What are the Issues?

The East Asia region, encompassing Southeast Asia, has been undergoing a process of ‘natural’ economic integration with the growth trade and investment between countries of the region. In recent years, however, much has been made of the economic impact of the re-emergence of the People’s Republic of China (PRC) as a regional (and indeed global) economic power. In the neighbouring countries of East and Southeast Asia the threat from Chinese competition is feared at least as much as the opportunities created by its rapid growth are welcomed. What is the economic theory of this and what do we know from empirical studies on the likely balance of effects? This chapter first addresses the conceptual issues before turning to the evidence.

At a static level conventional trade theory implies that having a large neighbour growing rapidly over an extended period of time, whilst unilaterally lowering its barriers to trade through its WTO accession and contemplating further reductions through its entry into various regional free trade agreement can only be strongly positive for regional economies.¹ This freeing of trade with PRC will allow specialization on the basis of comparative advantage. How far different partners will benefit depend on their trade and production structures and how far these are complementary to those of PRC.

As a large economy with a strong FDI presence PRC can produce a great variety of goods from the simple to the highly sophisticated in a technological sense. This is sometimes seen as posing a threat to a wide variety of industries in the region. However standard theory says it is impossible by definition for PRC to have a comparative advantage in everything and that it is comparative not absolute advantage that matters in determining trade flows. Labour in PRC may still be cheap in an absolute sense, but what matters in terms of determining comparative advantage is its cost relative to the cost of capital and land. Economic efficiency in PRC will be determined by the relative scarcities of its factors of production (their ‘opportunity costs’), not by their efficiency in comparison with factors elsewhere. Furthermore within different categories goods from the simple to the most sophisticated, there will be goods in which PRC will specialize, whilst importing others from its trading partners in the region.

From this perspective possible loss of market share either in domestic or export markets should not pose a threat to regional producers, if they can shift to other products where their comparative advantage is greater. In theory if wages and prices adjust flexibly to demand and supply factors there can be no long-run problem for PRC’s regional partners. If export markets for one activity are lost, provided prices and wages fall the relative attractiveness of this activity for investors will also decline and if there are no supply side constraints resources will move into other more promising lines of production, where comparative advantage is greater. Hence conventional trade theory sees absolutely no cause for concern in the region over ‘PRC’s re-emergence’ and many new trading opportunities.

The story becomes more nuanced once we allow for dynamic considerations. Here PRC’s emergence can be seen as part of the broader process of globalization, defined loosely as the expansion of trade and international capital flows in response to the liberalization of international commodity, service and financial markets and the decline in transport and communications costs. The picture regarding specialization becomes less clear once one introduces the possibility of cumulative gains in efficiency over time arising from learning by doing and economies of scale.

Now ‘first mover advantages’ can be important so if an industry is established in one country its comparative advantage and competitive strength will grow relative to late-comers. Hence both history and geography, that determine where an initial production centre emerges, can influence long-run trade patterns. To these concerns can be added realistic assumptions about the inflexibility of economies, since with price and wage inflexibility and real world barriers to entry in various markets there can be no guarantee that resources can shift readily from declining to expanding sectors in response to changing comparative advantage. Hence the more inflexible is an economy the greater is the potential risk from trade competition.

From this dynamic perspective in relation to PRC’s regional economic impact there are both positive and negative forces to be assessed and the net outcome will be an empirical question. On the positive side we have what we can term a ‘demand effect’ and a ‘production specialization effect’. In relation to demand a strongly growing Chinese economy will create a market for regionally produced goods. In addition this growing market allows regional specialization with neighbouring economies either building on an existing comparative advantage relative to PRC (for example in primary commodities like foodstuffs and raw materials) or developing new niches (for example in the supply of parts and components for goods assembled in PRC as part of global production networks).

The negative side arises from what we can term a ‘competitive effect’. Here PRC’s growth may create difficulties for its neighbours in a number of ways. Rapid expansion of Chinese exports may erode neighbors’ market share (either domestically or in third countries) and this will potentially lower income, where two conditions hold; first where increasing returns to scale and dynamic externalities are important, so that output expansion is cumulative and once market share is lost it is difficult to recapture and second where resources are inflexible, so new opportunities are not taken advantage of. Given the size of the Chinese economy there may also be competitive price effects, where PRC’s demand for natural resources (such as energy products and metals) is strong enough to raise world prices and thus increase the import prices neighbouring economies have to pay (that is a negative terms of trade shock).

Finally, and potentially most significantly in the eyes of many observers, PRC may be competition with many of its neighbors for the receipt of capital inflows, particularly FDI. FDI is seen by many as a catalyst for development principally due to the technology, management and marketing expertise that it is judged to bring to recipient economies. If FDI flows to the region in any year are limited, then increased receipts by PRC will be at the expense of others and competition to attract foreign firms will be a ‘zero-sum game’ with the success of one country at the expense of others. This is the opposite interpretation from the production specialization story, where with FDI driving the spread of global production networks, with genuine specialization and an emerging regional division of labour, FDI to one country may be complementary to, not competitive with, FDI to its neighbour.

Assessing the validity of these arguments requires detailed empirical analysis. We do not yet know all of the answers, but a body of empirical work now exists. In the following sections we survey this empirical literature selectively. To organize the discussion we focus on the evidence on demand, production specialization and competitive effects separately, although in principle they may be related and isolating their impact will be difficult.

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1. Kazi Iqbal Sayeed
   (posted 03 September 2005 / 07:09:19 PM)
   
   Just define the way exactly you want to fetch results from and proceed it with 100 %. That's all that makes a pattern of success. Thank you.
   - Kazi I.S.