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China Takes on the World

China's pressure on U.S. markets will only grow stronger. Companies that until now hesitated about shifting production to the country due to union agreements or for fear of a consumer backlash now realize they may have no choice if they wish to stay in business. Firms initially protected from Chinese competition by high transportation costs find themselves on the firing line as logistic costs decline and as productivity rises on the Chinese side. Others are following their industrial customers who have moved to China and need their suppliers and service providers to be close by. Even companies supplying the U.S. defense establishment now realize they may have little choice, although they try hard to keep their core operations at home. Consultants and other service personnel follow to provide support for those operations and discover that China, like some other low-cost nations, is a good base from which to support overseas operations.

"The great and well-known amount of imports of the productions of China into the United States," wrote Daniel Webster, Secretary of State in the John Tyler administration, in 1843, "are not likely to be diminished."4 Eventually, of course, it did. But while the quote serves as a reminder of the limits of forecasting, indications are that for now, the tide of Chinese exports will only grow. It will also not stop at America's shores. For now, the EU runs a merchandise trade deficit of about $45 billion with China, but imports from China represent merely 1.8 percent of its total imports (EU countries included), and half its volume of Japanese imports (2002 figures). Once Chinese exports grow—and especially when they begin to challenge Europe's strategic and politically influential industries such as motor vehicles—the sentiment may change there, too, although it will remain subdued as long as European exports remain strong and as long as the more influential EU nations, such as Germany, have a relatively small deficit. Japan, whose worries about China are also geo-political, is especially vulnerable to China's ascent, because its competitive advantage lies in manufacturing, its economy has stagnated for over a decade, and its governance and corporate practices have slowed its adjustment to a changing global economy. Like the U.S., Japan's exports to China are about half its import level, and as in the case of the U.S., many of its imports from China are by Japanese firms that now manufacture there. However, unlike in the U.S. case, China is the only major economy with which Japan runs a significant trade deficit (Japan's exports to the U.S. are about twice its import level), which cushions the impact. And, being much more dependent on trade than both the U.S. and China, Japan can ill-afford to challenge the free trade system.

While the industrialized countries take (artificial) solace from the belief that China only threatens the labor-intensive part of their economies, developing nations do not have that luxury. Developing countries find themselves trailing in the contest for developed country investment dollars and watch with trepidation as foreign investors uproot operations in their markets and shift them to China. The Chinese edge in terms of cheaper labor cost, a modern infrastructure, and the benefits of scale and agglomeration is now often sufficient to erase the proximity advantage of countries like Mexico, who have been counting on the combination of geography and NAFTA as a sort of insurance policy in the U.S. market. They are now finding out that payout is not guaranteed.

For emerging and developing economies in Asia, the Chinese impact is more ambivalent. While Asian countries continue to lose foreign investment to their powerful neighbor, the country is becoming an engine of growth for the entire region and a complement if not a substitute to developed country markets. (For instance, China has now replaced the United States as South Korea's largest foreign market.) With the notable exception of Japan, most Asian economies are running a trade surplus with China, and so do not see Chinese imports as an immediate concern. Nevertheless, China is considered a possible worry among Asian nations, some of which are only one step ahead on the development ladder and hence vulnerable to Chinese economic progress. In addition, there is considerable unease about the influence of the Chinese business elite, especially in the Muslim nations of Indonesia and Malaysia, as well as suspicion that the Chinese minority will benefit from China's rise while the ethnic masses will suffer as low-paying jobs move to China. Finally, Asian nations are concerned with changing geo-politics: Post World War II Japan was suspected because of its prewar and war record, but it did not have the military might and was a close U.S. ally. China, while historically nonexpansionist, is still a Communist nation, with the largest standing army in the world and strong geo-political aspirations.

In the heels of the China impact will come numerous aftershocks that will ripple their way throughout the world: rising prices for the energy and commodities that the burgeoning Chinese economy is devouring, severe "dislocations" for employees and their communities in regions and industries unable to compete or restructure, waves of immigrants pushed out of Central America and other regions by the devastation of the labor-intensive operations they have come to rely upon, and, down the road, a new geo-political order in which China takes one of the leadership roles.

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