[SERI COLUMN]Warning signs from China

For the past several years, East Asian countries have exhibited relatively stable growth despite sluggish domestic demand. Robust exports to China have powered much of the growth, which has benefited from aggressive investments by businesses from neighboring countries.
Korea, Taiwan, and Japan began to invest heavily in China in the 1990s. High domestic costs spurred Japanese companies to expand to China to strengthen their global production, while Korean and Taiwanese firms moved there to maintain their export competitiveness. All three countries were drawn by the promise of cheap Chinese labor. They all weighted their investments in labor-intensive industries, such as textiles and low-end electronics products.
By 2000, however, the investment focus had begun to shift. With China’s economy spiraling and domestic demand ballooning, many Western multinationals eagerly sought a niche in the Chinese market. Likewise, Korean firms shifted their focus to higher tech industries such as automobiles, semiconductors and cellular phones, while Taiwanese firms moved into semiconductors and laptops.
As a result, the trade patterns changed. Many East Asian subsidiaries in China imported parts and intermediate goods from their parent company (or another subsidiary of their parent company) for final assembly in China because the Chinese economy was not yet able to provide the parts and materials needed. Exports from East Asian countries to China increased as a result, with exports from the top five electronics intermediate products accounting for mo re than 50 percent of Taiwanese and Malaysian exports in 2006. Korea’s corresponding figure was 42.2 percent, while the figure for the Philippines was 83.7 percent.
In 2005, the share of parts and intermediate goods in the total exports from China jumped to 80 percent from less than 20 percent in 1987. In contrast, parts accounted for less than 20 percent of China’s total exports to the United States in 2005, down sharply from more than 50 percent in 1987. China’s export process now consists of importing parts from other East Asian countries and exporting finished goods to industrialized countries including the United States.
This indicates that a division of labor, or production sharing, has formed between China and neighboring East Asian countries. It deploys the comparative advantage of each East Asian nation based on their manufacturing technologies and component availability.
Recently, however, the assigned economic roles has shown signs of changing again. Asian companies investing in China now import fewer and fewer parts from their home countries and instead source goods directly within China. In 2005, Korean companies sourced 44.5 percent of their parts and materials from China, 39.9 percent from Korea and 15.6 percent from third countries, compared with 40.8 percent, 51.3 percent and 9.9 percent respectively in 2004. This indicates that Korean firms are buying fewer parts and materials from their home country, and more and more from China and other countries.
Similarly, Taiwanese companies imported 56.3 percent of parts from Taiwan in 1995, but only 40 percent in 2006. In 2006, Taiwanese manufacturers purchased 26.5 percent of their products from Taiwanese firms operating in China and 26.1 percent from non-Taiwanese firms in China compared to 18.3 percent and 18.8 percent in 1995.
Why is this happening? First, China’s technological capabilities are rapidly improving, prompting companies operating there to source parts directly in China. Second, Western multinational firms have induced investments from their parent companies, facilitating the transfer of advanced technology to China. Finally, any product sourced or sold in China can draw on the economies of scale that come from China’s ever-increasing market size.
The international division of labor has boosted East Asian exports to China and contributed to the integration of the region’s economy. However, as China strengthens its production capabilities, intra-regional trade faces an increased potential for a slowdown, in turn slowing exports of Chinese finished goods to areas outside East Asia.
East Asian countries, including Korea, that have depended upon exports to China for their economic growth will need to work even harder to develop goods with better value, higher quality and more selection, as China continues to upgrade its industrial prowess.

*The writer is a senior fellow on Asian economies at the Samsung Economic Research Institute. Inquiries on this article should be addressed to pbs21@seri.org.

by Park Bun-soon