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(Can China save the world)?
(Can China save the world)?
Tim Harcourt
Chief Economist
Australian Trade Commission
So what role does China play in the global economy? It was often assumed that China ‘exported’ deflation but supplying cheap goods to the west – particularly the USA in the manufacturing goods space. With an artificially low exchange rate, China’s low labour cost-base produced trade surpluses at home, trade deficits in the USA, and large pools of savings in China and the rest of Asia. For the most part this scenario is good news for Australia, as China’s industrial expansion has fuelled strong demand and there fore higher for our commodity exports (like coal, iron, liquefied natural gas (LNG)) whilst putting downward pressure on prices for the manufactured goods that we mainly import (toys, textile, clothing and footwear and other consumer goods and materials). As a result Australia’s ‘terms of trade’ – the price of exports as a ratio of the price of imports – is at historical highs therefore boosting real incomes.
But has this scenario changed? To some extent it has for a number of reasons.
Firstly, China’s export focus has been more concentrated on the rest of Asia (through intra-Asian trade and regional industrial supply chains) and on the European Union than the USA.
Secondly, other countries – such as Vietnam, Thailand, India and Indonesia – have also played this role in some sectors as China tries to moves up the value chain. For instance, Thailand’s eastern seaboard is becoming a focal point for the global automotive industry and the southern region of India centred on Chennai and Bangalore is doing similar things in information technologies and communications.
Thirdly, to some extent China is moving away from being an exporter (of deflation or other good and services for that matter) towards domestic consumption and investment. As CLSA Economist Andy Rothman has pointed out net exports are just the “froth” worth 1 to 2 per cent percentage points on a double digit Chinese growth rate that is primarily domestically driven. And as Beijing directs investment to the western provinces and the second and thirds tier cities (so-called ‘country towns’ of 8 to 9 million people!) the processes of urbanisation and industrialisation will see that domestic process continue.
Fourthly, China is having some slowing pains itself. As well as the stock market falls there’s been lay-offs in the industrial heartland of the Pearl River Delta, falls in retail sales at the same time as key skilled labour shortages in growing sectors of the Chinese economy. The property markets in the richer coastal cities like Shanghai and Guangzhou are also exhibiting some weaknesses in terms of values and behaving like any western industrialised cities in terms of real estate.
Finally, it’s important to watch investment flows as well as trade flows. Strong outward FDI flows from China are replacing the traditional trade route as a form of global engagement – or more strictly regional engagement within the Asian hemisphere. We’ve witnessed this in Australia recently with an estimated $30 billion of Chinese FDI in Australian projects since November 2007 compared to around $10 billion over 2005-06 and 2006-07, according to Australian National University economists Christopher Findlay and Peter Drysdale. This is occurring mainly through China’s state owned enterprises –w ho have preferential access to credit – although many are moving to be on a more commercially-based footing.
So what does this mean for Australia and for the rest of the world? For Australia, the trade and investment links with China and the emerging economies are going to especially help us endure the global credit crisis. Australia’s share of good exports to emerging countries has risen from 53 per cent compared to 43 per cent 10 years around China (and India) are an important part of that story. In 1999, China and India accounted for just under 6 per cent of Australian exports, whilst in 2007, ‘Chindia’ accounted for 18 per cent (with Japan on 16 per cent and ‘other East Asia’ on 16.7 per cent). Over this period average annual growth rate of Australian exports was 24.8 per cent for China and 24.7 per cent for India. Australia, by opening up our economy and re-focussing towards Asia, has managed to improve our trade share in the part of the world where there is most economic growth.
But the risks to China are not to be underestimated. Firstly the challenge of domestic economic development – especially in the poor rural areas – are colossal despite Beijing’s clear focus on the western inner regions of the country. Secondly, whilst China has opened up to trade by joining the World Trade Organisation (WTO), the focus on FDI and building market-based outward looking international businesses will be a major challenge to China (and its financial institutions that will fund them). In some ways, India has developed many global brands like Tata and Infosys that are confidently strutting the world stage whilst China’s past over reliance on inward FDI may have stifled the development of China’s own global business brands. Thirdly, China still has to deal with the challenges of climate change and the balance between environmental goals on one hand and industrial development and poverty reduction goals on the other. In many ways, China has to save itself before it can save the world.
But how has this affected the Australian economy? Of course, we are not immune here – no country really is - but Australia, more than most developed economies, is in a strong position to ride out the storm. Why is this so? There are several reasons. Some are due to good fortune, others due to a quarter of a century of successful economic reform.
Firstly, the Australian economy is in a strong position with positive economic growth prospects (2.5 per cent over the coming year according to latest International Monetary Fund forecasts), low unemployment (4.3 per cent, seasonally adjusted according to the latest Australian Bureau of Statistics data), a strong budget surplus and banks that have healthy balance sheets by global standards.
Secondly, Australia’s export diversity is also in our favour. Australia’s share of good exports to developing countries has risen from 53 per cent compared to 43 per cent 10 years ago. Australia’s trade action is now occurring outside the G7 and given that the developing world is increasing its influence in terms of contributions to global GDP. To date, the emerging markets have been less affected by the credit crisis relative to the USA and Europe.
Thirdly, Australia’s economic foundations have made us an attractive market for foreign direct investment (FDI) and our own financial services sector is also strengthening in its own right. Australia’s financial markets have combined assets of more than $4.2 trillion and the world’s fourth largest pool of funds under management globally (which now exceeds $A1.2 trillion).
Finally, Australia’s economic institutions from financial regulation to the labour market have placed us in a good position. We’ve dealt with our own financial weaknesses before with the state banks and our own external crises (like the Asian financial crisis of 1997) and learnt from experience. We’ve also seen the benefits of the floating exchange rate regime both in 1997 and now, where the Australian dollar takes on the burden of adjustment rather than the whole economy. One price adjusts instead of the whole range of prices and quantities in the domestic economy.
One institutional reform we should also be grateful for is the independence of our central bank, the Reserve Bank of Australia (RBA). And it is significant that the RBA was the first to act with a lowering of the cash rate by a full percentage point – a move that was followed by central banks around the world.
However, there is a reason to be concerned on the export front as credit is likely to be restricted in this uncertain environment. This may put exporters at a disadvantage as Austrade research shows that lack of finance is a major barrier to exporting and exporting small and medium enterprises (SMEs) are less likely to receive credit than other SMEs. However, mitigating this constraint is that evidence that exporters are, on average, more profitable than other businesses and they grow faster, are more productive and provide more job security than other businesses. In addition, the lower Australian dollar will assist the nominal competitiveness of exporters and the relative attractiveness of Australia as a target for FDI.
Australian exporters successfully dealt with the Asian financial crisis of 1997-99 and the dot.com crash of 2001 due to their own endurance, innovation and ability to forge lasting business relationships and the flexibility of the exchange rate to take on the burden of adjustment to insulate the Australian economy. With the credit crunch we are in unchartered waters but the hard work of economic reform, our proximity to Asia – particularly the emerging powers of China and India - and the benefit of experience with past crises, means Australian exporters can have some confidence that they can ride out the storm.