77910 MAY 2013 • Number 118 A Changing China: Implications for Developing Countries Philip Schellekens Three decades of rapid growth and structural change have transformed China into an upper-middle-income country and global economic powerhouse. China’s transformations over this period wielded increasing influence over the development path of other countries, either directly through bilateral trade and financial flows or indirectly through growth spillovers and terms of trade effects. Looking ahead, as China embarks on a new phase in its development journey—a phase charac- terized by slower but higher-quality growth—the economic landscape facing the developing world is expected to be rede- fined yet again. As China changes, so will its interactions with the outside world. China is expected to remain both a market and a competitor, but its changes are likely to lead to new opportunities for many and new challenges for some. Key questions in this respect are: (i) how will the level and composition of China’s import demand evolve as its economy slows and rebalances; (ii) to what extent will the presumed out-migration of labor-intensive manufacturing materialize and create new opportunities elsewhere; and (iii) how quickly will China move up the value chain and redefine its competitive advantage in the global marketplace? How these uncertain long-term developments affect individual countries will depend on differences in total supply chain costs, resource availability, and innovation capability. As in the past, China’s transfor- mations are expected to put formidable pressure on countries to adapt and reform, requiring both political will and entrepreneurial capacity, in a collective race where success will be measured against a rapidly moving frontier.1 A Changing China: Five Decades of produce large efficiency gains and have facilitated China’s Structural Transformation emergence as a world-class competitive powerhouse. China’s growth spurt translated into considerable im- Historical trends over the last three decades provements in living standards. China sustained average China’s economic performance over the last three decades has growth rates of 10 percent over the last three decades, which been nothing short of impressive. Rapid urbanization trans- led to a dramatic rise in per capita income (figure 1). In 1978, formed China from a primarily rural, agricultural economy the year that marked the beginning of China’s remarkable into an increasingly urban one with a more diversified eco- transformation, per capita income was merely one-third of nomic structure. The last three decades also saw a transforma- that of Sub-Saharan Africa. Within three decades, China tion from a command-based economy to a more decentral- managed to reach upper-middle-income status. In doing so, ized and market-based system. These two factors coalesced to the country lifted over half a billion people out of poverty. 1 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK    www.worldbank.org/economicpremise Figure 1. China Quickly Climbs the Income Ladder nally, many of the policies that generated China’s internal Republic of Korea high imbalances also contributed to its twin current and capital GNI per capita (US$, Atlas method) account surpluses. Along with China’s expanding global 10,000 upper market share, these fueled protectionist pressures in key for- middle eign markets. lower Anticipated transformations over the next two decades middle Looking ahead into the next two decades, it appears highly 1,000 Sub-Saharan Africa unlikely that the structural trends outlined above can be sus- tained for that length of time. One concern, which is not the low focus of this note, relates to the fragility of the near-term out- China look for growth (figure 3). With growth having slowed from a 100 three-decade annual average of 10 percent to 7.8 percent in 2012, recent economic commentary on China has focused 78 82 86 90 94 98 02 06 10 19 19 19 19 19 19 20 20 20 predominantly on the possibility of a hard landing. This con- Source: World Development Indicators and World Bank staff calculations. cern has emerged as a result of persistent domestic and exter- While serving China well in many respects, the rapid nal risks. While the World Bank’s baseline outlook for China growth and accompanying structural change have also intro- remains a soft landing—with even a modest recovery expected duced economic imbalances. Spurred by high savings, cheap at 8.3 percent in 2013 and 8.0 percent in 2014—it is clear finance and other inputs, and export-oriented policies, growth that the downside risks remain significant and that the real- has been led by industry and investment. The priority accord- ization of a downward scenario would carry significant conse- ed to industry stunted services development—particularly in quences, not only for China, but also for the rest of the region productivity terms—while the emphasis on physical invest- and the world (World Bank 2013). ment constrained investment in human capital (Bosworth A second concern, explored further in this note, relates and Collins 2008). With wages lagging productivity growth, to China’s longer-term structural challenges. Key to this issue the share of wage income in gross