terça-feira, 28 de agosto de 2012

The implications of China’s slowdown


Teenage angst

CHINA, an ancient civilisation, is still in its economic adolescence, a phase marked by growth spurts and mood swings. Other emerging economies endure this awkward period in relative obscurity, attracting only cursory attention. China has no such luck. It has become big before becoming rich, inviting scrutiny typically reserved for mature economies.
China may not be a member of the G7 group of big, rich democracies. But it is already a member of the so-called S5, or Systemic Five, a group of economies subject to extra IMF attention because of their “systemic” significance. China, according to the fund, is the most “central” trading power in the world, based on its extensive trade links to other economies that are themselves tightly interwoven. It is the biggest or second-biggest trading partner for 78 countries. Its appetite for imports, especially the base metals and oil that feed its vast industrial machine, flatters the exports of countries as far afield as Azerbaijan and Angola.
Trade is not the only measure of China’s economic influence. Many foreign companies have set up shop inside the country, profiting from its market without having to export to it. To obtain a broader measure of multinational exposure to the Middle Kingdom, The Economist has prepared a stockmarket index made up of 135 S&P 500 companies, weighted by China’s reported share of their revenues. (For companies that report revenues only for the Asia-Pacific region as a whole, we have assumed China’s share of regional revenues reflects its share of the region’s GDP.)

This new and improved “Sinodependency” index has massively outperformed the S&P 500 in recent years, climbing by almost 129% since the beginning of 2009, compared with the S&P 500’s gain of 57% (see chart 1). It has also performed far better than China’s own stockmarkets. Buying American firms exposed to China may be a better investment strategy than buying Chinese firms themselves. That is just as well, because foreign participation in China’s stockmarkets is still circumscribed.
China’s precocious economy has, however, turned sullen and morose of late. The preliminary results of HSBC’s August survey of over 420 manufacturing firms, many of them private, showed orders falling and inventories backing up. The ratio of orders to inventories was at its worst since December 2008. This disappointment followed the announcement that house prices rose in 49 out of 70 cities last month, a revival deemed bad news as it might delay further monetary easing.
A sharp slowdown in Chinese investment was one of the risks examined by the IMF in a report this month on the systemic five. Ashvin Ahuja and Malhar Nabar of the fund have calculated the impact on China’s trading partners of a one-percentage-point slowdown in Chinese capital formation. In the second chart, we have extrapolated their results. Our baseline is the IMF’s 2012 growth forecasts for each country (made back in April, a happier time). The chart shows the effect on growth of a soft landing, which we define as a two-percentage-point slowdown in China’s investment growth. It also depicts a harder landing, which we define as a 3.9-point slowdown, the same as it endured in 2008.

A hard landing would hobble South Korea and bring Taiwan’s growth to a shuddering halt. But growth in Brazil and Australia would hold up surprisingly well, perhaps because their currencies would fall, absorbing some of the shock. However, these estimates capture only the direct impact of a Chinese slowdown, as transmitted through its trade links. Messrs Ahuja and Nabar point out that stockmarkets around the world would also swoon. And some countries would be hit by indirect effects: Germany, for example, would suffer both a loss of exports to China and to countries that sell a lot to China. Adolescents have an uncanny ability to spoil things for everybody.

Dependence on China

The indispensable economy?

