To What Extent Has Globalisation Been Benefical to China’s Economic Growth?

Introduction

China’s economic transformation is one of the most dramatic economic developments of recent decades. Indeed, during the period 1979-2005, China’s growth rate has averaged 9.7% per annum, and its integration into the world trading system has been as remarkable: its share in world trade has increased from less than 1% in 1979 to 6.4% in 2005. China became the third largest trading nation after the United States and Germany in 2005. China’s major trading partners are the European Union followed by the United States and Japan. Together, they provided markets for over 51% of China’s total exports in 2005, and made up almost 34% of China’s import bill.

During the past 50 years, China’s industrial structure has evolved in three phases. Firstly, there was a period of heavy industrial development during 1952-78. The government prioritised the development of heavy industries such as steel, machinery and chemicals. Secondly, in 1979-94, China diversified its industrial structure by emphasising on lighter manufacturing industries, such as food and textiles. However, since 1995, the Chinese industry had suffered from massive over-capacity resulting from extensive industrial investment. To rectify structural weaknesses, China entered its third period of industrial development, which was focused on expanding technology-intensive sectors and upgrading the technological level of all industries.

Today, China is a major driver of growth in the world economy boosting both global supply and demand with many of its industries completely integrated into the world supply chain. As one of the largest global production platform and emerging market, China is contributing to the emergence of a truly globalised world economy. With the largest population and one of the world’s fastest growing economies, China has the largest potential market of any WTO member.

In this investigation, I aim to identify to what extent, has globalisation through trade and FDI been beneficial to China’s economic growth?

Investigation

Just over 25 years ago, China began the renovation from a centrally planned to a more market based economy, by gradual economic reforms. In order to make this transition happen, the Chinese Government realised that it would be necessary to promote access to foreign capital and advanced technology through greater integration into the multilateral trading system. China went from autarky to a more open economy through a gradual and highly managed transition. China did not officially join the WTO until the 11th December 2001, after 15 years of negotiations with GATT, the original organisation of the WTO. China’s accession to the WTO symbolised its ongoing integration into the world economy, providing more secure and predictable market access both for China and its trading partners.

China has seen incredible economic growth from the late 1970’s to the new generation we live in today. Economic growth is most frequently measured using gross domestic product (GDP), as you can see from the table below1; China’s real GDP has seen a constant trend of growth, averaging an 8% rise per annum in the selected years below.

Table 1: China’s Economic Indicators, 1998-2003

Year

1998

1999

2000

2001

2002

2003

GDP (RMB billion)

7,834.5

8,206.8

8,946.8

9,731.5

10,479.1

11,669.4

Real GDP growth (%)

7.8

7.1

8.0

7.5

8.0

9.1

Consumer price index (%)

-0.8

-1.4

0.4

0.7

-0.8

1.2

Country

Subject

Units

Scale

1998

1999

2000

2001

2002

2003

Germany

GDP

National currency

Billions

1,962.01

1,999.91

2,062.50

2,088.05

2,088.28

2,083.22

Germany

GDP

% change

2.0

1.9

3.1

1.2

0.0

-0.2

United States

GDP

National currency

Billions

9,066.87

9,470.35

9,816.95

9,890.65

10,048.85

10,301.10

United States

GDP

% change

4.2

4.4

3.7

0.8

1.6

2.5

Table 22: Germany and US Economic indicators, 1998-2003

The extent of China’s economic growth can be expressed by comparing the figures to other large economies. Changes that took decades to achieve in other countries are occurring in China over the course of just a few years. While China routinely grows at rates of 7 to 9% annually, the United States achieved its position as the world’s largest economy by sustained growth of about 3% over a period of 100 years, Germany only experienced an average 1.3% growth and Japan’s average growth rate between 1971 and 1991 was just 3.85%. Even the other “Asian miracle” countries have not grown as fast as China. South Korea, Taiwan, and Malaysia achieved growth rates between 1971 and 2003 of 7.06, 7.35 and 6.53%, respectively.3

Since 2000, China’s contribution to global GDP growth (in purchasing power terms) has been more than half as big as the combined contribution of India, Brazil and Russia, the three next largest emerging economies. China’s increasing demand for imports (to meet rising domestic demand and exports) has been an important source of growth for the world economy.4

Its thirst for basic commodities such as aluminium, steel, copper, coal and oil has helped push their world prices to record levels. When a large country like China supplies additional quantities of a product on world markets, it will cause the world price to fall. Likewise, when such a large country increases imports, it drives world prices up. Simple economic theory explains this by supply and demand diagrams of products. If we use aluminium as an example, you can see from the graphs below, if supply of aluminium increase, than prices will fall. If demand for aluminium increases, than the price will increase.

