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Chapter 6. Implications for Asia from Rebalancing in China

Author(s):
Anoop Singh, Malhar Nabar, and Papa N'Diaye
Published Date:
November 2013
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Information about Asia and the Pacific Asia y el Pacífico
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Author(s)
Olaf Unteroberdoerster

The second section of the book, beginning with this chapter, examines how China’s main trading partners have been affected by the developments analyzed in the first part. This chapter studies the implications for Asian economies of China’s declining external surplus. The rest of Asia has benefited from China’s strong domestic demand, in particular for commodities and capital goods, since the worldwide recession touched off by the 2008–09 global financial crisis. But even as China’s external surplus has declined, concern has arisen that new domestic imbalances may be emerging. As a result, Asian trading partners may face growing headwinds to their exports should China’s domestic imbalances eventually disrupt its high growth. The importance of vertical supply-chain linkages also suggests that trading partners’ exports to China would also be hurt if China’s exports were to slow.

Introduction

How China rebalances can have profound implications for Asian trading partners. For example, Asian capital goods and commodities exporters may benefit from continued strong Chinese investment demand, but could be in for a hard landing if Chinese investment is the source of growing domestic imbalances, as discussed in the preceding part of this book. However, consumption-based rebalancing in China would benefit those Asian trading partners with a relatively large share of consumer goods in their exports. To the extent that China’s exports may slow permanently relative to rapid growth during the first decade of the 2000s, exports of those Asian economies that are highly integrated in Chinese supply-chain networks may also slow. Therefore, to analyze the implications of China’s rebalancing, this chapter looks at the relative importance for different economies in the Asia region of China as a market for final goods, a supply-chain hub, and a potential competitor.

China as a Source of Regional Final Demand

Which economies in Asia will benefit from more domestic-demand-led growth in China? As highlighted in Chapter 1, it is important to distinguish between investment- and consumption-based growth. Although China has become a growing source of demand for other economies in Asia, its demand for investment goods has risen more sharply than its demand for consumer goods, generally by a ratio of 2:1 (Figure 6.1).1 The traditional capital goods exporters in Asia—Japan and the Republic of Korea—have been particularly exposed to China’s investment demand.

Figure 6.1Value Added Linked to China’s Final Demand: Selected Asian Economies

(investment demand relative to consumption demand)

Sources: United Nations, Comtrade database; and IMF staff calculations.

Note: ASEAN = Association of Southeast Asian Nations.

* ASEAN includes Indonesia, Malaysia, the Philippines, Singapore, and Thailand.

High investment ratios in China may not be sustainable from a domestic perspective, but they may also fall if China’s export growth were to slow permanently. There is a close relationship between China’s investment and its exports. First, both exports and manufacturing fixed asset investment have been shifting from low- to high-tech products. Second, China’s major sources of foreign direct investment are aligned with its major import sources in the manufacturing process (Figure 6.2), which is a result of the growing vertical trade integration that has fueled China’s rise as a leading exporter (see discussion below).

Figure 6.2China: Distribution of Foreign Direct Investment and Imported Value Added

(country share as a percentage of total)

Source: IMF staff calculations.

Were China to rebalance through consumption-based growth, Association of Southeast Asian Nations (ASEAN) economies appear well positioned to benefit, given their relative strength in consumer goods exports. However, the benefits for regional trading partners may be small. First, despite rapid growth, China’s role as an importer of consumer goods is still marginal, accounting for only 2 percent of global consumer goods imports. Second, its share in global consumer goods imports has risen less since 1995 than its share in global consumption (Figure 6.3).

Figure 6.3China: Share in Global Consumption Versus Share in Global Consumer Goods Imports

(share in percent of total)

Source: IMF staff calculations.

In other words, Chinese consumers have turned increasingly toward domestically produced goods. This may reflect the inability of foreign producers to overcome implicit barriers, such as setting up large retail and distribution networks, increased competitiveness from domestic producers, and differences in consumer preferences, as well as the need to be closer to the customer. Thus, whatever the reasons for the relative decline in imports, a shift in global demand shares toward China would not automatically result in a commensurate shift in global import demand, resulting in a demand gap for exporters.

China as a Supply-Chain Hub

How would potentially slower export growth in China affect the rest of Asia? The rise of China as a leading exporter has been closely linked to the rapid growth of supply-chain networks in Asia that are centered on China. Based on direct and indirect trade flows for intermediate goods, and on data from Asian input-output tables, China accounts for about 50 percent of all intra-Asian trade flows in imported inputs, more than double its share in 1995 (Figure 6.4).2 For many of its Asian trading partners, China has become the single most important destination of intermediate goods exports. The predominant intermediate goods suppliers to China have consistently been Japan, Korea, and Taiwan Province of China, accounting for almost 80 percent of China’s imported inputs, which broadly reflects their relative size. Korea has the closest link to China. It directly sends nearly 40 percent of its intermediate goods exports to China, four times more than it exports to Japan, its second most important export destination for intermediate goods. Adding indirect exports—intermediate goods Korea exports to other countries in the region, such as the ASEAN economies, that eventually find their way into Chinese production—Korea exports about 60 percent of its intermediate goods to China.

Figure 6.4Change in Intermediate Goods Flows for Selected Asian Economies

(change in share in regional flows)

Sources: Institute of Development Economics, Japan External Trade Research Organization, Asian Input Output Tables, 2000; United Nations, Comtrade database; and IMF staff estimates.

