China's Foreign Trade—Time for a Reality Check

By Liu Jian and Yan Fei

China's foreign trade has maintained strong growth momentum overall, but it is facing near term and longer term challenges.

C hina's foreign trade has so far avoided a serious impact from the Sino-US trade dispute thanks to the sustained recovery of the world economy and the steady growth of global merchandise trade much of this year. While a truce has been called in the dispute, there is no longer term resolution. For the time being, the economy has generally maintained strong growth momentum. The pattern of trade is being optimized,and gains have been made in industrial restructuring. Nevertheless, there are near-term and long-term challenges that need to be addressed. China is facing possible adverse effects from a global economic downturn and its likely impact on trade. It is reasonable to prepare for a setback to global trade. In the longer term there will be adjustments in global trade. China should strive to boost investment and embrace advanced technology that meets the demands of the digital economy. The following essay takes a close look at these challenges and how China should respond.

China's foreign trade saw unexpected growth in October.Exports reached 1,490.71 billion yuan,up 17.8%, and imports were 1,257.09 billion yuan, up 20.3%. Nearly 70% of the increase in gross import and export values reflected expanded volumes.Although import growth slowed slightly compared with the 22.3% year on year rise in September, it reached a record high for the year in value terms. Exports had an even bettFer performance, with growth reaching a four-year high.

The trade increase topped expectations as a result of several factors. External demand was buoyed by the strength of the global economy, a weaker renminbi against the dollar, and the use of export rebates. Exporters may have also tried to speed up shipments to avoid punitive tariffs.

Foreign trade growth has decelerated

While imports and exports have risen, the trade surplus has narrowed.The surplus was 233.63 billion yuan in October 2018. Although it has continued to rise since August, it was down 5.1%year on year. The trade surplus from January to October of this year stood at 1,658.8 billion yuan, down 26%. The surplus in October in dollar terms was US$34.02 billion, down 7.8%, and the cumulative surplus was US$254.2 billion,a 22.3% decline.

China's exports to the US rose 13.1%to US$42.7 billion in October while imports from the US reached US$10.94 billion, a slight drop of 1.8%. China's exports to the US in the first 10 months of 2018 amounted to US$392.1 billion,up 13.3%, and imports from the US were US$133.98 billion, up 8.5%. China's trade surplus with the US stood at US$31.8 billion in October, up 19.4% over the same period last year. For the January-October period it totaled US$258.1 billion, up 15.8% from a year ago.

Despite the strong rebound in trade,the role of China's net exports in total output growth has declined. Although the contribution to GDP and the pull factor of net exports of goods and services rose 1 percentage point and 0.1 percentage point, respectively, in the third quarter compared with a year ago, they remained negative at -9.7%and -0.6%. The role of net exports has fallen since the outset of the financial crisis in 2008 when external demand declined significantly. Domestic factors such as China's effort to adjust its industrial structure and transform its development mode have also played a role in the weaker contribution of net exports to total output and overall economic growth. Even China's overall dependence on foreign trade has been reduced. Economic growth is more driven by domestic demand, especially consumption, rather than investment.This shift has had a positive significance for China in the face of a potential longterm downturn in the economy. It has spurred the shift from "quantitative change to qualitative change" as China strives for high-quality development.

Chart 1: Contribution rate and pull rate of net export to output growth since 1978

China's monthly trade balance since its joining WTO

Chart 2: Changes in the volume, growth rate and balance of China's import and export

The shift can be seen from the following data. China's net exports of goods and services accelerated from 423.56 billion yuan to more than 2.34 trillion yuan from 2004 to 2007 (valued at the then-prevailing exchange rates).Its compound annual growth rate was 68%, much higher than the nominal GDP growth rate of the same period.The proportion of net exports of goods and services in GDP also increased rapidly, from 2.6% to a peak of 8.6%in 2007. However, after the outbreak of the financial crisis, except for a slight rebound in 2015, the proportion declined. China's net exports accounted for only 1.97% of total output in 2017,the lowest level in more than 20 years.Though the contribution rate and pull factor for net exports to GDP growth in that year hit a new post-financial crisis high, they were only 9.1% and 0.6%,respectively. Meanwhile, the average contribution of final consumption expenditure to the growth in China's total output has increased from about 45% in the years around the financial crisis to 60% or so in recent years. Over the same time, the average contribution of investment to total output growth decreased, falling from about 60% to less than 40%. The contribution of investment to GDP growth - as high as 86% in 2009 - dropped to 32% in 2017,down by more than 50 percentage points.

