September 5, 2006    Volume 13, No. 16

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China Replaces U.S. As World's Largest Exporter: Trade Imbalances Could Cause Financial Upheaval; MAPI Analyst Implores U.S., IMF To Act Now On China's Yuan



BY RICHARD McCORMACK richard@manufacturingnews.com


China's surging trade surplus this year, driven by continued increases in high-tech exports, "constitutes a major challenge to U.S. global competitiveness," declares the Manufacturers Alliance/MAPI. If the issue is not addressed and the trade imbalance continues to grow -- "like the gallows" -- then "sooner rather than later the markets will trigger the inevitable adjustment, with what will almost certainly be more grim financial reaping," says the analysis prepared by Ernest Preeg, MAPI's senior fellow in trade and productivity.

During the first six months of this year, China surpassed the United States as being the world's largest exporter. Only five years ago, the United States exported more than double the amount of China. During the first half of 2006, Chinese exports of manufactured goods reached $404 billion compared to $367 billion in exports by the United States.

"This dramatic reversal, together with the increasingly high-tech orientation of Chinese exports, poses a serious challenge to U.S. export competitiveness and long-standing leadership in technological innovation," writes Preeg.

The composition of Chinese exports is undergoing a "structural shift" away from labor-intensive products to high tech and value-added goods. Chinese exports of textiles and apparel declined to 14.6 percent of total exports during the first half of 2006.

China's trade surplus in manufactured goods increased to $128 billion during the first half of 2006, an increase of $43 billion over the same period of 2005. China's trade surplus in information technology products has more than doubled from the first half of 2004 to the first half of 2006, from $18.8 billion to $44.8 billion.

China's large and growing external trade imbalance "foreshadows what will be a difficult and potentially disruptive adjustment for the Chinese economy, again concentrated in the manufacturing sector," warns Preeg. "It will certainly be a central subject for discussion at the IMF and World Bank annual meetings in September and will trigger congressional action to impose tariffs on imports from China unless the yuan is promptly revalued."

Exports of mechanical and electrical products during the first half of 2006 reached $244 billion, "more than two and one-half times larger than the $91.5 billion of labor-intensive exports," according to Preeg. The "hi-tech products" category recorded exports of $123.5 billion, also higher than the labor-intensive category. "The highest growth sectors during the first half of 2006 were other transport equipment (68 percent), telecommunications equipment (40 percent), auto parts (37 percent), scientific instruments (36 percent), electrical machinery and parts (34 percent), and machinery, except electronics (31 percent)."

The data also reflect another fundamental change in Chinese manufacturing. For years, China imported large quantities of parts and components and its cheap labor shops were used as a platform for final assembly. But the share of imported content "is not nearly as large as sometimes reported, and the share of Chinese value added is rising steadily," writes Preeg.

Foreign firms manufacturing in China are buying more of their parts from local suppliers. Large companies are providing suppliers with training, technical support and systems for improving quality. "One Japanese automotive company is in the process of increasing Chinese value added from 75 percent to 95 percent, as a result of almost all of its Japanese parts suppliers shifting production to China," says Preeg. "The Chinese export platform issue...has been largely a myth."

If Chinese exports continue growing at their current pace, then Chinese manufactured exports will be more than double those of the United States in five years, Preeg points out. "This dramatic reversal defines the bottom line challenge to U.S. export competitiveness."

Preeg implores policymakers to be alert to the major economic consequences of such a development. "The very large and growing Chinese current account surplus, linked to other large surpluses throughout East Asia and the counterpart U.S. deficit, have created the greatest and most threatening imbalance in the global economy since the Second World War. If steps are not taken to restore greater balance, a market-induced adjustment could have serious impact on the global economy."

China's projected current account surplus this year of $230 billion represents 9 percent of China's GDP. Combined with other East Asian countries, Asia's current account surplus will run about $500 billion this year, while the U.S. current account deficit will top $800 billion -- or more than 7 percent of U.S. GDP. Yet despite repeated warnings, U.S. and Chinese policymakers have done nothing to address the growing imbalance.

A major revaluation of the yuan of between 25 percent and 50 percent will be painful but necessary. The IMF can no longer ignore the issue, particularly since Article IV of its charter states that "members should avoid manipulating exchange rates...in order...to gain an unfair competitive advantage." The IMF charter defines currency manipulation as "protracted large scale" purchases of foreign exchange by central banks.

"Can there be any question that the Chinese purchases of $200 billion a year are not protracted and large scale?" Preeg asks in the paper entitled "China's Surging Trade Surplus Being Driven By High-Tech Manufactured Exports; Policy Consequences of the Growing Imbalance," available for purchase by calling 703-841-9000.



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