from Follow the Money

Highly recommended: the World Bank’s latest China Quarterly.

February 14, 2007

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What jumped out at me in the latest quarterly from the World Bank’s Beijing office?

First, the data showing that labor income is falling as a share of Chinese GDP.    Moreover, its fall seems to have accelerated recently, just after the Chinese government started talking about the need to rebalance the economy.   See Figure 9 on p. 7.   As the World Bank hints, it will be hard to shift the basis of Chinese growth toward consumption if labor income keeps falling as a share of GDP…

Second, the data on China’s processing trade, or perhaps, the beginning of the end of China’s processing trade.   Non-processing exports are now growing faster than processing exports.   And processing import growth didn’t keep up with processing export growth (See Figures 3 and 4).    As the World Bank notes in a footnote: 

“The import/ export ratio in processing started to decline in 2005, after years of broad stability.”

Why?  Most likely because more and more components are made in China. 

Stage one involves shifting final assembly to China.  But once the one-off cost savings from that shift have been realized, getting more cost savings requires shifting parts production.   Stage two consequently involves shifting component production to China.  

The development of an internal Chinese supply chain for its final assembly plants is, I suspect, a bit reason why China’s trade surplus has increased so dramatically recently.

Third, the World Bank’s forecast for China’s 2007 balance of payments.   The World Bank’s economists forecast a slowdown in export growth (maybe, but there isn’t yet much evidence that it is happening) will keep China’s current account surplus from increasing by all that much.  It rises from $230b in 2006 to $260b in 2007 (See Table 2 of the Quarterly).  Personally, I think China’s 07 surplus will be higher.    They also forecast continued net FDI inflows. 

Fair enough: China wants to buy more oil companies, but most don’t seem to be for sale – and right now, there is still quite a strong incentive to locate production in China.  Indeed, high levels of investment in China may explain relative low levels of investment in the US.  Ragu Rajan, formerly of the IMF:

“”Indeed, it makes less and less sense for corporations in industrial countries to make large domestic investments in the manufacturing sector. But as they look to invest in non-industrial countries, they become subject to the uncertainties of policy there. Not only do they have to worry about whether China is a better place to invest than Vietnam but also whether it will continue to be better 10 years from now.” 

I agree more with the first point Rajan makes (about limited investment in the manufacturing sector of [formerly] industrial countries) than the second – there doesn’t seem to be any shortage of investment, foreign or domestic, in Chinese manufacturing right now.  Capacity is growing so fast that the increase in China’s 2007 exports could match its total exports in 2001 … .

The trade and current account though is only half of the balance payments.  Capital flows matter too.  Add $52b in net FDI flows to the projected $260b current account surplus and 2007 Chinese reserve growth should be $312b range.    The World Bank only forecasts $268b.    They implicitly are forecasting $44b in non-FDI capital outflows.   

Hmmm.   China’s stock market is doing pretty well.   The RMB is expected to appreciate significantly.  The Bank of China hasn’t been able to convince private Chinese investors to buy dollar or euro bonds.   I could go on.   It isn’t clear to me why lots of Chinese savers will want to buy US or European assets.   Not unless they are forced to.  Both the dollar and euro are expected to depreciate against the RMB.   You don’t need to take my word for it either.  Those on the ground seem to agree

““Under the current circumstances, all ordinary folks would prefer to keep their money at home,” said Yu Rongquan, chief investment officer of Fortune SGAM Fund Management Co. Ltd., a Sino-French securities fund with around 25 billion yuan.”

Suppose China’s current account surplus is a bit bigger – say $300b.  Say suppose more money wants to get into China than get out.  Then rather than offsetting FDI inflows, private non-FDI flows would add to them … and China’s total foreign asset growth might approach $400b.   

It just probably won’t all show up in the PBoC’s reserves.

Finally kudos to Louis Kuijs, Bert Hofman and the rest of the Beijing office for another superb report.  Their ongoing analysis really is essential to understanding the fast changing Chinese economy.

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