Evolving patterns of regional trade: Catching a cold from China?

The saying used to be, “when America sneezes, the world catches a cold”. Today, it is China’s health that many Asia-Pacific countries worry about. The latest Asia-Pacific Trade and Investment Report (APTIR) from the United Nations Economic and Social Commission for Asia and the Pacific (ESCAP) shows that many Asia-Pacific economies have become more integrated with China, and more dependent on Chinese demand for their exports over recent years. But as China restructures its economy what consequences will this have for growth and employment elsewhere?

China’s strong economic growth over the past decade has drawn in rising volumes of imports from the Asia-Pacific region. Some economies, like Indonesia, export mainly commodities to China and have done well from China’s growing demand for raw materials. Others, like Thailand and Malaysia, supply components which are then assembled in Chinese factories into final products, like electronics or household goods, for export elsewhere, such as the European Union and the United States. ESCAP analysis shows that the connection between China’s industrial output and total exports from countries like India, Malaysia and the Republic of Korea was much higher in the past decade than in the 1990s.

But China is now changing: as it rebalances its economy away from export- and investment-led expansion to a model of growth based on innovation and domestic demand, it may be entering a new phase characterized by lower growth rates. While the economy continues to expand, it is unlikely to recapture the double-digit growth rates seen in the recent past. China’s export growth continues to outperform the region overall; in 2013 China’s merchandise exports grew by 7.8 per cent and service exports grew by 7.5 per cent compared with figures for the Asia-Pacific of 2.1 per cent and 4.9 per cent respectively. However, the first five months of 2014 saw a considerably weaker performance in China: exports dropped by 0.3 per cent on a year-on-year basis. This weaker growth will have knock-on effects for many regional economies - meaning slower growth and less employment.

Further, it seems that other Asia-Pacific economies may not be benefitting from Chinese export growth as much as in the past. China’s imports from other regional developing economies fell by 1.4 per cent in 2013 even though, as noted, total Chinese exports continued to expand relatively strongly by 7.8 per cent.

What is causing this shift? It may be that China is now producing domestically the intermediate inputs for manufacturing that it used to import. If true, this could have serious consequences for firms in countries like Thailand or Republic of Korea, which are in growing competition with Chinese companies to supply inputs for China-centric production networks. Separately, new investment is also slowing as returns diminish, not least in the construction sector. Countries which are mainly commodity exporters will therefore also be affected by the resulting dent in demand for, say, timber or metals.

However, restructuring in China could also mean new opportunities for emerging Asia-Pacific economies over the long-term. As China moves into more sophisticated production activities, and wages in China continue to rise, other countries can take over the production and assembly work previously done in China. Viet Nam, for instance, could be well positioned to expand its manufacturing sector and has already seen growing exports.

The analysis in APTIR 2014 suggests that growing exports and rising regional economic integration have helped countries to create productive employment and have shared the benefits of growth more widely. China has been at the center of many of these trends. Yet the patterns of regional trade and integration are evolving and countries, including China, will need to adapt.

So what is the prescription for those Asia-Pacific economies feeling under the weather? While ‘immunization’ is not possible; ESCAP is making a number of recommendations for policy makers and governments – to take steps to support domestic demand; increase competitiveness (with a focus on services); and improve connectivity with the wider region and the world.

More independent analyses and recommendations on trade and investment in Asia and the Pacific region are available in the report.