China's backyard

Since China started to open up its economy in the 1980s, millions of words have been devoted to analysing its role in the world economy. But little seems to have been said about the economic impact of this giant on its immediate neighbours.

by Emilie Filou, World Business
Last Updated: 23 Jul 2013

The received wisdom - in line with hyperbolic predictions that China would take over the world - was that the Chinese juggernaut would swamp Asia. China would crowd other countries' export markets, steal their manufacturing and suck their natural resources dry. The reality is a lot more complex and rather more positive. On the whole, Asia has profited from China's economic growth. For most countries, it's been a blessing, even though they have had to work hard to adapt; for Japan, it's been a saving grace; and for an unfortunate few, the final straw.

China's achievement is impressive. Its economy doubled between 1987 and 1995 and again between 1995 and 2003. It is now the world's sixth largest economy in dollar value and second only to the US in terms of purchasing power.

China is also the largest global supplier of textiles, light manufacturing and electronic goods. Conversely, it is also set to become the largest importer of many raw materials and commodities, and imports substantial quantities of components and heavy machinery to sustain its manufacturing and assembly industry.

China specialised early in low-wage, labour-intensive activities because of its seemingly inexhaustible pool of cheap labour and a relatively good infrastructure. Countries that competed in sectors such as textiles, garment manufacturing and white goods therefore suffered; not only did China crowd out their export markets with its products, it also had less demand for goods it could produce domestically. Indonesia was perhaps the worst hit, with many Western companies moving their clothes manufacturing to China. Vietnam, Malaysia, Bangladesh and Pakistan were also badly affected.

"With Malaysia, it was purely a cost reason," says Michael Backman, an expert on Asia and author of several books, including Asian Eclipse: exposing the dark side of business in Asia (1999). "With Indonesia, the Philippines and Bangladesh, it's more a question of standards. The Chinese are better educated and they are also more savvy."

But countries that were able to form a supply chain with China and export the raw materials and parts required for the country's huge manufacturing needs were given a lifeline. China's manufacturing output trebled between 1990 and 2003, and proximity put Asia in a strong trade position, ahead of other emerging markets, such as Latin America.

Laixiang Sun, professor of Chinese business at SOAS in London, says that China now does 55% of its trade with its near neighbours. The country's balance sheet has run a consistent trade deficit with Asia for many years and currently makes up 12% of non-Japan Asia exports. Electronics, machinery and vehicles, instruments and metals are high on the list of its imports (see over).

The initial negative effect on Asia was quickly overtaken by China's own import needs. Indonesia is now a major provider of oil, gas and timber, while Malaysia, the Philippines and South Korea export semi-conductors and high value-added electronics, which China does not manufacture itself. In a study entitled How China is reorganising the world economy (Asian Economic Policy Review, 2006), Barry Eichengreen, professor of economics at Berkeley, and Hui Tong, economist at the IMF, found that only four countries had not benefited from China's strong economic growth: Bangladesh, Cambodia, Sri Lanka and Pakistan. These low-income economies were already challenged in many ways: poor natural resources, an unskilled workforce, an embryonic manufacturing sector and an overdependence on textiles.

Foreign direct investment (FDI) is a little more complex. Although some countries lost out to China in sectors where it had a competitive advantage, in many cases this was recouped by increased Chinese demand for products and services in other areas of the supply chain. However, a study by Swiss bank UBS in 2006 suggests that as little as 25% of all FDI in China in 2004 went into export-oriented capacity, with the rest aimed at the domestic Chinese market.

One of the results of China's huge economic growth has been the rise of a middle class. Per capita income has quadrupled over the last 20 years and half the country's imports are for domestic consumption. This suggests that companies have invested into China to produce goods and services for Chinese consumers - an observation, UBS notes, that corroborates company-level surveys of foreign businesses in China. These foreign companies are chasing the one billion customers rather than China's cheap labour.

This is another reason why fears that China will become a global manufacturing hub are unfounded. China's industrial output may have tripled since 1990, but so has its domestic industrial consumption. Its exports are also relatively low value-added: China's specialisation is in assembling high value-added goods imported from its neighbours. Backman also points out that many manufacturers in China are foreign-owned: China is more of a Chinese manufacturing hub than a global one.

Japan is perhaps the country that has profited most from economic developments in China. Despite the two countries' historically complicated relationship, Japan has adopted an active outsourcing policy over the past decade, with many of its factories moving to China to take advantage of the cheap labour. China also became Japan's fastest growing export market: Japanese products and brands have long been popular with Chinese consumers and during the 2001 recession, exports to China grew some 15% against an overall export decline of more than 5%. Trade between the two has since boomed and China finally overtook the US as Japan's main trading partner in 2004.

Roberto Herrera-Lim, analyst at Eurasia Group, says that the trick for Asian countries is to adapt and discover their own competitive advantage. Many, he says, have found ways of diversifying their economy: India has gone for services; Thailand has focused on its successful light pick-up truck industry; Malaysia has developed a new financial niche to channel Middle East oil money; and South Korea has strong brands, such as Hyundai, LG and Samsung, with long-term strategies to keep it going.

Singapore is pushing the development of biotechnology to move away from semi-conductors. "Singapore has been very conscious of the fact that it has to stay two or three steps ahead of China," says Herrera-Lim. "And if there is any economy that can do this, it's that one."

Backman also points out that the increase in Chinese tourists to neighbouring countries has turned out to be a windfall for the gambling industry. "China used to be circled by tanks," he says. "Now it's circled by casinos." Casinos are illegal in China, yet the Chinese love gambling. According to the China Center for Lottery Studies at Beijing University, Rmb600 billion ($75 billion) in gambling money leaves China every year, a fact that hasn't escaped the country's near neighbours. Most have opened casinos right on the border and Macau is making a fortune by becoming the new Vegas of the East.