domestic product (GDP) is the expectation that fundamental factors are expected to declined to 48 percent by 2008, with the consumption share weaken the drivers of growth over time. This growth slow- at low levels for a major economy. down will require compensating policy efforts for the country These trends also contributed to imbalances in other to find new growth engines and in the process redefine its spheres. Income disparity widened to high levels and social competitive advantage in the global marketplace. In addition, imbalances were exacerbated by unevenness in access to ba- to prevent rising imbalances from reaching pressure points, sic public services and by tensions surrounding land acquisi- the patterns of development are likely to undergo fundamen- tion (figure 2). On the back of industry-driven growth and tal changes as policy makers are expected to respond with a urbanization, China became the world’s largest energy user. gradual shift of policy emphasis from the rate of economic Fast growth also led to serious environmental pollution. Fi- expansion to the quality of socioeconomic development. Figure 2. Urban-Rural Income Disparity Significantly Rises Figure 3. Near-Term Uncertainties Center on Risk of Hard Landing 3.5 disposable income ratio: 100 14 China GDP growth 3.3 urban/rural index (right axis) 12 80 3.1 10 growth rate (%) 2.9 60 8 index 2.7 40 6 2.5 “China hard landing� 4 2.3 Google worldwide 20 2.1 search intensity 2 (left axis) 1.9 0 0 Jan 2008 Jul 2008 Jan 2009 Jul 2009 Jan 2010 Jul 2010 Jan 2011 Jul 2011 Jan 2012 Jul 2012 Jan 2013 1.7 1.5 1985 1988 1991 1994 1997 2000 2003 2006 2009 Source: Google Trends; NBS; World Bank staff calculations. Source: National Bureau of Statistics (NBS) of China and World Bank staff calculations. 2 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK    www.worldbank.org/economicpremise Transformation #1: China registers a structural slowdown 8.5 percent in 2011–15 to around 5 percent by 2030 (figure While the traditional driving forces of growth are far from ex- 4).2 It should be noted, however, that given the diversity of hausted, many signs suggest that they are likely to gradually China’s provinces, the slowdown would be uneven across the weaken over time (Eichengreen, Park, and Shin 2011). First, country, with the more developed provinces slowing more much of the growth contribution from shifting resources than those with more catch-up potential left (Malkin and from agriculture to industry has already occurred. Going for- Spiegel 2012). ward, the continued accumulation of capital, although siz- Transformation #2: China rebalances able, will inevitably contribute less to growth as the capital- Addressing the imbalances that accompanied rapid earlier labor ratio rises, even though further capital accumulation growth, as the 12th Five-Year Plan seeks to do, would be ex- will be needed given that China’s current capital stock per pected to fundamentally alter the patterns of development in worker is estimated at only about a tenth of the U.S. level. economic, social, and environmental spheres. Second, China is also poised to go through major demo- First, as domestic sources of growth are emphasized, the graphic change: the old-age dependency ratio will double in Chinese economy would see a higher share of services and the next two decades, reaching the current level in Norway consumption and a lower share of exports, savings, and invest- and the Netherlands by 2030 (between 22 and 23 percent), ment (figure 5). Reforms that encourage urban job creation and the size of China’s labor force is projected to start shrink- and greater upward pressure on wages boost the share of wag- ing as soon as 2015, dampening savings. Yet workers will be- es and household income in GDP, increasing the role of come more productive as the physical and human capital household consumption. Government consumption would stock per worker continues to rise. These demographic chang- rise to meet increasing expenditure demands in the social sec- es should have a sizable impact on the rate of potential growth tor and on operations and maintenance. (Cai and Lu 2013). Savings and investment as a share of GDP decline over Third, total factor productivity growth—a measure of im- time. Corporate savings decrease as real wages rise and as the provements in economic efficiency and technological prog- economy becomes less capital intensive and less industry ress—would also decline, in part because the economy has ex- based. Government savings fall because of more current and hausted gains from first-generation reforms and the less capital spending. Reforms in health, education, and social absorption of imported technologies that were relatively easy security work to reduce household saving. Despite lower in- to access, adopt, and adapt. As a result, the distance to the vestment, the current account surplus gradually declines rela- technological frontier has shrunk, and second-generation tive to GDP, easing external imbalances. policy reforms are likely to have a smaller impact on growth. Second, income inequality would be expected to flatten Illustrative scenarios based on the World Bank and De- and eventually decline as: (i) faster growth in the middle and velopment