Inter-American Development Bank Integration and Regional Programs Department (INT) Research Department (RES)

The Emergence of China: Opportunities and Challenges for Latin America and the Caribbean

Coordinators: Robert Devlin, Deputy Manager (INT) Antoni Estevadeordal, Principal Economist (INT) Andrés Rodríguez (RES)

An increasing importance in world trade…

Growth of Trade: China vs. World (1970 = 1)

160 140 120 100 80 60 40 20 0 19 70 19 72 19 74 19 76 19 78 19 80 19 82 19 84 Source: IMF.

19 86 Year 19 88 19 90 China Exports 19 92 19 94 19 96 19 98 China Imports 20 00 20 02 World Exports

Liberalization of China’s Trade Policy Regime

MFN Tariff Liberalization (unweighted averages)

50 25 20 15 10 5 0 45 40 35 30 CHINA WTO ACCESSION 19 85 19 86 19 87 19 88 19 89 19 90 19 91 China 19 92 19 93 19 94 19 95 Latin America 19 96 19 97 19 98 19 99 20 00 20 01 20 02

China as a Market…

Top LA Exports to China

BRAZIL: Soya beans CHILE: Refined copper, unwrought ARGENTINA: Soya beans BRAZIL: Iron ore and concentrates, not agglomerated ARGENTINA: Soya bean oil BRAZIL: Iron ore agglomerates CHILE: Copper ores and concentrates CHILE: Chemical wood pulp, bleached ARGENTINA: Leather of other bovine cattle 0

Importer Rank

Mkt. Share(%)

2002

200,000 400,000 600,000 800,000 Thousands US Dollars 1,000,000 2 (37) 1 (43) 3 (26) 2 (25) 1 (60) 1 (51) 1 (24) 4 (11) 6 (5)

Competing with China in Global Trade

A highly diversified export basket

800 700 600 500 400 300 200 100 0 OECD United States

Export Concentration Index

2002 LAC Mexico Argentina Chile China 2002

Comparing Chinese and LAC Export Structure by Technological Content

China 1987 China 2002 LAC 1987 LAC 2002 0% Primary prod.

Low-tech manuf.

Other 20% 40% 60% 80% 100% Resource-based manuf.

Medium- and high-tech manuf.

China as a whole is extremely labor abundant…it should compete with the world’s lowest wage countries

CAPITAL US LA CHINA LABOR

But China’s provinces exhibit substantial endowment heterogeneity…Shanghai may compete with some OECD countries!

CAPITAL US LA

Shanghai

CHINA

Guizhou

LABOR

Market Share in the US (Manufacturing)

100 90 80 70 60 50 40 30 20 10 0 1972 OECD 1981 Latin America 1991 Asia (incl. China) 2001

Product Penetration in the US Market (Manufacturing)…

Number of Products in the Manufacturing Sector 1972 6,136 goods 2001 13,242 goods

40 30 20 10 0 100 90 80 70 60 50 OECD Latin America China OECD Latin America China

Product Penetration in the US Market (Manufacturing)…

Number of Products in the Manufacturing Sector 1972 6,136 goods 2001 13,242 goods

100 90 80 70 60 50 40 30 20 10 0 OECD Latin America China OECD Latin America China

Product Penetration in the US Market (Manufacturing)…

Number of Products in the Manufacturing Sector 1972 6,136 goods 2001 13,242 goods

100 90 80 70 60 50 40 30 20 10 0 OECD Latin America China OECD Latin America China

30 25 20 15 10 5 0

Head-to-Head Product Competition with China in the US Market…

Export Similarity Index

1972 1981 1991 2001 OECD S.E. Asia Latin America

Head-to-Head Product Competition with China in the US Market…

Export Similarity Index

25 20 15 10 5 0 Mexico Brazil Costa Rica Argentina Chile 1972 1981 1991 2001

FDI Competition?

The Surge of FDI to China

 There is a surge of FDI to China  This due to China’s clear competitive advantages and recent reforms, most recently WTO accession  Should Latin America be concerned?

Should Latin America be Concerned?

 Conceptually, reforms that allow FDI in a country such as China could divert investment…  But magnitudes would be small… at most 4% reduction in FDI flows to the region  But it could be that some countries are affected more than others…

Are Some Countries More Likely to be Affected?

 FDI competition may be stronger across countries with same FDI sources  It may also be stronger across countries that get FDI in the same sectors… … especially if these are traded sectors

FDI sources differ greatly

 A comparison of sources of FDI in Latin America and China reveals large differences: – FDI to China is predominantly from Asia – FDI to Latin America is predominantly from U.S. and Europe  The reduction in investment flows from general FDI competition is thus likely to be even lower than the 4% mentioned earlier… … Asian countries (e.g., Korea, India) have much more to worry!

