How to win with China
By MARTIN WOLF
FINANCIAL TIMES

Until recently, the world happily ignored Napoleon's warning. But China
is now shaking the world. The United States was the first continental,
capitalist, economy. The European Union is trying to become a second.
Potentially, China dwarfs them both. Already it is a big, and
controversial, presence in the global economy. Its impact is certain to
increase still further.

Fear is an inevitable response to this growing upheaval. But how far is
it justified? And what is the best response?

China's trade performance has been astonishing. Between 1980 and 2002,
China's share in global exports and imports rose from 1.2 per cent and
1.1 per cent, to 5.2 and 4.2 per cent, respectively. From 1993 to 2002,
the volume of China's exports of goods rose at an annual rate of 17.3
per cent.

If current trends were sustained (which is unlikely), China's exports
would surpass those of the US by about 2010. Over the 12 months to May
this year, Chinese exports of US$366 billion (S$633 billion) were the
world's fourth largest, after those of the US, Germany and Japan. Its
imports, at US$323 billion, were the sixth largest, but will soon be
bigger than those of Japan, the United Kingdom and France.

This growth recalls that of Japan. But China's expansion is different.

First, China's economy is far more open: Its ratio of trade to gross
domestic product, at market prices, was 44 per cent in 2001, while
Japan's was only 18 per cent. Second, China's exports are far more
dependent on inward direct investment. In 2000, according to the United
Nations' World Investment Report, half of China's exports came from
foreign affiliates. China will be a bigger force in the world economy
than Japan, not only because its potential is far larger but also
because it will be far more deeply integrated within it.

To assess the impact of China's trade, one must start with its
comparative advantage and trade policies. The former rests on almost
limitless supplies of cheap labour. The latter have become remarkably
liberal.

In 1992, average statutory tariffs on manufactured goods were 46.5 per
cent. After accession to the World Trade Organisation, this will be down
to 6.9 per cent. For primary products, the decline is from 22.3 to 3.6
per cent. China also reduced the coverage of non-tariff barriers from
32.5 per cent of imports to 21.6 per cent between 1996 and 2001.

This liberalisation further increases the competitiveness of China's
exports, because a tax on imports is also a tax on exports. Between 1979
and 2001, China's terms of trade - the ratio of the prices of its
exports to those of its imports - fell by 30 per cent.

As China's growth drives down the relative price of her exports,
countries that compete in third markets suffer declining profitability
and market shares. But net importers of China's exports and net
exporters of her imports benefit. In general, commodity exporters and
exporters of sophisticated goods and services gain, while other
labour-abundant countries lose.

An analysis of the impact on Latin America by Goldman Sachs notes that
Mexico is a loser, while Argentina, Brazil and Chile - all big commodity
exporters - are gainers. Last year, for example, China overtook Mexico
as a supplier of manufactured goods to the US market.

China's wages were still about a quarter of Mexico's last year, even
though they have been soaring. Mexico's productivity is not rising fast
enough to offset this Chinese advantage. As Mexico loses market share,
it also risks losing inward foreign direct investment. This explains, in
part, why inward foreign direct investment fell from US$25 billion in
2001 (admittedly, a very high level) to US$14 billion last year.

In all, argues Goldman Sachs, the impact of China on Mexico's balance of
payments amounts to 4 per cent of gross domestic product, which could
increase further.

What has been bad for Mexico has been good for Argentina, Brazil and
Chile, which have enjoyed rising trade surpluses with China. Goldman
Sachs estimates the positive impact on Argentina and Brazil at 0.75 per
cent of their combined GDPs for this year.

Gains come to other commodity exporters, as well. Among them are
Australia and New Zealand and the oil exporters, which now possess a
voracious market in the decades ahead.

Gains are even available to countries that would seem vulnerable to
direct Chinese competition. The reason is the vertical integration of
Chinese production. In 1998, just under a quarter of the value of
Chinese exports contained direct and indirect imports.

Not surprisingly, such production is particularly relevant to China's
neighbours. Another World Bank study notes, for example, that between
1985 and 2001, exports from other East Asian emerging market economies
to China grew from US$5.9 billion to US$83.5 billion. In 2001, 15 per
cent of East Asia's exports to China consisted of parts of office
machines and telecommunications equipment and electronic microcircuits,
all of which were for assembly and re-export.

How should other countries respond to the Chinese shock? 'Calmly' is the
best advice.

One reason is economic: The most adversely affected countries can do
little about China's rise, while those that can do something also
benefit most from it. Unless Mexico can persuade its trading partners to
increase their protectionist barriers against China, on a discriminatory
basis, it can do nothing to remedy the averse impact. But net importers
from China are gainers. Imposing protection is to inflict losses upon
themselves.

But the bigger reason for calm comes from history. If China is permitted
to thrive as a dynamic exporter of cheap manufactured goods, its people
will obtain the prosperity they want. If China is thwarted by
protectionist barriers, its people will be correspondingly frustrated
and dangerous.

The challenges of accommodating a wide-awake China will be huge. But
they can - and must - be risen to.