The International Economics program aims to explain developments in the international economy, and influence policy. It does so by undertaking independent analytical research.
The International Economics program contributes to the Lowy Institute’s core publications: policy briefs and policy analyses. For example, the program contributed the Lowy Institute Paper, John Edwards’ Beyond the Boom, which argued that Australia’s transition away from the commodities boom will be quite smooth.
At a time when stability and predictability are needed most, the body at the heart of the rules-based trading system — the World Trade Organization — is reeling from far more than just a paralysed Appellate Body and antagonistic Trump administration.
For a second there the global economy was off to a slightly better start for 2020. The US and China finally inked an initial “phase one” trade deal that at least promised to pause hostilities for a while. That provided some much-needed respite for a world economy, which last year reached its weakest point since the global financial crisis. Shortly after, the International Monetary Fund was quick to provide a more upbeat global growth outlook, suggesting that slowing economic activity might be bottoming out.
Enter the Wuhan coronavirus. We can only speculate what ultimate impact – both human and economic – the virus will have, depending on how far it ends up spreading.
The most important channel of economic impact will likely be the hit to Chinese consumer spending. That’s less a function of the inherent danger of the virus – which is still unknown – and more about the precautionary response of the government and Chinese consumers leading people to stay home instead of heading to the shops, eating out, travelling or doing leisure activities. Other government containment efforts will also add to this – including lost output as businesses stay shut for longer following the Lunar New Year.
The indirect effect of a sharply slowing Chinese economy would be felt by others and could be a major difference compared to the SARS experience.
How big of an impact for the Chinese economy might this prove? Comparing it to the 2002–03 SARS outbreak suggests the shock could be substantial. While China’s economy continued to grow briskly through that episode, the underlying story suggests today’s experience could be quite different.
In 2003 Chinese consumption growth suffered a sharp slowdown. The economy was only able to escape a drop in headline growth because investment and exports were booming at the time, with China having entered its hyper export-led growth phase following its 2001 accession to the World Trade Organisation. The government was also able to help with stimulus measures.
This time around things are very different. Consumption is now an even more important driver of the economy while investment and exports have been weakening – reflecting China’s efforts to reduce its reliance on debt fuelled investment and pressure on the external front from the trade war with America.
There is also much less scope for sizeable stimulus today, with Chinese policymakers aiming to stabilise macro leverage in the economy in order to contain systemic financial risks. China might also be reluctant to let a weaker yuan serve as a natural exhaust valve – for fear of encouraging capital outflows but also potentially reigniting economic tensions with the Trump administration over the exchange rate. Having said that, if things worsen China’s top leadership may eventually judge that more support is needed to buttress things.
All up, if the Wuhan coronavirus crisis proves around the same scale as the SARS episode then China’s economy could conceivably be looking at economic growth dipping from the current 6.1% rate to something in the 4-5% range this year, even on the government’s rosy numbers. This is of course simply a guess. A lot of variables could influence that. A wider epidemic would spell bigger problems. Conversely, even successful government and public precautions might still impose a significant cost on the economy, if that is what it takes to halt the spread of the virus.
What might the impact be on the global economy? China accounts for about a fifth of world output on a purchasing power parity basis – the IMF’s preferred measure – meaning a Chinese slowdown to say 4.5% would directly knock off 0.3 percentage points from the fund’s latest global forecast of 3.3% for 2020 (made only last week). That alone would effectively wipe out the 2020 uptick in global growth that the IMF was hoping for, and instead keep the world economy growing at a similar pace to last year – already the slowest pace of global growth since the 2008–09 crisis.
Knock on effects for other economies could however make things worse. It is not clear how far the virus itself might spread in other countries. But the indirect effect of a sharply slowing Chinese economy would be felt by others and could be a major difference compared to the SARS experience. Not only are the risks of a sharp Chinese slowdown greater this time around but China is also now a far more important source of demand for the rest of the world, particularly in Asia.
What about for Australia? Australia’s tourism and education exports to China would appear most in the firing line. China has announced a halt to overseas tour groups. However, Australia’s tourism exports to China only amount to about 0.2% of GDP. Education exports amount to a more sizeable 0.6%. But the experience during the SARS epidemic was that education exports remained resilient, suggesting less cause for concern.
Meanwhile, the fact that the overall slowdown in China’s economy will be consumption led should help insulate Australia’s more important commodity exports from major damage (if China were to resort to renewed stimulus it could even provide some boost). Australia’s much less significant agricultural exports could however take a hit from weaker Chinese consumption.
