China’s competitive threat to Latin America

Sanjaya Lall (Oxford University) and John Weiss (ADBI)

2004 LAEB ANNUAL CONFERENCETHE EMERGENCE OF CHINA: CHALLENGES AND OPPORTUNITIES FOR LATIN AMERICA AND ASIA Beijing, 3-4 December, 2004

Outline

Analytical backgroundWhat is a ‘competitive threat’?Measuring the ‘threat’ in third markets

Data analysis: China vs. LAC Global trends and regional performance Technological & product level overlap Relative market share changes Bilateral trade

Conclusions

Some LAC countries worry about the Chinese competitive threat…

Share of US imports (%)

7

8

9

10

11

12

13

1997 1998 1999 2000 2001 2002 2003

Mexico

China

The Economist (July 24, 2003), in ‘The sucking sound from the East’ says

“Labour costs in China … are about a quarter of their level in Mexico. The

result: about 300 manufacturing plants have moved from Mexico to China in the past two years”. The International

Herald Tribune is more gloomy: “In all, 500 of Mexico’s 3,700 maquila plants

have shut down since 2001, at a cost of 218,000 jobs”. September 3, 2003

Popular perception of a ‘competitive threat’

Rapid export growth by China reduces exports and (if they are open to imports) domestic production by other countries

This leads to losses in incomes, jobs and growth

Rapid growth by China can also reduce access to, or raise cost of, resources like capital (esp. FDI) and natural resources

Economists dislike this perception: trade is not a zero-sum game

Countries do not compete like firms where gain for one is loss for another Comparative advantage theory:

Resources move between activities: loss of one is offset by the rise of another, with greater welfare as a resultEntry of low wage competitor induces others to move up skill/technology scale: China accelerates upgrading elsewhere

Thus, to Krugman, “competitiveness is a meaningless word when applied to national economies. And the obsession with competitiveness is both wrong and dangerous.” (1994)

But this simple trade theory is based on strong assumptions…

It assumes efficient & competitive markets, with perfect information, identical production functions, no scale economies, no learning, fully mobile factors within economies, full employment, no transport costs, etc.It implies the pattern of specialization does not matter. With no externalities, cumulative learning or agglomeration, all activities are equally beneficial. Structural change is automatic and instantaneous in response to changing factor prices

If these assumptions are relaxed, implications are different

With scale economies, cumulative learning, technology gaps, unemployment, risk & uncertainty, externalities, information failures, immobile factors, and so on:

While there are certainly potential benefits from specialization & trade can be non-zero sum gameThe realisation of benefits from trade depends on the ability of economy to create competitive capabilities and exploit activities that offer the best opportunities for growth, technology & spilloversThe process may not be automatic, instantaneous, costless or complete: there are cumulative, path-dependent effects (leading to multiple equilibria)Strategy is necessary, given widespread market failures, to create capabilities and move from low to high equilibrium. “Success breeds success”

In this (more realistic) world…

Entry of a large, efficient low-wage competitor like China can involve significant adjustment costs:

Quantitative loss of income, employment, exportsQualitative decline of production/export structure into slower growing, technologically inferior activities

The outcome depends on: The similarity of export structures in competing countries (extent of competitive overlap)Nature of export structures in both countries (nature of technological specialisation)The speed and extent of adjustment in each country (ability to upgrade within and across competing activities, move into fast growing segments, reach new markets and so on)

If there is a possible competitive threat, how can we measure it?

Computable general equilibrium model (needs strong simplifying assumptions) Detailed case studies of each industry (rich but limited in coverage)Trade data analysis to gauge potential for competition & competitive performance (needs careful interpretation)This study uses last method: 1990-2002 trade data on market shares in world/US and bilateral trade by technology categories

Five possible combinations of relative market share changes

Matrix of competitive interactions between China and other country in export markets

Chinese export market shares

Rising Falling

Other country’s

export market shares

Rising

A. No threatBoth China and other country have rising market shares and latter is gaining more than China B. Partial threatBoth are gaining market share but China is gaining faster than other country

C. Reverse threatNo competitive threat from China. The threat is the reverse, from the other country to China.

Falling

D. Direct threatChina gains market share and other country loses, this may indicate causal connection unless other country was losing market shares in the absence of Chinese entry.