Research Center’s recent China 2030 report sug- western regions would continue, reducing the gap with coast- al areas; (ii) migrant wages would continue to rise rapidly, re- gest that these structural trends would have a profound im- ducing the income gap with urban residents; and (iii) even if pact on the Chinese economy (World Bank and Development urbanization continues, rural-urban migration will gradually Research Center of the State Council 2013). Overall GDP slow as the structural shift from agriculture to manufacturing growth is expected to decline gradually from an average near eases and the rural-urban wage gap narrows. Figure 4. Prospect of Structural Slowdown Looms over Figure 5. Investment as a Share of GDP Falls: Consumption Share Longer-Term Horizon Picks Up Slack 12 70 investment/GDP ratio contribution to GDP growth (%) labor productivity growth consumption/GDP ratio 10 60 labor growth 8 50 share in GDP (%) 6 40 4 30 2 20 0 10 -2 1995–2010 2011–15 2016–20 2012–25 2025–30 0 Source: World Bank and Development Research Center of the State Council 2013, 1995–2010 2011–15 2016–20 2012–25 2025–30 Overview chapter. Source: World Bank and Development Research Center of the State Council 2013, Overview chapter. 3 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK    www.worldbank.org/economicpremise Third, China would be expected to use fewer primary ress in strengthening its technological capabilities and up- commodities, consume less energy, and produce less pollu- grading the technological sophistication of production and tion. This is because it would have less industry (figure 6) and, exports (figure 7). These efforts were supported by large in- within industry, less heavy and dirty industry, largely because vestments in physical infrastructure, such as logistics, renew- of better pricing of energy, commodities, and environmental able energy, and communications. In addition, China’s ex- degradation. panding education system and large supply of workers with science and engineering skills bode well for the future Transformation #3: China moves up the value chain (Schellekens 2012a). China’s growth success has been mainly the result of rapid Building on these assets, China is expected to steer its productivity growth. The growth of labor productivity—a economy up the value chain by reinvigorating its human com- key indicator of economic efficiency and a fundamental de- petencies and technological capabilities. China is expected to terminant of real wages—was sustained at high levels, partic- further deepen its human capital base and to impart the flex- ularly in industry. China’s performance in industry has been ible core competencies that workers of the future will need to closely tied to its ability to facilitate industrial upgrading, remain productive across their working lives in the face of and, during its recent past, China has gone through several rapid technological change and structural shifts in China’s la- such stages. As a result, the structure of production and ex- bor market. In addition, China is expected to upgrade its tech- ports has progressively shifted from resource-intensive raw nological capabilities by fostering a learning and research en- materials and primary products to labor-intensive manufac- vironment that encourages new ideas and lateral thinking and tures of textile and clothing, and eventually machinery, elec- gradually making the pursuit of innovation more sensitive to tronics, and other products supported by more sophisticated market signals, with the government playing a more facilitat- production processes. ing role (Schellekens 2012a). Looking ahead, for China to sustain relatively rapid Implications for the Developing World: growth and maintain its competitiveness in the global market- New Opportunities and Challenges place, it will need to sustain productivity growth as a driver of growth and remain on the lookout for further upgrading of its Three decades of rapid growth and structural change have re- economic activities, both in the tradable and nontradable sec- defined China’s position in the global economy. Initially a tors. Essential to success is China’s innovation agenda, where- low-income country with a relatively closed economy, China by through technological catch-up and original innovation transformed itself into upper-middle-income country and China could further improve cost efficiency, introduce new economic powerhouse with deep links to the global economy. organizational forms, and break into new product markets. China has become the world’s second-largest economy and The source of the country’s competitive strength would thus also the world’s largest producer and exporter of manufac- be expected to progressively shift from low cost to high value, tured goods. supported by innovation. As China expanded its economic clout, it wielded in- Against this backdrop, China’s 12th Five-Year Plan lays creasing influence over the development path of other coun- the foundation for the country’s aspiration to move further tries. This influence exerted itself in various ways, either di- up the value chain. China has already made significant prog- rectly through bilateral trade and financial flows, or indirectly Figure 6. Rebalancing: Share of Services in Production and Figure 7. Sophistication of China’s Exports Has Grown Rapidly Employment Rises 100 50 1988 2000 1990 2005 ratio of product sophistication 2010 1995 2010 80 relative to Japan (%) 40 2030 60 share (%) 30 40 20 20 10 0 0 Korea, China Russian India South Brazil primary industry services primary industry services Rep. of Federation Africa production employment Source: World Bank staff calculations. Note: Ratio is EXPY relative to Japan, with PRODY averaged over the period Source: World Bank and Development Research Center of the State Council 2013, 2000–2009. EXPY maps a country’s export mix into a per capita income level that Overview chapter. represents the level of development at which such goods are typically produced. 