China's Growing External Dependence

• Author: Li Cui
• Position: Senior Economist in the IMF's Asia and Pacific Department
• Pages: 42-45

Page 42

The country's economic fortunes are increasingly tied to those of the global economy

RAPIDLY growing foreign trade has been key to China's remarkable economic performance of the past three decades, yet the conventional view is that China's growth has been largely domestically driven. According to this view, China uses its abundant labor to assemble imported inputs into low-tech consumer goods and capital goods exports, making it the world's workshop.

Such processing trade typically adds little value to the domestic economy because the import content of exports is high. As a result, the argument goes, changes in global demand or in the exchange rate will have little direct impact on the economy's trade balance or growth-any change in exports will be largely offset by changes in imports.

So how does trade contribute to growth? the answer is through the transfer of better technology. This caricature of China's trade underlies many formal analyses and policy discussions and even garners support from some empirical studies. For instance, Shu and Yip (2006) find that relative price changes have had a small effect on China's exports and trade balance, an outcome that has been attributed to its role as a processing center.

But such a reading of China's economy does not reflect current realities. Although it may have described the Chinese economy in the early stages of reform, when China lacked domestic technological know-how and had to rely on imported intermediate products and capital goods for its production and exports (see Lemoine and Ünal-Kesenci, 2002), a Page 43 recent IMF study suggests that it may have become less accurate in recent years (Cui and Syed, 2007). The domestic content of China's exports has increased and its products have become more sophisticated, in part because of substantial investments and technological upgrades that have expanded the economy's production capacity.

Advancements in regional vertical integration (the degree to which a firm owns its upstream suppliers and its downstream buyers) have helped to extend China's domestic value added in the global supply chain, particularly in less sophisticated sectors. These developments, together with a shift in product composition that could make exports more responsive to external shocks, imply that China's trade balance and economic growth have become more sensitive to external demand and exchange rate changes than is generally recognized or estimated from historical averages. This trend is likely to continue as China's trade structure continues to evolve.

A closer look at the trade surplus .

Over the past four years, China's trade surplus has risen sharply, reaching about $218 billion, or more than 8 percent of GDP in 2006, from an average of about 3 percent of GDP between 2000 and 2004. The trade surplus has been propelled by a sharp rise in the manufacturing sector surplus. In particular, machinery, electronic appliances, and transportation equipment account for more than half of the trade surplus, compared with a significant deficit only a few years ago.

"With the expansion of domestic supply, China is increasingly shifting from simple assembly operations toward operations that have greater scope for using domestic inputs."

The widening of the trade surplus has been driven mainly by a significant slowdown in imports, which started to lag export growth by large margins in early 2005. In contrast, during most of the past decade, import and export growth were typically on a par, consistent with China's role as a processing...