China Economic Review 14 (2003) 164 – 185
China as an economic powerhouse: Implications on
its neighbors
Tilak ABEYSINGHE, Ding LU *
Department of Economics, National University of Singapore, AS2 Level 6, 1 Arts Link, 117570, Singapore
Accepted 18 April 2003
Abstract
The rise of China as an economic powerhouse has caused concerns in its neighbors. Prevailing in
the region is the fear that China is becoming a gigantic ‘‘regional factory’’ that will ‘‘hollow out’’
neighboring economies’ industries. In this paper, we emphasize the economic benefits that a rising
Chinese economy can bring into the region. A discussion on the country’s growth strategy suggests
that China has recently started shifting from an export-oriented economy to a more domesticdemand-driven one. Such a shift, in the backdrop of China’s entry into the World Trade
Organization, is opening up the country’s huge domestic market for imports, thus providing great
opportunities for the regional economies. A custom-made structural VAR analysis based on tradelinks in the region provides empirical evidence that China had quickly emerged as a growth engine in
the region even before China joined the WTO and made a full transformation of its growth model.
D 2003 Elsevier Inc. All rights reserved.
JEL classification: F42; C53; O53
Keywords: Export-driven economy; Internal-demand-driven economy; Structural VAR analysis; Trade links;
Output multiplier effects
1. Introduction
Over the past two decades, China has been not only the world’s fastest growing large
economy but also an outstanding exporter. Its exports have increased at a hefty annual rate
of 17%, from US$13.7 billion in 1979 to US$266 billion in 2001. This made the nation the
world’s sixth largest exporting economy. Its merchandise trade balance with the world
* Corresponding author. Tel.: +65-6874-6108; fax: +65-6775-2646.
E-mail address: [email protected] (D. Lu).
1043-951X/$ - see front matter D 2003 Elsevier Inc. All rights reserved.
doi:10.1016/S1043-951X(03)00017-8
T. Abeysinghe, D. Lu / China Economic Review 14 (2003) 164–185
165
Table 1
Exports from China and ASEAN5 to major markets as a share of total exports (2000)
China (mainland)
ASEAN5
USA
EU
Japan
26.5
20.1
18.8
18.2
14.3
13.0
Source: Econometric Studies Unit database, National University of Singapore.
Note: ASEAN5=Indonesia, Malaysia, Philippines, Singapore, Thailand.
turned into surplus in 1990 and peaked at US$38 billion in 1998. The composition of trade
shifted drastically from primary products to manufactures, which now account for about
90% of China’s exports and 80% of its imports.1
China’s efforts to attract foreign direct investment (FDI) have been even more
successful. From 1988 to 2000, actual or utilized FDI in China increased at an annual
rate of 23% to reach a cumulative total of US$339 billion. No other country in the world,
besides the United States, receives more FDI.
Fuelled by ‘‘twin surpluses’’ of trade balance and capital flow, China’s foreign reserves
rose 20 times in the last decade from less than US$10 billion to over US$200 billion by
2001. This made China’s foreign reserves the second largest next only to Japan’s.
All these changes have drastically changed the economic geography in the Pacific Asia.
In Southeast Asia, the general impression of China’s impact on the region is pessimistic.
There are concerns about the pressure of export-competitiveness brought in by the rise of
Chinese manufacturing industries. Confidence in the region’s economic future is also
dampened by the fear that the opening Chinese market will be a ‘‘vacuum machine’’ to
suck in almost all the foreign capital flowing to East Asia, depriving the development
opportunity for the neighboring countries. Only a few optimists present the prospect for
China to rise as a growth engine for the region (Cheong, 2001).
In this paper, we will first look at how the rise of China’s economic power has brought
in competitive pressures on the Southeast Asian economies. We will then discuss the
possibility for the Chinese economy to emerge as a growth engine for the region by
examining its growth model. Finally we will apply a structural VAR approach developed
by Abeysinghe (1998) to assess how the rise of China’s economic power has actually
changed the growth gravity in the region so far.
2. China as a competitor
The concerns over the competitive pressure that arises with China’s economic power
are not unfounded. First, the rising China’s economic power is well reflected in several
important physical indicators. China not only tops the world in grain production
(necessarily so because of its large population) but also in coal, steel, and cement. Before
Deng Xiaoping introduced economic reform in 1978, home electronics manufacturing was
1
Statistics of China’s international trade and finance in this and the following paragraphs are cited from
China Statistical Yearbook (various years) Beijing: China Statistics Press and China’s Ministry of Foreign Trade
and Economic Cooperation web site http://www.moftec.gov.cn/.
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T. Abeysinghe, D. Lu / China Economic Review 14 (2003) 164–185
Table 2
Features of labor force of selected countries (1999)
Per capita GNP (PPP US$)
Female adult literacy (%)
Female life expectancy (year)
Agriculture’s share of total
employment (%)
China
India
Indonesia
Malaysia
Philippines
Thailand
Singapore
3550
75
72
46.1
2226
44
64
57.3
2660
81
68
46.2
7640
83
75
19.1
3990
95
71
39.2
5950
93
71
51.5
22,310
88
80
0.2
Source: World Bank online database (http://www.worldbank.org) and Global Market Information database (http://
www.euromonitor.com).
trivial in China. Today, one in four of the world’s color TVs and one in five of the world’s
refrigerators are produced in China.
China and Southeast Asian countries overlap each other in their major export markets
(Table 1). China, however, commands a wider competitive edge in terms of labor cost.
China has a labor force with population health and education quality not inferior to South
Asian and ASEAN economies. It also has a large proportion of agricultural labor as a
source of surplus labor supply to industrialization (Table 2). As the Chinese economy
grows, the abundant labor outflow from its rural sector will continue to keep China’s labor
cost the cheapest and the most competitive in the region (Fig. 1).
