Think again (China no longer just assembles imported components)
Dated perceptions of China:
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Chinese banks are filled with NPLs.
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China runs a surplus with the US but a deficit with the rest of the world, so its trade is in rough balance.
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China just assembles imported components with little value-added.
New realities:
Chinese banks are stuffed with sterilization bills. The asset management companies are now stuffed with the bad loans formerly held by 3 of the 4 big state banks (ABC is still a mess). Most of the loans extended in the recent boom are performing – with nominal GDP growing so much faster than bank’s lending rate, it is hard not to come up with the funds to pay the banks interest. That – plus a juicy lending to deposit spread — is the underlying reason why the former state commercial banks are now worth quite a lot, even if they may not be worth quite as much as the markets now think they are worth. The risk facing the banks is that a large share of the current crop of loans will go bad …
China runs a big surplus with the world, not just the US. The World Bank estimates that China’s 2006 current account surplus will reach $230b, or 8.7% of China’s GDP. Net exports – incidentally – contributed an estimated 3.3% to China’s GDP growth in the second half of 2006, up from 2% in the first half of 06. So much for rebalancing. Export growth accelerated even more in the first couple of months of 2007. Citi now expects China to run a $30b monthly trade surplus in the second half of the year.
And China is rapidly developing the capacity to manufacture high-value added components, not just to do the final assembly. You don’t need to trust me on this. JP Morgan and the World Bank have reached a similar conclusion.
Grace Ng and Qian Wang of JP Morgan note:
Following its 2001 WTO accession, China has steadily evolved from a simple assembly and finishing hub. In the past, China used to import a high portion of the capital equipment and intermediate goods needed by its manufacturing sector. But the surge in FDI into China early this decade – with WTO entry as an important catalyst – from tech-heavy North Asian economies, including Japan, Korea and Taiwan, has been important in lifting China up the valued-added chain. Domestic manufacturers are now able to produce machinery, equipment and intermediate goods onshore. At the same time, as foreign manufacturers have become more entrenched in China, they have begun to source equipment (as well as funding) domestically.
Ng and Wang provide details from the auto sector and the capital goods sector. But the basic trend is also apparent in the broad data.
Despite the rise in commodity prices and despite the perception that China’s exports have a rather high import content, import growth has lagged export growth by a significant margin … while merchandise exports as a share of GDP have been rising steadily, imports as a share of GDP have been rather stable since late 2004. In part, slower import growth reflects Chinese manufacturers rising ability to produce onshore higher value-added capital goods and intermediate products, categories for which they have relied heavily on imports in the past.
(Source: JP Morgan, Global Data Watch, February 2, 2007)
The same story emerges from the World Bank’s most recent report on East Asia. The graphics are well-done, and tell the story well. Look, for example, at Exhibit 2 (p. 9). It highlights the strong recent acceleration in Chinese export growth.
The World Bank also highlights that some of the synergies between China’s growth and the rest of the region seem to be breaking down – likely because a Chinese supply chain (think of Intel’s planned investment) is replacing the regional supply chain. The pick-up in China’s export growth hasn’t been matched by a pick-up in export growth in other Asian economies.
The contrast between accelerating export growth in china and decelerating export growth in the rest of the region suggests that competition for international market share among Asian economies may also be intensifying. For example China’s exports to the sluggish US market were still growing at 25-30% in year over year dollar terms in the later part of 2006 and in early 2007, a time when Korea, Taiwan (China) and Malaysia’s exports to this market slowed to around 5%. …
China’s own import growth has been slowing over the course of 2006, which partly reflects some slowing in the face of investment spending, but also as China deepens its domestic supply chain for domestic goods.”
The World Bank report is full of other useful information – and, remarkably for a publication from the IFIs, actually reflects the most recent data. The coverage of China, for example, includes the January and February trade data. I am impressed.
The World Bank also hints – I suspect correctly – that the ongoing slump in investment in some Asian countries is probably linked to the surge in investment in China and China’s progression up the value-added chain, which has created uncertainty about the competitive advantage of other Asian economies. The argument that low levels of investment reflect a hangover from the 97-98 crisis no longer works as well, as the balance sheets of non-Chinese banks have been cleaned. The ADB told a somewhat different story, but I think that they looked only at FDI (rising direct investment in China doesn’t seem to have reduced investment elsewhere) not overall levels of investment. Exhibits 35 and 36 (p. 37) show the contrast between the surge in investment in China, and the prolonged slump in investment in six other regional economies.
