TABLE OF CONTENTS

Table of Contents and Executive Summary in pdf (43KB)

CHAPTER 1 CHINA'S IMPACT ON EAST ASIAN TRADE 1

Surging China

Economic Growth

Expanding Exports

Inward Investment

China's Exports Compared with East Asia's

Is China Out-Competing the Region?

Changing Trade Flows

Accounting for Import Patterns Tells a Different Story

Sectoral Analysis

Implications

Appendix 1.1 Trade Similarity Indices

CHAPTER 2 EAST ASIAN ECONOMIES RESPOND TO CHINA

China's Changing Comparative Advantage
North East Asia's Reponses to China

Japan

Trade Flow Comparisons

Japan's Revealed Comparative Advantage

Republic of Korea

Trade Flow Comparisons

ROK Revealed Comparative Advantage

Taiwan

Trade Flow Comparisons

Taiwan's Revealed Comparative Advantage

Hong Kong

Trade Flow Comparisons

Hong Kong's Revealed Comparative Advantage
South East Asian Responses to China

Indonesia

Trade Flow Comparisons

Indonesia's Revealed Comparative Advantage

Malaysia

Trade Flow Comparisons

Malaysia's Revealed Comparative Advantage

The Philippines

Trade Flow Comparisons

The Philippines' Revealed Comparative Advantage

Singapore

Trade Flow Comparisons

Singapore's Revealed Comparative Advantage

Thailand

Trade Flow Comparisons

Thailand's Revealed Comparative Advantage

Implications

Appendix 2.1 Michaely Indices of Revealed Comparative Advantage

CHAPTER 3 IMPLICATIONS FOR AUSTRALIA

Trade Flow Comparisons

Australia's Revealed Comparative Advantage

Implications for Australia

Changing Export Destinations

Forecasts for Chinese Demand for Raw Materials

Future Prospects

Summing Up

EXECUTIVE SUMMARY

Is China developing so fast that it threatens to dominate completely regional
manufacturing, even high technology manufacturing, undermining developing
and developed East Asian economies' economic prospects? This report seeks
to answer this question by examining the major restructuring underway in regional
economies' trade flows China appears to be causing, drawing implications for
regional economic prospects and Australian business. This report finds China's
industrial rise is a positive sum game for the region and Australia; overall,
all economies appear to be gaining. However, some economies like Australia
are gaining more than others that are constrained by rigid policies and weak
markets. This is because the comparative advantage of China, Australia and
other regional economies is dynamic. Firms, markets and economic policies
must be flexible and open to remain winners in this rapidly evolving environment.

China's strong growth and large economy is causing rapid changes in production
patterns and trade flows within East Asia and between the region and third
markets. These changes not only are affecting regional economies but also
could significantly influence Australian exporters, most of whom supply industrial
inputs to China and other East Asian economies.

This report firstly examines recent production and export growth patterns,
assessing concerns China's expanding exports of assembled high technology
products could damage middle and high income East Asian economies by making
redundant many advanced industrial plants. It also examines concerns China's
rapidly expanding production of more traditional labour intensive manufactures
is damaging economic prospects in developing South East Asian economies.

China already is, or is fast becoming, the region's largest exporter of many
products, from fully assembled high technology products to traditional labour
intensive manufactures. At first glance, human capital and technology abundant
economies such as Taiwan, the Republic of Korea and Singapore seem to confront
rising Chinese competition in markets for some of their high technology exports.
Labour abundant economies in South East Asia also appear to face increased
competition in world export markets for clothing, footwear, toys, consumer
electrical goods and other labour intensive products.

However, detailed analyses of regional trade flows over the past decade this
report undertakes shows China's continuing industrial expansion is not damaging
but benefiting other regional economies. China is more closely integrating
into mutually beneficial regional production chains, stimulating regional
trade growth. In more advanced regional economies, exports of advanced components
and capital equipment to China and elsewhere are more than compensating for
losses in labour intensive manufacturing sectors. In developing regional economies,
China's industrial expansion certainly is challenging competing regional industries,
encouraging them to specialise and adjust but, overall, competing sectors
are still expanding strongly. Furthermore, China's expanding imports, including
of advanced components, capital equipment and raw materials, are generating
lucrative new markets for East Asian and Australian exporters. Nevertheless,
the study highlights the fact that policy settings need to promote flexibility
and resource mobility within regional economies to maximise benefits from
China's expansion.

