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Monday, September 22, 2003

China: At Last the Voice of Reason

Phew, what a relief. I've spent half the week arguing with people who believe the China growth phenomenon is 'pure hype' (I will post on this tomorrow). Suddenly comes the voice of reality. Thank god for Andy Xie, giving us some facts about China:

Several US congressmen are reportedly proposing legislation that would impose punitive tariffs on Chinese imports.

In the media reports, one reads “unfair”, “illegal”, “manipulation”, “deception”, and “out-of-control” in quotes from politicians on Capitol Hill describing China. Indeed, it appears that those whipping up negative sentiment know how easy the old prejudices against China could be rekindled. But, strangely, the indignant congressmen are not smashing Chinese products on the Hill for TV cameras. I can still recollect the vivid images of the US congressmen smashing made-in-Japan tape recorders in the mid-1980s. This is the clue why I believe the furore on the Hill will not lead to any substantive measures.

China’s development model shares its upside with everyone who can contribute. More than US$500 billion in foreign direct investment has flowed into China. The supply chain from an industrial park in Suzhou to a hypermart in Chicago, for example, is full of different participants from all over the world. A Singapore company may own the real estate. A Hong Kong company may own and manage the factories. A Japanese company may supply the equipment. A US brand owner may design, brand, and import the products from China. A Korean shipping company may take the goods to the US. A US chain store may arrange the logistics and retail to the consumers in Chicago. “Made in China” is fundamentally different from “Made in Japan”. Japan’s keiretsu system kept the value chain for export production among Japanese businesses. The value chain for China’s export production is spread across the globe. Most of value added in China trade actually goes to Americans and other countries.

For each dollar of China’s exports to the US, American businesses add on about four dollars in value before the goods reach the US consumers. My estimate is based on the disclosed information from export companies listed in Hong Kong or Taiwan. China’s exports to the US, according to US government statistics, reached US$125 billion last year and grew by 25% in 1H03. If the trend continues, US imports from China would reach US$156 billion this year. US businesses would then add US$625 billion in value before the Chinese goods reach US consumers. This amount of value would be the equivalent to 5.8% of the US GDP. Moreover, this portion of the US GDP is probably more labor intensive than the US economy as a whole. I estimate it would imply that more than 8 million American jobs are tied up with the Chinese imports.

Could the US quickly switch to other sources? Who else has the scale and low-cost base to replace China? Since 1997, American consumers have already saved US$100 billion a year in the import bills just on the decline in the price of goods from East Asian relative to those from other regions. These savings have come as other countries in East Asia relocated their production to China. Would American consumers be willing to pay so much again to switch to another supply source? Now you can see why I believe congressmen are not smashing made-in-China products on Capitol Hill. If they were to do so, they would be smashing American jobs, American businesses, and American prosperity.

Let’s take the US statistics on China trade and see how much damage any disruption would hurt China. The value of the materials China imports to produce its exports to the US represents about 30% of the final value of the exports. The Hong Kong, Taiwan, American, or Japanese businesses that own the factories take away about another 15% of the gross sales as profits. This leaves 55% to represent the value added that benefits China, or about US$86 billion this year. China’s GDP should reach US$1.4 trillion this year. These exports to the US would be about 6.1% of China’s GDP. If the trade between the two countries were seriously disrupted, the extent of damage would be similar for China as it would be for the US. Furthermore, I believe US financial markets are much more vulnerable to any disruption in US-China trade. Profits for companies in the US retail and IT sectors depend on keeping supplies from China cheap. The market values of these companies would be severely affected if trade were disrupted. This is why I do not believe that the US Congress will bludgeon China into doing something harmful to the interests of the US. And, why I say it would hurt the US more than China.

The irony is that East Asia, including China, is losing market share in the US. The region’s share of US imports peaked at 40% in 1994, falling to 32.5% for 1H03. China’s exports to the US are rapidly rising, mainly because Japan, Taiwan, and other East Asia economies are shifting their production of goods destined for the US market to China. The relocation is generating cost savings that are being passed onto US consumers. The political rhetoric, however, could be ominous for the global economy in the long run. It could mean that the US commitment to free trade is not as solid as it was. It also reminds me of what the US did after the crash of 1929, when the bursting of the financial bubble led to high unemployment. The US Congress eventually legislated to restrict trade to protect jobs at home. As other nations also resorted to protectionism for the same purpose, it became a negative-sum game for the global economy that caused the Great Depression.
Source: Morgan Stanley Global Economic Forum

I'm not convinced that Andy is right about the last point. I don't think the Hawley-Smoot tarrif caused the Great Depression, which was anyway primarily a US phenomenon - I don't mean there wasn't depresion elsewhere, but that what Lionel Robbins called the Depression has very specific characteristics in the US. On the other hand, I think it is impossible to foresee whether there could be a US withdrawal from globalisation. I do, however, agree, that the consequences would be quite important, especially since it would probably lead to a less US centric global economy, and the US itself would probably have difficulty financing its debts. Something like shooting yourself in the foot, perhaps. But with the ideological climate in the US these days, virtually anything is possible. We may yet even get to see Bush and co joining forces with José Bose.

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