E. Mutual withdrawal: no threatBoth parties lose shares in export markets to other competitors.

Technological structure

Primary productsManufactured products

RB (Resource based): e.g. food, wood & forestry products, processed minerals, petroleum productsLT (Low technology): e.g. textiles, clothing, footwear, toys, sports goods, simple metal productsMT (Medium technology): e.g. automotive products, consumer durables (incl. simple electronics), most industrial machinery, chemicals, steelHT (High technology): Advanced ICT and electricals, pharmaceuticals, aerospace, precision instruments

Shares of world exports by technology (%)

0%

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20%

25%

30%

35%

40%

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

Medium technology

Primary

Resource based

Low technology

High technology

Shares of developing countries in world exports (1990-2002)

0%

5%

10%

15%

20%

25%

30%

35%

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45%

PP RB LT MT HT

19902002

LAC’s manufacturing value added record (world share, 1980-2000)

Figure 9: Developing regions' shares of global MVA (%)

0

2

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14

E A

sia

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LAC

ME

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1980

1990

2000

World market shares of LAC and East Asian exports (1990-2002)

0%

5%

10%

15%

20%

25%

30%

1990 2002 1990 2002

LAC 18 EA 9

Primary RB LT MT HT

Changes in world market shares, 1990-2002

-8%

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-4%

-2%

0%

2%

4%

6%

8%

10%

12%

LAC-M Mexico China EA 8

RB LT MT HT

World market share performance in LAC and EA

EA 8 and China perform impressively across most sectors, with increasing specialization in technology-based products. China outperforms rest of EA in most categories, suggesting a growing competitive threat within the region, particularly in LT products. But in HT there is growing complementarity within EA. LAC without Mexico does poorly, raising its world market share in all manufactured exports by less than 0.2 percentage points; the weakest performance is by the two giant economies, Argentina and Brazil. The largest world market shares held by LAC-M are in primary and resource-based products and MT process industriesMexico behaves like an EA Tiger, with significant gains across the spectrum (primary products excepted).

Technological similarity of export structures, China and LAC

Figure 19: Structure of total exports in China and LAC (%)

0%

10%

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100%

1990 2002 1990 2002 1990 2002 1990 2002 1990 2002 1990 2002

China Mex ico LAC-M LAC Big 2 LAC Med 4 LAC Small 11

HT

MT

LT

RB

Primary

Structural stability of exports (181 three-digit manufactured products)

Figure 22: Structural stability of exports in LAC and China, 1990-2002

0.00.10.20.30.40.50.60.70.80.91.0

China

Cost

a Ri

ca

Mex

ico

El S

alvad

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ma

Urug

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guay

Peru

Boliv

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emala

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ntina

Colom

bia

Chile

Ecua

dor

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aica

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zuela

Correlation of Chinese and LAC export structures, 1990 & 2000

Figure 26: Correlation between export structures of China and LAC (manufactured products)

-0.2

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China 2002 China 1990

Measuring the competitive threat by relative WMS changes…

Competitive threat from China for LAC 18

Values ($ m.) Distribution (%)

1990 2002 1990 2002

Partial Threat 17,164.8 91,288.9 14.6% 28.0%

No Threat 12,661.4 102,644.9 10.8% 31.5%

Direct Threat 35,809.9 37,142.1 30.5% 11.4%

China under Threat 14,229.0 47,648.8 12.1% 14.6%

Mutual Withdrawal 37,538.4 47,253.8 32.0% 14.5%

Total 117,403.4 325,978.5 100.0% 100.0%

Chinese competitive threat by LAC country in 2000 (% of manufactured exports)

Figure 30: China's threat to LAC in world markets (2002) ranked by direct+partial threat

