriculture and services do not contain information on ownership, so they are exempted from the level 2 aggregation across ownerships. At the top level, the products of all industries are aggregated. 2.2 Input-output table transformation The CGE model is constructed based on an input-output table transformed from the original Chinese input-output table for 2002. A transformation of an input-output table mainly involves two major steps: (1) aggregating original 122 by 122 Chinese input-output table into a 39 by 39 table (see Table 5.1 for the list of aggregated industries), as data of FDI inflows are only available for 39 aggregate industries; (2) with data estimated for FIE, SOE and Private (see Table 5.2), 31 out of the 39 sectors can be further disaggregated into 31∗3 = 93 ownership-sectors following the similar strategy of Gillespie et al. (2001, 2002), as shown in Figure 5.2. Therefore we can get a 93 + 8 = 101 dimension input-output table. This procedure enables the CGE model constructed on this input-output table to address productivity spillovers from foreigninvested enterprises to state-owned and private enterprises more effectively.

Import

Figure 5.1 Consumption aggregation.

N2 firms

N1 firms

SOE s4

Import

s3

Armington aggregate

s4

FIE

Armington aggregate s3

s2

1st Ownership aggregate

93 sectors with ownership differentiation. Suitable for modelling FDI spillovers

N3 firms

s4

PRIVATE

s3 Import

Armington aggregate

……

s1

Composite demand

31st Ownership aggregate

N94 firms

s4

Domestic aggregate

s3 Import

Armington aggregate

……

Level 4 aggregation (s4 =15)

Level 3 aggregation (s2 from GTAP version 6 data)

Level 2 aggregation (s3 = 10)

Level 1 aggregation (s1 =1)

8 sectors without ownership differentiation. Without FDI spillovers

94 Ziliang Deng et al. Table 5.1 List of aggregated industries Category

Industries

Description

Mining∗

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38

Resource manufacturing (coal, petroleum and gas) Ferrous metals mining and dressing Nonferrous metals mining and dressing Mining of non-metal, other minerals and other ores Food, beverage and tobacco manufacturing Textile industry Garments and other fibre products Leather, furs, down and related products Timber processing, bamboo, cane, palm fibre, etc. Furniture manufacturing Papermaking and paper products Printing and record medium reproduction Cultural, educational and sports goods Petroleum processing and coking Raw chemical materials and chemical products Medical and pharmaceutical products Chemical fibre Rubber products Plastic products Non-metal mineral products Smelting and pressing of ferrous metals Smelting and pressing of nonferrous metals Metal products Ordinary machinery Special purpose equipment Transport equipment Electronic and electric products Instruments, meters, cultural and office machinery Production of electric power, steam and hot water Production of gas Production of tap water Farming, forestry, animal husbandry & fishing Manufacture of artwork and other manufacturing Recycling and disposal of waste Construction Banking and insurance Real estate Geological perambulation & water conservancy; transport, storage, post & telecommunication services; wholesale & retail trade & catering; Social services; healthcare, sports & social welfare; Education, culture and arts, radio, films & television; Scientific and technical services Public administration & other services

Manufacturing∗

Utilities∗ Agriculture Other manufacturing Construction Banking and Insurance Real Estate Other services

39

Note: Categories marked with ‘∗ ’ (i.e. MMU sectors) can be further disaggregated by three types of ownership, namely FIE, SOE and Private.

FDI productivity spillovers in China 95

Table 5.2 Shares of output and value-added of SOEs, FIEs and private enterprises in each sector of MMU (%) Sector name

Resource manufacturing (coal, petroleum and gas) Ferrous metals mining and dressing Nonferrous metals mining and dressing Mining of non-metal, other minerals and other ores Food, beverage and tobacco manufacturing Textile industry Garments and other fibre products Leather, furs, down and related products Timber processing, bamboo, cane, palm fibre, etc. Furniture manufacturing Papermaking and paper products Printing and record medium reproduction Cultural, educational and sports goods Petroleum processing and coking Raw chemical materials and chemical products Medical and pharmaceutical products Chemical fibre Rubber products Plastic products Non-metal mineral products Smelting and pressing of ferrous metals Smelting and pressing of nonferrous metals Metal products Ordinary machinery Special purpose equipment Transport equipment Electronic and electric products Instruments, meters, cultural and office machinery Production of electric power, steam and hot water Production of gas Production of tap water

SOEs

FIEs

Y

VA

Y

29.5

13.6

5.2

6.0 13.3 4.7

3.8 9.8 2.9

21.0 8.2 1.4 0.9 2.1

Private VA

Y

VA

3.9

65.3

82.5

0.5 1.3 1.7

0.3 0.9 1.0

93.5 85.4 93.7

95.9 89.3 96.0

19.7 9.7 1.5 1.3 2.2

34.8 24.8 51.2 60.1 12.7

31.8 24.2 47.5 72.5 11.0

44.2 67.0 47.4 39.0 85.2

48.4 66.1 51.0 26.1 86.8

0.7 5.7 8.4 1.2 27.3 15.1

0.8 5.6 5.8 1.2 46.4 17.5

29.2 30.5 20.0 53.0 12.7 24.0

29.2 28.8 15.1 44.0 15.9 25.5

70.1 63.9 71.7 45.7 60.0 60.9

70.1 65.6 79.1 54.8 37.8 57.0

15.9 11.8 11.1 1.5 10.0 24.6 15.9 3.0 9.9 14.1 25.8 6.4 5.5

12.0 16.0 11.8 1.8 8.9 27.6 23.5 3.7 10.2 14.9 28.8 8.5 6.3

29.7 38.2 39.0 30.5 23.4 6.8 13.1 31.3 19.8 17.4 43.7 81.5 63.3

28.4 39.6 39.8 32.1 20.8 5.9 13.0 31.9 19.1 17.7 45.2 78.7 51.4

54.4 50.0 49.8 68.0 66.5 68.5 71.0 65.7 70.3 68.4 30.4 12.1 31.1

59.7 44.4 48.5 66.1 70.3 66.5 63.5 64.5 70.7 67.4 26.0 12.8 42.3

32.2

18.8

21.7

22.9

46.1

58.3

22.5 29.5

32.2 17.2

27.7 3.9

14.0 3.0

49.9 66.7

53.8 79.8

Source: National Bureau of Statistics of China (2006); National Bureau of Statistics of China (2003b); Girma and Gong (2008). Note: ‘Y ’ and ‘VA’ denote output and value added, respectively.

96 Ziliang Deng et al.

Sector i (Qi )

SOEs (Q iS )

FIEs (Q iF )

Private (Q iP )

Figure 5.2 Disaggregation of output and value-added by ownership.

Data employed are mainly from China Input-Output Table (hereafter ‘I /O’), China Statistical Yearbook and China Industry Economy Statistical Yearbook (hereafter ‘CIESY ’) for 2002. All of them were published by the National Bureau of Statistics of China (hereafter ‘NBS’, 2003a, b, 2006). 2.3 Productivity decomposition The benchmark CGE model can be extended to endogenously incorporate four possible productivity spillover channels, namely backward linkages, forward linkages, exports of FIEs and horizontal effects (including demonstration, competition, and resource reallocation). Suppose VAi,t = TFPi, t ∗G(Ki,t , Li,t ), where G(Ki,t , Li,t ) = Kiα,tK Liα,Lt , where Ki,t and Li,t , denote capital and labour respectively. Then TFP can be decomposed into: TFP = TFPindigenous + TFPspillover

(1)

where TFPindigenous captures all indigenous factors that contribute the TFP of a firm (e.g. R&D, employee education level, employee training hours and management skills), while TFPspillover measures the FDI productivity spillover effects. The TFP and spillover effects can be estimated in two stages: ln(VAi,t ) = α0 + αK ln Ki,t + αL ln Li,t + εi,t

(2)

TFPi,t = exp(α0 + εi,t ) = α1 + β ∗ SPLi,t + ζi,t

(3)

where vector SPL collectively denotes four FDI spillover channel variables: backward linkages BLi,t , forward linkages FLi,t , export concentration of multinational enterprises EXCOi,t and horizontal demonstration, HZDSi,t . HZDSj,t is the share of the gross output of foreign-invested firms in sector j at time t. Backward linkages BLj and forward linkages FLj are intended to capture local firm interactions with FIEs as purchasers and suppliers. The specifications

FDI productivity spillovers in China 97 of these two variables are similar to those of Javorcik (2004): BLj =



αj,k ∗ HZDSk

k

FLj =



βk , j ∗ HZDSk

k

where αj,k and βk , j are input-output coefficients taken from the Input-Output Table of Chinafor 2002. αj,k is the proportion of sector j’s output supplied to sector k, with k αj,k = 1; βk ,j is the proportion of sector k’s output supplied to  sector j, with k βk ,j = 1. For example, assume the foreign presences at industry 1, 2, 3 are 10 per cent, 20 per cent and 30 per cent, respectively. Industry 1 provides its products to itself, industry 2 and 3 with proportion of 40 per cent, 35 per cent and 25 per cent. Then coefficient of backward linkage is BL = 40% ∗ 10% + 20% ∗ 35% + 30% ∗ 25% = 0.185. EXCOi is the ratio of the export of foreign-invested firms sector i to the total export in sector i, which measures ‘export concentration’ as another spillover channel. Equation (2) and (3) are estimated with industry-level panel data. As discussed by Görg and Strobl (2001), panel data analyses are superior to cross-sectional studies in their capability of capturing time-invariant sector-specific factors which may impact on the relationship between foreign presence and the performance of domestic enterprises. Ignorance of such time-invariant factors usually leads to an overestimation of FDI productivity spillovers. We can then calculate the ratio of TFP caused by spillovers over total TFP. ˆ SPL TFPspillover β× = ˆ SPL TFPtotal αˆ 1 + β×

(4)

where βˆ × SPL ≡ βˆ1 BLi,t + βˆ2 FLi,t + βˆ3 HZDSi,t + βˆ4 EXCOi,t . In the CGE modelling all the spillover variables, i.e. BLi , FLi , HZDS i and EXCOi will be endogenously determined in counterfactual experiments. Therefore, the ratio of productivity spillovers over total TFP as measured by equation (4), is also endogenously determined. 2.4 Econometric estimation of spillover parameters The CGE model is built on the China Input-output Table for 2002, so the FDI spillover parameters β should be estimated for the years around 2002 to make the parameters compatible with the Input-output Table. Main data sources of estimations are China Industrial Economy Statistical Yearbook and the Input-output Table. The available CIESY s around the year of 2002 are for the years of 2001–3 and 2005–6. NBS releases I/O tables every five years and the latest one is for the year of 2002. So the I/O table of 2002 only

98 Ziliang Deng et al. Table 5.3 Industry-level panel data Variables

Symbols

Source

Years

Value added

VA

CIESY

Net fixed assets

K

CIESY

Total employment

L

CIESY

Input-output coefficients

δi,j

I/O

2001–3, 2005–6 2001–3, 2005–6 2001–3, 2005–6 2002

Backward linkages

BLj =

αj ,k ∗ HZDSk

CIESY, I/O

2002

βk ,j ∗ HZDSk

CIESY, I/O

2002 2001–3, 2005–6 2001–3, 2005–6

FLj =

Forward linkages

 k  k

Horizontal demonstrations

HZDS

CIESY

Export concentration

EXCO

CIESY

Notes: CIESY is the abbreviation of China Industrial Economy Statistical Yearbook (2001–3 and 2005–6); I /O denotes China Input-output Table for 2002. Value added VA will be deflated with an ‘ex-factory or wholesale price index’. Net fixed assets K will be deflated with a ‘fixed asset investment price index’. Both indexes are obtained from China Statistical Yearbook (National Bureau of Statistics of China 2007).

will be employed to calculate all the input-output coefficients δi,j,t (thus t can be suppressed) for the years of 2001–3 and 2005–6. The available data sources are summarized in Table 5.3. There are 31 (industries) ∗ 5 (years) = 155 observations (panel data) for estimations of SOEs. But the data for private enterprises are only available in 2005 and 2006, so total observations of private sectors are only 62. Tables 5.4 and 5.5 report the econometric estimation of productivity and spillovers, respectively. As shown by Table 5.5, there is a significant relationship between the productivity of domestic enterprises and FDI. Both SOEs and Private domestic firms benefit from spillovers from foreign-invested firms in upstream and horizontal sectors, and the coefficients for private enterprises are larger and more statistically significant. However, it seems that private enterprises are negatively affected by the competition in export market with Table 5.4 Estimation of productivity Firm types

Constant

K

L

Obs.

R2

SOEs

0.13 (0.04)∗∗∗ 1.01 (0.19)∗∗∗

0.91 (0.02)∗∗∗ 0.39 (0.06)∗∗∗

0.09 (0.03)∗∗∗ 0.70 (0.04)∗∗∗

155

0.99

62

0.97

Private

Note: (a) Estimation of equation (2). (b) Standard errors in parentheses. ∗ , ∗∗ , ∗∗∗ denote statistically significant at 10%, 5% and 1% level, respectively. (c) ‘SOEs’ stands for state-owned enterprises; ‘Private’ denotes domestic private enterprises.

FDI productivity spillovers in China 99 Table 5.5 Estimation of productivity spillovers Firm types

Constant

BL

FL

HZDS

SOEs

0.91 (0.05)∗∗∗ 2.21 (0.32)∗∗∗

0.40 (0.42) 0.15 (2.73)

0.29 (0.15)∗ 2.58 (0.97)∗∗∗

0.33 (0.17)∗ 2.88 (1.11)∗∗∗

Private

EXCO 0.04 (0.07) −1.74 (0.47)∗∗∗

Obs.

R2

155

0.31

62

0.30

Notes: (a) Estimation of equation (3). (b) and (c): same as Table 5.4.

multinational affiliates. The average contribution of FDI productivity spillovers to the overall TFP (calculated with equation (4) of SOEs and private enterprises are 22 per cent and 20 per cent, respectively.

3 CGE simulations and results 3.1 FDI shocks without spillovers An FDI shock is introduced into the economy by increasing the capital stock in each foreign-invested sector. The increased investment amount takes the data of FDI inflows in 2003, i.e. the subsequent year of the benchmark year. As shown in Table 5.6, FDI into the manufacturing sectors account for almost 70 per cent of total FDI in 2003. Among manufacturing sectors, the top five sectors in attracting Table 5.6 FDI to China by sectors in 2003 ($ million) Groups

Sectors

Mining

Coal, petroleum and gas Ferrous metals mining and dressing Nonferrous metals mining and dressing Mining of non-metal, other minerals, and other ores Food, beverage and tobacco manufacturing Textile industry Garments and other fibre products Leather, furs, down and related products Timber processing, bamboo, cane, palm fibre, etc. Furniture manufacturing Papermaking and paper products Printing and record medium reproduction Cultural, educational and sports goods Petroleum processing and coking Raw chemical materials and chemical products

Manufacturing

FDI

%

2, 779 0 0 0

0.6 0.0 0.0 0.0

11, 206

2.5

22, 591 19, 653 14, 344

5.1 4.4 3.2

3, 252

0.7

4, 438 9, 807 4, 268

1.0 2.2 1.0

7, 083 2, 354 21, 518

1.6 0.5 4.9 (continued)

100 Ziliang Deng et al. Table 5.6 Cont’d Groups

Utilities

Agriculture Construction Banking and Insurance Real Estate Other services

Subtotal Total

Sectors

FDI

Medical and pharmaceutical products 7, 864 Chemical fibre 3, 595 Rubber products 5, 966 Plastic products 16, 201 Non-metal mineral products 13, 615 Smelting and pressing of ferrous metals 10, 809 Smelting and pressing of nonferrous 5, 836 metals Metal products 16, 635 Ordinary machinery 12, 906 Special purpose equipment 10, 128 Transport equipment 19, 622 Electronic and electric products 52, 490 Instruments, meters, cultural and 13, 671 office machinery Production of electric power, steam 4, 549 and hot water Production of gas 3, 919 Production of tap water 2, 244 Farming, forestry, animal husbandry 8, 278 & fishing Construction 5, 061 Banking and insurance 1, 919 Real estate 43, 302 Geological perambulation & water 60, 578 conservancy; transport, storage, post & telecommunication services; wholesale & retail trade & catering; social services; healthcare, sports & social welfare; education, culture, radio, films & television; scientific and technical services Public administration & other services 0 All manufacturing 309, 852 All sectors 442,481

% 1 .8 0 .8 1 .3 3 .7 3 .1 2 .4 1 .3 3 .8 2 .9 2 .3 4.4 11.9 3 .1 1 .0 0 .9 0 .5 1 .9 1 .1 0 .4 9 .8 13.7

0 .0 69.9 100

Source: Chinese Ministry of Commerce; China Industrial Economy Statistical Yearbook 2004 (National Bureau of Statistics of China 2004). Compilations by the authors.

FDI are electronical products (11.9 per cent of total FDI), textile (5.1 per cent), raw chemical materials and chemical products (4.9 per cent), garments and other fibre products (4.4 per cent), and transport equipment (4.4 per cent). When these FDI inflows are simultaneously introduced into the CGE model, the changes in sectors of different ownerships are different, as shown in Table 5.7. As we can see, an FDI shock to the benchmark economy can help the foreign-invested enterprises in MMU (including manufacturing, mining and productions of utilities) to surge by 20.8 per cent, while the domestic enterprises (both SOEs and private) are

FDI productivity spillovers in China 101 Table 5.7 Effects of FDI shocks to the benchmark economy Variables

Change (%)

National output GDP Output of foreign-invested enterprises in MMU Output of domestic enterprises (SOEs + private) in MMU –SOEs –private enterprises Output of non-MMU sectors (both foreign and domestic) Welfare (equivalent variation)

5 .9 5.7 20.8 −1.9 −0.6 −2.3 6.3 2.5

Note: ‘MMU’ refers to mining, manufacturing and utilities.

negatively affected. This negative impact is caused by the expansion of foreigninvested sectors which attract labour away from those domestic enterprises in the same industries. Nonetheless, the overall impact of FDI to the economy is positive – total output, GDP and equivalent variation increase by 5.9 per cent, 5.7 per cent and 2.5 per cent, respectively. Table 5.8 shows how FDI affect the performance of enterprises of different ownerships in the top five FDI recipient sectors. The change patterns of output, value added and export are completely consistent with that of Table 5.7, i.e. the outputs of foreign-invested enterprises increase dramatically, while the production scales of domestic enterprises contract. Prices of capital are generally pulled down by the influx supply of foreign capital. Due to a relatively high but still imperfect transformability (with a Table 5.8 Impact of FDI inflow on enterprises of different ownerships (%)

Textile

Garments

Chemicals

Transport

Electronicals

FIEs SOEs Private FIEs SOEs Private FIEs SOEs Private FIEs SOEs Private FIEs SOEs Private

Export

Output

PL

PK

46.1 −7.9 −8.8 43.4 −5.9 −5.9 41.6 −5.5 −6.0 31.0 0.5 −0.9 15.7 −5.2 −5.3

39.9 −4.0 −4.7 31.9 −9.1 −9.1 32.7 −3.2 −3.6 16.1 −4.6 −5.5 12.0 −4.6 −4.7

7.7 −4.6 −5.4 5.2 −9.0 −9.0 6.5 −2.6 −3.0 −2.2 −7.5 −8.5 4.7 −0.8 −0.9

−39.3 −1.3 −2.4 −34.4 −4.6 −4.6 −29.2 −0.5 −1.2 −24.6 −2.3 −3.7 −12.5 0.0 −0.1

Note: PL and PK denote prices of labour and capital, respectively.

102 Ziliang Deng et al. benchmark elasticity of 2.0) of capital between foreign-invested and domestic enterprises, prices of capital in domestic sectors do not decrease as much as those in foreign-invested sectors. Prices of labour in foreign-invested sectors are generally higher as more foreign capital is pursuing the limited amount of labour. Due to the very low transformability (with an benchmark elasticity of 0.5) of labour between foreigninvested and domestic enterprises, a contraction of domestic sectors will lead to less demand for labour and pulls down the price of labour. The elasticity of transformation of labour between ownerships is lower than that of capital because inter-ownership labour mobility is still very low in China. According to a recent firm-level survey conducted by the Asia Market Intelligence (see Table 5.9), in the 1,500 firms surveyed, only about 0.2 per cent of the employees had work experience in foreign-invested enterprises in 2000. The labour mobility in the other direction, i.e. from domestic firms to foreign-invested firms should be higher given the higher salary (Zhao 2002) and more vibrant work environment in the latter. In brief, the labour mobility between ownerships is a rather unidirectional one, if any. Therefore it is reasonable to set a low benchmark parameter value for the elasticity of substation of labour. However, we can also try different parameter values for the elasticities of capital (σK ) and labour (σL ) transformations and see how the results will change accordingly. In the experiments, σK takes ten values (σK = 0.1, 0.4, 0.7, . . ., 2.8) consecutively, and σL also takes these ten values consecutively as well. Therefore there are in total 10∗10 = 100 sets of combinations of elasticity values (σK , σL ). The CGE model is simulated for each of these 100 sets of parameters and thus can generate 100 simulation results. The impacts of the FDI shock to national total output without spillovers are shown in the top panel (‘without spillovers’) of Table 5.10. As we can find, total output always increases. The magnitude of changes gradually increases as the combination of (σK , σL ) moves from one corner (2.8, 0.1) towards the other (0.1, 2.8). This implies that a higher degree of labour mobility Table 5.9 Employees with employment history in foreign-invested firms Industries Accounting and related services Advertising and marketing Apparel and leather goods Business logistics services Communication services Consumer products Electronic components Electronic equipment Information technology services Vehicles and vehicle parts Total Source: Asia Market Intelligence.

Number of firms

Percentage

104 89 222 110 71 165 203 192 128 216

0.5% 0.4% 0.1% 0.0% 0.0% 0.1% 0.2% 0.6% 0.6% 0.1%

1,500

0.2%

FDI productivity spillovers in China 103 Table 5.10 Impact of FDI shock on national output with and without spillovers

0.1

0.4

0.7

1.0

1.3

1.6

1.9

2.2

2.5

2.8

Without spillovers

0.1 0.4 0.7 1.0 1.3 1.6 1.9 2.2 2.5 2.8

5.8 5.7 5.7 5.7 5.6 5.6 5.6 5.6 5.6 5.5

5.9 5.8 5.7 5.7 5.7 5.6 5.6 5.6 5.6 5.6

5.9 5.9 5.8 5.7 5.7 5.7 5.7 5.6 5.6 5.6

6.0 5.9 5.8 5.8 5.7 5.7 5.7 5.7 5.6 5.6

6.0 5.9 5.9 5.8 5.8 5.7 5.7 5.7 5.7 5.6

6.1 6.0 5.9 5.8 5.8 5.8 5.7 5.7 5.7 5.7

6.1 6.0 5.9 5.9 5.8 5.8 5.7 5.7 5.7 5.7

6.1 6.0 5.9 5.9 5.8 5.8 5.8 5.7 5.7 5.7

6.1 6.0 6.0 5.9 5.8 5.8 5.8 5.7 5.7 5.7

6.1 6.0 6.0 5.9 5.9 5.8 5.8 5.8 5.7 5.7

With spillovers

Elasticity of transformation ( L)

0.1 0.4 0.7 1.0 1.3 1.6 1.9 2.2 2.5 2.8

7.7 7.4 7.2 7.0 6.9 6.8 6.7 6.7 6.6 6.5

7.8 7.6 7.4 7.2 7.1 6.9 6.9 6.8 6.7 6.6

8.0 7.7 7.5 7.3 7.2 7.0 6.9 6.9 6.8 6.7

8.1 7.8 7.6 7.4 7.2 7.1 7.0 6.9 6.8 6.8

8.2 7.9 7.6 7.5 7.3 7.2 7.1 7.0 6.9 6.8

8.2 7.9 7.7 7.5 7.4 7.2 7.1 7.0 6.9 6.9

8.3 8.0 7.7 7.6 7.4 7.3 7.2 7.1 7.0 6.9

8.4 8.0 7.8 7.6 7.4 7.3 7.2 7.1 7.0 6.9

8.4 8.1 7.8 7.6 7.5 7.3 7.2 7.1 7.0 7.0

8.4 8.1 7.9 7.7 7.5 7.4 7.2 7.1 7.1 7.0

Spillover premium

Elasticity of transformation ( K)

National output change (%)

0.1 0.4 0.7 1.0 1.3 1.6 1.9 2.2 2.5 2.8

1.9 1.7 1.5 1.4 1.3 1.2 1.1 1.1 1.0 1.0

2.0 1.8 1.6 1.5 1.4 1.3 1.2 1.2 1.1 1.1

2.1 1.8 1.7 1.6 1.4 1.4 1.3 1.2 1.2 1.1

2.1 1.9 1.7 1.6 1.5 1.4 1.3 1.3 1.2 1.2

2.2 1.9 1.8 1.6 1.5 1.4 1.4 1.3 1.2 1.2

2.2 2.0 1.8 1.7 1.6 1.5 1.4 1.3 1.3 1.2

2.2 2.0 1.8 1.7 1.6 1.5 1.4 1.3 1.3 1.2

2.2 2.0 1.9 1.7 1.6 1.5 1.4 1.4 1.3 1.2

2.3 2.0 1.9 1.7 1.6 1.5 1.5 1.4 1.3 1.3

2.3 2.1 1.9 1.8 1.6 1.6 1.5 1.4 1.3 1.3

will be beneficial to the economy. The changes of GDP and national welfare are all positive and their patterns (not reported here) are very similar to that of national total output shown in Table 5.10. 3.2 FDI shocks with spillovers This section examines the effects of FDI spillovers under perfect competition. As shown in the middle panel (‘with spillovers’) of Table 5.10, the changes of the national total output follow the similar pattern as shown in the top panel (‘without spillovers’). Figure 5.3 illustrates the impact of FDI shocks to enterprises with different ownerships with three-dimension diagrams (national total output in panel (a), SOEs in panel (b), Private enterprises in panel (c) and FIEs in panel (d)). The X and Y axes are parameter values of the elasticity of transformation of capital

104 Ziliang Deng et al. or labour, while the vertical Z axis represents the percentage changes of values in question. The ‘value net’ has 100 knots with each of them corresponding to a combination of (σ K , σ L ). Panel (b) and (c) exhibit the similar pattern, i.e. when (σK , σL ) moves from the corner (2.8, 0.1) to the other (0.1, 2.8), total output of SOEs and Private enterprises switches from the positive regime into the negative regime. In another word, if the transformability of labour between foreign firms and domestic firms is relatively higher, FDI shocks can attract away the labour from domestic firms, making the total output of the latter decrease. On the other hand, if the transformability of capital between foreign firms and domestic firms is relatively higher, then domestic enterprises can benefit more from the influx of FDI. Panel (d) exhibits the same logic, i.e. when σK is higher, foreign-invested firms will be negatively affected most. But panel (a) implies that the impact of FDI shocks on foreign-invested firms dominates the impact on the domestic firms. For example, when (σK , σL ) = (2.8, 0.1), the national total output increases with the largest magnitude. (a) Total output change (%) Change (%) 9.0

8.0

7.0 2.5

0.1 Elasticity of transformation (L)

2.5

1.9

1.3

0.7

1.3 0.1

6.0

Elasticity of transformation (K) (b) Change of domestic SOEs’ output (%) Change (%) 3.0 2.0 1.0 0.0

Elasticity of transformation (L)

2.5

1.3

1.9

0.7

1.6 0.1

−1.0

0.1

Elasticity of transformation (K)

Figure 5.3 Impact of FDI shock on output with spillovers.

