Chapter 12 Chapter 10 How dependent is China on the global economy?

How important is trade to China?In the context of the current global economic contraction and a slow recovery until 2010, this question has never been more important.Before the crisis broke out, some insiders in China's political and academic circles expressed concerns that China was vulnerable to the global economic slowdown, but in the eyes of some banking economists, the global economic slowdown will not affect China - despite the large scale of China's exports, But the Chinese economy has been "decoupled" from the global economy.I've always been skeptical about the latter claim.However, I also know that from the standpoint of traditional economics, China, whose economic growth depends on exports, should be hit hard.Similar expressions have appeared many times in officials' speeches and articles, based on expectations of a darkening economic outlook.In my opinion, the real situation lies somewhere between "dependency" and "decoupling".What is the specific degree between the two is the answer that this chapter wants to find.

Therefore, in this chapter, with the help of some economists' painstaking research in the field of trade, we will try to find out the correct way to measure the importance of trade to China. The easiest (and most problematic) way to assess how important trade is to an economy is by looking at its exports. In 2008, China's total exports reached US$1.4 trillion, accounting for 31% of China's GDP.That's a huge scale, and an economy the size of China typically exports far less than that.A big problem with this method is that the export data includes a large number of imports. These imported materials will soon become exports after certain procedures, and the added value left in China is very low. This is the so-called "processing trade" economy.Simply put, processing trade means importing raw materials and accessories, assembling them and then exporting them.The key here is added value.Take the $300 Ipod as an example. It is assembled from imported materials in a factory near Shanghai. It is far less important to China than its $300 price tag implies, and the added value created in Shanghai may not be enough. $30.All really worthwhile accessories are made in Japan, Korea, or the US, etc.This means that exporting Ipods is less important to China - the value of employment and profit creation is only $30 (more jobs and profits are captured by component producing countries).Of China's US$1.4 trillion exports in 2008, nearly half were "processing trade" exports, with a scale of US$675 billion.Therefore, headline trade data may overstate the importance of trade to the Chinese economy.

A better way to assess trade is to look at non-processing (ie general trade) exports. In 2008, China's general trade exports reached US$752 billion.Such exports are exports of products produced by Chinese companies using domestic raw materials, create almost all of their value in China, and are far more important to China in terms of jobs and profits.General trade exports, which account for 16% of GDP, are a better indicator of the importance of trade to the Chinese economy.But this approach is also problematic because it also ignores the value added by general trade in China.There is a difference between exporting crude oil and cars - the latter is more valuable to China because the export is based on a longer supply chain and creates more jobs.

The traditional way of dealing with this problem is to subtract all imports from all exports to get a net export figure, from which we can theoretically derive total domestic value added.To better understand the importance of exports to the overall Chinese economy, we also need to look at GDP data, that is, GDP calculated by the expenditure method.That is, we can look at how much money is being spent—how much is invested, how much is consumed by households and the government, and how much is spent on net exports (that is, the amount of exports minus the amount of imports).Adding up the above expenditures is a way to calculate GDP. In 2008, 6.5 percent of nominal GDP was net exports, only slightly lower than the previous year's 7.6 percent.Viewed in this way, exports appear to be much less important to the Chinese economy.

The growth of the overall GDP is contributed by the 4 growth engines, and the contribution of net exports changes every year.In terms of real growth (that is, after adjusting for price changes), China's economy grew by 11.9% year-on-year in 2007, and net exports contributed 2.6 percentage points to the overall economic growth.In other words, net exports accounted for 22% of overall economic growth that year. In 2008, China's economy actually grew by about 10% year-on-year, but net exports only contributed 0.7 percentage points, accounting for only 7% of the overall economic growth.From this perspective, therefore, it is difficult to draw the conclusion that some years of growth in net exports are more important than others.

