Coupling, recoupling or decoupling: China in the global economy*

LIN Yue

CEAO UAM

The biggest economic story for the latest thirty years is the rise of China’s economy

and its integration into global networks. The emergence of a dynamic continental

economy in the region of East Asia changes largely the business networks of this area.

The regional production and trade is more and more organized around the nexus of

China. Economists expect theoretically that emerging Asian economy will benefit from

this regional economic power and can develop independently from the core industrial

nations. This is referred to as decoupling of business cycles in the recent literature1.

The global impact of the current financial crisis opposes to this “decoupling” thesis.

Neither China nor other emerging Asian economies was immune to the shocks emanated

from US. Nevertheless, the issue of decoupling remains highly contentious. In the post-

crisis period, it is now a question of whether China can manage a growth independent

from the recovery of developed countries. The fact that china successfully maintained a

GDP growth rate over 9% in 2009 and surpassed Japan becoming the second largest

economy seems support the proponents of “decoupling” thesis.

Before answering the question whether China is decoupling or not, we should first

clarify the signification of the concept of “decoupling”. Decoupling or uncoupling, as

defined by the Asia Development Bank, is “the emergence of a business-cycle dynamic

that is relatively independent of global demand trends and that is driven mainly by

* I wish to acknowledge useful comments on previous drafts by participants at 3rd EAN Research Workshop at Asia Research Centre of Copenhagen Business School, and those participating 4th EAN Research Workshop at Institute of East Asia Studies of Charles University in Prague. Financial assistance was provided by Spanish Ministry of Education for the research project of identity. The author is solely responsible for the views expressed and for the remaining errors.1 Kose, M.A., Prasad, E., & Otrok, C.,"Global business cycles: convergence or decoupling?", NBER Working Paper No. 14292, 2008, pp. 1-49. Akin, C. & Kose, M.A.,"Changing nature of North-South linkages: Stylized facts and explanations", Journal of Asian Economics, 2008, vol. 19, n° 1, pp. 1-28.

autonomous changes in internal demand"2. This definition has at least three implications.

First, decoupling is not a static phenomenon, but a dynamic one, a transformation from a

coupled situation toward an uncoupled one. Thus, when one speaks of decoupling, there

is an assumption of a preexistent coupled relation between one economy and another. An

economy that is permanently isolated from the world market, such as North Korea, can

never be qualified as decoupling. Second, there exists a relationship of dependency

between two economies. When it considers a macroeconomic relationship between

developing and developed countries, it implies an uni-directional dependence between

them, often described as “North-South relationship”—with cyclical fluctuations and

growth in the South (developing countries) being determined primarily by the

developments in the North (developed countries). Third, a decoupling process also

implies a change of development strategy, from an external demand driven one toward an

internal demand based, from export-led to domestic-consumption-based.

In this light, I would demonstrate that China’s economy during the reform era from

1978 is rather a coupling process than a decoupling one, especially after 1997 when

China’s development strategy turned to be more dependent on external demand. The

current financial crisis may accelerate an inevitable structural change favoring a post-

crisis “decoupling” trajectory. Nevertheless, the latest data suggests that this kind of

transformation cannot be fulfilled in the short run. There is little space for China to

escape from the ongoing “coupling” process, although maybe in a different recoupling

way. The future place of China in the global economy would largely depend on the effect

of ongoing policies and reforms.

A coupling process

China’s annual GDP growth rate counted on constant 2000 US dollars fluctuates

not only at a much higher level than that of G7 and US, but also quite differently from the

leading economies especially since late 1980s, which favors the decoupling hypothesis

(Figure 1). However a closer look at the business cycles correlation generates a different

picture.

2 Asia, U., "Uncoupling Asia: Myth and reality", in ADB (ed.), Asian Development Outlook 2007, 2007, Tokyo: ABD Institute Publications, p. 66.