China has already made significant achievements in industrial upgrading and the transformation of its development mode to one that is more innovation-driven, according to the National Bureau of Statistics.China's final consumption expenditure contributed 78% to economic growth in the first three quarters of 2018, 46 percentage points higher than the contribution from investment. As for consumption, the proportion of service consumption continued to increase,which led to the rapid development of tertiary industry. The proportion of added value of tertiary industry in GDP reached 53% in the first three quarters,nearly 13 percentage points higher than that of secondary industry. Investment in high-tech manufacturing increased by nearly 15% year on year, nearly 10 percentage points faster than the growth in gross investment.

Optimized Structure

In addition to the above quantitative changes, China's foreign trade is undergoing some positive structural shifts.

China's trade surplus has gradually narrowed since the end of 2015 and the trend is expected to continue. China has taken the initiative to expand imports in the recent years, and imports have begun to grow faster than exports.The seasonally adjusted growth rate of imports has been about 7 percentage points higher than that of exports each month since August 2016. The trade surplus in October 2018 touched 233 billion yuan, down 40% from the peak level over the past seven years. It is

expected that China's total imports of goods and services will exceed US$30 trillion and US$10 trillion over the next 15 years, respectively. This will promote the transformation of China's development mode and expand the nation's contribution to global trade and world economic growth.

China has also made progress in advancing its trade with countries besides the US. Trade with Russia, the European Union and the Association of Southeast Asian Nations increased by 19.4%, 7.3% and 12.6%, respectively, in the first three quarters of this year. Trade with the countries participating in the"Belt and Road" program also gained momentum. The growth in trade with Poland and Kazakhstan rose 11.9% and 11.8%, respectively. The same period saw growth of only 6.5% for trade with the US. Trade with the "Belt and Road"countries was 3.3 percentage points higher than trade overall while trade with Africa was 3.9 percentage points higher and trade with Latin America was 3.8 percentage points higher.

Furthermore, foreign trade has seen an increased role for the private sector while the contribution from the nation's central and western regions has been advancing. The import and export volume from China's private sector reached 8.77 trillion yuan since the beginning of the year, an increase of 12.9% over the previous year. The volume accounted for nearly 40% of China's total imports and exports in value terms. The foreign trade of 12 provinces and cities in China's western region and 6 provinces and cities in the central region has increased by 16.3%and 13.9%, respectively. That exceeds the national average growth rate by 6.4 percentage points and 4 percentage points.

Lastly, improvement in the quality of foreign trade has been steady. China's general trade, which has a lengthy industrial chain and has high added value, witnessed a 13.5% growth rate in the first three quarters, approximately 4 percentage points higher than the overall growth rate of imports and exports. Exports of mechanical and electrical products gained in the same period, making up nearly 60%of China's total exports. Among these products, automobiles and metalprocessing machines saw gains of 16.3% and 18.7%, respectively. At the same time, there has been a steady decline in the contribution from exports of products that are in sectors that are high contributors to pollution or energy intensive or wasteful of natural resources. Meanwhile, imports of some consumer goods have grown rapidly owing to reduced import duties. For example, imports of cosmetics surged 75% while marine products climbed 37%. Imports of high-tech products in the first three quarters rose 14.8%to 3.26 trillion yuan. These imports supported China's transformation to more innovative development.

The above shifts reflect the change in China's role in the international division of labor and its position in the global value chain. With these changes, China's economy has been more resilient to shocks from eternal demand.

Mounting Risks

But downside risks to economic growth are mounting. These include diverging growth prospects in different economies, the normalization of monetary policies in major developed economies, the overall tightening of global finance and the escalation of global trade tensions. There could be a notable slowdown in global trade growth in the next one to two years, and this would have an impact on China's foreign trade.

The International Monetary Fund (IMF)recently cut its forecast for GDP growth of 19 countries and regions, including the US, the Eurozone, the UK, Japan and China. The IMF puts global economic growth this year and next year at 3.7%.The World Trade Organization (WTO) also lowered its projections for the growth rate of global trade and economic growth next year from 4.4% and 4.0% to 3.9%and 3.7%, respectively. The risk factors in China include weak sub-indexes of the Purchasing Managers' Index. The figure for new export orders, a key leading indicator,slid further to 46.9% in October. It was the fifth month in a row with a reading below 50 - the threshold separating contraction from expansion. The figure was also close to the lowest level seen in the past three years.

