Written evidence submitted by Catherine
R Schenk, Professor of International Economic History, University
of Glasgow
CHINA'S
INTERNATIONAL ECONOMIC
RELATIONS
HONG KONG
SAR-MAINLAND CHINA
RELATIONS
It is now commonly understood that the international
economy has been and will continue to be profoundly affected by
the economic development of the People's Republic of China. This
will pose challenges and opportunities both globally and for the
United Kingdom. This brief will set out the key features of China's
international economic relations and then present some key issues
that should be considered in anticipating future policy. At the
end of the brief is a section on Hong Kong SAR's changing economic
and political relations with Mainland China.
China's economic growth has been driven by high
levels of capital accumulation, both from domestic investment
and also from foreign investment. In 2003 the IMF identified potential
over-heating of the economy and recommended policies to reduce
the growth rate of capital accumulation to prevent bottlenecks
(by slowing monetary growth, bank lending, reigning in the property
sector). These appeared to have been somewhat successful in the
first half of 2005 but there was a further acceleration in the
second half of the year. Growth is predicted to have been about
9.3% in 2005 according to the World Bank in November 2005, and
9.8% according to the latest Chinese official estimate in January
2006.
Over the past few years, China has vied with
the USA to be the largest single recipient of foreign direct investment.
In 2005 inward FDI amounted to US$60.3 billion, a slight fall
of 0.5% from 2004. The table below shows that the UK is not a
major investor in China, although there may be some indirect investment
from the UK to China through Hong Kong SAR that is not captured
in this data. Even within the EU, the UK falls behind Germany
as a direct source of investment. The value of contracted FDI
increased by over 6% in 2004, which is an indication of the potential
growth in realized flows in the future.
SOURCES OF FDI INFLOWS TO MAINLAND CHINA
| Shared of total Realized Value of FDI in China (%)
| 2004 | Jan-Oct 2005
|
| UK | 1.31
|
| 1.60 | | EU Total
|
| 6.99 | 8.61 |
|
| USA | 6.50 | 5.07
|
| East Asia | 61.47
|
| 58.58 | |
|
Data from China's Ministry of Commerce (www.fdi.gov.cn)
China's competitiveness in export of labour intensive production
has already generated considerable trade friction with the USA
and the EU. In 2005 the USA trade deficit with China grew 45%
and the USA launched 11 antidumping investigations against China.
The impact of new trade restrictions is complicated by the
large number of foreign companies engaged in production for export
in China, who will suffer from trade barriers.
In the first 11 months of 2005, 58% of China's exports were
produced by Foreign Invested Enterprises. In 2003 ½ of exports
from FIEs went to the USA. While China has a huge bilateral surplus
with the USA, its overall trade is more balanced. China tends
to run large surpluses with the USA and EU, which are partly offset
by deficits with Taiwan, Korea, Japan and ASEAN countries. In
2005, total exports grew 28% while imports grew only 18%, generating
a trade surplus of $US102 billion. The EU is China's biggest trading
partner (imports and exports amounted to US$217 billion p 22.6%
in 2005). The USA comes a close second with US$212 billion in
exports plus imports. Japan is in third place with US$184 billion.
Chinese exports will continue to diversify away from labour intensive
products. In January 2006 Geely International exhibited the first
Chinese-made car at the Detroit auto-show.
Another Chinese car manufacturer, Chery, plans to begin exports
to the USA at the end of 2007.
A further aspect of China's growing surplus has been the
accumulation of huge foreign exchange reserves, much of which
is denominated in US government debt. In 2005 foreign exchange
reserves increased by US$208.9 billion or 34%. This gives the
PRC some degree of leverage over the USA. Should China cease to
acquire US Treasury Bills and other US debt or seek to diversify
its portfolio of assets, this would impinge the ability of the
US government to fund its deficits and on the exchange rate of
the US$, which has already fallen substantially in international
markets over the last two years.
Prospects for the future include:
1. China's outward foreign investment: the growing shortage
of key resources threatens to create a bottle-neck in China's
industrial development. The World Bank reported that in 2004,
China accounted for half of global growth in the demand for metals,
and one-third of the global growth in demand for oil. In 2005
China imported 130 million tons of crude oil, the cost of which
increased 18% over 2004. The PRC has begun to address this through
outward foreign direct investment in developing countries to capture
control of the exploitation and supply of key resources. China
has plans to invest US$1 billion in a refinery in Khartoum, has
loaned US$2 billion to Angola in return for oil and is building
a pipeline through Kazakhstan.
China has also begun outward FDI in manufacturing—eg
Lenovo's purchase of IBM's PC manufacturing. This trend will continue
and there are indications that China, along with other countries,
is seeking to take advantage of the geographical expansion of
the EU. In December 2005 a major Chinese TV manufacturer announced
a US$30 million investment in the Czech Republic for R&D,
manufacturing and European marketing. In 2005 overseas investment
in USA, Europe, Africa, Asia and Oceania increased by 80%. Most
of the investment was destined for the Asian region.
2. The huge foreign exchange reserves of the PRC provide
considerable scope for development loans as well as FDI. In January
2006, for example, the government announced it had agreed a US$20m
9 year loan to Uzbekistan for its economic development. This may
have important political implications should China hope to develop
spheres of influence in developing economies, particularly those
with poor human rights records such as Zimbabwe (China invested
US$600 million in 2004) and Sudan (where China has large investments
in oil production and infrastructure). It is already reported
that China's threat to veto a harsh UN resolution against Sudan
led to a watering down of that resolution. The potential for China
to increase their political influence by giving aid and loans
to countries with poor human rights records is amplified by the
recent decision of the British government to curtail aid to Ethiopia
on political grounds.
