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Fear of China: Is There a Future for Manufacturing in Latin America? Mauricio Mesquita Moreira IDB The Emergence of China: Challenges and Opportunities for Latin America and Asia 3-4 December 2004, Beijing, China Motivation “It’s the manufacturing stupid!” If anything, China’s emergence in the world market challenges the view that the future of LAC is in manufacturing. Outline • • • • Does manufacturing really matter for LAC’s development? The nature and size of the challenge. The effects so far in terms of trade flows. Economic and policy implications. Manufacturing? • • • Manufacturing “bias” in the traditional development literature. “Normal pattern of development”. Evidence of this “bias” in the endogenous growth theories and contemporary development literature Empirical evidence, for the most part, is circumstantial. “Virtually every country that experienced rapid growth of productivity and living standards over the last 200 years has done so by industrializing…” Murphy, Shleifer and Vishny (1989), Manufacturing? • • • • Sachs and Warner (1995, 1997) , the first to present hard facts about the link between manufacturing and growth: increasing returns and all that.. Later disputed by , e.g., Lederman and Maloney (2003) and Manzano and Rigobon’s (2001). The issue would be export concentration and debt overhang. Yet, little is said about the link between natural resources and export concentration and debt. Stingy (2003), e.g. present robust evidence of Dutch disease. Indirect and negative impact of natural resource specialization on growth. E.g. Isham, Woolcock, Pritchett and Busby (2003), Manufacturing? • • • • • The issue is far from settled but the police debate rages on in LAC. Two strands of manufacturing pessimism seems to prevail : The World Bank (2002,2003) sticks to traditional trade theory and suggests that the region’s future is agriculture and mining, seen a pathway to a “knowledge economy”. Look at Canada, Finland, Sweden. Blum and Leamer (2003) “Natural resource rich communities invest their resources in land, permanent crops and extractive equipment and very little in human capital” ..“Countries that cannot attract manufacturing activities face the very difficult problem of how to find work both for new entrants into the labor force ….” But “LAC is far way, rich in natural endowments and has a tropical climate […]” “[…] far away resource abundant tropical countries have great difficulties attracting manufacturing activities, other than mundane and labor intensive tasks … Manufacturing? • • • Outright manufacturing pessimism seems to be unwarranted. Empirical evidence and Latin American own past belies enthusiasm for a natural resource solution. There are the issues of human capital, technological externalities, export concentration and institutions. Geographical and endowment determinism does not go a long way. As the “new” theories of growth suggest, accumulation of human capital and the ensuing process of learning and innovation can change a country’s destiny beyond its geography and natural endowments. Whatever the “truth” , the fact is… Manufacturing accounts in average for 19% of the GDP (2002). Manufacturing Value Added (% of GDP) 40 35 30 25 20 15 Brazil Colombia Latin America & Caribbean Source: World Development Indicators Mexico 2001 1999 1997 1995 1993 1991 1989 1987 1985 1983 1981 1979 1977 1975 1973 1971 1969 1967 10 1965 • • Venezuela, RB Manufacturing? • True: the manufacturing share of GDP has been declining rapidly; still dominated by “mundane” resource and labor intensive goods or are concentrated in the laborintensive links of the value chain; has been thoroughly outperformed by East Asia • But, there seems to be more to it than geography and endowments Manufacturing? Figure 2: Predicted and observed manufacturing share of GDP: Selected LAC and resource-intensive countries 11 7 10 9 10 11 7 8 3 3.5 9 2.5 10 6 8 9 7 10 11 8 1970 6 7 8 9 10 11 6 7 8 THAILAND Fixed effects regression 2 y = 2.281x – 0.1348x – 6.8564 2 R = 0.06 Source: WDI and Penn World Tables 6.1 3 3.5 2000 2 2.5 1965 6 7 8 9 10 9 10 11 SWEDEN 2000 1970 3 7 1970 2000 11 1.5 6 11 2 6 2 2 8 2000 FINLAND 1.5 2 1.5 7 10 1.5 11 2000 1970 9 VENEZUELA 2.5 2000 2.5 9 2.5 3 1970 6 1975 CANADA 3 3.5 AUSTRALIA 8 8 3.5 6 7 3 11 6 2000 2.5 10 11 2 9 10 1.5 8 9 URUGUAY 3.5 7 8 1.5 2 6 7 3 2000 2000 2 6 2.5 10 1.5 1.5 2 9 1965 2.5 1965 8 