This is precisely what has happened over the past few years. China is a net importer of raw materials, a net exporter of manufactured goods, and is large enough to exert pressure on the prices of these goods. With rapid urbanisation, industrialisation and infrastructure construction, China is importing ever greater amounts of raw materials and primary products, pushing up world prices of key commodities. You can see from Appendix.2 that Ore, slag and ash, Mineral fuel and oil, and cooper have seen a 141.0%, 64.2% and 46.3% change in demand respectively from China, which have pushed world prices, especially copper, dramatically.

Trade liberalisation is vital to any economy that seeks to become a global power. In theory, free trade makes the world a richer place, as businesses and countries seek to be competitive, they must move forwards by finding the products that they can produce most effectively and processes that keep costs to minimum.

When China applied to join the GATT in 1986, it was essentially a centrally planned economy with a dense trading regime and high tariffs. Its main trading partners were socialist countries such as the USSR and Yugoslavia. It was not until 1992 when China declared its intention to establish a “socialist market economy” that it began to lower tariffs. During this time, China began to make substantial tariff cuts.

Table 3 shows the reduction of tariffs on simple and weighted products in primary and secondary sectors of the economy. For all simple products, tariffs decreased by 26.3% from 1992 to 2001, and a further 6.8% after the joining of the WTO. Furthermore, tariffs for all weighted products were reduced from 40.6% in 1992 to only 6.8% after the China joined the WTO. Beyond the increase in market access for its trading partners, this reduction has spurred major efficiency and productivity improvements in China.

Table 3: China- Simple and Trade-Weighted Statutory Tariffs5

(Percentage)

All Products

Primary Products

Manufactures

Simple

Weighted

Simple

Weighted

Simple

Weighted

1992

42.9

40.6

36.2

22.3

44.6

46.5

1996

23.6

22.6

25.4

20.0

23.1

23.2

2001

16.6

12.0

21.6

17.7

16.2

13.0

After joining the WTO

9.8

6.8

13.2

3.6

9.5

6.9

China is a major driver of growth in the world economy boosting both global supply and demand with many of its industries completely integrated into global supply chains. China’s exports and imports of goods have surged over the past two decades, with a trade surplus reaching USD 102 billion by 2005, as you can see in figure 16:

China: Trend in Foreign Trade

From the table below, you can see that China’s top exporting goods are main electrical machinery/equipment, having a 45.8% increase change in just 1 year, and power generation equipment seeing a 41.7% increase.

China’s Top Exports7

(USD billion)

Commodity

2003

2004

% change

Electrical machinery & equipment

88.97

129.66

45.8

Power generation equipment

83.47

118.15

41.7

Apparel

45.76

54.78

19.7

Iron and steel

12.86

25.22

96.0

Furniture and bedding

12.90

17.32

29.1

Optics & medical equipment

10.56

16.22

53.6

Footwear and parts thereof

12.96

15.20

17.4

Toys and games

13.28

15.10

13.6

Mineral fuel and oil

11.11

14.48

30.2

Inorganic and organic chemicals

10.73

13.94

29.8

As with tangible goods, China’s service sectors have also seen an expansion on the world market in recent years. For a sector once considered to be un-tradable, there has been an important increase over the past decade in the proportion of total trade accounted for by services. However, as compared with its goods traded, China’s services exports remain at lower levels. As you can see from the table below8, even though both imports and exports have increased, compared to tangible goods, China’s service sectors remain at low levels. In 2004, services exports accounted for only 2.79 % of total world trade.