FDI productivity spillovers in China 105 (c) Change of private enterprises’ output (%) Change (%) 3.0 2.0 1.0 0.0 −1.0

2.5

1.9

1.3

0.7

1.6 0.1

−2.0

0.1

Elasticity of transformation (L)

Elasticity of transformation (K)

(d) Change of foreign-invested enterprises’ output (%) Change (%) 25.0

20.0

15.0 2.5

2.5

1.9

1.3

0.7

1.3 0.1

10.0

0.1

Elasticity of transformation (L)

Elasticity of transformation (K)

Figure 5.3 Continued

The changes of GDP and national welfare are all positive and their patterns are very similar to the one shown in panel (a) of Figure 5.3, so their diagrams are not included here. Tables 5.11 and 5.12 show the changes of SOEs and Private enterprises by sector. The column of ‘FDI’ measures the percentage of FDI in total FDI to China in 2003. As introduced in Section 2.3, the changes of the values of the above spillover variables will affect the productivity spilt over from foreign firms to domestic firms. The contribution of FDI productivity spillovers to the total productivity measured by equation (4) will also change endogenously. This change is shown in the column ‘NTFP’. For both SOEs and Private firms in almost all industries, the contribution of FDI spillovers to their productivity has increased. For both SOEs and Private enterprises, the ‘production of tap water’ sector gains the most (26.3 per cent and 40.7 per cent respectively) from the FDI spillovers. This is probably because the initial FDI volume in this industry was

7.8 7.2 8.8 9.6 4.7 14.0 14.8 9.5 13.3 13.5 12.4 12.9 10.5 7.2 10.7 9.8 11.0 12.2 12.7 10.9 14.7 16.1 15.8 9.9 10.7 7.9 3.7 5.6 6.2 9.3 9.0

0.6 0.0 0.0 0.0 2.5 5.1 4.4 3.2 0.7 1.0 2.2 1.0 1.6 0.5 4.9 1.8 0.8 1.3 3.7 3.1 2.4 1.3 3.8 2.9 2.3 4.4 11.9 3.1 1.0 0.9 0.5

7.6 18.0 19.7 13.9 3.0 12.6 9.6 10.4 13.9 8.9 9.3 7.6 8.7 11.0 10.9 9.9 11.8 7.8 7.0 6.8 11.9 6.8 7.8 8.2 12.9 6.1 2.5 7.9 11.4 10.2 10.9

FL 6 .8 −2.6 −2.0 −1.9 0 .8 16.6 9.9 10.2 17.4 17.4 13.8 11.9 9 .8 6 .6 13.3 10.2 10.1 12.4 14.1 14.7 31.0 24.4 13.7 12.9 19.7 5.6 1.5 11.4 1 .4 20.8 160.2

HZDS 9.6 N.A. −2.9 −2.5 1.4 21.0 9.2 10.5 23.6 17.3 9.2 9.3 8.5 8.6 16.5 14.3 12.8 14.3 12.3 14.2 46.0 38.3 15.4 13.6 14.8 5.7 1.2 8.4 0.1 51.1 N.A.

EXCO 6 .7 11.2 12.3 9 .6 1 .4 11.8 8.7 7 .1 13.3 13.6 9 .4 10.0 7 .6 7 .2 9.4 8 .4 8 .1 8 .7 8 .5 10.2 15.0 10.4 10.2 8 .7 13.0 4.9 1.5 6 .2 4 .5 14.2 26.3

NTFP 0.8 1.2 1.3 0.8 0.2 2.6 2.4 2.8 1.6 2.3 2.4 1.7 2.3 0.7 2.2 1.6 2.5 2.3 2.5 1.7 1.7 2.1 2.2 1.7 1.8 1.5 0.8 2.7 0.8 2.3 2.9

TFP −4.5 −3.9 −6.4 −4.2 −16.2 0.6 6.6 5.7 −1.6 6.4 5.0 5.7 4.3 −1.9 2.6 −1.6 9.4 1.5 7.7 8.0 1.1 0.4 9.2 3.9 7.9 9.7 2.9 1.4 −3.7 7.7 −4.3

Export 8.8 9.1 15.4 7.7 22.2 7.8 −7.5 4.0 3.1 −7.6 −3.0 −8.3 −5.1 6.9 3.5 −3.6 −1.1 0.3 −1.6 −10.7 3.3 7.5 −5.2 −0.7 −6.1 −7.1 2.4 3.1 12.5 −8.5 −8.2

Import 1.3 1.8 3.5 0.6 0.0 2.0 0.3 4.2 −0.6 −0.3 −1.6 −3.6 0.7 1.8 1.7 −5.2 2.5 −0.8 1.5 −3.9 1.0 2.8 1.5 0.8 −0.3 0.4 1.5 0.8 4.2 −1.6 −13.0

Output 2.0 1.9 3.4 1.6 6.1 0.4 −1.6 −0.4 0.3 −1.7 −2.2 −3.1 −0.9 1.8 −0.3 −1.1 −2.0 −0.7 −1.8 −3.9 0.0 0.6 −1.9 −0.7 −1.9 −2.0 −0.3 −0.2 2.8 −3.2 −3.3

P

Notes: (1) ∗ FDI : percentage of total FDI in corresponding sectors; (2) BL: backward linkages; FL: forward linkages; HZDS: horizontal demonstration; EXCO: export concentration of FIEs; SPL: the percentage of TFP spillovers in total TFP; NTFP: the contribution of FDI productivity spillovers to total productivity; TFP: industry-level productivity; Export: export of SOEs. (3) (σ K , σ L ) = (2.0, 0.5); (4) Some data are not available and marked ‘N.A.’ because the initial values are zero. So it is not possible to calculate the percentage changes.

Coal, petroleum and gas Ferrous metals mining and dressing Nonferrous metals mining and dressing Mining of non-metal, other minerals and other ores Food, beverage and tobacco manufacturing Textile industry Garments and other fibre products Leather, furs, down and related products Timber processing, bamboo, cane, palm fibre, etc. Furniture manufacturing Papermaking and paper products Printing and record medium reproduction Cultural, educational and sports goods Petroleum processing and coking Raw chemical materials and chemical products Medical and pharmaceutical products Chemical fibre Rubber products Plastic products Non-metal mineral products Smelting and pressing of ferrous metals Smelting and pressing of nonferrous metals Metal products Ordinary machinery Special purpose equipment Transport equipment Electronic and electric products Instruments, meters, cultural and office machinery Production of electric power, steam and hot water Production of gas Production of tap water

BL

FDI*

Table 5.11 Impact (%) of FDI shocks on SOEs with spillovers

Note: Same as Table 5.11.

Coal, petroleum and gas Ferrous metals mining and dressing Nonferrous metals mining and dressing Mining of non-metal, other minerals and other ores Food, beverage and tobacco manufacturing Textile industry Garments and other fibre products Leather, furs, down and related products Timber processing, bamboo, cane, palm fibre, etc. Furniture manufacturing Papermaking and paper products Printing and record medium reproduction Cultural, educational and sports goods Petroleum processing and coking Raw chemical materials and chemical products Medical and pharmaceutical products Chemical fibre Rubber products Plastic products Non-metal mineral products Smelting and pressing of ferrous metals Smelting and pressing of nonferrous metals Metal products Ordinary machinery Special purpose equipment Transport equipment Electronic and electric products Instruments, meters, cultural and office machinery Production of electric power, steam and hot water Production of gas Production of tap water

BL 7.8 7.2 8.8 9.6 4.7 14.0 14.8 9.5 13.3 13.5 12.4 12.9 10.5 7.2 10.7 9.8 11.0 12.2 12.7 10.9 14.7 16.1 15.8 9.9 10.7 7.9 3.7 5.6 6.2 9.3 9.0

FDI 0.6 0.0 0.0 0.0 2.5 5.1 4.4 3.2 0.7 1.0 2.2 1.0 1.6 0.5 4.9 1.8 0.8 1.3 3.7 3.1 2.4 1.3 3.8 2.9 2.3 4.4 11.9 3.1 1.0 0.9 0.5

7.6 18.0 19.7 13.9 3.0 12.6 9.6 10.4 13.9 8.9 9.3 7.6 8.7 11.0 10.9 9.9 11.8 7.8 7.0 6.8 11.9 6.8 7.8 8.2 12.9 6.1 2.5 7.9 11.4 10.2 10.9

FL

Table 5.12 Impact (%) of FDI shocks on private enterprises with spillovers

6.8 −2.6 −2.0 −1.9 0.8 16.6 9.9 10.2 17.4 17.4 13.8 11.9 9.8 6.6 13.3 10.2 10.1 12.4 14.1 14.7 31.0 24.4 13.7 12.9 19.7 5.6 1.5 11.4 1.4 20.8 160.2

HZDS 9.6 N.A. −2.9 −2.5 1.4 21.0 9.2 10.5 23.6 17.3 9.2 9.3 8.5 8.6 16.5 14.3 12.8 14.3 12.3 14.2 46.0 38.3 15.4 13.6 14.8 5.7 1.2 8.4 0.1 51.1 N.A.

EXCO 6.0 13.7 14.1 10.1 1.2 9.3 5.1 5.6 11.7 10.9 6.6 7.8 5.6 6.5 7.1 6.6 5.5 5.9 5.7 7.9 12.9 7.0 6.6 7.1 13.4 3.1 0.7 7.2 3.4 12.0 40.7

NTFP 1.5 2.9 3.2 1.5 0.6 5.0 2.9 4.9 3.6 3.9 4.9 2.7 2.9 1.8 4.5 3.0 5.0 4.2 4.5 3.5 4.0 4.3 4.0 3.2 3.9 2.3 1.0 5.0 1.5 5.8 8.1

TFP −3.5 −1.9 −5.5 −2.9 −14.6 0.2 6.3 −6.1 −0.1 6.1 6.8 11.6 5.3 −2.2 2.3 5.7 5.1 0.4 6.9 13.2 2.6 −1.5 7.2 5.0 9.5 7.5 2.2 3.3 −5.0 0.9 21.3

Export 8.8 9.1 15.4 7.7 22.2 7.8 −7.5 4.0 3.1 −7.6 −3.0 −8.3 −5.1 6.9 3.5 −3.6 −1.1 0.3 −1.6 −10.7 3.3 7.5 −5.2 −0.7 −6.1 −7.1 2.4 3.1 12.5 −8.5 −8.2

Import 2.1 3.5 4.3 1.6 1.4 1.7 0.1 −5.5 0.6 −0.6 −0.3 0.5 1.5 1.6 1.5 0.2 −0.6 −1.7 0.9 −0.2 2.1 1.4 0.0 1.6 0.8 −1.0 1.0 2.5 3.0 −6.8 4.8

Output 1.9 1.8 3.3 1.5 6.0 0.4 −1.6 0.2 0.2 −1.7 −2.3 −3.5 −1.0 1.8 −0.2 −1.6 −1.7 −0.6 −1.7 −4.3 −0.1 0.7 −1.8 −0.8 −2.0 −1.9 −0.3 −0.2 2.9 −2.8 −5.1

P

108 Ziliang Deng et al. relatively low, while an FDI shock (accounting for 0.5 per cent of total FDI) to this industry can bring the largest increase in terms of the contribution rate of FDI spillovers in total TFP, as measured by equation (4). While the column ‘NTFP’ measures the contribution rate of FDI spillovers to total productivity, ‘TFP’ simply measures the percentage change of the level of total productivity. As we can see, the FDI productivity spillovers also make the total TFP of each industry improve. The top five FDI recipient industries are electronic and electric products (11.9 per cent), textile industry (5.1 per cent), raw chemical materials and chemical products (4.9 per cent), garments and other fibre products (4.4 per cent), and transport equipment (4.4 per cent). However, these top five FDI recipient sectors are not necessarily among the top recipient sectors of such FDI spillovers. The reason for this ‘inconsistency’ is that FDI shock affects the productivity of domestic enterprises via four spillover channels, but the corresponding channel variables however do not increase with the same magnitude. Due to the similar reasons, the top five FDI recipient industries are not necessarily the largest gainers in terms of output increase. The changes of export and import are ambiguous, while the product prices (P) are overwhelmingly lower due to the contraction of domestic sectors and cheaper labour and capital. Regarding the total output in the ‘output’ column, the results are also mixed. On the one hand, the FDI shock can generally improve the productivity of domestic enterprises (SOEs and Private firms), which can potentially raise their total output. On the other hand, the FDI shock can attract away resources from domestic firms and pose threat to the latter. The above two forces make the collective results ambiguous. Returning to Table 5.10, the bottom panel illustrates the difference between the scenario without spillover and the scenario with spillovers (as discussed). It clearly indicates a positive ‘spillover premium’, i.e. the total output increases even more in the latter scenario. Such premia are shown in Figure 5.4 with three-dimensional diagrams. Panel (b) and (c) show positive premia which SOEs and Private enterprises obtain from FDI productivity spillovers. Nonetheless, the increased rate of FIEs’ output is lower than that in the scenario without FDI productivity spillovers given the same combination of (σK , σL ), i.e. negative spillover premium (see panel (d) in Figure 5.4). This contrast has important implications, i.e. FDI productivity spillovers are beneficial to promoting host country’s total output (see panel (a); and similarly GDP and national welfare which are not shown in the diagrams), although total output of foreign-invested sectors will increase with a smaller magnitude. In another words, the slower increase rate of FIEs is outweighed by even better performance of domestic sectors thanks to the FDI productivity spillovers.

4 Concluding remarks This is the first paper in the literature to endogenise FDI productivity spillovers by incorporating spillover channels within a CGE framework. This model is

FDI productivity spillovers in China 109 suitable for modelling the economy-wide and cross-industry effects of FDI productivity spillovers. The results show that the FDI productivity spillover effects are eminent in China. Although FDI productivity spillovers negatively affect the performance of foreign-invested enterprises, they do promote the productivity of domestic enterprises, and improve their performance. Collectively, there does exist a positive spillover premium in terms of total output, GDP and national welfare. This research can be further extended in two dimensions. First is to analyse the spillover effects in two more market structures. One is monopolistic competition

(a) Positive spillover premium of national total output (%) Spillover premium (%) 2.5

1.5

2.5

1.9

0.7

1.3

1.6 0.1

0.5

0.1

Elasticity of transformation (L)

Elasticity of transformation (K) (b) Positive spillover premium of domestic SOEs’ output (%) Spillover premium (%) 1.4

0.9

2.5 1.3 2.5

1.9

1.3

0.7

0.1

0.4 0.1

Elasticity of transformation (L)

Elasticity of transformation (K)

Figure 5.4 Impact of FDI shock on output: spillover premium.

110 Ziliang Deng et al. (c) Positive spillover premium of private enterprises’ output (%) Spillover premium (%) 3.0

2.0

2.5 1.3 2.5

1.9

1.3

0.7

0.1

1.0 0.1

Elasticity of transformation (L)

Elasticity of transformation (K) (d) Negative spillover premium of foreign-invested enterprises’ output (%) Spillover premium (%) −0.4

−0.8

2.5 −1.2 2.5

1.9

1.3

0.7

0.1

1.3 0.1

Elasticity of transformation (K)

Elasticity of transformation (L)

Figure 5.4 Continued

(Dixit and Stiglitz 1977) under which the competition degree of a market can affect the effects of FDI productivity spillovers. The other is the newly explored monopolistic competition with heterogeneous firms (Melitz 2003) under which FDI shocks with productivity spillovers might cause intra- and interindustry resource reallocation towards those most productive enterprises, leading to potentially even prominent FDI productivity spillover effects. Second, this

FDI productivity spillovers in China 111 research can also be employed to simulate possible tax reforms on the corporate income tax system favourable to foreign-invested firms, and check if preferential taxes can help FDI productivity spillovers to occur. Such policy experiments would be appealing as countries have ‘increasingly’ relied on policy incentives (United Nations Conference on Trade and Development 2000: 3) partially allured by the potential FDI productivity spillovers.

Acknowledgements Deng’s research was sponsored by the UK-China Scholarships for Excellence (2005–2008). Falvey gratefully acknowledges financial support from the Leverhulme Trust under Programme Grant F/00 114/AM. The authors are grateful to the constructive comments from Sourafel Girma, Yundan Gong, Aoife Hanley, Richard Kneller, Chris Milner, Chengqi Wang, Fan Zhai and the participants of the 19th Chinese Economic Association (UK) Annual Conference (Cambridge, April 2008), 7th GEP International Postgraduate Conference (Nottingham, April 2008), the 11th Annual Conference on Global Economic Analysis (Helsinki, June 2008), and the University of Oxford–China Centre for Economic Research Conference (Oxford, September 2008).

References Aitken, B., Hanson, G.H. and Harrison, A.E. (1997) ‘Spillovers, foreign investment, and export behavior’. Journal of International Economics, 43: 103–32. Clerides, S., Lach, S. and Tybout, J. (1998) ‘Is learning by exporting important? microdynamic evidence from Colombia, Mexico, and Morocco’. Quarterly Journal of Economics, 113: 903–47. Dixit, A.K. and Stiglitz, J.E. (1977) ‘Monopolistic competition and optimum product diversity’. American Economic Review, 67: 297–308. Findlay, R. (1978) ‘Relative backwardness, direct foreign investment, and the transfer of technology: A simple dynamic model. Quarterly Journal of Economics, 92: 1–16. Gillespie, G., McGregor, P.G., Swales, J.K. and Yin, Y.P. (2001) A Regional CGE Analysis of the Demand and ‘Efficiency Spillover’ Effects of Foreign Direct Investment, in Pain, N. (ed.) Inward Investment, Technological Change and Growth: The Impact of Multinational Corporations on the UK Economy. Basingstoke: Palgrave. Gillespie, G., McGregor, P.G., Swales, J.K. and Yin, Y.P. (2002) The Regional Impact of Foreign Direct Investment: Structure and Behavior in an OwnershipDisaggregated Computable General Equilibrium Model, in Hewings, G., Sonis, M. and Boyce, D.E. (eds) Trade, Networks and Hierarchies: Modeling Regional and Interregional Economies. Berlin: Springer-Verlag. Girma, S. and Gong, Y. (2008) ‘FDI, linkages and the efficiency of state-owned enterprises in China’. Journal of Development Studies, 44: 728–49. Görg, H. and Strobl, E.A. (2001) Multinational companies and productivity spillovers: A meta-analysis. The Economic Journal, 111: 723–39. Greenaway, D., Sousa, N. and Wakelin, K. (2004) ‘Do domestic firms learn to export from multinationals?’ European Journal of Political Economy, 20: 1027–43.

112 Ziliang Deng et al. Javorcik, B.S. (2004) ‘Does foreign direct investment increase the productivity of domestic firms? In search of Spillovers through backward linkages’. American Economic Review, 94: 605–27. Koizumi, T. and Kopecky, K.J. (1977) ‘Economic growth, capital movements and the international transfer of technical knowledge’. Journal of International Economics, 7: 45–65. Long, G. (2005) China’s Policies on FDI: Review and Evaluation, in Theodore H. Moran, Edward M. Graham and Blomström, M. (eds) Does Foreign Direct Investment Promote Development? Washington D.C.: Institute for International Economics. Markusen, J.R. and Venables, A.J. (1999) ‘Foreign direct investment as a catalyst for industrial development’. European Economic Review, 43: 335–56. Melitz, M.J. (2003) ‘The impact of trade on intra-industry reallocations and aggregate industry productivity’. Econometrica, 71: 1695–725. National Bureau of Statistics of China (2003a) China Industrial Economy Statistical Yearbook 2003, Beijing: China Statistics Press. National Bureau of Statistics of China (2003b) China Statistical Yearbook 2003, Beijing: China Statistics Press. National Bureau of Statistics of China (2004) China Industrial Economy Statistical Yearbook 2004, Beijing: China Statistics Press. National Bureau of Statistics of China (2006) Input-output Tables of China, 2002, Beijing: China Statistics Press. National Bureau of Statistics of China (2007) China Statistical Yearbook 2007, Beijing: China Statistics Press. Pack, H. and Saggi, K. (2001) ‘Vertical technology transfer via international outsourcing’. Journal of Development Economics, 65: 389–415. United Nations Conference on Trade and Development (2000) Tax Incentives and Foreign Direct Investment: A Global Survey. New York and Geneva: United Nations. Wang, J.-Y. and Blomström, M. (1992) ‘Foreign investment and technology transfer: A simple model’. European Economic Review, 36: 137–55. Zhao, Y. (2002) ‘Earnings differentials between state and non-state enterprises in urban China’. Pacific Economic Review, 7: 181–97.

6

Domestic capital, sources of foreign direct investment, and national output in China Busakorn Chantasasawat, K.C. Fung, Francis Ng, and Alan Siu1

1 Introduction In 1978, China introduced the open door policy, inviting foreign capital and advanced technologies to drive economic development in China.2 Foreign direct investment (FDI) has become one of the most important sources contributing to a sustained long-term growth in developing countries.3 It not only brings employment to recipient countries but also acts as a channel of technology, management and marketing skills, as well as export outlets. Certain sources of FDI may channel more technology and advanced knowledge than others. For example, direct investments from the US and Japan tend to be in capital-intensive sectors, bringing in more technology, whereas direct investment from Hong Kong and Taiwan are more labor-intensive, generating more growth on the employment side. As such, Fung et al. (2002, 2005), utilizing China provincial data from 1991 to 1997, find that each source of FDI with different characteristics is attracted by different FDI determinants to various degrees. In particular, infrastructure is a very important determinant for Hong Kong and Taiwan FDI but is less crucial when it comes to FDI from Japan and the US. Due to the job-rotation nature of Japanese working culture, labor quality, on the other hand, is more important to direct investment from Japan than those from the US, Hong Kong, and Taiwan. Labor cost is more important to Taiwan and Hong Kong direct investment, possibly due to its labor-intensive nature of investment from these countries. Accordingly Fung et al. (2002, 2005) suggest that since each FDI source has different characteristics in itself, provinces may want to focus on different determinants when attempting to attract a certain source of FDI. If that is so, do different sources of FDI then have different impacts on China provincial output? The purpose of this chapter is to examine five individual sources of investment and how they contribute to output in China provincial economies. The five sources are direct investment from the United States, Japan, Hong Kong, Taiwan, and the Republic of Korea.

114 Busakorn Chantasasawat et al.

2 FDI as a determinant of output A large number of articles on growth explore the impact of FDI on growth using a wide variety of techniques and data sets. The one by Bromström et al. (1992) is among the early attempts to study determinants of growth in developing countries. FDI inflow in this empirical study is included to capture the spillover effect of technology from foreign countries. High- and low-income developing countries are separated in their analysis since they believe that higher-income developing countries are ready and at more advantage to learning and applying higher technology from abroad. Their results suggest that developing countries need to reach a certain threshold level of development in order to absorb technology before the benefit of foreign investment becomes apparent. Balasubramanyam et al. (1996) examine the role of FDI on growth in exportpromoting countries versus import-substituting countries. The tested hypothesis is that the impact of FDI on growth should be stronger in export-promoting countries than in import-substituting countries. Similar to Bromström et al. (1992), FDI is included to capture the spillover effect of knowledge and technologies. Cross-sectional data of forty-six developing countries averaging over the period of 1970–85 are used. Their findings support the hypothesis that FDI has a stronger positive relationship on export-promoting countries due to more neutral policies between export and import than import-substituting countries. Borensztein et al. (1998) use data of sixty-nine developing countries over the period 1970–89 in a cross-country regression to test the effect of FDI on growth. The model also views FDI as a channel of advanced knowledge and technology, which contributes to higher growth. In order for the developing countries to capture this benefit, a sufficient initial level of human capital must be present. Consequently, the positive effect of FDI on growth holds only when this threshold level of human capital suffices. Given an adequate level of education, their empirical results confirm this position and, in addition, indicate that FDI has a higher impact on growth than domestic investment. Additional evidence that emphasizes the need of a presence of other factors in order to reap the benefit of FDI is by Alfaro et al. (2003). Their study finds that a better financial system, represented by various financial development terms interacting with FDI, helps a country exploit FDI benefit more efficiently, using data from both developed and less-developed countries during the period 1980–95. Although cross-section examinations of FDI on growth generally report a positive contribution of FDI, at the opposite end, Carkovic and Levine (2003) side with other firm-level evidences that there is no significant effect of FDI on economic growth. They implement the Generalized Method of Moments (GMM) on their panel data, and thus avoid the simultaneity bias between growth and FDI. Alfaro et al. (2003) also find that FDI by itself and without the FDI-financial market interaction terms, is insignificant. Blonigen and Wang (2004) suggest that pooled data of developed countries and less-developed countries should not be used together to determine the effect of FDI

FDI and growth in China 115 on economic growth. They repeat the Balasubramanyam et al. and Borensztein et al. techniques using as similar data as possible to the previous papers and also test on developed countries. Their finding indicates that magnitudes of FDI on the pooled data and on less-developed countries alone are sufficiently different, and hence, pooled data should not be used. The case of China The important role of FDI in China in the early period is investigated by Chen et al. (1995) using annual data from 1968 to 1990. To avoid causality problems between FDI and GNP, their dependent variable is determined by a one-year lagged FDI. They find a positive relationship between them; 1 percent increase in FDI can increase GNP by 0.635 percent. They conclude that there is no doubt that FDI is a driving force behind the rapid growth of China. This is especially true for Fujian and Guangdong, whose major sources of FDI are Taiwan and Hong Kong, respectively. Liu and Li (2001) use China provincial data from 1985 to 1998 and decompose total investment in fixed assets in four sources: state budget appropriation; national bank domestic loans; utilized foreign investment; and self-raised funds and others. They implement fixed effects, random effects, and a combination of fixed effects and time dummy. FDI is found to be significant in all fixed effect models in three different samples: all provinces; coastal provinces; and interior provinces. However, FDI is not significant in time-effect or random effect models. The authors conclude that due to its small ratio to the total investment in fixed assets, FDI has less or no impact on the output growth. Moreover, FDI, by its nature, has more impact on coastal provinces. They find that domestic loan and self-raised funds have larger effects on China provincial growth. Furthermore, these two sources of investment are also influential to coastal provinces, whereas for interior provinces the influential factors are state budget appropriation and domestic loans. The authors emphasize the importance of efficient use of financial sources to growth, in which they say state budget appropriation is less efficient than domestic investment and self-raised funds and that increases in resource allocation toward non-state sector sources will lead to economic growth.