3. China's economic growth has been accompanied by worsening
inequalities in the geographic distribution of income. This has
generated a flow of migrants from rural and poorer provinces to
the main cities, not all of whom have been able to find employment.
In 2005 the government's statistics showed that the poorest
10% of families own less than 2% of residents' assets, while top
10% of families own over 40% of total assets. The widening gap
between rich and poor is being addressed by the government through
devoting resources to developing the Western provinces and rural
enterprise, but it remains a threat to social and therefore political
stability. The 11th Five Year Plan (adopted November 2005) puts
more emphasis on income distribution, social security and rural
development with the slogan "common prosperity".
4. On 21 July 2005 the PRC moved from an effective pegged
rate against the US$ to a more flexible link to a basket of currencies.
This move was widely seen as a response to intense international
pressure from the USA, the G10 and IMF to revalue the RMB in order
to reduce the competitiveness of Chinese exports. After an initial
2% revaluation of the RMB in July 2005, the rate has remained
steady (rising about 0.5% by December 2005) leading to some disappointment
and mounting pressure again for greater flexibility. There is
no consensus among economists as to the extent to which the RMB
has been undervalued.
It is not likely that a revaluation of the RMB will be the
main route through which the Chinese surplus will be addressed
(the price competitiveness of Chinese production is so great that
even a 10% or 20% revaluation could make little difference). Adjustment
will require increasing domestic Chinese demand for imports and
for domestic production, increasing protection of intellectual
property to encourage exports of IP-rich products from the US
and EU, and restructuring declining uncompetitive industries in
the US and EU.
5. Financial stability—the Chinese banking system
continues to be burdened with non-performing loans, mainly to
state-owned enterprises. These are being dealt with through Asset
Management Companies, which buy the bad debt from the banks to
improve their balance sheets. Foreign participation in Chinese
banks has accelerated the last year but this may not directly
help the problem.
Foreign bank participation is restricted to minority interest
and is mainly aimed at developing the local credit-card and retail
market. The impact on governance of the banks is not clear. On
the other hand, Chinese banks may suffer from increased competition
as foreign banks widen their operations in China under the WTO
requirements.
6. If the EU and UN confrontation with Iran continues
to escalate, this may draw China into international political
conflict. They are unlikely to support sanctions against Iran.
In December 2005 the USA announced sanctions against six Chinese
companies accused of supplying military equipment and technology
to Iran. In 2004 the Chinese state oil company, SINOPEC, signed
a 25-year oil supply agreement with Iran, reportedly worth US$70
billion.
HONG KONG'S
RELATIONS WITH
CHINA
After the Asian Financial Crisis of 1997 and the global economic
downturn of 2001-02 combined with the SARS crisis, Hong Kong went
into a recession that included rising unemployment and falling
prices. The Hong Kong economy is particularly vulnerable to shocks
to asset prices (property and shares) which made the recovery
difficult. From 2001-03 the changing fortunes of Hong Kong SAR
vis a vis Mainland China have transformed both their economic
and political relationships.
Economically it is much more evident now that Hong Kong's
economic future lies through further integration with the booming
mainland economy and, indeed, that prosperity in Hong Kong
is dependent on this relationship. This is evident in the negotiation
in 2003 of the Closer Economic Partnership Agreement (CEPA) whereby
Hong Kong producers gain tariff-free access to the China market
for 1370 products and 23 services. The impact of CEPA has been
limited since most Hong Kong trade with China is re-exports. However,
Hong Kong's retail and service sector is benefiting from the dramatic
increase in the flow of tourists from the Mainland after the liberalisation
of travel restrictions. In 2004 12 million mainland tourists visited
Hong Kong, accounting for 56% of total tourist arrivals.
Beijing has recently interfered with the progress to democracy
in Hong Kong, provoking public protests culminating in a mass
protest march in December 2005. In April 2004 the National People's
Council in Beijing decreed that Hong Kong would not move forward
to full democracy at the pace suggested by the Basic Law, which
set a time frame for reform to begin in 2007. At the beginning
of December 2005 tens of thousands of Hong Kong residents protested
against the Executive's proposal to make limited reforms to increase
participation in the election of the Chief Executive slightly
and to increase the number of legislators, with no commitment
for a timetable to full universal suffrage and direct elections.
The protests were successful in defeating this legislation
on 21 December 2005, but it is not yet clear what will replace
it.
Hong Kong's Total Trade with Mainland China (Imports+Exports)
| | |
|
| | |
|
| | |
|
| HK$ billion | China Total
| Trade with China as a Share of total trade%
|
| | |
|
| 2000 | 1,258 | 3,231
| 38.9 |
| 2001 | 1,228 | 3,049
| 40.3 |
| 2002 | 1,330 | 3,180
| 41.8 |
| 2003 | 1,528 | 3,548
| 43.1 |
| 2004 | 1,807 | 4,130
| 43.8 |
| 2005 | 1,882 | 4,186
| 45.0 |
2005 data for January to November only.
Catherine R Schenk
University of Glasgow
20 January 2006
| 