Share of China’s Services Trade in World Total

(Percentage)

1994

2001

2004

Exports

1.54

2.18

2.79

Imports

1.48

2.53

3.25

Total Services Trade

1.46

2.47

3.14

Since 2004, Chinese goods make up 90% of their total exports, which is significantly higher than the world average of 80%. However, Chinese services only make up 10% of total exports, which is half of the average world exports. This suggests that China’s services are still underdeveloped and its main source of integration in the world market is driven solely on goods traded, where it has a comparative advantage.

Trade in Goods and Services, World and China9 (Percentage)

Goods

Services

World

China

World

China

Exports

1994

80

86

20

14

2001

80

89

20

11

2004

80

90

20

10

Imports

1994

79

85

21

15

2001

80

85

20

15

2004

80

88

20

12

In contrast to imports and exports of goods, where exports exceeded the total of imports, China’s services sectors imports grew faster than services exports, which was contributing to a gradual increase in China’s deficit in services trade. This suggests that China remained a net importer of services (appex 1) and the increasing services trade deficit implies that China’s export capacity is limited and possibly further restricted.

China’s greater capacity in selling manufactured goods rather than services worldwide can help improve their economic situation by using the theory of Comparative advantage, developed by David Ricardo. This relates to the opportunity cost of production, assuming that opportunity cost structures differ between countries, if a country specialises in a product with the lowest opportunity cost and reallocates resources into production they can exchange with other countries for its lowest opportunity cost product. When countries specialise, using their resources in their lowest cost uses, they maximise their overall output, and are able to produce more goods and services than they can if there is no trade. This could be one explanation for the link between China and economic growth. Already establish in the investigation, China specialises in exporting manufactured goods rather than services, so we can assume that China has a comparative advantage in trading manufactured goods, meaning they can obtain other goods and services they cannot produce efficiently themselves, and increase their international trade.

The extent to which China has opened to foreign trade can be illustrated by the share of total trade in GDP over time. According to the World Bank Development Indicators10, in 1970, trade contributed 5.3 to GDP climbing to 34.8% in 1990, 44.2% in 2000 and rising sharply after WTO accession to reach a massive 65.4% in 2004

China: Share of Trade in GDP

(Percentage)

1970

1975

1980

1985

1990

1995

2000

2003

2004

5.3

9.2

21.8

24.1

34.8

43.9

44.2

56.9

65.4

Theoretically, opening up domestic markets to international trade would increase the level of competitiveness in the market place, making businesses find better ways of producing goods more efficiently (at a lower cost). This is because trade encourages greater specialisation, which dramatically lowers costs and more intense competition, which is central to innovation.

The graph below shows the correlation of trade and china’s economic growth. As you can see there is a positive correlation between trade and GDP, suggesting that trade is an important factor for the economic growth in China.

However, China’s trade surplus (the value of exports net of imports) is a better measure of the contribution of international trade to the economy. Since 1990, the trade surplus has averaged about 2 to 3% of GDP, exports have grown faster than imports and China has had trade surpluses in all but 1 year from 1990 to 2003. The trade surplus peaked at 4.5% in 1997-98. China’s trade surplus of $25 billion amounted to 1.8% of GDP in 2003.

China’s trade liberalisation has created an attractive business environment and therefore has had a significant impact on FDI inflows. Foreign Direct Investment is usually imported in a country by multi-national companies seeking to take advantage of particular laws (such as cheaper land value, cheaper taxes etc…) to reduce the cost of production and to gain a competitive edge over rival companies. Similarly with international trade, an increase in FDI would increase a country’s GDP, because FDI brings in valuable funds which can be used to increase industrial output, create new job opportunities and sometimes, technology transfer which could increase innovation.

However, the already lack of investment, coupled with an uncertain political climate and other unfavorable factors, at first severely hindered Chinese attempts to attract FDI. In the graph below11, you can see that in 1980, the flow of FDI into China totaled less than $200 million. In 1997, however, the flow of FDI exceeded $44.9 billion, more than 225 times larger than the flow in 1980.