A weaker Aussie dollar in response to increased global risk aversion and slower Chinese growth should however provide at least a partial offset – giving a boost to Australia’s international competitiveness, including tourism, education, and agricultural exports to other countries.
The economic risks for Australia therefore look less severe than some might fear.
All of this, however, depends on how far the virus ultimately spreads.
US President Donald Trump was quite right when he declared the 15 January US–China “Stage One” agreement an “unbelievable deal” for the United States. Unbelievable it is, though not in a good way – and especially not for Australia.
The deal requires China to import $200 billion more from the US this year and next, compared to the baseline of China’s imports from the US in 2017. The arithmetic (see below) implies that China’s imports from the US this year must be 80% higher than its imports from the US last year.
That won’t be easy, and may well be impossible.
If China succeeds in doing so it will almost certainly be partly at the expense of other exporters to China. Europe is well aware of this, and has already threatened a World Trade Organisation dispute against China. Australia, too, should be wary of how this deal will play out, although Trade Minister Simon Birmingham seems unfussed.
Birmingham ought to be a little more bothered than he appears because the additional goods purchases from the US in 2020 to which China is now committed total more than the entirety of Australian goods exports to China in 2018, and not very much less than the entirety of Australian goods exports to China in 2019.
For Australia and other third countries with strong economic relationships with China, the only really good news in this agreement is that America is clearly not detaching from China.
Not only is the increase required equivalent to the total of Australian goods exports to China. It also covers many of the same products. Australia supplies 7% of China’s farm imports and 8% of its energy imports. The US is now the third biggest exporter of liquid natural gas after Australia and Qatar, and it has plenty of capacity. It is a big coal exporter. It exports liquid petroleum gas. It exports meat, dairy and wine. Iron ore is a big exception, but iron ore apart most the merchandise Australia otherwise sells to China competes with exports by the United States. Because iron ore exports account for well over a third of Australian goods exports to China, it follows that the total of Australia’s non-iron ore exports to China is much less than the addition to non-iron ore US goods exports to China required in 2020 under the new agreement.
Having admonished Australia (and Germany, Japan, and South Korea) for depending too much on the China market, the US is now elbowing Australia and other allies out of the way in a race for that same market.
The deal also includes China commitments on behind the border impediments to US farm exports, additional liberalisation of foreign investment in financial services, commitments on protection of intellectual property, and an undertaking to ban authorities seeking technology transfer to Chinese partners in joint ventures.
Many of these commitments were blessed at the National People’s Congress in March 2019, some already legislated, and some others are minor.
For Australia and other third countries with strong economic relationships with China, the only really good news in this agreement is that America is clearly not detaching from China.
The agreement goes in the opposite direction from decoupling. It increases the value of the Chinese export market to the US, and places no additional restriction on China’s exports to the US (compared for example to the 1981 US “voluntary restraint” auto agreement with Japan).
It also increases US direct investment access to the finance industry in China, and removes some impediments to deploying US intellectual property in China. It formalises dispute settling and consultation procedures.
All these understandings will tend to increase economic integration of the US and China. At his 15 January signing ceremony for the agreement, Trump promised that stage two of the negotiations would open up much more opportunities for US businesses to invest in China.
The stage one agreement itself reflects a change in the Trump administration’s declaratory posture towards the China US economic relationship. It includes a statement that:
The Parties believe that expanding trade is conducive to the improvement of their bilateral trade relationship, the optimal allocation of resources, economic restructuring, and sustainable economic development, given the high degree of complementarity in trade between them.
In respect of its two biggest national economies, together accounting for four tenths of global output, the trend towards global economic integration remains intact.
The arithmetic (all figures in US dollars)
In the Stage One agreement China agreed to buy from the US an additional $76.7 billion in goods and services this year, and $123.3 billion in 2021. The baseline year is 2017, the peak year for China’s imports from the US.
For goods (as opposed to services), the requirement is for an additional $64 billion in 2020, and $98 billion in 2021, for a total of $162 billion over the 2017 baseline.
In 2017 US goods exports to China totalled $130 billion, according to the US Census Bureau. China has therefore committed to a minimum level of goods imports from the US of $194 billion in 2020, and $228 billion in 2021, to reach the total increase of $162 billion in goods imports over the 2017 baseline over two years.
China’s goods imports from the US are likely to come in around $107 billion in 2019 (December 2019 data is not available until 5 February). If so, the increase required in 2020 over 2019 is $87 billion, or 81% over the 2019 level.
The increase required is equivalent to around 4.4% of China’s total goods imports in 2018. For comparison, the value of Australian goods exports to China in 2018 was around $82 billion. For 2019 Australian goods export to China are likely to be worth around $101 billion.