China may not matter quite as much as you think

THE town of Alpha in Queensland, Australia, has only 400 residents, including one part-time ambulance driver and a lone policeman, according to Mark Imber of Waratah Coal, an exploration firm. But over the next few years it should quintuple in size, thanks to an A$7.5 billion ($7.3 billion) investment by his company and the Metallurgical Corporation of China, a state-owned firm that serves China's mining and metals industry. This will build Australia's biggest coal mine, as well as a 490km (300-mile) railway to carry the black stuff to the coast, and thence to China's ravenous industrial maw.
It is hard to exaggerate the Chinese economy's far-reaching impact on the world, from small towns to big markets. It accounted for about 46% of global coal consumption in 2009, according to the World Coal Institute, an industry body, and consumes a similar share of the world's zinc and aluminium. In 2009 it got through twice as much crude steel as the European Union, America and Japan combined. It bought more cars than America last year and this year looks set to buy more mobile phones than the rest of the world put together, according to China First Capital, an investment bank.
In China growth of 9.6% (recorded in the year to the third quarter) represents a slowdown. China will account for almost a fifth of world growth this year, according to the IMF; at purchasing-power parity, it will account for just over a quarter.
The Economist has constructed a “Sinodependency index”, comprising 22 members of America's S&P 500 stockmarket index with a high proportion of revenues in China. The index is weighted by the firms' market capitalisation and the share of their revenues they get from China. It includes Intel and Qualcomm, both chipmakers; Yum! Brands, which owns KFC and other restaurant chains; Boeing, which makes aircraft; and Corning, a glassmaker. The index outperformed the broader S&P 500 by 10% in 2009, when China's economy outpaced America's by over 11 percentage points. But it reconverged in April, as the Chinese government grappled with a nascent housing bubble.
China is, in itself, a big and dynamic part of the world economy. For that reason alone it will make a sizeable contribution to world growth this year. The harder question is whether it can make a big contribution to the rest of the world's growth.
China is now the biggest export market for countries as far afield as Brazil (accounting for 12.5% of Brazilian exports in 2009), South Africa (10.3%), Japan (18.9%) and Australia (21.8%). But exports are only one component of GDP. In most economies of any size, domestic spending matters more. Thus exports to China are only 3.4% of GDP in Australia, 2.2% in Japan, 2% in South Africa and 1.2% in Brazil (see map).
Export earnings can, of course, have a ripple effect throughout an economy. In Alpha, the prospect of selling coal to China is stimulating investment in mines, railways and probably even policing. But these “multipliers” are rarely higher than 1.5 or 2, which is to say, they rarely do more than double the contribution to GDP. Moreover, just as expanding exports add to growth, burgeoning imports subtract from it. Most countries outside East Asia suffered a deteriorating trade balance with China from 2001 to 2008. By the simple arithmetic of growth, trade with China made a (small) negative contribution, not a positive one.
China plays a larger role in the economies of its immediate neighbours. Exports to China accounted for over 14% of Taiwan's GDP last year, and over 10% of South Korea's. But according to a number of studies, roughly half of East Asia's exports to China are components, such as semiconductors and hard drives, for goods that are ultimately exported elsewhere. In these industries, China is not so much an engine of demand as a transmission belt for demand originating elsewhere.
The share of parts and components in its imports is, however, falling. From almost 40% a decade ago, it fell to 27% in 2008, according to a recent paper by Soyoung Kim of Seoul National University, as well as Jong-Wha Lee and Cyn-Young Park of the Asian Development Bank. This reflects China's gradual “transformation from being the world's factory, toward increasingly being the world's consumer,” they write. Gabor Pula and Tuomas Peltonen of the European Central Bank calculate that the Philippine, South Korean and Taiwanese economies now depend more on Chinese demand than American.
Trade is not the only way that China's ups and downs can spill over to the rest of the world. Its purchases of foreign assets keep the cost of capital down and its appetite for raw materials keeps their price up, to the benefit of commodity producers wherever they sell their wares. Its success can boost confidence and productivity. One attempt to measure these broad spillovers is a paper by Vivek Arora and Athanasios Vamvakidis of the IMF. According to their estimates, if China's growth quickened by 1 percentage point for a year, it would boost the rest of the world's GDP by 0.4% (about $290 billion) after five years.
Since the crisis, China has shown that its economy can grow even when America's shrinks. It is not entirely dependent on the world's biggest economy. But that does not mean it can substitute for it. In April the Bank Credit Analyst, an independent research firm, asked what would happen if China suffered a “hard landing”. Its answer to this “apocalyptic” question was quite “benign”. As it pointed out, Japan at the start of the 1990s accounted for a bigger share of GDP than China does today. Its growth slowed from about 5% to 1% in the first half of the 1990s without any discernible effect on global trends. It is hard to exaggerate China's weight in the world economy. But not impossible.

