The Chinese growth engine

As Australia’s economic fortunes continue to surpass the likes of the US, UK and Europe, it is hard to escape a lingering nervousness about what could happen if the mining boom were to collapse. What if the Chinese juggernaut were to falter? Would we be doomed?

Having a conversation exactly like this earlier in the week, I was reminded of a post I wrote more than a year ago which showed surprisingly (to me at least) that exports to China were contributing only 3% to Australia’s gross domestic product (GDP). In yesterday’s Sydney Morning Herald, economist Ross Gittins tried to bring some perspective to the nervous by pointing out that 80% of Australia’s economic activity is domestic and concluded that:

Take away mining and we wouldn’t be quite as rich as we are, but most of the economy would look much the same as it does. Most of us would still have good, secure, well-paid jobs.

Of course, not everyone is taking such an encouraging line. Over on the Mule Stable, one econo-pessimist drew my attention to this interview with hedge fund manager John Chanos, who has been predicting a bursting of the Chinese economic bubble for some time now. As well as showing a very detailed knowledge of China’s construction industry, Chanos notes that were China’s economy to stall, the US would be much better positioned to cope with it than countries like, say, Australia. That was supposed to be good news for American viewers…not so cheering for those of us on this side of the globe!

All of this suggested that an update of the trade statistics was overdue. The results are as one might expect: the contribution that exports to China make to Australia’s GDP has risen from the 3% I noted in August 2009 to almost 4% as at September 2010.

Exports to ChinaGDP from Exports to China (Dec-1988 to Sep-2010)

So, while 4% may still be small compared to the 80% of activity that is generated internally in Australia, the real story here is growth, as the steepness of the chart dramatically illustrates. That increase in exports has contributed almost 1% to Australia’s GDP growth for the year! Here is the rolling annual change in the contribution that exports to China make to Australia’s GDP.

Exports to China - changesAnnual Change in GDP from Exports to China (Dec-1988 to Sep-2010)

Not wishing to forget Gittins’ point that we should consider total contributions to the economy, not just exports, it is hard to resist wondering how many of our exports now go to China. The answer is: a lot and growing.

China export shareChina’s Share of Exports (Dec-1988 to Sep-2010)

So, where does that leave us? Gittins is not wrong, and a collapse in the Chinese economy would not suddenly put everyone in Australia out of work. Nevertheless, it would certainly take a lot of the wind out of our economic sails. Furthermore, given the amount of attention China and the mining industry have in our national consciousness at the moment, it is worth recalling the words of that sage John Maynard Keynes:

Even apart from the instability due to speculation, there is the instability due to the characteristic of human nature that a large proportion of our positive activities depend on spontaneous optimism rather than mathematical expectations, whether moral or hedonistic or economic. Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as the result of animal spirits – a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities.

There is little doubt that if Chanos is right about China, our animal spirits would not take it too well.

Data source: based on Australian Bureau of Statistics (copyright Creative Commons Attribution). Note that all export figures here represent exports of merchandise, so exclude services.

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19 thoughts on “The Chinese growth engine

  1. Senexx

    The Australian dollar is currently overvalued as it is being used as a proxy for China and the devaluation of our dollar from the loss of our growing China exports should help lower domestic unemployment thus rectifying any loss from China. ‘Should’ does not mean ‘will’ though.

  2. Danny

    I don’t think you can look at Australia’s trade with China in isolation. If Chinese growth suffers a setback, that will not just affect how much iron ore, coal, etc. we export to China, but will also hammer commodity prices. Which will affect Australian exports to Japan, South Korea, India, etc. This might double the effects you’ve charted…

    Hugh Hendry is shorting China via the debt of exposed Japanese companies.

  3. Magpie

    Hey Stubborn,

    I largely agree with you and Gittins on this.

    In your case, I find your analysis highly plausible, well informed and measured, and the observations I have are mainly formal (I was a proofreader, remember? And a damned grumpy and annoying one, at that!):

    (1). The first chart’s title has to be wrong: Exports to China as a proportion of GDP (Dec-1998 to Sep-2010). The data starts earlier (I guess you did not proofread it, eh? ;-D).

    (2) When you mention: “That increase in exports has contributed almost 1% to Australia!” I believe what you meant to say is that about a third of the change in GDP growth was due to an increase in mining exports. If I’m right, that is not clear from that line or from the following charts titles.

    This clearly does not affect the quality of the opinion, but it does make it a little harder to grasp the sense.

    In Gittins case, I do have a deeper, more serious, observation: the importance of exports in general to an economy is not only that they allow us to buy imported stuff. They generate a multiplier effect, which is often larger than 1. Falling exports mean that this multiplier effect becomes less potent. In other words: a loss of say X% GDP due directly to mining could possibly be followed by another loss of X%+ in goods and services required by the mining sector. And this extends to employment, too.

    As you can see, that would hardly be the end of the world, but is certainly more meaningful than what Gittins said.

    What I often find irritating, not only in Gittins but also in most other professional economic commentators and journos, is their generally panglossian outlook. It’s like they feel obliged to sell not so much a realistic view of the world (that in this case is not terribly scary), but an overly optimistic view.

    Like when he said: “Take away mining and we wouldn’t be quite as rich as we are, but most of the economy would look much the same as it does. Most of us would still have good, secure, well-paid jobs.”

    Who is this “most of us” who are “rich” and “have good, secure, well-paid jobs”?

    Besides, it’s the media themselves that have oversold this mining boom as the best thing since the invention of sandwich bread.

  4. Stubborn Mule Post author

    Magpie thanks for the proofing: errors duly corrected.

