Copyright U.S.-China Business Council Jan/Feb
2002
[Headnote] |
WTO AT LAST. |
COMMENTARY |
Asia is now considering its economic prospects as
China enters the World Trade Organization (WTO). Some investors are concerned
that China will become a major deflationary force in Asia. Others are worried
that China will inflict significant damage on Asia's growth by pulling away
foreign investment and by increasingly hollowing out Asia's manufacturing base
as facilities continue to shift to the mainland.
Though the deflation concern is valid, as entry to
the WTO will help consolidate China's competitive power, the second fear is
flawed. Asia has not lost, and will not lose, foreign investment to China.
Rather, China's improving economic well-being will benefit Asia's exports in the
long term and will exert external pressure on Asian economies to restructure.
China will not enjoy a free lunch in the WTO,
however. The short-term economic pains from creative destruction will be high.
This creative destruction has been under way for some time and includes the
ongoing reform of China's inefficient state sector, which now produces less than
25 percent of China's total industrial output, down from over 80 percent in the
early 1980s. In recent years, the closure of state-- owned enterprises has
released about 7 million surplus laborers into China's economy annually, raising
China's true unemployment rate to an estimated 8 percent or more, as opposed to
the official 3.1 percent. But the country's positive cyclical and reform
outlooks point to steady economic growth, in turn encouraging continued reforms.
China thus will remain an attractive investment hub while Asia struggles in the
short term to find balance in an ever-more competitive world.
A formidable force
Chinese exports recovered quickly after the 1997-98
Asian financial crisis, even though China was not a WTO member and did not
devalue its currency like its Asian neighbors. Indeed, other Asian countries
were unable to prevent a loss of market share to China despite their currency
devaluations. China now accounts for 24 percent of US imports from the Pacific
Rim, up from less than 20 percent in 1997 (see Figure 1). The composition of
these imports has remained relatively unchanged during this period and includes
electrical and power-generation equipment, apparel, furniture, and plastics.
China's advantage over other Asian nations is that it
has the lowest labor costs in the region after Indonesia (see Figure 2). In
addition, China's excess capacity remains high, despite inventory reductions in
the past few years (see Figure 3). Inventory liquidation has put pressure on
supply levels and, together with low labor costs, enabled China to cut export
prices and win market share from its neighbors.
WTO-induced reform and rising competition will
increase China's competitive power and put downward pressure on most Asian
currencies in the years to come. China's export push has already exerted
deflationary pressures on Asian export prices (see Figure 4) and currencies,
though China's currency has not come under such pressure itself. There is
nevertheless a chance that volatility in the foreign-exchange market could lead
to a vicious cycle of competitive devaluation, which could pressure China to
lower the value of the renminbi (RMB).
A difficult transition
Opening up to foreign competition will inflict
short-term negative shocks on the Chinese economy. The dismantling of nontariff
trade barriers, such as burdensome administrative and customs procedures, will
cause a greater competitive shock than the nominal tariff cuts imply. Industries
that have relied on these protective barriers to survive will suffer. Rising
competition will also shock China's financial system, given its shaky
foundations.
WTO membership will boost China's labor-- intensive
industries and increase exports that rely on imported inputs, since imports will
become cheaper. However, capital-intensive industries, such as steel,
automobiles, agriculture, machinery, and heavy chemicals, will suffer in the
short term, given China's comparative disadvantage in capital-intensive
production.
In the next few years, China may opt to undertake
policies, like those that other Asian countries have implemented, to boost
exports further. These include granting exporters lower taxes and loans at lower
interest rates, and even devaluing the RMB. China is unlikely to choose
devaluation in the short-term, however; there is actually strong underlying
pressure on the RMB to appreciate, not depreciate, because of the country's
strong balance of payments surplus. There is also little political necessity.
Beijing wants to avoid any move that could trigger instability, including
currency devaluation, in the run up to the leadership change late this year.
Challenging Japan
Chinese exporters are already competing with Japanese
companies, as China's export structure has shifted rapidly towards electronics
and machinery and away from primary goods (see Figure 5). Last year China's
trade surplus with the United States finally surpassed Japan's US trade surplus
(see Figure 6).
Japan has good reason to worry: the fast climb of
Chinese exports up the value-added ladder has led to a record trade surplus with
Japan. The cheap prices and rising quality of Chinese exports have prompted many
Japanese industries to seek government protection. The irony is that, after the
initial wave of expansion into China's vast domestic market in the late 1980s,
Japanese firms are rediscovering China as a cheap production base for export
back to Japan. Thus, many of the products on Japan's protection list are
actually made by Japanese subsidiaries in China.
Pressuring Asia
China's enhanced competitive power will not only have
short-term economic effects on Asia, it will become a long-term source of
deflation for tradable goods, squeezing Asia's pricing power. Foreign capital
inflows will augment China's supply of capital while an abundant labor supply,
which will include surplus labor resulting from structural reforms, will curb
any sharp rise in Chinese labor costs. China's downward pressure on Asian
currencies will also continue under WTO.