Figure 1: Annual GDP Growth Rate (1978-2007)

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1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006

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(Source: http://data.worldbank.org/)

A HP filter3 adjustment of real GDP figures allows us to calculate the correlation

coefficient between China and core industrial countries. As presented in Table 1, a

comparison of this coefficient between 1978-1997 and 1998-2007 shows an increasing

synchronization of business cycles between China and US as well as China and G7, from

0.37 to 0.60 and 0.0.3 to 0.57 respectively. This rough calculation corresponds to the

findings using other methods; such as Asia U. using Band-pass filter4 and Kim S. et al.

employing a panel vector auto-regression model5. Both authors conclude that the

correlations of the China’s cycles with the advanced economies have increased

significantly after 1997. Although the correlation coefficient doesn’t imply any causal

relationship, it is undeniable that China is not heading toward “decoupling” recently.

3 The Hodrick-Prescott filter is a mathematical tool used in macroeconomics, especially in real business cycle theory to separate the cyclical component of a time series from raw data. It is used to obtain a smoothed non-linear representation of a time series, one that is more sensitive to long-term than to short-term fluctuations. http://en.wikipedia.org/wiki/Hodrick-Prescott_filter 4 Asia, U. op. cit., p. 74.5 Kim, S., Lee, J.W., & Park, C.Y.,"Emerging Asia: decoupling or recoupling", ADB Working Papers Series on Regional Economic Integration, 2009, n° 31, p. 15.

Table 1: Cyclical GDP components

China EU G7 Correlation coefficient1978 0.01 0.03 0.02 0.37 0.0251979 0.01 0.03 0.021980 0.00 0.00 0.011981 -0.04 0.00 0.001982 -0.04 -0.05 -0.031983 -0.03 -0.04 -0.031984 0.01 0.00 -0.021985 0.05 0.01 -0.011986 0.03 0.01 -0.011987 0.05 0.01 -0.011988 0.06 0.02 0.011989 0.01 0.02 0.021990 -0.05 0.01 0.021991 -0.06 -0.02 0.011992 -0.02 -0.02 0.001993 0.01 -0.02 -0.011994 0.03 -0.01 -0.011995 0.04 -0.02 -0.011996 0.04 -0.02 -0.011997 0.03 0.00 0.001998 0.01 0.00 0.00 0.595 0.5691999 -0.01 0.02 0.002000 -0.03 0.02 0.012001 -0.04 0.00 0.002002 -0.06 -0.01 -0.012003 -0.06 -0.01 -0.012004 -0.06 0.00 0.002005 -0.04 0.01 0.012006 -0.02 0.02 0.022007 0.03 0.02 0.02

(Source: author’s calculation using data of World Bank)

The increasing synchronization of business cycles coincides with the openness of

China’s economy to international trade during the same period. The share of merchandise

exports in GDP has risen from 4.65% in 1978 to 35.52% in 2007 (Figure 2). Almost 8

folds increase over 30 years. China’s trade expansion has no doubt exceeded that of any

of the industrialized economies in the first globalization era. In the golden ages of those

industrialized economies, such as the UK during 1820-1870, Germany during 1870-1913

and 1950-1973, and Japan during 1950-1973, the share of merchandise exports in total

GDP increased by factors of approximately three to four over a 40 to 50 year period6.

Figure 2: Growth of Merchandise Exports (1978-2007)

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(Source: Department of Comprehensive Statistics of National Bureau of Statistics, China

Compendium of Statistics 1949-2008, 2009, Beijing: Zhongguo tongji chubanshe, p. 60.)

Nevertheless, it is widely acknowledged that China’s export to GDP ratio

exaggerates its export dependence because of the heavy import dependence of assembly

exports. Consider the example of iPhone, which China assembles for Apple and exports

to the United States and other countries. In trade statistics, the Chinese export value for a

unit of iPhone 3G in 2009 was about $178.96. However, the best estimate of the value

added attributable to producers in China was only $6.50, with the remaining value added

coming from the Japan, Korea, Germany and United States7. Thus, a high concentration

of assembly exports in total exports allows China to minimize the shocks transmitted

6 Zhu, Y., "Trade, capital flows and external balance: is China unique in two hundred years of globalisation?", Journal of Chinese Economic and Business Studies, 2010, vol. 8, n° 1, p. 3.7 Xing, Y. & Detert, N.,"How the iPhone Widens the United States Trade Deficit with the People's Republic of China", ADBI Working Papers Series, 2010, n° 257, p. 4.

from end consumers by reducing the imports of necessary components from other trading

partners. The better way to estimate the real exposure of China’s economy to exports

should be preceded in a domestic value added method. According to John, Vivien and

Jonathan from McKinsey, roughly half of China’s exports represent domestic value

added from 2002 to 20088. That is under 10% of GDP exposed really to exports as

Anderson J. from USB put it9.