3 Empirical estimation and data We start out with a conventional production function where output depends on labor and capital. FDI is part of the capital, in addition to domestic investment. The production function can be written as follows: Y = F(L, K , X )

(1)

where Y is nominal GDP, L labor, K capital, and X other variables. In this chapter, X includes human capital and an interaction term between human capital and FDI.

116 Busakorn Chantasasawat et al. Assuming (1) to be linear in logs, output of province i at time t is: ln(Yi,t ) = α + β1 ln(EMPi,t ) + β2 ln(DINVi,t ) + β3 ln(FDIi,t ) + β4 ln(Xi,t )

(2)

where EMP is employment of labor; DINV is cumulative domestic investment; FDI is provincial cumulative aggregate FDI or FDI by source; and X is human capital (HE) and FDI-human capital interaction term (HEFDI). All variables enter the equation in natural log form. The coefficient β s represent elasticities of each variable. Our proxy for human capital (HE) is the number of students enrolled in institutions of higher education. Studies, both theoretically and empirically, find human capital to be one of the essential variables for host countries to absorb technology.4 Domestic investment (DINV) is total fixed investment in fixed assets subtracted by FDI. Employment (EMP) is number of employed persons. The expected signs for all the variables are positive. The data for all four variables are from China Statistical Yearbook. One concern addressed here is the possible causality linkage between FDI and output since one of the reasons multinationals decide to invest in a country also includes the market size, particularly when FDI is of horizontal type. Empirically, Shan et al. (1997) apply VAR method to test the causality between FDI and growth, using China quarterly time series data from 1985:2–1996:2. Their results indicate a two-way Granger causality between output growth and FDI inflows. Choe (2003), testing causality with data of eighty countries between 1971 and 1995 using panel VAR model, find FDI Granger-cause economic growth and vice versa. However, they note that the effect is higher on the growth Granger-cause FDI direction. Deducing from the previous studies, causality linkage is evident, and thus we estimate the output equation using two-stage least squares. The instrument variables implemented, besides employment and domestic investment, are determinants of FDI. The variables are average wage and its lag (WAGE or LWAGE), infrastructure (INFRA), closeness, human capital (HE) and policy. Although human capital is one of the FDI determinants, we omit this variable and choose to employ it in the output equation. Infrastructure variable measures quality of roads and railways. Policy variable of each province is constructed from special economic zones (SEZ), economic and technological development zones (ETDZ), and open coastal cities (OCC) in that certain region. A province receives a score of 1 for each special area that it has. A province that has one SEZ and two OCC receives the score of 3. These special regions offer various incentives and policies in attempts to attract more foreign investment. Closeness is fraction of state-owned industry output over total industry output of that province. It is a proxy for degree of liberalization as opposed to a strict control by local government. The equation used to determine FDI is: ln(FDIi,t ) = ϕ + γ1 ln(GDPi,t ) + γ2 ln(WAGEi,t ) + γ3 ln(INFRAi,t ) + γ4 ln(POLICYi,t ) + γ5 ln(CLOSENESSi,t )

(3)

FDI and growth in China 117 Thus, we use combinations of these determinants, except GDP, as instrumental variables to find results that do not violate over-identification requirement. We estimate two versions: pooled two-staged least square (2SLS) and random effect 2SLS.5 The random effect model includes an individual effect for each province. In the pooled 2SLS model, the system of equations is given by: yi,t = α + β  xi,t + εi,t

(4)

fdii,t = φ + γ  zi,t + ηi,t

(5)

εi,t and ηi,t are assumed to be i.i.d disturbances with mean zero and variance σε2 and ση2 , respectively. In the random effects 2SLS, the system of equations is given by:

yi,t = μ + ω xi,t + ui + ei,t

(6)

fdii,t = λ + ρ  zi,t + vi + wi,t

(7)

ei,t and wi,t are i.i.d disturbances with mean zero and variance σe2 and σw2 , respectively. vi and ui are individual effect with mean zero and variance σv2 and σu2 , and are assumed to be uncorrelated with all the regressors in equation (6) and (7), respectively, i.e., Cov(ui , xi,t ) = Cov(vi , zi,t ) = 0. Variables in x are the regressors in equation (2), and variables in z are the regressors in equation (3). All variables enter the system of equations in log form. In general, multinational enterprises (MNEs) make their decisions to invest according to whether they are catering to the host economies’ domestic markets or whether they are utilizing the host economies’ cheaper labor to produce goods to export to the rich economies or to export markets in the surrounding region. For the former, the FDI is described as horizontal. The determinants in this case relate to the size of the host economy and the purchasing power of the domestic consumers. For the latter case, the FDI is vertical and the factors influencing the extent of FDI in this case relate to the cost of labor, the quality of labor as well as the infrastructure that may facilitate exports. Other variables that affect the profitability of the MNEs will also play a role. The determinants of FDI in the general case also apply to our specific case of China. We merely modify our specifications to make the regression equation more appropriate. The above discussion relates to the first stage of our regression. The second stage links FDI to national output. In a standard growth accounting framework, a change in a country’s output can be linked to changes to all its inputs, including domestic capital, foreign capital, a change in the quantity of labor as well as potential technical progress. There are many other channels through which a change in FDI can lead to a change in output that are not easily captured in the standard aggregate production function approach. For example, FDI can facilitate a change of the host economy’s institutions such as an improvement in the rule of law, a lower incidence of corruption, etc. These induced changes in turn can lead to a more efficient economy and more national output. In addition,

118 Busakorn Chantasasawat et al. endogenous growth theory highlights the role of human capital in fostering economic development. Human capital can also interact with FDI to increase national output. To implement our empirical estimations, we utilized the provincial data set of China. The five major sources of the contracted FDI data available are USA, Japan, Hong Kong, Taiwan, and Republic of Korea. The provincial FDI data are from 1990 to 2002, except for Korean data which are from 1991 to 2000. We use contracted FDI calculated from the Almanac of China Foreign Relations and Trade and China Foreign Economic Statistical Yearbook. Aggregate FDI is obtained from China Statistical Yearbook. The Appendix contains data sources and definitions in detail.6

4 Results The purpose of this empirical investigation is to estimate the effect of FDI by source on output. Our main results are: FDI from the US has the largest effect on GDP, following by FDI from Hong Kong, Japan, Taiwan, and Republic of Korea, respectively. However, the driving force of growth is domestic investment. Tables 6.1–6.5 report results of regressions using FDI by the US, Japan, Hong Kong, Taiwan, and Korea, respectively. Column 1 only considers employment, domestic investment and FDI by source. Column 2 takes into account human capital. Column 3 includes an additional interaction term between FDI and human capital. Since FDI is treated as an endogenous variable, in this and the next column we treat the FDI-human capital interaction as endogenous. The interaction term is a product of the aggregate FDI and human capital. The aggregate FDI is used instead of the direct FDI source to avoid high correlation between the source FDI and the interaction term. Column 4 keeps the product term but ignores human capital. Column 5 treats the interaction term as an exogenous factor. Overall, all sources of FDI have larger effects on output. FDI by the US has the largest effect among all sources; an increase of 10 percent in FDI from the US adds as much as 2 percent to output. Overlooking the different sample sizes, in terms of magnitude of coefficients, USA is the strongest, following by Hong Kong, Taiwan, Japan, and Republic of Korea. Including human capital in the regression does not improve the regression performance. It is not surprising that human capital seems to be insignificant in most cases, and when significant its impact is rather small. As suggested by Nelson and Phelps (1966), education alone may not contribute much if placing directly in the production function. Except in the Korean case, human capital is always positive though only in specification 3 for USA, Hong Kong, and Taiwan cases. In the case of Republic of Korea, it was even negative, although not significant. When it is significant, a 1 percent increase in human capital increases output by about 0.1 percent.

Table 6.1 Pooled 2SLS using FDI from USA

USA EMP DINV

(1)(a)

(2)(b)

(3)(c) (4)(d) Endogenous product term

(5)(e)

0.1354∗∗∗ (0.0377) 0.3279∗∗∗ (0.0358) 0.6300∗∗∗ (0.0625)

0.1341∗∗∗ (0.0399) 0.3539∗∗∗ (0.0442) 0.6037∗∗∗ (0.0585) 0.0420 (0.0564)

0.2364∗∗ (0.1083) 0.4871∗∗∗ (0.1149) 0.5165∗∗∗ (0.1121) 0.1675∗ (0.0920) −0.0646 (0.0526) 3.3491∗∗∗ (1.0582)

0.1536∗∗ (0.0711) 0.3372∗∗∗ (0.0495) 0.6232∗∗∗ (0.0723)

0.1312∗∗ (0.0542) 0.3255∗∗∗ (0.0408) 0.6259∗∗∗ (0.0684)

−0.0091 (0.0253) 2.6562∗∗∗ (0.8009)

0.0042 (0.0117) 2.9213∗∗∗ (0.7276)

HE HEFDI Constant Observations R-squared

2.7825∗∗∗ (0.7821) 345 0.953

3.2587∗∗∗ (0.7892) 345 0.953

345 0.900

345 0.947

345 0.954

Robust standard errors in parentheses. ∗ significant at 10%; ∗∗ significant at 5%; ∗∗∗ significant at 1%. (a) Instruments: EMP DINV CLOSENESS POLICY INFRA. (b) Instruments: EMP DINV HE CLOSENESS POLICY INFRA. (c) Instruments: EMP DINV HE CWAGE CLOSENESS POLICY INFRA. (d) Instruments: EMP DINV CLOSENESS POLICY INFRA. (e) Instruments: EMP DINV HEFDI CLOSENESS POLICY INFRA.

Table 6.2 Pooled 2SLS using FDI from Japan

JP EMP DINV

(1)(a)

(2)(b)

(4)(d) (3)(c) Endogenous product term

(5)(e)

0.0910∗∗∗ (0.0253) 0.2966∗∗∗ (0.0364) 0.7004∗∗∗ (0.0438)

0.0915∗∗∗ (0.0274) 0.3073∗∗∗ (0.0461) 0.6889∗∗∗ (0.0395) 0.0163 (0.0590)

0.0986∗∗ (0.0461) 0.3163∗∗∗ (0.0565) 0.6868∗∗∗ (0.0411) 0.0271 (0.0522) −0.0066 (0.0288) 2.0433∗∗ (0.8635)

0.0879∗ (0.0466) 0.2956∗∗∗ (0.0409) 0.7009∗∗∗ (0.0392)

0.0739∗∗ (0.0306) 0.2915∗∗∗ (0.0361) 0.6907∗∗∗ (0.0425)

0.0019 (0.0269) 1.9551∗∗ (0.8438)

0.0151∗ (0.0088) 2.3344∗∗∗ (0.6071)

HE HEFDI Constant Observations R-squared

1.9205∗∗∗ (0.6288) 312 0.959

2.1116∗∗∗ (0.7086) 312 0.959

312 0.956

312 0.960

312 0.963

Robust standard errors in parentheses. ∗ significant at 10%; ∗∗ significant at 5%; ∗∗∗ significant at 1%. (a) Instruments: EMP DINV CLOSENESS POLICY INFRA. (b) Instruments: EMP DINV HE CLOSENESS POLICY INFRA. (c) Instruments: EMP DINV HE CLOSENESS POLICY INFRA. (d) Instruments: EMP DINV POLICY INFRA. (e) Instruments: EMP DINV HEFDI CLOSENESS POLICY INFRA.

120 Busakorn Chantasasawat et al. Table 6.3 Pooled 2SLS using FDI from Hong Kong

HK EMP DINV

(1)(a)

(2)(b)

0.1083∗∗∗ (0.0219) 0.2754∗∗∗ (0.0270) 0.7175∗∗∗ (0.0302)

0.1059∗∗∗ (0.0227) 0.3123∗∗∗ (0.0333) 0.6804∗∗∗ (0.0290) 0.0609 (0.0533)

HE HEFDI Constant Observations R-squared

1.2655∗∗∗ (0.3125) 362 0.963

(3)(c) (4)(d) Endogenous product term

0.1111∗∗ 0.1422∗∗∗ (0.0415) (0.0412) 0.3585∗∗∗ 0.2760∗∗∗ (0.0539) (0.0305) 0.6638∗∗∗ 0.7185∗∗∗ (0.0330) (0.0277) 0.1217∗ (0.0600) −0.0258 −0.0017 (0.0190) (0.0256) 1.9689∗∗∗ 1.5820∗ 1.1969 (0.5897) (0.8578) (0.8092) 362 0.964

362 0.953

362 0.963

(5)(e) 0.1001∗∗∗ (0.0317) 0.2731∗∗∗ (0.0281) 0.7113∗∗∗ (0.0274) 0.0062 (0.0079) 1.5355∗∗∗ (0.4161) 362 0.965

Robust standard errors in parentheses. ∗ significant at 10%; ∗∗ significant at 5%; ∗∗∗ significant at 1%. (a) Instruments: EMP DINV POLICY INFRA. (b) Instruments: EMP DINV HE CLOSENESS POLICY INFRA. (c) Instruments: EMP DINV HE CLOSENESS POLICY INFRA. (d) Instruments: EMP DINV POLICY INFRA. (e) Instruments: EMP DINV HEFDI CLOSENESS POLICY INFRA.

Table 6.4 Pooled 2SLS using FDI from Taiwan

TW EMP DINV

(1)(a)

(2)(b)

(3)(c) (4)(d) Endogenous product term

(5)(e)

0.0924∗∗∗ (0.0189) 0.2476∗∗∗ (0.0277) 0.7495∗∗∗ (0.0213)

0.0924∗∗∗ (0.0190) 0.2803∗∗∗ (0.0365) 0.7160∗∗∗ (0.0277) 0.0513 (0.0465)

0.1167∗∗∗ (0.0324) 0.2939∗∗∗ (0.0375) 0.7225∗∗∗ (0.0347) 0.0911∗∗ (0.0443) −0.0226 (0.0236) 1.7462∗∗ (0.8105)

0.0853∗∗∗ (0.0276) 0.2512∗∗∗ (0.0270) 0.7372∗∗∗ (0.0182)

HE HEFDI Constant Observations R-squared

1.4472∗∗∗ (0.3703) 339 0.965

2.0269∗∗∗ (0.5934) 339 0.965

0.0928∗∗∗ (0.0319) 0.2474∗∗∗ (0.0285) 0.7499∗∗∗ (0.0309) −0.0003 (0.0184) 1.4381∗ (0.7513)

339 0.959

339 0.965

0.0077 (0.0099) 1.7095∗∗∗ (0.5099) 339 0.966

Robust standard errors in parentheses. ∗ significant at 10%; ∗∗ significant at 5%; ∗∗∗ significant at 1%. (a) Instruments: EMP DINV CLOSENESS POLICY INFRA. (b) Instruments: EMP DINV HE CLOSENESS POLICY INFRA. (c) Instruments: EMP DINV HE CLOSENESS POLICY INFRA. (d) Instruments: EMP DINV CLOSENESS POLICY INFRA. (e) Instruments: EMP DINV HEFDI CLOSENESS POLICY INFRA.

FDI and growth in China 121 Table 6.5 Pooled 2SLS using FDI from Republic of Korea

KR EMP DINV

(1)(a)

(2)(b)

(3)(c) (4)(d) Endogenous product term

(5)(e)

0.0963∗ (0.0486) 0.3256∗∗∗ (0.0800) 0.6848∗∗∗ (0.0886)

0.0940∗∗ (0.0418) 0.3131∗∗∗ (0.0448) 0.6960∗∗∗ (0.0593) −0.0114 (0.0640)

0.0747 (0.0455) 0.2968∗∗∗ (0.0473) 0.6919∗∗∗ (0.0549) −0.0368 (0.0660) 0.0248 (0.0394) 2.0283∗∗ (0.9359)

0.0202 (0.0334) 0.3026∗∗∗ (0.0616) 0.6853∗∗∗ (0.0771)

0.0787 (0.0514) 0.3398∗∗∗ (0.0725) 0.6491∗∗∗ (0.0749)

0.0565 (0.0467) 2.7153∗∗∗ (0.8429)

0.0308 (0.0249) 2.4114∗∗∗ (0.8115)

HE HEFDI Constant Observations R-squared

1.9739∗∗ (0.7983) 222 0.910

1.8810∗ (0.9770) 222 0.912

222 0.929

222 0.946

222 0.926

Robust standard errors in parentheses. ∗ significant at 10%; ∗∗ significant at 5%; ∗∗∗ significant at 1%. (a) Instruments: EMP DINV CLOSENESS POLICY INFRA. (b) Instruments: EMP DINV HE CLOSENESS POLICY INFRA. (c) Instruments: EMP DINV HE CLOSENESS POLICY INFRA. (d) Instruments: EMP DINV CWAGE CLOSENESS POLICY INFRA. (e) Instruments: EMP DINV HEFDI CLOSENESS POLICY INFRA.

The interaction term is not significant in any specification of any countries, but one. Additionally, the interaction term is negative in two out of three specifications, although it is not statistically significant. In our empirical examinations, human capital by itself and as a channel through which technology is carried is not important to output. The only case that the interaction term is slightly significant at 10 percent is in the case of Japan. When the FDI-human capital interaction is treated as an endogenous variable, all sources of FDI, except Korea, possess stronger impact on output. This is also true for the magnitude of employment. However, in most cases, the magnitude of domestic investment declines. What remains consistently important are domestic investment and employment. Domestic investment, in fact, is the most important variable and is highly significant in all specifications; 1 percent rise in domestic investment increases output by 6 percent. This is not surprising as a lot of economic growth in China, especially for the inland province, is fueled by, though inefficient, domestic investment for a long period of time. A 1 percent increase in employment, on average, raises output by 3 percent. Results on Korean FDI are not as significant as other sources of FDI. Magnitudes of FDI coefficient are much smaller. This might be due to the missing contract FDI data of which Korean has the highest numbers. Tables 6.6–6.10 present results of the random effects two-stage least square regressions. In general, all sources of FDI, including Korean, are still

122 Busakorn Chantasasawat et al. very significant. However, the random effects results are less consistent than results of the pooled 2SLS, and the magnitudes are slightly smaller than the pooled 2SLS model. The effects of domestic investment and employment, nevertheless, are still fairly consistent as those in the pooled 2SLS model, where an increase of 1 percent raises output by roughly 0.7 and 0.3 percent, respectively. Domestic investment and employment are, thus, vital mechanisms behind China’s economic development. The interaction term in the random effects model, when source of FDI is Japan, is highly significant despite the diminutive coefficients. This finding coincides with that of Fung et al. (2002) where human capital is an important determinant of FDI from Japan. This has an interesting implication. Japanese firms, which are known for practicing job rotation, view education as a crucial factor when investing in China. Consequently, Japanese FDI together with adequate human capital seems to produce a positive impact on output more so than investments from other sources in our samples. FDI-human capital is also important for Republic of Korea in the random effect model. The coefficients are slightly larger than those of Japan. It is possible that Korean firms are investing more in China’s hi-tech sector, where human capital is an essential condition to efficient production. Although Hong Kong and Taiwan FDI are recognized for their labor-intensive investment, which is not necessarily a major source of advanced technology transfer, our results indicate that FDI from these two sources contributes to expansion of provincial economies more than capital-intensive FDI from Japan. Table 6.6 Random effects 2SLS using FDI from USA

USA EMP DINV

(1)(a)

(2)(b)

(3)(c) (4)(d) Endogenous product term

(5)(e)

0.1050∗∗∗ (0.0243) 0.3167∗∗∗ (0.0298) 0.6948∗∗∗ (0.0375)

0.1144∗∗∗ (0.0195) 0.3445∗∗∗ (0.0294) 0.6499∗∗∗ (0.0387) 0.0480 (0.0334)

0.1039∗∗∗ (0.0349) 0.3316∗∗∗ (0.0442) 0.6591∗∗∗ (0.0448) 0.0357 (0.0439) 0.0058 (0.0160) 2.6087∗∗∗ (0.6048)

0.0801∗∗∗ (0.0273) 0.3021∗∗∗ (0.0214) 0.7011∗∗∗ (0.0318)

0.0944∗∗∗ (0.0271) 0.3103∗∗∗ (0.0316) 0.6951∗∗∗ (0.0359)

0.0112 (0.0104) 2.1426∗∗∗ (0.4548)

0.0069 (0.0062) 2.0023∗∗∗ (0.6321)

HE HEFDI Constant Observations R-square

1.8442∗∗∗ (0.6265) 345 0.960

2.6195∗∗∗ (0.6368) 345 0.959

345 0.961

345 0.965

345 0.962

Standard errors in parentheses. ∗ significant at 10%; ∗∗ significant at 5%; ∗∗∗ significant at 1%. (a) Instruments: EMP DINV CLOSENESS POLICY INFRA. (b) Instruments: EMP DINV HE CLOSENESS POLICY INFRA. (c) Instruments: EMP DINV HE CWAGE CLOSENESS POLICY INFRA. (d) Instruments: EMP DINV CLOSENESS POLICY INFRA. (e) Instruments: EMP DINV HEFDI CLOSENESS POLICY INFRA.

Table 6.7 Random effects 2SLS using FDI from Japan

JP EMP DINV

(1)(a)

(2)(b)

(3)(c) (4)(d) Endogenous product term

(5)(e)

0.0674∗∗∗ (0.0167) 0.2871∗∗∗ (0.0287) 0.7755∗∗∗ (0.0240)

0.0550∗∗∗ (0.0177) 0.3174∗∗∗ (0.0341) 0.7569∗∗∗ (0.0321) 0.0621∗ (0.0342)

0.0403∗∗ (0.0157) 0.2492∗∗∗ (0.0293) 0.7292∗∗∗ (0.0257) −0.0327 (0.0338) 0.0386∗∗∗ (0.0107) 2.1827∗∗∗ (0.5122)

0.0404∗∗∗ (0.0150) 0.2733∗∗∗ (0.0182) 0.7171∗∗∗ (0.0249)

0.0546∗∗∗ (0.0142) 0.2824∗∗∗ (0.0172) 0.7347∗∗∗ (0.0216)

0.0344∗∗∗ (0.0092) 2.3339∗∗∗ (0.4870)

0.0162∗∗∗ (0.0053) 1.7576∗∗∗ (0.3572)

HE HEFDI Constant Observations R-square

0.6895 (0.5072)

1.2403∗ (0.6649)

312 0.963

312 0.964

312 0.966

312 0.967

312 0.966

Standard errors in parentheses. ∗ significant at 10%; ∗∗ significant at 5%; ∗∗∗ significant at 1%. (a) Instruments: EMP DINV CLOSENESS POLICY INFRA. (b) Instruments: EMP DINV HE CLOSENESS POLICY INFRA. (c) Instruments: EMP DINV HE CLOSENESS POLICY INFRA. (d) Instruments: EMP DINV POLICY INFRA. (e) Instruments: EMP DINV HEFDI CLOSENESS POLICY INFRA. (f) Instruments: EMP DINV POLICY INFRA.

Table 6.8 Random effects 2SLS using FDI from Hong Kong

HK EMP DINV

(1)(a)

(2)(b)

(3)(c) (4)(d) Endogenous product term

(5)(e)

0.0958∗∗∗ (0.0179) 0.2760∗∗∗ (0.0234) 0.7467∗∗∗ (0.0217)

0.0922∗∗∗ (0.0165) 0.3056∗∗∗ (0.0274) 0.7171∗∗∗ (0.0277) 0.0555∗ (0.0315)

0.0881∗∗∗ (0.0200) 0.3042∗∗∗ (0.0290) 0.6936∗∗∗ (0.0241) 0.0502 (0.0358) 0.0059 (0.0115) 2.0080∗∗∗ (0.4134)

0.0834∗∗∗ (0.0263) 0.2725∗∗∗ (0.0238) 0.7410∗∗∗ (0.0230)

0.0907∗∗∗ (0.0234) 0.2746∗∗∗ (0.0242) 0.7432∗∗∗ (0.0207)

0.0078 (0.0122) 1.1527∗ (0.6738)

0.0038 (0.0065) 0.9691∗∗ (0.4824)

HE HEFDI Constant Observations R-square

0.8077∗∗ (0.3885) 362 0.966

1.4457∗∗∗ (0.5190) 362 0.967

362 0.967

362 0.968

362 0.967

Standard errors in parentheses. ∗ significant at 10%; ∗∗ significant at 5%; ∗∗∗ significant at 1%. (a) Instruments: EMP DINV HE CLOSENESS POLICY INFRA. (b) Instruments: EMP DINV HE CLOSENESS POLICY INFRA. (c) Instruments: EMP DINV POLICY INFRA. (d) Instruments: EMP DINV HEFDI CLOSENESS POLICY INFRA. (e) Instruments: EMP DINV CLOSENESS POLICY INFRA.

Table 6.9 Random effects 2SLS using FDI from Taiwan

TW EMP DINV

(1)(a)

(2)(b)

(3)(c) (4)(d) Endogenous product term

(5)(e)

0.0887∗∗∗ (0.0109) 0.2485∗∗∗ (0.0171) 0.7639∗∗∗ (0.0166)

0.0931∗∗∗ (0.0098) 0.2798∗∗∗ (0.0220) 0.7155∗∗∗ (0.0215) 0.0509∗∗ (0.0241)

0.0881∗∗∗ (0.0341) 0.2553∗∗∗ (0.0394) 0.7545∗∗∗ (0.0304) 0.0188 (0.0416) 0.0062 (0.0176) 1.2991 (0.8197)

0.0864∗∗∗ (0.0151) 0.2501∗∗∗ (0.0161) 0.7468∗∗∗ (0.0208)

0.0578∗∗∗ (0.0127) 0.2614∗∗∗ (0.0150) 0.7425∗∗∗ (0.0158)

0.0035 (0.0098) 1.5374∗∗∗ (0.4175)

0.0168∗∗∗ (0.0057) 1.8106∗∗∗ (0.3077)

HE HEFDI Constant Observations R-square

1.1543∗∗∗ (0.3079) 339 0.965

2.0292∗∗∗ (0.3829) 339 0.965

339 0.966

339 0.967

339 0.969

Standard errors in parentheses. ∗ significant at 10%; ∗∗ significant at 5%; ∗∗∗ significant at 1%. (a) Instruments: EMP DINV HE CLOSENESS POLICY INFRA. (b) Instruments: EMP DINV HE CLOSENESS POLICY INFRA. (c) Instruments: EMP DINV HE CLOSENESS POLICY INFRA. (d) Instruments: EMP DINV CLOSENESS POLICY INFRA. (e) Instruments: EMP DINV HEFDI CLOSENESS POLICY INFRA.

