A Balancing Act

China’s economy today is driven more by domestic consumption than exports. To what extent are exports still vital to China’s growth?

China’s phenomenal growth and rising prosperity over the past four decades was kickstarted by export manufacturing. This remains a crucial part of the economy even though domestic demand is becoming ever more important. But China’s export industries are being challenged by a growing list of issues, including economic growth rates elsewhere, protectionism, rising costs, security concerns and trade restrictions.

Exports as a proportion of China’s total economic activity have been shrinking for years, and maybe soon in absolute terms too. This has significant consequences in terms of China’s trade balance, but also domestically in terms of employment rates and tax revenue flows.

Domestic consumption playing a bigger contributor to economic growth than exports is a positive sign in terms of the growing maturity of the economy. World Bank data confirms China is now significantly less export-oriented than it was a decade ago. The contribution of exports to gross domestic product (GDP) declined from 36% at its peak in 2006, to 19.5% in 2018. This is low compared to, for instance, South Korea where the export contribution in 2018 was calculated at 44%.

But China is still the world’s largest exporter by value. The country shipped $2.294 trillion worth of products around the globe in 2018, according to statistics reported by the International Trade Centre. About half of exports by value—47.8%—were delivered to other Asian countries, while 22.4% were sold to North American importers. China shipped another 19.1% worth of products to Europe. Africa took just 4.21% of the total exported goods and South America 4.17%.

The top categories for exports are electrical equipment and machinery, including computers and smartphones, accounting in total for over $1.1 trillion in 2019, or around 44% of total exports. Clothing amounts to around 6% of exports and building materials and furniture account for 4%.

“The trajectory of export growth matters much in areas like employment and tax revenue, especially for provinces that still rely heavily on the manufacturing-for-export industries, such as Guangdong, Jiangsu and Zhejiang,” says Nick Marro, China Lead Analyst of the UK-based Economist Intelligence Unit (EIU). “This dependency will likely persist for some time, even as China works to develop the domestic services market as a bigger part of its economy.”

China’s accession to the World Trade Organization in 2001 super-charged its export industries and was a key milestone in the country’s astounding economic rise, but the area seeing big increases these days is online domestic retail. The latest Singles Day, a Chinese shopping holiday that falls November 11 every year, generated RMB 268 billion ($38.2 billion) in sales in 2019, up almost 26% from the previous year and coming close to the $42.8 billion earned through cross-border trade in that month.

In 2018, domestic consumption contributed 76% of  GDP, compared to only 50% in 2013, according to data from the Australian-based financial services company ANZ. Growth in domestic consumption has been the driving force behind income growth, industrial upgrades, job creation and the revolutionized service sector. The country’s services sector is being transformed by the fast growth of instant credit verification, inventive mobile consumer applications and mobile payment systems.

“Hot areas in service consumption frequently emerge, and the innovation capability of sectors including culture, education, tourism, sports, elderly care and home service sectors is constantly improving,” Chen Lifen, an official with the Ministry of Commerce, told the state-run Xinhua News Agency in October.

Julian Evans-Pritchard, Senior China Economist at UK-based Capital Economics, says China has cushioned itself from the impact of a slowing export sector by relying more on domestic growth drivers, most important of which is the construction of housing and infrastructure.

“Although incomes are rising, there still are many people whose incomes rely on the export, infrastructure and property sectors, especially in inland regions,” he says.

But prospects for significant growth in infrastructure and property are no longer bright, and despite the benefits that a rise in domestic consumption has brought, China’s role as the “factory to the world” is still fundamental to its overall economic health. This role is becoming difficult to sustain in the face of all sorts of macroeconomic and geopolitical headwinds, including the China-US trade dispute.

Exports increased by just 0.5% in 2019 from a year earlier, according to China customs data, a sharp fall from a rise of 9.9% in 2018. And while a China-US “Phase One” trade deal was signed in January, the prospects for the sector in 2020 are not considered rosy, which has big implications for the wider economy.

“Domestic consumption has increased significantly over the past decade but its role as ‘factory of the world’ still remains in place,” says Fraser Howie, co-author of Red Capitalism: The Fragile Financial Foundations of China’s Extraordinary Rise. “Exports still make up nearly 20% of GDP, down from a decade before but still a hugely important part of the economy. Tariffs on those exports and hostility to ‘Made in China’ will have a corrosive effect on the economy. At a time of domestic deleveraging trade conflicts are a knock upon a bruise.”

The imposition of the tariffs by the US government on Chinese imports has had a chilling impact on China’s export industries, but also on the many companies that over the past decades have become reliant on China-based supply chains. The tariffs and confrontations have convinced many companies of the need to diversify and create alternatives to China production, in spite of its efficiencies and advantages.

This has contributed to the slowdown in export growth with the shift of manufacturing capacity to places like Cambodia and Vietnam. These are moves also aimed at escaping China’s rising labor costs and increasingly stringent environmental regulations, as well as the import tariffs the US slapped on Chinese goods as part of the trade war, says David Collins, CEO of Shenzhen-based China Manufacturing Consultants (CMC).