MEXICO 3 3 2000 2.5 7 3.5 3.5 COSTA RICA 6 1965 1.5 2 11 3.5 10 3 9 2.5 8 2000 2 7 COLOMBIA 1.5 2 2 6 1965 2.5 2000 2.5 2000 3 1965 3 1965 CHILE 3.5 BRAZIL 3.5 2.5 3.5 3 4 ARGENTINA 11 log real PPP per capita income 9 10 11 Manufacturing? • In fact, there two important “omitted variables” in this story : The poor and volatile macroeconomic environment throughout the 1980s and 1990s; a reform of the state which has gone well beyond weeding out the excesses of the import substitution era. • So, at the very least, it would risky and hasty for LAC to turn its back on manufacturing; Manufacturing? • In fact, there are least two important “omitted variables” in this story: • The poor and volatile macroeconomic environment that prevailed in most countries in the region throughout the eighties and nineties and a reform of the state which has gone well beyond weeding out the excesses of the import substitution era. China’s Challenge • • • • Four main factors: Endowments Productivity Scale The Role of Government China’s Challenge: endowments Average Nominal Annual Wages in Manufacturing: China, Brazil and Mexico (1000 current US$) 10.0 Brasil Mexico China 8.0 6.0 4.0 2.0 0.0 1996 1997 1998 1999 2000 Source: China Statistical Yearbook, IBGE and INEGI annual industrial surveys 2001 2002 Productivity Labor Productivity in China and Selected Countries. 2001. 120 100 80 US Korea Korea Korea Mexico Mexico 60 40 20 Korea Brazil Brazil India India Mexico China 0 Auto India Mexico Brazil India India China Mexico China Consumer Electronics Source: McKinsey&Co 2003 Brazil Brazil China White Goods China Brown Goods PCs Productivity Labor Productivity in Manufacturing: China, Brazil and Mexico (valued-added per worker, national accounts data. 1990=100). 450 400 350 China (implicit deflator) China (ex-factory deflator) Brazil Mexico 300 250 200 150 100 50 0 1990 1991 1992 Source: statistical offices 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 Productivity Labor Productivity at the Firm Level: China, Brazil and Mexico. Annual Average (%) Mexico (1995-2000) Brazil (1996-2000) China (1995-99) 0 2 4 6 8 10 Source: Lopez-Cordova and Moreira (2004) and Hu, Jeffeson, Xiaojing and Jinchang (2003) 12 Scale • • • • • The largest population in the world; A surface that is roughly as large as the United States and 15 per cent larger than Brazil; A US$1.3 billion economy, which is edging closer to the size of the entire LAC economy (US$1.6 billion). The PPP figures are even more impressive, putting the Chinese economy only behind that of the United States. The largest Latin American economy in PPP terms—Brazil—is ranked 9th, with approximately 20 percent of the size of the Chinese economy. Chinese exports, at US$365 billion, are already higher than those of LAC as a whole. Scale • Advantages Cost edge on high fixed cost, high-tech industries (e.g. consumer electronics, domestic sales of US$ 41 billion, whereas Mexico has US$ 10 billion and Brazil, US$ 9 billion); Better conditions to deepen the supply chain (the division labor depends on the size of the market); Lower infrastructure cost The Role of Government Factor and product markets. •Factor side: abundant supply of credit to local firms, at very “competitive” interest rates; a public funded national innovation system, which has contributed to reduce the costs and risks of R&D; a pragmatic enforcement of IPRs. The Role of Government Real Average Lending Rates for Selected Countries. 1990-2003, CPI deflator. % per annum BRAZIL* 58.5 COLOMBIA 12.7 CHILE 9.1 MEXICO** 6.6 INDIA 6.1 FRANCE 5.8 MALAYSIA 5.7 SPAIN 4.6 US 4.5 KOREA 4.2 CHINA,P.R 2.7 0 Source: IMF_IFS 5 10 15 20 * 1997-2003 ** 1993-2003 25 30 The Role of Government Domestic Credit Provided by Banking Sector (% of GDP) Colombia 35.7 Mexico 38.5 Brazil 61.1 105.6 Korea, Rep. High Income Countries 125.1 China 178.8 0 20 40 60 80 100 120 140 160 180 200 The Role of Government Factor and product markets. •Product side: Sector targeting: e.g. semiconductors, automobile and software Firm targeting: “National Champions”. Still complex dual trade regime, which favor exports and restricts access to the domestic market (trading rights and distribution services, import and export regulation, non-tariff measures and national treatment) Trade effects LAC Net Exports to CHINA by factor intensity. US$ million 1980-2002 4,000 3,000 2,000 1,000 -2,000 -3,000 High Tech Low Tech Primary Products Resource Based -4,000 Source: Comtrade Medium Tech 2002 2000 1998 1996 1994 1992 1990 1988 1986 1984 1982 -1,000 1980 0 Trade effects World market shares for manufactured exports: 1981-2002 (%) 18.0% China E. Asia excl. China Mexico LAC LAC excl. Mexico 15.0% 12.0% 9.0% 6.0% 3.0% Source: Comtrade Note: Manufacturing is defined as SITC 5 to minus 68 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 1990 1989 1988 1987 1986 1985 1984 1983 1982 1981 0.0% Trade effects LAC's World Market losses to China by technology intensity (1990-2002). 