Table 6.10 Random effects 2SLS using FDI from Republic of Korea

KR EMP DINV

(1)(a)

(2)(b)

(3)(c) (4)(d) Endogenous product term

(5)(e)

0.0960∗∗∗ (0.0195) 0.2909∗∗∗ (0.0458) 0.7693∗∗∗ (0.0304)

0.0852∗∗∗ (0.0207) 0.2955∗∗∗ (0.0579) 0.7765∗∗∗ (0.0416) 0.0156 (0.0448)

0.0575∗∗∗ (0.0196) 0.2591∗∗∗ (0.0457) 0.7305∗∗∗ (0.0356) −0.0382 (0.0412) 0.0493∗∗∗ (0.0163) 1.5824∗∗ (0.7069)

0.0723∗∗∗ (0.0232) 0.3001∗∗∗ (0.0401) 0.7046∗∗∗ (0.0305)

0.0722∗∗∗ (0.0203) 0.2847∗∗∗ (0.0377) 0.7430∗∗∗ (0.0270)

0.0479∗∗∗ (0.0171) 1.5319∗ (0.8067)

0.0255∗∗ (0.0118) 1.2019∗ (0.7204)

HE HEFDI Constant Observations R-square

0.4586 (0.7709)

0.4732 (0.9458)

222 0.914

222 0.920

222 0.937

222 0.930

222 0.930

Standard errors in parentheses. ∗ significant at 10%; ∗∗ significant at 5%; ∗∗∗ significant at 1%. (a) Instruments: EMP DINV CLOSENESS POLICY INFRA. (b) Instruments: EMP DINV HE CLOSENESS POLICY INFRA. (c) Instruments: EMP DINV HE CLOSENESS POLICY INFRA. (d) Instruments: EMP DINV CWAGE CLOSENESS POLICY INFRA. (e) Instruments: EMP DINV HEFDI CLOSENESS POLICY INFRA.

FDI and growth in China 125

5 Conclusion The objective of this chapter is to study the effects of domestic investment and five sources of FDI on Chinese outputs. The sources of FDI are USA, Japan, Hong Kong, Taiwan, and Republic of Korea. We have the following results: (1) the effects of FDI by source are quite consistent and are positively significant. (2) US foreign direct investment has the largest impact on Chinese outputs, followed by FDI from Hong Kong, Japan, Taiwan, and Republic of Korea; (3) but by far, it is domestic investment that has the largest impact on China’s national output; (4) in some cases, the interaction of human capital and FDI from Korea and Japan also contributes significantly to the growth of Chinese outputs.

Appendix: Data definition and sources EMP DINV

Employment of labor Domestic cumulative investment = Total cumulative investment in fixed assets – cumulative FDI FDI Aggregate cumulative foreign direct investment HE Number of students enrolled in institutions of higher education HEFDI HE * FDI INFRA Infrastructure variable is kilometers of both high quality roads and railway per square kilometer of land mass CLOSENESS (State-owned industry output) / (total industry output) POLICY # of SEZ + # of OCC + # of ETDZ WAGE Average nominal wage LWAGE Lagged average nominal wage The following data are taken from the Almanac of China Foreign Relations and Trade (various issues): Contracted Japanese direct investment (DI) for 1993 to1997 Contracted U.S. DI for 1993 to 1997 The following data are taken from China Foreign Economic Statistical Yearbook 1994 and from national sources: Contracted Japanese DI for all other years Contracted U.S. DI for all other years Contracted Hong Kong DI for all other years Contracted Taiwan DI for all other years Contracted Korean DI for all other years The following regional data are taken from the China Statistical Yearbook and from China Regional Economy: A Profile of 17 years of Reform and Opening-Up 1996: Aggregate foreign direct investment GDP Employment Total investment in fixed assets

126 Busakorn Chantasasawat et al. Number of students enrolled in higher education Distance of roadway Distance of railway Average lagged nominal wage State-owned industry output Total industry output Special Economic Zones: Shenzhen, Zhuhai, and Shantou in Guangdong; Xizmen in Fujian; Hainan. Open Coastal Cities: Dalian in Liaoning; Qinhuangdao in Hebei; Tianjin; Yantai and Quingdao in Shandong; Lianyungang and Nantong in Jiangsu; Shanghai; Ningbo and Wenzhou in Zhejiang; Fuzhou in Fujian; Guangzhou and Zhanjiang in Guangdong; Beihai in Guangxi. Economic and Technological Development Zones: Dalian, Yingkou and Shenyang in Liaoning; Qinhuangdao in Hebei; Tianjin; Yantai, Quingdao and Weihai in Shandong; Lianyunggang, Kunshan and Nantong in Jiangsu; Guangzhou and Zhanjiang in Guangdong; Ningbo in Zhejiang; Fuzhou, Rongqiao and Dongshan in Fujian; Minhang, Hongqiao and Caohejin in Shanghai; Wenzhou in Zhejiang; Harbin in Heilongjizng; Changchun in Jilin; Wuhu in Anhui; Wuhan in Hubei; Chongqing in Sichuan; Dayawan and Pnyu’s Nansha in Guangdong; Xiaoshan and Hangzhou in Zhejiang, Beijing; Urumqi in Xinjiang.

Notes 1 The findings, interpretations, and conclusions expressed herein are those of the authors and do not reflect the views of their institutions or The World Bank Group, its Executive Directors, or its staff. 2 See Chen et al. 1995 for extensive reviews of China’s open door policy. 3 Blomström et al. (1992); Balasubramanyam et al. (1996) and Borensztein et al. (1998). 4 Nelson and Phelps (1966), Mankiw et al. (1992), Borensztein et al. (1998). 5 Since the regressors are not correlated with the disturbances, we do not implement fixed effects model. 6 To obtain domestic capital stock, we need to use domestic investment data that go back to the pre-reform era. The quality of such data is highly uncertain. This caveat must be kept in mind for the purpose of our chapter. Foreign direct investment before 1980 was assumed to be zero.

References Agosin, Manuel R. and Ricardo Mayer (2000) Foreign Investment in Developing Countries: Does it Crowd in Domestic Investment? UNCTAD Discussion Papers, 146: 1–16, February. Alfaro, L., A. Chanda, S. Kalemli-Ozcan and S. Sayek (2003) ‘FDI spillovers, financial markets and economic development’, IMF Working Papers 30/186, International Monetary Fund.

FDI and growth in China 127 Balasubramanyam, V.N., M. Salisu and D. Sapsford (1996) ‘Foreign Direct Investment and Growth in EP and IS Countries,’ The Economic Journal, 106(434): 92–105. Blomström, Magnus, Robert E. Lipsey, and Mario Zejan (1992) What Explains Developing Country Growth? NBER Working Paper, No. 4132. Blonigen, Bruce A. and Miao Wang (2004) Inappropriate Pooling of Wealthy and Poor Countries FDI Studies, NBER Working Paper, No. 10378. Borensztein, E., J. De Gregorio and J-W. Lee (1998) ‘How Does Foreign Direct Investment Affect Economic Growth?’ Journal of International economics, 45: 115–35. Carkovic, Maria and Ross Levine (2003) Does Foreign Direct Investment Accelerate Economic Growth? Mimeo, Department of Finance, University of Minnesota. Chen, Chung, Lawrence Chang and Yimin Zhang (1995) ‘The Role of Foreign Direct Investment in China’s Post-1978 Economic Development,’ World Development, 23(4): 691–703. Choe, Jong II (2003) ‘Do Foreign Direct Investment and Gross Domestic Investment Promote Economic Growth?’ Review of Development Economics, 7(1): 44–57. Fung, K.C., Hitomi Iizaka and Stephen Parker (2002) ‘Determinants of U.S. and Japanese Direct Investment in China,’ Journal of Comparative Economics, 30: 567–78. Fung, K.C., H. Iizaka and S.Y. Tong (2004) ‘FDI in China: Policy, recent trend and impact’, Global Economic Review, 32(2), 99–130. Fung, K.C., Alicia Garcia-Herrero, Hitomi Iizaka and Alan Siu (2005) ‘Hard or Soft? Institutional Reforms and Infrastructure Spending as Determinants of Foreign Direct Investment in China,’ Japanese Economic Review, 56(4): 408–16. Harrold, Peter (1993) Macroeconomic Management in China: Proceedings of a Conference in Dalian, June 1993, World Bank discussion papers, Washington, DC: World Bank. Lardy, Nicholas (1995) ‘The Role of Foreign Trade and Investment in China’s Economic Transformation,’ China Quarterly (U.K.), 144: 1065–82, December. Liu, Tung and Kui-Wai Li (2001) ‘Impact of Liberalization of Financial Resources in China’s Economic Growth: Evidence from Provinces,’ Journal of Asian Economics, 12: 245–62. Liu, Xiangfeng (2005) The Impact of FDI from South Korea to China on Bilateral Trade, Seoul, Korea: Korea Institute for International Economic Policy. Mankiw, Gregory, David Romer and David N. Weil (1992) ‘A Contribution to the Empirics of Economic Growth,’ The Quarterly Journal of Economics, 107(2): 407–37. Moosa, Imad A. (2002) Foreign Direct Investment: Theory, Evidence and Practice, Houndmills, Basingstoke, Hamshire, New York: Palgrave. Nelson, Richard R. and Phelps Edmund S. (1996) ‘Investment in Humans, Technological Diffusion, and Economic Growth,’ The American Economic Review, 56(1/2): 69–75. Petrochilos, G. (1989) Foreign Direct Investment: The Case of Greece, Aldershot: Avebury. Pomfret, Richard (1997) ‘Growth and Transition: Why has China’s Performance been so Different?’ Journal of Comparative Economics, 25: 422–40, December. Shan, Jordan, Garry Gang Tian and Fiona Sun (1997) The FDI-Led Growth Hypothesis: Further Econometric Evidence from China, National Centre for Development Studies, The Australian National University, Economics Division Working Papers. Tseng, Wanda and Harm Zebregs (2002) Foreign Direct Investment in China: Some Lessons from Other Countries, IMF Policy Discussion Paper, PDP/02/3, February. UNCTAD: Global Investment Prospects Assessment (2004) ‘Prospects for FDI Flows, Transnational Corporation Strategies and Policy Developments, 2004–2007,’ Research Note 1: Results of a Survey of Location Experts, Geneva: UNCTAD.

128 Busakorn Chantasasawat et al. UNCTAD: Global Investment Prospects Assessment (2004) ‘Prospects for FDI Flows, Transnational Corporation Strategies and Policy Developments, 2004–2007,’ Research Note 2: UNCTAD’s Findings of the Second Worldwide Survey of Investment Promotion Agencies, Geneva: UNCTAD. UNCTAD: Global Investment Prospects Assessment (2004) ‘Prospects for FDI Flows, Transnational Corporation Strategies and Policy Developments, 2004–2007,’ Research Note 3: A Worldwide Survey of the World’s Largest Transnational Corporation (TNCs), Geneva: UNCTAD. Yao, Shujie and Kailei Wei (2007) ‘Economic Growth in the Presence of FDI: the Perspective of Newly Industrializing Economies,’ Journal of Comparative Economics, 35(1): 211–34, March.

Part II

Impact on the rest of Asia

7

The role of China in Asia Engine, conduit or steamroller?∗ Jane T. Haltmaier, Shaghil Ahmed, Brahima Coulibaly, Ross Knippenberg, Sylvain Leduc, Mario Marazzi and Beth Anne Wilson

1 Introduction Over the past two decades China has embarked on a process of development that has taken it at breathtaking speed from a poor, largely rural economy to a global economic force. The sheer size of its workforce and the speed of its transformation have posed enormous challenges for many countries around the world, but nowhere more than in its own backyard. The challenge is particularly important in Asia because most of these countries, including Japan, have tended to rely on the same export-led model of growth that China has used so successfully. From the point of view of smaller and in some cases more-developed Asian economies, it would be hard not to see China’s low-cost labour force and enormous scope for economies of scale as a fearsome competitive threat. At the same time, however, China offers enormous opportunities as both a partner in production and a huge potential market of more than a billion consumers. Ignoring China’s growing presence in international markets is obviously not a possibility for the other Asian economies. Nevertheless, these countries do have several (not mutually exclusive) options for dealing with the rise of China: (1) Try to rely more on domestic demand and monetary policy to provide full employment and less on exports as either a trigger or a significant source of growth. (2) Try to seek out markets in China, perhaps in upscale consumer goods likely to be of interest to the burgeoning middle class. This strategy may also include increasing efforts to attract Chinese tourists. (3) Try to ‘piggy-back’ on China’s extraordinary success as a low-cost exporter by integrating production processes through trade fragmentation. (4) Try to avoid direct competition with China. This could involve looking for ‘niches’ where China is less active and shifting export-oriented industries in those directions. This does not necessarily require any active government

132 Jane Haltmaier et al. effort, as markets should tend to do this on their own. Trying to avoid competition with China in third markets can also involve shifting exportoriented production facilities to China, thus reducing investment at home. In this chapter, we use the available data, both macro and micro, to assess the extent to which any or all of these reactions are taking place. To the extent that these economies are reducing their reliance on exports, as suggested in (1) above, China would be a neutral force for growth in the region, as each economy would use policy to guide its own economy to reach potential output. In a simple growth accounting exercise using macro data we find that reliance on external demand as a source of growth has in fact fallen considerably in some of these countries. However, it is primarily the less-advanced economies in which this is the case, while net exports remain a very important source of growth in the more-advanced group, i.e., the Asian newly industrialized countries (NIEs) and Japan. It is also noteworthy that the increased reliance on domestic demand in the less-developed countries does not appear to have been reflected in lower rates of GDP growth in these countries. To the extent that countries are able to use China as a market, as in (2), China may be becoming an independent engine of growth for the region. We examined both macroeconomic and microeconomic data to shed some light on this issue. Specifically, we estimated VARs that provide some evidence that China’s demand for imports has become an important independent factor influencing growth in several Asian emerging economies. Korea, Singapore, Taiwan and Thailand were found to be particularly responsive to movements in Chinese import demand. We also estimated rolling regressions that show a recent substantial increase in the co-movements of GDP growth of many Asian economies with China, controlling for growth in the United States. In the micro data, we find some evidence that the more advanced economies have begun to sell more finished goods in China, but this is still quite limited. To the extent that countries are partnering with China in production, as in (3), China is acting as a conduit of growth for the rest of the region, perhaps displacing some demand for finished product exports, but at the same time creating a new source of demand for parts and components produced in other countries. This arrangement of production uses China’s relatively low-cost, low-skilled labour force to perform the less-demanding task of putting together the pieces built in other countries. Other papers have found substantial evidence that such ‘production fragmentation’ is in fact taking place. This chapter takes a fresh look at this issue using highly disaggregated trade data and finds that the degree may in fact be even larger than previous estimates have indicated. Our estimates differ from the earlier ones mainly because we have significantly extended the decomposition of trade – one of the main contributions of this chapter. Interestingly, we also find that production integration with China appears to be far more important for the more advanced countries in the region than for the less-developed countries. It may not be a coincidence that the more advanced economies are also the ones for which external demand remains a very important source of growth.

The role of China in Asia 133 To the extent that China is taking market share from other countries, as in (4), China is acting somewhat like a steamroller, driving countries out of some areas of production, a process that may entail painful adjustments in the short run. However, in the longer run the principle of comparative advantage should dominate, and all countries should benefit as each country specializes in the products which it produces relatively most efficiently. We find some evidence that this is in fact taking place. For instance, the trade data show shifts in relative comparative advantage that suggest that some countries are attempting to move production to areas where they face less competition from China. A prime example is increased comparative advantage in auto production by auto giants Korea and Japan. A cautionary note, though, is that recent data suggest that China is on the move in these industries as well, suggesting that these countries may soon need to seek other niches. Additional evidence of the potential ‘crowding out’ effect of China on other emerging Asian exports is provided by the results of regressions of changes in highly disaggregated categories of exports on a number of variables, including China’s share of world exports in each category. We find that increases in China’s market shares of low- and mid-technology products have in fact had a significant negative impact on exports from some other East Asian economies. However, we do not find such an effect in the important high-technology category, suggesting that integration may be working more effectively there. Our work in this area represents an extension of the analysis in Ahearne et al. (2006), which focused on changes in market shares of exports from various emerging Asian economies just to the United States. The balance of the chapter is organized as follows. Section 2 begins with some background information on the relative size of the Asian economies we have included in our analysis and on how patterns of trade in the region are changing. It then uses macro data to examine the extent to which reactions to China in the region fall into categories (1) and/or (2) above. This includes the growth accounting exercise that documents the importance of net exports to GDP growth in these countries. It then analyzes the cross-country linkages using the VAR model and the rolling regressions. Section 3 primarily examines the role of China as a conduit of industrial growth for the region. We first describe our trade dataset, then look at the structure of exports in the region from various angles and detail the extent of product fragmentation. This section also provides some further insight into China’s role as an independent engine of growth, by looking at the extent to which China’s imports of finished goods from other countries in the region have changed. Section 4 looks at China’s role as a steamroller, including the changes in comparative advantage and the results of the regressions of changes in trade on the size of China’s market share of an industry. We also look at the extent to which production shifting may be having a negative effect on investment in some of the other countries in the region. Section 5 concludes. Our main conclusion is that China is largely a positive force for economic growth in the rest of the region, particularly for the advanced economies, but that it is still more of a conduit than an engine. This suggests that the region

134 Jane Haltmaier et al. remains vulnerable to economic cycles in industrial countries. There is also some evidence that China is acting as a steamroller in some industries, pushing some of its smaller competitors out of the way. Nevertheless, it should be noted that economic growth in the region remains higher than in most of the rest of the world, including other emerging markets. This suggests that despite the presence of an increasingly powerful player in Asia and the world economy, the other countries are managing to find ways to stay in the game.

2 China as an engine of growth: Does the rest of Asia still need an external engine? Is it China? In this section we first look at some implications of the relative size of the Chinese and other Asian economies and at how patterns of trade among them are changing. We then consider the following questions: How reliant are key emerging Asian economies on external demand, and has this reliance changed over time? In other words, to what extent do these countries still need an external engine of growth? We also ask: What is the relative importance of China and the United States as a source of external demand for the rest of emerging Asia, and has this relationship changed over time? If external demand remains key to growth in the region, and if China is becoming a stronger engine of that growth, we would expect to see that Chinese economic growth has had a significant independent impact on the other economies in recent years. 2.1 Some background 2.1.1 China compared with other Asian economies As shown in Figure 7.1, China is the second-largest economy in Asia, behind Japan, in U.S. dollar terms. This was also true in 1990, although barely; at that time the Chinese economy was only about 13 per cent the size of Japan’s, whereas

US$ billions

Gross Domestic Product 1990 2006

5000 4500 4000 3500 3000 2500 2000 1500 1000 500 0 India

Indonesia Malaysia Philippines Thailand Hong Kong

Korea

Singapore

Taiwan

China

Japan

Figure 7.1 Asia economies’ GDP, 1990 and 2006 (Source: CEIC, Haver Analytics).

The role of China in Asia 135 US$

PPP GDP Per Capita

45000 1990 2006

40000 35000 30000 25000 20000 15000 10000 5000 0 India

Indonesia Malaysia Philippines Thailand Hong Kong

Korea

Singapore

Taiwan

China

Japan

Figure 7.2 Asia economies’ GDP (adjusted for PPP), 1990 and 2006 (Source: IMF WEO database).

in 2006 it was 60 per cent as large. In contrast, as measured by PPP per capita (Figure 7.2), the Chinese standard of living remains only a fraction of that of the advanced economies. However, China now compares much more favorably with the less-developed Asian economies, as sixteen years of rapid growth between 1990 and 2006 have brought its standard of living well above those of India, Indonesia and the Philippines, all of which had higher levels of PPP GDP per capita than China in 1990. Nevertheless, China’s standard of living is still below that of Thailand, although it is getting close, and it is further below that of Malaysia. There are at least two important implications of these data. First, China, despite its remarkable economic performance of the past two decades, is still a poor country. This is consistent with its relatively low labour costs. However, it is rapidly catching up and has already surpassed some of its less-developed Asian neighbors. This may suggest that China’s competitive edge may begin to erode. There is in fact some evidence that this is already happening, as farm incomes in China have been rising, decreasing the attraction of moving to the city for a poorly paid factory job. There are reports that manufacturing firms have needed to raise wages and improve benefits to fulfill their labour needs, and there are also reports of firms moving operations to countries such as Vietnam to take advantage of labour that is less costly. Secondly, the contrast between China’s rank in the area in PPP terms with its rank in dollar terms illustrates the vast scale of its economy compared with the others in the area. This suggests that even without rock-bottom wages China stands to be able to exploit economies of scale that may well remain out of reach for the other economies in the region.

136 Jane Haltmaier et al. US$ billions 3000

Asian Exports Rest of the World Intra-regional

2500 2000 1500 1000 500 0 1990

1995

2000

2005

Figure 7.3 Goods exports from Asia, 1990–2005 (Source: U.N. COMTRADE database, SourceOECD).

2.1.2 Patterns of trade in Asia As seen in Figure 7.3,1 goods exports from Asia (defined as Japan plus emerging Asia) nearly quadrupled between 1990 and 2005, increasing from $725 billion to $2,826 billion. (This chapter focuses mainly on trade in goods, which is much larger than trade in services and for which considerably more detailed data are available. For a brief discussion of trade in services in the region, see Box 7.1. Box 7.2 looks at a specific category of services trade, tourism.) Although in 1990 the value of exports to destinations outside of the region was greater than the value of intra-regional trade, by 2005 they were about the same size, suggestive of greater integration of production across the region. Nevertheless, as shown in Figure 7.4, changes in trade patterns have not been uniform across the region. Although the total proportion of Asian trade that was intra-regional rose from 41 per cent in 1990 to 52 per cent in 2005, it actually dropped somewhat for China/Hong Kong, as China became more of a force in global trade. In contrast, intra-regional trade rose for all of the other countries in the region. Even for the larger and more diversified Korean and Japanese economies, intra-regional trade now accounts for nearly half of their exports, up considerably from 1990. In sum, these data are suggestive (although not conclusive evidence) of greater production integration within the region, a topic to which we return later. 2.2 Growth accounting Just how important is trade to the overall economies in the region? As shown in Figure 7.5, the ratio of real exports to GDP is sizeable for most of the emerging

The role of China in Asia 137 Box 7.1 Regional growth in service exports One additional response of Asian economies to competition from China in the manufacturing sector has been to move toward greater export of services. Although still under 15 per cent of total regional exports, service exports from Asia have risen at a sharp 181/2 per cent annual rate between 2001 and 2006. Over this period, as a share of total exports, services have fallen a touch for China, but have held steady or edged up, on average, for the rest of the region, suggesting some increasing relative specialization in services outside of China (chart). Services Share of Exports

Per cent 17

Emerging Asia (ex. China)

16 15

Emerging Asia

14 13 12 China

11 10 9 8 2001

2002

2003

2004

2005

2006

Source: CEIC, National Statistics Offices.

The success of India’s outsourcing sector provides a key example of specializing in services. Between 2001 and 2006, India’s service exports rose at a 341/2 per cent annual rate – almost double the average pace of the region. Moreover, the share of services in India’s total exports rose to almost 40 per cent in 2006, compared with 13 per cent for the region as a whole. The Philippines is another oft-cited example of a country with a rising emphasis on outsourcing and service exports. Exports of business services and computer and information services have risen at an over 30 per cent annual pace in the past 5 years and now account for nearly 20 per cent of the country’s service exports. Surprisingly, the share of services in the Philippines total exports has actually fallen slightly to 16 per cent since 2001, reflecting the country’s even faster pace of manufacturing export growth. Although there is some evidence that certain Asian countries are increasingly specializing in service exports, China’s service sector is Continued

138 Jane Haltmaier et al. Box 7.1 Cont’d expanding as well. In terms of GDP growth in the service sector, China matches India’s pace recently and service exports for China have been growing at 22 per cent annual rate since 2001, above the regional average. China has also been a strong competitor in the computer and information services industries, where export growth has risen almost 45 per cent annually since 2001, though exports are still roughly 15 per cent of the level of India software services exports. The fast pace of China’s manufacturing export growth over the past 5 years has led to a shrinking share of services in overall Chinese exports. For the region, however, China’s share of services exports has risen sharply (chart). Overall, these figures suggest that service exports from Asia are growing and represent another avenue of growth for the region – both for China and for the other countries.

Per cent

Services Share of Exports

17

Emerging Asia (ex. China)

16 15

Emerging Asia 14 13 12 China

11 10 9 8 2001

2002

2003

2004

2005

2006

Source: CEIC, National Statistics Offices.

Asian countries. It is interesting that China actually falls toward the lower end of the scale at a still-high 40 per cent, reflective of the vast size of its economy. The very high ratios for Hong Kong (about 180 per cent) and Singapore (nearly 250 per cent) are partly due to their role as trade hubs. The ratio is lower for India (20 per cent) and Japan (14 per cent). For the United States, shown for comparison, the ratio is considerably lower at 11 per cent. The chart also illustrates the extent to which the importance of exports has been rising in recent years for all of these countries, in some cases quite substantially.

The role of China in Asia 139 Box 7.2 The tourism strategy China’s recent explosive growth has created a sizable middle class with cash to spend and hungry for goods they cannot obtain in the mainland. This transformation has changed the very face of the global tourism industry. Chinese tourists are now being welcomed (and indeed actively attracted) to far-away destinations never imagined possible previously.1 One country that took early advantage of the market for Chinese tourism is Hong Kong. In 2004, China and Hong Kong signed the Closer Economic Partnership Agreement, which among other things allowed a greater number of Chinese tourists to visit Hong Kong. The results have been stunning. The following year, visitor arrivals to Hong Kong from China were nearly twice the resident population of Hong Kong, accounting for over half of all visitors arriving. Chart 1: Chinese Arrivals Per cent of Foreign Arrivals in Asia* 25

20

15

10

5

0 1995 1997 1999 2001 2003 *Asia excludes Philippines and Taiwan.

2005

Source: CEIC.

However, this phenomenon is not unique to Hong Kong. The share of Chinese visitors arriving in almost every Asian country has steadily risen since at least 1995. The exceptions are the relatively less-expensive destinations of Malaysia and Thailand. The share of Chinese visitors to all other Asian countries rose from about 7 per cent in 1995 to about 20 per cent in 2005.2 Continued

140 Jane Haltmaier et al. Box 7.2 Cont’d However, China still maintains a positive net visitor arrival with almost every country in the region. For example, in 2005, China registered 3 million more visitor arrivals from Japan than Japan registered from China.3 Chart 2: Net Visitor Arrivals to China, 2005 Thousands of visitors

83500 83000 3500 3000 2500 2000 1500 1000 500 0

Hong kong

Japan

Malaysia

Philippines

Indonesia

Singapore

Thailand

−500

Source: CEIC.

