VOLUME 12, ISSUE I - JANUARY 2010

How important is China to Washington’s economy?

• Washington State engages in more international trade on a per capita basis than any other with $66.9 billion in exports (2008). This translates into $8,300 per person compared to the national average of $3,300 per person.
• In Washington one job in four is directly dependent on exports (total of 650,000 jobs); one job in three is directly dependent on total international trade including imports. 100,000 of these export dependent jobs are in the aerospace sector, spread among 600 companies.
• Washington’s top export markets (including pass-through exports) in 2007 were:
  • China ($9.93 billion)
  • Canada ($9.18 billion)
  • Japan ($8.97 billion)
  • United Arab Emirates ($3.49 billion)
  • South Korea ($3.38 billion)

As the data above indicate, China’s importance to Washington’s trade-dependent economy cannot be overstated. Washington-origin export products and commodities sold to China in 2007 amounted to nearly one-eighth of our global exports. And while aircraft and aerospace parts dominate our exports to China as they do to nearly every country, other product categories have shown strong growth over the past seven years. In 2007, for example, 45 different product categories enjoyed sales to China of a million dollars or more.

China is also our state’s fastest growing export market. In 2002, the first full year of China’s membership in the WTO, less than ten percent of the state’s total exports went to China, which was then our third largest export market behind Japan and Canada. By 2007 China had become our largest export market.

While our heavy reliance on international trade is generally beneficial to Washington, when global trade declines as it has for much of the past year the impact is magnified here. Washington’s total exports grew 23.5 percent in 2007 over 2006, but declined 5.5 percent in 2008 over 2009 and plunged 27 percent more in 2009 (through October) over 2008. The contrast was even sharper with our exports to China: after nearly 32 percent growth in 2007 over 2006, declines of 24 percent in 2008 and 11 percent in 2009 (through October) followed.

Back in November 2008, Beijing announced it had put together a RMB 4 trillion (US$586 billion) package to reverse the country’s rapidly declining growth rate and rising unemployment. China’s slide had begun around the middle of 2008 initially with a sharp drop in real estate activity and the construction industry that supported it, along with a decline in fixed asset investment and infrastructure spending. This was closely tied to the government’s decision earlier in 2008 to tighten credit and reduce government spending to combat inflation which had topped eight percent by March 2008.

As the global financial crisis deepened in the fall of 2008, China’s already flagging economy was rocked further by a rapid decline in exports as consumers in its major export markets (in particular, the U.S.) reduced spending. In November 2008, China’s exports collapsed to minus 2.2 percent from November 2007, the first negative export growth in more than seven years. By year end, more than 100,000 factories in China, primarily in the export manufacturing sector, had closed their doors and millions of workers had been laid off. Exports fell further to minus 2.8 percent in December, and then plummeted to minus 17.5 percent year-on-year in January 2009. Economists were predicting a further decline of the economic growth rate through at least the first half of 2009 and even in a best case scenario were seeing growth for the year at no more than 6.5-7.5 percent.

The RMB 4 trillion stimulus package (2 trillion per year in 2009 and 2010) includes both new investment and projects that had already been planned. Some of this investment was made directly by the central government, but most of it is being funded by state owned enterprises and local governments through their own revenue, bonds and bank lending. Financing the stimulus package has not significantly raised the government’s low debt to GDP ratio, nor required it to call in its overseas investments (in, for example, U.S. Treasuries).

Actual spending could reach well above RMB 4 trillion since this figure refers only to expected investments. Investments are being channeled into areas including low income housing, rural infrastructure, utilities, transportation (primarily rail for easier movement of passengers and coal), the environment, technology innovation, health and education (particularly rural), and to speed-up reconstruction from earthquakes and other disasters. In addition to investments in the areas above, the government is also raising rural incomes through higher grain prices and direct subsidies to farmers while lowering corporate taxes by allowing producer goods to be deducted from corporate value added taxes. To get investment funds moving quickly the government has lowered bank loan interest rates several times and scrapped limits on bank lending that had been put in place in mid-2008.

Although exports plummeted to minus 17.5 percent year-on-year in January 2009, the RMB 4 trillion stimulus package, by then in its third month, had started to kick in. According to UBS, total new bank lending in the 1st quarter of 2009 reached RMB 4.6 trillion (in the vicinity of $700 billion), about 20 percent more than for all of 2007. It appears that much of this lending actually did find its way to stimulus related activities such as infrastructure projects and fixed asset investment, including in the manufacturing sector. This in turn led to a rapid growth in new orders in the second and third quarters of 2009.

In quarter three of 2009, China’s GDP grew by 8.9 percent and UBS was predicting 8.4 percent growth for 2009 and 9.0 percent for 2010, numbers approaching the pre-2008 growth rates. Growth drivers this year will continue to be those in play through 2009 – fixed asset investment in infrastructure and government related sectors, property investment and construction. Stimulus related investment is likely to decline during the coming year, but UBS expects that this will be more than offset by a rebound in trade and also some growth in household consumption.

Washington exports to China showed some improvement through the first 10 months of 2009 vs. 2008, declining only 11.03 percent in 2009 after dropping 24 percent in 2008 (over 2007). Sales of aircraft and parts were the principal drag both years, declining about 16 percent through the first 10 months of 2009 and almost 34 percent through the first 10 months of 2008 (a consequence, no doubt of the strike at Boeing during the fall of 2008). However, non-aerospace exports to China actually grew 2.3 percent through the first 10 months of 2009, and China was our only export market among our top ten to post a growth.

