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Will China be the world's new growth catalyst?

Economic Report

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  • Rising US protectionism creates opportunities for Asian countries to fill the void
  • China can move up to the center stage, but the government will have to tackle major unbalances and risks within and outside its economy
  • The implementation of an innovation and education agenda in combination with a substantial improvement of China’s institutional quality could lead to substantial economic gains
  • These gains could be as high as USD 6.5trn of additional value added in China by 2025. This is equivalent to one-third of total US GDP today

During his election campaign, US President Donald Trump has shown a tough stance against countries with which the US runs large trade deficits, particularly China and Mexico. In contrast to his fiscal plans, for which the newly-elected president needs the approval of Congress, the White House has the upper hand in the implementation of trade policies. Hence, trade barriers, such as the withdrawal of trade agreements (e.g. and NAFTA) or the implementation of tariffs on foreign imports, can be implemented on short notice, without consent of Congress. Going forward, we expect a downward trajectory of less trade integration as a result of the Trump policy, which could have negative repercussions on global growth as well (see Marey et al. 2017).

Can China step in as the new leader of the pack?

This raises the question if Asia, and China in particular, can serve as the new global growth catalyst. President Xi Jinping gave a keynote speech in Davos in January stating that we have to be committed to global free trade, thereby showing his willingness to step in as the guardian of globalization. Xi’s rhetoric is not yet matched by his policies, which so far have supported large trade surpluses (Figure 1) and investment imbalances, and continues to stand in the way of global leadership.

Figure 1: China runs huge trade surplus and US huge trade deficit with Europe
Figure 1: China runs huge trade surplus and US huge trade deficit with EuropeSource: UNCTAD, Rabobank

Although ASEAN[1] plus China, Japan and South Korea are importing the same value of goods and services in US dollar terms from the European Union as the US does, it appears that China is only willing to import major goods and services volumes against the backdrop of exports outpacing imports by almost a factor two. And these figures only illustrate the trade position against the EU28, let alone the surplus China runs on the US directly. Moreover, China imposes higher tariffs on goods and services from the US than vice versa (see South China Morning Post, 2017). Finally, FDI flows between China and the rest of the world are unbalanced, as Chinese capital markets are sheltered and private investment in many so-called strategic Chinese industries are still prohibited. Although in the thirteenth Five-Year Plan, the government announced to open up its capital markets, the liberalization has been continuing at a snail’s pace. More specifically, it is expected that a so-called nationwide negative list, which limits restrictions on foreign investments to some sectors is expected to pass China’s National People’s Congress in March[2].

Tackling structural imbalances

If China is actually willing to step up and replace the US as the major conduit to foster trade and growth worldwide, the government will have to tackle major unbalances and risks within and outside its economy. On the internal imbalances, authorities face a major challenge to meet desired reduction of excess production capacity in heavy industries. Over the next five years, the government aims to reduce production capacity by 450 million metric tons in the steel sector alone. Furthermore, the government has to crank up efforts to scale down on its huge debt pile and address unhealthy developments in the housing market (see Erken et al., 2017). On the external environment, political tensions have to be relaxed, capital markets liberalization has to speed up and trade barriers lowered. In this respect, the so-called ‘One Belt, One Road ’ (OB OR) initiative could cement China at the centre of a hub-and-spokes trading network. Addressing internal and external imbalances would allow China to take up a credible leadership role in the global economy.

The pot of gold at the end of the rainbow

If all these conditions are met and China diverts heavy investment from solid brick and mortar to knowledge and education, anything is possible (Figure 2). Other Asian economies, such as Japan, South Korea and Singapore have been successful in transforming their economy by boosting innovation, human capital and institutional quality. For China, the implementation of an innovation and education agenda in combination with an improved institutional framework could lead to substantial economic gains. Scenario analyses by Erken (2017) illustrate that under relative conservative assumptions these gains could be as high as USD 6.5trn of additional value added in China by 2025. This is equivalent to one-third of total US GDP today (roughly USD 18trn, 2015 USD PPP). In an extreme scenario where China would follow-up on the innovative trailblazers in Asia, economic gains in 2025 could even be as high as USD 19trn of additional value added, which is somewhat more than US GDP now.

Figure 2: Which path will China choose?
Figure 2: Which path will China choose?Source: Rabobank, Every (2017). OB-OR: One Belt, One Road; RCEP: Regional Comprehensive Economic Partnership

Footnotes
[1] Association of Southeast Asian Nations (ASEAN) members: Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, Philippines, Singapore, Thailand, Vietnam.

[2] On a state council meeting on the 22th of June 2016, premier Li Keqiang has urged to speed up reforms to open up more possibilities for private sector investments. In October last year, the government already planned to update a negative list of sectors in which private-sector companies are prohibited to invest, which will most likely be expanded by previously restricted sectors, such as civilian aviation, telecom, petroleum exploration, health care and education.

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Author(s)
Hugo Erken
RaboResearch Global Economics & Markets Rabobank KEO
+31 30 21 52308
Björn Giesbergen
RaboResearch Global Economics & Markets Rabobank KEO
+31 (0)30 21 62562
Carlijn Prins
RaboResearch Netherlands Rabobank KEO
+31 30 21 60033

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