It is wrong to use net exports as an indicator to measure the dependence of China's economy on external demand.This is because we have broadly assumed in our estimates that all imports go to exports, and therefore subtract imports from exports to get a net amount.But obviously, this is not in line with the facts - part of China's imports is used for investment and its own consumption. To understand the essence of this problem, it is necessary to dig deep into the interior of the Chinese economy, and track the added value step by step according to various products and production processes.Only in this way can we know how much of China's industrial capacity is produced for export.Only then can we know that only 10% of the added value of certain industries is generated in China, and 90% is obtained by other countries.Only by doing so can we calculate the average overall domestic value added.Just looking at how many dollars exports are worth, or just how big the trade surplus is can't tell you that.

But the difficulty with this approach is that calculating the added value created is extremely complex and time-consuming—far beyond the reach of us bank analysts, most of whom have neither the brains nor the time to do so. do these complicated calculations.Fortunately, some smart and well-educated economists have done this work, and their research has given us a lot of reference and inspiration. The key to solving this problem is the input-output table.The numbers in the huge input-output table, after certain assumptions and calculations, can track the entire link of raw material input, production and outflow of goods from an economy.When we track the flow of goods in this way, we can know which links have really added value.Two economists at the European Central Bank, Gabor Pula and Tuomas Peltonen, used a unique Asian input-output table to analyze the added value. "Has Emerging Asia Decoupled?", Working Paper, G Pula, T Peltonen, June 2008, they specifically ask the question: Where does all this value-added demand come from, domestic or foreign?

Their research found that the vast majority of demand in Asian economies, especially large ones such as China and Indonesia, still comes from domestic sources.70% of the demand for products and services produced in China and Indonesia is domestic.But another extreme example is that less than 30% of the demand for products produced in Singapore comes from domestic sources, and the rest of the demand comes from abroad.On average, 37 percent of value-added demand in Asian emerging market economies came from the outside world in 2006. An equally striking finding is that this rate is much higher than it was 10 years ago.That is to say, Asian economies have become more “linked” (rather than “decoupled”) from the outside world, despite relatively large increases in domestic consumption in these economies in recent years.Of the total final demand in Asia, the three major economies of Europe, America and Japan accounted for 16%, Asia accounted for 7%, and other countries and regions in the world accounted for 14%.Indonesia, China and South Korea are the most prominent economies in Asia driven by domestic demand.Singapore and Malaysia are most vulnerable to lower global demand.

China's dependence on the outside world is generally weaker than that of Asian emerging market economies.However, according to the estimates of Pula and Pertonen, 30% of the value-added demand in 2006 was driven by overseas consumers and investors. In 2000, the rate was 25.5%.This suggests that, since 2000, the Chinese economy has become more dependent on the outside world, not the other way around.This conclusion seems to me valid given the substantial increase in exports since China became a member of the WTO in 2001. Several Washington and New York-based economists, Robert Koopman, Wang Zhi, and Wei Shangjin, approach the issue from another angle. "How Much of Chinese Exportsis Really Madein China? Assessing Domestic Value added when Processing is Persuasive", NBER Working Paper #14109, June 2008, Pura and Pertonen look at the source of final demand.Koopman and others start from exports to discover how much domestic added value is contained in them.Their answer: a lot.The domestic value added ratio of world average exports is 75%.That is, of the $100 worth of goods exported by a country, $75 is domestically created value.This is an interesting point, showing that the whole world is involved in some form of "processing" trade to some extent.In other words, even if it is as developed as the United States, it still imports raw materials that need to be processed, and then exports them after processing.Many previous studies believed that 75% of the added value of China's exports was created domestically.However, according to repeated calculations by Koopman and others, the domestically created portion of China's export value should be around 50%.