With China's economy predicted to grow by about 9 percent this year driven in part by a rebound in the country’s trade sector, we can expect that Washington’s trade with China will grow, too, for both exports and imports (the latter assuming our recession has bottomed out, the unemployment rate starts falling and consumer confidence rises). Deliveries of the Boeing 787 to Chinese airlines probably won’t begin until 2011, but will buoy our exports to China even more when they commence.

Whether or not we witness growth in our trade with China this year will depend to some extent on how well the U.S. and Chinese governments manage overall relations, and trade relations in particular. The challenges are many and emanate from both sides.

Over the past several years it has appeared increasingly clear that China’s current leadership has pulled back from the relatively open trade and investment regime that marked the period following China’s accession to the WTO in late 2001. Instead, Beijing appears to be embracing industrial policy, deciding industrial winners and losers and favoring state owned enterprises over both private companies and foreign invested enterprises. The latest example of this was the publication by the Ministries of Finance and of Science and Technology on November 15, 2009 of the “Measures for the Administration of the Accreditation of National Indigenous Innovation Products.” Under this program the Ministry of Science and Technology will publish a catalog of accredited products that will be given priority in government procurement including infrastructure construction. To qualify for accreditation, a product must fall within one or more of six high tech categories, must have its intellectual property (trademarks, etc.) registered first in China and must not be restricted by related foreign brands.

There are several concerns with this new measure. Whether intended or not the measure would almost by definition expand the protection of and favoritism toward Chinese state owned enterprises. At minimum it appear the measure will lead to the exclusion of non-Chinese companies from the government’s stimulus and procurement plans, seemingly in direct contravention to the commitment made by China at the Strategic and Economic Dialog meeting in July 2009 to open its procurement policies to foreign enterprises. Second, it will strengthen even more a growing government practice of purchasing domestic technology over foreign technology, or even technology developed jointly by Chinese and foreign entities. Third, the measure is likely to lead to even more piracy of foreign owned intellectual property.

In a rare display of public displeasure with the Chinese government, the American Chambers of Commerce in China along with more than 30 other international business organizations issued a letter of protest over the measure on December 10, the date that the measure was to take effect.

Beyond a growing penchant for industrial policy and protectionism, other Chinese practices that stir deep concern within the U.S. (and the U.S. Congress, in particular) are those related to the Chinese currency’s exchange rate and protection (or lack thereof) for intellectual property. On currency, in July 2005 the Chinese government ended the Renminbi’s (RMB) peg to the U.S. Dollar and tied it to a basket of currencies instead. Coupled with an expansion of the band within which the Chinese government allowed the RMB to be traded, the end of the Dollar peg led to an appreciation of the RMB against the Dollar of about 20 percent by the summer of 2008. Since that time, however, China’s government has quietly reinstated the Dollar peg at 6.83 RMB to the Dollar. Beijing has signaled that it will keep the peg in place until China’s exports improve, probably sometime later this year.

Thus, while the Dollar weakened against most major currencies in 2009, it did not move at all against the RMB. China’s continued undervaluation of the RMB against the Dollar weakens U.S. exports to China. Other trade surplus countries are following China’s lead making it nearly impossible for the Dollar to depreciate against their currencies. This in turn forces prices upward of U.S. exports to these countries (including China) while making imports from these countries cheaper than would be the case if the RMB and other Asian currencies were allowed to float.

The RMB's peg to the US. Dollar and the undervaluation of China’s currency it supports have long been a bone of contention with Congress, organized labor and those U.S. manufacturers who depend more on the U.S. market and less on international trade. Since mid-decade at least, legislation has been proposed in both houses that would raise import tariffs and/or impose countervailing duties and anti-dumping penalties on imports from China if Beijing continues to block appreciation of the RMB (some members of Congress believe that the RMB is undervalued by as much as 40 percent).

This is an issue that cries out for strong leadership in both countries to help manage outcomes successfully. The problem is complicated and a rising RMB is not likely to solve it. More than 60 percent of what China exports is manufactured or assembled by foreign invested enterprises, many of them U.S. Actual value added in China to Chinese exports is in the range of 25-30 percent, the rest coming from components imported from other countries. Thus, any increase in import prices on Chinese products here resulting from an appreciating RMB would be somewhat offset by the reduced price of components shipped to China from the U.S. There is also some price elasticity available to Chinese exporters. Therefore, an appreciating RMB would not necessarily translate into higher shelf prices for Chinese products in the U.S.

While there is room to doubt the efficacy of raising tariffs and/or initiating countervailing duties, there should be no doubt with regard to the impact on our economic relations with China, nor on the outcome for global trade. Although China can be expected to act with restraint (in its own self interest) to the occasional trade action brought against it by the U.S. government (as it did in the cases of steel pipe and low cost auto tires in 2009), there would be no reason for such restraint if Beijing felt that access to its most important export market were to be systematically curtailed. Retaliatory measures would quickly be put in place potentially bringing bilateral trade to a grinding halt and setting up a cascade of protectionist measures around the globe not seen since the Smoot-Hawley era of the 1930s. And nowhere in the U.S. would the pain of this be felt more acutely than in Washington State.

We have tried to illustrate the importance to Washington State of its economic relations with China. There is no question that China presents enormous opportunities for this state’s farms, businesses and workforce. Washington companies large and small are engaging China in business and collectively they represent virtually every sector of the state’s economy.

But, where there is opportunity there often is challenge as well. In that regard we have also tried to convey the sense of just how much the economies of the U.S. and China have become interdependent, and how much both countries are interlinked in the global economy. Whether the issue be currency manipulation, industrial policy, intellectual property rights, or trade protectionism ultimately the issue in both countries is about saving and creating jobs. Both sides must be sensitive to this and work together to create optimal win-win outcomes. The alternative could be catastrophic.