Beginning in 2000, investment surged again through a combination of massive government infrastructure spending and investment in manufacturing facilities by both foreign and domestic investors. Preparations to host the 2008 Olympic Games contributed to a further frenzy of construction projects. China’s late-2002 accession to the World Trade Organization spurred many companies, both domestic and multinational, to invest in China in anticipation of greater market opportunities (appex.2)

During this time, China was the largest recipient of FDI among developing countries, and the second largest in the world. Several factors have contributed to the increase in FDI inflows. China liberalised its FDI regime concurrently with the implementation of its economic reform and ‘open doors’ policies in the late 1970s and especially since the early 1990s (Appex.3). Implementing a series of laws and regulations governing FDI, China has substantially reduced investment barriers and improved its investment environment by opening more regions and economic sectors to foreign investors. In addition to such policies, it has the world’s largest population providing an abundance of cheap labour (Appex.4) and a potentially huge market. Recognising the potential since the early 1980s, countries in the region such as Hong Kong and the ‘Asian Tiger economies’ have become important capital suppliers.

To understand China’s rapid expansion in foreign trade, it is important to acknowledge how vital Multi-Nationals companies (MNC’s) have been to its export growth. It should be noticed that China’s opening to foreign investment occurred simultaneously with an opening to foreign trade. Even without large inflows of FDI, export capacity might still have expanded but perhaps at a less rapid pace.

However, unlike China’s trade values, FDI had seen a small decline in the years 1999 and 2000. When you combine both FDI inflows with GDP in China over the last 10 years, you can see that

even if FDI decreases or remains level, economic growth via GDP still increase, suggesting that FDI is not as important to economic growth as trade.

It is also important to note that China’s FDI performance must be viewed in an international perspective. “In terms of FDI inflows per capita, China ranks lower than all OECD countries save for one, and even ranks relatively low among developing countries”12. Much of China’s FDI is short-term, in labour intensive manufacturing, with foreign investment in high-tech machinery and the services sectors lagging behind, “Though investment in processing and assembling declined 10%, the manufacturing sector garnered 70% of FDI from 2000-2005. Telecom, electronics, and chemicals also received significant shares of foreign investment”.13

China could be encouraging FDI in high technology based manufactures as a way to encourage domestically owned firms to move up the ‘value-added’ chain.

However, trade and investment liberalisation cannot by itself improve China’s economic growth. Arguably much of China’s rapid economic growth is due to changes in government policies that created a “socialist market economy” in which the private sector plays a key role. Enterprises either owned or controlled by government entities now account for less than 30% of industrial output.

We must not forget that the domestic industry has also been a driver of China’s phenomenal economic growth of the past 30 years. Industrial development has hastened since reform began in the late 1970s, growing at an annual rate of over 11% between 1978 and 2000 compared to an average GDP growth rate of 9.6% during this period, as you can see from the graph on the next page.

China’s GDP growth and industrial growth rates14

The importance of industrial output in the Chinese economy has increased over time, from 21% of GDP in 1952 to 51% at present.

Changes in the composition of China’s GDP, 1952-200215

Government polices provided several short-term burst of productivity within the industry, in 1980 when China began the renovation from a centrally planned to a more market based economy, industrial output rose 16.5% from 1981-1985. Before any Government reforms, growth rate of GDP was 5.3%, but post-reforms saw the growth rate increase to 9.7% (Appex.5)

Economists such as Wayne Morrison and Mathew Shane have concluded that productivity gains (i.e. increases in efficiency) were another major factor in China’s rapid economic growth.

The improvements to productivity were caused largely by a reallocation of resources to more productive uses, especially in sectors that were formerly heavily controlled by the central government, such as agriculture, trade, and services. For example, agricultural reforms boosted production16, freeing workers to pursue employment in the more productive manufacturing sector.

Productivity can be increased by using factors of production more efficiently, by improving the quality of the basic factors of production, for example, increasing the skill or education of labor.

Consumption spending contributed too much of China’s early growth following economic reforms in the early 1980s. The aggregate demand and supply diagram below shows the level of output at any given level of aggregate demand.

As consumption was increasing in China from 1878 to 1882, this would lead the aggregate demand line to shift to the right, where the economy is approaching full capacity output.

The increase in demand induces businesses to take more employment and increase output. However, inflation will occur as costs will rise and then prices, as businesses try to pass the costs on to consumers.

