Reports of Study Groups, etc. No.07

Report of the Study Group on China;
Issues in the 21st Century and Influences on the International Economy


January, 2003
Ebina Makoto
(Mizuho Research Institute)
Hamada Koichi
(Economic and Social Research Institute,Cabinet Office) (Chairman)
Ito Motoshige
(University of Tokyo)
KawaiMasahiro
(Ministry of Finance)
Kitaoka Shinichi
(University of Tokyo)
Kuniyoshi Sumio
(Toshiba Corporation)
Kwan Chi Hung
(Research Institute of Economy, Trade and Industry)
Nakagane Katsuji
(University of Tokyo)
Nakajima Atsushi
(Mizuho Corporate Bank)
Sakaiya Taichi
(Special adviser to Prime Minister)
The full text is written in Japanese.     
(Abstract)

[Major points]
 
[Outline]
 
    The future roles of China in the world economy attract increasing interests of both foreign and Japanese specialists and spur the discussion from the numerous points of view. In May 2002 the Economic and Social Research Institute launched the study group on China and the World Economy in the 21st Century consisting of 10 experts (Chairman: Koichi Hamada, President of the Economic and Social Research Institute, a list of study group members is attached in Appendix) in order to contribute to the study of this issue. Moreover, on November 18, an international forum was held in the presence of the foreign and Japanese experts invited in addition to the study group members. Based on the outcome of the Workshop, we compiled the final report whose chapters are written by the study group members.
    Below is the outline of the four main themes taken up for the discussion in the Workshop: (1) Risk Factors of the Chinese Development,(2) Capability of the Chinese Manufacturing Industry, (3) 'a China Threat Theory' and (4) Roles of Exchange Rate.
 
  1. Risk Factors of the Chinese Development
 
    Vigorous researches and analyses in connection with China are conducted in many ministries, research institutes and universities etc. An opinion concerning China, however, is divided into two diametrically opposite ones: 'China Threat Theory' and 'China Collapse Theory'.
    From the economic standpoint, China has such problems as a problem of the adjustment of the domestic industrial structure under the pressure of liberalization after the WTO entry, a problem of disposal of non-performing loans on the balance sheet of banks and reform of the government-owned enterprises, a problem of financial burden involved in economic reform and others.
    From the social standpoint, there are problems of farmers, problem of economic disparity and imbalance between rural and urban areas, a problem of industrial distribution connecting rural and urban areas and others. Besides, there is an environmental problem, a problem of aging population entailed by one-child policy.
    From the standpoint of governance, the most uncertain problem is that to what extent the Chinese top leaders are able to promote the economic and political reforms while maintaining political stability.
 
  2. Capability of the Chinese Manufacturing Industry
 
  1. China is often called a "factory of the world". It is true concerning the assembly industries. However, capital-intensive and technology-intensive manufacturing industries have not yet reached the scope and the level of the "factory of the world". In addition, based on the theory of international specialization, manufacturing industries utilizing abundant labor force are expected to be the main driving force of the further development.
  2. The bottleneck problem of the infrastructure is getting improved step by step. It became possible to procure cheap domestic raw materials and equipment except for high-tech ones.
  3. Although the assembly industries are expanding, the major parts of the high value added depend on the imports.
  4. Although technology-intensive industries in China lag behind the technological level of industrialized countries, the Chinese enterprises rapidly improve the technology, equipments, and business management by the enormous investment of foreign-affiliated companies.
  5. The strength of the Chinese manufacturing industry is found at the jobsite level of a factory. It is different from the Japanese having competitiveness in production including design, marketing, product planning,R&D, human resource management and others. Since the Chinese companies do not have the world-class technologies and brands, they lag behind the foreign companies in funds, human resources, business management. This leaves no choice but to attribute the export competitiveness to the cheap labor force.
  6. Chinese factories can recruit as many young, willing excellent workers as possible. It is also possible to improve flexibility of production by introducing a three-shifts-system.
  7. Since approximately a half of the export is conducted by the foreign affiliate companies, it is necessary to pay dividends, interests, technology use fees and others to overseas.
     
  3. 'A China Threat Theory'
 
(1) Does China pose a threat under the present circumstances?
    In general, when China is said to pose a threat, a sense of danger is often expressed in the following three phrases.
(a) China makes great progresses and will soon become a world's major economic power.
(b) Chinese products have strong international competitiveness,China is going to become the "factory of the world" in the near future.
(c) The increased imports from China cause the hollowing-out of the Japanese industry.
    In regard to (a), although the Chinese economy is developing fast, it is necessary to take into account that the GDP in 2001 did not exceed 1/4 of the Japanese and GDP per capita was no more than approximately 1/40 . In conjunction with (b), it is necessary to keep in mind that China has a competitiveness not in every industry, but only in those of labor-intensive goods such as clothing, footwear, textile goods, miscellaneous goods and others in addition to the consumer electronics and electronic components, for example, desktop computers, cellular telephones, DVD players and TV sets assembled with imported core parts. Concerning (c), the share of China in the total imports of Japan is 16.6% and rising, it is less than approximately 1.3% of the Japanese GDP. Notwithstanding a sharp increase in import of manufactured goods from China to Japan, the Japanese overseas production ratio in all industries does not exceed 14.5%. It can be hardly said high when compared with about 25% of Western industrialized countries'. Besides, production expansion by the overseas affiliated companies leads to an increase in the Japanese exports of intermediate goods to those and, thus, contributes to the growth of the Japanese exports. The Japanese trade with China records a significant deficit, but looking at the trade balance including Hong Kong whose exports is mainly to China, it becomes clear that Japan maintained a surplus of balance of trade until recently. In addition, since China mainly exports low-tech products while Japan exports mainly high-tech products, the Japan-China trade relation is not competing, but complementary in most of the cases.
    Judging from the above, China can hardly be said to pose a threat at this moment.
 
