Sunday, September 17, 2006
Protectionism could block the 'China effect'
Posted by David Smith at 11:00 AM
Category: David Smith's other articles

Economic events in China are inextricably linked to those in Britain, and in particular the current worries over inflation. Is the “China effect”, low-cost imports which have helped keep prices down, coming to an end?

You don’t have to look at the official statistics to know the Chinese economy is booming; some would say dangerously overheating. Visiting Beijing last week, I was struck by the forest of construction cranes, the traffic jams at all hours, a permanent smog haze and non-stop bustle and activity.

The figures, mind you, are pretty impressive. In the first half of this year the economy grew by 10.9% compared with a year earlier. That is hot but not necessarily untypical. Since 1978, growth has averaged 9.6% a year. Retail sales are rising by 13%, exports by 33%, imports by 25%, incomes by 11-12%. Employment is growing by more than 1m a month.

The question is whether this boom has got to the point where it is doing the rest of the world more harm than good. The China effect has been crucially important in recent years. Without it, inflation and interest rates would have been significantly higher. Imports from China have transformed what would have been an environment of relatively low inflation into one in which - until recently - prices were increasing at a snail’s pace and goods’ prices falling.

But now, if the China effect is coming to an end, it raises questions about the past decade. Was it all just a short-term party, giving us, on the back of low inflation and interest rates, a housing and consumer boom but with not much to show for it in the long run? Have we sacrificed much of what remained of our manufacturing industry but without gaining permanently lower prices? Add in China’s contribution to high oil and commodity prices, now thankfully easing back, and the doubts multiply.

One of the things I was doing in Beijing was attending the World Economic Forum’s (WEF) China Business Summit. Participants from multinationals and domestic firms expressed concern about levels of wage inflation. That and booming property prices suggests a degree of overheating that may mean higher export prices. Anecdotal reports suggest it is already happening.

I have touched on the puzzle of China’s export prices before, expressing scepticism about whether the China effect is ending. That scepticism still seems justified. In the absence of data for the import prices into the UK from China, the best source is America’s official data. Figures from the Bureau of Labor Statistics show that US imports from China in July were 1.3% cheaper than a year earlier, and have continued to fall, month-on-month, in recent months.
That is supported by official data on consumer price inflation within China, which has averaged 1.2% this year, with goods prices falling.

How can China be avoiding inflation? The investment boom has led, at the very least, adequate capacity. or more likely overcapacity. Productivity, partly as a result of this investment, is rising strongly.

Can the China effect continue? Yes, said every Chinese Communist Party representative at the China business summit, including Zeng Peiyan, the vice-premier. He and others extolled the country’s 11th five-year plan (2006-2010), with its emphasis on science, innovation and technology.

The aim is to extend China’s reach up the value chain in manufacturing and into services. The prospect, in other words, is of a further rise in China’s market share, exerting a disinflationary efffect on Britain and other advanced economies. Even if sock prices do not keep falling, though they might, higher value-added goods will. Certainly there seems to be no let-up in China’s ability to gain market share. The trade surplus was a record $18.8 billion (£10 billion) last month.

The biggest risk to the China effect comes from another source. The WEF, in an attempt to peer into China’s future, has been working with 150 experts to flesh out prospects over the next two decades.

Its most optimistic scenario, which it calls “New Silk Road” has China continuing to grow at a rapid rate, averaging 9% a year, between now and 2025. China, on this view, pushes through economic and banking reforms and internal political dissent is contained. The middle-class grows, individual rights are enhanced and action is taken to tackle inequality and environmental damage. Most importantly, China is seen as a positive partner by the rest of the world, both political - contributing to peacekeeping operations - and economically, as the world’s motor.

At the other end of the scale is what the WEF calls “Unfulfilled Promise”. Growth is still strong by normal standards, averaging 6%, but it falls short of what China has achieved in the past quarter-century. The reform process grinds to a halt for fear of dissent. Export growth weakens as competitiveness declines. China fails to become a major global player.

Perhaps most interesting, however, was what Professor Jean-Pierre Lehmann of the International Institute of Management Development described as the base case. This, called “Regional Ties” sees China continuing to grow strongly, averaging 7.5%, but with the emphasis on trade with Asia.

Trade with the rest of the world is hit firstly by a sharp American slowdown and secondly by protectionism. Both look plausible. Protectionism is already evident in Peter Mandelson’s bra wars and shoe wars with China on behalf of the EU.

In Brussels and Washington protectionism is never far below the surface, particularly as far as China is concerned. If it increases it will have the effect of depriving European and US consumers of the China effect of falling prices.

