January 2004 - Association of Dutch Businessmen

FINANCIAL INSIGHT
China: Threat or engine of growth?
Jan Lambregts
Economist / Strategist
Rabobank
A number of threats are supposed to originate from China. Flying accusations include the
export of deflation, responsibility for manufacturing employment losses in the rest of
the world and manipulation of its currency for unfair trade advantages, much to the
detriment of the US trade balance. Should the world be worried?
China’s export of deflation just one of many deflationary forces in play
China’s labor cost advantage over most other countries in the world is substantial. In an attempt to retain
high levels of profitability, many Western and Japanese companies have tried to winter the economic downturn
by aggressively cutting costs through a shift of (part of) their production facilities into China. The resulting
downwards pressure on global prices compounded to the weak price environment of the economic downturn,
which was in turn largely the result of the investment boom that preceded it. The spectre of a liquidity trap
surfaced, but appears to have passed. While it is true that the China factor added to the risk of a liquidity
trap at an unfortunate time, its cost deflation would normally be considered benign to consumers and
overall was a relatively limited factor compared to other deflationary forces in play.
Chart 1: Export deflation accusation may turn into export
inflation 1
Chart 2: What about China’s employment losses after Asian
Crisis?
Source: CEIC, Rabobank Research
Source: CEIC, Rabobank Research
1
Official Chinese data series
regularly draw heavy criticism
for their unreliability. Since
these are often the only data
sources available on China, it
is hard to escape using them.
In particular the charts on
export deflation/inflation and
employment losses above
should be interpreted with
caution. The charts on trade
are more reliable, while the
charts on export/GDP and
Hong Kong visitor arrivals draw
their data from other sources.
China will not absorb all manufacturing activity
It cannot be denied that the reallocation of production facilities to China has hurt (employment in) certain
industries and forces many countries to rethink their economic development strategies. The notion that
China is about to absorb most of the world’s manufacturing activity, however, is too simplistic. First, China’s
newfound capitalism is built on fragile fundamentals. The country still faces enormous challenges that will
likely limit its potential to endlessly absorb manufacturing activity. Second, standard economic trade theory
teaches us that allocation decisions are about comparative rather than absolute advantages. So while China
may be the cheapest place to produce just about anything, it can be expected to specialize in those industries
in which it is relatively speaking the most efficient, leaving plenty of other areas for other countries to
specialize in. True, some industries and countries will face painful decisions; yet rather than investing
energy in fighting these outcomes, countries ultimately stand to gain more from focussing on how best to
position and benefit from the emerging Chinese economy.
China not primarily to blame for large US trade deficit
Various studies have shown the Chinese renminbi, which has de facto been pegged to the US dollar since 1994,
to be undervalued by a range of 15-40% (REER basis). This has prompted the US to blame China for its growing
trade deficit, claiming Chinese policymakers are using the peg to gain unfair trade advantages. A casual
examination of the large bilateral trade deficit of the US with China would seem to confirm this, yet that road
is too simplistic. The large US trade deficit with the world is the combined result of the US consumer living it
large while the rest of the world has proven both willing to supply the products and plug the resulting financing
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Vol.14 • No. 1 • January 2004