As a major raw material supplier and a smaller but still significant exporter
of advanced manufactures and services to China, Australia already is benefiting
significantly from China's rapid growth. Furthermore, as other East Asian
economies appear to be adjusting successfully to the rise of China's industry,
Australia also should retain and expand its traditional markets in these economies.
This detailed understanding of how East Asian economies are adjusting to the
rise of Chinese industry aims to assist Australian businesses anticipate and
benefit from these major emerging market trends.

Regional Hollowing Out Concerns Unfounded

This report's analysis indicates concerns of widespread hollowing out are
unwarranted. It shows China's core competitiveness still lies largely in labour
intensive production. To produce more technologically advanced products, it
mainly assembles imported components from developed East Asian economies.
Most developed East Asian economies continue to expand their exports of more
technologically advanced products. They also are responding to China's efficiency
in labour intensive manufacturing by contracting exports in these industries
and expanding exports from more capital and human capital intensive industries
where they retain relative strength. By developing new markets and maintaining
old ones most developing East Asian economies are achieving strong export
growth even in sectors where they compete with China.

While China's more high technology exports appear to be expanding into sectors
other East Asian economies supply, closer examination indicates a key driver
in this apparent trade convergence is the internationalisation of production
chains. Export similarity analysis using gross export data appears to show
China's export profile gradually is becoming more similar to the export profiles
of many developed East Asian economies in recent years. However, export similarity
analysis undertaken using net (export minus import) data shows China's overall
export specialisation is not becoming more similar to those of most other
East Asian economies. This is because rather than taking over the whole production
process for computers, televisions and other electronic products, China is
becoming more embedded in regional production chains producing these products.
These chains typically take advantage of the strengths of different regional
economies to produce the range of required components and assemble completed
products. They often involve industrialised Japan, the ROK and Taiwan producing
sophisticated components and shipping them to low cost China and South East
Asia for assembly into final consumer goods. Once trade flows associated with
these integrated production chains are factored in to analyses of regional
net trade flows, no overall trend emerges of Chinese exports encroaching on
its neighbours' export markets.

In addition, China is becoming an increasingly important market for other
East Asian economies and Australia through their increasing trade complementarity.
China's expanding industries are providing all East Asian economies with rapidly
expanding markets for raw material, component and capital equipment exports.
Australia's exports to China are growing rapidly, particularly raw materials
and energy. Regional economies with more established consumer bases, such
as Japan, Hong Kong, Singapore and Australia, also are benefiting from cost
competitive Chinese consumer good exports.

Chinese Manufacturing Expands

Sectoral analysis of Chinese trade flows confirms significant restructuring
and some movement up the value chain is underway in Chinese manufacturing.
China maintains a strong competitive edge in labour intensive products like
clothing, footwear and toys and rapidly is becoming a more competitive office
machine assembler. Over the last five years China also has reduced its comparative
trade weakness in more capital intensive industries like non-office machinery
and synthetic textiles while its comparative strength in traditional labour
intensive products like clothing and footwear is waning. However, China now
relies more on imports for human capital intensive products like integrated
circuits and energy imports like crude oil.

Strongly Complementary Japan Consolidates Advanced Manufacturing

Japan faces moderate competition from Chinese exports but is responding by
moving out of the labour intensive sectors where China is more competitive.
Japan is facing increasing competition from Chinese exports in about a quarter
of its net export sectors by value. In two thirds of these sectors, mainly
labour intensive industries like assembled computers, Japan's net exports
are declining. Japan continues to expand its net exports of the other third
of export categories, which includes more advanced products like video and
digital cameras, mobile phones and motorcycles. Another quarter of Japanese
net exports by value, including integrated circuits and steel, complement
Chinese net imports and this complementarity is increasing. Around a quarter
of Japanese net imports, such as clothing, are complementary with Chinese
net exports. Japan retains a strong specialisation in capital and human capital
intensive products including non-office machinery and passenger vehicles,
and an equally strong reliance on imports for primary commodities like crude
oil and meat and labour intensive goods such as clothing.

