China's trade relationship with the rest of the world is changing, as it sheds its 'factory' status and becomes a vital trade partner to every global region. James King assesses this journey.

Over the past three decades China has reached the pinnacle of global trade. In 1990, the country accounted for about 2% of world trade in goods. By 2012, this figure had jumped to 12%, according to research from the McKinsey Global Institute. This meteoric rise saw China surpass the US in terms of total goods traded globally in 2013, with the combined value of the country’s imports and exports reaching $4160bn, against $3880bn for the US, according to Thomson Reuters Datastream.

China has been described as the ‘factory of the world’, in recognition of the volume of goods either assembled or produced and then exported from the country. More accurately, however, the term ‘mega-trader’, coined by researchers from the Peterson Institute, has come to define China’s status in the global economy. Based on this research, China’s role as a substantial over-trader, in which exports as a share of gross domestic product (GDP) come close to 50%, as well as its total export relative to world trade, are unparalleled by any country since the UK in the late 19th century.

For China’s trade partners, both new and old, this growth has had a profound impact on their relationship with the country. For some, this has led to an inclusion in China’s supply-chain orbit. For others, the rapid growth of China’s affluent middle class is opening up opportunities for the flow of goods and services to a previously untapped market. 

Shifting economy

These trends are also reshaping the global economy along so called south-south lines, as trade flows between China and the world’s emerging economies gather pace. “The southern hemisphere and Asia will significantly outgrow trade flows with China compared to both Europe and North America,” says Christian Edelmann, partner and Asia-Pacific region head of consultancy Oliver Wyman.

While China’s trade growth has accelerated, the authorities have been keen to rebalance the economy towards domestic consumption. This has emerged as its export-intensive model faces a number of challenges, including slowing international demand, as well as the appreciation of the renminbi.

“While the US and European markets have shown signs of recovery, we still face a situation of weak demand. [Moreover,] the unilateral appreciation of the renminbi has brought significant impact and pressure to Chinese export activity, which has weakened Chinese export expansion,” according to the Industrial and Commercial Bank of China’s cross-border renminbi department.

Moreover, China’s changing demography is exposing weaknesses in its economy. “China’s demographics are among the worst in the emerging markets. As such, it has reached a point where the old model – of manufacturing low-end exports – won’t work anymore simply because this is too labour intensive,” says Jade Fu, an investment manager at Heartwood Investment Management.

Tapping demand

As this economic rebalancing unfolds and domestic consumption accelerates, new opportunities are expected to present themselves, particularly for regional exporters that can tap into this demand. “I think we will certainly see a change over the next decade as China moves towards domestic consumption. This will be a big opportunity for the regional economies in Asia to benefit from this growth and to some extent that’s already happened over the past couple of years,” says Mr Edelmann. 

Although this process will take some time to mature, it is likely to fundamentally alter the trade relationship China currently shares with the rest of the Asia-Pacific region. In January 2013, intra-regional trade with Asia accounted for 55.9% of China’s total imports and 51.4% of total exports, according to data from HSBC. In particular, the constituent members of the Association of South-east Asian Nations (Asean), with their strengths in consumer goods, stand to benefit from this trend. Total trade flows between Asean and China reached $358bn in 2013, up from $37bn in 2000, making China the Asean region’s largest export and import partner.

Moreover, as China continues its gradual climb up the value chain, coupled with the increasing cost of labour in the country, low-end manufacturing activity is expected to migrate to cheaper centres of production, including Cambodia and Vietnam. In turn, this should drive the integration of an already developed regional supply chain around China.

Anke Martens, a senior economist with ING Economics, says: “As wages have grown in China, a second wave of outsourcing has occurred, this time within the region. As a result, other emerging Asian countries are moving up the global manufacturing chain, with office, telecom and electrical equipment having become increasingly important in the export mix. These other emerging Asian economies, to some extent, are becoming a subcontractor for China, as well as [South] Korea and Japan.”