However, over time, the role of consumption has declined and the contribution of investment has generally risen. Since 1978, gross capital formation (investment) accounted for an average of 37% of GDP, while the share due to consumption expenditures averaged 62%. Consumption’s contribution to GDP peaked at about two-thirds in the early 1980s and fell to 55% in 2003. By comparison, consumption accounts for 70% of GDP in the United States.

China’s substantial consumption contributing to growth of GDP17

This lower rate of consumption has made way for the impressive level of domestic savings to increase in China, which has helped stimulate economic growth. When reforms were initiated in 1979, domestic savings as a percentage of GDP stood at 32%. However, most Chinese savings during this period were generated by the profits of state-owned enterprises, which were used by the central government for domestic investment. Economic reforms however, led to substantial growth in Chinese household savings. As a result, savings as a percentage of GDP has steadily risen; it reached 49% in 2003, among the highest savings rates in the world.18

China’s rise as an economic superpower is likely to pose both opportunities and challenges for the world trading system. China’s rapid economic growth has boosted incomes and is making China a huge market for a variety of goods and services. In addition, China’s abundant low-cost labor has led multinational corporations to shift their export-oriented, labor-intensive manufacturing facilities to China. This process has lowered prices for consumers, boosting their purchasing power. It has also lowered costs for firms that import and use Chinese-made components and parts to produce manufactured goods, boosting their competitiveness.

Conversely, China’s role as a major international manufacturer has raised a number of concerns. Many developing countries worry that growing FDI in China is coming at the expense of FDI in their country. Policymakers in both developing and developed countries have expressed concern over the loss of domestic manufacturing jobs that have shifted to China.

Conclusion

Throughout my investigation I have demonstrated the importance of trade liberalisation and Foreign Direct Investment to China’s record breaking economic growth. It is however, very hard to put an exact figure to show the extent of how beneficial trade and FDI have been to China’s economic growth, but undeniably they have all been part of a cycle, each factor helping stimulate economic growth in certain ways. I do believe that to an extent trade liberalisation and FDI are interdependent on each other, the opening up of markets to free trade has spurred more FDI than it would have if it had not liberalised.

Nevertheless, trade liberalisation and FDI cannot by itself improve China’s overall economic growth. The benefits of trade liberalisation and FDI to particular sectors of the industry will rely not only on their theoretical comparative advantage but also upon their ability to restructure and upgrade operations through technological improvements to take advantage of market opportunities. All factors including industrial output, increased productivity and efficiently within the industry, high level of consumer saving, early consumption and Government policies have all had an impact on the outcome of economic growth.

China has the potential to continue its rapid growth in the foreseeable future. The factors that have propelled growth over the past 30 years are still in place. China’s economy is still a long way from “mature” status where growth rates tail off. If the Chinese Government wishes to keep their economic growth at such a high rate, they must face challenges such as exchange rates, structural imbalances and a troubled banking system, in order for them to continue to grow

As long as China maintains an open attitude toward foreign investment and invests heavily in infrastructure and other capital, it will continue to grow rapidly.

1 Table 1- source/information from internet site: www.uscbc.org – The US-China business council

2 Table 2 – source/information from internet site: www.imf.org – The International Monetary Fund

3 As stated by, “China: A study of dynamic Growth”…www.ers.usda.gov

4 Data from www.imf.org

5 Source/information – World Bank and UN Commodity Trade Statistics as reported in World Bank (2004), Table 13.2

6 Graph – UN Commodity Trade Statistics Database (COMTRADE)

7 Source: China’s Customs Statistics

8 Source/information – IMF Balance of Payments Statistics (2006)

9 Source/information – IMF Balance of Payments Statistics (2006)

10 Source – World Bank World Development Indicators Database

11 Data from http://www.uschina.org/

12 OECD (2003) op. cit., pp. 37-40

13 http://www.uschina.org/statistics/2004foreigninvestment.html

14 OECD – China’s industrial linkages: Trends and policy implications.p7

15 OECD – China’s industrial linkages: Trends and policy implications.p.7

16 Information – http://www.index-china.com/index-english/agr-reform-s.html

17 Source – China national Bureau of Statistics

18 In comparison, the U.S. savings rate was 10.7% in 2004. Savings defined as aggregate national savings by the public and private sector as a percentage of nominal GDP- Economist Intelligence Unit database