China Economy ENG United States

The long view: What is the real economic dependence of the United States on China?

In order to better measure the impact of value chains fragmentation, we conducted an “input-output” analysis to highlight the dependence of the US economy on Chinese output, branch by branch.

China’s spectacular development over the 1980-2020 period

China’s economic weight is indisputable. The former “colossus with feet of clay” described by the economic literature of the 1960s has become, in the space of half a century, the world’s second largest economy in nominal terms, and the world’s largest economy in purchasing power parity (PPP). China has only just regained the position it formerly enjoyed until the 18th century, according to the long-term calculations made by economist Angus Maddison. In 2019, China’s GDP represented one-fifth of world GDP in PPP terms and Chinese exports accounted for 13% of world exports, a share roughly equal to that of its imports. The 2000s saw an acceleration of Chinese growth, following China’s accession to the WTO in 2001, with the blessing of the United States, which viewed it mainly as a means of accelerating the democratisation of the last remaining great communist power after the fall of the USSR.

This development did not come to fruition. On the contrary, integration into the world economy has consolidated the power of the Chinese Communist Party and has offered this country-continent of more than 1.3 billion inhabitants considerable opportunities by enabling it to strengthen its role as a ” world factory ” while quietly evolving towards becoming a ” world laboratory “. China then began to manufacture and export just about everything from apples to laptops. The takeover of IBM’s PC division by China’s Lenovo was a milestone in this phase of rapid growth and transformation. The emergence of large-scale Chinese IT and telecommunications companies, capable of withstanding the competition from the West and of conquering the planet, crowned this transformation process, which is unprecedented by world standards.

From 2010 onwards, however, a slowdown in industrial production has been observed in China, in line with the slowdown in global demand. Since then, China has been striving to change its business model by restructuring its economy and making it more oriented towards domestic consumption. However, China continues to play a pivotal role in world trade.

China’s development followed a model that had been outlined by the British economist Arthur Lewis, winner of the Nobel Prize in Economics in 1979, and subsequently developed by economists Arthur Fei and Gustav Ranis. The abundant underemployed rural labour force in the interior provinces was used by factories in the coastal areas, which were directly connected to regional and global trade and had long been embedded in global trade networks. It should be recalled that when Deng Xiaoping initiated the Open Door policy, he turned to the former colonial concessions, returning them to their former vocation as free trade zones before the founding of the People’s Republic of China. Since then, if the political semantics and context had changed, from an economic perspective, it was a return to the pre-communist era. This tends to be forgotten today, but in the 1920s and 1930s Japanese companies had already begun to relocate part of their production to China, creating the first transnational production networks in Asia. The Bund built in Shanghai is a testimony to the economic dynamism of that period, even if for the Chinese it was also a period of humiliation, wars and occupation that had to be ended as soon as possible.

Deciphering globalization

Beyond these general considerations, there is a need to study in greater depth China’s place in what is commonly referred to as globalization, i.e that tangled web of fragmented production and trade networks which, according to Grossman and Rossi-Hansberg, has at least partially replaced trade in goods with “trade in tasks”.

In recent years, a small group of economists scattered around the world have set themselves the task of replacing indicators of cross-border trade in goods with indicators that quantify the value added embedded in each country’s exports. Because of the multiplicity of flows between different countries and their circular nature along the production chain of a product, it was indeed very difficult to quantify the local shares of value added embedded in each product and to avoid double counting.

Nevertheless, breakthroughs have been made thanks to the transposal in an international framework of the methodology known as “Input-Output”, which we owe to the Russian-American economist Vassili Léontief, . The latter had very elegantly highlighted an algebraic relationship that linked the intermediate consumption of all economic branches with the final consumption corresponding to the added value produced in each branch. His work was awarded the Nobel Prize in 1973.

Building on this approach and adapting it to a multi-country and multi-sector framework, Johnson and Noguera found, for example, that statistics on Chinese merchandise exports to the United States gave a very distorted picture of the actual local content of goods exported by China to the United States, because of the intensity of the Sino-US cross-production networks, which resulted in the import of US intermediate goods used to produce the goods subsequently re-exported to the United States, as well as of course through multiple triangular production chains – with third countries – in which the two countries were inserted.

The result, as Johnson and Noguera show, is that while the United States has a trade deficit with China, this deficit is much smaller in terms of value added traded, because Chinese products exported to the United States include a significant share of imported intermediate products of US or third country origin. Made in China products and Made in America products are de facto imbricated with each other and it is difficult to separate them.

At the aggregate level, the sum of the trade balances of all countries is equal to the sum of the balances expressed as “exported value added”. But the distribution of bilateral surpluses and deficits changes depending on whether one looks at merchandise trade expressed in gross terms or “value added trade”.

Evidence by example: the dependence of US final demand on Chinese production

In order to better measure the impact of value chain fragmentation, we conducted an “input-output” analysis to highlight the dependence of the US economy on Chinese output, branch by branch. More superficial indicators such as the share of Chinese imports in total US imports, or the share of imported Chinese inputs in each sector, are of little use in understanding this reality. More specifically, we sought to determine the dependence of final demand in the United States on Chinese output. To do this, we applied Leontief’s methodology using the data provided by the World Input Output Database (WIOD).

By taking into account not only the direct bilateral flows between the two countries but also all indirect flows passing through other countries, we can, thanks to this analysis, better assess the degree of economic dependence of the United States on China, and its vulnerability to a sudden disruption of Chinese output, as was the case during the first months of this year, following the outbreak of the coronavirus epidemic and the drastic health measures taken by the Chinese government.

The detailed results are shown in the graph below. We can see that in some industries, the dependence of US final demand is particularly high on Chinese output, since the latter accounts – directly and indirectly – for more than 25% of the final demand generated in the United States in certain industrial sectors. Not surprisingly, this is particularly the case in the mechanical, electrical and electronic industries, as well as in the manufacturing of textiles and clothing. Dependence peaks at 47% for the manufacturing of computers and other electronic products. More surprisingly, there is also a relatively high dependence on Chinese production in services such as construction, air transport, and technical and scientific activities.

By way of comparison, the same analysis was done for Canadian and Mexican output. We find that the dependency of U.S. final demand is much lower on the output of these two countries than it is on that of China. This seems surprising at first glance given the importance of these two NAFTA countries in U.S. imports. Nevertheless, it primarily means that these two countries are also highly dependent on China, importing Chinese products and services, which they process and then re-export to the United States.

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