Last week, the Economist discussed the potential for China to become the driver of the world economy. Unlike the US, China is a ‘surplus country’ (as are Germany and Japan), in that the Chinese spend internationally less than they earn from international trade. As a result, commentators – particularly OECD-based ones staring down the barrel of anemic growth over the coming years – view China as having the capacity to “live a little more”, i.e. undergo sustained growth in consumption. The argument is that China is now about one eighth of the world economy (measured by PPP), so its size in the world economy would mean that sustained growth in consumption by Chinese people would have an impact on growth globally.
Taking stock, this means that China has come a long way in the last generation. Similar progress over the next generation – particularly if the next five to ten years is one of subdued growth in more developed economies – would mean that China could do to the US what the US did to the UK during the Long Depression of the 1870s and 1880s: overtake it and become the largest economy in the world.
Not surprisingly, this has resulted in a wealth of current research on the Chinese economy and its impact on everything from oil prices and exchange rates to sub-Saharan African development. Econbrowser reviews some of this research on China’s economic impact, focusing in particular on the findings from a recent symposium on China’s impact on the world economy.
One particular issue is whether China’s growth has de-industrialised other developing countries. Jörg Mayer of UNCTAD and Adrian Wood of Oxford ask this question and find that China’s opening up to trade has diminished labour-intensive manufacturing in other developing economies, primarily in East Asia, but that its impact has not been massive, and other developments often swamped its influence.
Theory: What Heckscher & Ohlin would say about flooding the global economy with workers
The economic reasoning behind this is a trade theory known as Heckscher-Ohlin. In its simplest terms, Heckscher-Ohlin suggests that countries will specialise in – and export – goods and services that involve factors of production (such as a particular type of land or skill) abundant in that country. China has lots and lots people, so when China opened up to world trade, it “effectively lowered the world average land/labour ratio and increased the share of workers with a basic education in the world labour force”. Whatever else was going on, what China’s opening up to trade meant in practice was that all other countries saw their relative endowment of factors such as land and labour change. More specifically, countries saw their comparative advantage move away from “labour-intensive manufacturing, which requires many workers with a basic education but little land”.
In plain English, economic theory suggests that the flooding of the world market with so many workers with a basic education should push developing countries further down the economic value chain, while it should push developed countries upwards, out of basic manufacturing and into more skill-intensive output.
Evidence: China’s impact on everywhere from East Asia to Latin America
So much for the theory, what about the evidence? To see whether China had this sort of Heckscher-Ohlin effect during the 1990s, the researchers set out to estimate (a) the size of the impact of China’s opening on world average factor endowments and (b) the average effect of a country’s relative endowments on the sectoral composition of its output and trade. Combining (a) and (b) allows a calculation of the impact of China on the average country’s sectoral structure.
The graph below shows some initial evidence suggesting that this may be the case. It shows the change in production of labour-intensive manufacturing relative to primary production in various regions of developing countries between 1980 and 2000. A positive fraction means that the economy’s output switched away from primary production to labour-intensive manufacturing, while a negative fraction means that the economy ‘regressed’ back into primary production.
In East Asia (excluding China), it would certainly seem the case that rapid industrialization was slowed by China’s entry on to the world market, but not so South Asia (driven by India). Elsewhere in the world, the impact of China might be more diluted, due to geographic and other factors, but in both Latin America/Caribbean (LAC) and Middle East/North Africa (MENA), some of the relative decline in manufacturing might be due to China. Sub-Saharan Africa (SSA) seems to be dancing to its own beat, a reflection perhaps of stronger development in that region in the 1990s compared to the lost decade of the 1980s.
Correcting for concurrent changes in other factors that may impact the growth in output and exports of particular sectors of the economy, they estimate that China’s opening lowered the ratio of labour-intensive manufacturing to primary output in other countries by 7-10%, and the corresponding ratio of exports by 10-15%.
Question: Is manufacturing still necessary for development?
Implicit in their own research and their overview of the literature is that “industrialisation is vital for development”, that manufacturing is a necessary intermediate step between a commodity-based economy and a services-based economy. I wonder, though, how much this is still the case. Manufacturing certainly brings with it a much greater employment multiplier effect upstream, but presumably downstream effects – worker spending and tax raised from salaries paid – are similar.
Production networks are becoming increasingly disaggregated across separate activities, rather than clustered in one place. The growth in foreign direct investment in services activities around the world – in places like Bulgaria, the Philippines and Morocco but particularly in India – shows the current extent to which countries can leapfrog manufacturing. The technological revolution underway shows the potential for that to continue and intensify.
karl deeter ,
I don’t know if I buy into the ‘Services are the only future’ idea, having a strong manufacturing base is not a bad thing, it also helps employ workers who may lack the education/skillset to work within higher end services which are ultimately the profitable exportable sector.
If anything I think the secular trend will be back towards actual ‘things’ as services and technology are consolidated and simplified, for instance – a website 10yrs ago was expensive, now you can get one for €200 that would have cost you €20,000 in 1999. If services get commoditized (as they inevitably do) then the ability to produce will actually be of greater value, Ireland has lost most of that already and it’s to our detriment, it means a reliance on imports will remain and unless we can export increasingly cheaper services faster than we import the actual goods and products that we need to survive on then there is trouble down the line, that’s not a very convincing business model!
Ronan Lyons ,
Hi Karl,
Interesting comment – if I can phrase my point along similar lines, it would be I don’t know if I buy into the ‘Manufacturing is the only future’ idea, which was what I thought I’d spotted in the literature. Not for a minute would I suggest that having manufacturing is a bad thing.
R
Aspect Investments ,
There is no doubt in my mind that China will at some point overtake the US as the worlds largest economy. They have more people than the US, they have more land than the US, and they work harder than the US. So it is inevitable. I think it could take anything from 10 to 20 years for China to take the number 1 spot though.