If current trends continue, China may emerge as the world's largest economy by 2020.

Discuss the possible implications of such a development for

(! "he world trading system.
(2! "he world monetary system.
(#!"he business strategy of today's $uropean and %.&. based global corporations.
('!(lobal commodity prices
Answer:
The world trading system would clearly be affected by such a development. Currently China
enjoys a somewhat privileged status within the World Trade Organization as a developing
country. !uch a rise to eminence" however" would clearly force it to become a full and e#ual
member" with all the rights and responsibilities. China would also be in a position to actively
affect the terms of trade between many countries. On the monetary front" one would e$pect that
China would have to have fully convertible and trading currency" and it could become one of the
benchmar% currencies of the world. &rom the perspective of Western global firms" China
would represent both a huge mar%et" and potentially the home base of some very capable
competitors. &inally" commodity prices would probably fall.
a) The world trading system
The impact of one economys growth on the world economy is transmitted through its impact on
the terms of trade - which depends on the bias of its growth. (Hicks 19!" #orden 19$"
%hagwati" 19&). 'n #hinas case there appears to ha(e been a strong e)port bias" so that #hinas
growth has most likely caused an impro(ement in the terms of trade for its trade partners (*miti
and +reund ,--&" Harris et al ,-1-).
*n e)tensi(e literature e)ists trying to assess the .uantitati(e implications of these two effects on
trade flows" (*hearne et al. ,--!" /all and *lbalade0o ,--122 3oland-Holst and 4eiss ,--"
#o)head ,--5" 6ichengreen et al. ,--5" *thukorala ,-1-" Hanson" and 3obertson ,-1-). 7(erall
the e(idence is mi)ed. +or e)ample /all and *lbalade0o (,--1) find e(idence of strong
competiti(e effects but Hanson" and 3obertson (,-1-) find that" for the countries with the most
similar trade patterns to #hina" its growth represents only a small negati(e shock in e)port
demand. 6ichengreen et al. (,--5) find positi(e effect on the e)ports high income *sian
economies that are significant e)porters of capital goods" and a strong negati(e effect on low
income *sian countries that are dependent on the production and e)ports of consumer goods.
*thukorala (,-1-)" howe(er" argues that these studies fail to take account of the comple) *sian
production networks. He finds that #hinas e)ports to third country markets ha(e had
'
complementary effects on *sian e)ports due to the effect of components trade" and that the
impact of #hinas growth on *sia is o(erwhelmingly positi(e.
*nother limitation of this gra(ity literature is that it is focused on trade flows only. To that end
4ood" and 8ayer (,-11) use on a factor content approach" familiar from the 9trade-wage:
literature" to e)amine at the impact of #hinas emergence on industry composition in other
countries. They argue that an upper estimate of the effect of a world with #hina" relati(e to one
without out it" would be to increase the world share of basic skilled workers by appro)imately
1-;. They find that this would reduce the output shares of other countries primary and
manufacturing sectors by only up to 1-!.;" with the *sian economies being the most se(erely
affected.
'n contrast *utor et al (,-1,) assess the impact of #hinas import penetration on <=*
manufacturing" focusing on not 0ust wage effects but also regional employment effects. They
find that the rising e)posure to #hinese import competition e)plains between !!-; of the <.=.
manufacturing employment decline between 199- and ,---. This is a dramatic contrast with
much of the earlier trade wage literature that found minimal effects on wages from trade in the
<=*" though this can be accounted for the fact that #hina is now much larger than it was when
most of trade-wage studies were undertaken.
b) 4orld monetary
#hina does not allow its currency to float and therefore must make large-scale purchases of
dollars to keep the e)change rate within certain target le(els. *lthough the renminbi (38%)
has appreciated against the dollar in real terms by about 1-; since reforms were introduced in
>uly ,--" some analysts contend that it remains highly under(alued. #hinas under(alued
currency makes its e)ports less e)pensi(e" and its imports more e)pensi(e" than would occur
under a floating e)change rate system. 'n order to maintain its e)change rate target" the
go(ernment must purchase foreign currency (such as the dollar) by e)panding the money
supply. This makes it much more difficult for the go(ernment to use monetary policy to
combat inflation. 8any economists argue that #hinas industrial policies ha(e sharply limited
competition and the growth of the pri(ate sector" caused o(er-capacity in many industries" and
distorted markets by artificially lowering the costs of (arious factor costs (such as capital"
water" land" and energy) below market le(els in order to promote targeted industrial sectors.
