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China’s and India’s Implications for the
World Economy by Helmut Reisen, OECD Development Centre
1.




China and India Growth
contribution to global growth
sources & structure
China’s raw material hunger
impact of slowdown
2.






The Global Labour Pool Has Doubled: Lower Wages, Fatter Profits
labour & wages
China’s surplus labour
the Lewis model with unlimited supplies of labour
a Krugman-Lewis three-sector model
rich-country wages: a simple Cobb-Douglas function
the Stolper-Samuelson theorem
3.



Price and Wage Effects: The Large-Country Case
China’s terms of trade
large-country trade analysis
Implications for investors
1. China and India Growth
 contribution to global growth
Table 1: China and India’s Contribution to Global Growth, 2000-2004
Percentage share of annual growth rate
2000
2001
2002
2003
2004
Global growth,
per cent p.a.
6.9
4.8
4.6
5.7
7.4
China
16.3
24
26.4
24.4
20.6
India
6
7.5
8.3
9.3
7.1
Source: IMF, World Economic Outlook, April 2005
N.B: GDP based on purchasing-power-parity (PPP) valuation of country GDP.
Each year since 2001, their combined contribution to global output
growth has been around 30 per cent.
Helped to hold global output growth above the 4 per cent threshold which
is critical for improving the terms of trade for primary commodity
producers.
Formula to compute a country’s contribution to world growth:
c 
c
Yc
Yw
Yc
Yr

r *
Yw
Yw
China’s (India’s) growth rate times China’s (India’s) percentage share in world
output divided by the sum of China’s growth rate plus the growth rate of the
rest of the world, each weighted by their respective share in world output.
 sources & structure
Table 2: Sources of China’s Income and Output Growth, 1998-2003
-Percentage points-
Avg. 19982003
2003
Employment
Contribution
0.3
0.4
Capital
Contribution
4.9
5.5
Residual
Factors
2.8
3.1
- Sectoral
change,
0.5
0.7
- Education,
1.1
0.8
- Multi factor
productivity
1.3
Source: OECD (2005)
1.6
•An analysis of the determinants of
growth in China suggests that rapid
growth should continue for the foreseeable
future, albeit at a somewhat slower rate.
•Thanks to capital accumulation
(investment growth), potential growth in
2005 has reached 9.5 per cent. It is
unlikely that the current savings rate
(which has risen to 45 per cent of GDP)
can be sustained in the long term.
•But considerable room for further
institutional and trade reforms to raise
efficiency.
•The continued re-allocation of labour
from agriculture to manufacturing is a
further source of productivity growth.
Table 3: China and India’s Rising Energy and Steel Use
Year-on-year growth rates (per cent)
China
Annual
average:
Industrial
production
Energy
consumption
Energy
production
Crude steel
consumption
Crude steel
production
India
1996-1999
2000-2003
1996-1999
2000-2003
9.90
10.07
4.97
5.84
1.16
6.16
3.35
2.41
0.15
6.16
1.49
2.51
7.78
17.74
3.56
4.04
6.78
15.70
2.60
7.01
Sources: China Statistical Yearbook (2004), International Energy Agency Data
Service, Steel Statistical Yearbook (2004), International Iron and Steel
Institute
•The current process of capital
deepening has spurred the drastic
increase in both energy and metal
use in China.
•China has become the largest
marginal consumer of many raw
materials and energy products,
benefitting raw material, food and
energy providers in Africa,
Australia and Latin America.
•Indian energy and steel use also
accelerates in the second period
(2000-2003), although at are more
moderate pace.
FX Reserves and US Treasury Holdings
-end 2005Source: treas.gov/tic; central banks;HKMA
FX Reserves
US Treasury
Holdings
bn US$ , of which
%UST
bn US$
China
+ Hong Kong
980
India
145
30.2 296
9.7
14
% of sum
13.6
0.7
 impact of slowdown
Table 4: Selected Key Country Elements
Net foreign
debt/asset pos.
--------------------Raw materials
Net exporter
High net debt
Medium net debt
Low net debt
High net FX assets
Brazil
Australia
South Africa
Norway
Net importer
Turkey
India
EU
Japan
Source: Reisen, Grandes and Pinaud (2004).
•The country examples in Table 4 illustrate that the impact of a China slowdown
will be uneven; the Dornbusch-van Wijnbergen analysis helps to predict
respective outcomes in a general-equilibrium framework, which can be
empirically calibrated and tested. It is likely that various outcomes on
macroeconomic variables may deviate considerably from what partialequilibrium analysis would predict.
What impact should a slowdown of China’s growth have on the
world economy?
Figure 1: China’s Hard vs Soft Landing
China’s trading partners
Leading indicators
Soft landing (to potential output
growth, i.e. 9 % p.a.):
LI Commodity
exporters (incl.
Australia)
• a very limited impact on global
growth, could even be positive
overall.
LI OECD All
•Commodity exporters (Australia,
Argentina, Brazil, Russia, South
Africa) would be the main losers,
raw material importers benefit
thanks to lower prices.
LI EU
LI , Japan,,
South Korea,
Taiwan
China’s GDP growth (%)
4
8
12
2. The Global Labour Pool Has
Doubled: Lower Wages, Fatter Profits
 labour & wages
Table 5
Figure 2: The Global Labour Pool and Real Per Capita Incomes, 1980 and 2000
Source: E. Leamer and P.K. Schott
(2005), “The Rich (and Poor) Keep
Getting Richer”’Harvard Business
Review, Vol. 83(4), April.
•Each country is represented by a horizontal line segment, with the length indicating the
country’s share in world population (or labour force).
China and India (large populations, low per capita income) appear as a long line along the
bottom.
•As a look at the graph makes clear, wage and income convergence would be an alarming
outcome from the perspective of advanced countries
China’s Surplus Labour
•Much of China’s and India’s rural labour force is underemployed, engaged only in
seasonal agricultural work with little earnings.
China has about 2.5 agricultural workers for every hectare of arable land. And many
of China’s construction sites and labour-intensive factories are staffed with rural
migrants for who the alternative is to survive on one acre per person.
•According to the US Department for Agriculture. China’s Ministry of Agriculture
estimates that rural China has 150 million surplus workers.
Add to this urban unemployment caused by the restructuring of loss-making state
enterprises, estimated at ca. 14% in 2002.
.
With employment at ca. 750 million in China and an estimated annual employment
growth of 1 percent (resulting from prospective GDP growth minus increases in labour
productivity), we can dare a back-of-the-envelope prediction:
China’s Surplus Labour
• Over the coming 20 years, China’s rural surplus labour will not be
exhausted.
• The shape and speed of China’s and India’s integration into the
world economy will depend importantly on the transfer of labour
from mostly rural low-productivity areas to mostly urban highproductivity sectors.
• This process can be well described by a core model of economic
development, the Lewis-Ranis-Fei or surplus labour model. The
crucial feature of the model is that the modern sector – and by
extension the world economy (!) – faces an unlimited supply of
labour at wages not far from the subsistence level.
•
 Lewis model with unlimited supplies of labour
Figure 3: The Lewis Model
•The model is a ‘classical’ rather
than a ‘neoclassical’ model; the
latter would assume that labour
is scarce and has to be bid away
from other uses, an assumption
that can be hardly defended in
view of the labour force in China
and India.
•It is rather realistic to assume
with Arthur Lewis that the
supply of labour to the modern
is perfectly elastic. By offering a
wage above the subsistence
income level, the modern sector
can attract an unlimited supply
of labour.
•In figure 3, labour is available at wage w^ up to
L*. As the value of the marginal product of
labour in the modern sector exceeds the wage
rate, profits are high (shaded area). They are
reinvested, raising the demand for labour in the
modern sector so that the marginal product of
labour curve is shifted to the right from VMPL0
to VMPL1. The model allows us to pose the
crucial question now: When and how does the
absorption of surplus labour come to a halt?
Essentially, there are two possibilities.
•Either investment opportunities cease to exist in
the modern sector (before L* is reached); for
example, this will be the case where the modern
sector is based on the exploitation of exhaustable
resources. The drying up of investment
opportunities leaves a modern enclave in an
economy which remains dualistic. This
possibility seems to apply more to the African
context than for either China or India. Wage
differences and inequality between the modern
sector and the traditional, informal sector will
then persist
.
• Or in China and India, however, the expansion into
the modern sector will eventually start to exhaust the
supply of labour, and the effective labour supply
curve turns positively sloped.
• Rising food prices, skills accumulation and rising
modern-sector wages will lead to a period (between
L* and L**) where the labour supply curve to the
modern sector in terms of its own prices is upward
sloping. Such a point is reached at L1, where wages
rise slightly above the subsistence level to w1.
• Finally with the end of unlimited supplies of labour
at the subsistence wage, the labour market becomes
unified. Real wages rise throughout the economy in a
world turned neoclassical again where workers in
both sectors receive the value of their marginal
products.
Figure 4
•Figure 4 suggests that China is still miles
away from reaching the point where wages
would start to converge between the rural
and the urban sector.
•In the quarter century from 1978-2003,
urban per capita income has risen much
faster than rural income; while the ratio of
urban to rural per capita incomes hovered
around two during the 1980s, urban
incomes are now three times higher than
the rural average.
The Krugman-Lewis Model
•
How does that China’s wage pressure spill abroad in theory? For an
answer, Paul Krugman has offered a useful extension of the Lewis model
in a three-goods (low-tech, intermediate, high-tech) one-factor (labour)
perspective[1].
•
It is assumed that, say, OECD labour is more productive than Chinese
labour in all three types of goods, but that productivity advantage is huge
in high-tech, moderate in medium-tech, and small in low-tech.
•
Competition will ensure that the ratio of the wage rate in the OECD area
to that in China will equal the ratio of labour productivity in those sectors
in which workers in the two regions compete head to head.
[1] Paul Krugman (1994), “Does Third World Growth Hurt First World
Prosperity?”, www.pkarchive.org.
•
Consider the following numerical example for wages determined by the ratio of
labour productivity in the intermediate sectors; hence wages in the OECD area
would be five times higher than in China:
Low-Tech
Intermediate
High-Tech
Productivity
OECD/China
2/1
5/1
10/1
LabourCost
OECD/China
5/2
1/1
1/2
If China’s productivity increase occurs in low-tech output, there is no reason to expect the ratio of
OECD to China’s wages to change. China will produce low-tech goods more cheaply, and the fall in the
price of those goods will raise real wages in the OECD (and Africa likewise). Falling (relative) prices
raise the purchasing power of importers and consumers, in other words: their real wages; so surplus
labour in China benefits in particular the low-income segments in the importing countries as low-tech
products weigh relatively heavily in their consumption
.
Only under three conditions will higher labour productivity in China
translate into higher low-tech prices and reduced real wages abroad:
•
(i) productivity rises in the competitive medium-tech sector;
•
(ii) Chinese wages will rise accordingly as China has entered the phase
where the labour supply curve starts to slope upwards; and
•
(iii) productivity has not risen in low-tech production, so that low-tech
prices will rise as a result of higher labour unit cost. This potential
adverse effect should show up in a rise of China’s terms of trade, or the
ratio of her export to import prices.
•
We will see later that China’s terms of trade have worsened.
•
So the purchasing power of OECD workers’ wages rises as a result of
China’s pressure on low-tech and intermediate goods prices, but that may
offer little comfort to workers if their nominal wages drop faster still.
• The entry of China, India and the former Soviet bloc
into the global economy cut the global capital/labour
ratio by 55% to 60% compared to what it otherwise
would have been.
• Even considering the high savings rate in the new
entrants ( e.g. in China ca. 40 percent of GDP), it will
take 30 or so years for the world to re-attain the
capital/labor ratio among the countries that had
previously made up the global economy.
• How much pressure has this placed on wages in
advanced countries? The capital/labor ratio is a critical
determinant of the wages paid to workers and of the
rewards to capital. The more capital each worker has,
the higher will be their productivity and pay.
Real equilibrium wages down 15% (?)
•
Multiplied with the intial shock
to the capital-labour ratio, a
back-of-the-envelope calculation
suggests that the inclusion of the
Asian giants and of the former
Soviet block has reduced OECD
equilibrium wages by ca. 15
percent. A reduction of the
capital stock by 1% reduces
productivity by less than 1%,
since capital is only one input;
standard estimates put the
number at about 0.3%.
 the Stolper-Samuelson theorem
•
The Heckscher-Ohlin model - the factor-proportions theory of
comparative advantage – also can define conditions under which countries
that are richer in human and physical capital than in labour move, as a
result of China’s integration, towards a lower wage level.
•
In the context of China’s emergence, the predictions of the StolperSamuelson theorem seem indeed to have been confirmed:
•
A drop in the price of wage-intensive products causes a reduction in the realwage rate and an increase in the real return to capital[1].
•
If the Stolper-Samuelson theorem is correct and if the emergence of China
and India does reduce relative prices of labour-intensive products in
world markets, the large reductions predicted above by the calibration of
a simple production function will be vindicated.
•
[1] Edward E. Leamer (1995), “The Heckscher-Ohlin Model in Theory and
Practice”, Princeton Studies in International Finance, No. 77, February.