The goods increase required must be in farm products, energy and manufacturing and in the industry categories nominated in the agreement, though the categories are very wide. This appears to leave open the possibility that China could increase US imports in the nominated areas and decrease them in other areas. I assume that for obvious reasons that is not a practical possibility for China.
“CHINA’S GDP GROWS AT SLOWEST RATE IN 29 YEARS” bellowed the Financial Timesheadline last week. Never mind that this rate was still three times faster than OECD growth. The past decade has seen a relentlessly alarmist narrative about China’s slowing growth, yet China is still recording over 6%, despite US President Donald Trump’s best efforts to make life hard for them.
Let’s recall some of the forecasting failures.
Given that we have just completed the decade, it’s time to call out Beijing-based economic academic Michael Pettis, asking him to pay up on his 2012 wager with The Economist, having confidently predicted China’s growth would “barely break 3%” this past decade. You might say he was nearly half-right. The decade average was more than twice that, at 7.2%. Sure, the official figures might over-state, but the message is clear enough: his pessimism was unfounded.
In 2014, Larry Summers and World Bank economist Lant Pritchett read the tea-leaves from the global growth experience. They observed the economic equivalent of “trees don’t grow to the sky”, that eventually fast-growing economies such as pre-1990 Japan, Taiwan, Hong Kong, Singapore, and South Korea use up the opportunities for rapid technological catch-up, and growth slows to the modest pace seen in advanced economies. On this flimsy basis, they predicted “reversion to the global mean” for China, with 3.9% annual growth for the subsequent two decades.
There are enough examples of countries which have successfully made the transition to refute the idea that failure is inevitable.
Longer-term predictions like this can’t be quickly refuted, but China is still far from the technological frontier, and its capital stock per head is a small fraction of that in economies such as Singapore or Japan. On the basis of potential catch-up, current growth seems feasible for the next decade or two. Not inevitable, of course, but a prospect not to be dismissed on the basis of a melange of diverse global experience.
Given that China’s financial sector expanded spectacularly after 2009, initiated by its stimulatory response to the global financial crisis, predictions of financial collapse have been ten-a-penny. More definite than most, in 2015 prolific economist/author Tyler Cowen predicted imminent financial collapse, putting the economy in sustained recession. I tried to entice him into betting on this outcome, but he didn’t want to play. I never doubted his street-smarts.
More recently, Stephen Joske made a similar prediction of financial doom, although less imminent. “China’s road to a crisis became irreversible in 2015” … “They will not have two years to sort out their policies” … it is likely to occur “early next decade”. Again, this prediction made in October 2018 still has time to run. But more recent commentary sees the possibility that the financial sector can be made safer over time.
No-one disputes that the transition from poverty to riches is littered with traps and dead ends. The huge literature on the “middle-income trap” attests to this. It’s also true that just about every economy that deregulated its financial sector had some form of crisis not long afterwards. But there are enough examples of countries which have successfully made the transition to refute the idea that failure is inevitable.
You have to look at the specifics of each country. China has some factors that give it a better chance of avoiding a financial crisis. It has some of the characteristics which helped Singapore’s success: a strong interventionist government with technocratic expertise, prepared to combine the allocative power of free-markets with regulation in order to steer and discipline market excesses and inefficiencies.
Politics is crucial and this could go drastically awry. But if the focus here is just on economics, then sensible policy-making, boring though this sounds, is the key. There is no technical reason why economic cycles get old and die, as Australia has demonstrated over the past three decades.
There is similarly no in-built reason why the path from “developing” to “advanced” must be thwarted by a middle-income trap. Mechanical reversion-to-mean is not relevant in this diverse world. Indonesia’s three decades of 7% growth didn’t end in 1997 because it was unsustainable. It ended because of a series of disastrous policy mistakes.
Can China scale-up the sort of flexibility, consistency of policy focus and adjustment capacity demonstrated by Singapore? Will policy mistakes in the balance between market-forces and intrusive regulation prove to be China’s undoing? China expert Nicholas Lardy, previously an optimist, has become more pessimistic because policy choices have favoured state-owned enterprises, thus depriving China of the dynamism it enjoyed in the three decades before 2009.
There is too much focus on China’s deceleration from double-digit growth before 2009 to the present 6%. Rather than focus on the slowing, the more important issue is whether the current rate is enough to cope with the huge challenges ahead. Annual growth of 6% doubles GDP in 12 years, and today’s 6% growth represents much more in terms of actual output than the higher growth rates of earlier decades, when the GDP base was much smaller.
