The next dimension for EU-China relations

Statement by Gertrude Tumpel-Gugerell, Member of the Executive Board of the ECB,
Roundtable “Charting China’s impact on the world economy”,
Brussels, 19 April 2005

Ladies and gentlemen,

During a recent visit to China, I had the wonderful opportunity to stay briefly in Xian, the end point of the Silk Road. I remember looking down the tiny road as it disappeared over the horizon, taking travellers on a journey across thousands of kilometres and through many inhospitable landscapes. I was overcome by a feeling of deep respect for the generations of traders who – despite the enormous strains and difficulties that the journey entailed – had made this path the crucial link between China and Europe for some time.

Fortunately, exchanges between China and Europe are much easier nowadays. And I am particularly grateful that many descendents of those bold traders of ancient times have been able to make it here today. However, when we discuss contemporary EU-China relations, we do so against the backdrop of intense domestic debates in the EU about China’s emergence on the global economic stage. This includes questions such as:

  • Does competition from China pose a threat to our economy?

  • Have China’s rapidly growing exports already crowded out European exports in third markets?

  • Should the EU adopt legislation, as the US Senate is expected to do by July this year, that would increase tariffs on Chinese imports unless China agrees to revalue its currency?

There is no question that China’s performance in international trade since the mid-1980s has been remarkable, especially since China joined the World Trade Organization in November 2001. This development has also had a significant impact on the rest of the world. Between 1990 and 2003, in the euro area, the value of imports from China has increased by eight times, and the value of exports to China has increased seven-fold. In particular, China’s share in euro area imports rose from 2% to 7.5% in the same period.

Does this mean therefore that we Europeans should just look at ourselves as net losers in the process of competition with China? Or are we facing unique opportunities that we can take advantage of?

I would like to address this issue by first looking at past and present developments, and then at possible future trends. In doing so, I will focus mainly on trade and FDI relations between China and the euro area.

A close examination of the performance of the main trading blocks over the past 20 years shows that the trade share gains recorded by China were accompanied by a significant loss by Japan. In terms of euro area imports, for instance, Japan’s share declined from 11.5% in 1985 to 7.9% in 2003. Losses were also recorded by a few other Asian economies. On balance, the market share of the Asian region as a whole with trading partners outside the region has remained broadly unchanged in markets such as the euro area and the United States.

But why has the increase of China’s market share in third markets gone together with a decline in the market share of the rest of Asia? The main reason is that a growing number of firms in other Asian economies have relocated their final assembly sites to China, and export final products from there. Production in the region has been described as being akin to a single production line: and by that I mean that there are sites of high skill and productivity, such as Japan and South Korea, that provide the most technologically sophisticated goods and components, with the more labour-intensive products being produced in locations such as China. As many of the exports are component-intensive (such as electronics, in which the Asian region excels), much regional trade is intra-industry trade in intermediate goods.

Data also show that euro area exports have not been severely affected by the emergence of China as a trading party in the world economy. The share of euro area products in the imports of major partners has remained broadly unchanged, except for a slight decline in China and a few other Asian tigers.

In this regard, it is interesting to observe that while US exports have a smaller market share in the Chinese market than euro area exports, Chinese exports constitute a larger share of US imports than of euro area imports. This difference, which is of course reflected in different bilateral trade balances, may help us to better understand why the implications of China’s competitiveness is debated much more frequently in the United States than in Europe.

One may object to these arguments in saying that the real challenge comes from China’s high-tech exports, which have increased dramatically over the past two decades. In 2000-01, these products accounted for 28.7% of total Chinese exports, compared with 4.4% in the period 1985-89. However, the main reason for this rapid increase is that the final production stage has been transferred to China from industrialised economies, while the actual Chinese value added is still estimated to be relatively low. As a result, the subsidiaries of multinational firms still account for the bulk – nearly 90% – of total Chinese high-tech exports.

Over the medium term, however, China is expected to climb the technology ladder rather quickly, aided partly by the dissemination of technology and management skills due to foreign direct investments. The enhanced technological capability of Chinese products can already be seen from the angle of the product composition of the euro area’s imports from China. More sophisticated goods from China, such as office machinery and telecommunications equipment, have experienced a significant increase in euro area’s imports over the past five years, even though traditional and more labour-intensive goods – such as handbags, clothing and footwear products – remain the main import items.

These considerations lead me to draw an initial, preliminary conclusion. Although Chinese exports, if seen as part of the Asian production and export chain, may not yet represent a strong threat to euro area competitiveness, the further progress expected, in terms of both an FDI-induced upgrade of Chinese exports and the catching-up of local firms, will be an important test for the euro area (and, I believe, EU) economy in the years to come.

While correct per se, this conclusion does overlook the full picture of Europe’s economic relationship which China; a picture that also includes clear opportunities. Let me give you two examples:

  • First of all, as incomes in China and, more generally, emerging Asia rise, the region is increasingly developing into a target market for final goods in its own right. China is becoming a key player in the global economy, not only on the supply side, but also on the demand side. It is the seventh largest economy in the world in terms of nominal GDP, and it already ranks second in purchasing power parity (PPP) terms. Its demand for imports is already one of the main engines of export growth in countries such as Japan and the emerging economies in Asia and Latin America. And it is estimated that China contributed around one-quarter of world GDP growth in PPP terms in 2001-03.

  • Second, with regard to foreign direct investment, it should be noted that, although the bulk of FDI flows to China still originates from other Asian economies, the EU countries together accounted for 7% of such flows last year. European FDI has recently gained important ground in some of the fastest growing sectors servicing the domestic Chinese market, such as the domestic car industry, where European firms are amongst the leading players. This is good news for the future of such firms.

Based on these considerations, my general assessment is that China should be understood primarily as a challenge to the European economy. This means that future developments will depend to a large extent on the actual behaviour of all European parties involved – with protectionism being neither a proper nor a useful avenue. These parties involve citizens as well as firms, trade unions and policy-makers. However, the process includes also the Chinese authorities in charge of macroeconomic stability, as China is currently playing a fundamental role in both the accumulation and financing of global external imbalances, and is considered equally important in view of the adjustment of such imbalances. This was recognised again at the recent IMF and World Bank Spring Meetings and reiterated in statements by the G7 and the International Monetary and Financial Committee – emphasising “that more flexibility in exchange rates is desirable for major countries or economic areas that lack such flexibility”.

Having said all this, it should come as no surprise to hear that, in recent years, the ECB and the Eurosystem have intensified both their analysis of China and their relations with the Chinese authorities. The ECB now has a well-established high-level policy dialogue with the People’s Bank of China. Both institutions have made considerable progress in terms of encouraging dialogue between staff, for instance through joint seminars, workshops, cooperation in the field of training and staff exchanges.

Only by having more exchanges and more discussions, like today’s conference, can we improve the understanding of China here in Europe, which in my view is paramount to dispelling fears and misconceptions.

Thank you very much for your attention.

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