Big dragon, little dragons : China's challenge to the machinery exports of southeast Asia

WPS4297 Policy ReseaRch WoRking PaPeR 4297 Big Dragon, Little Dragons: China's Challenge to the Machinery Exports of Southeast Asia Sjamsu Rahardja The World Bank East Asia and Pacific Region Financial and Private Sector Unit August 2007  Policy ReseaRch WoRking PaPeR 4297- Abstract This paper investigates the extent of China's export boom evidence that China's expansion in the world machinery in machinery and analyzes trade in components and market has squeezed the market shares of Southeast finished machinery between China and Southeast Asia. Asian machinery exports. Instead, components made by China has increased its world market share in machinery Southeast Asian countries are increasing in unit value and exports. The median relative unit value of its finished gaining market share in China. machinery exports has also risen. Yet the author finds no This paper--a product of the East Asia Poverty Reduction and Economic Management, Financial and Private Sector Unit--is part of a larger effort in the department to study changes in trade pattern among countries in East Asia. Copies of the paper are available free from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contact Katie S. Shaw,roomMC8-188,telephone202-458-1307,fax202-522-3094,emailaddresskshaw@worldbank.org.PolicyResearch Working Papers are also posted on the Web at http://econ.worldbank.org. The author may be contacted at srahardja@ worldbank.org. August 2007. (36 pages) The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the views of the International Bank for Reconstruction and Development/World Bank and its affiliated organizations, or those of the Executive Directors of the World Bank or the governments they represent. Produced by the Research Support Team  Big Dragon, Little Dragons: China's Challenge to the Machinery Exports of Southeast Asia Sjamsu Rahardja JEL Code: F1, F2 This is a revised version of a background paper for trade chapter in "East Asia Project" of The World Bank. Previously this work was titled "Big dragon, little dragons: the role of China in Export of Machinery from Developing Southeast Asia The author would like to thank Mona E. Haddad, Hal Hill, Homi Kharas, and Silja Baller for various comments, discussions and helpful suggestions. The World Bank Office in Jakarta   I. Introduction Machinery products are important for the trade and economic development of East Asia. Studies and informal observations show that export promotion in machinery was part of the success story of Japan and the newly industrialized economies, South Korea and Taiwan, China.1 In recent years, machinery has also become a key driver of trade in developing East Asia i.e., China, Indonesia, Malaysia, Philippines, and Thailand. In 2000-2004, machinery products accounted for half of the total imports of these countries. Excluding China, the share of machinery in total exports of those countries has increased to 51 percent in 2000- 2004 from 38 percent in 1990-1994, superseding shares of other product groups. The story for the "big dragon" China is even more fascinating. China transformed its export structure with full thrust into a machinery exporting giant with interesting dynamics. The share of machinery in China's total exports leaped to 41 percent in 2000-2004 from 18 percent in 1990-1994. China's share in world machinery exports has increased almost 5 times in a decade, from 2.3 percent in 1994 to 11 percent in 2004. Thanks to FDI influx, Chinese machinery products are also showing signs of moving up the technology ladder. Having started out as a mass producer of labor-intensive and low technology goods, casual observations suggest that current Chinese exports of machinery have incorporated the latest innovations and more advanced technology. The share of personal computers with the latest processor and related accessories have overtaken the share of metalworking tools in China's total exports. China is also exporting more cellular phones, personal digital assistants and flat screen TVs rather than transistor radios as previously. Given these developments, manufacturers in Southeast Asia i.e., "little dragons" (Indonesia, Malaysia, Philippines, and Thailand) have become anxious about China's rising capability in producing machinery.2 They now feel competitive pressure from machinery "made in 1Kokko (2002) provided a survey on how Japan used government intervention to promote 44 strategic industries including steel and shipbuilding. 2I exclude Singapore from the list because in my opinion it has successfully transformed its economy into a services hub for the region. 