EconSouth (Second Quarter 2005)

China’s Economic Emergence

Once referred to as a “sleeping giant,” China is waking up. Its rapidly growing economy is creating economic ripples and shaking up industries worldwide.

China’s emergence as a global economic power has been among the most dramatic economic developments of recent decades. Its impact on the U.S. and Southeastern economies—in terms of both imports and exports—has transformed national and regional economic policies and business practices. Decisions by policymakers, firms, and consumers will likely be affected by China’s emerging economic clout.

From 1980 to 2004 China’s economy averaged a real gross domestic product (GDP) growth rate of 9.5 percent and became the world’s sixth-largest economy (see chart 1). The country’s integration into the global economy is reflected mainly in its rapidly growing role in international trade, with the country’s total share in world trade expanding from 1 percent in 1980 to almost 6 percent in 2003. By 2004, China had become the third-largest trading nation in dollar terms, behind the United States and Germany and just ahead of Japan.

Rapid economic growth has moved a great number of Chinese out of poverty, but many remain mired there. In 2004 China’s per capita GDP (the ratio of GDP to population) was $1,100, according to the World Bank, which lists the country as a “lower middle income country,” on par with Paraguay and below countries like Albania ($1,740) and Guatemala ($1,910). China remains much poorer than many of its neighbors, including South Korea ($12,020) and Singapore ($21,230).

Seeds of growth planted years ago
The beginning of the transformation from an economy whose output was determined by the central government into a more market-based economy was made possible through major economic reforms and the general opening of the economy. Beginning in 1979, Deng Xiaoping, who emerged as China’s leader in 1978, launched an economic reform program that would slowly change the way the country’s economy functioned. Initially, his reforms focused on the agricultural sector. Prices of agricultural goods increased, production restrictions and taxes went down, and, most importantly, responsibility, ownership, and production decisions were transferred from communes and local governments to households. These changes raised household income, which in turn increased investment, savings, and overall demand for goods in the country.

In the mid-1980s, the industrial sector underwent reforms that allowed privately and individually owned enterprises to supplement existing state-owned companies, introducing some price and wage liberalization to state-owned enterprises. In addition, some state-owned enterprises were allowed to retain a portion of their profits as an incentive for good performance, and 14 major cities along the coast were opened to foreign trade and investment. These reforms attracted foreign direct investment in the form of new enterprises (mainly joint ventures) and foreign capital, which increased the development of technology and infrastructure industries, such as energy and transportation, and created new jobs.

Through the late 1980s and into the 1990s, Chinese authorities continued to improve the reform process by using “models” to experiment with new policies and reforms. They put models in place in specific regions and firms to evaluate the success of a policy before full implementation took place. As a result, failed reforms would have relatively contained costs. Deng Xiaoping said this approach was like “crossing the river by feeling the stones under the feet.”

Special economic zones, which gradually introduced foreign capital, technology, and trade, were also maintained and expanded. Chinese authorities substantially reduced tariffs, and most import and export controls were relaxed. Exports from China diversified from textiles and other light manufacturing goods such as toys, clothing, and footwear to more sophisticated electronics, furniture, industrial supplies, and travel goods such as luggage, purses, briefcases, and laptop computer bags.

In addition, the country turned itself into a regional production center and manufacturing point for reexports, or exports of previously imported goods. Imports to China increasingly came from other Asian countries, and a corresponding increase in exports was flowing to developed countries, especially the United States and Europe. Overall, from 1990 to 2000 exports grew almost 300 percent while imports grew 318 percent. During that period, exports from China to the United States alone grew 880 percent, and U.S. exports to China grew almost 230 percent.

Reaping the fruit
Foreign direct investment in China soared during this time. In the 1980s foreign direct investment in China averaged less than $5 billion a year, and during the 1990s that figure rose to nearly $30 billion. In 2004, total foreign direct investment in China was just over $60 billion, according to the Chinese Ministry of Commerce.

Chart 1
China’s Economic Growth
Source: China’s National Bureau of Statistics
Chart 2
U.S. Trade Balances
Source: U. S. Census Bureau

China’s admission into the World Trade Organization (WTO) on Dec. 11, 2001, furthered the country’s ongoing integration into the global economy and demonstrated its perseverance in converting itself into a market-based economy. Chinese authorities continue to lower tariffs and trade barriers in compliance with its WTO commitments. Prices have become increasingly market determined, and traded goods’ prices have substantially converged with international prices.

China’s economy continues to grow rapidly, mainly driven by investment and exports. In 2004 government authorities took steps to prevent the economy from overheating. These measures included raising bank reserve requirements, which limited loans and restricted investment, and restricting certain industries’ land-use authorizations (especially the real estate, steel, cement, and aluminum industries). However, real GDP growth in 2004 remained at an estimated 9.5 percent, the highest rate since 1996. The average forecast for Chinese economic growth points to expansions in real GDP of 8 percent to 8.5 percent in 2005 and 2006.

