Policy changes in China are expected to have a broad impact on growth patterns around South Asia. In this article, we investigate what is going on, what it means for South Asian economies, and discuss the ways in which New Zealand is different.
Why must China, and the rest of Asia rebalance?
The changes currently underway in China, and around Asia as a whole, are more significant for the outlook for the New Zealand economy than all other global events.
Rapid growth in China and developing Asia has taken place as the governments in these regions have transferred wealth from households to businesses. This process has led to a significant increase in inequality, and has shaped what these countries have invested in and the ways that the “South Asian supply chain” is integrated.
We have discussed the idea of rebalancing in China previously, and although China is the main player in the area, there is a broader story. In essence, the economic policies established by the government in China have had a massive effect on the design of institutions and industry throughout South Asia and into Australia (ie the mining boom).
This vertical trade integration across Asia is incredibly important for trying to understand the effects of any policy changes in China. Furthermore, given how poor economic data from China is, we can use the knowledge about supply chains to interpret movements in prices or activity in other Asian countries as information about China itself!
Why China must change
The growth in economic activity in China has been phenomenal, making China a world power, and pulling millions of people out of absolute poverty.
However, the growth in incomes and increasing urbanisation of China is only part of the story. An often-ignored element is the growth in inequality, both in terms of incomes and opportunity. While the incomes and opportunities of the worst-off in China have risen in recent decades, those who are favoured by the government have seen a disproportionately stronger increase.
When we think about the stability of a society, these relative incomes and opportunities matter.
China was able to sustain rapid economic growth by forcing households to heavily subsidise business investment, through forced household savings and direct payments to business. When a country is using antiquated technology and methods (an economist would say they are below their “production frontier”), such subsidisation can, in some conditions, help out both businesses and households.
However, with Chinese factories now relatively modern, these subsidises are increasingly propping up inefficient methods and unfairly taking income away from employees to improve the bottom line of business owners who are friendly with the regime.
The Gini coefficient shown in Graph 5.1 is a measure of how unequal (after taxes and transfers) incomes within a country are. Although this measure is far from perfect, it gives an objective indication of changes in income inequality through time and between nations.
To give Graph 5.1 some context, the Gini coefficient (after taxes and transfers) in New Zealand tends to sit at around 33. Furthermore, even though official Chinese estimates give a Gini coefficient of around 47 or 48, research from the Survey and Research Centre for China Household Finance estimated that the coefficient in China was actually 61, due to the significant underreporting of income by wealthier Chinese residents.
In this case, the Chinese government would like to “rebalance” activity, or change incentives, so that decisions about where to invest and what to produce are more closely aligned with genuine underlying value. In the end, such a change would make growth in China more sustainable and reduce inequality in incomes and opportunities from its current nose-bleedingly high levels. However, the concern is the transition.
Since we wrote about rebalancing in China in mid-2012, rhetoric from the Chinese government and data from China have pointed to a controlled shift in policy settings.
- China cut its economic growth target for 2013 to 7.5%. Furthermore, there has been significant talk of the growth target for 2014 being cut to somewhere in the range of 6-7%pa.
- For most of 2013, China’s performance of manufacturing index has been at, or close to, contractionary readings.
- The bankruptcy of Suntech, a previously highly subsidised producer of solar panels, is the most high-profile sign of a change in industrial policy within China. Direct subsidies and access to more favourable loans for exporters are being cut back.
- There has been the release of a new government-sanctioned Gini index, combined with public pronouncements to reduce inequality.
As a result, although there are still significant risks around China, their programme of rebalancing appears to have been successful so far.
Previously we have made the point that lower Chinese subsidises on manufactured goods will lead to higher prices for these products around the world, including in New Zealand. However, given the integrated nature of the South Asian supply chain, what will the changes in China do to export prices around the region?
The effect on the Asian supply chain
With China seemingly on top of the transition in its economy, it becomes important to ask about the effects of these changes on the countries that China trades with.