4 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK    www.worldbank.org/economicpremise in the form of cross-country growth spillovers and impacts on 2030, with roughly two-thirds residing in Asia. All of the world market prices of commodities and manufactures, and above is expected to lead to a multiplication in the opportuni- hence the terms of trade of most countries. With China’s rise, ties for countries to connect with each other through trade, the developing world saw new opportunities and challenges. investment, and other channels. The upsurge of commodity prices—partly a result of China’s In the same vein, China’s gradual slowdown and rebal- resource-intensive growth—benefited, for example, net pro- ancing would continue to give ample scope for other coun- ducer countries, but hurt the terms of trade of net consumer tries to tap into opportunities in its domestic economy. If in- countries. In turn, access to lower-priced manufacture im- deed, as predicted, China were to gradually halve its growth ports expanded the consumption possibilities of many coun- rate from the 10 percent in recent decades to 5 percent by tries and elevated their middle classes, but at the same time 2030, it would still be expected to become a high-income also created tough competitive pressure for domestic manu- economy and outstrip the U.S. economy by then as well. De- facturing industries at home and in third markets. spite the slowdown, China’s national income would rise If China’s development over the last three decades has through this period, and this would add an equivalent of 15 helped shape the global economic landscape as it is known to- of today’s Republic of Korea to the world economy. Of course, day, and along with it significantly shaped the opportunities due to the size of its massive population, China’s per capita and challenges facing developing countries, then the impor- income would still remain a fraction of richer high-income tance of structural changes that China takes going forward economies. But the rise of income that slows from a high base cannot be overstated. Indeed, given the current size of the should create tremendous opportunities for trade, because in Chinese economy and the complex ways in which it connects addition the income elasticity of China’s imports is expected with the world economy, it would be safe to conjecture that as to rise as the country becomes richer, providing a further China changes, so will the rest of the world, and particularly boost to import demand. Thus, even if China slows and rebal- the developing world. However, as has been the case in the ances, the intensity of import demand is expected to remain past, the impact of a changing China is unlikely to be uniform robust. across countries. While China will likely remain both a mar- Yet, the patterns of China’s import demand are likely to ket and a competitor, the structural transformations outlined change. China’s recent growth patterns have brought large in this note are likely to significantly change the intensity and benefits to exporters of commodities as well as capital goods— patterns of China’s import demand as well as the nature of even if China has also become a significant exporter of capital competition between nations. These changes should provide goods (Eichengreen, Rhee, and Tong 2004). As China rebal- opportunities and challenges that will differ across countries ances and looks more inwardly, there is hope not only that the and should also give rise to new policy questions, as discussed competitive pressure exerted by China in third markets below. would recede somewhat, providing breathing space to export- ers in other countries, but that also new opportunities would China as a Maturing Market: open up in China’s domestic market that could be accessed by Impact on Import Demand? such exporters. Such opportunities could be accessed directly The broader context in which China is anticipated to slow through the export of consumption goods or indirectly by in- down and rebalance is one where the world economy is likely puts into the production networks supplying such goods to to remain multipolar and where the developing world would China, of which a large share are expected to remain located continue outperforming high-income countries. Over the last within China itself. China’s efforts to raise domestic con- decade or so, the emergence of developing countries, and in sumption are also expected to raise the demand for services, particular