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The benefits and perils of riding China’s coat-tails - FT.com

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July 31, 2013 4:18 pm

The benefits and perils of riding China’s coat-tails

Many Latin American nations have bet the mine on an economy that is now slowing
Few parts of the world have benefited as much from China’s rise as Latin America. In 1990, China was a lowly 17th on the list of destinations for Latin American exports. By 2011, it had become the number one export market for Brazil, Chile and Peru and number two for Argentina, Cuba, Uruguay, Colombia and Venezuela. Over that time, annual trade rose from an unremarkable $8bn to an irreplaceable $230bn. Chinese leaders predict it will reach $400bn by 2017.
As China builds its colossal cities, constructs its networks of highways and railways, and feeds its evermore carnivorous people, Latin America has much of what it takes to keep the show on the road. Chilean copper, Peruvian zinc and Brazilian iron ore are being shipped in vast quantities. The region is the Middle East of food, accounting for 40 per cent of global farming exports. It supplies water-poor China with dizzying amounts of beef, poultry, soya, corn, coffee and animal feed. If Chatinamerica rolled off the tongue as easily as Chindia or Chindonesia, someone would have coined the term long ago.

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DAVID PILLING

The speed with which economic relations have flourished raises two important questions equally applicable to other parts of the world. First, what happens when Chinese growth and investment slows, a process that has already begun? Second, how can Latin America forge an economic relationship that is more than just a rerun of its commodity dependency of eras past?
To work out what might happen as China slows, we should first look at how different countries fared as it took off in the 1990s. As Alfredo Toro Hardy, a Venezuelan academic and diplomat, makes clear in his book, The World Turned Upside Down, there were losers as well as winners.
Broadly, the losers were Mexico and the “Mexico-type economies” of Central America with low-costmaquiladora plants for assembly and manufacturing. For Mexico, a net importer of raw materials, including corn and soya, the rise in commodity prices accompanying China’s ascent had a largely negative impact. More important, as China’s manufacturing prowess grew, Mexico’s factories lost competitiveness. From 2001 to 2006 its share of US personal computer imports halved to 7 per cent. Over the same period China’s share more than tripled to 45 per cent.
The winners were Brazil and the “Brazilian-type economies” of South America. Not only did China vastly increase its imports of commodities from the likes of Peru and Chile but the commodity supercycle also pushed prices of raw materials to record highs. Kevin Gallagher and Roberto Porzecanski estimate in their book The Dragon in the Room that three-quarters of recent Latin American growth can be attributed to commodity exports. Growth rates in countries with the tightest trade links to China reached a rough average of 5 per cent.
Yet even during the bonanza years, now ending, there were concerns. Cheap Chinese imports undermined Latin American manufacturers even in countries such as Brazil with a sophisticated industrial base. The currencies of commodity exporters appreciated – a classic case of “Dutch disease” – making their manufactured goods still less competitive. Some, such as Mr Toro Hardy, worried that over-reliance on commodities might imply “going back in time” to a primary export economy. For a high-technology producer such as Brazil, he said, this smacked of neo-colonialism.
Such concerns, though they have particular resonance in Latin America, apply to other countries that have ridden China’s commodity train, from Australia to Mongolia. Many countries have bet the farm – or rather the mine – on everlasting demand from a China whose economy is now slowing.
As China decelerates from double-digit growth to a projected 7.5 per cent this year, the economies of some commodity exporters have stumbled. Brazil is a case in point. Partly as a result of slowing exports to China and falling commodity prices – copper, iron ore and coal are 30-50 per cent off their 2011 peaks – it registered average growth of just 1.8 per cent in 2011 and 2012, down from a roaring 7.5 per cent in 2010.
That process could have further to go. China’s economy may slow more sharply than expected or it may rebalance more quickly from investment-led to consumption-driven growth. The Economist, perhaps prematurely, has already declared a structural “Great Deceleration” in emerging markets. In a report entitled If China sneezes, Nomura estimates the impact on several economies if 2014 growth in China’s $8tn-plus economy slips 1 percentage point below Nomura’s baseline forecast of 6.9 per cent. It finds that a 1 point fall would shave a further half-point off Latin American growth. Some countries such as Australia, down 0.7 per cent, and trade-dependent Singapore, down 1.3 per cent, would fare worse.
It is not all bad. Mexico may actually have benefited from the changing nature of China’s economy, where higher wages have breathed new life into the maquiladorasystem. Nor has it suffered from the fall in commodity prices.
Even in countries such as Brazil, the effects of a Chinese slowdown need not be all negative. China will continue to urbanise, putting a floor under metals prices. To the extent that its demand for hard commodities does slow, its appetite for meat and grains should rise. The key for Latin America – and for other suppliers of China’s needs – is to construct a trade relationship that maximises value added, even if that is only branding or processing raw materials. Canada, Australia and, closer to home, Chile show that being a first-rate commodity exporter does not necessarily mean having a second-rate economy.
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  1. ReportAussie Red | August 1 10:06am | Permalink
    I agree (I'm Australian), that China slowing contains big dangers for the Australian economy. But there are a host of big western industrial concerns who have bet their futures on China - the German and US car makers, big drug companies, advertising companies, tech groups, the media. Slowing China undermines their growth plans (many escaped their own sluggish or weak economies for the one more thong theory of making money in China). And what about economies that have failed to make any impression in China or Asia (hint, the UK)? What's their future if slowing China starts cutting global demand, and then output? Recovering Europe needs a strong China to help pull it higher, - the US may be OK with its new oil and gas reserves. But if slowing China starts selling off its US T bonds, the impact could be greater than the slowing from QE... just imagine if, as the fed finishes QE 3 in mid to late 2014, news leaks of Safe selling T bonds to raise cash to handle a new round of stimulus in China, or to meet a run on the shadow banks...
  2. ReportSam Rye | August 1 7:08am | Permalink
    Good article - succinct and to the point. Fall from grace of Brazil in particular has been rapid.
  3. ReportDavidPilling | August 1 5:30am | Permalink
    @EMMEXICO Mexico has grown over past five years 1.2%, -6%, 5.3%, 3.9%, 3.9%. That might not be bad considering the weakness of the US economy during those years, but I'd suggest that's not terrific for a country with a 1 per cent annual population growth.

