China as the World Factory

Kevin H. Zhang

• Publisher: Routledge
• Year: 2006
• ISBN:
  9781135992897
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

Few countries have integrated into the world economy as fast – or as dramatically – as China has since 1978. The world's most populous country is emerging as a world workshop and export machine: a visit to a department store in any country will unearth a plethora of goods manufactured in the People's Republic. China is now the world's fourth largest exporting nation. In this important book, Kevin Zhang brings together an international team of contributors to analyze this development process. Taking a thematic approach, the book covers:

* manufacturing exports and the world workshop
* foreign capital and china's industrial development
* challenges from the WTO and openness.

This topical analysis will be an excellent resource for postgraduate students and researchers in the fields of Asian and Chinese studies, export studies, and economics.

Part I
Export competitiveness

1 China’s foreign trade and export boom: 1978–2004

Kevin Honglin Zhang

China has been the most dynamic trading nation in the world for two decades since 1978, when it started economic reforms. China’s foreign trade experienced a phenomenal growth in volume. A visit to any department store in an industrialized country will reveal that many of today’s consumer goods are made in China. In 1978 China’s exports and imports accounted for only 10 percent of GDP – one of the lowest nations in the world. Since then China’s trade has surged to 75 percent of GDP. As shown in Table 1.1, trade volume increased 56-fold in 26 years, from $21 billion in 1978 to $1,155 billion in 2004. As a result China has become the world’s third largest trading nation, accounting for 6.5 percent of world exports. It is virtually certain that China will become even more important in the future because of its size, dynamic economic growth, and continuing policy reforms.

While these numbers are impressive, there is relatively less understanding of some fundamental elements of China’s trade miracle, ranging from factors behind the trade boom to the extent of its integration with the global economy.¹ China’s real distinction is its huge size and enormous population. The combination of the trade boom and its size raises a host of interesting questions, including how China achieved the success of the trade boom, and is it really as great as it appears?

This chapter addresses these two questions. Since China’s emerging as a trading nation has immense implications for the world economy as well as the Chinese economy, a study of the prospect of the change and the factors behind the process should be of interest to policy-makers and in academic circles. The general conclusions of the study are as follows. China’s achievement in foreign trade is real, but not as great as it appears or what is suggested by the raw numbers. The emergence of China as a trading nation may be explained by the rapid growth of the domestic economy, large inflows of foreign direct investment, liberalized trade institutions and policies, and the devaluation in China’s real official exchange rate. Along with the trade boom, five features about China’s trade can be identified: the critical role of processing trade, improving trade structure of products, concentrated exporting and importing markets, geographic concentration in trade surplus and deficits, and coastal regions of China as trade leaders.

Table 1.1 China’s trade and exports, 1978–2004

Some cautious explanations are needed, however, for China’s trade miracle. First, China’s openness index (defined as trade to GDP ratio) is somewhat deceptive because of underestimated GDP and devaluations of China’s real exchange rate. Second, the booming trade is misleading since most of the trade growth does not come from the ordinary trade, but the processing trade, which has little effect on the domestic economy. Third, China’s trade structure of commodity is a typical inter-industry trade, in which China exports labor-intensive goods and imports capital-intensive products. The raw statistics do not indicate this clearly but suggest a dominance of intra-industry trade in manufacturing products.

Causes of trade growth: a theory

There are two basic reasons for countries to engage in international trade:comparative advantages and economies of scale (Krugman and Obsfeld, 2003). Countries differ from each other because of either factor endowments or technology. The differences thus result in lower opportunity costs for a country to produce particular goods relative to other countries. The country therefore has comparative advantage in these goods in the international markets. Countries would be better off if they produced and exported goods that have comparative advantages. International trade can also be caused by economies of scale (or increasing returns) that make each country better off by specializing in the production of only a limited range of goods.