Based on the official trade statistics of Chinese government, we try to build a

chronological evolution of domestic contribution in exports between 1978 and 2007.

Following the findings of Koopman R., Wang Z. and Wei S. J.10, we suppose that the

share of domestic valued added is high in normal exports (between 88-95%), but low in

processing exports (between 18-26%). After recalculation (Figure 3), the share of

domestic value in merchandise exports declined constantly between 1981 and 1996, from

between 84.08% and 91.11% to 46.66% and 54.04%. Consequently, the share of GDP

exposed to external demand grew much slower than the gross export to GDP ratio

suggests.

8 John, Vivien, & Jonathan,"A truer picture of China's export machine", McKinsey Quarterly, 2010, p. 2.9 Anderson, J., "Is China export-led", UBS Investment Research, 2007, p. 3.10 Koopman, R., Wang, Z., & Wei, S.J.,"How much of Chinese exports is really made in China? Assessing domestic value-added when processing trade is pervasive", NBER Working Paper Series, 2008, n° 14109, p. 16.

Figure 3: Domestic Value Added in Exports

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Merchandise Exports/GDP Dometic value added/GDP (1) Dometic value added/GDP (2)

(Source: Department of Comprehensive Statistics of National Bureau of Statistics, China

Compendium of Statistics 1949-2008, 2009, Beijing: Zhongguo tongji chubanshe, p. 61.)

*Domestic value added/GDP (1) is calculated under the assumption that domestic valued

added accounts for 18% in processing trade and 88% in normal trade; Domestic value

added/GDP (2) is calculated under the assumption that domestic valued added accounts

for 26% in processing trade and 95% in normal trade.

The economic growth during this period was mainly driven by gross capital

formation and internal consumption as massive labor moved from the low-productivity

sectors to higher ones. Each factor represented averagely 36.56% and 63.09% of GDP.

However, ever since 1997, the domestic value added represents stably around 47-54%.

The growth of real GDP share exposed to external demand catches up that of gross export

to GDP ratio, doubled over ten years, reaching almost 20% in 2007.

This transformation could be due to the change of development strategy from the

late 1990s after the Asia financial crisis in 1997. The growth of household income was

permanently slower than the general GDP growth, causing shrinking contribution of

domestic consumption in GDP formation. From 2000 to 2007, the share of domestic

consumption in GDP reduced from 62.3% to less than 50%, while the weight of

investment increased, accounting for 41.7% in 2007 (Figure 4). A higher capital

formation usually implies a higher capacity of production, which has to be ultimately

consumed by the final demand. In this light, it is not surprising to notice a higher

dependence of China’s economy on external demand in order to compensate the loss of

internal demand while investment is speeding up. The coupling process is thus an integral

part of the development strategy favoring investment but discouraging consumption.

Figure 4: Latest Change of GDP Components

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Final Consumption Rate (%)

Capital Formation Rate (%)

(Source: China Statistical Yearbook 2010, 2010, Beijing: Zongguo tongji chubanshe)

Despite of the theoretical ambiguity about relationship between trade integration

and business cycle synchronization11, China's experience echoes the empirical findings

11 On the one hand Frankel and Rose propose that greater trade integration stimulates the spillover of aggregate demand shocks, thereby increasing output co-movement (see Frankel, J.A. & Rose, A.K.,"The endogenity of the optimum currency area criteria", The Economic Journal, 1998, vol. 108, n° 449, pp. 1009-1225.), and on the other hand, Krugman assumes that trade integration may also lead economies to specialize in the production of goods for which they have a comparative advantage, hence reducing co-movements (see Krugman, P., "Lessons of Massachusetts for EMU", in Torres, F. &

that stronger trade linkages lead to greater business cycle synchronization. During the

crisis, this increased correlation of business cycles turned out to be the collapse of foreign

trade and a slowdown of economic growth. The monthly variation of exportation became

negative from November of 2008, and the cumulated quarterly GDP growth rate over the

same period declined drastically in 2009, from a high level of 9.6% at the end of year

2008 to 6.5% in the first quarter of 2009 and 7.4% in the second, below the magical

figure of 8% considered as crucial to control the unemployment rate12.

