Monday, March 14, 2016


Comview 2016

As you may have noticed, earlier this year I went on a journalists’ junket to China, which has rekindled my interest in the rise of the Chinese economy and its influence on our own economy. I know this is a subject of interest to many economics teachers and their students, so I’m going to start with China’s effect on our economy and a discussion of ChAFTA, then evaluate the policies used to promote growth and development in China and, finally, look at the influence of globalisation on China’s economy - though, in the case of China, it makes more sense to look at the influence of China on globalisation. I probably won’t get time to cover all the material in my full paper, so it would be worth reading full version after you get home.

China’s effect on our economy

As I’m sure you know, for many years Australia’s largest trading partner - taking the most of our exports and supplying the most of our imports - was Japan. But Japan’s relative stagnation since the 1990s and China’s remarkable economic reawakening since the late 1970s, caused China to overtake Japan as our major trading partner in 2007.

Even before the start of the resources boom in 2003, China accounted for more than 8 per cent of our combined exports and imports of goods and services. Twelve years later, in 2015, China’s share is more than 22 per cent. Now China’s $86 billion of our exports gives it the largest share, at 27 per cent, while our imports from it of $64 billion give it the largest share at 18 per cent. Note that, as with Japan, we have a perpetual trade surplus with China.

Between China, Japan, South Korea, India, the ASEAN countries and more, Asia takes about 70 per cent of our exports. So we have been highly successful in enmeshing ourselves with the fastest growing region of the world. This has been good for us, since our major trading partners (weighted according to their shares of our trade) are growing by about 4 per cent a year, compared with less than 2 per cent for the developed countries. Of course, having so many eggs in the Asian basket does mean we’d be hit hard if China’s economy were to have a “hard landing”, to which you’d have to attach a reasonable probability. We’re by no means the only country with China as its major trading partner; it’s also true of many Asian economies. Much trade is “intra-regional”. Note, too, that the US is China’s largest trading partner, while China is the US’s second biggest (after Canada) - and its biggest creditor. So any trade war between the US and China would be so mutually destructive as to make it unlikely.

Our economy is highly complementary with China’s. We specialise in exporting the minerals, energy and other primary products they need; they specialise in exporting the manufactures we aren’t good at making ourselves. The past 20 years have seen China become manufacturer to the world, causing slower growth in the manufacturing sectors of all the developed countries.

China’s protracted period of rapid economic growth, which started slowing only about five years ago, combined with its huge size - its population is now almost 1.4 billion - could not help but have involved huge consumption of minerals and energy. China presently accounts for more than half the world’s annual consumption of iron ore and steaming coal, and more than 40 per cent of aluminium, copper, nickel, zinc and lead. So it was inevitable that China’s rapid growth in the years leading up to and immediately after the global financial crisis would have big implications for a major resource exporting country like ours. We benefited greatly from the huge rise in coal and iron ore prices - which peaked in 2011 - and from the consequent boom in mining and natural gas construction activity, which peaked in 2013 and is still falling back.

It’s a mistake to think mineral commodities are pretty much the only thing we sell the Chinese.  At present, resources account for about two-thirds of the total value of exports to China, leaving 21 per cent for other goods (mainly rural) and 11 per cent for services.

However, China is now facing challenging times. Its annual rate of growth has slowed - to 6.7 per cent over the year to September, 2016 - simply because, when you are coming from a low base, it gets harder and then impossible to maintain a very high rate of growth. At 10 per cent a year, the economy doubles about every seven years; at 6.7 per cent, it doubles about every 10 years.

But China must now move on to a new stage of economic development if its rate of growth isn’t to slow a lot further. Its exports of low-value manufactures have probably reached saturation point in the world market, and its growing prosperity means that real wages are rising strongly (about 8 per cent a year versus 3 per cent inflation) and eroding profit margins.

Because China remains a socialist market economy, the central government uses successive five-year plans setting out its goals, strategies and targets. As summarised by Asialink, the present, 13th five-year plan focuses on increasing China’s competitiveness through more efficient and increasingly advanced manufacturing on the east coast, attracting labour-intensive manufacturing to central provinces, and increasing domestic demand.

As expressed in the recent joint Australia-Chinese expert report, Partnership for Change, China is shifting its growth drivers from investment, exports and heavy industry to consumption, innovation and services. Chinese production is shifting from a model based on adaptation and imitation of goods, services and technologies developed elsewhere, to a model based on domestic innovation. Part of this involves a shift from labour-intensive, low-tech, low-value manufacturing to more advanced, high-tech, high-value manufacturing. This has already started.  Over the 20 years to 2015, low-tech manufacturing’s share of China’s total exports of goods has shrunk from almost half to less than 30 per cent.

So, at a time when our economy must adjust to the end of the resources construction boom and find new sources of growth, China must also make a (more fundamental) transition from investment and exports to consumption and imports. In this challenge our economies aren’t quite the same complementary fit, but there is scope for us to supply the ever more sophisticated demands of China’s rapidly expanding middle class, even if in more intensified competition with other developed countries.