ROK Expands Exports Regardless of Chinese Competition

The Republic of Korea, ROK, faces competition from Chinese net exports in
about half of its export sectors but continues to expand exports of these
products regardless, at a similar rate as China. For example, ROK net exports
of mobile phones, digital and video cameras, computers and computer parts
continue to expand strongly in the face of China's expansion in similar industries.
The mutually advantageous intra-industry component and finished product trade
between China and the ROK probably explains part of the ROK's success. Another
quarter of the ROK's net exports by value, including plastics in primary forms
and steel complement Chinese import demand. Hence, the ROK is integrating
its industry effectively with China, with few apparent negative impacts in
competing sectors and strong growth in clearly complementary sectors.

Taiwan Restructures to Adjust to Strong Competition

Taiwan also faces strong competition from China, competing with Chinese
exports in well over half its net export sectors by value. In a majority of
these competing sectors, including clothing and fully assembled computers,
Taiwan is reducing its net exports but it continues to expand its net exports
of other products, such as computer parts. About a quarter of Taiwan's total
net exports by value, including synthetic textiles and electronics components,
are complementary with Chinese net import demand. By specialising in its comparative
strengths, such as computer parts and products China demands, like textiles
and steel, Taiwanese industry has continued to expand its exports strongly.

Hong Kong's Entrepot Role Strongly Evident

As Hong Kong is a major re-exporter of Chinese goods, with local firms adding
some value to many of these re-exports as they pass through Hong Kong, even
analysing net trade flows between Hong Kong and China appears to show the
two economies have very similar net export profiles. However, only 9 per cent
of Hong Kong's workforce now is in manufacturing; most of its workforce is
in service industries, many of which also service China. Meanwhile, 20 per
cent of Hong Kong's net merchandise exports complement Chinese net import
needs and around a third of Chinese net exports match Hong Kong's net import
requirements. While goods trade data analysis provides only a partial picture,
the close integration of the two economies is clear. Hence, China's growth
should provide Hong Kong strong long term prospects.

Indonesian Resources Complement Chinese Growth

While China is a competitor in almost half of Indonesia's net export markets,
mainly for labour intensive manufactures, overall Indonesia is expanding its
net exports strongly in these competing sectors. So long as Indonesia retains
flexible labour markets and its financial system can recover sufficiently
to finance new investment in sectors competing with China, this competition
could promote Indonesian efficiency and product specialisation. With its strength
in primary commodity exports, Indonesia also is well placed to benefit from
Chinese industry's expanding demand for inputs.

Malaysia Boosts Exports despite Chinese Competition

Malaysia, like Indonesia, relies heavily on resource and labour intensive
manufactured exports, but has significantly more overlapping export sectors
with China than Indonesia. Almost two thirds' Malaysia's net exports compete
with China's, including a wide range of electronics. In the past six years,
despite strong Chinese net export growth in these markets, Malaysia significantly
increased its exports in the majority of these competing sectors. Hence, Chinese
competition does not appear to be damaging Malaysia's manufacturing export
sector and could well be strengthening it. Although its complementarity with
China currently is lower than that of most other regional economies, Malaysia
also is benefiting from China's increased demand for resources and components.

The Philippines Benefiting from Complementarity

The Philippines appears to be adjusting successfully to changing international
demand and Chinese competition, increasing its net exports in a majority of
sectors where it competes with China. However, China may present a low and
declining competitive challenge to the Philippines' net exports in part because
the Philippines is not a strong exporter of the labour intensive products
economies at a similar level of development usually rely on. Nevertheless,
the Philippines is highly complementary with China's net import demand, particularly
in electronic components, which should assist its future export growth.