2  China" in third markets as well as in their own backyards. In 1993 China's exports of machinery to the world were almost the same as Malaysia's, however, in 2004 China's machinery exports were already 4 times more than Malaysia's. As for home markets, manufacturers of motorcycles in Indonesia have complained about the flood of cheaper Chinese versions. Another concern is the loss of FDI resulting from positive externalities from manufacturing machinery products in China rather than in the other Southeast Asian countries. Firms in Japan, South Korea, and Taiwan, China might be leaning towards relocating to China instead of producing in Indonesia, Malaysia, Philippines, or Thailand, which could mean loss of jobs and investment in these countries. Despite China's bold maneuver, the big dragon shaking its tail could also benefit the little ones. China's increasing role as an assembly hub could provide opportunities for suppliers of components from Southeast Asia. The current pattern of trade and investment suggests that machinery is put together with the help of a network of suppliers known as a production network. As a result of the fragmentation of the production process, a Chinese assembler needs only to focus on its competitiveness in assembling parts and components while relying on highly skilled suppliers in Southeast Asia or elsewhere with lower cost.3 Chinese assemblers can also delegate the manufacturing process of components that mainly use resource-based inputs - such as rubber and metallic ores - to resource rich countries such as Indonesia and Malaysia. Thus what might be interesting for many, including policy makers in Southeast Asia, is the extent of externalities resulting from China's increasing machinery exports. Against this background, we explore how trade in components and finished products of machinery is behind the trade between Southeast Asia and China. Second, we look at the competitiveness and relative sophistication of China's machinery products versus those made by Southeast Asian countries. Third, we use regression analysis to look at whether expansion in Chinese machinery exports has any impact on unit value and export composition in machinery from 3Jones and Kierzkowski (2001) provide a general framework on the fragmentation of production activities. Ando and Kimura (2007) argue that falling costs of servicing different production blocks have driven the fragmentation process of trade in machinery towards economies in Developing East Asia. 3  Southeast Asia. Finally, we explore the extent to which Southeast Asian countries have been involved in the production sharing network to support China's role as the hub for final assembly. This study adds new findings to the already rich literature on trade in East Asia. We document both competing and complementary forces as economies in East Asia integrate. We also explore the extent to which changes in structure and value of exports in machinery from Southeast Asian countries can be credited to China. In many aspects our paper complements other studies on intraregional trade (such as Kawai, 2005), production fragmentation and trade (Ando and Kimura, 2003, 2007, and Kimura et al, 2005), and technology upgrading in exports from East Asia (Gaulier et al, 2005). In addition, this paper sheds light on China's and Southeast Asia's progress on the quality ladder of machinery products. II. The Pattern of Trade in Machinery in China and Southeast Asia The data show clearly that China has taken off to become one of the world's most important machinery exporters. Figure 1 indicates that in 1975 China was an underdog in the world market of machinery products, even compared to Malaysia and Singapore. In 1989, Chinese exports of machinery overtook Malaysia and less than 7 years later superseded Singapore. In 2003, total machinery exports from China were already higher than machinery exports from Indonesia, Malaysia, Philippines, Singapore, and Thailand combined. Office data and telecommunications products have played a crucial role in China's success in terms of machinery exports. China alone has market shares of almost 16 and 8 percent respectively in the global export of those commodities. However, other countries in Southeast Asia are also becoming important players in global trade in machinery. For example, exports of office/data processing machines, telecoms equipment and electrical machinery from Malaysia and Philippines are increasingly gaining importance. 4  Table 1 documents the changes in market share of export in machinery of countries in Developing East Asia (China and Southeast Asia excluding Singapore). Lightly shaded cells show products with decreasing market shares while dark shaded ones show those with increasing shares. When it comes to office/data processing and telecoms products, China alone holds almost 16 percent of market share in global exports. China's export market share in those two product categories increased more than 5-fold in 10 years, from 3 percent in 1993-94. China's second largest export mover is electrical machinery, the market share of which increased almost 3.5 times, from 2.4 percent in 1993-94 to 8 percent in 2003-04. Overall, Developing East Asia has clearly increased its presence in global trade in machinery. As a whole, in 2003-2004 the group had more than doubled their world market shares in office/data processing machines and telecoms equipment as compared to a decade earlier, jumping to almost 23 percent from 10 percent in 1993-1994. Countries in the group are also increasingly present as exporters of electrical machinery, their share in world exports having increased to 16 percent in 2003-2004 from 10 percent in 1993-2004. Most countries in developing East Asia are importers of components and exporters of finished machinery. Table 2 shows that shares of components and finished products, respectively, in total imports and exports of machinery have increased. With the exception of