    As for the multiplier effect, I suppose you can take a hit to animal spirits in the even of a China slowdown as a somewhat less scientific way of saying the same thing.

  5. Magpie

    Hey Stubborn,

    Nope, the multiplier effect is an objective thing, that can be measured. And it’s usually in proportion to the change in one stimulus, in this case exports, and affects mostly those industries directly involved, and largely depending on, with export mining: industrial construction and transport come to mind.

    The animal spirits thing, that you correctly pointed out, is different: it doesn’t need to be proportional and doesn’t need to even happen. But if it happened, people could just go panicky big time and the effect doesn’t need to be limited to industries directly related to export mining.

  6. Pfh007

    Considering the extent to which the CCP controls key key industries and enterprises and the extent to which the CCP perceives its poltical control to depend on economic growth there seems little chance that there will be a shortage of commodity intensive investment or consumption. What is far more likely is that the chinese will aggressively encourage new sources of supply to put downward pressure on commodity prices.

    In addition it doesnt really matter if the yuan does not rise against the US dollar if input (labour etc) prices in China are rising. When the world’s low cost producer becomes the world’s rising cost producer we will start to again appreciate the meaning of inflationary pressures and interest rate induced hip pocket pain

  7. Stubborn Mule Post author

    Magpie you are, of course, correct that animal spirits and multipliers are not the same. While much of a multiplier effect has nothing to do with animal spirits (e.g. the knock-on effect on, say, a local tyre manufacturer supplying to the mining industry if that industry were to decline significantly). However, I think that animal spirits effects can contribute to the multiplier, particularly multipliers can be difficult to measure in practice. If you measure it by saying that mining declined by x this month and GDP contracted by x+y (and y includes the result of the confidence decline triggered by the drop in such a high profile sector) then the multiplier (x+y)/x would have been affected by animal spirits! All very hand-wavy stuff, of course….not something I’d want to treat too seriously!

  8. Magpie

    The way multipliers are calculated is using Leontief ‘s Input-Output coefficients and they assume fixed proportions production functions.

    Have a look at:

    Input-output model

    From the initial formulation you get:

    x = inverse(ident(n) – A).c

    (x and c are [nx1]-vectors, ident(n) is the nxn identity matrix and A is the nxn matrix of coefficients). Inverse is, well, the inverse (to myself: duh!). And inverse(ident(n) – A) is the multiplier, if I’m not mistaken.

    In Australia the ABS calculates Input-Output tables (5209.0.55.001 – Australian National Accounts: Input-Output Tables): that’s matrix A.

    There is also an older set of somewhat related techniques called economic base analysis, which is indeed more ad hoc:

    Economic base analysis

    The example below, linked from the Wikipedia entry, seems good and instructive, although I only gave a quick glance:

    James Paul Quintero. Regional Economic Development: An Economic Base Study and Shift-Share Analysis of Hays County, Texas.
    Texas State University-San Marcos, Dept. of Political Science, Public Administration

  9. Danny Yee

    I’m not thinking about multipliers, but something much more direct. A drop in iron ore and coal prices will affect all Australia’s exports of those commodities, not just the ones to China!

  10. Stubborn Mule Post author

    Danny: you are correct that a fall in the price of commodities (in A$) would revenue on exports to other countries too. If China slowed commodity prices would most likely fall in US$ but the A$ may also fall as a result, mitigating the effect somewhat. In which case, the more significant effect would be the drop in export volume.

  11. Magpie

    @Stubborn and Danny,

    But a fall in the AU$ should also lower imports and increase non-mining exports volumes. GDP tends to grow when this happens.

  12. Stubborn Mule Post author

    I heard a talk a couple of years ago by Alan Greenspan and, while he may not be the most credible of sources on all things economic, one point he made was interesting. He said that for years now developing countries like China have been exporting deflation to the developed world (i.e. their overall inflation rate would have been lower without the cheap imports from China), but as they develop it will inevitably result in a switch to those countries exporting inflation.

  13. pfh007

    That does not surprise me.

    Inflation has been a non-event for so long in Australia that people forget what a difficult problem it was in the 70’s and 80’s to break the feedback loop of inflation expectations. To some extent talk of inflation is now seen as an obsession of fear mongers, old timers and cranks.

    While there is some inflation scare mongering going on the prospect of China actually doing what everyone wants them to do – namely re-balance their economy, stimulate domestic consumption and allow their currency to rise – brings to mind that great Peter Allen song

    “Don’t wish too hard for what you want ’cause then you might get it and then will wish that you had never been born”

    The decline of the great forces of deflation (and recycled dollars) emanating from China might reacquaint us with the unpleasant challenges of managing inflation expectations. Considering the perceptions of current national wealth, the lowish unemployment rate and the IR changes introduced by the current government that might be more difficult than we expect.

    People generally eat the last cookie in the jar before asking where did they all go!

  14. Lefty

    Hi Sean. One thing to consider is while mining exports may
    make a small-but-growing contribution to GDP………exactly how
    much of that headline contribution actually enters our domestic
    spending stream? The great bulk of our most lucrative mining is
    foreign owned. What does Australia get after well-heeled
    shareholders in New York, London and Zurich have taken their
    dividends? Further, while mine workers are often very well paid,
    mining is a tiny employer. Even taking all the ancillary services
    and downstream flows into account it still only employs a very
    small fraction of the labour force. Just how much of a “golden
    goose” for the overall economy is mining in real terms?

  15. Chris S

    It’s interesting to see all the different view on this. It’s simple as the mining boom fades Australia needs to be in the position to take advantage of China new middle class. China does not have the room to provide the crops at the level Australia can. We need to start making our market in China for primary produce.

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