China imports and exports

Growing imports

China’s relationship with the developed economies of Asia in value terms is also set to accelerate as domestic consumption increases. Imports from Japan and South Korea are expected to grow rapidly in the coming years. By 2018, they will account for 53% of total imports to China, according to research from ING. Industrial machinery, office, telecoms and electrical equipment will dominate this import picture.

Meanwhile, China’s relationship with Hong Kong, based on its entrepôt status, means that the available data is somewhat distorted. “Hong Kong is the main import and export market for China, though the formal statistics don’t provide the full picture. A lot of this activity is based on the re-import or re-export business, where Chinese firms have set-up in Hong Kong,” says Mr Edelmann.

China’s engagement with emerging economies in Africa and Latin America is also developing swiftly. As a percentage of total imports to China, Africa now accounts for 6%, up from 1.8% in 2002, according to data from HSBC. Total bilateral trade amounted to $210bn in 2013, up from $100m in 1960. About 80% of these imports are mineral products, including cobalt, manganese and chromium, sourced from sub-Saharan Africa, and zinc, iron ore and copper from across the continent. 

Commodity hunger

This commodity hunger is expected to define China's trade relationships for the foreseeable future. "Over the long term, it will depend on how investment-intensive China’s growth remains. One of the reasons growth has been more investment-intensive in recent years is because of a lack of external demand. As such, if this trend continues – coupled with the country’s urbanisation drive – China’s demand for commodities will probably be sustained for quite a while," says Julia Wang, a Greater China economist with HSBC.

Yet, there is a growing nuance to this relationship. China's exports to Africa as a share of the total grew from 2.1% to 4.2% between 2002 and 2013. These products included machinery and electrical goods, chemicals, textiles, plastics and rubber. In light of sub-Saharan Africa’s rising per capita incomes and consumer demand, China’s role as an exporter to the region is expected to grow.

Reflecting this trend, Chinese firms are now paying greater attention to countries based on their market potential and scope for future investments. This is counter to the historical trend, whereby China has focused its presence on the continent to larger, resource-rich countries such as Nigeria, Angola and Sudan.

In Latin America, the trade picture is following a similar pattern but its growth has been even more rapid. "I think the relationship is accelerating. For example, the US used to be Brazil’s most important trade partner. Now it is China. Brazil also used to be the most important trade partner of Argentina, now it has been replaced by China. I don’t see this trend diminishing," says Antonio Alves, principal and regional head for Latin America with the World Bank's International Finance Corporation.

China’s imports from Latin America as a share of the total have increased from 2.9% in 2002 to 6.1% in 2013. An important component of this relationship is Latin America’s agricultural wealth. "One of the largest exports from Latin America is agri-products including foodstuffs such as meat, soybeans, corn and rice. Latin America is historically one of the largest agri-producers in the world," says Mr Alves.

In terms of China’s exports to the region, electronic products and vehicles dominate the country’s outflows. Yet, there is a burgeoning imbalance in this relationship, particularly as Latin American exporters have been hit by falling commodity prices. Brazil has made efforts to move its exporters up the value chain, although access to the Chinese market has been hindered by various non-tariff barriers, making this endeavour costly and uncompetitive.

Nevertheless, the Latin America-China trade relationship is important in other ways. For both parties, it fosters the diversification of their international economic ties, allowing China to achieve greater resource security while offering Latin American countries the opportunity to look beyond their relationship with the US.

Middle East ties

The final element of China’s south-south trade relationship is the Middle East, which has experienced explosive growth in terms of its trading and economic relationship with China. According to a recent report from HSBC, Chinese imports of crude oil from the Middle East and north Africa region have grown from 400 million barrels a day in 2006 to 1.2 billion barrels a day in 2013.

The latest figure indicates that about half China’s oil imports are now sourced from the region, with Saudi Arabia providing about 20% of China’s total crude imports. 

The Middle East’s growing petrochemicals industry has also prospered as a result of Chinese demand, as polymers, chemicals and specialty steel exports from the region to China have seen huge increases in recent years. Middle East demand for Chinese goods is similarly impressive; total spending on Chinese goods in 2013 was $130bn, roughly double the numbers posted for 2009.