Correspondingly, two types of trade can be identified: inter-industry and intra-industry trade. Inter-industry trade (e.g. manufactures for food) reflects comparative advantage, in which a labor-abundant country (e.g. China) exports labor-intensive goods and imports capital-intensive products, and vice versa for a capital-abundant country (e.g. the US). Intra-industry trade (e.g. manufactures for manufactures) reflects economies of scale, in which countries with a similar capital–labor ratio would specialize in a limited range of differentiated goods and trade for foreign goods for greater variety of consumption. The relative importance of inter- and intra-industry trade depends on how similar or different countries are. Countries that are similar in factor endowments and technology will not have much inter-industry trade, however, inter-industry trade will be dominant for countries that are very different. In practice, the trade between developed and developing countries is basically inter-industry trade, while the majority of the trade between developed countries is intra-industry trade.

Trade volume of a country increases with the country’s economic size. As the domestic economy grows, capacity of production increases and therefore its exports expand. Demand for both domestic foreign goods becomes larger too due to economic growth. In sum, the larger the GDP for a country is, the greater trade volume. From an autarky to an open economy, liberalizing trade policy can also stimulate trade volume. Trade (especially exports) may rise when a country devaluates domestic currency relative to foreign currencies.

The pattern of trade: 1978–2004

China’s opening to the outside world was probably the most visible of its economic reforms since 1978. Staring from a position of a near-autarky and an inward-looking nation, China has become one of the major players in world trade. The pattern of China’s trade in the past 26 years may be characterized by the following features of this change: the significant expansion of trade volume; the increasing role of processing trade and FDI; improving trade structure of products; and the concentration of exporting and importing markets; concentrated sources of trade surplus and deficits; and coastal regions as China’s trade leader.

The trade boom is a result of several factors including: (a) the liberalization of trade institutions and policies; (b) the rapid growth of the Chinese economy; (c) the increase in foreign direct investment (FDI) inflows; and (d) devaluations of China’s real exchange rate (World Bank, 1994, 1997; Lardy, 1992, 1994; Naughton, 1996; Zhang, 2002; Zhang and Song, 2000). The first two are straightforward. In the 1980s China began trade reforms by moving from monopoly to decentralized system. Special economic zones and open cities led to greater openings for trade. Govern-

Sources of trade growth

At the outset of its economic reforms in the late 1970s, China was an insignificant participant in international market for goods and services. Since then China’s role in the international economy has been totally transformed. China’s trade boom in the past 26 years may be easily seen from several indicators. As shown in Table 1.1, China’s foreign trade volume (sum of exports and imports) in 1978–2004 grew by 56 times, with an average annual growth rate of 17 percent, more than double that of world trade (Tables 1.1 and 1.2). Exports increased by 61 times, from $10 billion in 1978 to $593 billion in 2004, at a growth rate of 17 percent. China’s faster growth in trade than the world results in a rapid rise in China’s ranking and share in the world trade. As shown in Table 1.2, China’s exports share in 1977 is only 0.6 percent of world exports, ranked as the thirty-fourth. By 2004 China had become the third largest exporting country in the world, and its share in world exports increased to 6.5 percent. The expansion of China’s trade has been faster than that of its gross domestic products (GDP), as indicated in Table 1.3. The ratio of trade to GDP rose from less than 10 percent in 1978 to 75 percent in 2004. ment direct controls on trade, especially restrictions on imports, have been gradually relaxed. Thus trade reforms as a necessary condition for the trade boom was created over time. According to the theory of international trade, trade volume in a country is positively associated with that country’s GDP. China’s GDP grew at a rate of near 10 percent in the last 26 years, the highest in the world for that period.

