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Does China Really Depend On The U.S. Economy?

April 5th, 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.

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.

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