Data on the departure destinations of residents in each country (not shown) are sketchy. But, they confirm that among countries in the region, Hong Kong is the favorite destination of Chinese travelers: over 40 per cent visited Hong Kong in 2005. They also confirm an increase in the extent of intra-regional tourism trade. In other words, a greater proportion of residents from the region are visiting other countries in the region. For some countries, such as Hong Kong, Korea and Thailand, visits to China are largely responsible for this increase. Whether it is as a destination or an origination country, the economic opening in China is changing Asian tourism in important ways.

Notes 1 See “Germany’s campaign to attract Chinese tourists”, “Japan, a Net Exporter of Tourists, Working Hard to Attract Chinese Tourist”, “Arabic nations attract Chinese tourists,” “Drive to attract Chinese golfers,” “Hawaii to attract Chinese tourists.” 2 Data for the Philippines is not available before 2001, but data since then confirm the rising trend of Chinese visitors. Taiwan does not report the number of tourist arrivals from China, partly reflecting the political tensions between the two countries. 3 This data must be analyzed with caution for several reasons. First, it does not distinguish between travel for business versus travel for pleasure. Second, it also fails to distinguish arrivals who are in transit to another country.

The role of China in Asia 141 Box 7.2 Cont’d

References “Arabic nations attract Chinese tourists,” People’s Daily Online, January 1, 2006. http://english.people.com.cn/200601/01/eng20060101_232179.html “Drive to attract Chinese golfers,” The Scotsman, March 21, 2006. http:// thescotsman.scotsman.com/index.cfm?id=440342006 “Germany’s campaign to attract Chinese tourists,” Expatica.com, August 2004. http://www.expatica.com/actual/article.asp?subchannel_id=214&story_id= 10373 “Hawaii to attract Chinese tourists,” Shandong Business Net, April 6, 2006. http:// www.shandongbusiness.gov.cn/english/php/show.php?id=3219 “Japan, a Net Exporter of Tourists, Working Hard to Attract Chinese Tourist,” The Yomiuri Shimbun, Aug. 6, 2005. http://www.hotel-online.com/News/PR2005_ 3rd/Aug05_JapanChina.html

Per cent 70

Per cent of Trade that is Intraregional 1990 2005

60 50 40 30 20 10 0 Total

CH/HK

Taiwan

Singapore

Korea

Japan

Philippines Thailand Indonesia Malaysia

India

Figure 7.4 Per cent of intra-regional trade in Asia, 1990–2005 (Source: U.N. COMTRADE database, SourceOECD).

Figure 7.6 shows the average contribution of real net exports to GDP growth over two periods, 1995–2000 and 2000–6.2 In the first period, the net export contribution ranged from small amounts in India and Japan to around 4 percentage points in Malaysia and Thailand. In China, the contribution of net exports was 1.8 percentage points. The contributions were also sizeble in Hong Kong, Korea and Indonesia. However, in the second period, a more defined pattern emerges. In particular, the contribution of net exports is large for all of the newly industrialized economies (Hong Kong, Taiwan, Korea and Singapore), ranging from 1.5 percentage points in Korea to 4.6 percentage points in Singapore. In contrast, the contribution of real net exports to growth is small or negative in

142 Jane Haltmaier et al. the second period for the less-developed emerging Asian economies (ASEAN4 and India). Nonetheless, as shown in Figure 7.7, GDP growth rates during this period were quite respectable in all of the latter group of countries, and were in some cases higher than in the earlier period. Thus, not all of the countries appear to be dependent to the same degree on net exports as drivers of growth. Somewhat paradoxically, it is the less-developed countries in the region that are showing less dependence on net exports, at least in an accounting sense. This of course does not rule out the possibility that exports are an important trigger of growth, with the paucity of the net export contribution a result of concurrent high growth in imports. However, it does suggest that domestic demand is playing an increasingly important role in these countries. 2.3 Aggregate cross-country linkages 2.3.1 Growth comovements If China were becoming more of an engine of growth for Asia, we would expect to see changing patterns of cross-country linkages in economic growth rates at the aggregate level. In particular, keeping fixed the growth rates of traditional engines of growth for the Asian economies, such as the United States, we would expect to see an increased correlation of growth with China. There is a fair amount of literature on how cross-country linkages in growth have shifted over time. Much of this literature pertains to the experience of industrialized countries – see for example, Doyle and Faust (2005). Some authors, such as Kose, Prasad and Terrones (2003), have also included the experience of developing countries, including those in Asia, to look at how increased trade integration has affected the synchronization of business cycles across countries. However, that work uses data only through 1999 and is, therefore, not recent enough to take into account the full effects of the emergence of China. We used rolling regressions to estimate the contemporaneous correlation of each country’s real GDP growth with U.S. and/or Chinese real GDP growth.3 The regressions were estimated over a ten-year period, starting in 1970: Q1–1980: Q1 and moving forward by one quarter, with the last regression ending in the fourth quarter of 2006. For each country we ran three regressions: one with both U.S. and Chinese GDP growth on the right-hand side, one with just U.S. growth, and one with just Chinese growth. Because of difficulties seasonally adjusting the data for some of these countries, especially China, which does not have an official quarterly real GDP level series, we used four-quarter growth rates in the regressions. Standard errors were calculated using the Newey-West method. These regressions were done for Hong Kong, Taiwan, Japan, Korea, Singapore, Malaysia, India, Indonesia, the Philippines and Thailand. The results we report are for the regressions that included both U.S. and Chinese growth. The results for the other regressions are not materially different. The reported results are shown in Figures 7.8–7.11, which plot the coefficients for China and the United States, along with 95 per cent confidence bands. The results

The role of China in Asia 143 Per cent

Real Exports as a Per cent of GDP

300 1990 1995 2000 2006

250

200

150

100

50

0 Singapore

Hong Kong

Malaysia Thailand

Taiwan

Korea Philippines Indonesia China*

India

Japan

U.S.

Figure 7.5 Exports as a percentage of GDP (Source: Haver Analytics).

Per cent 6

Percentage Point Contribution to Real Net Exports to GDP Growth

1995–2000 2000–2006

5 4 3 2 1 −1

China*

Japan

India*

Hong Kong Taiwan

Korea

Singapore Indonesia Malaysia Philippines Thailand

*China and India data only through 2005

Figure 7.6 Contribution of net exports to GDP growth (Source: Haver Analytics).

suggest that in recent years Chinese growth has become considerably more important for most countries. This pattern is most striking for Thailand, where the coefficient on Chinese growth is insignificant until around 2000, when it rises to about 1.7 and becomes significant, before falling back to 1.3 by the end of the sample. Over the same time period, the coefficient on U.S. growth in the Thai equation becomes negative and insignificant, after having been positive and significant earlier in the sample. The other less-developed countries, including India, all also show a substantial increase in the coefficient on Chinese growth in recent years, and it becomes significant in most cases. However, the results for the coefficient on U.S growth differ among countries. For Malaysia and India the

144 Jane Haltmaier et al. Per cent

Average Annual Rates of Real GDP Growth

10 1995 to 2000 2000 to 2006

9 8 7 6 5 4 3 2 1 0 China

Japan

India

Hong Kong Taiwan

Korea

Singapore Indonesia Malaysia Philippines Thailand

Figure 7.7 Average annual rates of real GDP growth (Source: Haver Analytics).

coefficient becomes negative and insignificant in the late 1990s. It then becomes positive again for Malaysia, but remains insignificant. For the Philippines and Indonesia, the coefficient becomes positive and significant in the second half of the 1990s, but it then falls off again. The more developed countries also show an increase in the coefficient on Chinese growth at the end of the sample, although it is not significant for Hong Kong and Korea. The coefficient on U.S. growth also generally increases at the end of the sample, although it is significant only for Singapore and Taiwan. By and large, these results suggest that Chinese growth has become more important for the region, while U.S. growth has become less important, particularly for the less-developed countries. In contrast, U.S. growth remains quite important for Singapore and Taiwan, and to a lesser extent for Hong Kong, but it appears to matter much less for either Korea or Japan. 2.3.2 Vector autoregressions (VARs) The changing patterns of growth comovements are interesting and informative and lead us to try to more specifically identify U.S. and Chinese demand shocks for the goods of the other emerging Asian economies. We do so through a VAR model where we assess the relative contributions of shocks to U.S. import demand and shocks to Chinese import demand for growth in various emerging Asian economies from 1993: Q2 to 2006: Q4, the period over which China has made great strides in its degree of trade openness.4 Specifically, we estimate a three-variable structural VAR for each of several major emerging Asian economies, including the following variables: domestic real GDP growth, growth of U.S. real imports from the country, and growth of Chinese real imports from the country. To obtain U.S. real imports from a given emerging

The role of China in Asia 145

Coefficients from Growth Regressions* Thailand China

1980

United States

1984

1988

1992

1996

2000

2004

3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 −0.5 −1.0 −1.5 −2.0 −2.5 −3.0 −3.5 −4.0

1980

1984

1988

1992

1996

2000

2004

3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 −0.5 −1.0 −1.5 −2.0 −2.5 −3.0 −3.5 −4.0

Malaysia China

1980

United States

1984

1988

1992

1996

2000

2004

3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 −0.5 −1.0 −1.5 −2.0 −2.5 −3.0 −3.5 −4.0

1980

1984

1988

1992

1996

2000

2004

3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 −0.5 −1.0 −1.5 −2.0 −2.5 −3.0 −3.5 −4.0

India China

1980 1984 1988 1992 1996 2000 2004 *Dashed lines indicate 95% confidence band.

United States 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 −0.5 −1.0 −1.5 −2.0 −2.5 −3.0 −3.5 −4.0

1980

1984

1988

1992

1996

2000

Figure 7.8 Coefficients from growth regressions (Thailand, Malaysia, India).

2004

3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 −0.5 −1.0 −1.5 −2.0 −2.5 −3.0 −3.5 −4.0

146 Jane Haltmaier et al. Coefficients from Growth Regressions (cont’d)* Philippines China

1980

United States

1984

1988

1992

1996

2000

2004

3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 −0.5 −1.0 −1.5 −2.0 −2.5 −3.0 −3.5 −4.0

1980

1984

1988

1992

1996

2000

2004

3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 −0.5 −1.0 −1.5 −2.0 −2.5 −3.0 −3.5 −4.0

Indonesia China

United States 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 −0.5 −1.0 −1.5 −2.0 −2.5 −3.0 −3.5 −4.0

3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 −0.5 −1.0 −1.5 −2.0 −2.5 −3.0 −3.5 −4.0 1980 1984 1988 1992 1996 2000 2004 *Dashed lines indicate 95% confidence band.

1980

1984

1988

1992

1996

2000

2004

Figure 7.9 Coefficients from growth regressions (Philippines, Indonesia).

Asian economy, nominal imports in U.S. dollars from that economy are deflated by the U.S. overall import price index. Chinese imports from a particular emerging Asian economy include imports of both mainland China as well as Hong Kong, since it can be difficult to separate direct trade with Hong Kong from indirect trade with mainland China occurring through Hong Kong. Because of a lack of an appropriate import price deflator for China, we use the producer price index (PPI) as a proxy. Chinese nominal imports are deflated by the Chinese PPI and those for Hong Kong by the Hong Kong implicit deflator for imports. To identify the U.S. demand and Chinese demand shocks a Cholesky decomposition based on the ordering U.S. real imports, Chinese real imports and domestic growth is used. Note that according to the Cholesky decomposition, a variable is contemporaneously affected by those variables coming before it in the ordering and contemporaneously influences but is not contemporaneously influenced by those variables coming after it in the ordering. This ordering makes some sense because the emerging Asian economies can be considered to be small open economies, which would take as given U.S. and Chinese incomes and the world prices of the

The role of China in Asia 147

Coefficients from Growth Regressions (cont’d)* Singapore China

1980

United States

1984

1988

1992

1996

2000

2004

3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 −0.5 −1.0 −1.5 −2.0 −2.5 −3.0 −3.5 −4.0

1980

1984

1988

1992

1996

2000

2004

3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 −0.5 −1.0 −1.5 −2.0 −2.5 −3.0 −3.5 −4.0

Taiwan China

United States 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 −0.5 −1.0 −1.5 −2.0 −2.5 −3.0 −3.5 −4.0

1980

1984

1988

1992

1996

2000

2004

3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 −0.5 −1.0 −1.5 −2.0 −2.5 −3.0 −3.5 −4.0 1980

1984

1988

1992

1996

2000

2004

Hong Kong China

United States 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 −0.5 −1.0 −1.5 −2.0 −2.5 −3.0 −3.5 −4.0

3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 −0.5 −1.0 −1.5 −2.0 −2.5 −3.0 −3.5 −4.0 1980 1984 1988 1992 1996 2000 2004 *Dashed lines indicate 95% confidence band.

1980

1984

1988

1992

1996

2000

2004

Figure 7.10 Coefficients on growth regressions (Singapore, Taiwan, Hong Kong).

148 Jane Haltmaier et al. Coefficients from Growth Regressions (cont’d)* Korea China

United States 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 −0.5 −1.0 −1.5 −2.0 −2.5 −3.0 −3.5 −4.0

1980

1984

1988

1992

1996

2000

2004

3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 −0.5 −1.0 −1.5 −2.0 −2.5 −3.0 −3.5 −4.0 1980

1984

1988

1992

1996

2000

2004

Japan United States

China

3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 −0.5 −1.0 −1.5 −2.0 −2.5 −3.0 −3.5 −4.0

3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 −0.5 −1.0 −1.5 −2.0 −2.5 −3.0 −3.5 −4.0 1980 1984 1988 1992 1996 2000 2004 *Dashed lines indicate 95% confidence band.

1980

1984

1988

1992

1996

2000

2004

Figure 7.11 Coefficients on growth regressions (Korea, Japan).

goods they export – which would be the main determinants of U.S. and Chinese demand for their goods. Given the small open economy assumption, we also make the system block recursive with even the lagged values of domestic growth not feeding back into the U.S. and Chinese variables. We estimate the reduced form VAR (with the appropriate choice of lag length based on statistical criteria) and then retrieve the structural VAR using the identification assumptions. We compute, for each country, dynamic responses of domestic growth to positive shocks to growth of U.S. and Chinese imports (impulse responses). These are then cumulated to give the effects over time on the level of domestic output. The responses of the level of domestic output to a one standard-deviation shock to U.S. and Chinese import growth (which, of course, are also shocks to exports to the U.S. and China from the viewpoint of these countries) are shown in Figure 7.12 for the NIEs of Korea, Singapore and Taiwan. Their 90 per cent confidence bands based on Monte Carlo simulations (5,000 replications) are also shown.

The role of China in Asia 149 Impulse response of level of domestic output to one standard-deviation check to exports to US

Impulse response of level of domestic output to one standard-deviation check to exports to China KOREA 7

5

5

3

3

1 −1

0

1

2

3

4

Per cent

Per cent

KOREA 7

1

−1

0

1

Horizon (quarters)

3

4

3

4

SINGAPORE 8

6

6

3

3

Per cent

Per cent

SINGAPORE

2 0 0

1

2

3

4

2 0 −2

0

1

2

−4

−4 Horizon (quarters)

Horizon (quarters)

0

1

2

Horizon (quarters)

TAIWAN

3

4

Per cent

TAIWAN

Per cent

4

Horizon (quarters)

8

4 3 2 1 0 −1 −2 −3 −4 −5

3

−5

−5

−2

2

−3

−3

4 3 2 1 0 −1 −2 −3 −4 −5

0

1

2

Horizon (quarters)

Figure 7.12 Impulse responses using structural VAR (NIEs).

As can be seen from the left-hand side panels in the chart, not surprisingly, a one-standard deviation shock to the exports of these countries to the United States has a significant positive effect on domestic output for each of these three economies.5 For example, after a lag of one-quarter, the effect on Korean real GDP is about 2 per cent at an annual rate, on real output in Singapore is about 3 per cent, and on real output in Taiwan is about 1 per cent. Interestingly, the right-hand panels show that a one standard-deviation shock to exports to China has about an equal initial effect, if not slightly bigger, as the U.S. shock on output in Korea, Singapore and Taiwan.6 The effects of the same type of shocks on the ASEAN-4 economies are shown in Figure 7.13. The effects of U.S. demand shocks on domestic GDP are clearly evident for Indonesia and Malaysia and even for Thailand, although with a lag. However, the Chinese demand shock does not appear to have a statistically significant effect on domestic output in the ASEAN-4, except for Thailand.7

150 Jane Haltmaier et al. How much of domestic growth fluctuations in these seven countries can be explained by the U.S. and Chinese demand shocks? The answer depends not just on the size of the impulse responses when given size shocks occur (shown in Figures 7.12 and 7.13), but also on how often and, on average, what size shocks hit the economy. The variance decompositions, which measure the percentage of the forecast error variance of domestic output growth at various forecast horizons that is attributable to each of the shocks, provide the answer. The results for the variance decompositions are reported in Table 7.1. External shocks originating in the United States and China are quite important for these seven emerging Asian economies. Together, the two shocks account for about 20 per cent to 50 per cent of the forecast error variance of domestic output growth at a 1–4 quarter horizon in the NIEs of Korea, Singapore and Taiwan. In the ASEAN-4, they account for less, from about 5 to 30 per cent. Looking at the two shocks individually, U.S. shocks account for up to 25 per cent of the forecast error variance of growth in Korea and Singapore, but only up to about 12 per cent of growth in Taiwan. Chinese shocks also account for about up to 25 per cent of domestic growth fluctuations in Korea and Singapore, and account for up to 30 per cent of growth fluctuations in Taiwan, significantly more than U.S. shocks. For Indonesia, Malaysia and the Philippines, Chinese demand shocks are not a major driving force behind domestic growth fluctuations, but U.S. demand shocks are. The case of Thailand is more like the NIEs with both U.S. demand shocks and Chinese demand shocks being important, with the latter more significant than the former. Two main conclusions can be made from the structural VAR analysis. First, external shocks have been quite important over the past fifteen years or so for domestic output fluctuations in our sample of emerging Asian economies. Second, over the same period, Chinese demand shocks have been at least as important, if not more, as shocks originating in the United States in explaining domestic growth fluctuations in Korea, Singapore, Taiwan and Thailand. In contrast, Chinese demand has not played a significant part in explaining the growth of Indonesia, Malaysia and the Philippines. It might be argued that the shock to exports to China in the above VAR analysis overestimates the extent to which China serves as a direct engine of growth for the rest of emerging Asia because these exports to China might represent derived demand. In other words, to a large extent, China may only import intermediate goods from these other emerging Asian economies in order to satisfy final external demand arising from the United States and other industrial countries. Although we will consider this issue in much more detail later using micro trade data, we also experimented with an augmented VAR of four variables which adds the variable real exports from China (including Hong Kong) to the United States. This variable was placed second in the causal ordering in the new VAR – that is, after real exports to the United States from the particular country whose model we are considering and before real exports of that country to China. If the added variable takes over in importance from real exports to China, this would be consistent with the ‘derived demand’ hypothesis.

The role of China in Asia 151

Impulse response of level of domestic output to one standard-deviation check to exports to US

Impulse response of level of domestic output to one standard-deviation check to exports to China

INDONESIA

INDONESIA 4 3

0

1

2

3

4

Horizon (quarters)

2 1 0 −1 −2 −3

Per cent

Per cent

4 3 2 1 0 −1 −2 −3

0

1

2

Per cent 1

2

3

4

Horizon (quarters)

6 5 4 3 2 1 0 −1 −2 −3

0

1

1 1

2

3

4

Per cent

Per cent

1 0

−2

3

4

3

4

0 −1

0

1

2

−2 −3

−3

Horizon (quarters)

Horizon (quarters)

Per cent

THAILAND

Per cent

THAILAND 6 5 4 3 2 1 0 −1 −2

4

PHILIPPINES 2

−1

2

Horizon (quarters)

PHILIPPINES 2

0

3

MALAYSIA

Per cent

0

4

Horizon (quarters)

MALAYSIA 6 5 4 3 2 1 0 −1 −2 −3

3

0

1

2

Horizon (quarters)

3

4

6 5 4 3 2 1 0 −1 −2

0

1

2

Horizon (quarters)

Figure 7.13 Impulse responses using structural VAR (ASEAN4).

152 Jane Haltmaier et al. Table 7.1 Variance decompositions based on the estimated VAR k (quarters)

1 2 3 4

Korea: per cent of the k-step ahead forecast error variance of domestic output growth explained by: Exports to U.S. shock

Exports to China shock

Other shocks

10.8 13.3∗ 25.5∗∗ 26.0∗

17.0∗ 20.6∗ 18.3∗ 24.2∗

72.1∗∗ 66.1∗∗ 56.2∗∗ 49.8∗∗

Notes: Results based on a 3-variable VAR consisting of growth of exports to U.S., growth of exports to China and HK and domestic growth; sample period 1993: 2 to 2006: 4, and 5 lags. A ‘∗ ’ and ‘∗∗ ’ indicate statistical significance based on 90 per cent and 95 per cent confidence bands, respectively, computed from Monte Carlo simulations (5000 replications).

k (quarters)

1 2 3 4

Singapore: percentage of the k-step ahead forecast error variance of domestic output growth explained by: Exports to U.S. shock

Exports to China shock

Other shocks

2.6 20.1∗ 21.3∗ 24.4∗

19.2∗∗ 17.5∗ 20.6∗∗ 21.2∗∗

78.2∗∗ 62.3∗∗ 58.1∗∗ 54.4∗∗

Notes: Results based on a 3-variable VAR consisting of growth of exports to U.S., growth of exports to China and HK and domestic growth; sample period 1993: 2 to 2006: 4, and 7 lags. A ‘∗ ’ and ‘∗∗ ’ indicate statistical significance based on 90 per cent and 95 per cent confidence bands, respectively, computed from Monte Carlo simulations (5000 replications).

k (quarters)

1 2 3 4

Taiwan: percentage of the k-step ahead forecast error variance of domestic output growth explained by: Exports to U.S. shock

Exports to China shock

Other shocks

6.3 10.2 11.1 12.3∗

24.3∗∗ 26.2∗∗ 29.9∗∗ 31.3∗∗

69.4∗∗ 63.6∗∗ 59.0∗∗ 56.4∗∗

Notes: Results based on a 3-variable VAR consisting of growth of exports to U.S., growth of exports to China and HK and domestic growth; sample period 1993: 2 to 2006: 4, and 4 lags. A ‘∗ ’ and ‘∗∗ ’ indicate statistical significance based on 90 per cent and 95 per cent confidence bands, respectively, computed from Monte Carlo simulations (5000 replications).

The role of China in Asia 153 Table 7.1 Cont’d k (quarters)

1 2 3 4

Indonesia: percentage of the k-step ahead forecast error variance of domestic output growth explained by: Exports to U.S. shock

Exports to China shock

Other shocks

8.9 10.5 12.9∗∗ 14.1∗∗

1.8 3.4 5.8 7.6

89.3∗∗ 86.1∗∗ 81.3∗∗ 78.3∗∗

Notes: Results based on a 3-variable VAR consisting of growth of exports to U.S., growth of exports to China and HK and domestic growth; sample period 1993: 2 to 2006: 4, and 4 lags. A ‘∗ ’ and ‘∗∗ ’ indicate statistical significance based on 90 per cent and 95 per cent confidence bands, respectively, computed from Monte Carlo simulations (5000 replications).

k (quarters)

1 2 3 4

Malaysia: percentage of the k-step ahead forecast error variance of domestic output growth explained by: Exports to U.S. shock

Exports to China shock

Other shocks

8.5 14.4∗ 20.3∗∗ 20.4∗∗

2.0 3.4 5.7 8.9

89.6∗∗ 82.1∗∗ 74.0∗∗ 70.6∗∗

Notes: Results based on a 3-variable VAR consisting of growth of exports to U.S., growth of exports to China and HK and domestic growth; sample period 1993: 2 to 2006: 4, and 7 lags. A ‘∗ ’ and ‘∗∗ ’ indicate statistical significance based on 90 per cent and 95 per cent confidence bands, respectively, computed from Monte Carlo simulations (5000 replications).

k (quarters)

1 2 3 4

Philippines: percentage of the k-step ahead forecast error variance of domestic output growth explained by: Exports to U.S. shock

Exports to China shock

Other shocks

3.4 5.9 8.2 14.9∗

2.2 4.3 6.7 8.8

94.4∗∗ 89.8∗∗ 85.1∗∗ 76.3∗∗

Notes: Results based on a 3-variable VAR consisting of growth of exports to U.S., growth of exports to China and HK and domestic growth; sample period 1993: 2 to 2006: 4, and 8 lags. A ‘∗ ’ and ‘∗∗ ’ indicate statistical significance based on 90 per cent and 95 per cent confidence bands, respectively, computed from Monte Carlo simulations (5000 replications). Continued

154 Jane Haltmaier et al. Table 7.1 Cont’d k (quarters)

1 2 3 4

Thailand: percentage of the k-step ahead forecast error variance of domestic output growth explained by: Exports to U.S. shock

Exports to China shock

Other shocks

2.0 4.7 11.8 13.3∗

8.9 14.2∗ 16.5∗∗ 17.3∗∗

89.1∗∗ 81.1∗∗ 71.7∗∗ 69.4∗∗

Notes: Results based on a 3-variable VAR consisting of growth of exports to U.S., growth of exports to China and HK and domestic growth, sample period 1993: 2 to 2006: 3, and 3 lags. A ‘∗ ’ and ‘∗∗ ’ indicate statistical significance based on 90 per cent and 95 per cent confidence bands, respectively, computed from Monte Carlo simulations (5000 replications).

None of the conclusions reached from the earlier VAR are overturned with the augmented VAR; in particular, economies for which exports to China were important before remain so. But the augmented VAR does give some additional insights. Real exports to the United States from China are significant in explaining domestic economic growth in some of the emerging Asian economies, most notably Singapore, Malaysia and Thailand. For two of these economies, Malaysia and Thailand, exports to China were not important in the first place. This suggests that the impact of real exports from China to the United States on these countries’ output growth in some cases may in part be representing such factors as the effects of export-oriented foreign direct investment from these countries to China.

3 China as a conduit of growth: Is China the endpoint of a giant Asian assembly line? The macro evidence presented in the previous section is consistent with an increasing effect of the Chinese economy on output and import fluctuations in emerging Asia, even when controlling for growth in the United States. This is suggestive of a greater role for China as an engine of growth rather than just a conduit for U.S. demand. However, it is not conclusive evidence, as the tighter correlation could also be consistent with greater integration of production through trade fragmentation, particularly if this were reflected in a higher degree of time synchronization within the region than with trading partners in other parts of the world. To look more closely at the extent to which China represents an independent engine of growth rather than acting as a conduit of industrial country demand, we turn now to an analysis of the micro trade data. As one of the main contributions of the chapter, we first provide a comprehensive decomposition of exports and imports into three categories: basic goods and construction materials (BP), parts and components (MPC) and finished manufactured goods (MFG). Others have done only partial decompositions. Key features and implications of the parts and components trade are then discussed.

