T C A Srinivasa-Raghavan: Can China be the 'engine of growth'?

OKONOMOS

The macro evidence may suggest so, but the micro evidence says China can't take up the slack.

Now that everyone has stopped guessing as to whether the US economy is going to slow down, all eyes have rotated towards China which, people hope, will carry the slack. An influential, though often schoolboyish, magazine published from London has told the the world not to worry because China is there (as, to a lesser extent, is India).

But the US Federal Reserve Board "" which may well have caused the problem for America in the first place "" may not think so. A recent paper* on its website has tried to examine the proposition that China can, in fact, act as an independent engine of growth if the US economy falters. The prognosis is not very hopeful. Jane T. Haltmaier, Shaghil Ahmed, Brahima Coulibaly, Ross Knippenberg say that "although China's rise as an economic powerhouse is undisputed, at this point it is unlikely that emerging Asia could weather a significant slowdown in the US economy, for example, without being noticeably affected." In short, China may not be the substitute engine of growth that the world is looking for.

This paper, apart from the macroeconomic analyses, looks at the microeconomic evidence as well. That is what gives it its real value.

The real question that needs answering is whether, for Asia, China is merely a "conduit of demand" from the industrial countries "" i.e. a country that imports parts and components for assembly "" or a competitor for its export markets.

The macro bit is mostly guesswork backed by some fancy econometrics. You can take it or leave it because time alone with tell, as will the timing of interventions whether by governments or central banks. The paper says that available evidence suggests that China will substitute the US economy.

But the latter bit, the microeconomic evidence, is expectedly more informative as it "decomposes trade into basic products, parts and components, and finished goods." Result: the authors say that parts and components are playing an important and increasing role as a conduit "" China's a country that assembles more than it makes, that is, your typical screwdriver economy.

More importantly perhaps, the authors say that " China's increasing presence in export markets has had a negative effect on exports of some products for some other Asian economies, but not for other products, including those of the important electronic high-technology industry." That seems obvious but I guess it points to a canceling out effect in current account terms.

The other key findings are that external demand continues to be crucial but largely only for the more advanced Asian economies and that production fragmentation appears to be more important for the more-advanced than for the less-advanced countries. It also turns out that with China moving up the value chain, the impact has been significant on the pattern of production in the region.

"For instance, Japan and Korea have further increased their presence in the medium-tech automotive industry and Singapore has developed its biomedical sector. Philippines has increased its revealed comparative advantage in exports of electronic high-tech products, a large proportion of which are parts and components."

Interestingly, China's increasing export share has had a negative effect in the medium-tech and low-tech industries. This perhaps holds a lesson for India for the future.

The crucial issue therefore is whether the Asian economies are seeking to find areas of complementarities with China or trying to compete with it. The picture is not yet very clear.

In the end, however, much will depend on how buoyant China's internal market is. This is where India offers the real alternative because it has always focused on developing the internal market before the foreign one. This has made the economy less vulnerable to foreign fools (although theimpact of Indian fools can no less devastating).

*The Role of China in Asia: Engine, Conduit, or Steamroller? Board ofGovernors of the Federal Reserve System, International Finance Discussion Papers Number 904, September 2007 http://www.federalreserve.gov/pubs/ifdp/2007/904/ifdp904.pdf