Fig. 1. Unit labor costs with projections until 2003. Average cost of labor in US$. Includes pay for time worked,
other direct pay (e.g., holiday pay), employer expenditures on legally required insurance programs and other labor
taxes. Source: EIU database, March 2002.
T. Abeysinghe, D. Lu / China Economic Review 14 (2003) 164–185
167
Table 3
Percentage share in world aggregate factor resources (1995)
Agricultural labor
Unskilled labor
Skilled labor
Capital
USA
EU
Japan
China
(mainland)
South Asia
ASEAN5
Rest of
the World
0.3
7.9
14.5
19.3
0.7
10.4
15.6
30.7
0.3
4.5
3.6
22.7
40.0
13.7
17.5
2.0
24.8
15.9
8.1
1.2
6.4
6.2
3.0
2.0
27.5
41.4
37.7
22.1
Source: Li et al. (2000).
Notes: ASEAN5=Indonesia, Malaysia, Philippines, Singapore, Thailand.
To international investors, China has the world’s largest pool of skilled labor and
untapped rural labor (Table 3). Investing in China also provides multinationals strong
location-specific advantages in an economy with huge market potentials.
Not just in the ‘‘old economy,’’ China is also making rapid progress in ‘‘New Economy’’
areas (Table 4). At the start of economic reforms, the whole of China counted only 2 million
fixed-line telephone subscribers. By early 2001, China had 160 million fixed-line telephone
subscribers, in addition to 111 million mobile phones and 45 million pagers. By the end of
2001, China set to have 40 million people online as Internet users, just slightly behind
Japan. Statistics in Table 4 demonstrate that China enjoys advantages not only in cheap and
abundant labor but also in information infrastructure and human capital. These will be very
important factors to make China a forerunner in the race to the information age.
Given these advantages, China has been perceived as ‘‘a giant sucking ground’’ or even
a ‘‘black hole’’ for foreign investment. China’s mainland now accounts for about one third
of emerging markets’ total stock of FDI. In recent years, nearly four fifths of all FDI going
to East and Southeast Asia, not counting Japan, ends up in China, as reported by The
Economist (UK).2 Thanks to the capital and technology inflow, China has become a
gigantic ‘‘regional factory’’ that makes goods spanning the entire value chain, on a scale
that determines world prices and ‘‘hollows out’’ out neighboring economies’ industries. A
representative perception of the ‘‘China impact’’ is that by Kenichi Ohmae, a veteran
Japanese consultant, who predicts that China’s rise will cause a ‘‘second Asian crisis,’’
more severe and drawn-out than that of 1997 –1998.3
Such alarms are perhaps timely as a wake-up call to shake Asia’s newly industrialized
economies out of complacency. The question, however, is ‘‘Would China’s tremendous
cost competitiveness eliminate the neighboring economies’ chances of development?’’
3. China as a growth engine
One thing the ‘‘hollowing-out thesis’’ may mean is that China’s rising economic power
will deprive its neighboring economies of the opportunities to develop their industries.
2
3
‘‘Enter the dragon,’’ The Economist (UK), 8 March 2001.
‘‘Asia’s next crisis: ‘Made in China,’’’ Japan Times (Tokyo), 30 July 2001.
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T. Abeysinghe, D. Lu / China Economic Review 14 (2003) 164–185
Table 4
‘‘New Economy’’ indicators
Scientists and engineers in
R&D (per million people)
High-tech exports % of
manufactured exports
TV sets (per 1000 people)
Phone lines (per 1000 people)
M-phones (per 1000 people)
Year
China
India
Indonesia
1987 – 1997
454
149
182
1999
17
6
1999
1999
1999
292
86
34
75
27
2
Malaysia
Philippines
Thailand
93
157
103
10
59
59
32
143
29
11
174
203
137
110
39
38
289
86
38
Source: World Bank online database (http://www.worldbank.org).
Such a fear of ‘‘hollowing out’’ is not supported by the basic theory of comparative
advantages of trade. For trading partners to benefit from trade, what matters is not absolute
cost advantage (which China undoubtedly has in many goods) but comparative advantages. Even if China can make all goods over the entire value chain cheaper than its
neighbors, the different categories of goods made in China cannot be equally cheaper than
those made by its neighbors. As long as that is true, both China and its neighbors can
potentially benefit from trading with each other by devoting resources to the production of
the goods or part of the value chain that each has its comparative advantages.
Empirical evidence has emerged to show some of these benefits predicted by the trade
theory. For instance, using ‘‘revealed comparative advantage indices’’, Hai (2000) has
shown that, despite the relatively higher labor costs in Japan, South Korea, Singapore, and
Taiwan, these economies enjoyed considerable comparative advantages in their trade with
China in the product categories of ‘‘Machines, Transport Equip’’ and ‘‘Chemicals’’ in the
late 1990s. Meanwhile, trading with China, the ASEAN4 economies—Malaysia, Indonesia, Thailand, and Philippines—also displayed comparative advantages in categories of
‘‘Crude Malts Exc. Fuels,’’ ‘‘Mineral Fuels etc.,’’ ‘‘Animal, Vegetable Oil, Fat,’’
‘‘Machines, Transport Equip’’, and ‘‘Misc. Manufactured Goods.’’ Other studies, such
as Deutsch Bank (2001), Chae (2000), Li, Wang, Zhai, and Xu (2000), and Wang (2002),
also identify the industries of which China’s trade partners have revealed comparative
advantages. On top of that, recent trends of production globalization have enhanced
international division of labor not only between industries but also within industries. The
global reorganization of value chains in many industries is creating more possibilities for
businesses in different countries to cooperate in production of the same line of products
along a shared value chain. As we will show in the next section, through the trade linkage,
the rising Chinese economy is set to become an increasingly important growth engine to
the region. This effect will be reinforced as China shifts its development strategy from an
export-oriented model to a free-trade based one.