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Venezuela

J amaica

Ecuador

Mexico

P araguay

Guatemala

Argentina

P eru

Bolivia

Brazil

Colombia

Nicaragua

P anama

Honduras

Uruguay

Chile

El Salvador

Costa Rica

Direct Threat Partial Threat No Threat China under Threat Mutual Withdraw al

Figure 31: Shares of exports under direct and partial threat from China, 1990 -2002

0% 10% 20% 30% 40% 50% 60% 70% 80%

Costa Rica

El Salvador

Chile

Uruguay

Honduras

P anama

Nicaragua

Colombia

Brazil

Bolivia

P eru

Argentina

Guatemala

P araguay

Mexico

Ecuador

J amaica

Venezuela

2002

1990

Some implications…Most ‘threatened’ LAC countries are C Rica, El Salvador, Chile. In Chile it reflects the large share of its exports in copper, where China gains WMS while Chile loses (direct threat). Its fish exports are partially threatened because China gains more WMSIn C Rica the Chinese threat is largely partial: China gains greater WMS in electronics, instruments, apparel and processed foods. In El Salvador, direct and partial threat in textiles and clothing Mexico faces the greatest potential threat from China, but because of its very rapid gains in WMS it has not actually faced a significant threat over 1990-2002. Brazil faces a larger competitive threat (30% direct and 31% partial threat in 2002) but the direct threat declines from 60% in 1990. The largest threatened exports by Brazil are in the ‘partial threat’ category: telecoms and footwear. But its largest single export, aircraft, faces no threat from China. EA faces much greater direct and partial threat than LAC. The unweighted average for EA 8 is 75.2%, much higher than LAC’s total of 39%. However, these results have to be interpreted with care (e.g. Chinese threat to Chile in copper). And past is not good guide to future (e.g. threat to Mexico)

Bilateral trade patterns

Figure 34: LAC 18's trade balance with China ($ m.)

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PP RB LT MT HT Total

1980

1990

2000

2002

Technology breakdown of bilateral trade between LAC & China

Distribution of bilateral exports between LAC and China (% of total exports)

LAC 18 exports to China China's exports to LAC 18 1990 1995 2000 2002 1990 1995 2000 2002

Primary Products 34.32% 24.69% 53.55% 42.52% 29.03% 1.66% 1.51% 3.17%

Manufactured 65.68% 75.31% 46.45% 57.48% 70.97% 98.34% 98.49% 96.83%

Resource based 31.84% 53.66% 28.81% 33.63% 10.52% 8.26% 9.27% 10.50%

Agro-based 22.97% 37.14% 8.50% 13.26% 0.48% 0.42% 0.45% 0.39%

Mineral-based 8.87% 16.52% 20.31% 20.37% 10.04% 7.84% 8.82% 10.11%

Low technology 10.30% 10.15% 5.98% 8.27% 30.37% 53.26% 48.32% 45.49%

Fashion cluster 1.71% 6.15% 5.18% 5.44% 19.49% 34.90% 32.09% 32.82%

Other LT 8.59% 3.99% 0.80% 2.83% 10.88% 18.36% 16.23% 12.67%

Medium technology 23.31% 10.75% 5.09% 9.00% 27.24% 30.94% 28.42% 26.43%

Automotive 0.91% 2.90% 0.51% 2.65% 3.17% 3.30% 2.44% 2.64%

Process 21.93% 5.10% 3.36% 4.25% 3.97% 6.25% 7.48% 7.28%

Engineering 0.48% 2.75% 1.22% 2.10% 20.10% 21.40% 18.50% 16.51%

High technology 0.24% 0.75% 6.57% 6.58% 2.83% 5.88% 12.48% 14.41%

Electronics 0.11% 0.17% 5.04% 5.69% 0.41% 3.20% 10.11% 11.75%

Other HT 0.13% 0.58% 1.53% 0.90% 2.42% 2.68% 2.37% 2.66%

Primary + RB 66.15% 78.36% 82.36% 76.15% 39.55% 9.92% 10.78% 13.67%

'Pure' manufactures 33.85% 21.64% 17.64% 23.85% 60.45% 90.08% 89.22% 86.33%

Bilateral trade of ‘big three’Figure 37: Technology structure of bilateral trade of LAC Big 3 with China

0%

10%

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100%

1990 2001 1990 2001 1990 2002 1990 2002 1990 2002 1990 2002

Ex port to China Import from China Ex port to China Import from China Ex port to China Import from China

Argentina Brazil Mex ico

Primary RB LT MT HT

Some findings on the big threeArgentina is overwhelmingly an exporter of primary products, with its share of RB declining significantly. It has no noticeable exports of HT products to China. Its imports from China are predominantly LT, but with large and growing shares of MT and HT products. Argentina runs a trade surplus with China, $763 m. in 2002, most of it in primary products, with a smaller surplus in agro-based RB products. Brazil also raises its exports of primary products but maintains a very large share for RB. It has a small, growing share for HT but a sharply falling one for MT. China’s exports to Brazil span all categories, with all manufactured categories growing at the expense of primary products. The largest category by far is HT products. Brazil runs a trade surplus with China, $823 m., mostly in primary products and RB manufactures (both mineral and agro-based products). Its largest deficit is in HT products, followed by MT engineering products. Mexico exports few primary or resource-based products to China, and makes a massive shift from MT to HT products. Chinese exports to Mexico have HT as the largest category. This suggests growing integration of electronics production in the 2 economies, similar to EA. The values of Mexican HT exports to China are far smaller than Chinese HT exports to Mexico. In 2002, the figures are $320 million and $2.1 billion, respectively. Overall, Mexico runs a huge $5.7 billion trade deficit with China. It also runs a deficit with China in every single category of trade, including primary products

To sum up on bilateral trade…

There is a rapid structural transformation of LAC’s trade pattern with China in the course of a relatively few years. This transformation is undesirable in technological terms. To the extent that this influences LAC’s future competitiveness patterns in bilateral trade or exports to third countries, it can be damaging

But bilateral trade so far is very small…

Exports destinations of China and LAC18

China's export to Export values (US$ million) Distribution (%)

2002 2000 1990 2002 2000 1990

World 325,596 249,203 62,091 100.0% 100.0% 100.0%

All LAC 7,742 5,594 661 2.4% 2.2% 1.1%

United States 70,050 52,156 5,175 21.5% 20.9% 8.3%

East Asia ( excl. China & Japan ) 105,242 79,051 32,670 32.3% 31.7% 52.6%

Japan 48,434 41,654 9,011 14.9% 16.7% 14.5%

EEC15 48,256 38,230 5,932 14.8% 15.3% 9.6%

LAC18's export to

Export values (US$ million) Distribution (%)

2002 2000 1990 2002 2000 1990

World 328,301 339,671 118,428 100.0% 100.0% 100.0%

China 6,224 3,691 864 1.9% 1.1% 0.7%

United States 192,619 202,024 46,305 58.7% 59.5% 39.1%

LAC total 43,299 49,852 15,216 13.2% 14.7% 12.8%

East Asia ( excl. China & Japan ) 8,676 7,277 4,436 2.6% 2.1% 3.7%

EEC15 38,481 38,433 28,707 11.7% 11.3% 24.2%

Japan 5,787 7,500 6,941 1.8% 2.2% 5.9%

ConclusionsSome LAC countries are benefiting from growing imports of primary and RB products by ChinaChina remains a relatively small market for LAC (but China overtook Japan as import supplier in 2003). The trade structure of most LAC is more complementary than competitive with that of China The main exceptions are Mexico and Costa Rica, but in HT they may benefit from intra-industry trade with China within MNC production networks WMS analysis suggests that all threatened exports (direct + partial) in LAC are well below comparable figure for EA. Goods in the more serious ‘direct threat’ category are only 11% of exportsThis suggests low competitive impact of China

But there are caveats…

Past is not good guide to future, in particular for Mexico LAC is suffering massive downgrading of comparative advantage in bilateral trade – not a good portent for futureChina may reinforce LAC poor export performance in third markets, pre-empting dynamic segments. Different export structures may be sign of LAC weakness if it means specialisation in slow-growing and technologically unrewarding products