Examine the significance of the effect of the Chinese economy to the future prosperity of developed and developing countries.

Examine the significance of the effect of the Chinese economy to the future prosperity of developed and developing countries

There is much speculation as to China’s economic future, underlined of late by their entry into the World Trade Organization (WTO). There is no doubt that China has the potential to become one of the most economically powerful nations in the world as it has access to vast numbers of employees in the labour pool. China’s population now exceeds the one billion mark. In fact, it is predicted by the WTO’s next director-general, Supachai Panitchpakdi, that if all goes well in the subsequent period after China’s entry into the WTO, the country will become one of the two or three biggest economies in half a century.

This has unsurprisingly lead to widespread alarm, and even panic, around the Western developed World. Some see it as an economic disaster for them; after all, how can they possibly compete with China with such phenomenally low costs in China as far as labour is concerned? We need only look at the Chinese exports over the period 1948-2001 to see how the Chinese economy has changed in comparison with that of post-war Japan.

Of course, if we were to examine the statistics of late, we would most likely see a continual increase in the percentage of exports that China commands, and if we were to go one step further and predict the future economic state of China, we would probably see (depending upon by whom the forecast was made) that from China’s introduction into the WTO, and the removal of many trade barriers, China’s economy would flourish and the statistics would show a much less gradual and much more rapid approach by China to reach such export levels as those of Japan, America and European communities.

The major problem that economies outside China are considering is that China will be producing goods at so much cheaper than in domestic markets and exporting, thus undercutting the current businesses ‘at home’, which will put domestic businesses out of business, which will of course inevitably damage the economy by reducing aggregate demand. In 2001, China’s exports rose by 23% to $266bn, and accounting for 4.4% of world exports. No one can deny that such an increase is not a significant indicator of the world’s economic future, and many people are now thinking of what to do in order to remedy the future situation, although uncertain, but more certain than many other things economically speaking.

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From the evidence seen, however, why are the Western economies still attracting inward investment at a reasonable rate and why are we not all destitute as a result of the emerging ‘monster’ in the East? What the ‘fear-of-China brigade’ fails to see is that: 1) Most, if not all, Western economies are primarily capital intensive, China is labour intensive. Capital-intensive goods such as computers, for example, are being increasingly produced in China for the domestic market but not exporting to foreign markets and attacking competitors at home. Legend Group, China’s largest computer brand and is enjoying super-normal profits at the moment supplying their domestic market, but Legend’s boss, Yang Yuanqing, has admitted that it would be many years before he would even consider going head-to-head with such computer giants as IBM in America. There is indeed a danger that the Western World could over-estimate China’s immediate as well as long term economic power, as the current mood with many people when spoken to forecast a doom-and-gloom period where China takes over the world economically and everyone else is sidelined as China flexes its newly found economic muscle. Which brings me onto 2) The future potential export market is being hastily overlooked in the fracas. Especially when other economies are faltering, China’s role in world demand is nothing less than crucial. GDP is approximately 12% but its share if world trade is only c.4%, the same as Italy’s. As a member of the WTO, China will be subject to increasing competition and its significance as a source of demand will intensify. German car manufacturer Volkswagen counts China as its second biggest market after Germany, supplying the increasing demand for cars in the increasingly wealthy economy, which is now moving away from bicycles as it’s most common mode of transport and into cars. This is dealing a huge blow to bicycle manufacturers who have maintained high profits over recent times due to high domestic consumer demand. But on the flip side, coupled with much reduced import tariffs (by as much as 80% for cars over 3 litres) and new trade regulations as a result of its entry into the WTO, ‘Western’ car companies can expect to make much larger profits within the next few years due to higher consumer demand; in 2001 the Chinese mainland and Hong Kong bought over 8000 Mercedes Benz luxury cars. Volkswagen and General Motors have also encountered much increased sales – rising by no less than 20% of late, pushing the total number of cars sold in China to over one million. This is just a taste of what is to come as far as China’s position in the world economy goes, and we can expect many more businesses to benefit from China’s cheap labour force and goods that are produced there: if the Chinese export goods to the UK, for example, consumers will be getting much cheaper products from overseas. Trade is never a zero-sum game. We should be looking towards establishing how extensive our comparative advantage will be, not our competitive advantage.