As HSBC notes, however, much of this trade relationship has been driven by markets in the Gulf Co-operation Council. China has yet to have a similar impact on the non-commodity exporting economies in the region.

Developed economies

While China’s trade relations with emerging markets are set for a period of sustained growth, its existing ties with the developed economies will continue to be crucial. In the case of the US, which is currently China’s second largest export market, dynamics in both countries are shifting the nature of trade relations. According to the US Congressional Research Service, total US-China trade increased from $2bn in 1979 to $562bn in 2013. Today, China is the US’s second largest trading partner and third largest export market.

However, long-term tensions over this trading relationship prevail. The US’s goods trade deficit with China hit $318.4bn in 2013. While some critics in the US have claimed that China is undervaluing its currency and subsidising state-owned companies, thereby impeding the process of free trade, other factors at play may ultimately end up transforming this relationship irrespective of these issues.

“In the US, as a result of the shale gas revolution, there has been a substantial increase in domestic manufacturing. As this trend develops, it will reduce the country’s export potential for Chinese manufacturing companies,” says Mr Edelmann.

This process of ‘reshoring’, whereby American manufacturers are gradually returning their production activity to the US as a consequence of increased transportation, logistics and labour costs in Asia, may start to accelerate in the medium term. However, as domestic consumption increases in China, coupled with growing demand for higher value-added products in emerging Asia, there is scope for this expected export slack to be minimised.

“I think we’ll see more exports from the advanced, technological industries in China. They will likely play to their scale advantage and distribute also to fast-growing markets in south-east Asia,” says Mr Edelmann.

EU dominance

While the US-China trade relationship has dominated the headlines in recent years, the EU remains China’s largest trade partner. EU imports from China predominantly comprise machinery and equipment, footwear and clothing, toys and furniture, according to data from the European Commission. Meanwhile, EU exports are focused on chemicals, vehicles, aircraft, machinery and equipment.

Yet, consumer goods are also considered to be a growth area for EU exporters looking to capitalise on a growing Chinese market. “There are about 100 million people in China who have a similar purchasing power to middle class consumers in the West. This demographic is interested in increasing its consumption of high-quality imported products. For European businesses that enjoy a particular advantage in areas such as high-end consumer products, this represents a massive opportunity,” says Roberto Bendini, an international trade analyst with the European Parliament.

Nevertheless, based on existing trends, China’s trade relations with Europe are expected to become less important in the longer term. The rapid growth in trade between China and other emerging markets, particularly on the import side, is already significantly outpacing current EU-China trade growth rates.

Risk of isolation?

Beyond the broader picture of China’s global trade flows, various external factors may come into play in the coming years with the potential to radically alter this current structure. First, two of these developments fall squarely outside of China’s control. The development of Trans-Pacific Partnership (TPP), a US-led free-trade agreement involving 11 other countries in the Asia-Pacific region, including Malaysia, Vietnam, Japan, Australia, Canada, Brunei, Mexico, New Zealand, Singapore, Peru and Chile, has the potential to fundamentally alter the global trade picture.

If the TPP is implemented by member countries, it will account for two-fifths of global trade. While the US has indicated that China is welcome to join the initiative, it has also made clear that any Chinese involvement will be contingent upon the country engaging and complying with the rules being negotiated. Meanwhile, the prospects of an EU-US free-trade agreement also have implications for China’s global trade picture. 

“The outlook for the [TPP] – and whether China will ultimately be included – is a key uncertainty facing the country’s trading outlook. The other question relates to the prospects of an EU-US free-trade agreement. These are both political uncertainties that could leave China somewhere out in the cold,” says Mr Edelmann.

This uncertain outlook has prompted China to actively pursue closer ties with existing trade partners. In March this year, president Xi Jinping travelled to Europe to discuss the outlook for EU-China trade. “Deepening trade relations with Europe is a good way for the Chinese to respond to the US-led TPP,” says Mr Bendini.

Regardless of how these events unfold, China’s international trade relations will continue to define the global economy. In particular, the ongoing transition in global economic power, from the old Atlantic economy to one based on south-south ties, will be a lasting testament to China’s status as the world’s sole mega-trader.

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