On a superficial level, the belief that a slump in China will affect the rest of the world is understandable. In addition to its economic size and importance as a trading partner to every major economy, China is also the leading manufacturing country by volume. It is hard to believe that an economy that constitutes just less than half of all global growth can sink without creating tsunami-like impacts in every corner of the globe.
But such statistics can be misleading. The Chinese economy is not nearly so important as a driver of global growth.
Take fixed investment, which drives around half of all Chinese economic expansion. Of the up to $4.5 trillion worth of new fixed investment in 2014, less than 3% originated from outside China.
In addition to a still heavily regulated and largely closed capital account, almost every significant sector of the Chinese economy, with the exception of export manufacturing, is designed to privilege state-owned enterprises at the expense of foreign and private-domestic firms. Just as SOEs have been the primary beneficiaries of Beijing’s political economy, they will also be far more exposed to any great slowdown than will multinational firms.
One illustration of this on-the-ground reality: The U.S. firm General Electric, which has targeted Chinese sectors including health care, finance, aviation and energy, recently revealed that it still derives more revenue from a midsize market like Australia than it does from China, despite employing approximately 20,000 people in the latter country.
Then consider China’s often misunderstood role as a trading powerhouse. Export manufacturing is dominated by foreign-owned and foreign-invested firms, which makes China the world’s preferred subcontractor. Any slowdown, or even liquidity crisis, in the Chinese economy is unlikely to significantly effect export-manufacturing operations since the majority of these are financed by foreign capital and is where more than 80% of all foreign direct investment into China ends up.
Even China’s status as a great trading nation is often overplayed. More than two-thirds of China’s trade is in processing trade, with advanced-economy consumption markets in North America, the European Union and even Japan more important as sources of final net demand.
In addition to the restricted access to the Chinese consumer offered to outsiders, some estimate that around 75% of China’s domestic market is made up of nontradable goods. In other words, the net demand China offers the world is significantly less important than the raw size of its economy might suggest. Yet it is increases in final demand that ultimately drive trade, global manufacturing and global growth.
In the 10 years before the global financial crisis, trade between China and the Association of Southeast Asian Nations countries grew at high double-digit rates per year. But when the crisis hit, that trade immediately contracted 7.8%, while GDP growth rates throughout East Asia plummeted. This occurred despite China’s economy, the largest in Asia, growing at almost 9% during that period.
The story is the same when it comes to the excess savings needed by businesses to invest in regional opportunities. It’s true that China consumes too little and saves too much. But most of the country’s savings cannot exit the country. Consequently, Chinese FDI is still dwarfed by U.S., European, Japanese and even South Korean FDI in the region. Neither is China a major source of technology transfers into developing economies around the world. Instead, it absorbs far more foreign technology than it provides to the world.