The role of China in Asia 155 3.1 Trade fragmentation Anecdotal evidence suggests that trade fragmentation or vertical integration has become increasingly important in emerging Asia. In particular, China’s low-cost labour force is thought to offer an attractive endpoint in a production chain that may stretch across one or more other economies at varying stages of development. In this process, Asian countries other than China specialize in production of intermediate goods in which they have comparative advantages and export them to China (sometimes through Hong Kong) for assembly and re-export. To the extent that this is the case, exports to China from other countries in the region should be highly concentrated in the parts and components categories. At the same time, Chinese exports should become more concentrated in finished goods. Distinguishing parts and components trade from other types of trade needs to be done at the 5-digit product level, as even the 3-digit level does not classify products finely enough. For example, SITC 727 consists of food processing machines and parts. SITC 72711, 72719 and 72721 include different types of food processing machines, an example of finished goods, while SITC 72722 and 72729 include the parts and components for these machines. Unfortunately, not all of the categories can be separated so neatly. The separation is somewhat easier for SITC 7 (machinery and transport equipment) and SITC 8 (miscellaneous manufactured articles), as was done in Athukorala (2003) and Athukorala and Yamashita (2006) than for SITC 5 (chemicals and chemical products) and SITC 6 (manufactured goods). Although Athukorala and Yamashita noted that SITC 5 and SITC 6 also have significant parts and components categories, they did not attempt a separation for them. We have largely followed Athukorala and Yamashita’s classification for SITC 7 and 8, although we have made some modifications. For instance, we moved ball bearings, piston engines and various kinds of pumps from finished goods to parts and components.8 With the exercise of some judgment, we have also extended the separation to SITC 5 and 6. In addition, we examined SITC 0–4 and found a few categories that are classifiable as parts and components, i.e. synthetic fibers (this includes all of the 5-digit sub-categories of two 3-digit industries). The rest of the trade in SITC 0–4 is unlikely to play a role in trade fragmentation. We have classified this group as basic products and construction materials. A full description of each category is provided in the appendix. Not surprisingly, our comprehensive decomposition of trade results in much higher estimates of the importance of trade fragmentation than was found in earlier studies, although direct comparisons are complicated by the fact that different studies not only measure parts and components differently, but also compare them to different aggregates. For instance, Ng and Yeats (1999) measure production fragmentation by trade in parts and components of SITC 7 and 8 using SITC Revision 2. They found that this measure of parts and components constituted 20 per cent of total East Asian exports of manufactured goods in industries in SITC 6 through 8 (excluding 68) in 1996. However, this ignores the substantial amounts of parts and components that we have identified for SITC 6. Using the more

156 Jane Haltmaier et al. Table 7.2 Share of parts and components in exports (percentage points) Share of parts and components in exports by 1-digit SITC code, total trade∗

Asia

1995 2005 China/HK 1995 2005 Other Asia 1995 2005 Rest of World 1995 2005

Crude materials, inedible exel fuel

Chemicals Manuf. & related goods products, n.e.s.

Machines, transport equipment

Misc. manuf. articles

(2)

(5)

(6)

(7)

(8)

14.9 12.8 1.4 6.5 16.7 13.8 5.3 5.2

56.8 59.2 49.1 52.1 56.4 59.0 45.4 38.8

73.2 68.1 56.5 54.1 74.9 73.6 68.6 67.3

51.4 52.0 45.7 41.2 51.5 52.8 48.6 46.0

5.6 7.2 2.0 3.0 8.5 13.5 3.3 9.2

Total

41.1 41.8 23.5 29.8 44.3 44.6 35.2 32.2

Share of parts and components in exports by 1-digit SITC code, manufacturing trade∗∗

Asia

1995 2005 China/HK 1995 2005 Other Asia 1995 2005 Rest of World 1995 2005

Crude materials, inedible exel fuel

Chemicals Manuf. & related goods products, n.e.s.

Machines, transport equipment

Misc. manuf. articles

(2)

(5)

(6)

(7)

(8)

100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0

57.7 59.8 49.7 53.6 57.3 59.4 47.0 39.7

75.8 70.6 58.6 56.5 77.8 76.2 72.1 70.7

51.4 52.0 45.7 41.2 51.5 52.8 48.6 46.0

5.6 7.2 2.0 3.0 8.5 13.5 8.3 9.2

∗ Includes parts and components, finished goods and basic ∗∗ Includes parts and components and finished goods.

Total

45.8 46.5 26.0 31.9 49.5 51.0 45.4 42.2

products.

Source: U.N. COMTRADE database, SourceOECD.

detailed SITC Revision 3, Athukorala (2003) calculated that parts and components accounted for 28 per cent of East Asian manufacturing exports in SITC 7 and 8 in 2003. As shown in Table 7.2, our more comprehensive definition of parts and components indicates that these products accounted for over 40 per cent of total Asian exports (the top half of the table) and nearly half of exports of manufactured goods (defined as the sum of parts and components and finished goods, our second and third categories described above, shown in the lower half of the table) in 2005.

The role of China in Asia 157 The reason that our measure is so much larger than in other studies is that SITC 5 and 6 in fact have the largest proportions of parts and components. SITC 8, in contrast, includes a very small fraction of parts and components. For the region as a whole, exports of parts and components constituted 46.5 per cent of total exports of manufactured goods in 2005, down a little from 1995. However, the decline was mainly due to an increased weight for China, where parts and components are a smaller share of exports, although even there the share rose over the ten-year period. For the rest of the region, the export share of parts and components was already high at 50 per cent in 1995, and it rose a little further, to 51 per cent in 2005. This share is a full 10 percentage points higher than that for the rest of the world, supporting the idea that trade fragmentation is more important in the Asian region than in other parts of the world. As illustrated in Figure 7.14, China is very much an outlier in the region in terms of the percentage of exports that are parts and components. For trade with the entire world, this category comprises less than 30 per cent of China’s exports, but it is about 50 per cent of exports for Japan, India, Korea, Malaysia and Thailand, 60 per cent for Taiwan and Singapore and nearly 70 per cent for the Philippines. The importance of trade fragmentation with China is supported by the fact that the percentages of parts and components in exports to China are considerably higher than for exports to the rest of the world , with the proportion for exports to China ranging from about 60 per cent for Japan, Thailand and Indonesia to over 80 per cent for India and the Philippines. The picture is considerably different for imports, shown in Figure 7.15. The percentage of China’s imports of manufactured goods that are parts and components was nearly 70 per cent in 2005, a little higher than for most of the other countries in the region, although lower than that for the Philippines. The rates for Japan, which is at a much higher level of development, and India, which, as noted earlier, is generally less integrated with the region, are considerably lower than the rest. The fact that many of these countries import as well as export large amounts of parts and components may suggest that production integration arrangements in the region are not confined to trade with China. However, as illustrated in Figure 7.16, which compares the percentage of parts and components in exports and imports in total trade for each country, the discrepancy for China is far larger than for any of the other countries, supporting the idea that China is more often than not the endpoint of the Asian assembly line. 3.2 The composition of trade balances The importance of trade in intermediate vs. final goods is further illustrated by an examination of trade balances. As shown in the second column of Table 7.3, the Asian region’s trade surplus with the world was $225 billion in 2005, more than three times its 1995 size. This surplus was fairly widely shared among countries, with only Thailand, the Philippines and India running trade deficits. Japan alone accounted for about a third of the region’s surplus in 2005, although its surplus declined significantly over the ten-year period.

158 Jane Haltmaier et al.

Parts and Components as a Percentage of Exports of Manufactured Goods: 2005

Per cent Trade with World

90

Trade with China 80

Rest of the World

70 60 50 40 30 20 10 0 Japan

India

Taiwan

Korea

Singapore

Malaysia

Thailand

Philippines

Indonesia

China/HK

Figure 7.14 Parts and components as a per cent of exports of manufactured goods, 2005 (Source: U.N. COMTRADE database, SourceOECD).

Per cent

Parts and Components as a Per cent of Imports of Manufactured Goods: 2005

90 Trade with World 80

Trade with China Rest of the World

70 60 50 40 30 20 10 0 Japan

India

Taiwan

Korea

Singapore

Malaysia

Thailand

Philippines

Indonesia

China/HK

Figure 7.15 Parts and components as a per cent of imports of manufactured goods, 2005 (Source: U.N. COMTRADE database, SourceOECD).

The role of China in Asia 159

Per cent

Parts and Components as a Per cent of Trade in Manufactured Goods: 2005

90 80

Exports Imports

70 60 50 40 30 20 10 0 Japan

India

Taiwan

Korea

Singapore Malaysia

Thailand Philippines Indonesia China/HK

Figure 7.16 Parts and components as a per cent of trade in manufactured goods, 2005 (Source: U.N. COMTRADE database, SourceOECD).

Table 7.3 Asian trade balances with the world (US$ billions)

Asia China/HK Asia ex. China/HK and India More advanced Japan Taiwan Korea Singapore Less advanced Malaysia Thailand Philippines Indonesia India

Total trade

MFG

1995

2005

1995

65.3 −5.5 75.7

224.7 187.7 576.1 55.8 86.5 −178.2 −438.0 94.0 46.2 304.2 −38.8 −103.3 −12.8 −106.9 177.0 139.3 279.6 95.8 193.5 −159.4 −296.0

99.6 139.0 79.1 106.8 7.1 9.1 −10.1 23.2 −6.2 29.6 −28.8 −8.3 −3.3 26.4 −14.3 −8.1 −11.0 −8.2 28.0 4.8 −4.9 −46.3

MPC 2005

1995

140.5 235.2 139.9 109.2 142.2 130.7 12.9 8.9 9.3 12.0 63.2 9.2 6.4 20.9 −9.3 1.0 36.7 −45.2 −0.4 20.3 −12.4 0.8 11.2 −18.3 −1.6 5.4 −6.2 −0.1 7.6 −7.1 2.3 −7.7 −1.2

BP 2005

218.2 141.1 23.9 34.9 18.4 −28.4 −8.5 −12.7 −6.5 2.9 −3.6

1995

2005

−180.8 −314.4 −133.1 −204.2 −13.2 −25.7 −31.2 −74.8 −3.3 −9.6 15.4 −16.6 9.5 14.6 3.1 −6.5 −3.3 −7.1 12.0 17.5 −6.0 −35.0

160 Jane Haltmaier et al. Consistent with China’s role as an assembler, its $94 billion surplus with the world in 2005 was entirely in manufactured finished goods (MFG), where the surplus ballooned from $46 billion in 1995 to over $300 billion in 2005. Over the same period, China’s trade deficits in the other categories expanded. In contrast, the rest of the region (excluding India, which had a deficit in all three categories) had large surpluses in both MFG and manufactured parts and components (MPC) in 2005, along with a large deficit on basic products (BP). However, trade patterns vary widely by country. The more advanced economies of Japan, Korea, Taiwan and Singapore all had surpluses in 2005 in both MFG and MPC, along with deficits in BP. In contrast, most of the less-advanced countries had deficits in MPC along with surpluses in MFG. (Indonesia was the only exception with small surpluses in both categories.) This suggests that the moreadvanced countries are the primary beneficiaries of China’s role as a conduit, while the other countries may in fact be playing an assembler role more similar to that of China, although on a smaller scale. Table 7.4, which breaks down the region’s trade with China/Hong Kong vs. the rest of the world, provides further evidence that China is still primarily a conduit rather than an engine for growth in the region, and affirms that this role is more important for the more advanced economies in the region. Asia outside of China and Hong Kong in the aggregate had a large surplus with China in 2005, double the 1995 level. Nearly all of this surplus was in parts and components, along with a much smaller surplus in basic products, and a small deficit in finished goods. Once again, the pattern of trade differs sharply across countries. Nearly all of the region’s surplus with China, both overall and in MPC, was accounted for by the more advanced economies. This group also had a small net deficit with China in MFG, although Korea and Taiwan both had small surpluses (which may suggest the beginnings of an increased role of China as an engine of growth). With the exception of India, which had a small deficit with China, the less-advanced group generally had small surpluses, the largest portion of which was in basic products. This group also had a small overall surplus in parts and components, mainly accounted for by Malaysia and the Philippines, and a deficit in finished goods, mainly accounted for by India. As shown in the lower part of the table, the region’s pattern of trade with the rest of the world is quite different from its trading relationship with China. In addition to the fact that the region had a very large deficit with the rest of the world in basic products (only Indonesia and Malaysia had surpluses in this category), it also had a very large surplus in finished goods. Although it also had a surplus with the rest of the world in parts and components, it was much smaller than its surplus with China in this category, consistent with the greater amount of trade fragmentation within the region than without. Once again, there were substantial differences across countries, including significant differences within the more and less-advanced groups. In particular, Japan, Korea and Singapore all had surpluses with the rest of the world in both finished goods and parts and components, along with deficits in basic products. However, Korea’s surplus categories were not large enough to offset its basic products deficit, while Taiwan had deficits in all three categories.

The role of China in Asia 161 Table 7.4 Asian trade balances with China versus rest of the world (U.S$ billions) China/HK Total trade

MFG

1995

1995

2005

MPC 2005

1995

BP 2005

1995

2005

10.7 −10.9 10.8 −6.0

46.9 116.6 45.8 117.3

−2.7 −2.7

5.2 1.4

10.6 −2.9 −0.4 −20.7 6.1 12.0 3.1 6.1 1.8 −0.4 0.1 −8.0 0.5 −2.0 0.2 −0.2 −0.5 0.0 0.0 −0.8 −0.1 −5.0

44.8 113.5 18.8 36.0 16.0 33.5 9.1 32.6 0.8 11.4 2.4 3.1 0.9 1.6 0.0 0.2 −0.5 2.3 0.9 −0.4 1.1 −0.7

−6.3 −7.4 −0.3 −0.7 2.2 3.6 1.1 1.5 0.0 0.9 0.0

−6.2 −9.3 −0.5 −2.0 5.6 11.5 1.9 2.6 −0.1 3.3 3.8

Total trade

MFG

MPC

1995

2005

1995

15.9 21.8

19.8 64.3

50.5 95.9 −12.8 −21.6 −11.0 −34.6 −5.8 −16.1 −10.0 3.2 −5.8

34.7 73.1 −37.9 −13.6 13.0 −14.8 24.9 −10.7 −10.5 25.9 −44.5

Asia ex. China 54.9 110.9 Asia ex. China/HK 54.0 112.7 and India More advanced 49.1 104.3 Japan 11.0 6.0 45.0 Taiwan 21.8 Korea 11.6 36.8 Singapore 4.7 16.6 Less advanced 5.8 6.6 1.5 Malaysia 2.5 Thailand 1.7 2.6 Philippines −1.0 2.3 2.0 Indonesia 1.6 India 1.0 −1.9 Rest of the world

Asia ex. China Asia ex. China/HK and India More advanced Japan Taiwan Korea Sinagpore Less advanced Malaysia Thailand Philippines Indonesia India

BP

2005

1995

130.8 282.8 128.4 285.6

47.8 50.0

73.3 −162.7 −336.3 76.3 −156.7 −297.5

95.1 111.9 −6.7 0.0 −10.1 −47.3 −13.3 −18.3 −5.7 −7.8 −2.2

104.7 −174.5 −308.2 105.1 −125.6 −194.9 −9.6 −12.8 −25.2 2.2 −30.6 −72.8 7.0 −5.5 −15.2 −31.5 11.8 −28.1 −10.1 8.4 12.6 −12.9 1.6 −9.1 −8.8 −3.3 −7.1 3.3 11.1 14.2 −3.0 −6.0 −38.8

129.9 109.6 6.1 8.9 4.6 0.9 −0.9 0.6 −1.1 −0.1 2.4

238.1 162.9 −3.1 57.0 21.3 44.7 22.3 11.4 5.4 8.4 −2.8

2005

1995

2005

Source: U.N. COMTRADE database, SourceOECD.

These two countries are thus dependent on trade with China to generate a surplus. For the less-advanced economies, only the commodity-exporters Malaysia and Indonesia had surpluses with the rest of the world, although all of them except India had surpluses in finished goods, while all but Indonesia had deficits in parts and components. This again suggests that these countries are more like China than they are like the more advanced economies in the region.

162 Jane Haltmaier et al. In sum, the evidence suggests that China remains largely an importer of inputs into its assembly trade in regard to the rest of Asia, and that it is mainly the more advanced economies that are feeding the Chinese assembly line. The less advanced countries appear to be gaining little net benefit from trade with China, although there are signs that this is changing. For instance, the Philippines showed a small surplus in parts and components trade with China in 2005, up from nearly balanced trade in 1995. This may suggest that the Philippines is moving into a role similar to that played by the advanced countries. (Box 7.3 explores recent developments in the Philippines economy in more detail.) However, other than the small surpluses in finished goods for Korea and Taiwan, there is very little evidence that China has become a source of final demand for the region. Box 7.3 The Philippines electronics sector Exports of high-tech products make up nearly 70 per cent of the Philippines’ total exports, the highest in emerging Asia. However, high-tech goods have not always been the dominant export product category. In what follows, we review the development of the high-tech sector in the Philippines and the unique role played by the globalization and fragmentation of the high-tech supply chain. Chart 1: Share of Product Category in Philippines Exports 80 Primary Products (PP) Resource Based (RB1+RB2) Low-Tech (LT1+LT2) Medium-Tech (MT1+MT2+MT3) High-Tech (HT1+HT2)

70

60

50

40

30

20

10

0 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 High-Tech Induced HT1, HT2 and SITC9

Source: U.N. COMTRADE database.

In the early 1990s, the share of electronics in Philippine’s total exports was not as high. It rose considerably from 24 per cent of exports in 1994 to 50 per cent in 1996, and has hovered at nearly 70 per cent since 1998.1

The role of China in Asia 163 Box 7.3 Cont’d During that period, exports of low technology products (LT), resource based products (RB) and primary products (PP) declined. Chart 2: Share of Product Category in Philippines Imports 80 Primary Products (PP) Resource Based (RB1+RB2) Low-Tech (LT1+LT2) Medium-Tech (MT1+MT2+MT3) High-Tech (HT1+HT2)

70 60 50 40 30 20 10 0

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 High-Tech Induced HT1, HT2 and SITC9

Source: U.N. COMTRADE database.

As the share of electronics in total exports rose, the share of imports of electronics rose in tandem. In 1991, the imports of high-tech products (the HT category) accounted for 22 per cent of total imports. Its share had risen to 35 per cent by 1996, and to over 45 per cent since 1998. The explanation for these features of the Philippine electronic sector is rooted in the history of the development of the global electronics industry, mainly by U.S. and Japanese firms. In the mid-1980s, U.S. firms had expanded production to emerging Asia in order to reduce production costs through relatively cheap labour. They expanded first to Singapore, and later to Thailand and Malaysia. The rapid development of the Philippines electronic sector was the result of policies by Japanese firms in order to remain competitive vis-à-vis U.S. firms in the global production of electronics. For example, Sunward Technology, a U.S. firm, began operations in the Philippines in March 1988. In May of the same year, Sunward Technology was followed by Tsukiden Electronics Industries, a subsidiary of the Japanese Tsukiden group. The momentum was interrupted by political instability in the Philippines, including a December 1989 military coup, and by a well-publicized kidnapping of a Japanese executive and a recession that lasted until 1993 (Tecson 1999). Continued

164 Jane Haltmaier et al. Box 7.3 Cont’d The return of political stability and an improved economic environment after 1993 marked the beginning of a new wave of investment in the electronics sector. In 1994, Hitachi, Fujitsu and Toshiba began expanding production capacity in the Philippines. The entry of these Japanese multinationals was accompanied by the relocation of Japanese supplier firms between 1994 and 1996, including Nidec Philippines Corporation (1995), Luzon Electronics Technology, Tsukuba Philippine, San Technology, Mette, Precision Technology etc.

Why the Philippines? Japanese and U.S. firms expanded production to Asia to reduce production costs. The high concentration of investment by Japanese firms in the Philippines in particular was motivated by the following reasons: First, the Philippines’ geographical location offers several advantages. It provides easy access to different countries of East and Southeast Asia which serve as sources of parts and components of electronics products. It is closer to Japan than Singapore, Malaysia and Thailand, which allows a better and faster interaction between headquarters and the subsidiaries in the Philippines. This close proximity between the Research and Development centers in Japan and subsidiaries and suppliers in the Philippines helped reduce the product cycle. Second, the Philippines has a relatively abundant supply of engineers, and graduates from technical schools. The relatively high supply lowered labour costs for skilled workers compared to other countries in the region. For example, as of 1997, the wages of a graduate from a technical school in Indonesia were 1.4 times higher than that of a Philippine graduate. The corresponding factor was 2.5 for Thailand, 3.1 for Malaysia and 6.9 for Singapore (see Table below). Third, many Philippine workers are fluent in English. This facilitated communication between Japanese and U.S. managers and their subsidiaries or contractors in the Philippines. It also Relative wages levels in ASEAN-5 Country

Factory workers

Junior high school graduates

Technical college graduates

Philippines Indonesia

1.0 0.63

1.0 0.54

1.0 1.36

Thailand Malaysia

1.23 1.28

1.29 1.36

2.46 3.12

Singapore

4.10

4.70

6.91

Source: Tecson (1999) Information Storage Industry Center.

The role of China in Asia 165 Box 7.3 Cont’d reduced the cost of training workers. It was estimated that a Japanese firm would have to provide at least 90 hours of language training in Thai to its Japanese engineers and managers assigned to Thailand in order for them to have the minimum communication capabilities. The outsourcing of production to the Philippines accounts for the rapid development of the high-tech sector in the country’s exports. In the fragmentation of the production process, parts and components are shipped from the headquarters of multinational firms located mostly in Japan or the United States, where the products are designed, to the Philippines. Plants in the Philippines assemble, test, and export the final product to markets in the United States, Japan and elsewhere. This feature of the production process accounts for the high share of electronics in Philippines trade, notably with the United States and Japan- its main trading partners. It is no surprise that about 50 per cent of the Philippines imports of high-tech (HT) products originated in Japan and the US, and about 50 per cent of HT exports were destined to the US and Japan, at least until 1997. Since 1997, the share of exports to the US and Japan has been declining steadily. This decline is mostly due to a fall in the share of exports to the US as the share of exports to Japan held steady (see Chart 3). Chart 3: U.S. and Japan Combined Share of High-Tech* Trade 80 Exports to U.S. and Japan Imports from U.S. and Japan

70 60 50 40 30 20 10 0

1992

1994

1996

1998

2000

2002

2004

*High-Tech is HT1+HT2+SITC9

Source: U.N. COMTRADE database.

On the other hand, the share of the Philippine’s high-tech trade with China, though small, has been increasing rapidly, especially on the export side. The share of Philippines’ HT exports going to China has risen from 1.3 per cent in 2000 to 13 per cent in 2005, and the share of exports has surpassed the share of imports. Continued

166 Jane Haltmaier et al. Box 7.3 Cont’d Chart 4: China’s Share of High-Tech* Trade 20 Exports to China Imports from China

16

12

8

4

0 1992

1994

1996

1998

2000

2002

2004

*High-Tech is HT1+HT2+SITC9

Source: U.N. COMTRADE database.

The relatively high share of high-tech products in exports of the Philippines is partially offset by high imports. Electronics exports have made up about 30 per cent of GDP since 1998, while imports have averaged 25 per cent. In 2005 exports of HT stood at 27.5 per cent of GDP and imports at 25.0 per cent, resulting in a trade balance of 2.5 per cent of GDP Chart 5: High-Tech* Trade as a Per cent of GDP 80 Exports/GDP

70

Imports/GDP 60 50 40 30 20 10 0 1992

1994

1996

1998

*High-Tech is HT1+HT2+SITC9

Source: U.N. COMTRADE database, CEIC.

2000

2002

2004

The role of China in Asia 167 Box 7.3 Cont’d for electronics. However, the trade balance in electronics does not capture all of the benefits of the electronic sector for the economy. These include employment creation and consequent domestic expenditures, technology spillovers, creation of domestic firms that are sub contractors or direct beneficiaries of the presence location of the multinationals in the country.

Notes 1 Electronics consists primarily of the HT1 and HT2 categories. With exercise of some judgment, we also include a category labeled “other”.

References Tecson, Gwendolyn R. (1999) “The Hard Disk Drive Industry in the Philippines” Information Storage Industry Center, Report 99–01, University of California, San Diego.

