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«Raphael Kaplinsky Department of Policy and Practice, The Open University R.Kaplinsky Paper prepared for Rise of China: Global ...»

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CHINA AND THE TERMS OF TRADE: THE

CHALLENGE TO DEVELOPMENT STRATEGY IN SSA

Raphael Kaplinsky

Department of Policy and Practice,

The Open University

R.Kaplinsky@open.ac.uk

Paper prepared for Rise of China: Global Opportunities and Challenges

Conference, Mount Holyoke, March 2008.

ABSTRACT

China‟s rapid and relatively recent accession to the global economy has had a number of important impacts for the global economy. Amongst these is the consequence of its rising manufacturing exports and commodity imports for the terms of trade. If this leads to a sustained reversal of the long-term relationship between the prices of manufactures and commodities, it challenges the basic premise of industrialisation which underlies much of development strategy in SSA (and elsewhere). This feeds into, and is in turn fed by, domestic and regional political processes.

1. INTRODUCTION Beyond the minutiae of everyday, annual and five-year cycles of policy lies the choice of development strategy. This shapes the trajectory of the economy over long periods, affecting not only the rate of economic growth but also its welfare and environmental impacts. It is customary (at least for economists) for this strategic choice to be located as a technical issue. “Which sectors should be privileged?”, “what should be the balance between public and private actors in resource allocation?”, and “what price signals will lead to the optimal outcome” are seen as decisions of economic rationality.

It is widely recognised that the core strategic choice in the development agenda has for some centuries been the commitment to industrialise and to reduce the relative importance of the commodity sectors of the economy.

There are both powerful historical and analytical reasons rationalising this strategic choice. But recent developments in the global economy, largely associated with the rise of China and India ( the “Asian Drivers”) challenge the logic of the commitment to industrialise at the expense of the commodity sectors. What implications does this hold for development strategies in general, and for the poor economies of sub-Sahara in particular? And, in what political context and with what political configurations will these challenges to core development strategy be associated?

These two questions are addressed in this paper, bearing in mind that the writer‟s expertise is predominantly in the realm of economics. In Section 2 we briefly outline the evolution of core development strategy favouring a path of industrialisation. In Section 3, we outline the very recent, rapid and globally integrated growth of China and India. In Section 4 we briefly discuss the mechanisms by which this has an impact on other countries. We follow this in Section 5 by showing the impact which these growth paths have on the terms of trade which underpin the choice of development strategy in favour of industry. In Section 6 we address the challenges this poses to development strategy in SSA, and then in the concluding Section we attempt to place these developments in a context of political economy.

2. INDUSTRIALISATION AS A CORE DEVELOPMENT STRATEGY

After an initial focus on the agricultural sector following Independence in 1947, a severe drought and associated famine during the first half of the 1950s led India to commit its development strategy to a path of industrialisation. In this choice Indian planners were not only influenced by powerful theoretical factors (see below), but also by the demonstration effect of Soviet Russia‟s rapid industrialisation as a defence against hostile powers during the 1920s and 1930s. The question of whether to commit this industrialisation path to a heavy- or light-industry focused strategy, echoing a debate in both postrevolutionary Russia and Marxist economics was a subsidiary concern, with India choosing to pursue the development of heavy industry and technologyand capital-intensive capital goods.

Most of the developing world mirrored this strategic commitment to industrial development during the second half of the 20th Century. But it was not just the demonstration effect of India, or soviet development (and indeed, the earlier experience of England, continental Europe and North America) which rationalised this strategic choice. Nor was it the evident association between countries with high levels of per capita income and high shares of industrial development. There were also clear analytical reasons why industry should be favoured at the expense of other sectors. Particularly important here was the trend in relative prices of manufactures and commodities, the terms of trade.

Until the 1950s it was widely believed that the terms of trade would turn against manufactures, and in favour of agricultural products. It was Hans Singer, and then Raul Prebisch, who deflated this belief in the early 1950s (Singer, 1950; Prebisch, 1950). They showed that in actual fact, the terms of trade were turning in favour of manufactures and against commodities (Figure 1 shows the data for the second half of the 20 th Century, but in fact the relationship goes back until at least the 1870s). In demolishing this orthodoxy, Singer and Prebisch explained these trends in the terms of trade as resulting from a number of factors – the lower income elasticity of demand and higher price elasticity of demand of commodities;1 the development of synthetic substitutes for primary products; and the fact that commodities were only one of many inputs into final manufactures meant that a proportionate increase in the price of manufactures would have a lower impact on commodity-producer incomes compared to those arising in the production of commodities.





Figure 1: Manufactures-commodities terms of trade, 1960-2004 1980=100

–  –  –

The income elasticity of demand for manufactures means that as consumer incomes grow, they tend to spend a greater proportion of manufactures than on commodities.

The price elasticity of demand for commodities means that for a given increase in prices, demand is likely to fall more than for manufactures.

The import of this observation on the terms of trade is that long-run income growth would be fostered by moving out of price-sensitive (and, as SingerPrebisch observed, price-volatile) primary products into income-elastic and price-inelastic manufactures, in other words by making a strategic commitment towards industrial development.

From the late 1970s, a twist was given to this widespread strategic commitment to industrialisation. Based on the extraordinary growth-success of Japan and then the Asian Tigers, the strategic agenda was not just a commitment to industrialisation, but to export-oriented industrialisation. This increasingly became a strategic orthodoxy. For example, the World Bank‟s influential assessment in 2002 of the link between poverty and deepening globalisation forcefully promoted the case for further globalisation, notably through rapid growth in developing country exports of manufactures. Although the Bank recognised that there was some dispute about the evidence, it pulled few punches - “the doubts that one can retain about each individual study threaten to block our view of the overall forest of evidence. Even though no one study has established that openness to trade [in general, and export oriented industrialisation in particular] has unambiguously helped the representative Third World economy, the preponderance of evidence supports this conclusion” (World Bank, 2002: xi).