Indonesia, the share of components in total machinery imports has increased significantly in developing East Asia. From 1993-1994 to 2003-2004, the share of components in total imports has increased by 36, 26, 15, and 9 percent in the Philippines, China, Malaysia, and Thailand, respectively. On the export side, Indonesia and the Philippines are lagging behind other developing East Asian countries when it comes to increasing the share of finished products in machinery exports. The East Asia region has become an important source of machinery imports for developing East Asia. First, Table 3 shows that more than half of East Asia's imports in finished machinery came from the region (summing up first seven columns in Table 3). Developing East Asia is increasingly sourcing machinery from the newly industrialized economies instead of Japan and the United States. Countries such as Indonesia, Malaysia, the Philippines, and Thailand increased their shares of imports of machinery from China and the 5  newly industrialized economies at the expense of Japan and the United States. The same pattern also appears on the export side. As shown in Table 4, more and more machinery exports from developing East Asia are heading to East Asia (excluding China). The rows of Table 4 indicate the increase in share of exports in components and finished machinery from developing East Asia to the East Asia region. We also confirm the results of other studies by showing that components are largely behind the trade in machinery in developing East Asia. As shown in Figure 2, exports of components contribute 76 percent to export growth in machinery from the Philippines. Exports in finished products contribute 59 percent in changes of export in machinery from China. The import side presents an even more dramatic picture. Figure 3 shows that components are a key driver of Philippines imports of machinery. Similarly the figure also shows that parts and components are driving China's imports of machinery, highlighting the importance of final goods assembly in China. For Southeast Asia, China is playing an important role as source of and market for machinery components. The proportion of machinery components coming from China to Southeast Asia has increased significantly. For example, the share of Malaysian and Thai imports of components from China increased almost 18 and 7 times, respectively, in 10 years. In the next section we will see evidence that China is an important supplier of components with relatively low value for manufacturers of machinery in Southeast Asia. This increase in shipping of components to Southeast Asia has been happening in parallel with the increase in China's exports of finished machinery. An interpretation could be that Chinese firms are taking advantage of Southeast Asian capacities for further refinement of components before they are shipped back to China and assembled to the final product. This hypothesis is supported by the fact, that China is becoming an important export destination for components made in Southeast Asia. Over the last 10 years, the proportion of exports in components which have been shifted to China has increased by almost 5 times for Indonesia, 15 times for Thailand, 19 times for Malaysia, and exponentially 60 times for Philippines. These findings suggest that there might be a certain degree of complementary between China and Southeast Asia regarding trade in components. 6  III. Comparing Performance of Exports of Machinery: China versus Southeast Asia Having described the broad pattern of trade in machinery in developing East Asia, we next look at performances in machinery exports within developing East Asia, comparing Southeast Asia with China. We will examine the similarity, competitiveness, and value of exports in machinery from Developing East Asia and how they have changed in the last ten years. The main conclusion from this analysis is that machinery exports between China and Southeast Asia are increasingly similar. To measure export similarity, we use the Finger and Kreinin index as it provides information on the extent of potential market displacement caused by competition (Finger and Kreinin, 1979).4 Calculating the index for various machinery products indicates that exports from China and countries in Southeast Asia are becoming increasingly comparable (Table 5). With the exception of road transportation, the index of export similarity has increased over the last ten years, both in components and finished machinery. Products that seem to have a high degree of export similarity are components of electronics products office machinery and telecommunications equipments. In fact, the index of export similarity between China and Southeast Asian countries on the latter product has increased significantly. We also consider a bilateral index of export similarity among countries in developing East Asia (Table 6). There we find that exports in components from China is becoming more similar to that from Indonesia and Thailand while Chinese exports in finished machinery is becoming highly similar to those produced by Malaysia.5 A Revealed Comparative Advantage (RCA) approach shows that all countries in developing East Asia have increased their comparative advantage in exporting machinery products vis- 4The formula for similarity index is given by: