China’s competitive threat to Latin America

1. China’s competitive threat to Latin America Sanjaya Lall (Oxford University) and John Weiss (ADBI) 2004 LAEB ANNUAL CONFERENCE THE EMERGENCE OF CHINA: CHALLENGES AND OPPORTUNITIES FOR LATIN AMERICA AND ASIA Beijing, 3-4 December, 2004

2. Outline • Analytical background • What 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

3. Some LAC countries worry about the Chinese competitive threat… 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 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

4. Popular perception of a ‘competitive threat’ Rapid growth by China can also reduce access to, or raise cost of, resources like capital (esp. FDI) and natural resources This leads to losses in incomes, jobs and growth Rapid export growth by China reduces exports and (if they are open to imports) domestic production by other countries

5. 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 result • Entry 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)

6. 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 patternof 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

7. 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 game • The 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 & spillovers • The 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”

8. In this (more realistic) world… • Entry of a large, efficient low-wage competitor like China caninvolvesignificant adjustment costs: • Quantitative loss of income, employment, exports • Qualitative 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)

9. 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 potentialfor 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

10. Five possible combinations of relative market share changes

11. Technological structure • Primary products • Manufactured products • RB (Resource based): e.g. food, wood & forestry products, processed minerals, petroleum products • LT (Low technology): e.g. textiles, clothing, footwear, toys, sports goods, simple metal products • MT (Medium technology): e.g. automotive products, consumer durables (incl. simple electronics), most industrial machinery, chemicals, steel • HT (High technology): Advanced ICT and electricals, pharmaceuticals, aerospace, precision instruments

12. Shares of world exports by technology (%)

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

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

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

16. Changes in world market shares, 1990-2002

17. 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 industries • Mexico behaves like an EA Tiger, with significant gains across the spectrum (primary products excepted).

18. Technological similarity of export structures, China and LAC

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

20. Correlation of Chinese and LAC export structures, 1990 & 2000

21. Measuring the competitive threat by relative WMS changes…

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

24. 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 WMS • In 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)

25. Bilateral trade patterns

26. Technology breakdown of bilateral trade between LAC & China

27. Bilateral trade of ‘big three’

28. Some findings on the big three • Argentina 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

29. 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

30. But bilateral trade so far is very small…

31. Conclusions • Some LAC countries are benefiting from growing imports of primary and RB products by China • China 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 exports • This suggests low competitive impact of China

32. 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 future • China 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