=uch policies ha(e come at the e)pense of other (non-industrial) sectors of the economy" such
as ser(ices.
c) the business strategy of 6uropean and <= global corporations
#hinas rapid economic growth and emergence as a ma0or economic power ha(e gi(en #hinas
leadership increased confidence in its economic model. 8any belie(e the key challenges for the
(
<nited =tates are to con(ince #hina that it has a stake in maintaining the international trading
system" which is largely responsible for its economic rise" and to take a more acti(e leadership
role in maintaining that system2 and that further economy and trade reforms are the surest way
for #hina to grow and moderni?e its economy. +or e)ample" by boosting domestic spending and
allowing its currency to appreciate" #hina would import more" which would help speed
economic reco(ery in other countries" promote more stable and balanced economic growth in
#hina" and lessen trade protectionist pressures around the world. /owering trade barriers on
imports would boost competition in #hina" lower costs for consumers" and increase economic
efficiency. Howe(er" many <.=. stakeholders are concerned that #hinas efforts to boost the
de(elopment of indigenous inno(ation and technology could result in greater inter(ention by the
state (such as subsidies" trade and in(estment barriers" and discriminatory policies)" which could
negati(ely affect <.=. '@-intensi(e firms. +ailure by #hina to take meaningful steps to rebalance
its economy could increase tensions with its trading partners" especially if #hinas share of
global e)ports continues to increase rapidly" and if that increase is (iewed as being the result of
nonmarket policies that gi(e #hinese e)ports an unfair competiti(e ad(antage. =ome economists
contend that some economic rebalancing by #hina appears to ha(e taken place in recent years"
noting that #hinas current account surplus as a percent of AB@ declined from a historical high
of 1-.1; in ,--5 to ,.; in ,-1!. 'n addition" pri(ate consumption as a percent of AB@ has
risen annually from ,-11 to ,-1!. Howe(er" many economists contend that much of the
reduction in #hinas current account surplus may largely the result of sluggish global demand for
#hinese products" rather than a significant change in #hinese economic policies. 'n >uly ,-1,"
the '8+ stated that" although the fall of #hinas current account surplus was a welcome sign" the
e)ternal rebalancing was achie(ed at the cost of rising internal imbalancesCnamely the high rate
of in(estment spending" which" the '8+ assessed" would be difficult to sustain.'n addition" gross
fi)ed in(estment as a percent of AB@ grew each year from ,-11 to ,-1!" and continues to be the
dominant source of #hinas AB@ growth.
d) Alobal commodity prices
#hinas unusually fast growing commodity intensity likely reflects the rapid e)pansion in the
tradable e)port sector and large-scale fi)ed asset in(estmentCparticularly since ,--- (Du"
,-11). %oth acti(ities are commodity intensi(e. +or e)ample" De (,--&) estimates that 0ust
o(er E of #hinas copper usage is accounted for by infrastructure in(estment and
construction" with F accounted for by consumer and industrial goods. 't is beyond the scope
of this paper to assess the root causes of #hinas structure of economic growth and the high
commodity intensity that results" but pre(ious studies ha(e highlighted the role of structural
factors and domestic policy distortions ('8+" ,-11a).
#hinas role in international commodity trade only matters to the e)tent that it affects the
relati(e distribution of supply and demand of different commodities across countries. +or
e)ample" #hinas strategic policy decision to stri(e for self-sufficiency in key grains but rely
on imports of oilseeds has likely had ma0or implications for global agricultural trade patterns.
'n terms of broad commodity groups" #hina has come to play a dominant role in base metals
markets and" to a somewhat lesser e)tent" agricultural raw material markets. 'n contrast"
#hina has not yet assumed a large role in global food and energy markets although its share of
world imports is rising gradually.
)
*t higher fre.uencies" #hinas influence on commodity markets will mainly reflect the
business cycle" seasonality" and unanticipated transitory changes in its supply-demand
balance. 'n general" we should e)pect unanticipated shocks to ha(e a larger impact (all else
e.ual)" since market participants may be able to ad0ust commodity in(entories to smooth out
the effects of anticipated fluctuations in supply and demand. *s a result" this paper considers
the effect of unanticipated demand shocks and also lea(es aside supply-side spillo(ers which
may be important in some cases.
*