Coupling or decoupling?

China did recover quickly and strongly. The annual growth rate of GDP in 2009

remained finally at 9.1% and heading into 2010, the cumulated quarterly GDP growth

was constantly above 10%. This formidable growth during the global turbulence, does it

indicate the starting of the “decoupling” process? It is still too early to answer this

question, for the key of short-term success was undoubtedly the expansionary fiscal and

monetary policy. The government announced a fiscal stimulus program of 4 trillion CNY

(486 billion USD) in November 2008. The largest share of the stimulus package is

intended for infrastructure projects (38%); the second largest share goes to the post-

earthquake reconstruction of Wenchuan in Sichuan Province (25%). Public utilities in

rural areas and the construction of affordable housing in urban areas receive shares of

9.25% and 10% respectively.

In addition to the fiscal stimulus package, the government is also applying some

monetary policy instruments. In December 2008, interest rates for loans and savings

deposits with a one-year duration were lowered to 5.31% and 2.25% respectively. The

easy access to loans resulted in an explosion of the total credit volume. Bank lending

amounted to 39.97 trillion yuan at the end of 2009, 9.63 trillion more than in 2008 and

had already exceeded the year’s target of 5 trillion in May13.

Government led investment helps China to maintain its high growth rate without

the engine of exports. While collapse of foreign trade affected negatively GDP growth

Giavazzi, F. (ed.), Adjustment and growth in the European monetary union, 1993, Cambridge: Cambridge University Press, pp. 241-266.)12 Quarterly economic data available at http://www.stats.gov.cn/tjsj/jidusj/ 13 http://www.pbc.gov.cn/publish/diaochatongjisi/126/index.html

with -3.7 percentage points, The gross capital formation accounted for 8.7 percentage

points in 2009, 4.1 percentage points more than in 2008, compensating entirely the

negative effect of collapse of foreign trade (Table 2). The development model before the

crisis was not only pursued but also enhanced. However, the policies which count heavily

on the government led investment expansion cannot be sustainable without the recovery

of final demand. The huge fiscal and monetary expansion has caused inflationary

pressure in 2010, forcing government to face rather an overheating threat than a recession

one14.

Table 2: Contribution Share and Contribution of the Three Components of GDP to

the Growth of GDP

Final Consumption

Expenditure

Gross Capital Formation Net exports of goods and

service

Contribution

share

Contribution

percentage

Contribution

share

Contribution

percentage

Contribution

share

Contribution

percentage

2008 43.5 4.2 47.5 4.6 9.0 0.8

2009 45.4 4.1 95.2 8.7 - 40.6 - 3.7

(Source: China Statistical Yearbook 2010, 2010, Beijing: Zongguo tongji chubanshe)

*Contribution share of the three components to the increase of the GDP refers to the

proportion of the increment of the each component of GDP by expenditure approach to

the increment of GDP.

*Contribution of the three components to GDP growth refers to the growth rate of GDP

multiplied by the contribution share of the three components.

In case of the stagnation of external demand in traditional exporting markets,

Chinese government will face a challenge to shift the development strategy in order to

level up the domestic consumption. In order to do so, China not only has to improve the

redistribution of the income by establishing a sound welfare system, but also has to fulfill

14 The CPI figure has risen to 4.4% in October of 2009, and 5.1% in November.

the unfinished labor structure evolution. About half of China’s massive labor force is still

engaged in agriculture where productivity is, on average, barely one-eighth of that in

industry and about a quarter of that in the service sector. Agriculture still accounts for

over 45% of total employment in the country even though agriculture’s share in GDP is

only 13%.