China’s greater demand for imported services certainly fits with our need for greater services-led growth in production and employment. And we are already showing success. Chinese tourist visits to Australia have risen from 350,000 visitors in 2009 to 1.2 million visitors in 2015, and are forecast to exceed 2.5 million visitors by 2024. In 2017 China is expected to overtake New Zealand as our largest source of overseas visitors.

With exports to all countries of almost $20 billion a year, education is our third largest export category (behind iron ore and coal), while tourism is the fifth largest. Chinese student enrolment numbers have risen from 140,000 to 170,000 in the past three years, and HSBC bank forecasts they could exceed 280,000 by 2020. China is the largest source of international students in Australia, accounting for more than a quarter of overall international enrolments. Chinese students spend more during their time in Australia than other international students, only partly because they tend to stay longer. China’s growing middle class mean a growing market for business services such as accounting, legal and financial services, and its ageing population will see rising demand for healthcare. As a whole, business services have risen by a similar amount to tourism and education in recent years.

Most of the growth in exports of “other goods” involves foodstuffs. This had been driven by grain exports, but these have fallen off in the past couple of years. But exports of “finer foods” - such as meat, dairy, sugar and edible oils - have risen. China recently became our largest export market for wine, at almost $500 million over the year to September, up 50 per cent on the previous year.

It is common for our major trading partners to want to invest in our economy, particularly to make direct investments in those of our industries that supply the exports they are buying. Since Australia has been a “capital importing” economy from the beginning of white settlement, this has always been acceptable to our governments, despite recurring popular concerns about “selling off the farm”. Our major trading partners have often been running current account surpluses, making them keen to find profitable investment opportunities in other countries.  There has been some resistance to China’s foreign investment in Australia but, as yet it represents less than 5 per cent of total stock of foreign investment, coming seventh behind the US (27 per cent), Britain (16 per cent), the rest of the EU (16 per cent), Japan 6 per cent), Singapore and Hong Kong. Chinese investment in residential property in Sydney and Melbourne has probably added to upward pressure on prices, but much has been in new apartment developments, which should add to supply as well as demand.

The China-Australia Free Trade Agreement

Like most economists, I am dubious about the benefits of the bilateral preferential trade agreements known misleadingly as “free trade agreements”. They tend to divert trade from to the favoured country from other, cheaper suppliers, while adding to administrative costs through complicated “country-of-origin” rules. The officials negotiating them seek maximum concessions from the other side while making minimum concessions of their own, whereas economic theory says the main efficiency benefits come from reducing your own barriers to imports, rather than achieving reductions in other countries’ barriers to your exports. In practice, many of the preferential agreements made in recent years have involved only modest concessions on either side.

However, the ChAFTA agreement which came into effect in December 2015 was more significant than the other agreements we have reached. This is mainly because China, having been a member of the World Trade Organisation only since 2001, had many more reductions in tariff protection it was able to make than other, more developed economies. China has made trade agreements with several other countries, but its agreement with us is said to be the most comprehensive and liberalising arrangement it has entered into.

China agreed to eliminate immediately or phase out tariffs on Australia coal, alumina, beef, dairy, sheep, pork, live animals, horticulture, wine and seafood. No reduction in tariffs on sugar, rice, wool, cotton or wheat were agreed. Restrictions on Australian direct investment in Chinese businesses have been reduced. For our part, Australia agreed to phase out its 5 per cent tariff on imports from China of various manufactured goods, including electronics and whitegoods. In theory, we liberalised our restrictions on Chinese direct investment in Australian firms, but several highly publicised proposals have been rejected on claimed grounds of national security. It is commonly observed that ChAFTA creates much opportunity for Australian firms to take advantage of in coming years, but it remains to be seen how much they do.

 Policies used to promote growth and development in China

 China has a long and illustrious economic history. It was a major centre of trade more than 2000 years ago with the establishment of the Silk Road in about 200 BC, which connected Asia with Europe and Africa. The Chinese are credited with inventions such as the compass, gunpowder, fireworks, silk, noodles, moveable-type printing and papermaking.

In the centuries since then, however, China became very inward-looking, limiting its trade and contact with other countries. Even so, economic historians estimate that by 1820 China accounted for about a third of world GDP, with India increasing the two countries’ share to almost half. So China and India are former super powers. Today they’re not emerging economies, but re-emerging economic giants. What happened after 1820, of course, was the growth of the European and new-world economies such as America and Australia, following the spread of the Industrial Revolution. By 1970, China’s share of world GDP had fallen to less than 5 per cent (with India’s share even smaller).

After China’s Communist revolution of 1949, led by Mao Zedong, the 1950s were spent expropriating private property and establishing a planned economy. After an initial surge in growth, the economy began to stagnate. But all that began changing after 1978, when Mao’s successor, Deng Xiaoping, began the far-reaching market-oriented reforms that have brought China’s economy to where it is today. He instituted what he called “socialism with Chinese characteristics”, but economists call a “socialist market economy” - one in which a big sector of state-owned enterprises (SOEs) exists in parallel with market capitalism and private ownership - both local and foreign.