They also use input-output tables, but with some differences.Most research on this issue assumes that all countries use imported materials in the manufacture of exports in the same manner and with the same intensity as developed countries such as the United States.This assumption simplifies the math, but it does not apply to an economy like China, where half of imports are processed and then exported, and many industries create very limited domestic value added.Koopman et al. solved this problem through complex calculations. In short, they estimate that on average about 50% of the value added in China's exports in 2006 was generated domestically.Of course, for processing trade exports, the domestic value added ratio is much lower, about 20%.The domestic value-added ratio of general trade is close to 90%.Combining the two types of trade together, it can be concluded that 50% of the added value of total exports is created in China.This ratio is significantly lower than the 75% used by many previous scholars.Stanford University economics professor Zunyi Liu's research also came to a conclusion similar to Koopman's, and the methods used in their related papers are also similar. "Estimates of US China Trade Balances in Terms of Domestic Valueadded", Working Paper #295, Stanford Center for International Development, November 2006, Liu Zunyi and others found that in China's total exports to the US in 2002, the proportion of domestic value added 37%.

Naturally, there are differences in the added value created by different industries in China.Superficially high-tech products such as the Ipod have the lowest domestic value added.This is of course expected - China is still a developing country, and many companies still place their truly high-tech manufacturing links abroad for various reasons.Sometimes it is because China does not yet have the high-end equipment required for production, and companies generally cooperate with universities or R&D centers in their home countries.Other reasons include that companies want to keep core high-tech in their home countries, so as not to be learned by Chinese competitors. At present, what China is doing well is not high-tech exports, but "medium-level technology" exports. The domestic added value of basic chemical, auto parts, and mechanical equipment exports is very high.In other words, these exports are more important to China - their supply chains run deeper into the domestic economy than abroad, thus creating more jobs (often with higher incomes) at home, but also for Chinese companies and their shareholders more profits. At the end of the study, the economists raised the question of whether China really wants to upgrade to "high technology", since high technology does not create much added value for the domestic economy.I guess, what the Chinese government really wants to see is that industries such as computers and communication equipment will generate more and longer industrial chains in the domestic economy, so as to generate more domestic added value.From the presentation by Koopman et al., there is little evidence that this is happening.On the basis of these studies, we can roughly calculate how important exports are to the Chinese economy.We know that 50% of the value added in China's exports is created domestically. In 2007, China's exports totaled US$1,218 billion, of which about US$609 billion came from domestic industry.From the data of the National Bureau of Statistics, we also know that the total industrial output value (excluding the construction industry) in that year was 1490.1 billion US dollars, accounting for about 43% of GDP.It follows that 41% of industrial value added goes to exports ($609 billion divided by $1,491 billion).This ratio is huge.It also means that industrial exports in 2007 were equivalent to 18% of the total GDP, which was equivalent to 17% of the total GDP in 2008.This ratio is of course smaller, because GDP also includes agriculture and service industries, and the trade volume of these two major industries in China is generally not much. The topic is not over here, we still need to estimate how much of the annual investment goes into the factory buildings and related infrastructure construction of export-oriented enterprises, including ports and workers' dormitories.This data is difficult to estimate. Simply put, it is impossible to estimate without great confidence.But we can make some (as reasonable as possible) guesses.We know that industrial investment accounted for 43% of official investment in 2007, and exports accounted for about 41% of industrial activities. Assuming that investment in export industries is consistent with export activities, we can estimate that 18% of investment in 2007 (43% of 41%) are investments in export industries. These estimates have profound implications for China's economic growth in 2009/2010.Colleagues who study the US economy expect the US economy to contract by 2.6% in 2009 and the European economy to contract by 3.8%.Many emerging market economies will also be affected – although most are still growing (we expect India to expand by 6.4% in 2009 and Brazil by 0.6%).The entire global economy will experience negative growth, or very close to zero growth. In November 2009, when this book was about to go to press, the global market was improving, but the prospects for 2010 were still uneasy.Many people are worried