This indicates a serious problem of underemployment. In 2000, China has about

200 million unemployed or underemployed workers to bring into the modern labor force,

and the urban unemployment rate had reached 11.5% according to estimation of Knight J.

and Xue J.15. Nevertheless, the policies of Chinese government to upgrade its industry

structure by politically privileging SOEs that are concentrated in the capital intensive

sectors affects the capability of employment creation of domestic industries. It is thus a

political challenge for Chinese government to create 10-12 million net new jobs per year

in the urban centers for political stability. If a growth rate of around 8% has served to

employ about 10 million new workers each year, about 3 million, as estimated by

Dooley, have been in the export sector16. The recent work of Feenstra R.C. and Hong C.

even suggests that export growth in principle can explain the entire employment growth

of 7.5 million workers per year for 2000-200517. Thus, China faces a formidable political

constraint in shifting policy emphasis away from export-oriented growth and towards

domestic-market oriented growth; there is strong domestic pressure to maintain the

momentum of employment-intensive growth through export orientation, especially after

1997.

This political pressure was even acknowledged by the Chinese officials who defend

publicly, for this excuse, the current exchange rate of yuan. The 10th of November 2009,

Li Ruogu, the president of the Export-Import Bank of China, made the following

remarks: “Every year China has more than 20 million people who need jobs. If we raise

15 Knight, J. & Xue, J.,"How high is urban unemployment in China?", Journal of Chinese Economic and Business Studies, 2006, vol. 4, n° 2, p. 96.16 Dooley, M., Folkerts-Landau, D., & Garber, P.,"A Map to the Revived Bretton Woods End Game: Direct Investment, Rising Real Wages, and the Absorption of Excess Labor in the Periphery", Deutsche Bank Global Markets Research, 2004, p. 4.17 Feenstra, R.C. & Hong, C."China’s exports and employment", in Feenstra & Wei (ed.), China's Growing Role in World Trade, 2010, University Of Chicago Press, p. 190.

largely the salary level, it will make China lose the global competitiveness, and the

unemployment problem cannot be solved. Are Western countries prepared to receive

every year 50 million Chinese immigrants? If so, we can reevaluate upward the Chinese

yuan”18.

Thus, although the current financial crisis spotlights the unsustainability of current

development model, there is little space for China to maneuver so as to detach from the

ongoing coupling process, at least in the short run. Under this context, the rapid recovery

of exports, as shown in the statistics of monthly variation of exports, is not only

understandable, but also theoretically expected (Figure 5).

Figure 5: Monthly Change of Exports (2008-2010)

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Gross Exports (milliards USD) Monthly Variation Rate (%)

(Source: http://zhs.mofcom.gov.cn/tongji.shtml)

Recoupling or decoupling?

The latest data suggests that post-crisis China may experience another round of

enhancing coupling process, as has been after 1997 Asia crisis. However, some tendency

merits attentions for there are signs that this time China may recouple its economy

without sacrificing its growth of exports in the way favoring an ultimate decoupling.

18 http://finance.ifeng.com/news/special/quanqiujingji/20101110/2858215.shtml

Ever since 1997, there is a diversification of China’s export regions. Between 1997

and 2009, the importance of high-income countries as a destination for the China’s

exports has steadily declined. From 87% in 1997, high-income countries’ share of

Chinese exports has fallen to 75.46% in 2009. Meanwhile, the share of China’s exports to

traditional trading partner in East Asia has increased from 4.92% to 6.64%, and that for

the developing economies outside of the region have been rising significantly from

8.07% to 17.67% (figure 6).

Figure 6: Destination of China's Exports (1978-2009)

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1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

High Income Countries

Developing Countries within region

Developing Countries outside region

(Source: http://data.worldbank.org/)

With the prediction of a long-term legacy of lower growth in advanced economies,

such a South-South linkage may allow China to pursue its exports growth in the post-

crisis period. It is a “recoupling” process that China might experience; a recoupling that

doesn't imply a shift of development strategy from export-led to domestic consumption

driven, but a diversification of external demand which is crucial for China's economic

growth with the goal to reduce the vulnerability to macroeconomic cycles of advanced

economies.

Whether such a “recoupling” can turn out to be "decoupling" or "switch over", as

Otaviano Canuto19 uses to describe the change of locomotives in the global economy

from developed countries to developing ones including China? Comprehensive efforts in

terms of domestic policies and reforms favoring a sustainable expansion of

domestic consumption will be fundamental to accomplish this mission.

Recent trade figures indicate that more and more imports are for domestic use. The

percentage of imports under processing trade regime in the total imports declined from

the peek 49.31% in 1997 to 32.36% in 2009, while ordinary trade represented 53.09% in

2009 from as low as 27.41% in 199720. Nevertheless, this significant increase of imports

under ordinary trade was principally due to the high rise of imports of basic goods.

China’s imports of primary commodities have risen from 20.69% to 35.13% between

1996 and 2008 according to data of UNCTAD21, a growth similar to the estimation of

Kim S. et al22. Within the primary commodities, it’s the fuels and ores that have grown

the fastest, with its share rising from 9.67% to 27.47%. Although the share of China’s

final goods imports increased to about 50% in 2003-2005, it has since fallen to 39.5% as

of 200823.

China faces still the challenge to boost its domestic consumption in order to sustain

the future economic growth. This challenge has been acknowledged by Chinese

government who shifts the goal of 12th five-year plan toward strategic adjustment of

economic structure, establish the long-term mechanism for internal consumption growth,

and rebalance the investment, exports and consumption. The main methods would be

composed of, among others, the rebalance of international current account, the

improvement of employment rate, the growth of service industry, and the increase of

19 Canuto, O., "Recoupling or Switchover: Developing countries in the global economy", in Canuto, O. & Giugale, M. (ed.), The Day After Tomorrow: The Future of Economic Policy in the Developing World, 2010, Washington D.C.: World Bank Publications, p. 38.20 Department of Comprehensive Statistics of National Bureau of Statistics, China Compendium of Statistics 1949-2008, 2009, Beijing: Zhongguo tongji chubanshe, p. 61. http://www.chinacustomsstat.com/aspx/1/NewData/Stat_Data.aspx?state=4 21 http://unctadstat.unctad.org/ReportFolders/reportFolders.aspx 22 Kim, S., Lee, J., & Park, C.,"The Ties that Bind Asia, Europe, and United States", ADB Economics Working Paper Series, 2010, n° 192, p. 13.23 Ibid.

urbanization rate24. The new five-year plan settles the tone for the future policies, but it

will depend on concrete measures and policies put in place to fulfill the painful structural

change.

Conclusion

The history of China’s economic growth is a history of its integration into global

economy. In the 1980s and the first half of 1990s, China, taking advantage of the

abundant labor, was first integrated into Asia’s production networks. The significant

growth of assembly exports, on the one hand favored the labor structure change, raised

the general income level and increased the internal consumption; on the other hand kept

at a low level the real exposure of China’s economy to external demand. Nevertheless,

since the second half of 1990s, the development strategy shifted to state sector reform

and capital-intensive industries. The discrepancy between investment and internal

demand pushed China to be more dependent on external demand. Since the integration

into WTO in 2001, the ratio of domestic value added exports to GDP rose significantly.

From 1978 to 2007, China experienced a “coupling” process, from a rather uncoupled

situation to a more coupled one.

The anti-crisis policies employed by Chinese government allowed China to

maintain a high growth rate, but also exacerbated the problems inherent to the current

development model. Without a painful structural change, there is little space that China

could be decoupled from the global demand. The recent rapid recovery of exports is

therefore a signal that China would continue its export-led model, but with a

diversification of its exports’ destination. A stronger South-South linkage implies a

potential post-crisis “recoupling”, which is characterized by reduced vulnerability to

macroeconomic cycles of advanced economies without sacrifice of exports growth. This

“recoupling” process provides a precious breathing space for Chinese government to

conduct the complicated and time-consuming domestic reforms, favoring a sustainable

expansion of domestic consumption and an ultimate “decoupling”.

24 http://news.xinhuanet.com/politics/2010-10/27/c_12708501.htm

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