The effect of vertical trade integration appears to dominate export-demand relationships between China and its Asian trading partners. Overall, intermediate goods exports have accounted for about 70 percent of the annual export growth in Asia over the first decade of this century, more than double the contribution of final (consumer and capital) goods. Outsourcing to China is likely significantly stronger if capital goods exports as inputs are also considered (Figure 6.5). As noted in Chapter 1, China’s ascent as a leading exporter has been accompanied by the highest investment rates of any emerging market economy in recent decades. Capital goods exports to China now account for 20 to 25 percent of Japan’s and Korea’s total capital goods exports, making China by far their single most important capital goods export destination in Asia, and comparable to the United States or the European Union as export markets.

Figure 6.5Japan and the Republic of Korea: Capital Goods Exports

(by destination)

Source: United Nations, Comtrade database; and IMF staff estimates.

As a result of greater vertical integration, the correlation of Asian economies’ exports to China with Chinese exports has increased for most economies since 2000 (Figure 6.6).

Figure 6.6Correlation of Exports to China with Exports from China for Selected Asian Economies

(1 quarter lag)

Source: IMF staff calculations.

Regression estimates suggest that a 1 percentage point drop in Chinese export growth would lower the growth of exports of other Asian economies to China by about ⅔ of 1 percentage point.3

At the same time, for most Asian countries for which exports are primarily in manufactured goods as opposed to commodities, exports to China are mainly a function of Chinese exports, rather than Chinese domestic demand, which would be suggested by standard trade models. By contrast, for those few economies in the region that export predominantly commodities, exports to China are determined by Chinese domestic demand (Table 6.1).4

Table 6.1Determinants of Asian Exports to China1
Chinese Domestic DemandChinese Exports
Commodity exportersAustralia (1.79)

Indonesia (0.68)

New Zealand (1.66)
Manufacturing exportersIndia (1.03)

Hong Kong SAR (0.81)

Japan (1.28)

Korea (1.18)

Malaysia (0.90)

Philippines (2.95)

Singapore (1.78)

Thailand (1.37)
Source: IMF staff estimates.

China as a Competitor

Because of vertical trade integration, shifts in export (and import) market shares do not fully capture China’s changing role as a competitor to other Asian economies. In fact, the increase of China’s share in leading markets, using gross exports based on direction of trade statistics, overstates its share on a value added basis netting out direct and indirect inputs from other Asian economies. In the United States, for example, China’s direct share of gross imports of final goods from Asia has increased to 62 percent in 2010, whereas, on a value added basis, China’s share is less than 50 percent (Figure 6.7). In other words, greater vertical specialization has so far mitigated the impact of horizontal competition.

Figure 6.7U.S. Imports from Asia for Final Demand, 2010

(market share by source)

Source: IMF staff calculations.

For more advanced economies in Asia, therefore, the increase in competition as China’s exports shift increasingly toward high-tech goods will also depend on China’s ability to capture a larger share of the value chain. Whereas the imported content in Chinese exports gradually increased through the mid-2000s, it started falling afterward.5 Going forward, these trends could be reinforced in the future by China’s rapid buildup in physical and human capital, allowing it to capture large parts of the technology-intensive value chain. In addition, rising fuel and transportation costs could also lead to a partial reversal of vertical trade integration by reducing the number of locations in a production chain.

Conclusion

China’s external trade surplus has fallen substantially. As discussed in Chapter 1, this decline mainly reflects a secular worsening of China’s terms of trade and robust import growth fueled by investment demand. Moreover, prospects for China to sustain the high export growth since 2003 remain uncertain. Taken together, while China’s external imbalances retreat, new domestic imbalances may be emerging. As a result, Asian trading partners that have benefited from investment-led growth in China may face growing headwinds to their exports. Given the importance of vertical supply-chain links with China, they would also be hurt if China’s exports were to slow. By contrast, increasing direct and indirect access to the Chinese consumer goods markets could offer lasting benefits for Asian trading partners.

References

    Eichengreen, B., Y.Rhee, and H.Tong,2007, “China and the Exports of Other Asian Countries,Review of World Economics, Vol. 143, No. 2, pp. 20126.

    International Monetary Fund, 2012, Regional Economic Outlook: Asia and Pacific, April (Washington).

    Johansson, F.,2006, “Chinese Export of Electrical Machinery Equipments: An Estimated Demand Function” (Jongkoping, Sweden: Internationella Handelshogskolan).

    Mohommad, A., P.N’Diaye, and O.Unteroberdoerster,2011, “Rebalancing Growth in Asia,” in Rebalancing Growth in Asia: Economic Dimensions for China, ed. by V. Arora and R.Cardarelli (Washington: International Monetary Fund).

    Mohommad, A., O.Unteroberdoerster, and J.Vichyanond,2012, “Implications of Asia’s Regional Supply Chain for Rebalancing Growth,Journal of Asian Business, Vol. 25, No. 1, pp. 527.

This chapter draws heavily on analysis of Asian supply-chain networks in Mohommad, Unteroberdoerster, and Vichyanond (2012), and analysis presented in IMF (2012).

This estimate is based on value added–based trade flows that net out intermediate goods exports destined for third markets other than China.

For a detailed description of the methodology to update Asian input-output tables and calculate direct and indirect trade exposures, see Mohommad, N’Diaye, and Unteroberdoerster (2011).

Based on a country fixed-effects panel regression (1995–2010) of countries’ exports to China on the real bilateral exchange rate, Chinese real domestic demand, and Chinese real exports.

Consistent with the role of capital goods as imported inputs, Eichengreen, Rhee, and Tong (2007) find that Asian exports to China are positively affected by the growth of Chinese exports and “that this effect is mainly felt in markets for capital goods (p. 201).” Similarly, Johansson (2006) finds that inward foreign direct investment positively affects Chinese electronics exports, providing further evidence of outsourcing through investment.

IMF staff estimates based on Asian input-output tables suggest that the domestic value added in Chinese manufactured goods fell from about 90 percent in 1995 to 75 percent in 2005, but has increased since then to about 80–85 percent in 2010.

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