Exhibit 6 – which shows the surge in China’s trade surplus (I don’t see any sign of a slowdown yet); Exhibit 12 – which shows East Asian reserve growth and Exhibit 22, which shows the contrast between the 10% real depreciation in China since 2002; the 10% plus real appreciation in Thailand and the 30% real appreciation in Korea are all worth looking at as well.
On one question, everyone (China, the US Treasury, the ADB, the World Bank, the IMF) now seems to agree. The World Bank – citing work by Jeanne and Rancierre of the IMF (talk about coordination) – estimates that “deepened financial integration” pushed optimal reserve levels up to around 25% of GDP. But with reserves equal to 45% of GDP, East Asia is clearly over-reserved. Alas there is no agreement on how to keep Asian reserves from continuing to soar, let alone on how to bring Asian reserve levels down …
12 Responses to “Think again (China no longer just assembles imported components)”
Emmanuel • April 5th, 2007 at 8:37 pm
Dr. Setser: Did you catch the notice for “The IMF Conference on Global Implications of China’s Trade, Investment and Growth”? There are good papers there that bolster your points on Chinese exports moving up in technological sophistication.
I have cherry-picked some of the more illustrative charts on my ‘umble site. On a related point, some now believe that countries are shying away from free-trade initiatives in fear of China overrunning everyone else.
Last point: bad loans for sterilization bonds yielding less than 2% is still a bad deal. In computer lingo, garbage in, garbage out.
Happy Easter to everyone. With a name like mine, it’s no mystery what religion I subscribe to 
Gheorghius • April 5th, 2007 at 9:11 pm
“Alas there is no agreement on how to keep Asian reserves from continuing to soar…”
I think N. Korea could help! Yes, by printing and circulating some fake Yuan (not just the same false good ol’ US$): the upward pressure on the RMB and Chinese reserves would be reduced…
The US, on the other hand – in the pure spirit of the “balance of financial terror” -, could threaten to strike China with $-bombs. Yes… Chinese people would then receive the fallout, dollars, and convert them into Yuan. Chinese M1 would explode; and with all the Chinese bubbles bubbling around … I can’t even think of it! No no, China would probably retreat, surrender, appreciate the Yuan…
But what if China retaliated instead? For ex., by sending more goods at discount prices in the US… pushing the US consumer further into debt?
The US$ then, currency of a (financially) would be “banana republic”, would surrender its role of international reserve currency, opening the door to an era of global Euro domination.(*)
Could it be that Chirac is behind all this (“Global imbalances” etc.)? He’s always been a troublemaker!
I don’t really know… I never understood economics … I just wanted to say: “Happy Easter, everybody”!
(*) See? No RMB intervention is good for the Euro/$ cross… I told you!
Dave Chiang • April 6th, 2007 at 6:44 am
From Nobel Economist Joseph Stiglitz:
Development in defiance of the Washington Consensus
China has carried off the world’s largest reduction in poverty by grasping that market economies cannot be left on autopilot
http://www.guardian.co.uk/china/story/0,,1752851,00.html
” China is about to adopt its 11th five-year plan, setting the stage for the continuation of probably the most remarkable economic transformation in history, while improving the well being of almost a quarter of the world’s population. Never before has the world seen such sustained growth; never before has there been so much poverty reduction.
While much of the rest of the developing world, following the Washington consensus, China has again made clear that it seeks sustainable and more equitable increases in real living standards. China realises that it has entered a phase of economic growth that is imposing enormous – and unsustainable – demands on the environment. Unless there is a change in course, living standards will eventually be compromised. That is why the new plan places great emphasis on the environment.
Greenhouse gases, for example, are global problems. While America says that it cannot afford to do anything about it, China’s senior officials have acted more responsibly. Within a month of the adoption of the plan, new environmental taxes on cars, petrol and wood products were imposed.
Market economies are not self-regulating. They cannot simply be left on autopilot, especially if one wants to ensure that their benefits are shared widely. But managing a market economy is no easy task. It is a balancing act that must constantly respond to economic changes. China’s plan provides a road map for that response. The world watches in awe, and hope, as the lives of 1.3 billion people continue to be transformed. ”
· Joseph Stiglitz, a Nobel laureate, is professor of economics at Columbia University and the World Bank’s former chief economist
Dave Chiang • April 6th, 2007 at 6:48 am
From Bloomberg, Chinese Economy deepens Industrial Base for high-value added manufacturing
http://www.bloomberg.com/apps/news?pid=20601101&sid=aduZ9vz44mCE&refer=japan
” China deepens local supply chains and produces more of the inputs its manufacturers need, the World Bank says.