4 China as a steamroller: How is the rest of Asia adjusting to China’s growing presence? The evidence shown in the previous section suggests that China has become an important partner in production with the more advanced Asian economies, but that it is providing little net stimulus to the rest of the region. However, as noted in the introduction, ignoring the Chinese giant is hardly an option for its closest neighbors. Like a massive rock dropped into a placid lake, China is clearly sending ripples (if not waves) in all directions, with the largest impact in the immediate region. The purpose of this section is to use our dataset to assess the effect of China on the region by looking at changes in export structure. In particular, we consider three aspects of changes in export structure: changes in technological sophistication, changes in revealed comparative advantage, and byproduct displacement of exports as a result of competition from China. We look at export structure in terms of the technological classification introduced by Lall (2000) (as was done in Lee and Plummer (2004)). This taxonomy includes ten categories, which are detailed in the appendix: primary products (PP); agricultural resource-based manufactures (RB1); other resource-based manufactures (RB2); low-technology textile manufactures (LT1); low-technology manufactures of other products (LT2); medium-technology automotive products (MT1); mediumtechnology process goods (MT2); medium-technology engineering products (MT3); high-technology electronic products (LT1) and other high-technology products (LT2). The magnitude of China’s rise in the region is illustrated in Table 7.5, which shows each country’s percentage of the region’s total exports by technological

168 Jane Haltmaier et al. category. As shown on the far right, China’s total merchandise exports increased from 11 per cent of the region’s exports in 1995 to 27 per cent in 2005, as they quintupled in value. In 2005 China accounted for 50 per cent of the region’s exports of textile products, almost 40 per cent of other low-tech manufactures and almost 30 per cent of electronic high-tech. China has come to dominate regional exports even in several categories which comprise only small proportions of its own exports. For instance, China was the largest exporter in the region in dollar terms in 2005 of primary products, which (as shown in Table 7.6) accounted for only 41/2 per cent of its own exports, as well as of agricultural resource-based manufactures 31/2 per cent of its exports. The data in Table 7.6 also make clear the extent to which China has moved up the value chain over the past ten years. In 1995, nearly half of China’s exports were of low-tech textile and other manufactures, more than 20 per cent were of primary products and resource-based manufactures, and 13 per cent were of high-tech products. However, by 2005, the proportion of China’s exports in the high-tech categories had risen to 33 per cent, while the share of low-tech manufactured exports had fallen to 32 per cent. Primary and resource-based products accounted for about 13 per cent of exports in 2005. 4.1 Index of technological sophistication In order to compare the technological structure of exports across countries and across time, we introduce a simple index of technological sophistication (ITS), shown on the far right of Table 7.6, that is higher the greater the percentage of each country’s exports in the more technologically sophisticated categories. The index is constructed by assigning lower values to the lower-technology categories and higher values to the higher categories. The values assigned to each category are: 1 for primary products (PP), 2 for resource-based manufacturing (RB1 and RB2), 3 for low-tech manufacturing (LT1 and LT2), 4 for medium-tech manufacturing (MT1, MT2 and MT3) and 5 for high-tech manufacturing (HT1 and HT2). The percentage of exports in each category is then multiplied by the appropriate value, and these are summed and divided by 100. The resulting index ranges from 1 to 5, with higher values indicating greater technological sophistication. It should be noted that the index is not a measure of the technological sophistication of the economy, but rather of the products that it exports. Although a country needs to have the technological capability to produce higher-tech products, it may or may not specialize in them for export purposes, as many other factors affect comparative advantage. China’s increased exports of more technologically advanced products is reflected in an increase in its ITS from 3.1 in 1990 to 3.7 in 2005. This is still below the 4.0 value of the index for Hong Kong, Taiwan, Japan and Singapore in 2005 and the 3.9 for Korea. However, the indexes for these countries have generally not changed much over the past ten years, suggesting that China is rapidly catching up. For Japan, the stagnation in the ITS has occurred as its export share has

6 .9 3 .1 6 .2 7 .7 6 .3 3 .9 12.8 13.2 16.8 13.0 2 .4 2 .0 8 .9 10.6

4.6 3.4 4.1 4.2 6.4 3.0

21.3 22.4 10.4 14.2 2.1 1.3 11.9 9.1

1995 2005 1995 2005 1995 2005 1995 2005

5.5 4.0 2.7 2.9 0.7 0.7 3.7 3.7

4.2 4.1 8.0 11.9 16.2 19.4 4.4 3.5 2.1 1.4 1.0 1.0 5.8 3.0

9.3 4.2 9.0 4.6 1.7 1.1

28.5 51.4 28.8 20.4 3.3 2.2 5.9 7.2

(LT1)

Textile, garment and footwear

2 .3 1 .8 2 .9 3 .1 0 .7 0 .4 4 .2 3 .5

13.3 8 .9 9 .5 8 .3 4 .2 3 .8

17.2 38.0 20.5 11.8 23.4 16.0 1 .7 4 .4

(LT2)

0.3 0.6 0.4 0.4 0.2 0.8 0.6 4.1

4.6 2.9 9.4 18.6 1.2 1.3

1.4 7.3 2.0 0.8 78.9 61.6 0.9 1.5

(MT1)

2.7 2.4 2.8 4.0 0.4 0.3 3.2 4.2

11.5 9.5 16.6 13.2 5.8 7.4

10.8 22.7 12.8 7.3 31.5 25.4 1.8 3.6

(MT2)

0.8 1.2 4.8 3.8 0.4 0.7 2.5 3.4

6.5 4.8 8.2 10.6 7.3 5.8

6.9 24.3 12.0 10.4 50.3 33.7 0.4 1.3

(MT3)

0.5 0.8 8.0 7.0 0.8 3.1 3.6 3.1

10.4 7.7 10.5 10.7 17.2 12.7

4.5 27.6 9.8 13.6 34.5 13.5 0.2 0.3

(HT1)

0.6 0.3 6.3 3.2 0.2 0.9 2.8 2.0

4.3 11.2 4.5 11.4 7.3 8.4

10.1 21.9 11.3 7.3 50.2 30.1 2.4 3.4

(HT2)

Other Automotive Chemicals Engineering Electronics Other low and basic products and high tech metals electrical tech manuf.

Source: UN COMTRADE database, SITC Rev.3, except data for Taiwan which is from SourceOECD.

Thailand

Philippines

Malaysia

Indonesia

Singapore

Korea

Taiwan

1995 2004 1995 2005 1995 2005

13.3 26.3 10.3 4 .1 14.5 13.3 1 .7 2 .6

1995 18.6 2005 24.1 Hong Kong 1995 6.2 2005 3.8 Japan 1995 6.6 2005 5.7 India 1995 7.9 2005 8.8

China

12.7 18.1 9.3 4.0 26.5 14.7 10.6 16.5

(RB2)

(PP)

(RB1)

Other resourcebased manuf.

Primary Agro-based products manuf.

Table 7.5 Percentage of total regional exports to the world by technological category (Percentage Points)

3.4 3.0 5.5 5.0 1.3 1.5 4.2 3.9

8.4 6.2 9.3 10.1 8.8 8.1

11.0 27.0 13.1 10.4 32.9 21.1 2.4 3.7

Overall

4.0 1.8 3.3 2.7 3.6 1.8 18.6 15.2 15.2 9.3 14.9 4.7 10.5 9.7

36.0 36.2 10.9 14.2 15.4 4.3 16.3 11.7

1995 2005 1995 2005 1995 2005 1995 2005

8 .3 10.0 2 .6 4 .5 4 .7 3 .7 4 .5 7 .2

15.7 10.9 4.6 2.7 14.4 6.4 16.7 7.2

6.9 6.0 5.6 6.3 9.6 2.9 10.5 9.2

16.4 14.5 10.7 8.2 5.1 4.8

16.2 14.0 0.2 0.0 7.5 7.9 7.6 12.1

(LT2)

0.7 1.5 0.5 0.6 2.2 3.9 1.1 7.5

4.0 3.3 7.5 13.1 1.0 1.2

1.0 1.9 6.2 4.8 18.0 21.7 2.8 3.0

(MT1)

5.5 5.3 3.7 5.5 3.7 1.2 5.4 7.4

9.6 10.4 12.8 8.8 4.8 6.4

6.9 5.7 16.6 12.1 6.9 8.5 5.4 6.6

(MT2)

4.3 6.3 15.5 12.4 8.2 7.3 10.3 14.1

13.3 12.5 15.5 16.7 14.6 11.8

10.8 14.4 32.4 52.3 27.0 26.7 2.9 5.9

(MT3)

3 .5 8 .1 38.7 42.4 26.4 63.7 23.0 24.4

32.5 37.5 30.1 31.7 52.6 48.7

10.8 30.6 38.5 27.7 28.1 20.1 2 .1 2 .3

(HT1)

0.4 0.4 2.8 2.2 0.5 2.0 1.7 1.7

1.2 6.0 1.2 3.7 2.1 3.5

2.2 2.7 0.6 1.1 3.8 4.9 2.5 3.1

(HT2)

Other Automotive Chemicals Engineering Electronics Other low and basic products and high tech metals electrical tech manuf.

Source: UN COMTRADE database, SITC Rev.3, except data for Taiwan which is from Source OECD. ∗ Technology Index is (1∗PP + 2∗RB + 3∗LT + 4∗MT + 5∗HT)/100.

Thailand

Philippines

Malaysia

Indonesia

Singapore

Korea

1995 2004 1995 2005 1995 2005

3.1 2.7 2.5 2.1 4.2 1.9

Taiwan

13.2 6.4 11.8 4.2 2.4 1.3

30.7 17.9 1.0 0.3 1.2 1.0 30.2 18.6

5 .9 5 .0 1 .8 0 .8 4 .2 5 .5 23.3 34.0

5.9 3.4 1.2 0.3 2.2 2.3 3.6 2.5

1995 9.6 2005 4.4 Hong Kong 1995 1.6 2005 0.6 Japan 1995 1.2 2005 1.4 India 1995 19.5 2005 11.9

China

2 .6 5 .0 4 .5 8 .8 9 .7 18.7

(LT1)

(RB2)

(RB1)

(PP)

Textile, garment and footwear

Other rosourcebased manuf.

Primary Agro-based products manuf.

Table 7.6 Distribution of total exports to the world by technological category (Per cent of Total Exports)

2.2 2.3 3.6 3.7 3.2 4.3 3.2 3.4

3.8 4.0 3.9 3.9 4.1 4.0

3.1 3.7 3.6 4.0 4.1 4.0 2.5 2.7

Tech index∗

The role of China in Asia 171 shifted from the electronic high-tech category where Chinese exports have been growing rapidly (consistent with reports that Japan has shifted production facilities for high-tech products to China) into the medium-tech automotive category where China is a much less important competitor. However, although exports of automotive products currently comprise the smallest share of China’s exports at (less than 2 per cent), they also are growing rapidly, with their share of the region’s exports rising from 11/2 per cent in 1995 to 7 per cent in 2005. This suggests that China may become a more important competitor in this area in the future. Korea also has seen a substantial increase in the share of its exports in the automotive category over the past ten years. This has been largely offset by a decline in the share of the low-technology categories. At the same time, the overall share of high-tech has risen, but the bigger increase has been in the HT2 category (non-electronic high-tech products), where China’s share is smaller and growing less rapidly. On net, Korea’s ITS has been unchanged over the period. Taiwan’s ITS rose from 3.8 to 4 over the period, along with a sharp increase in the share of its exports in the non-electronic high-tech category, where China is less dominant, from 1 to 6 per cent. This may suggest an effort to find a niche separate from China. However, at the same time, the share of Taiwan’s exports in the electronic high-tech category has continued to grow rapidly, and was up to almost 38 per cent in 2004. Like China, Taiwan is increasingly moving out of lowtech textile manufactures. Singapore’s ITS dropped slightly over the period, as the share of its exports that are electronic high-tech products fell 4 percentage points, although it remains high at nearly 50 per cent. The share of engineering products also has fallen. Offsetting these declines has been an increase in the share of nonagro resource-based manufactures, which includes Singapore’s rapidly-growing biomedical sector. Singapore’s share of regional exports of these products is now slightly larger than China’s. The Philippines’ ITS is actually the highest for the region at 4.3, having risen significantly over the ten-year period. This has occurred as the percentage of the Philippines exports of primary products, resource-based manufactures and lowtech products have all plummeted, while electronic high-tech exports have soared. This may suggest an ability to compete with China, although it may also suggest greater vertical specialization, a point to which we return later. The indexes for the other countries are generally lower. Malaysia’s ITS was 3.7 in 2005, nearly the same as in 1995, as an increase in the share of primary product exports, which includes oil, partly offset the effect of an increase in the share of electronic hightech products. Thailand’s ITS has risen slightly, from 3.2 in 1995 to 3.4 in 2005, mainly reflecting a move from primary into medium-tech products, including an increase in the share of automotive product exports. Thailand’s share of electronic high-tech products has risen a little, but it remains relatively low for the region at about 25 per cent. Goods exports of Indonesia and India are less technologically sophisticated than in the rest of the region; India’s ITS was 2.7 in 2005, little changed from 1995, with its largest percentage of exports in non-agro resource-based manufacturing.

172 Jane Haltmaier et al. Indonesia’s ITS was 2.3, with its largest export share in primary products. The share of low-tech textile manufactures has fallen, possibly reflecting increased competition from China. In sum, the response of other countries in the region to China’s increasingly dominant presence, particularly in electronic high-tech, has varied. Japan, Korea and Thailand appear to have increasingly shifted toward production of automotive products, while Singapore has increased its presence in the non-agro resourcebased manufactures market. (See Box 7.4 for a more detailed discussion of the region’s auto industry.) Both of these are areas where China is less dominant. Conversely, the Philippines has become increasingly specialized in the electronic high-tech category which currently comprises the largest share of China’s exports. Taiwan and Malaysia also have increased the share of their exports in the high-tech categories, although Malaysia also exports natural resources. Exports of Indonesia and India have remained at the lower end of the tech scale, although they still face plenty of competition from China in those categories. Box 7.4 The big 3 Asian automotive exporters Japan continues to be the top exporter of automotive products in Asia.1 For over 10 years, about a quarter of Japanese exports of goods have been in automotive products.2 However, as a share of global automotive exports, Japan’s share has actually fallen from 19 per cent in 1995 to 12 per cent in 2005. This decline has occurred in both finished automotive products and automotive parts and components. These developments have in part reflected a shift of Japanese firms’ production capacity toward foreign Global Automobile Export Shares

Source: U.N. COMTRADE database.

China Korea Japan Other Emerging Asia Other

The role of China in Asia 173 Box 7.4 Cont’d consumer markets abroad, replacing some Japanese exports with domestic production within the destination market country. Also known as horizontal FDI, this strategy poses numerous advantages for Japanese firms over the previous produce-at-home process. Initially, the strategy allowed Japanese firms to avoid U.S. quotas on finished motor vehicles. Today, some of the benefits include lower shipping costs, faster time to market and better customer feedback. The data also support this hypothesis in other ways. For instance, since 1990, an increasing proportion of Japan’s automotive exports are parts and components, presumably to be used in the assembly of finished automotive products in Japanese factories abroad. Per cent of Global Exports

Automotive Parts and Components Japan Korea China

15 10 5 0 1995

2000

2005

Source: U.N. COMTRADE database.

However, the fact that other countries (including some in Asia) have made important inroads in the automotive industry may also partly explain the reduction in Japan’s share of global automotive exports. One such country is Korea, whose automotive exports have risen significantly over the past decade. In the late 1990s, Korean automakers, such as Kia Motors, went global, supplying their cars to a broad set of countries. Today, Korean motor vehicles are considered similar in quality to Japanese automobiles in some cases. As a result, it is no surprise that the share of Korean exports accounted for by automotive products has been on the rise, reaching 15 per cent in 2005. Unlike Japan, Korea’s share of global automotive exports has risen significantly. In the automotive parts and components sector, Korea’s share of the global market more than doubled in a decade, reaching almost 2 per cent in 2005. In the automotive finished goods sector, Korea’s share was even larger at 6 per cent in 2005. The new kid on the block in the Asian automotive industry is of course China. In 2005, just 4 per cent of Chinese goods exports were in automotive products. Nevertheless, this is still a substantial increase from about 1 per cent in early the 1990s. Unlike Japan and Korea, where finished Continued

174 Jane Haltmaier et al. Box 7.4 Cont’d Per cent of Country Goods Exports 45 40 35 30 25 20 15 10 5 0

Automotive Finished Goods

Japan Korea China

1995

2000

2005

Source: U.N. COMTRADE database.

automotive products account for a large fraction of automotive exports, China has focused its incursion in the automotive industry in parts and components. Indeed, in 2005, Chinese exports of automotive parts and components accounted for almost 3 per cent of the global market, substantially higher than Korea’s share. Although China also has a large motor vehicle industry, its output is largely destined for the domestic market. One problem that Chinese exporters of finished motor vehicles face is serious skepticism about the quality of their product. Even though several Chinese automakers have stated their intention to export their cars, their ability to do so may remain limited until these quality issues are resolved. However, these issues are not insurmountable and the time may come when automotive safety governmental agencies in the industrialized countries certify Chinese cars as ready for their roads. For the time being, China continues to account for a miniscule portion of the global market for finished automobiles; just 1 per cent in 2005. However, the automotive industry is changing quickly in other ways. In particular, many industry analysts expect automobiles to become increasingly electronically sophisticated. Upgrades include flat panel screens showing video to improved electronic safety features. Some countries in the region are poised to take advantage of this these developments, leaving the more labour intensive automotive parts to low-cost China. For instance, Taiwan is actively trying to leverage its comparative advantage in electronics to get onto the automotive electronics bandwagon.3 For instance, the Taiwanese government has backed two groups actively engaged in auto electronics R&D (Hua-chuang Automobile Information Technical Center and the Automotive Research and Testing Center) and subsidized numerous R&D projects with the aim

The role of China in Asia 175

Box 7.4 Cont’d of developing niche products for Taiwanese automotive parts producers, including automotive multimedia entertainment systems, automotive navigation systems, tire pressure monitoring systems, automotive PCs, LED lights, solar windows and an automotive smart chip that will use radiofrequency identification and bio-identification technology to enhance the anti-theft functions and data management systems of automobiles. In the face of rising Chinese automotive production, the trend toward the integration of electronic technologies into the automotive sector has been a welcome development for other Asian countries that would like to keep or gain a foothold in the automotive industry. Per cent of Country Goods Exports 29 Finished Goods Parts and Components 24

Automotive Exports

19 14 9 4 −1

1995

2000

2005

1995

China

2000 Korea

2005

1995

2000

2005

Japan

Source: U.N. COMTRADE database.

Notes 1 Indeed, Toyota Corporation is now well on its way to becoming the largest automaker in the world. In the first quarter of 2007, Toyota surpassed General Motors in worldwide vehicle sales. See “Toyota ends GM’s reign as leader in global sales,” International Herald Tribune, April 24, 2007. 2 In this box, we do not use the technological definition of automotive products (MT1) described earlier in the paper, because this definition excludes important automotive parts and components. 3 See “Auto PCs Spark New Business Opportunities”, Taiwan Economic News 3/22/07 and “Taiwan Eyes Lucrative Auto-electronics Business,” Taiwan Economic News 3/19/2007.

176 Jane Haltmaier et al. 4.2 Revealed comparative advantage As another way of quantifying the changes in export structure that have taken place in the region over the past decade, we computed indices of revealed comparative advantage (RCA) in production of goods at the three-digit SITC level for each country. RCA is measured as a product’s share in the country’s total exports relative to the product’s share of total world exports. This comparison is based on the idea that countries reveal their comparative advantages by capturing a greater share of the world market in a product. A value less than unity indicates revealed comparative disadvantage and a value greater than unity indicates a revealed comparative advantage. The results for the three-digit codes are shown in Figures 7.17 and 7.18.

RCA

Asia

4.5

RCA

China

4.5

4.0

4.0

3.5

1995

3.5

1995

3.0

2005

3.0

2005

2.5

2.5

2.0

2.0

1.5

1.5

1.0

1.0

0.5

0.5

0.0

0.0 PP RB1 RB2 LT1 LT2 MT1 MT2 MT3 HT1 HT2

4.5

RCA

Hong Kong

PP RB1 RB2 LT1 LT2 MT1 MT2 MT3 HT1 HT2 4.5

3.5

1995

3.5

3.0

2005

3.0

2.5

2.5

2.0

2.0

1.5

1.5

1.0

1.0

0.5

0.5

Taiwan

1995 2005

0.0

0.0

PP RB1 RB2 LT1 LT2 MT1 MT2 MT3 HT1 HT2

PP RB1 RB2 LT1 LT2 MT1 MT2 MT3 HT1 HT2 4.5

RCA

4.0

4.0

RCA

Japan

4.0

4.5

RCA

Korea

4.0

3.5

1995

3.0

2005

3.5 3.0

2.5

2.5

2.0

2.0

1.5

1.5

1.0

1.0

0.5

0.5

1995 2005

0.0

0.0 PP RB1 RB2 LT1 LT2 MT1 MT2 MT3 HT1 HT2

PP RB1 RB2 LT1 LT2 MT1 MT2 MT3 HT1 HT2

Figure 7.17 Revealed comparative advantage: Asia, China, Hong Kong, Taiwan, Japan, Korea (Source: U.N. COMTRADE database).

The role of China in Asia 177 RCA

Singapore

RCA

Malaysia

4.5

4.5 4.0

4.0

3.5

1995

3.5

1995

3.0

2005

3.0

2005

2.5

2.5

2.0

2.0

1.5

1.5

1.0

1.0

0.5

0.5

0.0

0.0 PP RB1 RB2 LT1 LT2 MT1 MT2 MT3 HT1 HT2

4.5

RCA

Philippines

PP RB1 RB2 LT1 LT2 MT1 MT2 MT3 HT1 HT2

4.5

3.5

1995

3.5

3.0

2005

3.0

2.5

2.5

2.0

2.0

1.5

1.5

1.0

1.0

0.5

0.5

Thailand

1995 2005

0.0

0.0

PP RB1 RB2 LT1 LT2 MT1 MT2 MT3 HT1 HT2

PP RB1 RB2 LT1 LT2 MT1 MT2 MT3 HT1 HT2 4.5

RCA

4.0

4.0

RCA

Indonesia

4.0

4.5

RCA

India

4.0

3.5

1995

3.0

2005

3.5

1995

3.0

2005

2.5

2.5

2.0

2.0

1.5

1.5

1.0

1.0

0.5

0.5 0.0

0.0 PP RB1 RB2 LT1 LT2 MT1 MT2 MT3 HT1 HT2

PP RB1 RB2 LT1 LT2 MT1 MT2 MT3 HT1 HT2

Figure 7.18 Revealed comparative advantage: Singapore, Malaysia, Philippines, Thailand, Indonesia, India (Source: U.N. COMTRADE database).

Not surprisingly, for the region on average, RCA is highest in electronic hightech manufacturing and low-tech textiles, reflecting China’s strengths along with its size. There are some strong similarities among countries in the region, but also some important differences. Nine of the eleven countries had RCAs above one for HT1 in 2005 and seven had RCAs above one for LT1. Five, including China, had RCAs above one for both categories. The region’s RCA in HT1 rose from 1995 to 2005, while its RCA in LT1 fell slightly over this period, consistent with the increase in technological sophistication noted above. Although the increase in China’s RCA in HT1 over the past ten years raised it above one, which was not the case in 1995, its highest RCA (2.3) is still

178 Jane Haltmaier et al. in LT1, although it fell considerably over the same period. Apart from these two categories, its only other RCA above one is in other low-tech manufacturing, and that also fell over the ten-year period. Both Hong Kong and Taiwan show quite a bit of similarity with China. Their areas of comparative advantage are the same and the relative sizes are similar for Hong Kong (this may reflect the fact that Hong Kong re-exports a large quantity of its imports from China). Taiwan’s comparative advantage in electronic high-tech is still considerably higher than China’s, although it is not rising as fast. Taiwan also has lost comparative advantage in low-tech manufacturing, although it has gained in medium-tech exports of chemicals and basic products, an area where China does not have comparative advantage. Japan has lost comparative advantage in electronic high-tech, while increasing its comparative advantage in the medium-tech automotive category (MT1). Korea also has increased its comparative advantage in automotive and shown a smaller increase in electronic high-tech, but lost comparative advantage in the low-tech categories. Singapore and Malaysia also have high RCAs in electronic hightech, but their other areas of specialization are non-agricultural resource-based manufacturing (Singapore) and primary products and agricultural resource-based manufacturing (Malaysia). The Philippines has shown an enormous increase in its comparative advantage in electronic high-tech, where it now has the highest RCA in the region. Thailand’s areas of comparative advantage are similar to China’s, although none of its RCAs are very large. Its highest RCA is in electronic high-tech and is slightly larger than China’s but growing much more slowly. Thailand also has an RCA above one in textile manufacturing, but it has fallen sharply over the ten-year period. On the other hand, Thailand has gained comparative advantage in agricultural resource-based manufacturing. Indonesia’s areas of comparative advantage are primary products, resourcebased manufacturing and textiles. These have been relatively little changed over the ten-year period. India, like China, has RCAs above one in both low-tech manufacturing categories, although its RCAs in both are higher than China’s. It also has a large comparative advantage in non-agricultural resource-based manufacturing, and little presence in the electronic high-tech market. In sum, an examination of the patterns of revealed comparative advantage suggest that the other countries in the region have responded to China’s growing importance, but that the response has been far from uniform. One of the more interesting results is that several of the more advanced economies (Japan, Korea and Taiwan) have seen increases in their RCAs in one or more medium-tech category, where China is less dominant, while losing comparative advantage in China’s high RCA categories of low-tech manufactures and high-tech electronic manufactures. Singapore has seen a similar realignment of comparative advantage away from electronic high-tech to non-agricultural resource-based manufactures. In contrast, Malaysia, the Philippines and Thailand have all seen increases in their RCAs in the electronic high-tech category, which may be leading to more direct competition with China.

The role of China in Asia 179 4.3 Displacement of exports The analysis of the previous subsection implies that China’s increasing presence in global markets may have contributed to a realignment of export shares for other countries in the region. In this subsection, we more formally quantify the degree of displacement by country and by product category that has occurred in response to competition from China. We might note that displacement is not necessarily a negative result, as the other countries may have optimally responded either by shifting production resources toward sectors in which they can compete or by improving the quality of the goods they produce. For the global economy, such shifts should be a net positive, as long as they occur in accordance with the principle of comparative advantage. We measure degree of competition from China in terms of changes in its export share as follows: Vpt =

Xchina, pt  Xcpt

(1)

c∈world

Xchina, pt is the value of export of product p by China, Xcpt is the value of exports of product p by country c. Thus Vpt measures the world share of China’s export of product p at time t as a proxy for competition from China. In order to estimate the extent to which competition from China displaces exports of other countries in the region, we run the following Ordinary Least Squares (OLS) regression for each country in the region and by each technological category defined earlier:

Xpt +1 − Xpt = α0 + α1t yeart + α2 ln(Xpt −1 ) + α3 Vpt −1 + εpt Xpt

(2)

The dependent variable is the growth of each country’s total exports for product p at the five-digit SITC level.9 We include yearly dummy variables to control for time effects. The parameter α3 captures the displacement effect arising from competition from China. To the extent that competition from China is crowding a country out of a product market, the coefficient will be negative and statistically significant. Table 7.7 presents the results. The technological categories examined are: HT1, HT2, MT1, MT2, MT3, LT1 and LT2, as previously defined. An analysis of Vpt indicates that China’s share has increased across all product categories between 1990 and 2005. When all the sectors are pooled, the estimated coefficient (α3 ) is negative and statistically significant for seven of the nine countries, indicating that higher competition from China has resulted in lower export growth for these countries. For example, for Japan, a 1 percentage point increase in China’s share has reduced Japan’s export growth in these sectors by 0.16 per cent. The results vary by product category. Competition from China has generally had little or no effect on export growth of other Asian countries in the

Malayasia −0.18∗∗ 0.12 −0.57 −0.20 −0.34 −0.04 0.04 −0.25∗∗

Japan −0.16∗∗ −0.38∗∗ −0.11 0.69∗∗ −0.12 −0.30∗∗ −0.07∗∗ −0.10∗∗

0.21∗∗ −0.04 1.04∗∗ −0.04 −0.01 −0.26 0.27∗∗ 0.09

Philippines −0.27∗∗ −0.22 −0.06 −1.62∗∗ −0.50∗∗ −0.35∗∗ −0.14∗∗ −0.22∗∗

South Korea

Sample is annual data from 1990 through 2005. n.a. indicates no coefficient due to insufficient data. ∗,∗∗ indicates significance at the 10 and 5 per cent levels, respectively. Estimates of α2 were all negative and statistically significant. Estimates include yearly dummy variables. Adjusted-R2 generally varied between 0.03 and 0.20.

: export growth by commodity p at the SITC-8 level at time t. Vpt : China’s export as a share of regional exports.

