Exports: How Important Are They to China?

It may seem like a question with an all too obvious answer. After all, haven’t exports been the key driver of China’s development over the past 30 years? The many stories that have been written over the years about China’s emergence as the “workshop for the world” certainly suggest that exports are very important.
That is why the 25.7 percent plunge in China’s exports in February from a year earlier led many China observers to conclude that the country’s recovery might take longer than expected. Following are some reactions as reported by the Washington Post:

“This is an ugly number,” Merrill Lynch economists T.J. Bond and Ting Lu wrote in a note to clients.

While economic troubles spread through other parts of the world last year, China’s exports continued to rise, jumping 4.3 percent year over year in the fourth quarter of 2008. But now, Bond and Lu wrote, “The export slowdown has finally come home to China.”

The trade slump, which will significantly drag down China’s gross domestic product if it continues, shows the extent to which the country has been unable to disentangle itself from the global economy, despite a $586 billion stimulus package aimed at boosting domestic investment and demand.

There is no question that China is affected by the global economy, and that the dramatic fall in exports in February is a sign of weak demand in the United States and Europe. But what does a year of soft exports mean for China’s economy and its chances for recovery in 2009?

For the answer to this question, I turn, as I often do, to Andy Rothman, China Macro Strategist for CLSA Asia-Pacific Markets, based in Shanghai. I have known Andy for many years and consider him to be one of the most insightful of the China economists. He combines thoughtful analysis with thorough, on the-ground research.

In his latest Sinology report entitled Explaining Optimism, which is available only through CLSA, Andy analyzes the impact of exports on China’s economy.

He begins the discussion with a rhetorical question that he then answers:

Can China grow during a global recession? Yes, because China is a continental economy driven primarily by domestic investment and consumption. Exports are important, but much less so.

How can he make such a statement? Andy points out that about half of all Chinese exports are processed or assembled products where, on average, only 4 percent of the export price represents value created in China. Only that small share contributes to China’s GDP.

By way of illustration, he uses the example of the 30GB video iPod that went on sale in 2005 with a US retail price of $299.

When an iPod leaves China it has a factory cost of $150, but only 5% of that – – $7.50 – – was value created in China, as the high-value components were imported from other Asian countries and just snapped together in China. This is a key reason why economists use net exports (exports minus imports) rather than the gross value of exports to calculate GDP.

In recent years, according to Andy, net exports – – the part of trade that actually contributes to the Chinese economy – – has accounted for only 6 to 8 percent of the country’s GDP.

Andy concludes this portion of his report with a chart showing that the fluctuations in China’s GDP growth since 1990 are not highly correlated to changes in either export or net export growth. Changes in GDP over these years have instead been driven primarily by changes in domestic investment and consumption.
At the beginning of the annual session of China’s legislature last week, Premier Wen Jiabao expressed confidence that the government’s GDP growth target of 8 percent for 2009 would be achieved. At the same time, many independent economists have predicted 2009 growth rates for China as low as 5 percent; the International Monetary Fund has forecasted 6.7 percent; and the World Bank is at 7.5 percent.

Who will prove to be more right when all is said and done? If Andy’s analysis is correct, Premier Wen’s prediction will carry the day.

Although the Chinese government cannot control demand outside its borders, it has the ability to significantly influence domestic investment and consumption. At his news conference today, Premier Wen reassured the world that China would deliver on its promise of 8 percent growth, despite the challenges of doing so, and could roll out extra stimulus spending if needed to meet that goal.

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