The ‘‘hollowing-out’’ thesis makes better sense when it refers to the consequence of the
diversion of capital flows in the region to the emerging Chinese market. This may hurt
China’s neighboring economies since international direct investment is not only a source
of capital but also a vehicle for technology and knowledge transmission. It should be noted
that China emerged as a large recipient of FDI in the early 1990s. Although this led to
some drop in the FDI share going to its neighbors, subsequently, the FDI shares have
T. Abeysinghe, D. Lu / China Economic Review 14 (2003) 164–185
169
remained roughly stable (Thangavelu, 2001). Absolute drop in levels of FDI only occurred
to these economies during the Asian Financial Crisis.
The potentials of avoiding being ‘‘hollowed out’’ are available, although unlikely to
come naturally. A simulation exercise by McKibbin and Woo (2003) suggests that the full
integration of China’s huge labor force into the international division of labor could
deindustrialize the ASEAN4 when it leads to reduction of FDI flows to them. This will
happen, however, only if these countries allow the drop in FDI inflow to lower the rate of
technological diffusion to their economies. If the ASEAN4 can prevent themselves from
falling behind technologically, then they can find lucrative niches within the international
production chains that characterize manufacturing activities. In other words, the fate of
‘‘hollowing out’’ is avoidable if the ASEAN4 will give the highest priority in deepening
and widening their pools of human capital by speeding up the diffusion of new knowledge
to their scientists and managers, and providing appropriate retraining programs for the
displaced workers.
For China’s export-oriented neighbors, an immediate worry is the competitiveness
pressure that China’s low-cost exports have brought to their traditional export markets
such as the United States and Euro area. A strong countering factor, however, comes from
China’s own market. As China rises in its ranking among the world’s largest trading
powers, its import capacity has been growing tremendously with its rising domestic
demand. This trend is becoming more manifest as China shifts from an export-oriented
growth model to a more domestic-demand driven one.
When China launched its ambitious modernization program around 1980, its policy
makers quickly adopted an export-oriented growth model, which has dominated China’s
economic development since then. Around the late 1960s and early 1970s, the success of a
small number of East Asian manufactured exporters started to change the world’s
perspectives of the relative merits of export-oriented growth strategy and import substitution strategy. ‘‘The 1980s debt crisis, combined with slow economic growth in many
countries that were following the import substitution strategy, further reinforced support for
export-led growth. By the early 1990s, there was widespread consensus (although not
complete agreement) on the advantages of this strategy for developing countries’’ (Perkins,
Radelet, Snodgrass, Gillis, & Roemer, 2001, p. 706). One of the most influential documents
representing this consensus is the World Bank’s (1993) World Development Report, which
relates export performance to growth success in high-performing Asian economies.
The Chinese government started by imitating many policies and measures of other
export-oriented pioneers, such as setting up export-processing zones, improving infrastructure to attract FDI projects, duty exemption programs for imported parts and materials
in export industries, fiscal subsidies to exports in the form of priority loans and tax
exemptions, etc. Apart from imitation, China also developed some innovative incentives
and restrictive measures to ensure that trade balance will be improved by the exportoriented growth strategy. For instance, foreign funded enterprises are required to maintain
a certain ratio of local contents of their products, foreign exchange balance in fund usage,
and an export ratio of output. Export-oriented manufacturers can enjoy a wide range of
administrative supports, tax benefits, and subsidies, such as subsidized credits, valueadded tax (VAT) rebates, import duty exemptions and rebates for materials and equipment,
corporate tax reductions, tax refund for reinvested profits, etc. (Lu & Tang, 1997).
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T. Abeysinghe, D. Lu / China Economic Review 14 (2003) 164–185
China has been very successful so far pursuing this strategy to achieve growth and
structural changes. It is no doubt that the Chinese economy has benefited from many claimed
advantages of an export-oriented growth, including specialization and economies of scale in
export production, job creation by labor-intensive export manufacturing, foreign exchanges
earned by exports to pay for imported materials and capital goods, new technologies and new
ideas through export-oriented openness, etc. It remains, however, an open question whether
this strategy will be viable for the next stage of China’s economic growth.
Concerning the success of export-oriented growth strategy, there have been heated
debates among scholars about the magnitude of correlation between exports and growth as
well as the channels through which trade policies operate (Harrison & Hanson, 1999;
Rodriguez & Rodrik, 1999). As many of the successful Asian exporters fell victim to the
1997– 1998 Asian Financial Crisis, new skepticism towards the advisability of the exportoriented growth strategy has been rekindled. As summarized by Perkins et al. (2001), three
issues are at the center of concerns. First is the extent to which the export-oriented strategy
can continue to succeed as more and more countries shift to manufactured exports. Second
is the extent to which the imitators of the strategy could replicate the magnitude and speed
of the gains by the early practitioners, especially when surging exports from developing
world push the industrialized countries toward more protectionist policies. Third is
whether it is really worth for a developing economy to gain export competitiveness with
‘‘sweatshop’’ working conditions and meager wages.
Yu (1998) expressed the concern by looking into the national income account. By
definition, accumulation of foreign reserves is an inevitable result of China’s ‘‘twin
surpluses’’ of trade and capital flows in recent years. As shown in this relationship,
LTC þ STC þ ðX M Þ ¼ DFR
ð1Þ
where LTC=net long-term capital inflow, STC=net short-term capital inflow, X=exports,
M=imports, and DFR=changes in foreign reserves. However, the fundamental equation of
macroeconomic balances tells us that current account or trade surplus (XM) should
equate domestic net saving, which is the sum of saving (S) in excess of investment (I) and
government revenue (tax, T) in excess of government purchases ( G):
X M ¼ ðS IÞ þ ðT GÞ
ð2Þ
When current account or trade is in surplus, domestic net saving must be positive, a
scenario of net lending to foreigners. It is, therefore, no wonder that a successful
practitioner of export-oriented growth strategy is also typically a high-saving economy.
