The Development of China's Export Performance, Presentation by Javier Silva-Ruete, Alternate Executive Director, IMF

IMF News, March 7, 2006

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Authors: Javier Silva-Ruete Alternate Executive Director
Published: March 7, 2006

Overview and key macroeconomic indicators

Average annual GDP growth rate since the end of the 1970s: 9 percent.
Capital formation estimated at 50 percent of GDP (according to the latest IMF figures cited).
Annual inflation remained steady at around 1 percent between 1996 and 2003, with periods of deflation during that expansion.
Foreign direct investment currently: over a billion dollars in FDI are invested in China each week.
Poverty reduction: some 400 million people have been lifted out of poverty since the end of the 1970s.

China's integration in the global economy — export growth and market shares

Export growth averages:
- 1980s: 5.7 percent
- 1990s: 12.4 percent
- 2000–2003: 20.3 percent
By 2003, China's export growth rate was seven times higher than the export growth rate recorded by the world as a whole.
Chinese exports grew from US$25 billion in 1984 to US$383 billion in 2003, increasing China’s share in world exports from 1.5 percent to 5.8 percent.
China's participation (Chinese Imports/Total Imports) in main markets:
- Japan: 1970 — 1.4%; 1980 — 3.1%; 1990 — 5.1%; 1995 — 10.7%; 2000 — 14.5%; 2002 — 18.3%; 2003 — 18.5%
- USA: 1970 — 0.0%; 1980 — 0.5%; 1990 — 3.2%; 1995 — 6.3%; 2000 — 8.6%; 2002 — 11.1%; 2003 — 12.5%
- EU: 1970 — 0.6%; 1980 — 0.7%; 1990 — 2.0%; 1995 — 3.8%; 2000 — 6.2%; 2002 — 7.5%; 2003 — 8.9%

Characteristics of China's trade performance and export composition

Export dynamism and diversification:
- 1987: approximately a quarter of exports were products in high worldwide demand.
- 2002: that figure rose to 60 percent (comparable to the United States' exports).
Export composition shifts:
- Mid 1980s: almost 90 percent of exports were primary products or low-technology manufactured items.
- 2002: that low-tech/primary share fell to 50 percent.
- High-tech exports rose from less than 5 percent to 30 percent between the mid 1980s and 2002.

Underpinning reforms and implementation strategy

Three transformations driving development:
- centrally-planned to market-oriented economy;
- agriculturally-based to manufacturing- and services-based economy;
- closed to open economy.
Three supporting factors:
- Initial conditions: large population, low-wage labor market, favorable social indicators, geographic advantages, and positive regional influences.
- Structural reforms: quasi-privatization of communal farming, promotion of town and village enterprises, trade liberalization (including export-oriented processing and WTO accession), phased opening to FDI, gradual reforms of state-owned enterprises, removal of red tape, financial market opening, and fiscal reform.
- Implementation strategy: long-term vision, macroeconomic stability, vigorous investment growth, industry and technology policy, access to domestic credit, education improvements, pragmatic gradualism described as the "art of dualism", and compensation programs for reform "losers".

