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The Emerging Asian UnionChina Trade, Asian Investment, and a New Competitive Challengeby Edward Gresser Few topics received more attention in Washington, DC, in early spring 2004 than China. Last winter, the Bush Administration's Commerce and Treasury secretaries made pilgrimages to Beijing to deposit long lists of appeals, petitions, and protests. China is charged with delinquency in its World Trade Organization (WTO) commitments; the Bush Administration is charged with weakness in enforcing them. And lawsuits were flying: the AFL-CIO filed a case against Chinese labor abuses with the US Trade Representative (USTR) in March, and a group of manufacturers is said to have prepared one against Chinese currency policy. Rejecting both, the USTR itself has protested Chinese computer chip taxes at the WTO. The sheer number of complaints is striking. But equally striking is the fact that few of them are new. China's labor record has not notably improved in recent years—but neither has it deteriorated. China's currency rates have not changed since 1994. And while China's implementation of WTO commitments has gaps, with chips a high-profile dispute and intellectual property rights perhaps even more so, the Chinese economy is more open than ever before and sucking in imports at an extraordinary pace. With little attention in the United States, the twenty-first century has brought rapid integration of the Asian economy and the emergence of what can be termed an informal "Asian Union." For the first time, China's manpower and low costs are united with the money and technology of Japan, South Korea, Taiwan, Hong Kong, and Singapore. China's emergence as America's most visible source of goods thus reflects a structural change in the Asian economy more than it reflects new Chinese trade or labor policies. This development offers economic and security opportunities, carries with it potential sources of risk and financial instability, and also means a powerful new competitive challenge. Demographic realities mean that Asia's new competitive advantages are unlikely to last forever. But in the next decade American business, labor, and government may find themselves adjusting to a much more challenging environment. Economic integrationOne might begin with a single fact: last year Japan exported more to "Greater China" than to the United States. Japanese firms sent cars, computer chips, televisions, and other goods worth ¥13.7 trillion west to mainland China, Hong Kong, and Taiwan in 2003; and only ¥13.6 trillion worth of goods east to America.
Setting aside the World War II years as anomalous, one must go back to 1873 to find Japanese statisticians recording ¥4.3 million worth of exports to China and 4.2 million to the United States. By 1874, the United States had passed China to become Japan's major export market and did not trail again in peacetime for 130 years. Trends are similar in South Korea, Taiwan, Hong Kong, and much of Southeast Asia, with China first passing Japan and now approaching the United States as Asia's main export market. Their experience, like that of Japan, reflects a series of Asia-Pacific milestones passed in the 1990s. Some got little attention in America, but together they leave China more secure and more integrated into the Pacific economy than at any time since the early 1800s:
The consequence is a wave of investment in the mainland. American debate has focused intently on the "outsourcing" of American companies. But most investment in China comes from Asia's five rich economies: Japan, South Korea, Taiwan, Hong Kong, and Singapore. This investment is blurring Asia's economic borders, uniting the financial and technological power of Japan and the ex-tigers with China's low costs and vast manpower reserves. This is a healthy and long-delayed shift. In retrospect, Asian economic integration should have happened after World War II. But in the years when Europe began its long and slow union, the Chinese revolution and the Korean War prevented a similar evolution in Asia. The evolution is now, however, proceeding at extraordinary speed. One can think of the result as an informal Asian Union—an integrated economy roughly the same size as its $11 trillion European counterpart, though without its elaborate legal framework and policy coordination among governments.