Yu (1998) thus questions the necessity for a developing country like China to keep
persistent net lending to foreigners through trade surplus and raises concerns over its
impact on capital formation, which is the most important source of economic growth.
The crucial issue is thus the consequence of persistent net lending (or equivalently trade
surplus) on capital formation. For a developing economy at a stage of fast growth, interest
returns to lending to foreign land are likely to be lower than returns to investment at home.
Export-promoting policies often twist the use of domestic savings by channeling them to
foreign hands through trade surplus. They may therefore reduce the savings available for
domestic capital formation and eventually slow the long-term growth.
T. Abeysinghe, D. Lu / China Economic Review 14 (2003) 164–185
171
A simple macroeconomic analysis illustrates the effects of trade balance on economic
growth. According to macroeconomic accounting:
Y ¼ C þ I þ G þ ðX M Þ
ð3Þ
where national output or income Y is the sum of consumption (C), investment (I),
government purchases ( G), and net exports (XM). In the short run, increase in (XM)
increases aggregate demand and growth if there are unemployed resources. Its impact on
savings available for investment, however, is not straightforward.
By defining E=autonomous domestic (noninvestment) spending (by private and public
sectors), s=marginal propensity to save (or marginal domestic leakage, in a broad sense to
include both private and public savings), m=marginal propensity to import, M=autonomous import, we can rewrite Eq. (3) as:
Y ¼ E þ ð1 sÞY þ I þ ðX M mY Þ
ð4Þ
Rearrange Eq. (4) and define TBa=(XM) as ‘‘autonomous trade balance,’’ we have:
ðm þ sÞY E I TBa ¼ 0
ð5Þ
With a given level of labor force and technology, Y is a function of capital stock:
Y ¼ f ðKÞ and f VðKÞ > 0; f WðKÞ < 0:
ð6Þ
And capital stock is a function of the investment stream and at time t:
Kt ¼ KðIt Þ and KVðIÞ ¼ r > 0
ð7Þ
Substituting Eqs. (6) and (7) into Eq. (5) and totally differentiating the equation, we can
derive comparative statistics of investment to changes in the autonomous trade balance as:
dI
1
¼
dðTBa Þ ðm þ sÞf VðKÞr 1
ð8Þ
This function has the following features: (1) Starting with an initial positive value, the
function increases its value at an accelerating rate as capital accumulates and continuously
reduces value of f V(K). (2) At a certain stage, f V(K) will be small enough such that the
denominator falls below zero and the value of the whole function plunges deeply into the
negative range. (3) Further capital accumulation will diminish the function’s value towards
zero. (See Appendix A for a simulated diagram for these effects.)
This simple model indicates the transitional effectiveness of an export-oriented policy
that increases investment by improving the autonomous trade balance. Such a policy may
be very effective in raising investment streams, and consequently growth rates at early
stages of capital accumulation. However, when the level of capital accumulation reaches a
certain level, the effect may become highly uncertain and unstable. Eventually, further
augmentation of autonomous trade balance could only have a negative impact on investment and growth.
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T. Abeysinghe, D. Lu / China Economic Review 14 (2003) 164–185
Fig. 2. Trade balance of China and China with Hong Kong (US$ billion). Figures of 2001 – 2005 are EIU
estimates. Source: EIU database, March 2002.
There are already signs that China is shifting away from an export-oriented growth
model toward an internal-demand-driven growth model, as observed by Feldman and Xie
(2001). This is evident if we treat Hong Kong and Chinese trade data as one integrated
unit. The rationale to do so, as pointed out by the duo, lies in the fact that ‘‘a large portion
of Hong Kong’s imports flow to adjoining Guangdong province, without being recorded
by the customs service in China. The correct trade balance for China is thus the total of the
two.’’ Changes since 1998 and the forecast by Economic Intelligence Unit confirm the
trends observed by the duo (Fig. 2).
From the perspectives of national saving and investment, the essence of the exportoriented strategy is to build the capital stock and wealth ‘‘by serving markets abroad first,
and then serving domestic markets after income had risen far enough to become selfsustaining’’ (Feldman & Xie, 2001). Recent trends in the Chinese economy, however,
suggest that China has come to rely on foreign capital (Japanese, Taiwanese, American,
and European) for a greater portion of incremental savings and on domestic sources for
incremental demand. The duo perceives these trends as signs for the emergence of a new
Chinese development model, which is internal-demand driven, similar to that of the United
States in the 19th century.
Most of the economic fundamentals in China are favorable to this shift. By Eq. (2),
government budget balance is a major part of domestic net savings that determine the trade
balance. China’s budget deficit has increased sharply in recent years so that the budgetbalance-to-GDP ratio is going to stay in the negative range for the foreseeable future (Fig.
3). During the period of Chinese government’s Ninth Five-year Plan of Economic and
Social Development (1996 –2000), Beijing already switched its macroeconomic policy
from an export-oriented one to one of ‘‘expanding internal demand’’ through increasing
public spending and encouraging domestic consumption.4 The government has vowed to
continue this policy in the coming years under the Tenth Five-year Plan (2001 – 2005).
‘‘Expanding internal demand’’ is stated as ‘‘the basic drive for economic development and
4
Zhu Rongji, ‘‘Report on the Guidelines for the Tenth Five-year Plan of National Economy and Social
Development of the PRC,’’ Xinhua News Agency, 16 March 2001.
T. Abeysinghe, D. Lu / China Economic Review 14 (2003) 164–185
173
Fig. 3. China’s currency value and government budget balance. Figures of 2002 – 2005 are EIU estimates. Source:
EIU database, March 2002.
long-term strategic policy.’’ Specifically, the Plan aims to raise the private-consumptionto-GDP ratio from 45% to 50% by 2005.5
One reason to expect a chronic fiscal expansion lies in Beijing’s long-term plan to place
priority on West China development. China’s western region includes six provinces
(Sichuan, Yunnan, Guizhou, Shaanxi, Qinghai, and Gansu), five autonomous regions
(Ningxia, Xinjiang, Inner Mongolia, and Tibet), and one municipality (Chongqing) under
the direct administration of the central government. The region covers 5.4 million square
km (57% of the country’s land area) and is inhabited by 285 million people (23% of the
total population of the nation). To build up infrastructure for development in this vast
inland region, tremendous demand for public and private investment resources will arise.