A good answer for exporting companies, Collins believes, is to stick with China and find ways to cut costs and increase productivity through automation and improved management, allowing China-based factories to stay competitive both in China’s own consumer market as well as overseas. China’s unparalleled production ecosystem in places like Shenzhen and the Yangtze River Delta, and its efficient network of highways, ports and, railways make it difficult for many companies to shift production to other markets.

“Although some companies don’t like to face change and rather leave, we believe prospects are bright for those that do change, and this is why we are still here,” Collins says. “The government has an ace up its sleeve, as it could relatively easily facilitate the shift from export-oriented manufacturing to domestic market-oriented by reforming the value added tax regime.”

Collins explains that as it stands, export manufacturers are spared a portion of the VAT but are not allowed to sell into China without giving up this preferential treatment.

Nevertheless, Renaud Anjoran, a partner at CMC, a UK-based financial derivatives dealer, says that many export-oriented manufacturers are wary of focusing too much on the domestic market. “It is about risk management as selling 40% to the USA, 20% to UK, 15% to France and 10% to Australia and so on is safer than selling 80% to China,” Anjoran says. “Among the other factors are the fiercer price competition in their domestic market and the great R&D contribution they get from some of their overseas customers,” he added.

Last year, the government allowed the RMB to weaken, which helped exporters. “By allowing its currency to slide, China has partially cushioned itself against the damage caused by the trade war with the United States,” said Maximilian Kaernfeld, a researcher with the Germany-based think tank Mercator Institute for China Studies (Merics), in a late-October note. “Letting the yuan weaken has moved the cost of tariffs away from  exporters, though it has not removed them completely.”

Keeping a balance

While exporters remain crucial to economic health, returning to an export-led trajectory is no longer an option. “China must make private consumption its new major growth driver, which is easier said than done because at the end of the day, private consumption must also be funded somehow,” says Evans-Pritchard.

Other countries that underwent the transition from an export-oriented economy to a consumption-oriented one, such as Japan and South Korea, saw their GDP growth rates declining to a much slower pace than China today. But Evans-Pritchard stresses that Japan and South Korea faced this difficult transition when their levels of prosperity were significantly higher than China’s, meaning China’s transition will be riskier.

Eyes on the consumer

Data by market researcher Euromonitor International shows that consumers spent $5.3 trillion in 2018, up from $4.7 trillion in the previous year but still far less than the $13.6 trillion their American counterparts spent in 2018.

Chen Yangyang, an analyst with Shanghai-based market researcher CMR, points out that Chinese consumers’ desire for a better quality of life has consistently risen. A valuable parameter for this, Chen says, is the annual craze surrounding Alibaba’s Single’s Day, with the “What will you buy?” and “What did you buy?” questions in the event’s run-up and the aftermath replacing traditional weather-related conversation starters.

“From stocking necessities, such as shampoo and tissues, to purchasing high-end products, such as Lancôme skincare kit and Marshall speakers, consumers are getting more and more prepared to welcome [the idea of] ‘Buy Buy Buy,’” Chen says.

Notably, 2019’s Singles’ Day figures were largely driven by increased demand from smaller cities and less-developed parts of the country, as indicated by sales via Alibaba’s Juhuasuan e-commerce platform, which targets tier-3 cities and below. It therefore comes as no surprise that a growing number of companies that started off as contract manufacturers for international brands are now developing their own brands to sell directly to local consumers.

“We used to rely on overseas markets but are now making most of our revenue from selling directly to consumers via brick-and-mortar stores,” says Huang, the General Manager of Hong Yi Ka Dan, a Hangzhou-based manufacturer of high- and medium-end silk-made scarfs and shirts. “If you look at how eagerly international luxury brands are trying to enter China, you understand how many opportunities there are for companies like us in tier one to three cities.”

Persisting dependency

But exports remain important, not least because it earns China the US dollars it needs to pay for critical imports, such as coal, metals and oil.

Impacted by the export slowdown, and also by rising domestic demand for imported goods and outbound tourism, foreign currency reserves rose only marginally in 2019 after a fall of $67.2 billion in 2018. China’s current account surplus is also shrinking, from 10.3% of its GDP in the third quarter of 2017, to just 0.4% in the third quarter of 2018. A report from financial services firm Morgan Stanley expects a current account deficit of 0.3% in 2019, widening to 0.6% in 2020, a trend that has significant implications for China in the long term.

Nick Marro from The Economist Intelligence Unit singled out the ability of Chinese companies to service foreign debt, and lending related to the Belt and Road Initiative (BRI) as important aspects to watch in this regard. BRI lending is still mostly US dollar-denominated, making the China-led initiative for the strengthening of the global infrastructure network, or acquisitions of foreign companies along the route, costlier.

The exports business is going to get tougher, with long-term implications for its economy. “We expect shrinking exports will likely be one of the biggest drags on China’s economic growth in the coming months, as the tariff impact will be further in place, along with the pay-back effects,” Ting Lu, Chief China Economist at Nomura, says.

“Exports may no longer be as significant in percentage terms to the economy, but the importance of them should not be underestimated,” says Howie. “Trade is an essential part of fueling the economy via employment and infrastructure but also backing its global ambitions. China has things that all countries want to buy, especially developing countries, Chinese exports go hand in hand with the Belt and Road initiative.”