Asian investment trendsSince the late 1990s, China has received $40 billion to $50 billion a year in direct investment: factories, research stations, sales offices, and so on. Between 2000 and 2002 (complete 2003 statistics are not yet available), foreign firms opened 83,000 new projects in China. The Chinese government characterizes about three-quarters of them as manufacturing facilities. In other words, foreign firms set up roughly 60,000 new plants on the mainland in the first three years of the twenty-first century. This may overstate the total to some extent, as definitions of "manufacturing" and "foreign-invested facility" can be blurry. But nonetheless the total is very high. For context, the total number of manufacturing plants in the United States is about 350,000. Some investors are Americans, adding Chinese plants to existing American and international facilities or moving to China altogether. But as Table 1 shows, American investment is only a small fraction, and maybe not a growing one, of total investment in mainland China. So excluding those financed from offshore islands, about 80 percent of the new projects are Asian rather than western. The actual ratio is probably closer to 85 percent, since most offshore island projects are thought to involve Taiwan firms avoiding Taipei government scrutiny and mainland Chinese firms hoping to get incentives meant for foreign investors. Why are they coming? For one thing, China's government tries enthusiastically to lure them. Discriminatory taxes on foreign-made goods as opposed to locally produced counterparts are an example. The Bush Administration's recent filing of a WTO case over semiconductor taxation highlights an especially objectionable case. Other incentives range from tax rebates for exporters to the wine-and-dine sessions common worldwide. But the realities of geopolitics, economic comparative advantages, and demography mean that investment promotion policies simply accent a phenomenon that would happen in any case. To list these realities briefly:
China as exporterThe consequences are big enough to numb. Most visible in the United States are imports from China. As Japanese, South Korean, Taiwan, and other plants start production, "Chinese" exports to the United States boom. Between 2000 and 2003, such exports rose from $100 billion to $152 billion and accounted for all of America's net import growth. With most of these imports still concentrated in consumer goods, the phenomenon is even more visible and has a more powerful psychological impact than the numbers alone would suggest. But "Chinese" exports are diversifying as well as booming. Three popular consumer goods—clothes, shoes, and toys—accounted for nearly half of American imports from China in 1993. By 1999, these products made up only a third of the total, and by 2003 were less than a quarter. As Table 2 shows, the fastest-growing imports from China are now sophisticated, capital-intensive goods like TV sets, perfumes, and child safety seats. More is on the way—Taiwan firms, for example, are already reported to be building 19 state-of-the-art semiconductor plants around Shanghai, and firms from Malaysia, South Korea, and the United States are not far behind. America's direct imports from wealthy Asian countries, meanwhile, have plummeted. Table 3 shows how falling imports from Japan and the other four wealthy Asian economies almost precisely offset new purchases from China. This is actually a bit too precise—it reflects the fact that information technology imports have dropped as well as shifts of production to the mainland—but illustrates the fact that "Chinese imports" might more accurately be termed imports from an integrated Asian regional economy. China as importerThe other half of the ledger shows an equally striking trend. China is also emerging rapidly as one of the world's most enthusiastic importers. American exports to China, for example, have more than doubled in four years. The $13 billion exported in 1999 reached $28 billion last year. This is faster export growth than we see with any other major country and accounts for more than half of America's worldwide export growth over the past four years. Though the absolute totals are lower, the rate of export growth to China is actually a bit higher than the rate of growth of imports from China.
Even these statistics may understate the success of America's exporters. From the reopening of trade during the Nixon Administration to the late 1990s, America's main exports to China consisted of government purchases of grain and airplanes. Such purchases were often concluded for political reasons. But as Table 4 shows, American export growth since then has been concentrated in a long list of new products for which Chinese demand must be mainly commercial. Chinese purchases of aircraft remain an important part of the trade relationship, but have not noticeably grown since the 1990s. Grain exports, meanwhile, (except soybeans) plunged in the mid-1990s and have not recovered. But exports of American computer chips have tripled since 1999. Some other industrial inputs, including older products like textiles and steel, have done even better. And so have a long list of other goods, from auto parts to fish, cars, refined copper, spectacles, and oranges. Only a global perspective, however, shows the true scale of China's import boom. Since 1999, America's imports have grown by about a $100 billion. Japan's have grown by about $70 billion, and Europe's by about $100 billion. None of these are small figures. But China's imports have grown by nearly $250 billion—accounting for a quarter of the world's import growth since 1999, and nearly as much as the European Union, the United States, and Japan combined. As successful as American exporters may have been, the businesses of most other countries have done better. Filipino exports to China are typical, quadrupling from $500 million to $2 billion (plus another $1.5 billion to Hong Kong) in four years. Other mid-income Southeast Asian countries, such as Thailand and Malaysia, now supply Chinese factories with everything from rubber to chips. Turkish exports to China have grown tenfold, led by steel and auto parts. Pacific-basin natural resource exporters—Peru, Chile, and Russia—have similar records, with China's purchases large enough to raise world prices for lead, iron ore, and other raw materials. Even the profitability of Panama Canal operations has jumped, as ships arrive from China carrying clothes and bringing away ores and capital goods.