the BRICS (Brazil, Russian Federation, India, Chi- part of which again would be produced domestically, but oth- na, and South Africa), has provided significant impetus to ers could be supplied from overseas. world economic growth. These trends are expected to carry Zooming in on China’s demand for commodities, the im- on assuming certain aspects of the global environment re- pact of the slowdown and rebalancing is likely to be felt differ- main supportive—such as openness to cross-border trade and ently in different markets. Even if the United States remains a investment and the lowering of total supply chain costs on the key player in world commodity markets, China has come to back of improvements in logistics and advances in informa- occupy a major position as well (Roache 2012). While overall tion and communications technologies (ICTs). By some esti- commodity demand should broadly speaking remain strong mates, developing countries would contribute two-thirds of in light of China’s ongoing process of urbanization and given global growth (40 percent when excluding China) and half of that the capital stock remains only a fraction of the U.S. level, global output (30 percent without China) by 2030. This the rebalancing of the growth model would favor commodi- would be accompanied by a global expansion of the middle ties more closely related to consumption than investment de- class, from 1.8 billion people in 2009 to about 5 billion in mand. Among the former, for example, agricultural products 5 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK    www.worldbank.org/economicpremise should remain in high demand, particularly given that the Figure 8. Labor Productivity Growth Helped Contain Rise of Unit rise in the middle class should also lead to a rise in protein Labor Costs demand. Among the latter, metals and minerals might be 20 more significantly affected by the slowdown in investment, 15 Q4 even if continued residential construction demand, as well as demand for durable goods such as automobiles, limits some growth rate (percent) 10 of that slowdown (Yu 2011). Given that China’s demand for commodities is likely 5 to remain relatively robust, commodity-rich countries will continue to face the challenge of ensuring that the pursuit 0 of commodity wealth does not come at the expense of long- term growth. In the absence of suitable institutions and -5 2007 2008 2009 2010 2011 policies, there is a risk that the pattern of specialization into labor productivity growth in manufacturing industry commodities can result in negative side effects (Brahmb- -10 unit labor cost in manufacturing industry hatt and Canuto 2010). These include the prospect of real Source: NBS, CEIC, and World Bank staff calculations. exchange rate appreciation that may render the manufac- turing sector uncompetitive, the risk of becoming trapped What remains uncertain is the pace at which China’s in low-value structures that limit the scope for vertical or competitive advantage is eroding, and thus the extent to horizontal links, and the possibility of heightened volatility which this will present an opportunity to lower-cost coun- due to commodity price fluctuations (Chandra, Lin, and tries. Several factors that might impact potential opportuni- Wang 2012; IMF 2011; De Cavalcanti, Mohaddes, and ties are: Raissi 2012). The appropriate response to these potential • Sectoral characteristics. The opportunities that may pres- negative effects is not to limit commodity exports or to ent themselves will vary necessarily across sectors de- erect costly import barriers to protect domestic industries, pending on the labor intensity of production in each sec- but rather to alleviate demand and supply constraints on tor, as determined by the share of wages in total costs and productive activity by improving infrastructure, creating a the ability to pass on wage cost increases in prices. Com- conducive investment climate, and facilitating private sec- petitive industries such as low-value footwear, garments, tor access to capital, skills, technology, and markets (IMF and toys are therefore more likely candidates of out-mi- 2011). gration, and indeed, some of China’s production in these China as a Former Competitor: Whither the sectors has already shifted to countries such as Cambo- Out-Migration of Low-Cost Manufacturing? dia, Indonesia, and Vietnam. • Capital-labor substitution. The rise in wage costs may While fast productivity growth helped explain and absorb force producers in China to raise capital intensity where rapid wage growth, there is little doubt that the rise in Chi- possible. Recent survey data for the manufacturing-dom- na’s labor costs is gradually undermining the model of low- inated Pearl River Delta suggest that the primary re- cost, labor-intensive manufacturing. It is becoming increas- sponse (61 percent, figure 9) of companies to higher ingly evident that China has passed the Lewis turning point, wage costs is to invest in capital equipment (Lau, Naray- where it is no longer possible to tap into a surplus pool of an, and Green 2013). low-wage labor without raising wages (Lewis 1954). Indeed, • Inland migration. China also has the opportunity and in- for several years now, nominal wage growth has