1.4% Losses to China US$ 1,200 1.0% 1,000 0.8% 800 0.6% 600 400 0.2% 200 0.0% 0 High-tech Medium-tech Low-tech Source: Comtrade with author's own calculation. Resource- . 0.4% . % of Total Manuf Exports 2002 1.2% Total exports Losses to China (millions of USD$) 1,400 Losses as % of category exports in 2002 Trade effects LAC's Annual World Market losses to China (1990-2002, SITC 5 digits) 2.5% 2.0% 2.0% 1.5% 1.0% 1.0% 1.0% 0.6% 0.5% 0.3% 0.1% 0.2% 0.7% 0.5% 0.3% 0.4% 0.3% 0.4% 0.0% 90-91 91-92 92-93 93-94 94-95 95-96 Source: Comtrade, author's own calculation. 96-97 97-98 98-99 99-00 00-01 01-02 90-02 Trade effects: LAC World Market losses to China by selected countries and subregions, as a percentage of 2002 manufacturing exports (1990-2002, SITC 5 digits) 6.0% 5.0% 4.2% 4.0% 4.1% 4.0% 3.0% 2.0% 1.1% 1.2% 1.0% 0.3% 0.0% ANDEAN BRAZIL CACM Source: Comtrade, author's own calculation. CHILE MEXICO MERCOSUR Trade effects: LAC's World Market Losses to China by Selected Markets, as a percentage of 2002 manufacturing exports (1990-2002, SITC 5 digits) 9.0% 8.1% 8.0% 7.0% 6.1% 6.0% 5.0% 4.0% 3.0% 2.1% 2.0% 1.0% 1.4% 0.7% 0.4% 0.0% All East Asia Source: Comtrade, author's own calculation. EU LAC Rest of the World USA Trade effects: China's Share of Manufacturing Imports in Selected Sub-regions and Countries. 1990-2002 16% 1990 1995 2002 12% 8% 4% 0% Mexico Source: Comtrade Mercosur LAC Chile ANDEAN CACM USA Trade effects: the potential threat Brazil's and Mexico Import Penetration* in Manufacturing goods. World and China (1996 - 2003) World % 40 35 China % Brazil-World Mexico-World Brazil-China Mexico-China 1.4 1.3 1.2 1.1 1.0 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0.0 30 25 20 15 10 5 0 1996 1997 1998 1999 2000 2001 2002 2003 * Import divided by apparent consumption. Brazil's and Mexico's output data converted to US dollars using, respectively, 1998 and 1994 real exchange rate Source: own calculation based on IBGE and SECEX data. Trade effects: the potential competition Coefficient of Correlation for Export Composition LAC-China: Manufacturing, US market (HS 6 digits) 0.6 Andean Brazil CACM Chile LAC Mexico 0.5 0.4 0.3 0.2 0.1 0 1992 -0.1 1993 1994 Source: Comtrade 1995 1996 1997 1998 1999 2000 2001 2002 Trade effects: the potential competition Coefficient of Correlation for Export Composition LAC-China: Manufacturing, Rest of the world (HS 6 digits) 0.5 0.4 Andean Brazil CACM Chile LAC Mexico 0.3 0.2 0.1 0 1992 1993 1994 -0.1 Source: Comtrade 1995 1996 1997 1998 1999 2000 2001 2002 Conclusions Is there a future for manufacturing in Latin America? China does not make this future any brighter, given its combination of endowments, scale, fast productivity growth and a strong state. This is particularly true in a world market already overcrowded by at least three generations of Asian Tigers and facing the prospects of others, such as India, to come. Conclusions Not a reason for concern if manufacturing did not really matter for development. Yet, both theory and evidence suggest otherwise. Even leaving China apart, manufacturing in LAC is usually seen with pessimism on the grounds of geography and endowments. The tribulations of the sector on the last two decades seem to corroborate this view. Yet, geography and endowments do not tell the whole story. Conclusions the legacy of the ISI era, decades of macroeconomic volatility and the demonization government intervention, have to be factor in. These are all policy-related factors and welldesigned policies, backed by strong institutions, can overcome the restrictions imposed by endowments and geography. It all depends a policy agenda, which should aim at: a) the consolidation of the macro stability; b) the formation of a large regional market to reduce de disadvantage of scale; c) the relaxation of excruciating credit-constraints on local firms; d) the enhancement of frail local technological capabilities