Nor does this seem enough. In January, in an amusing echo of America's steel-tariff debates, Chinese manufacturers and construction firms were appealing to their government to lift antidumping penalties on Russian, Taiwan, Ukrainian, and South Korean steel. The South Korean government, meanwhile, imposed emergency export restraints on steel to avoid a supply crisis in the domestic Hyundai and Daewoo plants. Some cautionary pointsWhat does all this mean for American debates on US-China trade? The total picture certainly includes unfair trade practices, objectionable tax policies, investment promotion schemes and so on. A new generation of trade policy can usefully tackle them. But they are relatively small parts of a phenomenon that is much bigger and has little to do with concepts of fairness and unfairness. Economic integration means Asia can suddenly make high-quality goods at lower costs. Americans, in business and labor as well as government, need to respond appropriately. But we should remember that Asia has vulnerabilities and eroding areas of advantage as well. Three in particular are important to remember: the risk of unexpected political events and financial overheating; little-noted labor force trends in China; and larger demographic trends. • Unexpected events and asset bubbles Financial trends also provide grounds to expect a slowing, or even a sharp break, in China's growth and Asia's mainland investment. Of the three Asian countries hit hardest by the crisis, the two that recovered best were the democracies: Thailand and South Korea. Observers in the West and the Chinese government both note fears of credit-fueled booms and asset bubbles. Guo Shuqing, director of China's foreign-exchange bureau, hinted at this in a press release quoted by the Washington Post, stating that "the inflation rate is rising and the asset bubble problem is starting to get worrying." China finance expert Nicholas Lardy likewise noted last year that outstanding credit more than doubled between 2002 and early 2003, rising from ¥0.9 trillion to ¥1.9 trillion. This, he argues, probably implies growth in bad loans and poor investment, together with potential for rising inflation and excessive investments in real estate and manufacturing like those that presaged the financial crises of 1997-99. Trade figures tend to support the hypothesis that the Chinese economy is overheating. In 2003, China's imports grew by 40 percent, and exports by perhaps 35 percent. In US history, such rates of trade growth occur only in anomalous periods. The leading examples are 1866, the year after the Civil War; 1919, the year after the World War I; 1942, as the Lend-Lease program kicked into gear; and 1946, the year after World War II. By January 2004, annualized import growth seems to have been 77 percent—well beyond anything in modern American history. Obviously such comparisons are not perfect. China's economy is very different from that of the United States, and its rapid integration into the global economy may mean these figures are more benign than they would be in America. But the odds are that such trends are not wholly healthy. China is probably investing, buying, and borrowing too much, and Asia as a whole may pay a substantial price for the boom in coming years. This leads back to the potential for political shocks. Most countries hit by the financial crisis in 1997 were healthy again by the turn of the century. But it is interesting to note that of the three Asian countries hit hardest by the crisis, the two that recovered best were the democracies: Thailand and South Korea. The authoritarian Indonesian system, in contrast, collapsed under the strain and the country continues to struggle today. China might have more in common with Indonesia than with the other two. • Rising costs Repression of labor rights is a dismal fact of Chinese politics. But anti-union policies and immigration restrictions may not be enough to overcome the power of labor markets. Wage data is notoriously tangled and politicized, but several sources seem to show that Chinese wages and overall labor costs are rising. This is especially clear in the coastal urban areas that attract most foreign investment and produce most of China's exports. To cite a few anecdotal points:
If such trends continue, one of Asia's major advantages relative to the United States and some of its neighbors may erode sooner than most people predict. Bolstering this hypothesis are China's low fertility and immigration rates. The World Bank projects that over the next 10 years China's labor force will grow barely half as fast as that of the world as a whole (1.4 percent per year for the world, 0.8 percent for China), and even more slowly than the 0.9 percent annual rate projected for America. The result is likely to be a mild labor shortage in the next decade. Slow overall labor-force growth, of course, can still allow urban labor and therefore manufacturing industry to grow rapidly, as rural workers move to cities. But as time passes, coastal export platforms like Guangdong and Shanghai might find the supply of cheap workers running out. Thus they would come to look more like Taiwan and South Korea than like low-wage manufacturing parks. Strong education and capital investment would continue to spur growth, but wages and labor costs would likely begin converging with those of long-industrialized countries. • Aging China China is now by far the "youngest" of the great powers. Its median age is about 30, well below those of the other seven countries participating in the G-8, the UN Security Council, or both. The United States is second "youngest" with a median age of 35, while the others range up to the early forties for Italy and Japan. By the mid-2020s, China will catch the United States at 39 and age much more quickly afterward. The number of Chinese children has already dropped by 50 million since the 1970s and is continuing to fall. So the new factories now opening each week may, sooner than one expects, begin to encounter labor shortages. This may push the cost of labor up even faster than economic growth and productivity might suggest. Meanwhile, as there are fewer Chinese children there are also more elderly. By 2025, more than 200 million Chinese will be over 65. This means an extraordinary housing, health, and pension challenge—consider the fact that 200 million is more than two-thirds of the total US population. Even if this does not lead to the dire consequences a recent Central Intelligence Agency paper suggests—"China could confront slower growth, increased political instability, and perhaps even pressure for significant cultural change, given the lack of sophisticated pension systems, health facilities and capital markets"—it means that absent a new demographic shift, one of China's (and therefore East Asia's) principal sources of comparative advantage will probably erode over the next two decades. Benign challengeAn Asian Union has some powerful competitive strengths. But a competitive challenge is a benign challenge. For most of the twentieth century, China posed a very different set of questions for the United States: questions that related not to jobs and adjustment, but to Asia's political stability, the spread of radical ideologies, and in some cases war. For instance, the Korean War would have been improbable without a radicalized China, and the Vietnam War impossible. An Asian Union has some powerful competitive strengths. But a competitive challenge is a benign challenge. An economic challenge, by contrast, threatens no lives and can be met by peaceful negotiations abroad and reform at home. This is of course no reason to be complacent or dismiss the importance of economics. But it is a reason to keep the trade debate, as heated and controversial as it may be, in a healthy perspective.
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