Over the past several decades, Chinese trade has expanded at a breakneck pace. Favorable domestic policies have helped channel government and foreign direct investment (FDI) into expanding China’s production capabilities. These developments coincided with technological advances, competitive shipping, and strong international demand, which has propelled the Chinese economy to become the second largest in the world.
International Trade With China
* White areas on the above map represent locations where data is currently unavailable or territory is otherwise disputed.
China’s wealth provides it with considerable influence within the international system. As Michael Beckley notes, “wealthy states are better equipped to wield market access and economic sanctions as tools of influence over others.” Furthermore, its economic strength attracts other countries to enter mutually beneficial economic agreements with China. In this way, Chinese leaders can leverage the size and reach of the Chinese economy to influence other countries and the global economic order.
However, China primarily derives its economic strength from trade. Simply measuring the volume of trade does not take into account the value added to the Chinese economy or the strategic advantages gained through trade. While China may be the world’s number-one trading partner, it lags behind other economic leaders in outbound foreign direct investment (OFDI)—another important source of economic influence. This question explores Chinese power by examining the strengths and limitations of China’s economic strength.
China still lags other leading economies in OFDI—how do trade and investment contribute to global economic power?
Together, FDI and trade illustrate the extent of China’s economic influence. These two flows represent the four major components of a country’s transactions in the global economy: exports, imports, inbound FDI (foreign investment into a country), and outbound FDI (foreign investment out of a country). In the case of China, trade patterns indicate its high volume of exports and its growing imports, which are particularly significant to commodity markets. Large FDI inflows supported, and continue to support, China’s economic development. Conversely, OFDI from China is relatively low when compared with other major economies. While low OFDI levels support domestic production, they also indicate a potential weakness within the Chinese market.
China is commonly referred to as the “world’s factory,” and for good reason. Government and foreign investment have historically supported China’s manufacturing sector by expanding industrial capacity and attracting additional trade from abroad. This investment has fueled the Chinese export market, which has played a critical role in China’s economic development. In 2001, the year of China’s ascension to the World Trade Organization (WTO), exports accounted for approximately 20 percent of China’s GDP. This number soared in 2006 and 2007, when exports peaked at roughly 35 percent of China’s GDP.
The past decade witnessed a significant shift in the makeup of the Chinese economy. With export growth rates peaking in the mid-2000s, exports fell as a share of Chinese GDP. This decline has been attributed to lower rates of domestic migration, rising coastal wages and other inputs, and lower global demand following the 2008 global financial crisis. As exports have decreased as a share of China’s GDP, imports have increased. China is now a major importer and China’s import growth has outpaced export growth since 2007. During its stimulus program in 2010, China consumed 20 percent of the world’s nonrenewable energy resources, 23 percent of the world’s major agricultural crops, and 40 percent of the world’s base metals.
The reason the Chinese can fund the Belt and Road initiative, the reason they gave money to the Asian Infrastructure Bank, the reason they gave money to the BRICS bank, the reason their companies are competitive in these projects is very low cost financing out of their foreign exchange reserves[.]
Imports have helped drive the growth of the Chinese economy, which as of 2014 became the largest in the world in terms of purchasing power. Chinese imports have a considerable impact on the global economy; slowing Chinese growth rates have recently led to a drop in global commodity prices. However, high inflows of trade and FDI also present vulnerabilities. China’s ever-increasing need for foreign petroleum leaves it susceptible to external political variables. Similarly, bilateral tension between Japan and China resulted in a 42.2 percent drop in Japanese FDI into China over the first five months of 2014.
Despite exerting tremendous global influence in terms of trade and attracting high levels of FDI, China’s OFDI is low when compared to advanced economies. The total stock of China’s OFDI ranks 14th in the world, a considerably low number given China’s position as the world’s number-one exporter, number-two importer, and number-five source of inbound FDI.
Annual outflows are growing and now rank third internationally, yet China’s $88.2 billion in 2012 outflows amounted to only a quarter of American OFDI in the same year. Even in countries where China has a considerable political and economic interest, Chinese investment remains low. In the first quarter of 2015, China’s FDI in Indonesia was 6 percent of Singapore’s investment and 26 percent of U.S. investment. In 2014, the United States was responsible for the greatest share of FDI in the Association of Southeast Asian Nations (ASEAN), with its $226 billion greater than the investment of Japan, Korea, and China combined. In Africa, where China has been actively seeking to expand its influence, Chinese investment between 2013 and 2014 amounted to less than 5 percent of total FDI inflows into the continent. Furthermore, a considerable portion of Chinese OFDI flows into financial safe havens, like the British Virgin Islands and the Grand Cayman Islands, rather than supporting traditional overseas investment projects.
There is some indication that this trend is shifting. Outbound FDI growth rates now outpace inbound FDI growth. Some believe that outbound FDI may overtake inbound FDI in the coming years. China’s historically low outflows are largely a result of capital controls, which place restrictions (often through quotas) on most types of investment. Consequently, outflows thus far have been dominated by large Chinese firms (primarily state-owned enterprises), targeted investments in natural resources, and investments in or acquisitions of foreign firms. If China’s financial system moves toward greater liberalization, capital controls may gradually relax, leading to further outflows as domestic investors looking to diversify abroad.
How do regional economic structures affect China’s trade relations?
Asian trade patterns support a highly integrated cross-border flow of intermediate, unfinished goods. Although China plays a key role in the trade for intermediate goods, it is not confined to Asian trade relationships and maintains a large volume of purely bilateral trade with more distant partners as well.