Since the Chinese government launched its West China Plan in 2000, the state had already
invested about RMB 600 billion in infrastructure projects in the region by end of 2002.6
The amount of investment is equivalent to about 6% of China’s annual GDP. Consequently, the need to utilize more foreign capital and import more capital goods must have
significant impact on China’s trade volume and balance.
In a shorter run, real exchange rate plays a key role in determining current account
balance as a strong currency encourages imports and makes exports more expensive in
foreign market. Since 1994, RMB, the Chinese currency, has been de facto pegged to the
US dollar. A devaluation of Chinese currency is very unlikely in the foreseeable future,
thanks to China’s huge foreign reserves, continuous inflow of large amount of capital, and
its undervalued currency (highlighted by the fact that, in US$ terms, China’s nominal GDP
has been only about one fifth of its GDP measured by purchasing power parity in the
recent decade). Appreciation of China’s currency against a trade-weighted basket of
currencies is expected in the near future (Fig. 3). The IMF has repeatedly recommended in
recent years that China move towards greater flexibility in its exchange-rate regime.7
5
The Ninth People’s Congress of China, ‘‘Guidelines for the Tenth Five-year Plan of National Economy and
Social Development of the PRC,’’ Xinhua News Agency, 17 March 2001.
6
Office of the Leading Group for Western Region Development of the State Council web site, http://
www.chinawest.gov.cn.
7
Eisenman, ‘‘Freeing Up China’s Currency,’’ Far Eastern Economic Review, 28 November 2002.
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T. Abeysinghe, D. Lu / China Economic Review 14 (2003) 164–185
Table 5
Population projection for China, medium variant (millions)
Total
Age 0 – 4
Age 5 – 19
Age 20 – 49
Age 50+
1950 – 1995
1995 – 2010
2010 – 2025
2025 – 2050
1995 – 2050
670
27.4
154.6
366.3
121.7
153.7
11
29.2
70.3
123.6
107.7
6.4
12.3
67.1
193.4
3.7
8.2
32.6
68.2
105.2
257.7
25.6
74
65
422.2
Source: United Nations Population Division (1998). World Population Prospects (CD-ROM). New York, United
Nations.
The demographic change is set to have overwhelming effect on domestic savings.
According to United Nations’ projections (Table 5), while China is adding about 154
million to its population between 1995 and 2010, the population increase is slowing
down steadily and will turn negative in one-generation’s time. Meanwhile a significant
decline in the number of children and teenagers is in force. From 1995 to 2010,
children under the age of 5 will decline by about 11 million; the number of children
aged 5 – 19 will decline by more than 29 million. The shrinking of this segment of
population will reduce the part of savings planned for bequests to the minors. These
projections also indicate a massive increase in elderly Chinese, by 123 million between
1995 and 2010, and by another 193 million between 2010 and 2025. This massive
aging of the population again will reduce the overall savings and consequently bring in
strong negative impact on trade or current account balance.
All these indicators highlight that China’s growth model is shifting away from a
pure export-oriented one to the one more driven by internal demand. This has already
been happening since the second half of the 1990s. In Fig. 4, we can observe the
Fig. 4. China’s structure of aggregate demand (percentage share). (1) Net domestic demand consists of private
consumption, gross fixed investment, and government consumption. (2) Gross domestic demand is net domestic
demand plus stock (inventory) building. When it exceeds 100%, trade deficit occurs. Source: EIU database,
October 2001.
T. Abeysinghe, D. Lu / China Economic Review 14 (2003) 164–185
175
significant rise of export-to-GDP ratio over the past 15 years, reflecting increased
openness of the economy. Notwithstanding that, the domestic-demand-to-GDP ratio
reverted to an upward swing since 1997. With the slowing down of the US and the
Fig. 5. (a) Multiplier effect of a 1% positive shock to the GDP growth of Japan and China under the trade patterns
in 1986 (dashed line) and 2000 (solid line) on the GDP growth of ASEAN4. (b) Multiplier effect of a 1% positive
shock to the GDP growth of Japan and China under the trade patterns in 1986 (dashed line) and 2000 (solid line)
on the GDP growth of NIE4. (c) Multiplier effect of a 1% positive shock to the GDP growth of Japan and China
under the trade patterns in 1986 (dashed line) and 2000 (solid line) on the GDP growth of BIG4 (China, Japan,
ROECD, and USA).
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T. Abeysinghe, D. Lu / China Economic Review 14 (2003) 164–185
Fig. 5 (continued ).
world economies, China has to further increase its reliance on domestic demand for
growth. This trend implies a faster growth of China’s imports relative to its exports,
producing tremendous opportunities for exporters in the region.
Recent institutional and policy changes in China and the region are likely to
greatly facilitate the opening of China’s market for imports and foreign investment.
China’s accession to the World Trade Organization (WTO) in December 2001 set a
T. Abeysinghe, D. Lu / China Economic Review 14 (2003) 164–185
177
Fig. 5 (continued ).
landmark for the integration of the Chinese economy into the global economy. As a
result of the negotiations for China’s WTO entry, China will undertake a series of
important commitments in 3 – 5 years to open and liberalize its regime in order to
better integrate into the world economy and offer a more predictable environment for
trade and foreign investment in accordance with WTO rules.8 China will make
8
For a brief summary of these commitments, see WTO Press Release, ‘‘WTO successfully concludes
negotiations on China’s entry,’’ 17 September 2001, http://www.wto.org/english/news_e/news_e.htm.
