Can China Save the World?

What role will China play in helping solve the financial crisis?

October 30, 2008

What role will China play in helping solve the financial crisis?

With America’s Wall Street woes and no muscles in Brussels, can “Super Panda” save the global economy?

Many commentators have looked to Asia (and China in particular) with its vast pool of savings to help out the global economy in the wake of the financial crisis in the United States and Europe. Is this feasible or desirable in the wake of the global credit crunch?

So what role does China play in the global economy? It was often assumed that China “exported” deflation but supplied cheap goods to the West — particularly the United States in the manufacturing goods space.

With an artificially low exchange rate, China’s low labor cost-base produced trade surpluses at home, trade deficits in the United States and large pools of savings in China and the rest of Asia.

For the most part, this scenario is good news for Australia, as China’s industrial expansion has fueled strong demand for our commodity exports (like coal, iron, liquefied natural gas) while putting downward pressure on prices for the manufactured goods that we mainly import (toys, textile, clothing and footwear and other consumer goods and materials).

As a result, Australia’s “terms of trade” — the price of exports as a ratio of the price of imports — is at historical highs, therefore boosting real incomes.

But has this scenario changed? To some extent it has, for a number of reasons.

Firstly, China’s export focus has been more concentrated on the rest of Asia (through intra-Asian trade and regional industrial supply chains) and on the European Union than the USA.

Secondly, other countries — such as Vietnam, Thailand, India and Indonesia — have also played this role in some sectors as China tries to move up the value chain.

For instance, Thailand’s eastern seaboard is becoming a focal point for the global automotive industry, and the southern region of India centered on Chennai and Bangalore is doing similar things in information technologies and communications.

Thirdly, to some extent China is moving away from being an exporter towards domestic consumption and investment.

As CLSA economist Andy Rothman has pointed out, net exports are just the “froth” worth one to two percentage points on a double-digit Chinese growth rate that is primarily domestically driven.

And as Beijing directs investment to the Western provinces and the second- and third-tier cities (so-called “country towns” of eight to nine million people), the processes of urbanization and industrialization will see that domestic process continue.

Fourthly, China is having some slowing pains itself. As well as the stock market declines there have been lay-offs in the industrial heartland of the Pearl River Delta, and falls in retail decreases at the same time as skilled labor shortages in growing sectors of the Chinese economy.

The property markets in the richer coastal cities like Shanghai and Guangzhou are also exhibiting some weaknesses in terms of values and behaving like any western industrialized cities in terms of real estate.

Finally, it’s important to watch investment flows as well as trade flows. Strong outward FDI flows from China are replacing the traditional trade route as a form of global engagement — or more strictly regional engagement within the Asian hemisphere.

We’ve witnessed this in Australia recently with an estimated $30 billion of Chinese FDI in Australian projects since November 2007 compared to around $10 billion over 2005-06 and 2006-07, according to Australian National University economists Christopher Findlay and Peter Drysdale.

This is occurring mainly through China’s state-owned enterprises — which have preferential access to credit — although many are moving to be on a more commercially based footing.

So what does this mean for Australia and for the rest of the world? For Australia, the trade and investment links with China and the emerging economies are going to especially help us endure the global credit crisis.

Australia’s share of goods exports to emerging countries has risen from 53%, compared to 43% ten years ago. China and India are an important part of that story.

In 1999, China and India accounted for just under 6% of Australian exports, while in 2007, “Chindia” accounted for 18% (with Japan at 16% and “other East Asia” at 16.7%). Over this period, the average annual growth rate of Australian exports was 24.8% for China and 24.7% for India.

Australia, by opening up our economy and re-focusing towards Asia, has managed to improve our trade share in the part of the world where there is most economic growth.

But the risks to China are not to be underestimated. Firstly, the challenges of domestic economic development — especially in the poor rural areas — are colossal, despite Beijing’s clear focus on the western inner regions of the country.

Secondly, while China has opened up to trade by joining the World Trade Organization (WTO), the focus on FDI and building market-based, outward-looking international businesses will be a major challenge for China (and its financial institutions that will fund them).

In some ways, India has developed many global brands like Tata and Infosys that are confidently strutting the world stage while China’s past over-reliance on inward FDI may have stifled the development of China’s own global business brands.

Thirdly, China still has to deal with the challenges of climate change and the balance between environmental goals on one hand and industrial development and poverty reduction goals on the other. In many ways, China has to save itself before it can save the world.

Takeaways

The focus on FDI and building market-based, outward-looking international businesses will be a major challenge for China.

Strong outward FDI flows from China are replacing the traditional trade route as a form of global engagement — or more strictly regional engagement within the Asian hemisphere.

Net exports are just the "froth" worth one to two percentage points on a double-digit Chinese growth rate that is primarily domestically driven.

Many commentators have looked to Asia (and China in particular) with its vast pool of savings to help out the global economy in the wake of the financial crisis in the United States and Europe.