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Does China Really Depend On The U.S. Economy?
By Paul Midler | April 5, 2008
Many are saying that a downturn in the U.S. economy will necessarily have a negative impact on China. David Frum, a former speech writer for George W. Bush, reflected this sentiment at NPR:
“Probably no major economy has ever depended so much on one partner as China now depends on the United States. Eighty percent of China’s GDP derives from international trade, and the United States is far and away the top destination for Chinese merchandise exports.”
At the other end of the argument, some suggest that China is immune to our economic woes. The China economy is not “coupled” with the U.S. economy, they insist. Oddly enough, these comments are coming from the same sort who suggest that China’s rise necessarily lifts the U.S. economy (it is as if China’s economy were connected to the U.S. by a one-way valve — China can pump up our economy, but even our biggest problems cannot deflate theirs).
There is an overemphasis placed on the U.S. economy’s significance in China’s equation, and it needs a rethink. International trade may account for most of China’s GDP, and we may be China’s most significant trading partner, but the U.S. takes only one-fifth of China exports. That’s all – and we account for an even smaller proportion of profitability for China manufacturers.
Let me explain how we matter less…
The U.S. is a modern and well-coordinated economy. Its businesses enjoy economies of scale and its supply chain networks are efficient. One of the greatest ironies in the global economy is that products sold in the U.S. – the world’s wealthiest country – are often priced lower than the same products sold in many lesser developed economies. I once manufactured a product in China that retailed in the U.S. for a dollar and on a trip to Brazil found the same item selling for close to five dollars.
American importers purchase in large quantities, and because they do (and for other reasons I won’t go into here) U.S. importers receive significant discounts. The liberal argument is that we should feel sorry for China. The prices we are paying are too low, they say, but this claim takes in only a limited view. The reality is that China manufacturers earn a higher margin on products they produce for other markets, and that extra margin offsets some of the discounts we receive.
At a typical Chinese factory, a single buyer from the U.S. might account for as much as half of the factory’s book of business but almost none of its bottom line. The bulk of the supplier’s profitability instead comes from a large number of smaller customers — mostly non-U.S. — who willingly pay higher prices.
Since factories earn less profit on their U.S. accounts, it stands to reason that a downturn in the U.S. economy would affect China less. What needs to be taken into account is not a direct bilateral link, but the more complex dynamic between the U.S. and the global economy. A recession in the U.S. should affect China only to the extent that such a downturn affects the world more broadly.
Topics: China |
April 5th, 2008 at 7:34 am
Maybe, maybe not. Maybe the US purchases give China’s factories the economies of scale they need to profit from the additional orders.
April 5th, 2008 at 12:13 pm
When I ask a factory for a price, the first questions they ask is usually “which market?” The factories price products different depending on location. There’s no doubt about it.
April 5th, 2008 at 6:04 pm
CLB - I agree that U.S. buyers in China have helped China factories build economies of scale. The question is why some believe this is a bad thing. China has been built out thanks in part to orders that, while they don’t provide much margin, at the very least provide the means for covering China’s fixed costs. And there have been other benefits…
David - You understand already how the factories operate.
April 6th, 2008 at 3:47 pm
I agree that china does depend on the U.S. But I think that the U.S. depends on china just as much, if not more. Also I think the current economic troubles of America among many other reasons, are actually causing China to begin to look inwards, and become much more of a self sustaining economy in not only manufacturing but also consuming.
April 6th, 2008 at 11:21 pm
Well put Paul. In our own experience, we see much the same. With larger orders, the discounting gets higher, but more than anything they are banking on the commitment made by US buyers to pay the fixed costs of the investment so they can then go out and make their profit.
April 6th, 2008 at 11:46 pm
My 2 cents ….. the US part of a China factory mostly covers overhead and operating costs …. profits come from higher margin products sold into other countries (the mid-east is a prime target as is Japan - for small electric appliances).
However, as the US buys less the result is less overhead will be covered. This then has to come out of profits. The factory has to be affected by lower sales volume even if it is 0% margin product.
let’s look at land costs, energy, labor ,etc. A factory is bound to hire x amount of workers in order to get their ‘discount’ from the local government. So if the factory has agreed to keep a minimum of 5,000 workers employed, that is a fixed cost. Not enough workers = electricity shortage, VAT rebate lessened, land rental rates increased, increased inspections by local officials, delays at the border, etc. So the cost of these 5,000 workers is borne by all product in the factory.
The US volume goes down the cost is borne by the other country’s volume. Maybe those customers do not accept a price increase so the factory eats the profit loss.
So, yes, the factories’ should be less immune by a decrease in US volume, but they still feel it in the margin. Lose $1 in fixed cost, lose $1 in margin.
April 7th, 2008 at 6:37 pm
Related to the importance of fixed costs, in general, take into account that banks will not force bankruptcy. The importance of having your fixed costs covered in a market like the U.S. is not the same as in China. The China Game is played by different rules…
April 12th, 2008 at 10:00 am
This author hasn’t taken a course in microeconomics, as the other comments implicitly suggest. The factories must cover fixed costs. When they lose the low margin US orders, they will scramble to cover those costs, and it will be evident in their price negotiations with their remaining customers; i.e. another low margin buyer will replace the US low margin buyer, and profitability will be negatively effected. BTW, a recession in the US will have a negative effect on the rest of the world. You can bank on it. Huge structural impediments exist within China that hinder its development of a self sustaining domestic consumer driven economy; i.e. their 40% savings rate is very rational. A serious consumer driven recession in the US will have a large impact on Chinese company profitability, almost immediately. Not rocket science. Because of the highly stratified and developed consumer credit market in the US, a country of 300 million actually consumes as a country of 3 or 4 billion, relatively speaking. That’s the US “magic”. US consumer confidence is the #1 most important predictor of global economic health, and in this global economy, we are all joined at the hip whether we like it or not.
April 12th, 2008 at 10:32 am
J -
You may wish to consider that Chinese companies do not operate the same way as North American companies.
When factory cannot make a payment to the bank, it simply doesn’t make the payment. How would that reality figure into your insistence that these plants must break their backs in order to cover fixed costs?
Also, see my other post a few days later that talks about factories that are speculating on land. The factory in China does not need to worry about profitability in the traditional sense in order to realize profitability. China is another place. It ain’t Pittsburgh, that’s for sure.
April 12th, 2008 at 8:23 pm
I’m an ex-China banker