“Companies in China are developing their capabilities at an astonishing rate,” said John Ravenhill, a professor in international relations at the Australian National University in Canberra. “The government is keen to promote its own national champions, whether it’s automobiles or electronics.”
“Competition is increasing in China’s domestic market; in particular Chinese firms are deepening their supply chain within China itself,” Milan Brahmbatt, an economist at the World Bank, said in Tokyo. “That means an increase in competitive pressure for the rest of East Asia.”
China’s exports to the U.S. were still growing at 25 percent to 30 percent year-on-year in late 2006 and early 2007, while shipments from South Korea, Taiwan and Malaysia had slowed to around 5 percent, the World Bank said.
U.S. Market
“Toward the end of last year, exports were slowing in much of the region but were actually accelerating in China,” said Brahmbatt. “China may also be gaining market share.” “
Guest • April 6th, 2007 at 12:37 pm
From Businessweek, How the Commerce Dept. trade sanctions on Chinese paper exports will directly help political cronies in the Bush Administration.
http://www.businessweek.com/magazine/content/07_16/b4030049.htm
” It’s hard to think of an American product that’s less strategically important than the coated paper that magazines, annual reports, catalogs, and auto-dealer brochures are printed on. Yet there was Commerce Secretary Carlos M. Gutierrez, on Mar. 30, announcing tariffs on coated-paper imports from China.
The government action raises obvious questions about the political influence of private investment firms, especially since the chairman of Cerberus, John W. Snow, served as President George W. Bush’s Treasury Secretary from February, 2003, to July, 2006. Should the U.S. start a trade war with China to protect private equity investors? “
gillies • April 6th, 2007 at 1:52 pm
by printing dollars – if that is indeed true – north korea in effect joins the united states in the role of ‘consumer of last resort’ using self awarded fiat credit to buy and consume stuff, thus underpinning the global economy. i may be naive but i can’t see what they are doing wrong.
RebelEconomist • April 8th, 2007 at 3:24 am
I am not saying that 25% of GDP is the most appropriate level of reserves for the USA, but when that would suggest a figure of $3tn, versus actual US reserves of about $200bn including gold, the burden of proof should lie on those who consider US reserves, and by implication official US dollar sales in recent years, as adequate.
christofay • April 9th, 2007 at 6:18 am
From the William Pesek “Viewpoint” column “U.S. financial clout loses sway”, IHT, Apr 5, 2007, p. 19,
“the $41 billion of U.S. currency reserves seem puny compared with China’s $1.07 trillion, Japan’s $884 billion and even Malaysia’s $82 billion. At the moment, the United States has fewer reserves than Nigeria’s $42 billion, Indonesia’s $46 billion and Poland’s $49 billion.”
I am not sure of the value of the U. S. gold reserve, but I don’t think it is $160 billion.
christofay • April 9th, 2007 at 6:25 am
The value of central banks’ holdings of gold would be of personal interest. Are any central banks adding to their gold reserves?
RebelEconomist • April 9th, 2007 at 8:17 am
christofay,
Yes, Russia has been buying gold. The best source of information about gold in reserves that I know of is the World Gold Council (www.gold.org). According to them, Russia has a long term target of holding 10% of their reserves in gold, which means that, at moment, they have about 1200 more tonnes to buy.
According to the World Gold Council, the USA holds 8133.5 tonnes of gold, which is actually worth $176bn at the current gold price. It is interesting to note that one argument the Americans make against Asia’s large reserves holdings is the opportunity cost of the government bonds that reserves are typically held in, versus paying down domestic debt or investing in domestic infrastructure. Clearly, with a gold holding (which, particularly when they are as large as those of the USA, earn practically no return) more than twice as large as the next largest country (Germany), the US does not take its own advice. Conspiracy theorists may see this as a sign of how America intends to deal with its growing external debt, but I suspect that a more realistic explanation is just complacent neglect.
bsetser • April 9th, 2007 at 10:10 am
There is also a very active lobby in the US that stridently opposes the sale of the United States gold. They worry that it would drive down the market price of gold. They write the Treasury ALL the time. Back in the 90s, when gold was low, the gold bugs (mold bugs?) were convinced the US was secretly selling its gold, pushing the price down.
Joseph Wang • April 9th, 2007 at 11:51 am
One note. The asset management companies should all be wound up by the end of 2008. Also the strategy of limiting bank interest rates isn’t a new one. The United States had a similar strategy with Regulation Q from 1933 to about 1980.