FDI sector coincidence varies greatly across countries

0.7

0.6

0.5

0.4

0.3

0.2

0.1

0 Korea Mexico India

FDI Sector Coincidence Index

Brazil LAC Argentina

A Case Study

 Are multinationals in L.A. moving to China?

 A survey in Costa Rica: representative sample of 41 MNCs out of a total of 100 in the EPZ system  Two MNCs said they were moving to China  The threat is in sectors that rely on cheap labor and inputs coming from Asia  Countries whose main advantage in attracting FDI is low wages should be most concerned

Summing Up

 Overall FDI competition is modest  Main competition is for countries in Asia  L.A. countries that will be more affected are those specializing in exports dependent on cheap labor (e.g., Mexico, Central America)

The Future of Textiles in Latin America

 Several countries in L.A. have experienced high growth in exports of textiles and apparel to U.S.

 This has been one of the main sources of new formal jobs in several countries in CA  Unfortunately, this growth was a result of preferential access to the U.S. market that is about to be considerably weakened  January 2005: elimination of remaining U.S. MFA quotas on textiles and apparel  What will happen? What should be done?

A Snapshot of the Current Situation

 “The region” (Mexico, CA, DR) is heavily oriented towards the U.S., and is based on maquila (little vertical integration) and low wages  China is tremendously competitive: it has much lower wages and is vertically integrated (cluster)  When U.S. has removed quotas on some items recently, China’s share of the market has boomed

Advantages and Opportunities

 The region has two advantages: geography and market access  But NAFTA and CAFTA are not enough: tariff preference is small compared to cost gap with China  Differential transport costs represent a small advantage  The best opportunity is a large difference in the

time

it takes to ship the product to the U.S.

– Specialize in product lines where “speed to market” is critical

Policies

 Avoid protective measures and allow market to come up with solutions that take advantage of region’s advantages (geography, market access)  Policies (may require sub-regional cooperation): – Customs facilitation with U.S. and within region – Infrastructure (roads, ports, electricity) – Long term capital – Specialized human resources (engineering, design, marketing, procurement, etc.)  In addition, promote export diversification

Conclusions

China The Market: Opportunities for Latin America

 Systemic Factors – New Stimulus to Growth of World Economy in Face of Sluggish or Uncertain OECD Growth – Openness and X  M – Cost Effective Supply Finished Goods and Inputs – Savings Finance U.S. Treasury Bonds and Help Keep International Interest Rates in Check

China The Market: Opportunities for Latin America

 Latin America Specific – Bouyant World Commodity Prices – 1.3 Billion Consumers; Demand for • Agriculture and processed foods • Raw and processed materials • Services, especially tourism – FDI • Host (e.g. Embraer) • Source (e.g. Shanghai Bao Steel) – Cooperation • Support for multilateralism (e.g. G-20) • Policy best practices • Interchange (education, sciences and technology, etc.)

China The Competitor

 Endowments Give China Competitive Edge in Low, Medium and High-Tech Manufactures  Long-Term Policy Drivers of Competitiveness – Education • Small surplus in “predicted” secondary enrollment (L.A. has big deficit) • Like L.A., deficit in terciary but – Extremely high per student expenditure ratio for terciary education – Scale: 1.3 million graduates of higher education – 45% in science and engineering – World competitive test scores – Innovation • R & D researchers and patent applications in U.S. > L.A.

• R & D expenditures % GDP > 1% (> L.A.) • Absolute R & D expenditures  South Korea – Investment (incl. Infraestructure)

Coping with Chinese Competition

Coping with Chinese Competition

 China’s (and S.E. Asia) Success Raises Anxiety over Current and/or Future Competition – Intensify Criticisms of Washington Consensus?

– Risk Protectionist Backlash?

