China’s transition and the outlook for regional trade
01 Jun 2016
- Australian Economy
- Chinese Economy
- Global Value Chains
- International Trade
I’ve noted before that China’s ongoing economic transition has had a significant impact on Australia’s trade and investment profile. And given China’s size, critical role as an engine of global growth (China accounted for nearly one-third of global growth between 2000 and 2015), and increasing centrality in the global trading system (exports to China increased from three per cent to nine per cent of world exports and from nine per cent to 22 per cent of Asian exports over the same period), it’s no surprise that this transition is likewise having a substantial impact on both regional and global trade flows.
The IMF’s latest Regional economic outlook for Asia and the Pacific spends quite a bit of time looking at these issues and in particular the impact of various economic spillovers from China on the rest of the region, including Australia. The starting point for the Fund’s analysis is the now familiar observation that the Chinese economy is trying to move away from a growth model driven by investment and exports and towards one driven more by consumption and services, producing a slowdown in the overall pace of economic growth accompanied by a rebalancing in its composition:
In this new report, the IMF identifies three potential channels for regional spillovers from China’s transition:
- Trade: Exposed regional economies are defined as those having a relatively high share (that is, a share greater than four per cent of GDP) of value-added exports destined for China’s final demand.
- Commodity prices: here exposed regional economies are defined as all net commodity exporters.
- Financial linkages: Exposed regional economies in this group are classed as those having substantial financial linkages with China (defined as economies with financial claims on China and Hong Kong SAR1 greater than ten per cent of GDP) plus those economies sensitive to global risk aversion (‘risk-off’) episodes that could be/have been triggered by investor uncertainty about China’s growth and policy outlook.
According to the Fund’s metrics, Australia falls into both the first and second camps, but not (yet?) the third:
It seems likely that the changes in the Chinese economy are likely to have important consequences for regional (and global) trade performance. Not least since, as the IMF report points out, China, along with many other emerging markets, made a large negative contribution to global trade growth last year as measured by import volumes. At the same time, average annual growth in China’s real goods imports has more than halved in recent years, slowing from 13 per cent during 2006-11 to six per cent during 2012-15. And the slowdown has become even more pronounced lately, with import growth over 2014-15 falling to below four per cent.
Partly, this slowdown in China’s demand for imports is the straightforward outcome of softer Chinese growth overall. But there are other factors at work as well, with the IMF pointing out that the decline in China’s demand for some commodities and other products seems larger than might have been expected based purely on the growth readings.
One interesting source of this changing trade profile is that China’s own comparative advantage is shifting, reflecting an increasingly educated population and a shrinking supply of the cheap labour that had earlier powered China’s exports of labour-intensive manufactures. As a result, Chinese exporters are now moving up the value chain while their role in the so-called export processing trade has declined in parallel. For example, the IMF report points out that China’s increased competitiveness in high-technology, knowledge-intensive and more complex goods means that for some of these products, advanced upstream countries in global value chains (GVCs) have lost market share in China’s domestic market due to the onshoring of production of what were previously imported parts and components2.
The rebalancing process itself is another important factor at work. In part, this is because consumption tends to be less import-intensive than either investment or exports, so growth that is more consumption-intensive will also tend to be less trade-intensive. At the same time, however, the composition of trade also changes, as the import mix shifts towards consumption-related goods and services and way from investment- and export-related products. Similarly, the growth transition has also contributed to a slowdown in the demand for some commodities, and in particular those used mostly in investment, heavy industry and construction3. (And while a range of factors have contributed to the global fall in the price of resources, IMF economists estimate that Chinese rebalancing might account for between one-fifth and one-half of the decline in broad indices of commodity prices, albeit with big differences across individual commodities.)
All up, the Fund estimates that China’s rebalancing alone might explain perhaps half of the total import slowdown since 2012. The importance of rebalancing as a factor over and above the general slowdown in Chinese economic growth also means that regional economies’ trade exposure to China-related spillovers in the short term will depend to a significant degree on just how exposed they are to the precise nature of the shift in Chinese demand. For example, if regional exporters are relatively more reliant on Chinese investment as a source of external demand, then rebalancing will tend to have a greater adverse impact on their trade, while if they are relatively more engaged in selling to Chinese consumers, rebalancing may be a net positive.
To gauge how important these effects are across the region, the Fund measures each country’s exposure to China’s final demand using the Trade in value Added (TiVA) data constructed by the OECD and WTO (I took a look at the latest TiVA data for Australia). Each regional economy’s trade exposure is measured in terms of the domestic value-added content of its goods and services exports destined for China’s final demand4. The IMF’s economists then estimate the sensitivity (that is, the elasticity) of each country’s domestic value-added exports with respect to China’s consumption and investment growth. This is then reported in terms of the impact of a rebalancing of growth from investment to consumption in which the consumption growth rate increases by one percentage point and the investment growth rate decreases by the same amount:
The results show that the most adversely-affected economies from China’s rebalancing in terms of exports are those economies like Taiwan, Korea and Japan that are closely integrated with China through GVCs and hence most exposed to Chinese investment activity. With Australian exports of resources such as iron ore and coal likewise linked to Chinese investment, the IMF’s estimates show Australian exports also lose out from the rebalancing process. New Zealand, on the other hand, is expected to benefit from this kind of shift given the weight of consumption goods in its export basket.
Along with the direct impact on exports, the Fund also reports estimates for the consequences of these trade spillovers for economic growth. The results are similar to those for exports, although smaller open economies with a greater reliance on trade such as Singapore, Malaysia and the Philippines move up the exposure rankings while larger economies like Japan and Australia move down.
Finally, while these findings suggest that China’s slowdown and economic rebalancing is taking a toll on the region’s trade performance in the short term, the report also points out that there are more positive implications for the medium term. That’s because the IMF forecasts that a Chinese economy which successfully rebalances will have a higher growth trajectory than one that sticks with the old growth model, and these higher growth rates will eventually be good news for regional exporters. Moreover, as we have seen with Australia’s strong performance in terms of the exports of some services and consumer goods, in the meantime the rebalancing process will create winners as well as losers at a more disaggregated level.
1 Hong Kong is included as it serves as a financial gateway to China.
2 There has also been a smaller impact on third markets where China’s exports of these same products have also been increasing, but note that this latter effect would not change the level of trade flows, only their country composition.
3 In contrast, Chinese demand for food commodities has remained strong.
4 That means that a given economy’s trade exposure to China will be equal to the sum of direct exports of final goods and services to China plus exports of intermediate goods to third countries that are eventually re-exported to China to meet final demand, but will not include export of intermediate goods to China that are subsequently re-exported to third markets.