Sustained sensible policies would make this pace of expansion feasible, although certainly not inevitable. Gloom merchants take note.
It may go awry between now and the promised finalisation in January, but both the US and China now agree that phase one of the most difficult bilateral economic negotiation in recent decades is over.
Unusually for this negotiation, the two sides also seem to agree on what they have agreed – at least broadly.
China will buy more products from the US, especially farm goods but also manufactures. China agrees not to demand US businesses establishing in China transfer intellectual property to a Chinese partner. It agrees to increase intellectual property protections. Both these changes were announced by China earlier this year. It will also confirm its long-established declaratory policy that it will not manipulate its currency for trade advantage. It will open up more areas of financial services to foreign participation, again as already announced.
For its part, the US will halve the 15% penalty tariff on $300 billion of China imports imposed 1 September, and not impose another bigger round threatened for December. Existing tariffs will otherwise remain.
It offends a central aim of the trade policy of Australian foreign policy since 1944, which is to bind the great powers by rules.
This outcome has always been likely, and never been good. At the heart of this deal, China agrees to buy more stuff from the US. It will not import more in total so the additional imports from the US are at the expense of other exporting countries. Australia, for example, is not an important soybean producer, but it will lose China market share to the US in natural gas, beef, wine, and perhaps coal.
All along, Australia has vigorously protested this likely outcome, without effect. The US has obtained this advantage simply by applying high tariffs to China’s exports. It is kind of negotiation the rules and spirit of the World Trade Organisation and before it the General Agreement on Tariffs and Trade were designed to prevent. It offends a central aim of the trade policy of Australian foreign policy since 1944, which is to bind the great powers by rules. The liberal trade order the US helped create it is now helping to destroy.
Nor will this outcome advantage the US. This is because the trade deficit in the US case reflects the difference between domestic saving and domestic investment, not the trade policy of the administration. Increased US exports to China will be offset by diminished US exports elsewhere, or higher imports from elsewhere.
It is true that the overall US goods trade deficit for the first ten months of this year is very slightly less than for the first 10 months of last year. But this is not because exports are up and imports down, the goal of Trump administration trade policy. US goods exports for the first 10 months of this year fell by $15 billion compared to the same period in 2018. The trade deficit narrowed because imports also fell, and by $19 billion. Despite a year of trade policy turbulence, high tariffs, and loud denunciations, the US trade deficit is essentially unchanged.
This resilience of basic economic fact is one of the striking features of the 18 months of economic conflict. As has been pointed out, China’s exports to the US and US exports to China have both fallen over the last year, but with negligible impact on the GDP of either economy. Much of the decline in US imports from China has been in mobile phones and computers. Since neither of these products are subject to additional tariffs we are entitled to suspect the decline has nothing to do with the trade war. The largest part of the decline in China’s imports from the US has been in soybeans, much of which would have happened anyway because of the swine fever epidemic.
We could add that if the US aim had ever been to “decouple” from China or obstruct its economy, it has proved hard to do. No big US business has declared an intention to pull out of the China market. If the intent had ever been to disrupt global supply chains that run through China, one would expect that to be reflected in declining foreign investment. Yet on OECD numbers, foreign direct investment in China in the first six months of this year was higher than in the last six months of last year (and 2018 was well up on 2017).
For all that some decoupling is now set in motion, but more from the Chinese than the American side. China clearly cannot rely on American made or licensed high technology products as components in Chinese products, because the supply of these components is not assured. Longer term, China will devise ways of reducing its dependence on US dollar claims transacted though banks subject to US government control. The likelihood of China sharing data with US providers through cloud services, never high, is now zero.
When this phase one deal is done, according to numbers from the Petersen Institute for International Economics, average US tariffs on imports from China will remain at an elevated 19.3%, and average China tariffs on imports from the US 21.1%. Phase two will presumably be around removing these trade penalties, but it is not apparent there is much to discuss.
China will not agree to change or even to discuss the role of the Communist Party in the economy. It will not give way to American pressure on state economic planning. If the US presses on the role of state-owned enterprises, China will point out that most economies have state owned enterprises (including the US), and that by and large it observes such WTO disciplines on subsidies to SOEs as are generally applicable. As for subsidies more broadly, that could be a very long conversation indeed, one that would necessarily include Europe and Japan and the US.
Meanwhile Australia and its regional trading partners are proceeding with the Regional Comprehensive Economic Partnership. It may well conclude next year with a trade and investment agreement which includes China but not the US. Another instance of the resilience of basic economic fact.