Not infrequently one hears our political leaders sagely warning against the risks of over-dependence on trade with China. From those of a more historical bent, one sometimes hear talk of parallels with our historical dependence on UK export markets.
My impression is that those warnings and comparisons are mostly misplaced. In practice, comments often centre on the dairy industry – a sector in which the overwhelming bulk of domestic production is exported. New Zealand’s dairy industry is the eighth largest in the world, but New Zealand is the largest dairy exporting country. Decades ago, almost all our dairy exports went to the UK. But perhaps more importantly, there were then very few other possible export markets at all. There wasn’t much global trade in dairy products. People sometimes worry that our exports are concentrated in whole market powder, a product which New Zealand produces more of than any other country, and China consumes (and currently imports) far more than any other country. But even this seems overstated as a vulnerability, since the world dairy market seems (in aggregate) to be able to do quite a lot of substitution between products. One way of seeing this is simply to look at how closely the prices of skim milk powder and whole milk powder move together. Skim milk powder is a much less important product for New Zealand (and China).
China matters to New Zealand, as it matters to the rest of the world, largely because it is now a large economy. In PPP terms, China’s economy is estimated to now be around the same size as that of the United States. That is a somewhat misleading comparison, overstating the absolute economic importance of China (since most of China’s GDP occurs domestically at its – much lower – domestic prices). But equally comparisons of GDP at market prices tend to understate the importance of China, and are complicated by year-to-year exchange rate fluctuations. Another way of seeing the importance of China is to look at the contribution to total global growth.
This chart is drawn from the IMF WEO database, using PPP-based nominal GDP data.
On this measure, in the decade to 2004, China, the US, and the euro-area countries accounted for similar shares of global growth. In the last five years, the euro area has accounted for very little of the growth in the world economy while China has accounted for more than twice the US’s share of global growth. Again, it probably overstates the importance of China’s growth, but even if one could get some “true” numbers as the basis for comparisons, the stark change in the share of where world growth is occurring would remain.
And, if anything, simply using the make-up of world GDP as the basis for comparison probably understates the importance of China’s demand in the last few years. In addition to showing strong growth in GDP (domestic value-added), China also recorded a very sharp reduction in its current account surpluses (while those in the euro-area have increased). As recently as 2007, China was recording current account surpluses of 10 per cent of GDP. China will have accounted for a larger share of the growth in world demand since 2009 than its share in the growth of world production. Much of it was credit-fuelled, driven by policy choices that appear to have actively worsened credit standards across the economy – but as far as the rest of the world was concerned, it was still demand at a time when that was what the West was short of.
Of course, these data are only to 2014, and China’s growth now appears to be slowing quite rapidly. If growth slows to, say, 3 per cent, China will still be contributing as much to the growth in real global GDP as the United States this year. But the impulse effect of such a slowdown in growth might be quite large.
In absolute terms, China is still probably not quite as important to the world economy and financial system as either the United States or the euro-area. In part, that reflects the less developed financial system, and the weaker connections between the Chinese financial system and those of the rest of the world. For good or ill – mostly probably the latter – the Chinese government has the ability to mask more problems for longer, and even to use policy more aggressively to actively counter the effects of a slowdown (at what might prove to be a considerable longer-term cost to the efficiency of its own underperforming economy). If one is looking for risks of an economic explosion in the next few years, one would have to focus on the euro-area. But what is happening in China is both hard for outsiders to interpret, and likely to be very important to the state of global demand.
Developments in global dairy prices matter enormously to New Zealand. Developments in China matter a lot. But they are (largely) two separate issues. China matters to us (and other countries) primarily because, like Europe and the US, it is a very large economy, not because of the volume of direct trade with New Zealand. China also looks like a rather rickety economy, and one which continues to fail to deliver living standards for its people that match those generated by market economies, whether in East Asia or the West.