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T. Abeysinghe, D. Lu / China Economic Review 14 (2003) 164–185
sweeping cuts in tariff rates from the average level about 15% before its entry to
about 10%. For certain industrial products (such as cars and IT products) and
agricultural goods, the tariff cuts will be more substantial. China will also remove
many of its complicated nontariff barriers, such as quotas, trading right restrictions,
local content requirement, technology transfer requirement, and government procurement. As for investment, China will relax and gradually phase out various restrictions
imposed on foreign businesses in sectors like telecommunications, car manufacturing,
banking, insurance, security trading, energy, distribution and retails, etc. For instance,
foreign banks will be allowed to conduct domestic currency business with Chinese
firms two years after the WTO entry and with Chinese individuals five years after
the entry.
As China revamps its trade and industrial policy in line with WTO rules, its domestic
market must get much more open to foreign products (Chen, 2001; Lu, 2001). In other
words, the marginal propensity to import of this US$ 1 trillion economy with 1.3 billion
people will significantly increase.
On the eve of accession to the WTO, with Beijing’s initiative, China and ASEAN
reached the consensus to build the ASEAN – China free trade area (FTA) within the
next 10 years. The pact could be modeled along the lines of the ASEAN Free Trade
Area (AFTA). To placate ASEAN members who are apprehensive about the competitiveness of China’s economy, China has offered to open up its markets in some key
sectors earlier than the ASEAN countries in order to give the latter a head start.
Beijing also agreed to grant preferential tariff treatment for some goods from
Cambodia, Laos, and Myanmar. To push for success, more trade goodies can be
expected in the pipeline. The ASEAN –China FTA will mean a combined market of
1.7 billion people with a gross domestic product of US$2 trillion and two-way trade of
US$1.23 trillion. A study-group concluded that the pact would be a catalyst in
stimulating trade between ASEAN and China. Exports for both sides were expected
to grow by 50%.9 As economies of ASEAN and China become more interlocked, the
huge Chinese domestic market will be more accessible to its export-led neighboring
economies. With trade liberalization and regional economic integration, the rise of the
Chinese economy promises to offer tremendous business opportunities to its neighbors
and rest of the world.
4. Empirical evidence of growth engine effect
We are now going to provide some quantitative assessment of the impact of China’s
rising economic power of the past two decades on the economic growth of ASEAN4
(Indonesia, Malaysia, Philippines, Thailand), NIE4 (Hong Kong, Singapore, South Korea,
Taiwan), Japan, USA, and the rest of the OECD countries (considered as a group and
denoted by ROECD). For this purpose, we use the following structural VARX model
9
‘‘ASEAN, China plan FTA,’’ Straits Time (Singapore), 7 November 2001.
T. Abeysinghe, D. Lu / China Economic Review 14 (2003) 164–185
179
developed by Abeysinghe (See Abeysinghe, 1998, 2001a, 2001b, and Abeysinghe &
Forbes, 2001):10
ðB0 *W t Þyt ¼ k þ
p
p
p
X
X
X
ðBj *W tj Þytj þ
G 1j z*1tj þ . . . þ
G kj z*ktj þ et
j¼1
j¼0
ð9Þ
j¼0
where yt is an (n1) vector of GDP growth series, z*(i=1,.
. .,k) are (n1) vectors of
i
growth rates of exogenous variables, Wt is a known matrix of weights, Bs and Gs are
unknown parameter matrices and Et is a random vector with zero mean and Var(et)=V, a
diagonal matrix empirically. The asterisk indicates the element-wise (Hadamard) product
of the two matrices.
In standard VAR models each variable is regressed on its own past and the past of other
variables and the impulse response analysis is carried out by imposing a triangular
structure on the contemporaneous relations through the Cholesky decomposition of the
variance– covariance matrix of the residuals. It is well known that this approach may lead
to conflicting conclusions when the ordering of the variables is changed. Furthermore, as
the number of variables increases, as in our case, the model may produce highly
unreliable, perhaps nonsensical, results. Model (9) is a custom-made structural VAR
model designed to overcome these problems. The most important feature of Model (9) is
that it connects GDP of different countries through their trade linkages captured in Wt
matrix, which is derived from bilateral export shares. The weight wij represents the export
share of country i with country j such that Swij=1 ( j=1,2, . . .,n1; i p j). If n=3 and p=1
the parameter matrices take the form:
0
1
B
B
B0 ¼ B
B b02
@
b03
0
1
B
B
W¼B
B w21
@
w31
b01
1
b03
w12
1
w32
w13
b01
1
C
C
b02 C
C;
A
1
0
/11
B
B
B1 ¼ B
B b12
@
b13
b11
/22
b13
b11
1
C
C
b12 C
C;
A
/33
1
C
C
w23 C
C
A
1
and G matrices are diagonal. Since Wt is a known matrix, Model (9) is highly
parsimonious compared to standard VARX models. After estimating B matrices the
effective parameter matrices are obtained by the product (B*W
j
t), j=0,1,. . .,p.
10
To avoid too much digression from the main theme of the paper we state here only the main features of the
model. The derivation of the model with forecast and impulse response analyses can be found in Abeysinghe
(1998) and Abeysinghe and Forbes (2001).
180
T. Abeysinghe, D. Lu / China Economic Review 14 (2003) 164–185
Using the compact notation Bw( L) = (B*0 Wt ) (B*1 Wt ) L . . . (B*p Wt ) L p and
G (L) = G 0i + G 1i L +. . . + G pi Lp, where L is the lag operator, Model (9) can be written as
i
* þ . . . þ Bw ðLÞ1 G p ðLÞzkt* þ Bw ðLÞ1 et :
yt ¼ k* þ Bw ðLÞ1 G 1 ðLÞz1t
ð10Þ
Using Eq. (10) the impulse responses with respect to the ith exogenous variable can be
obtained from Bw(L)1G i(L). If the model does not contain exogenous variables then the
impulse responses with respect to random shocks are given by Bw(L)111 Unlike standard
VAR or VARX models, which produce fixed impulse responses, the impulse responses
produced by Model (9) change over time as the trading pattern changes. This allows us to
compute impulse responses at any point in time using a given trade matrix Wt.12
We estimate Model (9) without exogenous variables and examine how a positive shock
in one country spreads over to other countries through trade linkages. To estimate the
model we need 12 GDP series and 132 bilateral export share series. A detailed account of
how this database at quarterly frequency was created can be found in Abeysinghe (1998)
and Abeysinghe and Forbes (2001). The sample period spans over 1978Q1 to 2000Q4.
