Ties That Bind - Bay Area Council Economic Institute

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Ties That Bind
1980s, the past four years have seen a dramatic transformation in China, from an insular,
planned, developing economy to a more global, market-based, industrialized one.
The speed and scale of this transformation is remarkable. China’s economy has more than doubled
in size since 1999, to an estimated $2.2 trillion in 2005, and since 2002 has been growing at
9–10% annually. It now ranks as the world’s fourth largest economy. Much of this growth is tied
to market-based reforms. State-owned enterprises (SOEs), which once dominated China’s economy,
now account for less than one-fourth of its GDP, reflecting a surge in private and entrepreneurial
activity. This parallels China’s growth as a major consumer market. Where stateowned
enterprises in the auto, steel and oil industries once dominated the Asian Wall Street
Journal’s reader survey of China’s most admired companies, in 2006 all of the top ten were consumer-oriented
companies such as Haier (refrigerators and appliances), Lenovo (computers) and
Baidu.com (internet).
Foreign direct investment (FDI) has played a central part in this growth as China has opened
most industry sectors to foreign participation. Annual FDI has grown from $53.5 billion in 2003
to $60.6 billion in 2004 and $72.4 billion in 2005, with investments ranging from fixed asset investment
in export manufacturing plants, to mergers and acquisitions and equity positions in
state-owned enterprises. IBM Global Services reports that in 2005 China was the world’s top
destination for investment in manufacturing facilities, and its number two destination for investment
in research and development (R&D) facilities. Cumulative FDI in China is currently
about $941 billion, with the U.S. as the fifth largest investor.
U.S.-China trade has exploded in recent years, largely as the manufacture of consumer electronics,
apparel and footwear, home furnishings, building supplies, sporting goods, toys, machinery,
tools and other products has shifted from the U.S., Europe, Japan, Latin America and elsewhere
in Asia to China. U.S. exports have increased as well, as China’s appetite has grown for steel,
aluminum, petrochemicals, cotton, feed grains, paper, forest products, machinery and scientific
equipment, transportation equipment, semiconductors, consumer goods, food and beverages.
The U.S. ran a $201.6 billion trade deficit with China in 2005 ($243.5 billion in imports vs. $41.8
billion in exports).
It is worth noting, however, that China’s overall trade surplus with the world was far less, $101.9
billion. In part, the rising U.S.-China trade imbalance has been the result of an increasingly integrated
Asian economy, in which China is the final point of assembly before a product is shipped
to the U.S. Much of the value earned from those exports accrues to manufacturers and suppliers
in Hong Kong, Singapore, South Korea, Taiwan, Japan and the United States, from whom China
“imports” components and sub-assemblies. At the retail stage the U.S. benefits from branding
and advertising of the finished product. As the U.S.-China Business Council points out, China’s
share of the U.S. trade deficit grew from 23–26% between 1996 and 2005, while the rest of
Asia’s share fell during that period from 42–18%.
Manufactured exports have helped make China the world’s largest industrial producer and its
largest holder of foreign exchange reserves, which have grown from $286 billion in 2002 to an
expected $1 trillion by the end of 2006. Of that, as much as 70% is believed to be in the form of