 A Better Response: Treat China as a “Wake-up Call” to Rethink Development Policy  L.A. Does Not Face Challenge Unarmed – During Reforms Acquired or Reinforced Assets to Compete – Must Strategically Combine Existing Assets and Create New Ones to Become More Offensive Player in Global Economy

Towards a Policy Framework to Compete

 A Public-Private Alliance  National Social Process  Horizontal and Vertical Policies

A Public-Private Alliance

 Goal: A Constructive Partnership Between Public Sector and Private Sector  A Requirement: A Government with a Capacity to Engage the Private Sector in Pursuit of Policies to Compete – Long-Term Strategic Focus (strengths and weaknesses) – Experimentation – Learning – Development of Capacities  Focus: Identifying and Overcoming Market Failures that are a Binding Constraint

A Public-Private Alliance

 Bottom Line – China and East Asia Successes not based on purely market forces – Few Economic Success Stories are Entirely a Market Phenomenon – No Formulas for Proactive Policy –local creativity and adaptations – But a Strong State with Focus on Support of Industrial Diversification and Upgrading has been Important in China and East Asia Generally – Don’t Forget Services

Strategic National Social Process

Strategic National Social Process

 Start a National Social Process – Create Space for Active Collaboration Between Public and Private Sectors – Work Towards Forward Looking and Focused National Policy Framework to Compete Globally – Process Must Allow for Competition of Interests, Visions and Capacities in the Private Sector (broadly defined) – Government Must Ultimately Arbitrate with: • Predictability • Transparency • Accountability • Technical Criteria • Test of the International Market Place

Strategic National Social Process

– For Longer Term Focus Governments Need More Fiscal Space, Public Savings and Strengthening Public Sector Human Resources – Gradualism • All Governments Have Some Capacity to Engage in Intervention and Alliance Building • Try Pilot Programs First that Allow for Tests Against the Marketplace, Learning and Adaptation. • The Weaker Government Capacity, the Fewer and Simpler the Interventions Should be Until Capacity Develops – Beware of Unproductive Rent Seeking and Corruption – But Risks of Rent Seeking Lower than Past When • Protectionism much higher • Competition minimal • Little or no democracy • Little government accountability

Horizontal and Vertical Policies

Horizontal and Vertical Policies

 Horizontal Enabling Policies not Controversial  Vertical Policies are More Controversial Because of the need for Selectivity – Governments cannot intervene in all sectors – Fiscal resources are scarce – Public sector human resources limited

Horizontal and Vertical Policies

 Choosing Sectors for Support – Some Considerations – Support investment in activities that are socially very beneficial but unlikely to happen without public action – Selection of sectors not “picked” by government – must emerge from national social process

Horizontal and Vertical Policies

– Requirement: Cooperation from private sector Associations which have market based knowledge and experience – Sunset and performance clauses for support programs

Some Policy Areas to Support Industrial and Services Upgrading and Competitiveness

Dealing with the Dutch Disease

 What is it?

– A market failure – Happens when high commodity prices push economy away from more knowledge-based non-traditional agriculture and manufacturing  What to do?

– When systemic could tax commodity to finance support for diversification • Chile proposal: tax copper and use for an “Innovation Fund for Competitiveness”

Provision Public Goods

 Intervene to Overcome Classic Coordination Problems in Supply of Public Goods and Services Critical for Growth of Sectors – Overcoming free riding problems – Infrastructure – Identifying and supporting strong complementarities (e.g. hotel-airports)

Education

 Recent Emphasis: Primary Education  More Emphasis: Secondary and Higher Education – China’s advantage in low wage labor raises skill premium in Latin America – More focus on secondary and higher education deficits for supply of skilled professionals and development of R & D capacities – Upgrade curriculums (math, science and engineering) – Collaboration between universities and private sector for curriculums and research – More Equality of access

Export Development and Investment

 Need more than macro stability, financial deepening, property rights, etc.

– Specific support for discovery/investment/activities where social benefits of spillovers > benefits to single entrepreneur – Mechanisms = market credit, grants, specialized promotion agencies and programs for discovery of export markets, investment, and attraction FDI – Competitive real exchange rate – Predictable rules of the game for investors – role of investment contracts – Transport systems and infrastructure (scale, hub & spokes, etc)

Innovation

 Innovation activities generate substantial externalities and are under-produced by market  Horizontal policies like IPR and across the board corporate tax breaks not enough – Shift attention from traditional improvement of supply capacities to promoting demand driven innovation – Make supply relevant to demand – Focus support in universities and research centers on existing industry groups with comparative advantage – Support public-private collaborative innovation in potential cluster areas

Role of Economic Integration

 Regional Integration: Subregional; Latin America; Interregional FTAs (FTAA, EU, U.S., Japan).

 Regional Markets facilitate – Scale – Agglomeration – FDI Attraction – Reduce distance (tariffs and preferences, transport and search costs) – Cooperation (education, R & D, X promotion, clusters, joint negotiation, etc.) – But be careful of overly restrictive rules of origin  Role of WTO: Leveling Playing Field with China – Market Opening – Rules – Dispute Settlement