The third source of the trade boom is the emergence of export-oriented foreign-invested enterprises (FIEs) (Zhang and Song, 2000). China had been the largest FDI recipient among the developing countries and globally the second since 1993, and has become the number one in the world since 2002. Most of the inward FDI in China came from Asian newly industrialized economies (NIEs), in particular Hong Kong and Taiwan, based on changing comparative advantages between China and the NIEs. The NIE invested enterprises in China emerge as a result of reallocating production into China due to rising labor costs in their homes. As more FDI flows into China and the export-oriented FIEs are established, their contribution to China’s exports and imports increased dramatically. As indicated in Table 1.3, the share of exports by FIEs in total exports was 20 percent in 1992. The share was doubled after four years, and reached almost 50 percent in 2001. In fact, without exports by FIEs, China’s export growth would be less than its GDP growth.²

The fourth factor contributing to the trade boom is devaluation of the Chinese currency relative to foreign currencies. As shown in Table 1.3, the exchange rate of Chinese currency (denoted by RMB) to US dollar was RMB1.6836 per US dollar in 1978. The rate was devalued gradually in the 1980s to RMB³.7651 in 1989. Then in the following five years, the Chinese government lowered the rate substantially, to the level of RMB8.6187 per US dollar. According to international trade theory China’s devaluations would make its products cheaper in the world market and thus would cause its exports to grow. This is especially true, since the increase in the competitiveness of Chinese products in the world market was no as fast as it exports in the last ten years.

Table 1.2 China’s export share and ranking in the world, 1977–2004

Note
World exports and China’s exports are in nominal values of billions US dollars.

Table 1.3 China’s trade share in GDP, manufactured trade shares, exports by foreign-invested enterprises (FIEs), and exchange rate, 1980–2004

Note
World exports and China’s exports are in nominal values of billions USD.

Main characteristics of trade

The critical role of processing trade and FDI

The duty-free processing trade in China has two variants in practice: processing imported materials into exports (lai liao jia gong in Chinese) and processing imported components into exports (jin liao jia gong). The first one, referred to as processing materials, takes place under a contract in which a foreign firm (usually located in Hong Kong) ships materials to domestic factories for processing or assembly and subsequent re-export. The foreign firm retains ownership and pays a processing fee to the domestic factories, which usually play a fairly passive role in such contracts. The domestic factories, often township or village enterprises, account for the bulk (86 percent in 1995) of this type of processing trade (Naughton, 1996). In the second type of processing trade, called processing imports, a factory in China purchases the imported materials and organizes production and exports on its own. Foreign invested firms account for the bulk of trade value under this variant (74 percent in 1995).

As a new form of trade, the processing trade has increased rapidly in China during the past 24 years. The share of exports under processing trade in total exports rose from 18 percent in 1986, to 47 percent in 1992, and to 55 percent in 2004. The share of imports in total imports went up from 16 percent to 41 percent, correspondingly (Table 1.4). At least two factors contribute to the rapidly growing processing trade. First, the export-oriented FDI strategy adopted by the government encourages foreign firms (mainly from Hong Kong and Taiwan) to engage in processing trade. Table 1.5 shows trade by ownership in 2004. FIEs generate 57 percent of total exports and 58 percent of total imports. Most of exports and imports conducted by FIEs are associated with processing trade. Along with China’s cheap resources (e.g. labor and land), a variety of incentive policies also play a role in attracting large inflows of foreign investment to exporting production. The role of this kind of FIEs in processing trade increased significantly in the 1990s. The share of the trade by FIEs in total processing trade tripled in ten years from 21 percent in 1988 to 80 percent in 2004. Another factor is related to the classification method of processing trade. Due to growing globalization and international specialization of labor, more exports involve imported foreign contents, rather than traditional exports that have complete domestic contents only. Although domestic value-added in exports may constitute a small part in the total, the trade volume increases incredibly as a broad definition of processing trade is used in trade statistics.

Table 1.4 Exports by trade mode, 2004 (%)

Table 1.5 Trade by ownership, 2004

Improving commodity structure of trade

Due to industrial upgrading and rapid economic growth, China’s exports have being experiencing two shifts: one is from primary to manufacturing products, and the other from labor-intensive to capital-intensive manufacturing products. In 1978, more than half of China’s exports (63 percent) were primary products. The share fell to 30 percent in 1988 after ten years, and then...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• Illustrations
• Contributors
• Introduction
• Part I: Export Competitiveness
• Part II: Fdi, Trade, and Industrial Development
• Part III: Wto, Exchange Rates, and Labor Markets
• Part IV: Concluding Remarks