For starters, China’s current-account surplus has shrunk from its 2007 peak of 10% of GDP to just over 2% last year – its lowest level in nine years. In the third quarter of 2014, China’s external surplus stood at $81.5 billion and its capital and financial account deficits amounted to $81.6 billion, reflecting a more stable balance of payments.
This shift can partly be explained by the fact that, over the last two years, developed countries have been pursuing re-industrialization to boost their trade competitiveness. In the United States, for example, manufacturing grew at an annual rate of 4.3%, on average, in 2011-2012, and growth in durable-goods manufacturing reached 8% – having risen from 4.1% and 5.7%, respectively, in 2002 and 2007. Indeed, America’s manufacturing industry has helped to drive its macroeconomic recovery.
Meanwhile, as China’s wage costs rise, its labor-intensive manufacturing industries are facing increasingly intense competition, with the likes of India, Mexico, Vietnam, and some Eastern European economies acting as new, more cost-effective bases for industrial transfer from developed countries. As a result, the recovery in the advanced economies is not returning Chinese export demand to pre-crisis levels.
These trends – together with the continued appreciation of the renminbi – have contributed to the decline of Chinese goods’ market share in developed countries. Indeed, Chinese exports have lost some 2.3% of market share in the developed world since 2013, and about 2% in the US since 2011.
Incipient trade agreements like the Trans-Pacific Partnership, the Transatlantic Trade and Investment Partnership, and the Plurilateral Services Agreement will accelerate this process further, as they eliminate tariffs among certain countries and implement labor and environmental criteria. Add to that furtive protectionism, in the form of state assistance and government procurement, and Chinese exports are facing serious challenges.
China is also undergoing an internal rebalancing of investment and consumption. As it stands, declining growth in fixed-asset investment – from 33% in 2009 to 16% this year – is placing significant downward pressure on output growth. Investment’s contribution to GDP growth fell from 8.1 percentage points in 2009 to 4.2 last year.
One reason for the decline is that China has yet to absorb the production capacity created by large-scale investment in 2010-2011. Aside from traditional industries like steel, non-ferrous metals, construction materials, chemical engineering, and shipbuilding, excess capacity is now affecting emerging industries like wind power, photovoltaics, and carbon fiber, with many using less than 75% of their production capacity.
But the decline in investment is also directly correlated with that of capital formation. In 1996-2012, China’s average incremental capital-output ratio – the marginal capital investment needed to increase overall output by one unit – was a relatively high 3.9, meaning that capital investment in China was less efficient than in developing countries experiencing similar levels of growth.
Moreover, the cyclical increase in financing rates and factor costs has brought a gradual restoration of the price scissors of industrial and agricultural goods. As a result, industrial firms’ profits are likely to continue to fall, making it difficult to sustain high investment.
Meanwhile, the expansion of China’s middle class is having a major impact on consumption. Last year, China surpassed Japan to become the second-largest consumer market in the world, after the US.
To be sure, Chinese imports remain focused on intermediate goods, with imports of raw materials like iron ore having surged over the last decade. But, in the last few years, the share of imported consumption goods and mixed-use (consumption and investment) finished products, such as automobiles and computers, has increased considerably. This trend will contribute to a more balanced global environment.
The final piece of China’s rebalancing puzzle is technology. As it stands, a lag in technological adoption and innovation is contributing to the growing divide between China and the Western developed countries, stifling economic transformation and upgrading, and hampering China’s ability to move up global value chains.
But, as China’s per capita income increases, its consumer market matures, and its industrial structure is transformed, demand for capital equipment and commercial services will increase considerably. Indeed, over the next decade, China’s high-tech market is expected to reach annual growth rates of 20-40%.
If the US loosens restrictions on exports to China and maintains its 18.3% share of China’s total imports, American exports of high-tech products to China stand to reach more than $60 billion over this period. This would accelerate industrial upgrading and innovation in China, while improving global technological transmission and expanding related investment in developed countries.
China’s economy may be decelerating, but its prospects remain strong. Its GDP may have reached $10 trillion in 2014. Once it weathers the current rebalancing, it could well be stronger than ever.
Copyright: Project Syndicate, 2015.
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