Economist: "The Old Chinese Myth"

The Economist looks at China's ability to weather any fall in demand from the US if, as seems likely, it heads in a recession with consumers tightening their belts.

The issue is whether domestic consumption can be encouraged to offset any decline in exports.

An old Chinese myth [The Economist]

Contrary to popular wisdom, China's rapid growth is not hugely dependent on exports

MOST people suppose that China's economic success depends on exporting cheap goods to the rich world. If so, its growth would be seriously dented by a stuttering American economy. Headline figures show that China's exports surged from 20% of GDP in 2001 to almost 40% in 2007, which seems to suggest not only that exports are the main driver of growth, but also that China's economy would be hit much harder by an American downturn than it was during the previous recession in 2001. If exports are measured correctly, however, they account for a surprisingly modest share of China's economic growth.

When measured correctly (although the methodology employed is still debatable) then the ratio of exports to GDP falls to 10%.

But what about employment (and then all important political stability). Not such a problem:

Employment figures also confirm that exports' share of the economy is relatively small. Surveys suggest that one-third of manufacturing workers are in export-oriented sectors, which is equivalent to only 6% of the total workforce.

However, 6% of the Chinese work force is a seriously large number of people that you would not want camped out on your doorstep.

Many of China's foreign critics remain sceptical. They argue that China's massive current-account surplus (estimated at 11% of GDP in 2007) proves that it produces far more than it consumes and relies on foreign demand to buy the excess. In the six years to 2004, net exports (ie, exports minus imports) accounted for only 5% of China's GDP growth; 95% came from domestic demand.

The economist correctly goes on to link exports with investment. Whilst China moves up the quality ladder via increasing investment in high technology and high valued added products a lot of this investment is driven by export potential.

China's economy is driven not by exports but by investment, which accounts for over 40% of GDP. This raises an additional concern: that weaker exports could lead to a sharp drop in investment because exporters would need to add less capacity. But Arthur Kroeber at Dragonomics, a Beijing-based research firm, argues that investment is not as closely tied to exports as is often assumed: over half of all investment is in infrastructure and property. Mr Kroeber estimates that only 7% of total investment is directly linked to export production. Adding in the capital spending of local firms that produce inputs sold to exporters, he reckons that a still-modest 14% of investment is dependent on exports. Total investment is unlikely to collapse while investment in infrastructure and residential construction remains firm.

Again, things are not so simple. Property is built for a reason and needs to be sold to someone. Likewise with infrastructure. A fall in exports could trigger a reversal in more than just exports as the fall in confidence reverberates around the economy.

The article concludes:

Dragonomics forecasts that in 2008 the contribution of net exports to China's growth will shrink by half. If the impact on investment is also included, GDP growth will slow to about 10% from 11.5% in 2007. This is hardly catastrophic. Indeed, given Beijing's worries about the economy overheating, it would be welcome.

I think this is an overly optimistic forecast. For one a recession in the EU or Japan would have an effect of a similar magnitude to the US. Second, the asset bubbles in China do not require much encouragement to burst.

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