(2) Will China pose a threat in the future? :a 'Good Threat Theory' and a 'Bad Threat Theory'
    The comparative advantage of China lies still in abundant labor forces, contrary to Japan that has comparative advantage in technology. For example, in the manufactured imports of the U.S. from Japan and China (out of 10000 items), only 16% of goods from Japan and China compete with each other while 84% is complement each other. When competing relations are said to be a zero-sum game, complementary rations are a win-win game. Japan should reinforce the complementarity of the Japan-China trade relation and work on the policy of development without causing hollowing-out by combination of a shift of depressed industries to China and development of new domestic industries.
    'Good Threat Theory' means an acknowledgement of the rapid growth of China as a signal of the necessity of a shift of production base of industries that lost the competitiveness in Japan to overseas and a transfer of factors of the production to growing sectors. The reason of entrusting the production of sectors already technologically outdated to China is intended to upgrade of the industrial structure in Japan. This process will help the Japanese economy revitalized focusing on the internationally competitive sectors.
    On contrary, 'Bad Threat Theory' means a case of causing Japan-China trade friction by exercising political clout when some industries lost in competition with China . In this case, "China Threat Theory" is convenient for the authorities and managers to hide their lack of efforts. However, the cost for averting the attention from the true nature of the problem and further delay in reform is extremely high.
 
  4. The Roles of Exchange Rate
 
    In the decade ahead, if the China is going to double GDP under the present policy, it will follow the export-led growth due to a relative shortage of domestic demand. This will aggravate the external imbalance and further worsen the current problems such as tightening of export-competition with neighboring countries. A policy shift to the domestic demand-led growth pattern through The Renminbi appreciation is effective for the resolution of the present problems and returning greater benefits of the growth to the Chinese people. It is also desirable in regard to the impact on international division of labor and excessive export competition.
    First, basing on the assumption that labor is the only factor of production, Figure 1 examines the comparative productivity of industries in Japan vis-a-vis China. In 2000 real effective relative wage ratio in Tokyo and Shanghai is approximately 4.4. The intersection of this curve and the line of comparative productivity shows the critical point dividing exports from imports. For example, Japan will gain by producing higher productivity goods while by importing from China lower productivity goods. Figure 1 indicates Japan has a comparative advantage in such as automobiles or electric machinery. On the other hand, China has an advantage in clothing, coal and other goods shown on the side of lower productivity. If the productivity in China increases more quickly than in Japan in general, the curve of comparative productivity will shift down to the left and the larger area of imports will become more profitable.
    Second, price competitiveness is estimated on the basis of the Price Difference survey in Japan and China. Figure 2 indicates price differentials the Japanese consumers will face if they purchase the both countries goods on the domestic market. To this end, transport distribution costs and customs duties (corresponding to approximately 55% of the price on average) are added to the price differentials of products in 1995 compiled in 'Survey on Japanese-Chinese Services Prices and Estimates of New Purchasing Power Parity' (Keio University, 2002). Although the '95's prices differ partially from the present ones, Figure 2 shows that the existence of the substantial price differentials underpins the large-scale trade between Japan and China. Japan has competitiveness in precision machinery, metals, chemical products, transport equipment such as passenger vehicles and others. On the other hand, China can keep competitiveness in such labor-intensive industries as clothing, foods and others even in case of several fold the Yuan appreciation. Concerning with such goods as motorcycles, washing machines, refrigerator, which Japan was competitive once, China has now an edge even if Yuan appreciates to some degree. Nevertheless, for the international comparison it is necessary to pay attention to the fact that it is impossible to eliminate enough the differences in quality except for some standardized goods.
    Finally, policy implications are considered. Generalizing Figure 1, if comparative productivity turns out to be unfavorable (a shift from A to C on the figure), the once competitive industries will suffer a devastating blow. This is applicable to ASEAN whose exports compete with China now. Putting it another way, many countries may benefit from the economic development of China which employs abundant labor force by the introduction of large-scale FDI, but in export competing countries there is a possibility that they will suffer from the in creased Chinese exports. For this reason, taking into account not only worsening the terms of trade, but also aggravating external imbalance and negative impact on countries of China's export-competitors, there is no merit of maintaining the fixed exchange to by China. Figure 2 indicates that a shift to a floating exchange rate does not affect much the price advantage structure between Japan and China. For example, 50% appreciation of the Yuan will not entail changes in competitiveness of China.
    In other words, a policy shift to the domestic demand-led growth pattern through the Yuan appreciation has the greatest effect on alleviation of external imbalance, increase of GDP and enhancing of the economic welfare of China. This suggests that Yuan appreciation is desirable for China itself. Figure 3
 
* The views expressed in this report are those of the authors and are not to be interpreted as the official position of the Cabinet Office or Economic and Social Research Institute.




Figure 1: Multiple goods Ricardo-type model (production-value weighted)

Figure 2: Equilibrium rates by goods

Figure 3: Baseline case and impacts of domestic demand-led policy on economic welfare (1)
Figure 3: Baseline case and impacts of domestic demand-led policy on economic welfare (2)