Heavily influenced by this multilateral- and bilateral-agency policy agenda, and drawing on the successful growth and manufactured export experience of the first generation of Asian NICs, SSA economies have increasingly oriented their long-term growth objectives to a graduation from the export of primary products to the export of manufactures. The demonstration effect of the astonishing recent emergence of China as a major global exporter of manufactures and its relatively successful performance in meeting the $1/day Millennium Development Goal has provided further impetus to this policy consensus.

3. ARE THE ASIAN DRIVERS A DISRUPTIVE FORCE IN THE GLOBAL

ECONOMY?

On current trends, China will be the second biggest economy in the world by 2016, and India the third largest by 2035. A cluster of other countries in the Asian region, such as Thailand and Vietnam, are also growing rapidly. These newly dynamic Asian economies can collectively be characterised as the “Asian Drivers” of global change (hereafter the ADs). The two key AD economies are China and India. They disrupt the strategic and policy environment, and pose major and distinct challenges for the global and developing economies, for five major reasons.

The first is as a consequence of their size. As Figure 2 shows, from the beginning of their growth spurts (1979 and 1992 respectively), neither GDP or export growth in the two largest AD economies were unique. In recent years other Asian economies (for example Japan and Korea) have experienced similarly rapid growth paths. However, whilst China accounted for 20 per cent

–  –  –

horizons and are less risk-averse than their western counterparts (Tull, 2006).

Associated with these complex forms of ownership and links to regional and central state bodies, Chinese firms often operate abroad as a component of a broader strategic thrust. This is particularly prominent in China‟s advance in SSA in its search for the energy and commodities required to fuel its industrial advance (Kaplinsky, McCormick and Morris, 2007). What this means is that AD firms tend to invest with much longer time-horizons, are less averse to risk than their western counterparts and are able to call on active state assistance when this is required. Moreover, their base in low income economies means that they are not subject to the same pressures regarding corporate and environmental social responsibility as are the previously dominant western firms.

The fourth reason why the ADs present a new and significant challenge to the global and developing economies is that they combine low incomes and low wages with significant innovative potential. This means that they are able to compete across the range of factor prices. The oft-stated belief (and hope?) that China will run out of unskilled labour is belied by the size of its reserve army of unemployed, estimated at around 100m compared to the 83m people employed in formal sector manufacturing in 2002 (Kaplinsky, 2005). Moreover by 2030, India, also with a large reserve army of underemployed, is likely to have a larger – and younger - population than China. But China and India are not content to operate in this world of cheap labour and mature technologies, and are investing heavily in the building of technological capabilities. China, for example, overtook Japan to become the world‟s second largest investor in R&D in 2006 (Keeley and Wilsdon, 2007; Leadbeater and Wilson, 2007).

A fifth disruptive consequence of the rise of the ADs is their quest for secure supplies of raw materials. In the 2005-7 period this was an agenda largely played out in SSA, and largely in relation to access to energy. China became an active investor in the Sudan, Angola and Somalia in the search for secure oil supplies, running against established policy agendas of the hitherto dominant western powers, and displacing western energy firms. In Sudan this led to an easing of the pressure over Darfur; in Angola it allowed the government to escape pressure exerted by the Paris Club on transparency in government and in Somalia there is conflict within the state apparatus itself as to the legitimacy of the concession granted to Chinese companies. In Angola, China and India competed directly for access to the fuel deposits, in other cases (as in West Africa) they concentrated on different countries. But it is not just oil that the ADs have targeted in SSA. China has become a heavy investor in the Zambian copper fields, and in various mineral sectors in South and West Africa. Similarly, it is not just in SSA or in oil that their resource hunger is likely to be felt as a disruptive factor. A shortage of softwood in the global building industry in 2007 was a direct consequence of China‟s demand for timber, and water, too, has begun to loom on the horizon as a potential source of conflict.

As a consequence of these impacts, the ADs are beginning to disrupt the „political compact‟ which has underwritten the extension of globalisation in the post WW2 era. China and India are increasingly active in global institutions, demanding greater say in the regulation and shaping of the global economy.

Their own experience belies the efficacy of the Washington Consensus policy agenda, and China and India provide a different policy role-model for many developing economies, with the possible rise of a “Beijing Consensus” to rival the Washington Consensus (Ramo, 2004). These dynamics represent a transition from a quasi-unilateral US-dominated world order to a multipolar power constellation. This is likely to lead to new turbulences and conflicts between the rising and the declining powers within the global governance system (Humphrey and Messner, 2008).

How disruptive are the ADs? Although China‟s growth spurt began in the late 1970s and India‟s in the early 1990s, their presence in global markets and their global environmental impacts only really began to be felt at the turn of the Millennium. Indeed, India‟s impact is much more latent than real at present, although it is likely to become more significant in the future. It is perhaps too soon to conclude that they represent a historically decisive paradigm challenge to policy in SSA. However, as we will show below, their impacts are non-marginal and the pace of change has been, and continues to be extremely rapid. If this is the case, how are these disruptive forces transmitted to other economies, including those in SSA?

India‟s presence in Africa is predominantly of historical significance, although it is likely that this will change in the future as it too runs short of raw materials and increases its exports of manufactures. By contrast, China has a large and rapidly growing presence in SSA, and it is this presence which we will consider in the discussion below.

4. HOW ARE THESE DISRUPTIVE FORCES TRANSMITTED TO SSA?



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