Domestic markets Essay Example for Free

Domestic markets Essay Theoretically, opening up domestic markets to international trade would increase the level of competitiveness in the market place, making businesses find better ways of producing goods more efficiently (at a lower cost). This is because trade encourages greater specialisation, which dramatically lowers costs and more intense competition, which is central to innovation. The graph below shows the correlation of trade and chinas economic growth. As you can see there is a positive correlation between trade and GDP, suggesting that trade is an important factor for the economic growth in China. However, Chinas trade surplus (the value of exports net of imports) is a better measure of the contribution of international trade to the economy. Since 1990, the trade surplus has averaged about 2 to 3% of GDP, exports have grown faster than imports and China has had trade surpluses in all but 1 year from 1990 to 2003. The trade surplus peaked at 4. 5% in 1997-98. Chinas trade surplus of $25 billion amounted to 1. 8% of GDP in 2003. Chinas trade liberalisation has created an attractive business environment and therefore has had a significant impact on FDI inflows. Foreign Direct Investment is usually imported in a country by multi-national companies seeking to take advantage of particular laws (such as cheaper land value, cheaper taxes etc ) to reduce the cost of production and to gain a competitive edge over rival companies. Similarly with international trade, an increase in FDI would increase a countrys GDP, because FDI brings in valuable funds which can be used to increase industrial output, create new job opportunities and sometimes, technology transfer which could increase innovation. However, the already lack of investment, coupled with an uncertain political climate and other unfavorable factors, at first severely hindered Chinese attempts to attract FDI. In the graph below11, you can see that in 1980, the flow of FDI into China totaled less than $200 million. In 1997, however, the flow of FDI exceeded $44. 9 billion, more than 225 times larger than the flow in 1980. Beginning in 2000, investment surged again through a combination of massive government infrastructure spending and investment in manufacturing facilities by both foreign and domestic investors. Preparations to host the 2008 Olympic Games contributed to a further frenzy of construction projects. Chinas late-2002 accession to the World Trade Organization spurred many companies, both domestic and multinational, to invest in China in anticipation of greater market opportunities (appex. 2) During this time, China was the largest recipient of FDI among developing countries, and the second largest in the world. Several factors have contributed to the increase in FDI inflows. China liberalised its FDI regime concurrently with the implementation of its economic reform and open doors policies in the late 1970s and especially since the early 1990s (Appex. 3). Implementing a series of laws and regulations governing FDI, China has substantially reduced investment barriers and improved its investment environment by opening more regions and economic sectors to foreign investors. In addition to such policies, it has the worlds largest population providing an abundance of cheap labour (Appex. 4) and a potentially huge market. Recognising the potential since the early 1980s, countries in the region such as Hong Kong and the Asian Tiger economies have become important capital suppliers. To understand Chinas rapid expansion in foreign trade, it is important to acknowledge how vital Multi-Nationals companies (MNCs) have been to its export growth. It should be noticed that Chinas opening to foreign investment occurred simultaneously with an opening to foreign trade. Even without large inflows of FDI, export capacity might still have expanded but perhaps at a less rapid pace. However, unlike Chinas trade values, FDI had seen a small decline in the years 1999 and 2000. When you combine both FDI inflows with GDP in China over the last 10 years, you can see that even if FDI decreases or remains level, economic growth via GDP still increase, suggesting that FDI is not as important to economic growth as trade. It is also important to note that Chinas FDI performance must be viewed in an international perspective. In terms of FDI inflows per capita, China ranks lower than all OECD countries save for one, and even ranks relatively low among developing countries12. Much of Chinas FDI is short-term, in labour intensive manufacturing, with foreign investment in high-tech machinery and the services sectors lagging behind, Though investment in processing and assembling declined 10%, the manufacturing sector garnered 70% of FDI from 2000-2005. Telecom, electronics, and chemicals also received significant shares of foreign investment. 13 China could be encouraging FDI in high technology based manufactures as a way to encourage domestically owned firms to move up the value-added chain. However, trade and investment liberalisation cannot by itself improve Chinas economic growth. Arguably much of Chinas rapid economic growth is due to changes in government policies that created a socialist market economy in which the private sector plays a key role. Enterprises either owned or controlled by government entities now account for less than 30% of industrial output. We must not forget that the domestic industry has also been a driver of Chinas phenomenal economic growth of the past 30 years. Industrial development has hastened since reform began in the late 1970s, growing at an annual rate of over 11% between 1978 and 2000 compared to an average GDP growth rate of 9.6% during this period, as you can see from the graph on the next page. Chinas GDP growth and industrial growth rates14 The importance of industrial output in the Chinese economy has increased over time, from 21% of GDP in 1952 to 51% at present. Changes in the composition of Chinas GDP, 1952-200215 Government polices provided several short-term burst of productivity within the industry, in 1980 when China began the renovation from a centrally planned to a more market based economy, industrial output rose 16. 