The export shares are computed as 12-quarter moving averages so that they change slowly
over time. Estimation of Model (9) by OLS, 2SLS, and 3SLS produces similar results and
we use OLS estimates in this exercise.
We generate the multipliers (cumulative impulse responses) over 20 quarters based on
the trade matrices in 1986 and 2000. Although most of the impulse responses move
towards zero within 20 quarters some persist above zero much longer. Since the impulse
responses change over time with changing trading patterns, inferences based on very longterm impulse responses are likely to become irrelevant. Note that we chose 1986 simply
because that was the year that China applied to enter the GATT (the predecessor of the
WTO) and 2000 represents the end of our sample period.
To provide an important contrast Fig. 5a– c presents the multiplier effects on GDP
growth created by a 1% positive shock to China and Japan under the trading patterns in
1986 and 2000. Table 6 summarizes the results for all the countries/regions covered in the
study. This exercise reveals a number of interesting observations.
1. The most obvious is the substantial upward shift (from 1986 to 2000) in the multiplier
curves created by China and the downward shift of those pertaining to Japan. Although
the US also shows a similar downward shift, the loss of Japan’s foothold in these
countries is more pronounced (see Table 6).
2. China’s trade liberalizations have produced phenomenal increase in multiplier effects
on the trading partners. Table 6 shows that China’s multipliers have grown at
impressive rates between 1986 and 2000. The biggest incremental benefits have
accrued to South Korea and Taiwan.
11
Computer packages like SAS perform the inversion of matrix polynomials.
The trade matrix is made up of bilateral exports such that the rows represent exports and the columns
represent imports.
12
T. Abeysinghe, D. Lu / China Economic Review 14 (2003) 164–185
181
Table 6
Multiplier effects (after 5 years) on GDP growth of a 1% positive shock to China and other countries under 1986
and 2000 trading patterns
Effect on
1986
2000
Change Per
year %
ASEAN4
Indonesia
Malaysia
Philippines
Thailand
NIE4
Hong Kong
Singapore
S. Korea
Taiwan
BIG4
China
Japan
ROECD
USA
Shock in China
0.28
0.68
0.43
1.21
0.43
0.96
0.08
0.15
0.20
0.38
0.24
0.63
0.35
0.60
0.30
0.64
0.20
0.82
0.09
0.45
0.12
0.24
1.99
2.03
0.15
0.31
0.13
0.23
0.09
0.18
ASEAN4
Indonesia
Malaysia
Philippines
Thailand
NIE4
Hong Kong
Singapore
S. Korea
Taiwan
BIG4
China
Japan
ROECD
USA
Shock in ASEAN4
0.10
0.19
6.02
0.14
0.34
10.47
0.19
0.27
3.31
0.03
0.05
7.23
0.06
0.10
3.81
0.08
0.12
4.25
0.03
0.04
2.68
0.19
0.25
2.30
0.06
0.15
9.77
0.03
0.06
6.96
0.02
0.05
6.60
0.02
0.02
3.81
0.03
0.07
8.74
0.03
0.05
5.68
0.02
0.04
6.42
9.84
13.02
8.83
7.33
6.20
11.74
4.97
8.04
22.03
27.04
6.74
0.13
7.38
5.47
7.46
1986
2000
Shock in Japan
1.91
1.40
3.73
2.61
2.66
1.90
0.38
0.34
0.88
0.77
0.91
0.75
0.38
0.31
1.48
1.12
1.28
1.11
0.51
0.44
0.40
0.33
0.29
0.23
2.37
2.35
0.48
0.40
0.43
0.35
Shock in NIE4
0.25
0.40
0.36
0.65
0.44
0.63
0.05
0.10
0.15
0.21
0.13
0.23
0.06
0.08
0.20
0.32
0.17
0.35
0.08
0.16
0.07
0.11
0.07
0.07
0.09
0.16
0.07
0.11
0.06
0.09
Change Per
year %
1.89
2.14
2.03
0.74
0.89
1.29
1.30
1.72
0.92
0.95
1.23
1.30
0.07
1.15
1.27
4.19
5.67
3.05
6.55
3.13
5.34
1.51
4.35
7.27
6.65
3.77
0.01
5.91
4.48
4.57
1986
2000
Shock in US
2.32
2.27
3.69
3.67
3.53
3.43
0.66
0.64
1.41
1.34
1.69
1.44
0.88
0.73
2.28
2.10
2.44
2.07
1.15
0.85
0.92
1.18
0.40
0.45
1.13
1.04
1.22
2.05
2.08
2.05
Change Per
year %
0.16
0.04
0.20
0.25
0.32
1.05
1.26
0.54
1.09
1.83
2.04
0.85
0.61
4.89
0.10
Shock in ROECD
2.07
2.20
0.45
3.08
3.66
1.35
3.25
3.27
0.05
0.56
0.57
0.23
1.40
1.30
0.50
1.40
1.36
0.18
0.77
0.69
0.79
2.01
2.04
0.12
1.97
1.96
0.03
0.84
0.77
0.66
0.76
0.77
0.06
0.40
0.41
0.25
0.93
0.93
0.02
2.32
2.34
0.05
0.96
0.97
0.03
Note: The highlighted average effects for each group do not include ‘‘own effect.’’ The columns under Shock in
ASEAN4 and Shock in NIE4 are the averages for these groups excluding ‘‘own effects.’’
