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Simple Truth About China’s Trade Surplus

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China has been consistently incurring trade surpluses with developed countries—but incurring trade deficits with most countries in East Asia. While the trend is partly due to outsourcing, China’s sustained and rapid increase in exports cannot be explained by outsourcing alone.

In the mid-1980s, while China was still in its initial phase of economic transition, export power houses in East Asia were already beginning to restructure their export production networks. In 1986, Chinese policy-makers saw this opportunity and started supporting the Coastal Development Strategy (CDS), which allowed all types of firms in coastal provinces to engage in export-processing contracts that were initially confined only to special economic zones (SEZs).

The manufacturing companies of Hong Kong and Taiwan, exporting mainly labor-intensive low-tech to the US in the ‘70s, were shopping for lower-wage locations due to increasing wages, costs, and currency realignments. This restructuring was part of a worldwide trend toward international division of labor in production chains.

The CDS, together with the geographical proximity and hence low relocation costs, gave Hong Kong and Taiwan exporters opportunity as well as first-mover advantage to transfer labor-intensive, low-technology export production to China. As a result, China started picking up the niche of HK and Taiwan in generating trade surpluses with the US. HK and Taiwan, meanwhile, started moving up and into the production of higher value-added and more technology- and capital-intensive type goods.

Two characteristics of China’s foreign direct investment (FDI) inflows tell the same story but reveal the web of relationships woven into the economies of East Asia.

FDI inflows to China have been concentrated in export manufacturing (financial and services sectors have not as yet been liberalized) and are predominantly from East Asia.

In 2005, 70% of China’s FDI, based on actually utilized value, went to manufacturing. In both 2004 and 2005, Hong Kong’s non-financial FDI continued to account for 31% to 32% of inflows to China. Japan and Korea, accounted for around 20%, and Singapore and Taiwan, around 5%.

The relocation of production networks required foreign-invested enterprises (FIEs) to build production bases and other trade infrastructure. But, at the same time, FIEs based in China also import large quantities of inputs from other economies in East Asia, which are then processed and/or assembled. The finished goods are exported to developed countries such as US and EU.

In effect, the shift of FDI to China created the shift of trade surplus from the newly industrialized economies (NIEs) with the US in the ‘70s, to China in the mid-’80s. But simultaneously, the NIEs also incur trade surpluses with China, the same thing as China’s trade deficit with the NIEs.

China’s trade surplus with the world in 2005 was approximately US$100 billion—but it was US$114 billion with the US and US$74 with the EC(25). Its overall trade deficit with Asia was US$22 billion, but a whopping US$58 billion with Taiwan, US$42 with Korea, US$16.5 billion with Japan, and roughly US$20 billion with ASEAN.

China and ASEAN started implementing a free trade agreement (ACFTA) in 2005. Despite increasing imports from China, the Philippines posted a trade surplus of US$750 million with China.

This trend reveals the economic fabric that has been woven into the economies of East Asia—the sustained trade and investment linkages that actually began with the historical antecedent, the hub-and-spoke system, spawned by Japan’s FDI in East Asia.

Restructuring of regional production networks has started in labor-intensive, low-tech products such as toys, shoes, and garments. The relocation of these production bases was almost complete by the early-1990s. How then did China continue to sustain its rapid export growth and trade surpluses?

By the early-1990s, the restructuring of information technology (IT) products began as well. But unlike the previous wave, the relocation of IT-production bases was spread out over several successive waves.

It started with the most labor-intensive and least technology-intensive products such as keyboards and accessories, and then to more technology-intensive products such as mother boards, monitors, etc. To date, the most celebrated and successful restructuring has been the acquisition and takeover by Lenovo, originally “Legend” (Lianxiang), of the IBM PC division in 2004.

China has captured the opportunity—not just by good timing but, among other things, through the substantial reform of its trade and investment regimes. Economic history repeats itself.

As changing cost conditions and currency realignments continually alter the regional economic landscape, other countries in East Asia can pick up the niche China may leave open. China’s trade surplus today could be the trade surplus of other East Asian countries in the future.

print ed: 01/08


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