that the three major economies of the United States, Europe and Japan will experience a double dip.We believe that at least the economic growth rate of the United States and Europe will be lower than the potential growth rate, and the effectiveness of the economic stimulus policies of the United States and Europe will be weakened by the end of 2010. What impact will it have on the Chinese economy?The first thing we want to say is that the global slowdown will hit Chinese industry harder than most analysts predicted in late 2007/early 2008.According to the data I had before the global crisis broke out, from 2006 to 2007, 40% of China's manufacturing industry eventually became exports.Because we track value added along the supply chain, the value added data includes the value of processing trade imported parts and basic processed products that end up in exports.This means that 4 of every 10 manufacturing jobs are related to exports, which means that 4 yuan of every 10 yuan of enterprise sales revenue depends on the export market.Once the export declines, it will bring a large area of ​​unemployment pressure and have a great impact on corporate profits.Moreover, since we estimate that 1 out of every 5 investment projects is export-oriented, it will also have an impact on investment growth. So, how sensitive is China to a slowdown in external demand?According to IMF economists Jahangir Aziz and Li Xiangming, the sensitivity of China's exports to external demand has increased in the past 10 years due to the rising technological content of China's exports. "China's Changing Trade Elasticities", China and the World Economy, Vol16, No3, 2008, a basic law shown in recent years is that for every 1% increase in external demand, China's exports will increase by 4.5%. From 1995 to 1999, this ratio was 3.6%, when the US and European economies contracted by about 3%.It is reasonable to expect that China's exports to the US and European markets will shrink by about 15%. When it comes to exports, we cannot fail to mention the effect of changes in the RMB exchange rate.Research shows that Chinese exports are roughly half as sensitive to the RMB exchange rate as they are to external changes.That said, overseas demand for Chinese products is affected by the value of the renminbi, but not by as much as is often heard.For every 1 percent appreciation in the yuan, demand for Chinese products falls by about 2 percent.Nonetheless, the renminbi reached a 20-year high on a trade-weighted basis in the fourth quarter of 2008 and has remained there through the first quarter of 2009 amid a stronger dollar over the same period. In early 2009, compared with 2005, the trade-weighted exchange rate of RMB appreciated by about 20%, and compared with early 2008, it was also about 10% more expensive.That is to say, even though the renminbi may still be undervalued (after all, China still has a huge surplus in foreign trade), its appreciation relative to other currencies is also significant compared to before.During the same period, a number of Asian currencies weakened against the US dollar and the euro.This will also have a great impact on China's export industry. So, what conclusion does the above analysis bring us?The reduction in demand from the three major economies of the United States, Japan and Europe should lead to a drop of about 15% in China's exports.However, the contraction of demand in other markets should be weaker. Therefore, in general, the decline in China's exports in 2009 was between 10% and 15%.But the effect of RMB appreciation must also be taken into account.As a result, the contraction in export demand should be between 15% and 20%.Our projections for the trade surplus and current account for 2009 and 2010 are presented in Table 10.3, last updated in November 2009.Our forecast for exports in 2009 is basically in line with reality, that is, exports will contract by 18%.Of course the resulting drop in the trade surplus is welcome, but this contraction in exports will hit the industrial sector. An 18 percent fall in exports equates to a direct loss of seven percentage points to industry, implying an impact of three percentage points on overall GDP. What will happen to outward investment when the export market is sluggish?We assume that 18% of total investment in 2007 was outward-looking.Since many export-oriented enterprises slowed down their expansion pace in 2008 in anticipation of a slowdown in the global economy, we assume that only 10% of total investment in 2008 is related to exports.We expect no growth in export-related investment in 2009, resulting in four percentage points less GDP growth.In other words, if there is no growth in China's domestic economy in 2009, it is estimated that nominal GDP will fall by 7 percentage points. Assuming a slight increase in the price level, it means that real GDP will fall by 4 to 5 percentage points. This is a clear recession.Moreover, this judgment does not take into account all possible negative shocks to consumption caused by unemployment in labor-intensive export industries.In these estimates, we ignore the fact that the domestic economy was still growing in 2009.However, it is precisely against the background of heavy losses in exports that a huge economic stimulus plan was born to support the Chinese economy to survive 2009 safely.For an analysis of this huge investment program, see Chapter 9.