[Smart Q&A: Jeong Hwan-woo] The Eurozone Crisis and China's Economic Outlook

YouTube Link: video.eai.or.kr/120817_smart.flv

Dr. Jeong Hwan-woo holds a Ph.D. in Political Science (specializing in Chinese Politics) from Hankuk University of Foreign Studies and is currently a research fellow at the Korea Trade-Investment Promotion Agency (KOTRA), Korea Institute for International Economic Policy.

China's Response to the Eurozone Crisis

“Limited Efforts to Stabilize the EU: Aimed at Foreign Exchange Reserves, Profit Rates, and Risk Management”

“Focused Efforts to Minimize the Impact of the EU Crisis: ① Ending the Yuan Appreciation Trend ② Easing Trade Dependence on Developed Markets ③ Accelerating the Shift to a Domestic Demand-Driven Economy”

While it is true that China has made some efforts, such as purchasing Greek and Portuguese government bonds and taking various measures to increase investment to help resolve the European Union's (EU) economic crisis, its role has limitations. This is because China faces significant pressure to manage its foreign exchange reserves, profit rates, and risks stably, and its pursuit of state-led strategic investments makes it difficult to expand investments into crisis-stricken regions without economic considerations.

China is making greater efforts to block the impact of the EU economic crisis on its own economy rather than directly resolving the crisis itself.

First is the exchange rate policy. From 2010 to March 2012, China consistently appreciated the Yuan, pursuing a policy of expanding imports despite the burden on exports. However, following the EU crisis, China ended this Yuan appreciation trend to boost exports of Chinese products and began managing the exchange rate to maintain a stable level.

Second, China has consistently strived to diversify its exports to ease trade dependence on developed markets such as the United States and the EU. As a result, the EU market, which accounted for 20 percent of China's total exports in 2008, has decreased to 17 percent in the January-May period of this year. A change of about 3 percent in trade dependence on a single region within 3-4 years can be considered a significant shift, indicating that the Chinese government has made considerable efforts to explore emerging markets in Southeast Asia, South America, the Middle East, and Africa.

Third, China has recently accelerated its long-standing shift towards a domestic demand-driven economy. Compared to other East Asian countries, China's export dependence is not particularly high; however, to prevent economic contraction due to declining exports, it is pursuing various domestic industrial and technological policies to stimulate domestic consumption.

Future Outlook for the Chinese Economy

“Excluding the processing trade sector, which generates small profits through labor, China's export dependence is less than 20%.”

“China Still Has Room for Further Economic Stimulus, Including Domestic Demand and Investment Expansion.”

“China's Growth Rate Reduction Represents an Intentional Adjustment Under the 12th Five-Year Plan, Not a Hard Landing.”

The impact of the EU crisis on the Chinese economy is most evident in the export sector. From January to May of this year, China's export growth rate was 8.7 percent, which is quite favorable compared to other countries, but it is a considerably poor performance by Chinese standards. Analyses suggest that sluggish exports to the EU are contributing to the slowdown in China's Gross Domestic Product (GDP) growth rate.

However, to discuss the extent of the negative impact of sluggish exports on the Chinese economy, it is necessary to first examine the characteristics of China's export structure, namely the processing trade system. The processing trade system is a measure that exempts tariffs and value-added taxes when intermediate goods are imported from other countries, processed in China, and then exported to a third country, offering preferential treatment for domestic production. This system, adopted distinctively by China after its reform and opening-up due to its lack of capital and abundant labor, allows China to generate only small profits through labor in processing trade exports. Therefore, to analyze the actual impact of changes in the export sector on the Chinese economy, it is advisable to exclude the processing trade component. In this context, while exports accounted for 35 percent of China's GDP in 2010, after excluding processing trade, the export dependence is only about 18-20 percent. Consequently, the actual impact of export reductions due to the EU economic crisis on the Chinese economy is not very significant.

While the impact may be relatively less severe, the EU crisis is undoubtedly a burden on the Chinese economy. In fact, China's GDP growth rate has declined from 7.8 percent in the first quarter to 7.6 percent in the second quarter of this year. Some voices are calling for preparations for a hard landing in China; to make an accurate judgment, it is necessary to examine whether China has the capacity to compensate for the blow to its export sector through other areas. During the 2008 global economic crisis, China overcame the crisis through massive investment rather than exports, laying the groundwork for global economic recovery. Specifically, within about a year and a half from 2009, it launched 13 regional development plans, mobilizing local governments to stimulate investment. Although this led to the serious issue of local government debt, it ultimately succeeded in stimulating the economy. Similarly, in response to the EU crisis, China will seek breakthroughs through investment and domestic demand stimulation. While it is likely to prioritize domestic demand stimulus measures over large-scale investment policies due to local government debt issues, it is still assessed to have room for further investment expansion, so investment stimulus remains a viable option. Therefore, even if China faces difficulties due to export reductions caused by the EU crisis, the proportion of exports in the Chinese economy is not as high as perceived, and with the availability of domestic demand and investment stimulus measures, the likelihood of a hard landing for the Chinese economy is low.

Furthermore, China announced its intention to maintain an average annual economic growth rate of around 7.5 percent by 2015 under the 12th Five-Year Plan. This signifies a period of adjustment to minimize the negative effects of bubble formation and unbalanced development resulting from prolonged high growth, and to ensure sustainable, quality growth based on domestic demand in the future. China's current economic growth rate falls within the target range set by the Chinese government; therefore, predicting a hard landing based on this is an overstatement.

Challenges for Korea

“The EU crisis poses a greater threat to Korea, Japan, and Taiwan, which utilize China as a processing and manufacturing base, than to China itself.”

“Must move beyond growth driven by intra-regional production and extra-regional exports, and pursue regional economic integration to increase intra-regional consumption.”

From January to May of this year, China's export growth rate was 8.7 percent, while Korea's was 0.4 percent, Taiwan's was -5 percent, and Japan's was -6 percent. The primary reason for this difference is the aforementioned processing trade system. For example, in Korea's case, processing trade accounts for 45 percent of its exports to China. Taiwan and Japan face a similar situation; therefore, when export markets face problems, such as during the EU crisis, countries that utilize China as a processing and manufacturing base to export actual products are likely to suffer greater damage than China itself. This is reflected in the differences in the figures mentioned above.

Therefore, Korea must no longer rely solely on China as a processing and manufacturing base but should instead leverage China's domestic market as a driver of its own growth. Furthermore, East Asian economic integration is necessary. Moving away from the current international division of labor structure, where East Asian regions including China serve as the world's factory and developed and emerging markets act as consumption centers, we must establish an international economic order where production and consumption occur within the East Asian region. By continuously pursuing efforts to increase the intra-regional trade share among the three Northeast Asian countries, including the conclusion of Free Trade Agreements (FTAs), we can build a system that is resilient to external shocks in the long term.■

The East Asia Institute (EAI) has been selected as a core research institution for the MacArthur Foundation's 'Asia Security Initiative' program and is receiving financial support. EAI conducts Smart Q&A interviews with domestic and international experts to provide timely and in-depth analysis of current issues. This manuscript was compiled by Researcher Kim Yang-gyu (EAI Center for Asian Security Studies) and Team Leader Kim Ha-jeong (EAI Center for Asian Security Studies) from interview content. The opinions expressed are those of the individual experts and do not represent the official position of the East Asia Institute. Please cite the source when quoting from Smart Q&A.