China’s economy has shifted from export-led to domestic-led growth, with net exports – a component of GDP – not having contributed to economic growth since 2009 (Chart 1). Trade (i.e., imports plus exports) and exports account for about one-third and 18% of GDP, respectively, having peaked at 64% and 35% of GDP, respectively, in 2006 (Chart 2).
China’s total external exposure to the world peaked at around the same time, when its external surpluses topped out at more than 10% of GDP (Chart 3). Meanwhile, domestic consumption has been contributing more than 60% of GDP growth since 2015 and the trend is rising, albeit very slowly (Chart 4).
Sources: CEIC, BNPP AM (Asia)
Some data seems to show that China’s opening-up process has been losing momentum, raising concerns about Beijing’s policy focus turning inwards in the future. After joining the World Trade Organization in 2001, China cut its average tariff rate by more than half from 16.0% to around 7.0% in 2014. But by 2016, this had edged back up to 8.0% – more than double the US and European average (Chart 5).
Invisible barriers to foreign investment, especially in the services sector, have remained high, and the government launched its high-profile “Made in China 2025” industrial policy in 2015, which sets policy preferences for domestic conglomerates in 11 of 23 high-priority sectors.
Sources: CEIC, BNPP AM (Asia)
China’s national security concern and risk to the world
Meanwhile, US President Donald Trump’s “American First” approach has increasingly been seen by China as hostile to its ascent in the global system. On the one hand, this could create a benign unintended consequence for China by rallying more internal support for President Xi’s structural rebalancing efforts. On the other hand, China’s hardliners could hijack this perception of hostility and push for defending national security and reversing the opening-up policy.
The risk is that an aggressive US foreign policy could prompt aggressive Chinese resistance that could have adverse global effects, creating a spiral of contraction in global trade and investment dynamics. Rising Sino-US trade tensions are already raising concerns that slower growth in China, Europe and the US this year could lead to a global recession.
Meanwhile, some Chinese national security hawks have ‘demonised’ the Belt and Road initiative (BRI), forcing Beijing to scale back on this ambition. The slowdown in the BRI will inevitably choke off one of the world’s few resources of development finance for much-needed public infrastructure and goods in a number of developing countries.
No turning back
Nevertheless, an increasing autocratic China is not likely, in my view. From a self-interest perspective, since China is a major export market for many Asian economies, closing itself off would hurt its neighbours’ economies, thus destabilising its own backyard. This, in turn, would hamper Beijing’s ambition to become the regional leader in Asia with global influence, which is one of the goals that President Xi wants to achieve by 2049 in his “Chinese Dream”.
Furthermore, a reduction in trade could erode the reform momentum China needs to weed out the inefficiencies in its economy. Beijing has already slowed its debt reduction and structural reform efforts since last July to protect growth in the face of the trade dispute with the US. If it were forced to pump-prime the domestic sector further to make up for the trade losses due to an inward policy, that could derail its debt reduction and reform plans. Closing itself off would also erode the incentive stemming from foreign competition to overhaul the state-owned enterprises (SEOs), whose return on equity is less than half that in the private sector.
Despite the fears about China overtaking the US as the world technology leader, the fact is that it remains dependent on foreign technology. More than half of China’s technology imports come from just three countries – the US (27%), Japan (17%) and Germany (11%), despite its efforts to boost domestic innovation. Turning inward would not only reduce these technology imports but also limit investment and know-how from the multinational corporations operating in China (including JVs), which employ about 14 million Chinese workers and account for about 40% of China’s exports. In particular, foreign firms produce more than 85% of China’s electronics and almost 60% its machinery. These are the sectors most affected by the Sino-US trade dispute.
In a nutshell, a reversal of China’s opening-up would hurt everyone, including the US, via a domino effect on trade and investment links. Losing access to China’s markets, capital flows and skills would result in slower growth and higher prices in both developed and emerging markets. The costs would be too high for any rational Chinese policymaker to contemplate.
Accelerating the opening-up and reform processes
Indeed, China has tried to speed up its opening up and reform processes since the trade dispute with the US intensified in June 2018. In the second half of 2018, the Chinese authorities approved some significant investment deals, allowing numerous global-name multinationals to set up wholly-owned factories in China or acquire majority (75%) stakes in their Chinese JV partners. These deals were endorsed by senior Chinese officials, including Premier Li Keqiang.
By committing to these high-profile deals by pushing back against vested interests and a reluctant bureaucratic apparatus, Beijing seems to be ensuring that it would not delay or renege on its promises of opening up China’s markets, as it had in the past. In some cases, the policies that would enable these deals to go forward had not yet been fully enacted, but the Chinese government still pushed them through.
For example, while rules allowing foreign life insurers to own majority stakes in their China ventures have yet to be finalised, negotiations for such approvals have already gone ahead. In late November 2018, the insurance regulator approved a leading German insurer setting up the first wholly foreign-owned insurance holding company.
All this seems to suggest that China has finally understood the ‘promise fatigue’ among foreign investors and is trying to correct the problem. These recent moves complement Beijing’s other policy measures, especially tightening up on its industrial production protection policy, to address the developed world’s complaints about China’s structural behaviour.
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 See “Chi on China: Structural Rebalancing – Part I: The External Sector”, 3 July 2013, and
“Chi on China: Structural Rebalancing – Part II: The Domestic Sector, 16 July 2013, and
“Chi on China: Progress on China’s Structural Rebalancing and Reverse Migration”, 8 November 2017.
 See “Unintended Consequences of the Sino-US Trade Conflict (part I) ”, 8 November 2018.
 See reference in footnote 2.
 See “The Making of a 2020 Recession and Financial Crisis”, by Nouriel Roubini and Brunello Rosa, Project Syndicate September 13, 2018.
 See “China megatrends: Belt & Road Initiative raises spectre of ‘debt-trap finance’”, 16 October 2018.
 See “If the renminbi breaks the 7/USD threshold – well, so what?” 6 November 2018.