Have a look at the Lerner-Pearce diagram which depicts the
Heckscher-Ohlin framework
Figure 5: China and Stolper-Samuelson in a LernerPearce Diagram
•
The curved lines are isoquants for labourintensive toys and for sophisticated cars,
i.e. combinations of labour and capital to
produce a Euro’s worth of output.
•
China’s emergence shifts the toy isoquant
outward to reflect the fact that, at a lower
price for toys, more capital and labour are
needed to produce output worth a Euro.
•
This shift is accompanied by a stretching of
the unit-isocost line, reflecting a rise in 1/w
and – possibly - a drop in 1/r (as wages
drop and capital returns rise).
•
The Stolper-Samuelson theorem thus
predicts pressure on wages (where they are
flexible, unemployment otherwise) in those
sectors that compete directly with China.
This may be achieved through outsourcing
or offshoring of wage-intensive elements of
production.
It is not predicted, however, that wages in the rich world
will fall to China’s levels.
• First, economic integration of low-wage and high-wage countries
should bring worldwide gains from specialisation, which will raise
total world GDP and global labour earnings as well.
• Second, where wages are high, they partly reflect returns to
human capital, not just to raw labour (however, human capital is
rising fast in China).
• Third, low-wage competition produces strong incentives for
advanced countries to move up the value chain; this is confirmed
by a wealth of empirical evidence that shows that open economies
grow faster than those which respond to low-wage challenges with
protectionism.
3. Price and Wage Effects: The Large-Country
Case
•raw materials
Figure 6 Shares in world imports of selected primary commodities,
China and India, 1998 and 2003
Percen t
16.00
•China’s and India’s demand
for raw materials has been
rising since the late 1990s
(figure 6).
14.00
12.00
India 1998
10.00
India 2003
8.00
China 1998
6.00
China 2003
4.00
2.00
0.00
oil
metals
woods
cotton
Source: UN Comtrade database
precious
stones
•This exerts a growing
upward pressure on prices ,
especially for those primary
commodities that weigh
heavily in Africa’s exports.
•Trade theory usually works with the small-country assumption: a country that
engages in international trade faces given prices. But China (and for precious stones,
India) has monopsony power in some raw material markets – its demand raises prices.
Table 5: China and India’s contribution to growth of
world imports of selected commodities, 1998 - 2003
China
Oil
Metals
Woods
Cotton
Precious
stones
India
Average
annual
growth
for the
world
excluding
China
Average
annual
growth
for
China
Overall
contribution
to global
growth by
China
Average
annual
growth
for the
world
excluding
India
Average
annual
growth
for
India
Overall
contribution
to global
growth
by India
1.1
3.9
1.6
-2.3
31.6
27.9
34.4
105.0
29.9
30.4
94.1
91.3
1.3
5.5
2.8
0.1
18.8
6.1
18.9
52.9
17.9
1.3
12.8
4.0
7.9
32.2
9.1
7.5
15.1
17.5
Sources: IEA database and UN Comtrade
In recent years, e.g., China has contributed all the world growth in
demand for woods and cotton, and a third of global growth for oil and
metals.
Figure 7: Annual percentage change in commodity
import prices, 1994-2004
-US$ per Kgyoy, % change
100
80
60
40
20
0
-20
-40
-60
1995
1996
1997
Crude oil
1998
1999
2000
Iron ore
2001
2002
Copper
2003
2004
Cot t on
Source: UN Comtrade
No wonder: prices have been rising since 2001.
Prima facie, this is good for raw material producers.
Table 6: Volatility in Commodity Import Prices*
•The benefits of China’s and India’s rising global
demand (net imports) are, nevertheless, attenuated
by the volatility of demand of the Asian giants, partly
due to cyclical variations but importantly also to
arbitrage between home production and imports.
•Moreover, as about 70-80 per cent of
manufacturing exports from China is produced by
multinational corporations, high raw material
demand partially reflects relocation of raw material
demand from production sites elsewhere.
Note: * Standard deviation of annual percentage
changes
Source: Own calculations based on UN Comtrade
data
•Such relocation does not occur without friction,
which further fuels demand volatility. Consequently,
rising raw material demand from China and India
is not necessarily an unfettered blessing for Africa.
•manufactured goods
Figure 8: Declining World Manufacturing Export Price,
1986 – 2000
•China’s supply side has weighed as well on
prices.
•The rapid export growth of low-skill and
labour-intensive manufactures has increased
the market competition for these goods and
hence exerted a downward pressure on their
prices.