Hurdles still exist
Despite the current optimistic scenario, many challenges remain for China to fulfill its potential for strong, sustainable growth and continued integration into the global economy. In the near term, plans are in place to develop key service sectors such as telecommunications, insurance, and financial services. In the medium term, the country will likely move to improve labor markets and establish social safety nets, and policymakers may address exchange rate flexibility. Overall, as reforms are implemented, China’s role in the global economy will likely continue to become more pronounced.

China’s growing impact on U.S. trade
China’s emergence on the global economic stage has had a significant impact on the United States. The most visible effect is in the U.S. trade accounts, where the trade deficit with China accounts for nearly one-quarter of the total imbalance. Chart 2 shows that the U.S. trade balance has deteriorated against most major trading areas, but the imbalance with China has accelerated over the last several years.

China has also benefited from the elimination of textile quotas in the United States and elsewhere. Total U.S. textile and apparel imports from China rose sharply in early 2005, up over 60 percent year-over-year, according to the U.S. Census Bureau’s Foreign Trade Division.

While U.S. producers are concerned about losing market share to Chinese imports, China’s emergence has brought new opportunities for exporters, especially those of primary commodities and manufacturing inputs that fuel China’s production centers. With so much attention given to imports from China and the large trade imbalance, the increase in U.S. exports to China sometimes goes unnoticed. Total U.S. exports to China were up more than 20 percent in 2004 compared to 2003, according to U.S. Census Bureau figures. Exports of cotton doubled to more than $1.5 billion between 2003 and 2004. Shipments of industrial metals doubled to more than $2.3 billion between 2002 and 2004, and industrial machinery exports were up over 75 percent during the same period. Exports of higher-tech goods, like semiconductors and medical equipment, are up nearly 50 percent over the last two years. Overall, China is running a modest trade surplus with the rest of the world at just over $33 billion.

“Competition from Chinese exports has benefited consumers across the world as well,” according to Anne Krueger, first deputy managing director of the International Monetary Fund, in a January 2005 speech to the American Enterprise Institute Seminar. “Let us not forget that competition is one of the great benefits that freer trade brings, even when it forces some painful restructuring for those firms unused to it,” she said.

Southeast textiles hard hit
Painful restructuring is something the textile industry in the Southeast has been undergoing for some time, beginning well before China’s emergence on the global economic stage and its subsequent increase in textile shipments to the United States. (See “Challenges Loom Large for Southeastern Textile Producers and Cotton Growers.”) Other emerging markets in Latin America and Asia have also increased textile and apparel imports into the United States, so it’s not just China that has led to a decline in U.S. textile production and employment.

But with regard to textiles and apparel, the trade situation with China is unique because of China’s potential dominance of the global market for these goods. In the Southeast, where the textile and apparel industry presence is more pronounced, the impact will be even greater. On Feb. 3, 2005, in testimony before the U.S.-China Commission of the U.S. Congress, National Council of Textile Organizations President Cass Johnson said, “If governments do not act and act quickly [to address Chinese textile imports], the U.S. textile and apparel sector—along with much of the world’s textile and apparel production—is today on the cusp of an unprecedented disaster.”

At the same time, exports from the Southeast to China have risen significantly in recent years. State export data from the Census Bureau show that total exports from the Southeast doubled from 2002 to 2004 to just over $5.2 billion. Although these exports to China accounted for only 5.5 percent of that total in 2004, the figure is up from 3.3 percent just two years earlier. Agricultural exports from the Southeast also soared over that period, from just over $670 million to nearly $2.5 billion in 2004.

A large part of that increase can be attributed to shipments through the port of New Orleans, which are reported in the data as exports from Louisiana. Goods from upriver states outside the Southeast contribute to the total, so the value of shipments attributed to Louisiana is quite overstated. Nevertheless, Southeastern trade with China is growing rapidly.

The expansion of China’s textile and apparel industry has led to increased cotton exports to China. Don Shurley, an economist and coordinator of the University of Georgia’s Department of Agricultural and Applied Economics in Tifton, Ga., noted in a recent report that “Anyway you look at it, China is a major player. Clearly, the well-being of the U.S. cotton producer, at least for now, is largely dependent on China’s production and need for imports.”

Grabbing the tiger’s tail
China’s opening to the world economy presents opportunities and challenges to policymakers and business leaders. Fully integrating the Chinese economy into global commerce is in the early stages, and the persistent imbalances hint at the bumpy road ahead. Multilateral and bilateral treaties and discussions are needed to manage the process, and U.S. and regional businesses will have to continue to adjust to the reality of China’s emergence as a global economic player.

This article was written by Michael Chriszt, director of international and regional analysis for the regional group of the Atlanta Fed’s research department, and Elena Whisler, an economic analyst in the Atlanta Fed’s regional group.

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