Following China’s entrance into the WTO, the Asia-Pacific trade network has reconfigured and tightened international supply chains. According to the IMF, supply chains in Asia “[extend] across several countries, with goods-in-process crossing borders several times . . . before reaching their final destination.” The strength of this supply chain network is shown through Asia’s export composition: nearly 70 percent of Asian trade growth in the 2000s was attributed to intermediate, unfinished goods. To compare, the Organization for Economic Cooperation and Development (OECD) estimates that in 2000, non-EU import content stood at 20 percent in European exports; in 2005, import content stood around 10 percent in U.S. exports; and in 2005, import content stood at nearly 34 percent in Chinese exports. Intermediate goods thus move between various production sites with greater frequency in Asia.
These goods often flow through China in the process, which serves as a regional hub. The IMF found that lower export growth in China appears to also lower Asian exports to China, demonstrating its centrality within this trade network. For this reason, in Asia the renminbi (Chinese yuan) has become a “dominant reference currency,” as 7 of 10 currencies followed currency fluctuations in the renminbi more closely than fluctuations in the U.S. dollar in 2013.
China runs a huge trade surplus, which means that it is taking GDP away from the rest of the world.
Consequently, Asian trade patterns do not mirror North American and EU networks. North American and EU trade networks rely on regional source locations, as opposed to the Asia trade network, which both sources from and exports to global partners by way of China. Asia is also much more tightly integrated, with goods more likely to cross borders and exit through China.
That said, China is not solely dependent on its trade partners within the Asian regional bloc, and its importance extends outside the region. Its wider trade network can be seen as its bilateral export growth recalibrates trade networks beyond Asia. China specialist Jim O’Neill of Goldman Sachs has commented that “At this rate, by , many European countries will be doing more individual trade with China than with bilateral partners in Europe.”
China’s trade patterns are primarily defined by bilateral ties, vertical integration within Asia, and large import and export flows outside of Asia. These patterns illustrate China’s key production role within a larger Asian trading network, as well as strong and growing bilateral trade with more distant partners. Thus while China operates within a tightly integrated regional supply chain, it is not confined by that bloc.
How can we understand the value added to the Chinese economy from its trade relationships?
While trade was previously only measured by its total value into another country, economists have recently found ways to decompose a country’s exports into value created in the exporting country and value from components manufactured abroad. Asia’s integrated supply chain can be illustrated through analysis of foreign “value added” as a share of a country’s exports. OECD value-added trade data show that, unlike many of its Asian neighbors, in China the foreign value-added share of gross exports has been steady at around 35 percent since 1990 and has even begun to fall. Thus, China is working to both rebalance away from exports and move toward higher-value goods with higher domestic value-added content.
A Conversation With Derek Scissors
0:06 - How much has China contributed to global economic growth in recent decades?
2:15 - In what ways are global markets influenced by changes in China’s economic policy?
5:18 - How exposed is China to global economic instability?
7:05 - How will the Chinese economic slowdown impact its government’s ability to advance its foreign policy goals?
8:51 - In what ways does China’s large share of other countries’ imports give it leverage over other countries on a range of issues?
Value-added data and input-output tables help identify what portion of a product’s value should be attributed to an exporting country. For example, a mobile phone that costs $187.50 to produce might have components worth $22.88 produced in the United States, components worth $16.08 produced in Germany, and components worth $80.05 produced in Korea. A 2013 Asian Development Bank report revealed that the United States received 66.2 percent of the per-unit value of the iPhone 3G, while China received just 1.4 percent of the value. Federal Reserve researchers explained value added by saying that, rather than “Made in China,” a label could more accurately print, “Made 15 percent in Canada, 20 percent in Korea, 25 percent in Japan, 30 percent in the U.S., and 10 percent in China.” This type of breakdown not only offers a clearer picture of a country’s exports, but of its position in global trade patterns and trends in its own economic structure. Value-added measurements are particularly necessary given global integration in recent decades. The IMF has reported that since the 1970s, the foreign content portion of gross exports “on average has almost doubled.”
As illustrated by OECD data, the steady and falling ratio of foreign goods in China’s exports runs counter to the trends for Korea, Vietnam, and Taiwan, all of which have exceeded Chinese levels.
While India and Japan do not approach the same share of foreign value added, they too show increasing foreign value in their exports. China’s ratio of foreign value added to total exports decreased from 37 percent in 2005 to 32 percent in 2011, suggesting that while Asian markets are growing more integrated, the value of foreign products in Chinese exports has leveled off and even diminished. This trend implies China now produces a higher ratio of the technologically advanced and higher-quality materials in its exports. It reduces China’s dependence on foreign high-value goods in domestic production and helps China move up the value chain, thereby increasing the amount China economically benefits from its trade relationships.
In addition, China also exports goods with a higher value than often assumed. In 2006, lauded trade economist Dani Rodrik noted that China’s export bundle resembled “that of a country with an income-per-capita level three times that of China’s.” More recently, in its 2015 recommendations to China, the IMF observed that China’s increasing value added had encouraged more sophisticated products, improving its trade deficit with other electronics manufacturers in the region. This trend indicates China’s progression up the value chain and replacement of inputs from other Asian suppliers, part of an expansion into new industries that will lessen dependence on high-value imports. These developments, and of course its size, make China more independent economically than most of its Asian partners despite its trade integration.