5% from 1981-1985. Before any Government reforms, growth rate of GDP was 5.3%, but post-reforms saw the growth rate increase to 9. 7% (Appex. 5) Economists such as Wayne Morrison and Mathew Shane have concluded that productivity gains (i. e. increases in efficiency) were another major factor in Chinas rapid economic growth. The improvements to productivity were caused largely by a reallocation of resources to more productive uses, especially in sectors that were formerly heavily controlled by the central government, such as agriculture, trade, and services. For example, agricultural reforms boosted production16, freeing workers to pursue employment in the more productive manufacturing sector. Productivity can be increased by using factors of production more efficiently, by improving the quality of the basic factors of production, for example, increasing the skill or education of labor. Consumption spending contributed too much of Chinas early growth following economic reforms in the early 1980s. The aggregate demand and supply diagram below shows the level of output at any given level of aggregate demand. As consumption was increasing in China from 1878 to 1882, this would lead the aggregate demand line to shift to the right, where the economy is approaching full capacity output. The increase in demand induces businesses to take more employment and increase output. However, inflation will occur as costs will rise and then prices, as businesses try to pass the costs on to consumers. However, over time, the role of consumption has declined and the contribution of investment has generally risen. Since 1978, gross capital formation (investment) accounted for an average of 37% of GDP, while the share due to consumption expenditures averaged 62%. Consumptions contribution to GDP peaked at about two-thirds in the early 1980s and fell to 55% in 2003. By comparison, consumption accounts for 70% of GDP in the United States. Chinas substantial consumption contributing to growth of GDP17 This lower rate of consumption has made way for the impressive level of domestic savings to increase in China, which has helped stimulate economic growth. When reforms were initiated in 1979, domestic savings as a percentage of GDP stood at 32%. However, most Chinese savings during this period were generated by the profits of state-owned enterprises, which were used by the central government for domestic investment. Economic reforms however, led to substantial growth in Chinese household savings. As a result, savings as a percentage of GDP has steadily risen; it reached 49% in 2003, among the highest savings rates in the world. 18 Chinas rise as an economic superpower is likely to pose both opportunities and challenges for the world trading system. Chinas rapid economic growth has boosted incomes and is making China a huge market for a variety of goods and services. In addition, Chinas abundant low-cost labor has led multinational corporations to shift their export-oriented, labor-intensive manufacturing facilities to China. This process has lowered prices for consumers, boosting their purchasing power. It has also lowered costs for firms that import and use Chinese-made components and parts to produce manufactured goods, boosting their competitiveness. Conversely, Chinas role as a major international manufacturer has raised a number of concerns. Many developing countries worry that growing FDI in China is coming at the expense of FDI in their country. Policymakers in both developing and developed countries have expressed concern over the loss of domestic manufacturing jobs that have shifted to China. Conclusion Throughout my investigation I have demonstrated the importance of trade liberalisation and Foreign Direct Investment to Chinas record breaking economic growth. It is however, very hard to put an exact figure to show the extent of how beneficial trade and FDI have been to Chinas economic growth, but undeniably they have all been part of a cycle, each factor helping stimulate economic growth in certain ways. I do believe that to an extent trade liberalisation and FDI are interdependent on each other, the opening up of markets to free trade has spurred more FDI than it would have if it had not liberalised. Nevertheless, trade liberalisation and FDI cannot by itself improve Chinas overall economic growth. The benefits of trade liberalisation and FDI to particular sectors of the industry will rely not only on their theoretical comparative advantage but also upon their ability to restructure and upgrade operations through technological improvements to take advantage of market opportunities. All factors including industrial output, increased productivity and efficiently within the industry, high level of consumer saving, early consumption and Government policies have all had an impact on the outcome of economic growth. China has the potential to continue its rapid growth in the foreseeable future. The factors that have propelled growth over the past 30 years are still in place. Chinas economy is still a long way from mature status where growth rates tail off. If the Chinese Government wishes to keep their economic growth at such a high rate, they must face challenges such as exchange rates, structural imbalances and a troubled banking system, in order for them to continue to grow As long as China maintains an open attitude toward foreign investment and invests heavily in infrastructure and other capital, it will continue to grow rapidly.