As we will discuss below, New Zealand is a special example – we do not fit into the supply-chain story in the same way as other South Asian economies. So before discussing New Zealand, we need to look at what is going on with the rest of South Asia.
Recent research suggests that the manufacturing focus of China, compared with a growing number of free-trade agreements in Southern and Eastern Asia, has led to significant integration in the supply chains between countries in this region. A number of people call this “factory Asia”.
With China focusing on creating higher-value output while simultaneously opening its borders to trade, it has created opportunities for smaller nations to fulfil a number of roles in its relationship with China such as:
- providing access to the raw materials required for this production
- producing manufactured parts and components that are required for manufacturing more generally
- providing niche parts and components that fit a certain role within Chinese products
- providing human capital and the intellectual property behind value-added production.
In the past Japan and, to a lesser extent, Korea had filled these roles. But the scale of China, combined with its relatively higher reliance on other Asia economies (instead of imports from the West), has seen the demand for the first three types of products rise sharply.
Australia is a prime example of a country that has benefited from becoming part of the factory Asia supply chain. By providing coal, copper, and iron ore, the Australian economy has gained part of the value-add associated with Chinese economic development. These gains can be seen most clearly by looking at the Australian export commodity prices provided by the Reserve Bank of Australia.
Australia’s integration with China is also demonstrated by its growing trade reliance on China.
Similar trends to the one experienced in Australia have been observed in nations throughout Southern and Eastern Asia.
As well as demanding raw and intermediate materials along the supply chain, China has been building up its capabilities for producing both raw and intermediate products – which are often then on-sold to create final products in other Eastern and Southern Asian countries.
While these trends have been unfolding, it has appeared to many people that New Zealand has been the big loser. We have not been selling much in the way of raw hard commodities, we have not been providing intermediate parts and components, and we have not been putting together fancy value-added final production.
The sharp increase in dairy prices and corresponding significant lift in trade with China has started to change perceptions over the last few years. However, the boost to activity and income in New Zealand from Chinese demand has so far been more limited than that experienced in other countries throughout Southern and Eastern Asia.
Nevertheless, New Zealand has also benefited through lower import costs for manufactured products. Factory Asia has boosted global manufacturing productivity and driven down the price of manufactured goods. As importers of manufactured goods, and consumers of the services produced by manufactured consumable products, New Zealanders have benefited.
New Zealand – an inadvertent relative winner from this change?
Our preceding discussion treated South Asian countries as input providers, feeding inputs (for the right price) into the Chinese industrial machine. This trend has led businesses and policymakers to feel justifiably nervous about these changes in China and the effects they could have on the New Zealand economy.
But focusing solely on growth in China, and not the composition of growth, would lead us astray. The Chinese government, in its centrally planned glory, is concentrating on boosting household consumption, sharing the gains of growth more evenly, and pulling back from supporting manufactured goods industries as much.
These changes imply that demand for inputs for manufacturing should grow more weakly than China’s headline growth numbers suggest. Furthermore, they also imply that demand for consumption goods and durable products desired by households in China will rise more quickly than China’s growth numbers would suggest.
Unlike other South Asian countries, New Zealand’s focus is not on selling raw materials or intermediate products for producing Chinese manufactured goods. We largely sell dairy products, meat, horticultural products and wool.
As a result, New Zealand’s experience from changing policies in China will be very different to the experience in other South Asian economies (including Australia). The outcomes for New Zealand are discussed in more detail in Chinese rebalancing: NZ to outperform Aussie? (p38).
 Although “factory Asia” has concentrated on building up the trade in raw and intermediate inputs domestically, when it comes to final sales, the supply chain as a whole relies significantly on demand from the West. The fragility associated with this reliance, which was highlighted by the drop in trade during the Global Financial Crisis, adds to China’s determination to restructure.
 Forestry exports to China have also been strong, which would not be expected given our discussion above. However, the reasons for this outcome are described in Drivers of upturn in forestry industry lie beyond China (p42).
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