been persis- centive to relocate production further inland, a process tently robust, translating into significant increases in real which is ongoing, even if this is likely to be a temporizing wages. Even if the recent slowdown brought a slight soften- measure as wage pressures are also picking up there. This ing of labor market conditions, urban demand-supply ratios was considered a second choice (30 percent, figure 9) in remain at historically high levels. Whereas rapid productiv- the recent survey on the Pearl River Delta. ity growth has to some extent dampened the impact of these • Overseas relocation. Relocation overseas is an option con- cost pressures somewhat, the rise in manufacturing unit la- sidered by some firms (9 percent in the recent survey, bor costs remains significant (figure 8). These develop- figure 9), but depends on an additional set of consider- ments, as well as the observation of significant foreign direct ations such as the need of proximity for local suppliers investment outflows from China to establish industrial and customers (Berger 2011; Baldwin 2011). zones in other countries, underpin the concern that China • Total supply chain costs. Another important factor that is losing industrial competitiveness in low-cost, labor-inten- will determine the extent of relocation of firms currently sive manufacturing. based in China concerns the ability of other countries to 6 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK    www.worldbank.org/economicpremise Figure 9. Wage Pressures Trigger Labor Substitution and may have limited the breadth and depth of the industrializa- Relocation tion potential of these countries, and even may have led to de- 100 share of respondents (%) answering question: industrialization in certain cases. The slow process of indus- how do you plan to respond to labor shortages? trialization in Africa is used as an example by Chandra, Lin, 80 2012 and Wang (2012) and the literature is replete with country 2013 case studies on the question of whether China has crowded out domestic manufacturing industries through competitive 60 pressure in home and international markets (Eichengreen, Rhee, and Tong 2004; Yusuf and Nabeshima 2009; Arbache 40 2011). While there appears to be evidence in support of the hypothesis, two caveats apply. First, as in the case of Africa, 20 the effect of increased competition must be disentangled from the effect of resource pull away from manufacturing 0 raise capital move capacity move capacity due to the recent commodity boom—also partly China relat- intensity inland abroad ed. Second, the costs of trade diversion must be evaluated Source: Lau, Narayan, and Green 2013. against the benefits of trade creation, bilaterally as well as in- Note: Survey of manufacturers operating in Pearl River Delta. directly through growth spillovers. Against this backdrop, if past Chinese competition has attract them. Success in this competition will depend on dampened the possibilities of countries with similar endow- total supply chain cost concepts that go well beyond the ment structures, it is fair to conjecture that the same will hap- narrow metric of productivity-adjusted wages. pen as China repositions itself and moves up the value chain. As illustrated above, there are various reasons why the As a result, a new group of countries characterized by differ- presumed grand-scale out-migration of low-cost, labor-inten- ent endowment structures, and therefore different compara- sive manufacturing may not happen overnight and may never tive advantages, is likely to face head-to-head competition fully play out. Indeed, the concern among lower-income from a changing China. To some extent, this is already hap- countries is precisely that, while China moves up the value pening as evidenced by the increasing technological sophisti- chain and acquires new comparative advantages, it continues cation of China’s exports and the increasing share of capital to encapsulate within its borders the wage-sensitive chunks of good exports from China. Going forward, however, the pro- the cross-border supply chain. Thus, the fear is that China, cess is likely to intensify if China succeeds in its efforts to being a vast country of multiple regions with varying endow- drive growth through innovation (figure 10). As a result, ments, is not only acquiring new comparative advantages, but countries that are currently active or aspire to become active also keeping its existing ones, whereby China would straddle in production, investment, or trade of human capital–inten- the full span of technologies and labor intensities (Yusuf and sive and technologically sophisticated goods and services Nabeshima 2010). would likely face significant competitive challenges (Econo- A further complication arises with respect to the collec- mist Intelligence Unit 2011). tive ability of other countries to absorb the out-migration of manufacturing activities if it were to occur in full force. It Figure 10. China’s Technological Catch-Up Is Expected to may well be that China’s specific development path provided Continue the world with a unique and one-off opportunity to produc- growth in USPTO utility patents granted average annual growth (%, 2000–10) 40 tively tap into vast pools of surplus labor (Chandra, Lin, and 35 China Wang 2012). Hence, if other developing countries that are set to benefit from China’s gradual loss of competitiveness in 30 low-cost, labor-intensive manufacturing are collectively un- 25 India able to supplant China’s production capabilities, then what 20 appears the most likely trend going forward will be a reversal 15 Korea, Dem. Rep. of Hong Kong SAR of the “China price� effect and a return to more expensive fi- 10 nal and intermediate manufacture goods. 