Friday, December 31, 2010

'Reverse coupling' theory just wishful thinking

Dec 30, 2010
By Tan Meng Wah

MANY accolades have been sung about China's economic success over the last three decades. Along with those tributes has come the hope that China's high growth will help pull the world - especially developed economies - out of a slump, with talk of 'reverse coupling'.

That tantalising proposition, however, rests on the premise that China has sustained growth in its domestic consumption. But despite the huge and timely stimulus injected by the Chinese government at the height of the global financial crisis, domestic consumption today remains subdued.

Even if domestic consumption grows, the prospects of China becoming the engine that pulls the locomotive of world trade along are dim at best, and wishful thinking at worst.

It is too simplistic to assume that an upsurge in Chinese domestic consumption will automatically translate into a tremendous spike in its imports.

The American economy became the engine that pulled the world economy along over the past decades not only because of its unique privilege to print greenback at will. More pertinently, the gradual hollowing out of its industries also dictated that the United States had to import a good deal of what it needed.

That is far from being the case in China, which prefers to make its own goods, and where imports are not yet a game-changer for the domestic, let alone the global, economy.

Much of what China needs can be satisfied with goods and services produced domestically, without the need for imports. Even though the quality may not match that of imported goods, it will be acceptable for the relatively less-discerning Chinese consumers. Hence, expansion of domestic demand will only fuel the growth and innovative capability of Chinese enterprises, and transform them into increasingly formidable competitors in the global market.

Many foreign multinational corporations have relocated their production facilities in China to serve the domestic market. An increase in Chinese domestic demand will help churn production at these Chinese facilities, not create more job opportunities in developed countries.

In any case, many foreign small and medium-sized enterprises (SMEs) face daunting challenges trying to sell to China. With no production facilities located in China, their ability to serve Chinese consumers is greatly constrained. They also face overwhelming obstacles in marketing and distributing their products to Chinese consumers. This is exacerbated by the aggressive competition from Chinese manufacturers who have switched to selling to domestic customers in the aftermath of the 2008-09 global recession.

Chinese distribution channels are already congested with Chinese-made products, priced favourably and with improving quality. A visit to any outlet of a major Chinese supermarket chain will reveal that imported goods are not only more expensive but also harder to come by. A rise in the yuan may help to bring down their prices - but imported goods will still face a tough battle gaining shelf space in a Chinese supermarket, which typically devotes less then 5 per cent of total floor space in each store to imported goods. More imported goods are available at speciality stores frequented by foreigners, but at prices beyond the reach of ordinary Chinese folk.

With so many producers contending for limited shelf space, supermarkets are notorious for charging exorbitant entry fees and demanding long credit periods from suppliers. These may not be terms foreign importers are prepared to accept.

In short, foreign producers wishing to sell to China face a tough prospect with many hidden rules. Foreign SMEs, in particular, with a lack of financial clout and market knowledge, will face many obstacles in navigating China's cluttered distribution maze.

Only imports in the following categories are likely to grow: commodities that China lacks; high tech and proprietary machinery and equipment in areas of technology where China is still behind; and luxury goods for the growing middle-class.

During President Hu Jintao's recent visit to France, for example, the two countries signed deals amounting to € 16 billion (S$27 billion) that involved China buying uranium, nuclear technology and more than 100 Airbus planes.

One rosy picture painted by economists is that if China buys more of developed countries' high-tech exports, then these rich countries' economies will boom once again, and consumers there will start to buy from the rest of the world again.

It will, however, take far more than Chinese demand for exports to pull the developed world out of the trenches, given mounting public debt and the growing resistance of the Western public to painful economic reforms.

Globalisation has also resulted in developed economies relinquishing a good portion of their manufacturing might to emerging economies, limiting their current and future capacity to sell to China. British Prime Minister David Cameron's recent visit to China, for instance, yielded only a single contract to sell Rolls-Royce jet engines worth just US$1.2 billion (S$1.6 billion).

In the case of the US, where growth has so far been elusive despite the aggressive monetary stimulus, industries are struggling to create enough new jobs. With its higher cost structure, the US will find it hard to recover manufacturing jobs lost to emerging economies. Its hopes lie in new growth areas - for example, the green energy sector - or in high-tech industries where emerging economies have yet to build their competitive advantage.

In other words, even if Chinese domestic consumption picks up, there are limits to what the US can export to China. Even in high-tech areas, China is fast closing the gap. Already, China has overtaken the US to clinch the top spot in supercomputer rankings with its Tianhe-1A which has 1.4 times the horsepower of the top US computer.

In aerospace, long a stronghold of Boeing and Airbus, China's state-owned Commercial Aircraft Corp of China made headlines recently with its announcement of a 100-plane order from mostly Chinese airlines.

Given China's interminable supply of both skilled and unskilled labour, increasingly sophisticated infrastructure, and quick pace of industrial upgrading, its capacity to grow across industrial clusters will be unmatchable both in terms of scale, depth and capabilities. It appears likely that China will chomp off an increasing share of the global economic pie.

Even if the yuan appreciates substantially, Chinese exports may still be able to maintain their competitiveness due to a rise in productivity. In the coming years, Chinese firms are likely to benefit from internal economies of scale, as they continue to expand output in response to expanding domestic consumption; external economies of scale, as industrial clusters mature and deepen; productivity growth, as the relentless push for research and development bears fruit and new technologies are adopted; and new growth impetus, as structural reforms are unleashed.

Countries may find it harder to sell to China, while becoming more dependent on cheaper Chinese imports. This constitutes neither an encouraging nor a sustainable scenario for global trade - which could evolve to become more than ever a zero-sum game.

In short, though Chinese domestic consumption may pick up, the hope of reverse coupling between the Chinese and global economy may remain in the end just a figment of wishful thinking.

The writer, a Singaporean, is a PhD candidate in world economics at Nanjing University School of Business.

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