The Myth Behind China's Miracle

George J. Gilboy

From Foreign Affairs, July/August 2004

Summary:  Washington need not worry about China's economic boom, much less respond with protectionism. Although China controls more of the world's exports than ever before, its high-return high-tech industries are dominated by foreign companies. And Chinese firms will not displace them any time soon: Beijing's one-party politics have bred a timid business culture that prevents domestic firms from developing key technologies and keeps them dependent on the West.

George J. Gilboy is a senior manager at a major multinational firm in Beijing, where he has been working since 1995, and a research affiliate at the Center for International Studies at the Massachusetts Institute of Technology.

China is not just an exporter; it imports more than any other state in northeastern Asia. Although it had a $124 billion trade surplus with the United States in 2003, it had significant trade deficits with many other countries: $15 billion with Japan, $23 billion with South Korea, $40 billion with Taiwan, and $16 billion with the members of the Association of Southeast Asian Nations (ASEAN). Most significantly, China is a large and growing market for domestically consumed imports (ordinary trade that excludes imported goods that are processed and reexported). Chinese imports for domestic consumption rose to $187 billion in 2003, from $40 billion in the mid-1990s. Discounting the processing and reexport trade, China ran a $5 billion trade deficit in 2003, compared to a $20 billion surplus just five years earlier. In industries it classifies as "high tech," including electronic goods, components, and manufacturing equipment, China has averaged a $12 billion annual deficit for the last decade.

Unlike other U.S. trading partners in Asia, such as Japan and South Korea, which spurned U.S. imports and investment for decades, China is also a large, open market for U.S. products. Although total U.S. exports have stagnated in recent years, U.S. exports to China have tripled in the last decade. They increased by 28 percent last year alone (whereas overall U.S. exports went up by only 5 percent). In particular, China has become a staple market for advanced U.S. technology products. According to U.S. government data, U.S. aerospace exports to China were valued at more than $2 billion in 2003 -- about 5 percent of total U.S. aerospace exports and nearly as much as comparable exports to Germany. U.S. firms exported $500 million of advanced manufacturing equipment to China in 2003, more than they exported to France. And U.S. chip makers exported $2.4 billion of semiconductors to China in 2003, the same amount they exported to Japan.

Furthermore, China allows foreign firms to invest in its domestic market on a scale unprecedented in Asia. Since it launched reforms in 1978, China has taken in $500 billion in FDI, ten times the total stock of FDI Japan accumulated between 1945 and 2000. According to China's Ministry of Commerce, U.S. firms have invested more than $40 billion in more than 40,000 projects in China. Given its openness to FDI, China cannot maintain its domestic market as a protected bastion for domestic firms, something both Japan and South Korea did during their periods of rapid growth. Instead, it has allowed U.S. and other foreign firms to develop new markets for their goods and services, especially high-value-added products such as aircraft, software, industrial design, advanced machinery, and components such as semiconductors and integrated circuits.

Thanks to this appetite for imports, powerful domestic coalitions, particularly China's growing ranks of urban consumers and its most competitive firms, will continue to favor trade openness. Chinese consumers pride themselves on driving foreign-brand cars and using mobile phones and computers with circuits that were designed and manufactured abroad. Many Chinese firms resist protectionism, because they need to import critical components for their domestic operations and fear retaliation against their exports. For example, in the 1990s, China's machine tool and aircraft industries failed to secure effective state protection in the face of opposition from domestic firms that preferred imports, and they suffered significant decline as a result.

As an open economy and a large importing country, China could be an ally of the United States in many areas of global trade and finance. Already, Beijing has displayed a willingness to play by WTO rules. It has charged Japan and South Korea with unfair trade practices -- markets the United States has also long sought to crack open. China initiated 10 antidumping investigations in 2002 on products with import value of more than $7 billion, and another 20 investigations in 2003. China is now a leading promoter of regional trade and investment regimes, including a free trade zone with ASEAN and a bilateral free trade agreement with Australia, one of the United States' closest allies in the Pacific region. Already, Beijing's proposals on regional economic cooperation seem far more relevant to most Asian nations than do Washington's.

The final benefit the United States enjoys from China's global economic integration is in the long-term, patient battle to promote liberalism in Asia. Foreign trade and development have spurred advancements in Chinese commercial law, greater regulatory consultation with Chinese consumers, slimmed-down bureaucracies, and adherence to international safety and environmental standards. Although it is still limited, the people's freedom to debate economic and social issues has increased, especially in the robust financial media. This process of liberalization is incomplete and uneven, but it is in the interest of both China and the United States to see it continue.

OUTSIDE IN

Despite these benefits, business and political leaders in the United States now fear that China's growing share of world exports, especially of high technology and industrial goods, signals the rise of yet another mercantilist economic superpower in northeastern Asia. But these concerns are unwarranted, for three reasons. First, China's high-tech and industrial exports are dominated by foreign, not Chinese, firms. Second, Chinese industrial firms are deeply dependent on designs, critical components, and manufacturing equipment they import from the United States and other advanced industrialized democracies. Third, Chinese firms are taking few effective steps to absorb the technology they import and diffuse it throughout the local economy, making it unlikely that they will rapidly emerge as global industrial competitors.

A close look at the breakdown of China's exports by type of producing firm puts China's economic rise in perspective. Foreign-funded enterprises (FFEs) accounted for 55 percent of China's exports last year. In this respect, China diverges from the typical Asian success story. According to Huang Yasheng of the Massachusetts Institute of Technology, FFEs accounted for only 20 percent of Taiwan's manufactured exports in the mid-1970s and only 25 percent of South Korea's manufactured exports between 1974 and 1978. In Thailand, the FFEs' share dropped from 18 percent in the 1970s to 6 percent by the mid-1980s.