The 1980s saw much reform of China’s agricultural sector as the Russian collectivist system was dismantled and farmers incentivised by being allowed to sell their surplus production on the open market. The result has been a huge improvement in the productivity of China’s farms, such that China is the world’s largest producer of agricultural products - including rice, wheat, pork and fish - even while millions of rural workers have moved to the city to take factory jobs. Thus China’s industrialisation and urbanisation have gone hand in hand. Now more than half the Chinese population lives in cities.

The 1990s were devoted particularly to the growth of China’s manufacturing industry. It followed the Asian strategy of development first pursued by Japan and South Korea: exploiting the country’s abundance of cheap labour to produce and export low-value manufactures such as textiles, clothing and footwear, and toys. The strategy of export-led growth was promoted by keeping the exchange rate low and attracting financial capital, technology and the transfer of know-how by encouraging foreign investment.

This strategy does most to explain China’s rapid growth over the past 40 years, with annual growth averaging 10 per cent for about the middle 30 of those years. Those 30 years saw the size of China’s GDP multiply by about 48 times. With China’s population growth limited until very recently by its one-child policy, this meant a rapid rise in material living standards, as measured by income per person.

According to the World Bank, more than 500 million people were lifted out of poverty as China’s poverty rate fell from 88 per cent in 1981 to 6.5 per cent in 2012, as measured by the percentage of people living on the equivalent of US$1.90 or less per day in 2011 purchasing power parity terms. Because this is a measure of absolute poverty, however, it has not prevented some people’s incomes rising a lot faster relative to other people’s. China’s official Gini coefficient for the distribution of income is 0.46 (compared with Australia’s 0.33), but some unofficial estimates put it even higher.

Combine these decades of rapid growth with China’s population of 1.36 billion - the largest in the world - and it’s not surprising China is now the second largest economy in the world, when measured in nominal exchange rates, or already the largest when exchange rates are adjusted for purchasing power parity (because $US1 buys a lot more in China than it does in America).

Measured using PPP, China’s share of world GDP is about 16 per cent. It is already the world’s largest trading nation and largest producer of manufactures.

 According to standards set by the World Bank, China already has 300 million people with household incomes high enough to be considered “middle class”. However, when the World Bank compares countries rather than households, and looks at countries’ level of income per person, China is still classed as a middle-income country - no longer low income, but not yet high income. Its income per person is about $US8000 using nominal exchange rates, or about $US15,000 after adjusting for purchasing power parity, thus making it only the 84th richest country in the world. Many developing countries - particularly in Latin America - have managed to make it from poor to middle-income, but been unable to make the transition from middle-income to high-income. China must now break out of this “middle-income trap”, as economists call it.

By land area, China is the fourth largest country (after Russia, Canada and the US, followed by Australia as fifth), covering about 9.6 million square kilometres. It has three levels of government: the central government based in Beijing, 34 provincial-level governments and many local governments. Although we view it as one economy, according to Asialink it can also be viewed as a decentralised collection of several regional economies, with large wealth imbalances between rural and urban populations. The eastern provinces, which contain most of the manufacturing, are the wealthiest. Central China is more agriculture-focused and not as wealthy, although low-end manufacturing is increasingly moving into the region. Western China is the least economically prosperous region, although it has significant natural resources. The three wealthiest and most economically important regions are all on the east coast: the Pearl River Delta, close to Hong Kong; the Yangtze River Delta surrounding Shanghai; and the Bohai Bay region near Beijing.

Influence of globalisation on China’s economy

The story of how, since 1978, China has grown to become the world’s second or first biggest economy is all about how it opened up to trade and investment with a globalising world and, in the process, added greatly to the globalisation process and its effects on many other countries, not least of which is Australia.

China’s economy in the 1970s was poor and slow-growing mainly because it was cut off from the rest of the world. So when its leaders decided to introduce elements of the market system, they were consciously opening up to trade with the rest of the world - imports and well as exports - and to foreign investment in their economy and the acquisition of the latest technology and know-how.

One major landmark in the opening up process was China’s admission to membership of the World Trade Organisation in November 2001. This involved China agreeing to abide by all the rules governing trade between member countries and dismantling certain of its tariffs and restrictions on imports. More recently, China has concluded bilateral “free” (that is, preferential) trade agreements with South Korea, ASEAN, New Zealand, Switzerland, Pakistan and, of course, since 2015, with Australia.

But not all countries have found their economies to be such an easy fit with China’s. Unlike Australia, many developed countries have large manufacturing sectors, which have been threatened and then diminished as China has become the world’s largest trading and manufacturing nation, exporting not just low-value items but, increasingly, more advanced products such as steel and motor cars. Although the manufacturing workers of China have benefitted greatly from increased employment and rising wages, the opposite is true for many workers in developed countries.