Singapore Goes High Tech, Strongly Complementary

As one of the region's most developed economies, Singapore has a strong
technological edge over China; it continues to move rapidly out of more labour
intensive sectors where China is strong, focusing on higher technology exports.
This ongoing restructuring is increasing Singapore's trade complementarity
with China. Like other developed East Asian economies and Australia, Singapore
is well placed to take advantage of China's growth by exploiting its complementarities,
including by exporting components and capital goods and accessing China's
low cost exports to supply its mature consumer market.

Thailand Faces Toughest Competition: Continued Reform Important

Of all East Asian economies, Thailand has the most similar net export profile
to China's and faces competition from China in the great majority, 70 per
cent, of its net export sectors. Competitive pressure from expanding Chinese
exports appears to be pressing many Thai industries to either become more
efficient or move into more specialised markets. Thailand's complementarity
with China is the lowest in the region but is growing rapidly. Provided the
Thai economy can restructure flexibly it should gain from this competition;
however, if Thai economic reform programs were to stall, Chinese competition
could prove a serious challenge.

China's Economy Could Surpass Japan's by 2030

Over the next few decades, if China's reforms stay on track its economy
could expand until it approaches the size of Germany in 2010 and rivals Japan
by 2030. As its income per capita expands, China already is moving gradually
up the value chain and producing an increasingly wide range of goods. However,
it is unlikely to become a competitive net exporter of human capital intensive
products like high technology components or capital intensive industrial goods
for some decades. China's huge, low cost but on average low skill workforce
means its relative strength, and hence its trade specialisation should remain
in labour intensive exports for some decades.

Positive Implications for Australia and the Whole Region

Due to its complementary trade specialisation and role as a major input
supplier to Chinese industry, Australia should continue to profit from Chinese
economic expansion. In other East Asian economies, China's industrial expansion
is stimulating restructuring that should help boost industrial efficiency
and growth; this also should promote Australian exports to the region. However,
destinations of some Australian exports will continue to shift as developed
regional economies move out of labour and resource intensive industries to
more human capital intensive industries.

Vastly different Australian and Chinese economic endowments and strengths
mean Australia faces relatively little competition from China in export markets
and strongly complements China as a trading partner. As a net exporter of
many products China demands, particularly minerals, energy and agricultural
commodities, Australia is well placed to benefit from its rapid growth. Australia
also is a large net importer of goods China supplies to world markets, including
a wide variety of more labour intensive consumer goods. This strong trading
partnership will continue to generate considerable benefits for Australia
and China.

Over time, as China's raw material requirements continue to increase and
other economies restructure into more human capital and less raw material
intensive goods and services, some Australian exports will shift from other
East Asian economies to China. Economic Analytical Unit commissioned modelling
results indicate Chinese demand for many major Australian exports, including
copper and natural gas, should continue to grow strongly in the next decade.
Resource exports to maturing developed economies like Japan are likely to
grow more slowly and in some cases may fall. In the case of coal, Australia's
largest export to the region, while its exports to East Asia will continue
to rise in absolute terms, its share in total East Asian coal consumption
could fall if China's coal industry satisfies more Chinese and regional coal
demand.

As China continues to grow, its rapid economic development and on-going integration
into regional production chains should benefit the rest of East Asia and Australia.
To date, East Asian economies appear to have been sufficiently flexible to
restructure and maintain competitiveness to meet the challenge of China's
industrial rise. However, developing South East Asian economies require ongoing
reforms to ensure they maintain market flexibility so they remain competitive
with Chinese exports and capture rapidly growing export opportunities in China.
Chinese industries' growing appetite for resources, components and capital
goods expands total regional demand and provides significant opportunities
for regional economies to gain from increased specialisation, ensuring benefits
for Australia and its East Asian trading partners. Hence, China's industrial
rise is a major boon for the region, providing a strong engine of growth,
but the most flexible economies will reap the greatest benefits in the significant
industrial restructuring now underway.