But growth comes at a cost. Pushan Dutt, an economist at INSEAD, says that China has had a huge impact on the Asian environment. Between 2000 and 2030, China will emit as much CO2 as the rest of the industrialised world. The figure is daunting, but although it represents a threat globally, it is also a business opportunity: several renewable energy companies from Taiwan, Japan and Korea are already making a mark.

How this picture changes will be interesting. So rapid has been its expansion, to a certain extent, China is already a victim of its own success. Labour costs have increased and countries that had fallen out of grace with investors are finding themselves on the map again. Indonesia, for instance, has just received FDI worth nearly $200 million from the US, while Vietnam has seen a spate of investment in electronics worth more than $300 million from Japanese companies.

Despite its accession to the WTO and the end of the multi-fibre agreement in 2005, China is still liable to textile quotas in Europe and the US, which might explain why Indonesia is now experiencing a resurgence in textile manufacturing. Chinese textile companies are also buying factories in countries such as Vietnam and Egypt in order to bypass dumping sanctions.

Many of the adjustments that some countries have made are not viable in the long term. Notably, Indonesia is extremely vulnerable to commodity price fluctuations: oil and gas are not renewable energy sources, and its forestry activities are far from sustainable. Strong competition for energy provision will also emerge from central Asia, particularly Kazakhstan where the world's second biggest oil field was discovered in 2000 (see right). China's scramble for energy is likely to have more repercussions: the biggest issue now is the dispute between it and Japan over oil exploitation rights in the East China Sea. Both countries are heavily dependent on imported energy and both are seeking new sources to power their economies. Japan has begun allocating gas exploration rights in an area claimed by China, while China finished a new drilling platform last year and is completing a second.

China is also working on securing better trade arrangements with its neighbours, notably, a free trade area with the 10-member Association of Southeast Asian Nations (Asean). Many are sceptical about the success of the arrangement, if only because Asean has a reputation for ineffectiveness.

But although China wants to move away from manufacturing and into high value-added industries such as services or biotech, it's unlikely to happen soon, says Dutt: "There are still 200 to 300 million workers who could move from China's rural areas to its industrial centres. Even at the rate of 20 million per year, there is still 15 years to go."

Sun agrees: "China is a huge country. It will probably move up the chain, but there will always be some manufacturing."

The rest of Asia cannot wait for China to vacate the low end of the economic scale, but nor can it afford to rely too extensively on China to carry on at the same breakneck pace. On the whole, Asia has done well out of China, but it hasn't been an easy ride. Most countries have weathered the storm and come out stronger, but a few vulnerable economies have sunk further. How China will influence Asia in the future is unclear.

TRADING WITH CENTRAL ASIA

The five central Asian states of the former Soviet Union - Kazakhstan, Uzbekistan, Turkmenistan, Kyrgyzstan and Tajikistan - were a vacuum waiting to be filled after the demise of the USSR and China has made it a policy to agressively improve trade relations. It is now the main economic presence in the region and has trade missions in each country; it claims to have invested more than $1 billion in the republics in the 10 years to 2004 and increased trade 10-fold. However, although trade has grown substantially - bilateral trade between China and Kazakhstan grew by a factor of five from 1999 to 2003 - the central Asian states still make up only a fraction of China's total foreign trade.

The Stans' importance lies in their strategic and geographic value. Energy-hungry China has had its eyes fixed on the large oil and gas reserves of Kazakhstan, and even the modest gas reserves of Uzbekistan, since the early 1990s. It shares a border with Kazakhstan, Tajikistan and Kyrgyzstan, and has been importing oil and gas from Kazakhstan since the late 1990s - the world's second biggest oil field was discovered there in 2000 and a new 2,900km pipeline, a joint venture between Kazakhstan and China, is already partly operational. The China National Petroleum Corporation (CNPC) is one of the most important investors in central Asia and has control of several oilfields in the region, ensuring access to Caspian Sea oil and gas reserves. It has pledged more than $4 billion in investments in Kazakhstan alone.

However, investment is not limited to the oil and gas sectors: the 'Sinofication' of the central Asian economy, as it has been called, includes renminbi loans to Kyrgyzstan, Tajikistan and Kazakhstan, enabling them to buy Chinese goods, and increasing trade and dependence on Chinese investment. China's economic presence is strongest in Kyrgyzstan and Kazakhstan, and small and medium-sized investors now dominate a number of economic sectors. It is also a heavy investor in the transport sector, which, historically, Russia controlled.

Kazakhstan is the most economically advanced of the five states. It is the world's fourth biggest uranium producer and a great agricultural producer. Cotton production is a staple in the Stans and Uzbekistan is the world's second biggest producer, as well as the fourth largest producer of gold.

In recent years, border trade has focused on machinery, electronic and hi-tech goods, and investment projects in the agricultural sector. China is a big importer of scrap metal: old Soviet factories are dismantled and taken across the border into Xinjiang province.

Small enterprises in China's western provinces are also doing more trade over their borders; these provinces are some of the poorest and the increased business has had a positive effect. The borders between China and central Asia have opened up, re-establishing the strategic importance of the Silk Road.

OIL & GAS ENERGY-HUNGRY: China has its eyes on the large oil reserves of Kazakhstan

CASINOS: $75 billion in gambling money leaves China every year

ELECTRONICS: China assembles the high value-added goods imported from its neighbours

SCRAP METAL: Dismantled Soviet factories are imported from the central Asian states

JAPAN: Many of its factories have moved to China to take advantage of cheap labour

TIMBER: Indonesia is a major provider of timber, oil and gas to China.

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