Challenges and risks in the medium term

Soft landing and credit risks:
- IMF recommendation: be alert for surges in lending and investment; use open market transactions to reduce excess liquidity; consider interest rate hikes and legal reserve increases; improve credit supervision and strengthen prudential regulation to keep credit growth under control and maintain financial stability.
Monetary policy and exchange rate:
- IMF view: grant the central bank more discretionary power to set interest rates.
- Large accumulation of international reserves (from trade surplus and capital inflows) complicates monetary policy.
- IMF welcomes changes toward a more flexible exchange rate system and stresses the need for increased exchange rate flexibility (not just revaluation) to increase monetary policy independence and help correct global imbalances.
Fiscal policy recommendations:
- Support for medium-term fiscal consolidation plans to guarantee fiscal sustainability and prepare for future spending needs.
- IMF recommends continuing to lower the fiscal income target starting in 2006 and saving any income above that target to help curb domestic demand growth.
- Reorientation of public spending toward social projects (health care and education) is supported.
- Structural public finance improvements urged: revised budget classification, expansion of the Treasury's sole account coverage, tax reforms, correction of subnational finance imbalances, clarification of responsibilities, and creation of a regulated transfer system.
Investment sustainability risks:
- Concern that high investment levels concentrated in a few sectors (aluminum, automobile, cement, real estate and steel) — with investment levels rising over 50 percent in some sectors — may generate slack and unproductive capacity.
- Risk path: overinvestment driven by cheap credit and overoptimism could reduce prices and profits, increase nonperforming loans, and burden the banking system.
- Underlying problem: high savings fueling rapid investment generate low returns due to weaknesses in rate patterns and implicit costs from supporting unviable state-owned enterprises through cheap capital.
Financial system reform priorities:
- Reform state banking sector to intermediate huge savings towards productive investments; banking sector reform is top priority because banks dominate financial activity and the stock market is relatively underdeveloped.
- Progress noted: creation of the Banking Regulatory Commission (beginning of 2003) to improve regulation and supervision; capital injections into three main banks improving capitalization; admission of strategic foreign partners expected to enhance technical innovation and governance.
- Challenges: enormous size of banking system (hundreds of thousands of employees and dozens of thousands of branches), logistical challenge of reform, need to change lending practices from state-directed to commercial and risk-based decision-making.
- Relationship between banking reform and monetary policy: a commercially oriented banking system would improve resource allocation and strengthen monetary transmission; exchange rate flexibility remains necessary for independent monetary policy; current controls and sterilization of capital inflows have imposed heavy costs and distorted transmission mechanisms.
State-owned enterprises (SOEs):
- SOEs are becoming more market-oriented via management restructuring and foreign participation, but significant reforms remain necessary to ensure medium-term viability.
- IMF-supported measures: enhance role of the Commission for the Supervision and Administration of State Assets and establish obligation for SOEs to pay dividends to the government to incentivize net worth improvement.

China and Latin America — opportunities, competition, and lessons

Four dimensions Latin America should analyze (IDB framing referenced):
- China the success story:
- Historical comparison: in the mid 1950s Latin America’s per capita income grew faster than China’s; Latin America faltered in the 1960s–1970s while East Asia advanced via export-led industrialization; China later followed successful neighbors and widened the gap versus Latin America, achieving substantial poverty reduction.
- China the market:
- Latin America positioned to supply agricultural products, processed food and drink, and services like tourism as Chinese aggregate consumption rises.
- China is an attractive market and potential source of FDI for Latin American industry.
- Recent decades saw increasing bilateral trade linkages; many Latin American exports to China remain raw materials and commodities, but rising Chinese income may absorb higher value-added products and increase intra-industry trade.
- Possibility noted that a free trade agreement or economic complementation agreement with China could be considered in coming years.
- China the competitor:
- Sources of competitiveness: labor-intensive comparative advantage; improving primary education and growing tertiary education (1.3 million college graduates a year); fast progress in innovation (China leads Latin America in numbers of R&D researchers, patent applications, and total R&D expenditures as a percent of GDP); substantial infrastructure investment reducing production costs and enabling diversification.
Lessons and policy recommendations for Latin America:
- Treat China’s emergence as a "wakeup call" to rethink development policy, build on strengths, and address weaknesses.
- Latin America has assets from reforms, notably progress in economic stabilization; remaining weaknesses include equality and government, which should be development priorities.
- Emphasize education at all levels: not only increased resources but curriculum upgrades and better information about future job opportunities.
- Promote innovation with policies that generate externalities: demand-driven innovation, support for universities and research centers to complement private R&D, and encouragement of collaborative innovation in potential clusters.

Presentation by Javier Silva-Ruete, Alternate Executive Director of the IMF for the Constituency of Argentina, Bolivia, Chile, Paraguay, Peru, and Uruguay — Lima, Peru, March 7, 2006.