![Graph](C:\Documents and Settings\Jocelyn.Johnson-Butl\Desktop\MHM MODULE 2 ASIA'S COMPETITIVENESS ENDGAME_files\pqdweb(3).jpg) |
|
![Graph](C:\Documents and Settings\Jocelyn.Johnson-Butl\Desktop\MHM MODULE 2 ASIA'S COMPETITIVENESS ENDGAME_files\pqdweb(4).jpg) |
|
Economies with export structures similar to China's
will feel most of the competitive stress. Thailand, the Philippines, and even
Taiwan will face enormous competition from China in primary and low value-added
industries, such as agriculture and textiles, respectively. Taiwan faces a
particularly daunting next few years, as Taiwan investment moving to the
mainland will speed up. Hong Kong serves as a case in point. Hong Kong's entire
manufacturing base relocated to China within a decade in the 1980s to escape
high local production costs, leaving only the high value-added segments, such as
logistics and marketing, in the territory. Taiwan manufacturers are experiencing
the same pressure from falling export prices and rising Chinese competition.
Hong Kong succeeded in rejuvenating itself into a financial and services center,
thanks to its strong entrepreneurial spirit and unique geographical and
political positions. Taiwan's challenge is to reinvent itself under the shadow
of its political and economic problems (see p.28).
A growth and investment engine
Nevertheless, the emergence of Chinese economic clout
will also benefit Asia's growth by being a source of demand. As a percentage of
its GDP, China imports as much from Asia as Japan does. China has also been
running a trade deficit with Asia since 2000. This trend is likely to continue
as the WTO opens more doors for Asian exports to China and as China's import
appetite grows in step with incomes and demand for industrial upgrades.
Contrary to common perceptions, China has not gained
foreign direct investment (FDI) at the expense of the rest of Asia. In fact, FDI
inflows to Asia have risen along with inflows to China (see Figure 7). This is
in part because multinational companies want to be closer to their customers and
production partners and therefore have invested throughout the global production
chain. Also, Asian economies are at different stages of development and FDI has
gone to areas with comparative advantages-- some to countries with abundant
labor and some to countries with technological know-how.
Economic ties between China and Asia are buoying
intraregional investment and trade flows, providing a cushion for Asian exports
against slowing demand in the United States and Japan. While China is likely to
continue to receive the bulk of foreign investment to Asia, global outsourcing
means that the Asian investment pie is still growing. Strong FDI inflows to
China will benefit the rest of Asia via intraregional demand for goods and
services.
A push for reform
More subtly, China could also become a force for
reform in Asia. Most governments slipped on reforms as their resolve eroded
during the sharp economic rebound after the 1997-98 Asian crisis. Firms have
been reluctant to sell off assets and reduce debts, and banks have been slow to
write off bad loans.
The failure of many governments to implement reforms
after the Asian crisis is worsening Asia's economic drag, as weak banks and
inadequate corporate reform have crimped domestic expansion. Interest rate cuts
have become ineffective in boosting demand, as banks saddled with bad loans are
reluctant to lend and debt-- ridden companies cannot borrow.
Japan is a prime example of how fiscal expansion
without reform produces minimal growth. Tokyo has reportedly spent around $1
trillion since 1993 on stimulus packages, but the economy has only crawled along
at an annual average growth of 1.6 percent. Thus, from a reform perspective,
Asia's large trade surplus is not a sign of economic vigor; rather, it reflects,
in part, a failure to generate strong domestic demand because of insufficient
reforms. Asia's economies still rely on export demand for growth.
Southeast Asia, except Singapore, is at risk of being
marginalized as a site for foreign investment because the region lacks the
aggressive reforms and the economic size of China. Beijing has pushed ahead with
structural reforms since the Asian crisis, while many Asian governments have
failed to sustain their restructuring efforts. As Beijing continues to
liberalize its economy according to WTO mandates, other countries will be
pressed to follow to meet the Chinese challenge.
China's success will ideally spur Asia's reform
efforts and lead to a more productive region in the long term. In reality, Asia
may experience uneven development on its road to greater efficiency, with areas
of strong performance coexisting, uneasily, with areas of weakness.
Nevertheless, a strong Chinese economy will not be a bull in the china shop, but
rather will raise the level of welfare across all of Asia.
[Sidebar] |
China's economic liberalization after WTO entry will
lead to a more efficient and prosperous Asian economy
|
[Sidebar] |
Asia's large trade surplus is not a sign of economic
vigor; rather, it reflects, in part, a failure to generate strong domestic
demand because of insufficient reforms. |
[Author Affiliation] |
Chi Lo |
[Author Affiliation] |
Chi Lo is chief economist for Northeast Asia for
Standard Chartered Bank Global Markets, Hong Kong.
|