5 Taiwan, China Japan 0 China as a New Competitor: 10 100 1,000 10,000 100,000 Moving Up the Value Chain Together? number of USPTO utility patents granted, log scale (2000) An often-raised concern is that past competitive pressure ex- Source: United States Patent and Trademark Office and World Bank staff erted by China on other countries’ manufacturing industries calculations. 7 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK    www.worldbank.org/economicpremise Rising competition with respect to skill and technolo- individually and collectively—to take advantage of China’s gy-intensive production is expected to produce various ef- changes. Static comparative advantages will be based on fects. Countries that will face the brunt of China’s competi- cost competitiveness (to attract labor-intensive manufac- tion may have more difficulties in expanding their overseas turing), innovation capability (to mitigate the impact of market share and may also experience higher import pene- competition in higher-value products in home and third tration in markets domestically. The rise in competition markets), and resource availability (to benefit from comple- may also constrain the efforts of other countries to move up mentary trade). But equally important will be how coun- the value chain, dampening the prospects of these countries tries enhance existing comparative advantages and develop to generate productivity-led growth and impacting negative- new patterns of specialization. In this respect, China’s ly on global economic growth. At the same time, the rise in transformations will put formidable pressure on countries competitive pressure could trigger proactive and preventa- to adapt, requiring both political will and entrepreneurial tive responses from the private sector to boost innovation capacity for them to compete in a collective race where suc- and aggressively move up the value chain so as to be able to cess will be increasingly measured against a moving fron- ward off the competition from China. It may also lead to a tier. healthy competition in policy frameworks among similarly About the Author endowed economies to ensure that business environments are conducive to and fully support private sector entrepre- Philip Schellekens is Senior Country Economist with the Poverty neurship and innovation (Schellekens 2011; World Bank Reduction and Economic Management (PREM) Network of the 2011). World Bank, currently covering Brazil in the Latin America China’s move up the value chain is thus expected to pro- and Caribbean Region, and previously China in the East Asia duce both winners and losers, depending in large part on and Pacific Region. whether countries have the entrepreneurial capacity to inno- vate and the political determination to introduce structural Notes reforms that support innovation. Some countries may fail to 1. This note draws on three recent pieces of World Bank work: aggressively develop or strengthen their innovation capabili- the China 2030 study (World Bank and Development Re- ties. These countries may have to passively undergo lower search Center of the State Council 2013), the April 2012 rates of trend growth that are primarily led by domestic de- China Quarterly Update (Schellekens 2012a) and a presenta- mand. Other countries will be able to successfully adapt to tion on the impact of a changing China to country authorities the challenges posed by a changing China. They will be the in Brazil, Cambodia, Malaysia, and Indonesia in May and No- ones that are able to sharpen their current comparative advan- vember 2012 (Schellekens 2012b). tages and diversify sustainably into specialized niches of high- 2. Note that this is the central scenario considered on page 9 end goods and services. of the Overview chapter of World Bank and Development Re- search Center of the State Council (2013). Alternative high- Conclusion and low-growth scenarios are presented in supporting chapter China’s long-term outlook is expected to be shaped by three 5 of the same report. structural transformations that are key in terms of their po- References tential impact onto the developing world. 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China and India. Washington, DC: World Bank. The Economic Premise note series is intended to summarize good practices and key policy findings on topics related to economic policy. They are produced by the Poverty Reduction and Economic Management (PREM) Network Vice-Presidency of the World Bank. The views expressed here are those of the authors and do not necessarily reflect those of the World Bank. The notes are available at: www.worldbank.org/economicpremise. 9 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK    www.worldbank.org/economicpremise