Protectionism is not, of course, one-way traffic. China has just introduced media rules which discriminate against foreign businesses. The Chinese authorities have said they are examining controls on imports where local firms are subject to “unfair” competition. Many UK exporters will be shaking their heads in disbelief at that.

So protectionism could be the biggest risk. Left to its own devices, the China effect has many years to run. Protectionism, if allowed to take hold - and the collapse of the Doha world trade round was a pointer - could see this era of globalisation begin to run into the sand, and deprive the world of its contribution to low inflation.

China would probably do pretty well, even in these circumstances. For the rest of us, things might not be so good.

PS Pointed question. Has a Labour chancellor of the exchequer ever become a successful prime minister? Answer: No. This may be unfair on Gordon Brown, because the sample is only one. It may be unfair on the one, the late Jim Callaghan, who inherited an appalling economy from Harold Wilson (Callaghan had been chancellor some years earlier), improved things for a while but left office under the cloud of the 1978-9 winter of discontent.

Across all parties. some great prime ministers served as chancellor, includingGladstone (more than 12 years at the Treasury), Churchill (poor chancellor, good prime minister) and Lloyd George, who did both jobs pretty well. Harold Macmillan also made the transition. Aside from Callaghan, the only recent holder of both posts is John Major. When chancellor, he coined the phrase “if it isn’t hurting, it isn’t working”, then found life as PM painful.

So Brown has all to play for, assuming he makes it through the front door of No.10. His chancellorship is drawing to an end on an unhappy note. The “misery index” - a measure of economic wellbeing arrived at by combining the unemployment and retail price inflation rates stands at 9. It was last this high in March 1999 and higher in June 1998. Who said things could only get better?

From The Sunday Times, September 17 2006


Agree David, the protectionists are short sighted. If our clothing, frilly chinese underwear and trainers go up in price then so does our CPI. Which in turn exerts upward pressure on rates, which exerts downward pressure on us.

Surely the protectionist crowd must know this, or do they? If they do then why do they pursue such a policy? Is it to satisfy their politcal stakeholders and further their own careers? Are the Spanish textile firms etc and supporting politcal clout going to compromise us all?

Posted by: werewolves at September 17, 2006 11:56 AM

Interesting stuff, David. Radio 4 had an interesting, if one sided, programme about Chinese commerical espionage in the US. It was, in parts, a thinnly veiled attack on China's pilfering of US intellectual property for its own ends. Stuff like this will only add to the protectionist lobby's armoury.

The Economist has had some interesting thoughts on globalistaion over the last couple of weeks. A keen advocate of globalisation, they also noted that there are winners and losers in Western countries. For the top echelons things have been tickety boo, but for Joe average and below things haven't been so pretty. Their view is that without better mechanisms for sharing the benefits, the malcontents will grow in number and influence. All grist to the mill for protectionist politicians.

Posted by: Tom at September 18, 2006 09:43 AM


"A simple calculation will tell you that if China's exports are growing at 30%, and exports account for 30% of GDP, then the growth in exports alone will increase GDP by 9%. But hold on, that's how much China's entire economy is growing! So where is the internal demand? Where is the Chinese consumption that will propel base metal prices? Either the World Bank's data is completely useless, or else China's economy is far more dependent on exports that what some people think"

Posted by: Dan at September 20, 2006 01:45 PM

The total US$ volume of Chinese exports to the US in 2003 was $92 billion while the US GDP for 2003 was $10,948.5 billion. With an impact of a staggering .8%, I think Chinese imports effects on the US rate of inflation are fairly insignificant. With an economy the size of the US, China is nothing more than a fringe player. I'm sure more recent data is available but I doubt it would mean anything different. Is it really any different in England?

Posted by: Gary Bezowsky at September 25, 2006 06:38 AM

Fair point. In the case of the UK, Chinese imports are about £12 billion, in a £1,200 billion plus economy. The argument would be that the China effect goes beyond this, by imposing constraints on domestic price-setters as well as other countries

Posted by: David Smith at September 25, 2006 11:59 AM

Certainly China does pose some competition for domestic and international producers but it is hard to believe that with such an insignificant share of the economy it's really in that many markets to have much influence. The march of technology is really in play for all aspects of the economy. Prices march downward across the economy absent debasing the currency or the distortions of big government interference.

I think China is only the latest candidate for the blame game. We have our own US idiots in the Senate bashing China and they represent both political parties (Schumer and Graham). We'd be better off watching the growth of the money supply, lowering marginal tax rates and reducing the role of government in the economy.

Posted by: Gary Bezowsky at September 25, 2006 05:12 PM