Admittedly these are economic leakages, but are they significant enough to negate the much increased consumer surplus, the majority of which will be in all in all likelihood be spent in the domestic economy, thus increasing revenues for businesses and helping the economy grow as a consequence? It is difficult to tell, as with all economic predictions, because the further forward we try to look, the more uncertain the world becomes. We can make use of leading indicators course, such as GDP figures, industrial production and, normally, consumer prices. The big problem with looking at consumer prices in such a labour-intensive economy as that of China, is that because the supply of cheap labour is at such a level, it is unlikely that consumers will experience much reduced prices at such an early stage in China’s development.

Such figures as are mentioned in the graph can be seen as leading indicators for an emerging economy.

Another very relevant factor that is worth considering is that of the Chinese exchange rate. Normally when an economy grows quickly and businesses ‘steal’ markets from rivals, wage rates rise or exchange rates go up, or both. Both occurred in Japan and South Korea when their economies grew quickly, and the effect was to erode their previous cost advantage and make it easier for other countries to adjust in the process. This may well not be so in China. China’s labour pool is incredibly large, especially with state owned banks laying off 110,000 workers recently as the country becomes much more market orientated, so labour costs, or wages, will rise only very slowly because there is much more competition for jobs and employees are willing to work for much less than their foreign counterparts. Secondly, the Chinese exchange rate is fixed against the Dollar (8.3 Yuan to the Dollar) and protected by capital controls by the state. A possible solution to this problem is the revaluation of the currency to a higher peg. However it would not be advisable to implement this plan too soon in China’s economic emergence, as China’s banks own over $500billion of bad debts – 50% of all loans.

Obviously, therefore, such a scheme should only be acted upon when China is in a much more stable economic position and able to cope with the consequences of the bad debts is holds in it banks. Such a situation harks back to the time of the Asian Financial Crisis, where the near insolvency of banks and the sudden change in exchange rate put many banks out of business. The result was to dramatically reduce sources of finance for businesses, so they went out of business. Cuts in spending led to reduced demand for many goods and services and many of the Asian ‘Tiger economies’ were badly affected. This could affect us as badly as China, as over the last few years, FDI (Foreign Direct Investment) has been flooding into the Chinese economy, so much so that other smaller countries such as the Philippines as well as quite a lot of South-East Asia are feeling that they could be marginalized by the hype that the Chinese economy has received. After all, China received over $53bn worth of FDI in the last year, surpassing even that of the USA, although in all fairness this could have more to do with the collapse of investment in America than a significant increase in appeal of China as an area of investment.

Overall, there are two opinions when it comes to debating the economic significance of China: 1) That we should get very worried about our impending doom owing to the sudden emergence of an economic giant, and 2) We (capital intensive economies) should take the increased trade to be brought on by China as “wonders to be celebrated, not threats to be agonized over.” And also we should not jump-the-gun, so to speak, because China is very much a ‘bicycle economy’; that is, it must keep going in order to avoid falling over, and may suffer from numerous setbacks in the future, but if managed well, it could become the world’s largest economic power within the next fifty years.

Extra Notes

It is important that wages rates don’t rise significantly for China as the cheapness of its production is the main source of competitive advantage, so if wage rates increase due to soaring demand for Chinese products, costs for companies will rise and therefore prices for consumers will act similarly to account for the rise of costs, but only if the company thinks that it will not experience significantly lower profit margins as a result. In fact, Chinese costs can probably double and still maintain their competitiveness, except the consumer surplus level will be reduced. Wage rates are on average in China now approx. 40¢ an hour, dramatically less than the likes of Mexico, and even India. So China can afford to let its prices rise slightly higher before people will start buying abroad, although due to the phenomenal size of the Chinese workforce, plus the recent 110,000 lay offs taken place in the last few years, there needs to be significant numbers of new businesses to absorb the superfluous labour in the market.
Chinese labour is unskilled as a rule, so there will rarely be a skills mismatch in the labour-intensive sector of the market.

‘The Economist’ Feb. 15th-21st ’03 p.12

The Economist Feb. 15th-21st ’03 p.13