•Focusing on the major product-groupings
(classified at the 8-digit level) imported into
the EU where developing-country exporters
were prominent and reporting the
proportion of the sectors for which the unitprice of imports from different incomegroups fell between 1988 and 2001, Raphie
Kaplinsky (IDS Sussex) shows that in almost
one third of these sectors the price of
Chinese-origin products dropped. He
concludes that the greater China’s
participation in global product markets, the
more likely prices will fall[1].
Source: Kaplinsky (2005)
[1] Kaplinsky, Raphie (2005), “Revisiting the
Revisited Terms of Trade: Will China Make a
Difference?”, mimeo, Institute for
Development Studies.

•
•
•
China’s terms of trade
Terms of trade is defined as the ratio of the price a country must receive for its export
commodity to the price it pay for its import commodity.
Terms of trade can be calculated using a Laspeyres index.
Where
price of exports in the current period
quantity of exports in the base period
price of exports in the base period
price of imports in the current period
quantity of imports in the base period
price of imports in the base period
•
•
•
•
•
The net barter terms of trade is the ratio (expressed as a percentage) of relative export and
import prices when volume is held constant.
The gross barter terms of trade is the ratio (expressed as a percent) of a quantity index of
exports to a quantity index of inputs.
The income terms of trade is the ratio (expressed as a percent) of the value of exports to the
price of imports.
The single factorial terms of trade is the net barter terms of trade adjusted for changes in the
productivity of exports.
The double factorial terms of trade adjusts for both the productivity of exports and the
productivity of imports.
Terms of Trade: The Large-Country Case
•Monopsony (buyer) power means that China and
India often do not face an infinitely elastic supply
curve, such as Sw, for its imports. Their demand
rather pushes the curve up to SChina. Similar effects
occur with exportables, where a large country’s export
supply pushes up the world demand curve
from Dw to D
w1
•The existence of world market power for the large
a
country means that the difference between pre- and
a
t
post-trade terms of trade is smaller for
China
(Pa- P China) than for a small country (Pa- Pt).
•Gains from trade are depicted by the triangle under
the autarchy supply/demand curves for
exportables/importables and above the post-trade
supply/demand curves; these are horizontal for a small
country, but upward sloping for a large country.
Hence, gains from trade are smaller for the large
country as the triangle is smaller.
Is China’s Growth “Immiserising”?
•
Immiserising growth arises when an increase in economic activity is associated with
a fall in real living standards. The increased economic activity may be reflected in
greater inputs of labour (people; labour hours), capital, land or any other resources
which have an opportunity cost.
•
Bhagwati (1958)[1], who is responsible for the modern-day discussion of
immiserising growth, began by examining circumstances in which declining
[barter] terms of trade outweigh the benefits of growth.
•
Also, in a world of trade distortions, growth of production can induce a net loss of
output. For example, tariffs could induce FDI targeting the domestic market, but
with such inefficiencies that the result would be less favourable than a world free of
tariffs (and of tariff-hopping FDI. This provides an intellectual underpinning for
the neo-classical critique of market interventions underlying industrial policies.
[1] Bhagwati J. N. (1958), “Immiserizing Growth: A Geometrical Note”, Review of Economic
Studies, No. 3, pp. 201-5.
Bhagwati, J. N. (1987), “Immiserizing Growth”, in The New Palgrave: A Dictionary of Economics,
(J. Eatwell, M. Milgate and P. Newman, eds.), London: Macmillan .
Figure 9: Commodity import price, export volume and Terms of trade
(Index: 2000=100)
250
115
110
200
105
150
100
100
95
90
50
85
0
80
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
Volume index of exports (Left Axis)
Purchasing power of exports (Left Axis)
Unit value index of imports (Right Axis)
T erms of trade (Right Axis)
Unit value index of exports (Right Axis)
Source: UNCTAD (2005), Handbook of Statistics
•A rapid increase in commodity imports as a share of merchandise imports means that the price of
total imports is largely affected by volatile commodity import prices since non-commodity import
prices are fairly stable.
•However, the deterioration in net terms of trade is compensated by the volume of exports which
expand at 25.2 per cent a year (2000-2004) against 10.3 (1995-1999). This is illustrated by steady rise
in the purchasing power of exports at 22 per cent a year (2000-2004).
Implications for Investors
• Improvement in trade-off inflation & growth
• Equity risk premium = dividend yield + dividend growth
./. return on risk-free asset
• Ex. US: 2.8% = 1.8% + 3% (=GDP growth); UST = 2%
• Post-China => 4.6% = 1.8% + 4.5% ; UST = 1.7%
www.oecd.org/dev/reisen