    If you're convinced the rise of Chinese manufacturing has had no impact on Mexico that's fine. But with Chinese wages about one-third of Mexican ones in 2003 - according to McKinsey a Mexican assembly line worker earned $1.47 an hour vs $0.59 for a Chinese worker - I find it hard to believe China had no impact. The fact that Chinese exports to the US - Mexico's most important trading partner - grew 16-fold from 1990 to 2005 suggests something rather important was happening.

    Of course, Chinese wages are now growing rapidly, so Mexican manufacturing may gain some momentum.
  4. ReportDavidPilling | August 1 5:09am | Permalink
    @TheGrammarian Excellent point on evermore/ever more. Not quibbling, but what does "arniverous" mean?
  5. ReportLloyd Chin | August 1 2:46am | Permalink
    Quote: "It finds that a 1 point fall would shave a further half-point off Latin American growth. Some countries such as Australia, down 0.7 per cent"

    In Australia, 2% out of 3% of GDP growth (per year) over the last two years came from mining related activities, mainly CAPEX spending.

    Even if China does not slow and just maintained its current growth level, CAPEX in Australia will decline by about 10% in 2013. In 2014, CAPEX in Australia is forecasted to decline by 20% according to S&P.

    If China actually rebalanced its economy (instead of continuing to pump money into fixed asset investments) and its GDP growth declined by 1%, CAPEX would probably decline much faster than 20%.

    From this point of view, the forecast of a 0.7% decline in GDP growth in Australia actually looks optimistic. This is especially the case since Australian household debt levels continues to be elevated. High employment, high wages and high wage growth are required to support ongoing debt servicing requirements and current property prices.
  6. ReportTheGrammarian | August 1 2:23am | Permalink
    Note to editor re arnivorous Chinese: evermore means forever; ever more means increasingly
  7. ReportEquivocation | August 1 12:56am | Permalink
    @Bis

    Isn't it obvious? For anyone directly investing in the region, this article is about as profound as a Fox News op-ed.

    Mexico did not "lose" to China; Mexico went up the value chain. With the exception of 2008, Mexico has been growing quite well in a sustainable manner with some of the best macroeconomic indicators in the world. It has the lowest debt in the OECD, a balanced budget, burgeoning high value manufacturing and a booming service sector).

    Meanwhile, the rest of Latin America has indeed benefited from Chinese growth (but don't forget that also from the growth resulting from the overall reduction in world poverty - it is not only China). However, there are also deep rooted structural issues. Latin America is at its most politically stable environment in history. There is a rapidly expanding middle class. There is an improvement in the regulatory environment. Whilst, not at the level of Mexico, most Latin American nations are also a model of fiscal and monetary orthodoxy.

    A Chinese slow-down will shave off some percentage points from Latin American growth, but it will not derail the long-term secular growth story. Latin America is much more resilliant than what Pilling gives it credit. (To be fair I do expect a short term impact in Brazil)
  8. Reportbis | August 1 12:29am | Permalink
    @emmexico
    please explain why.
  9. ReportJerkan | July 31 9:17pm | Permalink
    Good article and a real talking point. David mentions likely outcomes of a China slowdown (or "Chinadown" as he previously has referred). Now if China has a hard landing or even (should the financial system freeze up again), a China meltdown?

    http://chinameltdown.blogspot.com/
  10. Reporttrblmkr | July 31 7:56pm | Permalink
    In the aftermath of NAFTA, before the ink was even dried, US multinationals, lead by Jack Welch, deemed even Mexican labor as too expensive. So, they used their lobbying might and bought China's entry into the Uruguay Round, most-favored nation status, and WTO membership.
    The resulting dislocation in Mexico was a big factor in the surge in the exodus of undocumented immigrants.
    Instead of supporting a nascent democracy south of our border, our corporations steered us into strengthening an authoritarian regime. China won the Cold war!
  11. ReportEMMEXICO | July 31 4:37pm | Permalink
    Mr. Pilling Gives a false, trivial and utterly superficial analysis of the problem. His ignorance about Mexico is amazing.