3. Although China’s multiplier effects have grown substantially over the years, they are still
much smaller in magnitude compared to those of ROECD and the US. However, the gap
between these multipliers has narrowed substantially. In 1986 ROECD and US multiplier
effects on ASEAN4 and NIE4 were, on average, 7 –9 times bigger than those of China’s.
By 2000 these average multipliers were only 2– 4 times bigger. On the other hand, with
Japan loosing some ground over this period some of Japan’s multipliers in 2000 are not
too far away from those of China’s. If we extrapolate these trends into the future, China’s
multiplier effects are bound to become more overwhelming as the country fulfills its trade
and investment liberalization agenda made for its entry into the WTO.
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T. Abeysinghe, D. Lu / China Economic Review 14 (2003) 164–185
4. The average multiplier effects generated by ASEAN4 and NIE4 also have grown over
this period but their magnitudes remain well below those of China’s. This highlights
that, despite the large difference in per capita incomes between China and these two
regions, China could offer substantial benefits to its trading partners through the sheer
size of its market.
5. In Table 6 the columns under Shock in China and the rows marked China tell us another
interesting story, the asymmetry of benefits China and the rest of the world have
derived from each other. While the incremental benefits that China has brought on
others by opening up its market has been very large (see the last column under Shock in
China), benefits that others have brought on China have been relatively small (read
across the rows China). In the case of Japan the multiplier effects on China have fallen
from 0.29 in 1986 to 0.23 in 2000. As for the others their multiplier effects on China
have grown only slowly over this period. Moreover, these multiplier effects on China
are still relatively very small. For example the largest multiplier effect on China comes
from the US (0.45 in 2000), but this is also the smallest US multiplier in the list. This
indicates that China’s overall growth was already much less dependent on external
demand than the other economies in the region in 2000.
In summary our empirical analysis of the trade-links in the region shows that the
Chinese economy started to emerge as an engine of growth for its trading partners in the
period 1986– 2000. Its multiplier-effects on the regional economies increased significantly
over the period as China rose as an economic powerhouse.
5. Concluding remarks
In this paper, we discuss the competitive pressures brought in by the rising Chinese
economic power on the Southeast Asian countries. We also point out that there are good
reasons to believe that a further developed China with greater market openness will
become an increasingly powerful growth engine in the region. Our statistical exercise
provides empirical evidence that, over the last 15 years in the 20th century, as the Chinese
economy opened up and took off, its positive multiplying effect on the neighboring
economies significantly magnified. This had happened even before China joined the WTO
and made a full transformation of its growth model. As China fulfills its trade
liberalization agenda with WTO and shifts towards a domestic-demand-driven growth
model, the multiplying effect of its growth on the region can only be reinforced and
multiplied. Driven by economic fundamentals, China’s domestic demand will increasingly
be the engine of growth not only for its own economy but also for the region and the
world. This will have far-reaching effect on the trade structure of the Pacific Asia and the
world economy.
Although our paper limits its focus on the macroeconomic effects of China emerging as a
regional growth engine, we should not ignore the microeconomic foundation for this
development. China’s rise as a ‘‘regional factory’’ and the largest host for FDI in the region
is part of the ongoing process of globalization and reorganization of value chains in many
industries. Recent development in world direct investment climate shows, a ‘‘greater focus
T. Abeysinghe, D. Lu / China Economic Review 14 (2003) 164–185
183
Fig. 6. Impact of autonomous trade balance on investment stream at different investment rates.
on core competencies, with flatter hierarchies and stronger emphasis on networking, steers
investments towards locations with advanced factors and institutions, and, where relevant,
distinct industrial clusters. New organizational methods (aided by new technologies) allow
a more efficient management of global operations, encouraging a greater relocation of
functions’’ (United Nations Conference on Trade and Development, 2001, p. 13). With the
surge of inward FDI, China has increasingly integrated itself into the system of global
division of labor and the interregional web of input – output linkage. Its low-cost output can
benefit other countries’ businesses that share these links along the value chains. This
microeconomic basis of China’s being a regional growth engine can be analyzed via sectorlevel trade data and interindustry/intraindustry linkages between China and its major trade
partners.13 In light of China’s contribution to the global and regional value chains in
specific industries, further studies can be pursued in future to investigate the trade and
growth implications of the changing investment patterns in the Pacific Asian region.
Acknowledgements
Earlier versions of the paper were presented at a Chinese Economists Society session at
AEA annual meetings at Atlanta, January 3 –5, 2002, and Kansai Econometric Conference
at Kyoto University, January 11, 2003. The authors thank the session participants for their
useful comments. The authors also benefited immensely from the comments of two
anonymous referees. This research was partially supported by the National University of
Singapore research grants RP3972032 and R122000068112.
13
For instance, Wang (2000) studies the effect of direct investment (and value chain relocation) from Taiwan
and South Korea on enhancing the two economies’ rapid growth of export trade to mainland China.
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T. Abeysinghe, D. Lu / China Economic Review 14 (2003) 164–185
Appendix A
To get a glimpse at how the comparative static in Eq. (8) changes over time, we run a
simulation exercise by making some reasonable specifications of the production function
and investment function: f(K)=AKa and Kt=(1+r)Kt1, where A is a constant, a and r are
both between 0 and 1. Substituting these into Eq. (8) we have:
dIt
¼
dðTBa Þ
1
ðA1Þ
1
1
r
Fig. 6 displays results with the assumptions that a=.25, s=0.30, m=0.10, K0=1, and A=1.
Several interesting observations can be made. First, in early stages of capital accumulation,
the autonomous trade balance has positive impact on value of investment stream. Second,
the magnitude of this impact increases overtime at a surging rate until it suddenly reverses
itself into the negative range. Afterwards, the impact gradually diminishes. Finally, the
higher the investment rate, the earlier the reversion comes.
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