By Andy Mukherjee, Bloomberg
Much of the analysis of China’s bloated trade surplus focuses on exports, when it’s the imports that deserve greater scrutiny.
In the first eight months of this year, China’s exports grew 28 percent. That’s less than the annual export growth of 35 percent recorded in both 2003 and 2004.
More importantly, the 20 percent increase in imports so far this year pales in comparison with the 36 percent expansion in 2004 and the 40 percent surge in 2003. Slower import growth, according to Louis Kuijs, a World Bank economist in Beijing, is a key reason why China’s trade surplus is spiraling out of control, creating an avalanche of domestic liquidity that’s fueling inflation and asset bubbles.
So what explains the slowdown in China’s import growth?
Chinese imports have decoupled from exports since 2005 because assembly lines in the country are increasingly purchasing intermediate parts from local suppliers, according to Li Cui, an economist at the International Monetary Fund.
The substitution of imports with locally produced components has important implications for the rest of Asia, which has become more and more reliant on Chinese factories to tap final demand in the U.S., Europe and Japan.
According to the Asian Development Bank, more than 70 percent of the trade between China, Hong Kong, Indonesia, South Korea, Malaysia, the Philippines, Singapore, Taiwan and Thailand includes “intermediate goods” — parts, components and semi- finished material. These are then used to manufacture products that are ultimately sold outside the continent. China is the “driver” of this regional trade, even though only 6 percent of it is on account of final consumption on the mainland.
This may help explain why other Asian countries have mostly avoided supporting U.S. calls for a stronger yuan. The region’s policy makers reckoned that if an appreciating yuan led to a drop in China’s competitiveness in industrialized markets, their nations would lose out as suppliers of parts used in those exports.
That calculation may now be under threat. If the cross- border supply chain breaks down because of China’s import substitution, other Asian countries will struggle to reach final consumers in rich nations.
“As China begins to specialize in more parts of the production chain, its imports of intermediate goods from the region could start to fall,” the IMF’s Li says.
In such a scenario, Asian policy makers, too, might join the clamor for faster yuan appreciation.
In the first eight months of this year, Singapore’s non-oil exports to China grew 1 percent, slowing from 13 percent in the same period in 2006 and 27 percent for all of 2005. Almost half of China’s foreign trade is of the so-called processing variety, in which everything from mobile phones and laptop computers to DVD players and plasma TVs are assembled in China using parts imported from around the world.
As long as the product is exported, the imported components are exempt from customs duty. Most of the factories that are engaged in this kind of trade are located in the more affluent coastal regions and owned by international investors.
Processing trade tends to complicate any analysis of China’s exports and imports.
“Trade statistics can mislead as much as inform,” concludes Greg Linden, an economist at the University of California, Berkeley. Along with two researchers from University of California, Irvine, he has done a preliminary analysis of who captures the value in Apple Inc.’s iPod music player, which is assembled in China.
“For every US$300 iPod sold in the U.S., the politically volatile U.S. trade deficit with China increased by about US$150, the factory cost,” notes Linden’s study. “Yet, the value added to the product through assembly in China is probably a few dollars at most.”
This could be changing now, and quite rapidly.
“With the expansion of domestic supply, China is increasingly shifting from simple assembly operations toward operations that have greater scope for using domestic inputs,” Li says. According to his research, the value that’s added locally in China’s processing export is now 40 percent. In the mid-1990s, the figure ranged from 13 percent to 19 percent.
The growing sophistication of Chinese exports is only to be expected. What isn’t so obvious is why China’s own final consumer demand hasn’t grown quickly enough to absorb more goods from the rest of Asia. Personal consumption accounts for just 40 percent of China’s gross domestic product. Raising this abysmally low rate to South Korea’s level of 50 percent would create US$250 billion of additional consumer demand a year. This, however, would require a major restructuring of China’s export- and investment-driven economy, including a substantial appreciation in the exchange rate. The government also has to spend more on education and health care, which are two of the biggest precautionary motives behind the country’s high household-savings rate.
Until the authorities back their intention to achieve this transition with appropriate policies, China’s import growth may continue to fall behind exports, expanding the trade surplus and squeezing out manufacturers in the rest of Asia.