The Sino-US trade dispute is also injecting uncertainty into the economic outlook. The two sides reached a temporary truce in their trade spat- delaying a planned 25% tariff that would have gone into effect on some US$200 billion worth of Chinese products as of January 1, 2019. But the agreement, announced at the G20 meeting in Buenos Aires, is a temporary fix for the underlying problems. Taking those problems into consideration, the short-term outlook for China's foreign trade is not encouraging. World Trade Organization Director-General Roberto Azevedo said that a serious worsening of the trade dispute would lead to a drop of about 17% in international trade growth and a 1.9% decline in global GDP. If the US put all of the threatened tariffs in place and that triggered retaliatory measures from its trading partners, there would be a drop of 0.9 percentage point in total output in Asia. Additionally, total output in 2020 would be cut by 0.8 percentage point,according to the IMF.

China is presently the largest exporter and second largest importer of global merchandise. It is the fifth largest exporter and second largest importer of global services. A downturn in the world economy and global trade would not only hit China's exports, but also possibly lead to a larger wave of trade protectionism and an escalation of trade disputes. If countries turn to more"beggar-thy-neighbor" policies such as increasing tariffs and raising trade barriers, the normal operation of the value chain is bound to be damaged and imports of a number of countries will be impacted. This kind of effect should not be underestimated.

Long-Term Trade Shifts

In the long run, technological progress as represented by the digital economy will continue to play a role in reducing trade costs, lowering trade barriers, and promoting global productivity. It will eventually become a main driver of sustained growth in global trade volume.

The technological progress represented by the digital economy has brought changes over the last two decades. It has not only deeply changed consumer behavior and consumption habits of global consumers, but has also played an important role in reducing trade costs, increasing product diversity,easing market access, expanding market share and promoting trade facilitation.In its report entitled Future of World Trade: How the Digital Economy Changes Global Commerce, the WTO pointed out that the digital economy will continue to play an important role in the next two decades in areas such as cutting trade costs, changing present comparative advantages among countries, affecting transnational production organization, and reshaping the global value chain. Additionally,it will undoubtedly have a profound impact on the patterns of global trade and the redistribution of trade benefits.

According to the WTO forecast, even considering the adverse effects that the escalating trade frictions may have in the coming years, the global trade volume will grow by more than 30% by 2030,with an average annual growth of about 1.8% - 2%. Trade of developing countries will account for 57% of total global trade.The contribution of trade in services to overall trade volume will rise from 21%to 25% by then.

China has advantages and disadvantages during the transition period. On one hand, the average trade volume per capita in China was US$1,586 in the 2015-2017 period,only one-fifth of the US$7,756 for the US. China's exports of services were valued at US$226.4 billion in 2017,making up 4.3% of the worldwide exports of services. However, US exports of services, worth US$761.7 billion,represented 14.4% of global exports in the same period. On the other hand,China has had some comparative advantages in the field of industrial intellectual property. There were 1.34 million patent applications and 650,000 industrial design patent applications in China in 2016. This was much higher than the 60,600 patent applications and 43,000 industrial design patent applications in the US. There were 2.1 million trademark applications in China,well above the 393,000 applications in the US. Although China is still exporting mainly labor-intensive products at present, it has huge potential for trade growth driven by technological advances.

The digital economy is versatile and has innovative applications that are particularly suited to consumption and the service sector. The upgrading of industry and the transformation of the development mode in China will continue for a long time in the future.This will no doubt lead to an increased proportion of consumption and services in China's gross domestic product.The increasing proportion will, in turn,help China take the lead in the future changes in worldwide division of labor and global trade development.

In conclusion, the present foreign trade situation in China is not depressed.The strong performance of imports and exports, the continuous optimization of the nation's trade structure and the narrowing of the trade surplus can promote domestic industrial upgrading and a developmental transformation.In addition, these factors are helpful to monetary authorities in keeping the renminbi exchange rate stable and permitting a more effective and independent monetary policy without relying on capital controls.

However, China needs to be alert to the possible impact on imports and exports from trade disputes. It also needs to continue to promote trade liberalization and optimize its own business environment. In the long run,the digital economy will cause a new round of global value chain remolding and international division of labor. China should actively strive to take the lead in the shift to sustainable and high-quality development in foreign trade. China needs to increase investment in cutting edge technology that is closely related to global division of production and international trade. These fields include big data, the Internet of things, artificial intelligence, blockchain technology and 3D printing.

Liu Jian is a researcher from the China Construction Bank Financial Leasing Co. Ltd Yan Fei is a researcher from the financial management department of Oceanwide Holdings Co. Ltd