Free exchange

Chains of gold

Modern supply chains are making it easier for economies to industrialise

GETTING rich used to be tough. For most of the past two centuries, few countries managed it. Lant Pritchett, an economist now at Harvard’s Kennedy School of Government, wrote in 1997 that “divergence, big time” between the rich and the rest was “the dominant feature of modern economic history.” But those stubborn gaps have begun to close. Industrialisation is suddenly everywhere. Since the mid-1980s, emerging markets have grown faster than advanced economies (see chart).
Liberal reforms and sound macroeconomic management surely helped. Yet recent research by Richard Baldwin of the Graduate Institute in Geneva suggests it is not so much the developing world that has changed as development itself. Today’s emerging markets face a different sort of globalisation than their predecessors 50 or 100 years ago.
Most advanced economies industrialised as part of what Mr Baldwin calls globalisation’s first great unbundling: the geographical separation of producers and consumers. Early in the industrial era, high transport costs restricted trade. Expensive shipping limited most manufacturers to sales within the same city or country. But as the industrial revolution progressed, steamships and railways slashed transport costs, exposing firms to foreign competition for the first time. The most productive firms were those best able to take advantage of economies of scale. A single large plant could produce goods at a lower unit cost than lots of smaller factories, and a cluster of large suppliers at lower cost still. Production clustered in massive cities in a few economies.
Catching the leaders meant building an entire supply chain from the ground up—and in the teeth of competition. Development was slow, laborious and rare. Japan and South Korea grew industries from modest beginnings. They entered global markets with inferior but cheap products, often supported by state aid, then slowly improved their technical competence. Painstaking accumulation of technological skill eventually enabled innovative multinational firms to emerge. Japanese and South Korean incomes converged with those in western Europe. Other emerging economies tried gamely to duplicate this success, to little avail. Aggressive industrial policies often strained government resources without delivering a critical mass in industry or the human capital needed for development.
A new model began to emerge in the 1980s. Lower transport costs were a catalyst. Yet more important, reckons Mr Baldwin, was a budding revolution in information and communication technology (ICT). Cheaper communications allowed firms to manage supply chains over ever greater distances. Companies discovered they could build plants in cheap locations, ship components there to be assembled and export the finished product around the world. While the first unbundling separated producing markets from consuming markets, the second broke up production entirely across long, multinational supply chains.
That made industrialisation a cakewalk compared with earlier times. A business-friendly government and cheap workers were often sufficient to get started; foreign firms provided technology and management. Emerging markets quickly signed on. Trade data analysed by Robert Johnson of Dartmouth College and Guillermo Noguera of Columbia University track the shift. Along multinational supply chains, they note, a single component may be exported several times, adding to tallies of gross trade but not to measures of value added. A fall in the ratio of the two measures (which they call the VAX) signifies an increase in supply-chain fragmentation. On this score, 1990 seems a critical point, after which the VAX sinks while trade volumes soar (see chart). Emerging-market growth surged at roughly that time.
Faster growth may be fickle growth, says Mr Baldwin. Whereas previous tigers built a deep technological capacity, many emerging markets now merely “borrow” technology from rich-world firms. Multinationals have an incentive to limit technology transfer, the better to preserve the bargaining power that comes with a credible threat to leave. Learning can still occur. China uses its size as leverage to extract concessions, often confining direct inward investment to joint ventures between foreign and domestic firms, for instance. Smaller markets lack that option. The limited spillovers from supply-chain industrialisation may leave them stuck in middle-income status. And there is always the risk that chains may shift again, leaving them high and dry.
Some worry that sprawling supply chains may allow ill winds from abroad to blow in more easily. But evidence suggests that supply-chain trade may have declined less and recovered faster than overall trade during the financial crisis. Japan’s 2011 earthquake echoed across the world but also demonstrated the system’s capacity for quick recovery. The more tenuous nature of supply-chain industrialisation may encourage governments to work harder to support trade and recovery in response to a crisis.
Ships and chips
The second unbundling has yet to banish distance. In a different paper, Messrs Johnson and Noguera find that supply-chain fragmentation has been greatest among neighbours. This has given rise to regional industrial clusters. Regional trade agreements are partly responsible, but time costs may be more important. ICT improvements have also made production more nimble, capable of just-in-time manufacturing and frequent design changes. Timely shipments of components are indispensable. Indeed, an analysis by David Hummels of Purdue University and Georg Schaur of the University of Tennessee estimates that a day in transit is equivalent to a tariff of between 0.6% and 2.3%, with the largest effects for parts and components trade. Industrialisation is now within easy reach of poor countries, provided they’re within easy reach of industrialisation.

Richard Baldwin, “Trade And Industrialisation After Globalisation's 2nd Unbundling: How Building And Joining A Supply Chain Are Different And Why It Matters”, NBER Working Paper No. 17716, December 2011
Robert C. Johnson, Guillermo Noguera, “Fragmentation and Trade in Value Added over Four Decades”, NBER Working Paper No. 18186, June 2012
Robert C. Johnson and Guillermo Noguera, “Proximity and Production Fragmentation”, American Economic Review, Vol. 102, No. 3, May 2012
David Hummels, Georg Schaur, “Time as a Trade Barrier”, NBER Working Paper No. 17758, January 2012

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