0.14 0.20 0.12 0.56 −0.25 −0.24 0.16∗ 0.07

−0.02 0.10 −0.46 0.06 −0.33∗ −0.28∗∗ 0.04 −0.16∗∗

All tech. products High-tech 1 (HT1) High-tech 2 (HT2) Mid-tech l (MT1) Mid-tech 2 (MT2) Mid-tech 3 (MT3) Low-tech 1 (LT1) Low-tech 2 (LT2)

Xpt +1 −Xpt Xpt

Indonesia

India

 Xpt +1 −Xpt = α0 + α1t yeart + α2 ln(Xpt −1 ) + α3 Vpt −1 + εpt Xpt

Sector

Estimation of α3 in :

−0.14∗∗ −0.03 0.01 −0.47 −0.28 −0.16∗∗ 0.01 −0.13∗∗

Singapore

Table 7.7 Effect of competition from China on rest of region’s exports to the rest of the world, including Asia (per cent)

−0.24∗∗ 0.01 −0.12 0.22 −0.34∗∗ −0.31∗∗ −0.12∗∗ −0.22∗∗

Taiwan

−0.01 −0.12∗∗ −0.42 0.01 −0.09 0.15 −0.04 −0.01

Thailand

The role of China in Asia 181 HT1 and HT2 categories, consistent with the previous finding that China still has a relatively low RCA in these sectors. In the automotive category (MT1), where China’s share rose to 7 per cent of total world exports in 2005 from 1 per cent in 1995, the regression results suggest that there has been some crowding-out of exports of Japan and South Korea, two important auto producers. For the MT2 and MT3 categories where China’s share has roughly tripled between 1990 and 2005, exports have generally shifted away from several countries in the region. The effect is most pronounced for Korea and India. In the LT1 category where China’s revealed comparative advantage is highest, although declining, exports of other countries have generally not experienced noticeable displacements. Quite to the contrary, China appears to have exerted a positive effect on Indonesia and the Philippines. For the LT2 category where competition from China has risen noticeably, export growth for most countries has registered significant displacements. The results are qualitatively similar to those of Ahearne et al. (2006), who focused on Asian exports by industry to just the United States. They concluded that an increase in Chinese exports to the United States has crowded out exports to the U.S. from other parts of the region in the case of some countries but not others.10 In sum, on aggregate, competition from China has risen and this has led to some displacement of exports from other countries in the region. The high-tech sector (HT1 and HT2) seem to have been largely unaffected thus far, although this could change as China increases its presence in this category. The displacement has been more pronounced in the mid-tech categories (MT1, MT2 and MT3), and has been less noticeable in the low-tech sectors (LT1 and LT2) where China’s share was already high in 1990. These findings are consistent with the hypothesis that China has conquered low-tech industries, notably textiles, garments and footwear, and is currently crowding out other countries in the mid-tech industries on its way up the value-chain. Of course, some countries may have upgraded the quality of their exports in response to competition from China, a subject for future research. (To some extent, the crowding-out of exports may reflect productionshifting from some of the more advanced economies to China, which might also be expected to have an impact on domestic investment. Box 7.5 looks at this issue.)

5 Conclusion Although many comparisons have been drawn between the rise of China as a global economic power and the earlier emergence of such Asian powerhouses as Japan and Korea, there are some fundamental differences between China and the others. Most importantly, China is huge. With a population of over a billion (one-fifth of the world total), many of whom are not yet in the urban labour force, China has the potential to affect markets both as a producer and consumer that few other countries have ever had. In addition, despite the increasing use of marketbased transactions in China, resource allocation is still to a large extent influenced

182 Jane Haltmaier et al. Box 7.5 Foreign direct investment by other Asian economies in China As shown in Chart 1, foreign direct investment in China from the more advanced countries in the Asian region is sizable, and rose particularly sharply in the 2003–2005 period for Japan and Korea.1 This is consistent with other evidence that these countries have shifted production to China to take advantage of its lower labour costs. FDI from Hong Kong into China is considerably larger than for the other countries, and is shown on a separate scale on the right of the chart. Although this investment undoubtedly reflects some production shifting, it also includes FDI from countries outside the region that flows into China from corporate affiliates in Hong Kong. Chart 1: Foreign Direct Investment in China by Other Asian Economies US$ billions

7000

25000

6000 20000 Hong Kong 5000 Japan

15000

4000 Taiwan 3000

10000

2000 Singapore

Korea

5000

1000

0

0 1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

Source: Haver analytics

What impact does such production-shifting have on the home economies? If corporations make investments abroad that they might otherwise have made at home, it may have the effect of depressing domestic investment, at least temporarily. As shown in Chart 2, the size of FDI into China from these countries as a portion of their domestic investment varies widely, from less than 1 per cent for Japan to 8–10 per cent for Singapore and 50 per cent for Hong Kong (again shown on a separate scale). Since 2000, the average amount of FDI has been 49 per cent of domestic investment for Hong Kong, 81/2 per cent for Singapore, 5 per cent for Taiwan, 2 per cent for Korea and 1/2 per cent for Japan. However, the percentage has generally declined in the past few years, suggesting that the current wave of production-shifting may have peaked. Continued

The role of China in Asia 183 Box 7.5 Cont’d Chart 2: Foreign Direct Investment in China by Other Asian Economies Per cent of Domestic Fixed Investment

12

60

Hong Kong 10

50

Singapore

8

40

6

30

Taiwan

4

2

20

10

Korea

Japan

0

0 1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

Source: Haver Analytics.

Chart 3 provides mixed evidence as to whether FDI to China has crowded out domestic investment in these economies in the past few years. It appears that this may have been the case in Taiwan between 2001 and 2004 and perhaps over the last several years for Japan. The other cases are less clear. Chart 3: FDI and Domestic Investment 4500

4000

Taiwan FDI (left axis)

80000 75000

Direct Investment

70000 65000

3500

60000 3000

55000 50000

2500

45000 2000

40000 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Continued

184 Jane Haltmaier et al. Box 7.5 Cont’d Japan

7000

1500000

FDI (left axis) 1400000

Direct Investment 6000

1300000 5000

1200000 1100000

4000

1000000 3000 900000 800000

2000 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 South Korea

6500

300000

FDI (left axis) 5500

Direct Investment 250000

4500 3500

200000

2500 150000 1500 500

100000 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Singapore

4000

40000

FDI (left axis) 3500

Direct Investment 35000

3000 30000

2500 2000

25000 1500 20000

1000 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Continued

The role of China in Asia 185 Box 7.5 Cont’d Hong Kong

25000

60000

FDI (left axis) 22500

55000

Direct Investment

20000

50000

17500

45000

15000

40000

12500

35000 30000

10000 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Source: Haver analytics Table 1 Effect of FDl on Domestic Investment Coefficient FDI

Sample period 1995–2006, annual Lagged Dom. Inv.

Adj.R2

DW

.48

1.77

.53

1.56

.39

1.51

.60

1.96

.60

1.99

−10.38∗ (3.30) −24.50 Japan (−32.65) Korea 7.32 (6.46) Singapore 4.33∗ (1.73) Hong Kong 1.85∗ (.78)

−.16 (.27) .63∗ (.21) .64 (.31) .69∗ (.20) .72∗ (.19)

Standard errors in parenthesis

∗ significant at the 5% level

Taiwan

Simple regressions of domestic investment on FDI into China suggest a similar conclusion (table 1). Domestic investment in both Taiwan and Japan show a negative correlation with FDI, while investment in Korea, Singapore and Hong Kong show a positive correlation. However, when a lagged dependent variable is included the results are not significant for either Japan or Korea. The coefficients are significant for Taiwan, where it appears that a $1 increase in Taiwanese FDI into China is associated with a $10 reduction in domestic investment, and for Singapore, where a $1 increase in Singaporean FDI into China is associated with a $4 increase in domestic investment. For Hong Kong, a $1 increase in FDI into China is associated with a $2 increase in domestic investment.

186 Jane Haltmaier et al. Box 7.5 Cont’d Although the results for Singapore and Hong Kong may appear to be contrary to expectations, they may reflect the fact that corporations from outside the area sometimes establish headquarters in the more advanced economies that are then used as a springboard for investment into China. In this situation, FDI into China and domestic investment are complements rather than substitutes.

Notes 1 Data are from China’s national statistics.

by government policy that looks favorably on export-led growth. As a result, it is easy to see why countries in the same region of the world might view China as a competitive threat in external markets. However, at the same time, China clearly offers enormous opportunities to its neighbors as both a customer and as a partner in production. China also offers the chance for all of these countries to exploit the principle of comparative advantage to achieve gains from trade, thus increasing income and contributing to improved standards of living across the region. And, as a country becomes more prosperous, domestic demand should also become an increasingly important source of economic growth, as more of the population moves into the middle class. In this chapter, we have examined the reaction of the other countries in the region to the rise of China from both a macro and a micro perspective. Our most important conclusions are: (1) External demand remains an important source of economic growth for the region, although in recent years it appears to have been more important for the more advanced economies in the region than for the less-developed. Nevertheless, economic growth has been robust across the region. (2) There is some macro evidence that China has become a more independent source of demand – an engine of growth – in recent years. However, the micro data suggest that China is still more of a conduit, importing parts and components from other countries in the region and assembling them into final goods. Moreover, this production fragmentation appears to be more important for the more-advanced than for the less-advanced countries. (3) As China has moved up the value chain in recent years, increasing its presence in electronic high-tech exports in particular, there have also been shifts in the pattern of production in the other economies in the region. For instance, Japan and Korea have further increased their presence in the medium-tech automotive industry and Singapore has developed its biomedical sector. At the same time, the Philippines has increased its revealed

The role of China in Asia 187 comparative advantage in exports of electronic high-tech products, a large proportion of which are parts and components. However, our analysis of product displacement suggests that China’s increasing export share has not reduced export growth for the other countries in the high-tech industries, although it has had a negative effect in the medium-tech and low-tech industries. Some of the implications we draw from these results are: First, although China’s rise as an economic powerhouse is undisputed, at this point it is unlikely that emerging Asia could weather a significant slowdown in the U.S. economy, for example, without being noticeably affected. Second, our results on displacement of exports and changes in product mix of exports suggest that for some countries the rising trade in parts and components may be an endogenous response to competition from China, as these countries try to find areas of complementarity with China rather than compete head-to-head. Third, China’s impact on the economies of the region is not uniform. Finally it should be emphasized that the debate on these issues is still evolving (the present chapter included) and is difficult to settle. Additional research is needed. In particular, acquiring a more detailed understanding of the country-specific responses to the rapid emergence of China would be a fruitful line of further inquiry.

Appendix Data sources Bilateral goods imports and exports are taken directly from the United Nations’ COMTRADE database for all countries except Taiwan. Data for Taiwan was downloaded from SourceOECD. The interactive software for COMTRADE allows the user to create country and commodity groups which automatically aggregate for specified goods and countries. All COMTRADE and SourceOECD data presented is SITC Revision 3 (Rev.3). Number of SITC Rev.3 codes 10 261 1073 763

1-digit SITC Rev.3 commodity codes. 3-digit SITC Rev.3 commodity codes. 5-digit SITC Rev.3 commodity codes identified as parts and components. 5-digit SITC Rev.3 commodity codes identified as basic products and resources. 1376 5-digit SITC Rev.3 commodity codes identified as finished goods. 3212 5-digit SITC Rev.3 commodity codes total (not including SITC 9): It is important to note that when data was downloaded at the five-digit level, some four-digit codes were also used. This only occurred when a four-digit code

188 Jane Haltmaier et al. was not an aggregate of five-digit codes. For example, 69421 and 69422 are breakdowns of 6942, however, the nearby commodity code 6941 is not split into five-digits subcategories. So 6941, 69421 and 69422 were downloaded, but 6942 was not.

Notes on methodology Technological categories For technological categories, we followed the lead of Sanjaya Lall. Lall broke down SITC Rev.2 commodity codes at the three-digit level into ten technological groups: Primary Products (PP), Agro-based Manufactures (RB1), Other Resource-based Manufactures (RB2), Textile, Garment and Footwear (LT1), Other Low-technology Manufactures (LT2), Automotive (MT1), Process: Chemicals and Basic Metals (MT2), Engineering Products (MT3), Electronics and Electrical (HT1) and Other High-technology Goods (HT2). The items of SITC 9 are considered not classifiable. Using Lall’s list we were able to correspond from SITC Rev.2 to SITC Rev.3. The list of these commodities can be found later in this Appendix. The number of 5-digit SITC Rev.3 codes for the technological categories are as follows: PP: 513 RB1: 365 LT1: 324 MT1: 53 HT1: 138

RB2: 370 LT2: 440 MT2: 345 HT2: 133

MT3: 531

Fragmentation categories Goods were separated into basic products, parts and components and finished goods by examining five-digit commodity codes. SITC 0, 1, 3, 4 did not contain any five-digit categories that were considered to be parts. SITC 2 had only a few (all of the five-digit subcategories of SITC 232, 266 and 267). We largely followed Athukorala’s paper for SITC 7 and 8. We used our own judgment to separate 5 and 6. We define parts and components as intermediate goods or manufactured items which are combined with other items and materials to produce finished goods. Goods classified as parts and components cannot typically be used as finished goods, but there are always exceptions to this. Finished goods, on the other hand, are all other goods requiring little or no processing before becoming consumable. Our ‘Other’ category consists of basic products, natural resources, food and beverages. Similarly, construction materials like railroad tracks, pipes, pipeline and cement, as well as raw materials such as fertilizers are contained in

The role of China in Asia 189 the Other category as they are not likely to be manufactured into an exportable, finished good. Some problems arise in distinguishing parts and components from finished goods. For example, ball bearings can be purchased by a consumer from a McMaster–Carr catalog, but are usually purchased by industrial firms to produce machinery. Thus ball bearings are considered parts and components. Other commodities are not so clear-cut. For example 88115 includes photographic flashlight parts and accessories. As this category includes both parts used to manufacture photographic flashlights as well as final goods accessories purchased to complement a photographic flashlight, classifying it is difficult. In this and similar situations, we consider what portion of the total value of the category likely consists of parts and components. If over half, then the commodity is classified as a part and component. Occasionally our search was aided by the word ‘parts’ or ‘pts’ in the commodity description, but this was not always the case. Another good method to distinguish parts from finished goods was to look at how a category is related to neighboring SITC codes. If the category in which we were interested contained parts of goods in nearby commodity codes, then the code could be classified as a part and component, otherwise the answer is more ambiguous. The process was far from perfect and leaves some room for refinement.

Three-digit products by technological category: (SITC REV.3) (PP) Primary products 001 011 022 025 034 036 041 042 043 044 045 054 057 071 072 074 075 081 091

Live animals except fish Beef, fresh/chilld/frozn Milk pr exc buttr/cheese Eggs, albumin Fish, live/frsh/chld/froz Crustaceans molluscs etc Wheat/meslin Rice Barley grain Maize except sweet corn. Cereal grain nes Vegetables, frsh/chld/frz Fruit/nuts, fresh/dried Coffee/coffee substitute Cocoa Tea and mate Spices Animal feed ex unml cer. Margarine/shortening

121 211 212 222 223 231 244 245 246 261 263 268 272 273 274 277 278 291 292

Tobacco, raw and wastes Hide/skin (ex fur) raw Furskins/pieces, raw Oil seeds etc – soft oil Oil seeds–not soft oil Natural rubber/latex/etc Cork natural/raw/waste Fuel wood/wood charcoal Wood chips/waste Silk Cotton Wool/animal hair Fertilizers crude Stone/sand/gravel Sulphur/unroastd pyrites Natural abrasives n.e.s. Other crude minerals Crude animal mterial nes Crude veg materials nes

190 Jane Haltmaier et al. 321 333 342 343 344 345 351

Coal non-agglomerated Petrol./bitum. oil, crude Liquid propane/butane Natural gas Petrol./hydrocarbon gas Coal gas/water gas/etc Electric current

681 682 683 684 685 686 687

Silver/platinum etc Copper Nickel Aluminium Lead Zinc Tin

(RB1) Agro-based manufactures: 012 016 017 023 024 035 037 046 047 048 056 058 059 061 062 073 098 111 112

Meat nes, fresh/chld/froz Meat/offal preserved Meat/offal presvd n.e.s Butter and cheese Cheese and curd Fish,dried/salted/smoked Fish/shellfish, prep/pres Flour/meal wheat/meslin Cereal meal/flour n.e.s Cereal etc flour/starch Veg root/tuber prep/pres Fruit presvd/fruit preps Fruit/veg juices Sugar/mollasses/honey Sugar confectionery Chocolate/cocoa preps Edible products n.e.s. Beverage non-alcohol nes Alcoholic beverages

122 232 247 248 251 264 265 269 421 422 431 621 625 629 633 634 635 641

Tobacco, manufactured Rubber synth/waste/etc Wood in rough/squared Wood simply worked Pulp and waste paper Jute/bast fibre raw/retd Veg text fibre ex cot/ju Worn clothing etc Fixed veg oil/fat, soft Fixed veg oils not soft Animal/veg oils proces’d Materials of rubber Rubber tyres/treads Articles of rubber nes Cork manufactures Veneer/plywood/etc Wood manufactures n.e.s. Paper/paperboard

335 411 511 514 515 516 522 523 524 531 532 551

Residual petrol. prods Animal oil/fat Hydrocarbons/derivatives Nitrogen function compds Organo-inorganic compnds Other organic compounds Elements/oxides/hal salt Metal salts of inorg acd Metal salts of inorg acd Synth org colour agents Dyeing/tanning extracts Essent.oil/perfume/flavr

(RB2) Other resource-based: 281 282 283 284 285 286 287 288 289 322 325 334

Iron ore/concentrates Ferrous waste/scrap Copper ores/concentrates Nickel ores/concs/etc Aluminium ores/concs/etc Uranium/thorium ore/conc Base metal ore/conc nes Nf base metal waste nes Precious metal ore/conc. Briquettes/lignite/peat Coke/semi-coke/retort c Heavy petrol/bitum oils

The role of China in Asia 191 592 661 662 663

Starches/glues/etc. Lime/cement/constr mat’l Clay/refractory material Mineral manufactures nes

664 667 689

Glass Pearls/precious stones Misc non-ferr base metal

(LT1) Textile, garment and footwear 611 612 613 651 652 654 655 656 657 658

Leather Leather manufactures Furskins tanned/dressed Textile yarn Cotton fabrics, woven Woven textile fabric nes Knit/crochet fabrics Tulle/lace/embr/trim etc Special yarns/fabrics Made-up textile articles

659 831 841 842 843 844 845 846 848 851

Floor coverings etc. Trunks and cases Mens/boys wear, woven Women/girl clothing wven Men/boy wear knit/croch Women/girl wear knit/cro Articles of apparel nes Clothing accessories Headgear/non-text clothg Footwear

(LT2) Other low-tech manufactures 642 665 666 673 674 675 676 677 678 691 692 693 694 695

Cut paper/board/articles Glassware Pottery Flat rolled iron/st prod Rolled plated m-steel Flat rolled alloy steel Iron/steel bars/rods/etc Iron/steel railway matl Iron/steel wire Iron/stl/alum structures Metal store/transpt cont Wire prod exc ins electr Nails/screws/nuts/bolts Hand/machine tools

(MT1) Automotive 781 782 783 784 785

Passenger cars etc Goods/service vehicles Road motor vehicles nes Motor veh parts/access Motorcycles/cycles/etc

696 697 699 811 821 892 893 894 895 896 897 898 899

Cutlery Base metal h’hold equipm Base metal manufac nes Prefabricated buildings Furniture/stuff furnishg Printed matter Articles nes of plastics Baby carr/toy/game/sport Office/stationery supply Art/collections/antiques Jewellery Musical instrums/records Misc manuf articles nes

192 Jane Haltmaier et al. (MT2) Chemicals and basic metals 266 267 512 513 533 553 554 562 571 572 573 574 575 579 581

Synthetic spinning fibre Man-made fibres nes/wast Alcohols/phenols/derivs Carboxylic acid compound Pigments/paints/varnish Perfume/toilet/cosmetics Soaps/cleansers/polishes Manufactured fertilizers Primary ethylene polymer Styrene primary polymers Vinyl chloride etc polym Polyacetals/polyesters. Plastic nes-primary form Plastic waste/scrap Plastic tube/pipe/hose

582 583 591 593 597 598 653 671 672 679 786 791 882 883

Plastic sheets/film/etc Monofilament rods/sticks Household/garden chemcal Explosives/pyrotechnics Oil etc additives/fluids Misc chemical prods nes Man-made woven fabrics Pig iron etc ferro alloy Primary/prods iron/steel Iron/steel pipe/tube/etc Trailers/caravans/etc Railway vehicles/equipmt Photographic supplies Cine fild developed

745 746 747 748 749 762 763 772 773 775 793 812 813 872 873 884 885 891

Non-electr machines nes Ball/roller bearings Taps/cocks/valves Mech transmission equmnt Non-elec parts/acc machn Radio broadcast receiver Sound/tv recorders etc Electric circuit equipmt Electrical distrib equip Domestic equipment Ships/boats/etc Sanitary/plumb/heat fixt Lighting fixtures etc Medical/etc instruments Meters and counters nes Optical fibres Watches and clocks Arms and ammunition

(MT3) Engineering products 711 713 714 721 722 723 724 725 726 727 728 731 733 735 737 741 742 743 744

Steam generating boilers Internal combust engines Engines non-electric nes Agric machine ex tractr Tractors Civil engineering plant Textile/leather machinry Paper industry machinery Printing industry machny Food processing machines Special indust machn nes Mach-tools remove mtrial Mtl m-tools w/o mtl-rmvl Metal machine tool parts Metalworking machine nes Indust heat/cool equipmt Pumps for liquids Fans/filters/gas pumps Mechanical handling equi

(HT1) Electronics and electrical 716 718

Rotating electr plant Power generating equ nes

751 752

Office machines Computer equipment

The role of China in Asia 193 759 761 764 771

Office equip parts/accs. Television receivers Telecomms equipment nes Elect power transm equip

774 776 778

Medical etc el diag equi Valves/transistors/etc Electrical equipment nes

(HT2) Other high-tech 525 541 542 712

Radio-active etc matrial Pharmaceut exc medicamnt Medicaments include vet Steam/vapour turbines

792 871 874 881

Aircraft/spacecraft/etc Optical instruments nes Measure/control app nes Photographic equipment

Other 911 931 961 971

Postal packets not class Special transactions nes Coin nongold non current Gold non-monetary ex ore

One-digit products by SITC: (SITC REV.3) 0 1 2 3 4

Food & live animals Beverages and tobacco Crude mater.ex food/fuel Mineral fuel/lubricants Animal/veg oil/fat/wax

5 6 7 8 9

Chemicals/products n.e.s Manufactured goods Machinery/transp equipmt Miscellaneous manuf arts Commodities nes

Products by use: (SITC REV.3) Parts and components: 232 266 267 511 515 516 52 531 532 5331 57

Rubber synth/waste/etc Synthetic spinning fibre Man-made fibres nes/wast Hydrocarbons/derivatives Organo-inorganic compnds Other organic compounds Inorganic chemicals Synth org colour agents Dyeing/tanning extracts Coloring preparation nes Plastics in primary form

58 611 613 621 625 62921 62929 634 6411 6412 6413

Plastics non-primry form Leather Furskins tanned/dressed Materials of rubber Rubber tyres/treads Conveyor/etc belts “v” Uh non-cell rub articles Veneer/plywood/etc Newsprint rolls/sheets Uncoated paper/board Paper coated/colourd etc

194 Jane Haltmaier et al. 6414 6415 6416 6417 64191 64192 64193 65112 65113 65115 65117 65118 65121 65133 65134 6514 6515 65162 65163 65164 65169 65172 65173 65174 65175 65176 65177 65182 65184 65186 65187 65188 65191 65192 65193 65195 65196 65197 65199 652 653 654 655 656 657

Uncoated kraft paper Kraft uncoat bulk nes Bulk corrug etc paper Bulk paper etc nes Tar-laminated paper etc. Composite paper bulk nes Paper pulp filter blocks Carded wool yarn in bulk Combed wool yarn in bulk Coarse hair yarn in bulk Carded wool blend yarn Combed wool blend yarn Cotton sewing thrd, bulk Cotton(>85%)yarn bulk Cotton(85%)yarn bulk Syn stap(85%)yarn bulk Art stap(67decitex Metallized textile yarn Silk yarn non waste,bulk Silk waste yarn in bulk Yarn etc of glass fibre Flax yarn Jute etc yarn Veg fibre yarn nes,paper Cotton fabrics, woven Man-made woven fabrics Woven textile fabric nes Knit/crochet fabrics Tulle/lace/embr/trim etc Special yarns/fabrics

6641 6643 6644 6645 6647 66481 6649 667 671 672 673 674 675 676 678 68 69129 69243 69244 694 6994 7112 7119 7128 713 714 716 7189 71819 71878 72119 72129 72139 72198 72199 7239 72439 72449 72467 72468 72488 7249 7259 72689 72691

Bulk/scrap glass Drawn/blown glass sheets Float/polished glass sht Cast/rolled glass sheets Tempr/lamin safety glass Vehicle rear-view mirror Glass n.e.s. Pearls/precious stones Pig iron etc ferro alloy Primary/prods iron/steel Flat rolled iron/st prod Rolled plated m-steel Flat rolled alloy steel Iron/steel bars/rods/etc Iron/steel wire Non-ferrous metals Structures, parts alumnm Irn/stl comp gas tanks Aluminium comp gas tanks Nails/screws/nuts/bolts Springs and leaves Aux plant for boilers Parts for boilers/etc Stm turbine(712.1)parts Internal combust engines Engines non-electric nes Rotating electr plant Engines/motors nes Parts nes hydraul turbin Nuclear reactor parts Agric machine(7211)parts Pts nes of machy of 7212 Pts nes dairy machinery Parts wine/etc machines Pts nes agric machines Earth moving mach parts Sew mch needles/furn/pts Pts nes textile machines Weaving loom parts/acces Loom/knitter etc pts/acc Parts for leather machns Washing/etc machine part Paper ind machine parts Pts nes of bookbind mchn Type-setting machn parts

The role of China in Asia 195 72699 72719 72729 72819 72839 7285 7359 73719 73729 73739 73749 7412 74135 74139 74149 74159 74172 7419 7422 7429 74311 74315 74345 7435 7438 7439 74419 7442 7449 74519 74529 74539 74568 74593 74597 746 747 748 749 7523 759 7649 7712 772 7731

Printing press parts Cereal/dry legm mach pts Indus food proc mach pts Pts nes of tools of 7281 Pts nes of machy of 7283 Parts spec indust machny Metalwork mach-tool pts Foundry machine parts Roll-mill pts nes, rolls Mtl weld/solder eq parts Parts gas welders etc. Non-elec furnaces/parts Elect furnace/oven parts Elect furnace/oven parts Pts nes indus refrig equ Air-conditioner parts Water proc gas gen parts Parts indus heat/cool eq Piston eng fuel/wtr pump Pump/liq elevator parts Vacuum pumps Refrigerator compressors Fan cooker hoods 0.4 or HIIT