Emerging Market Economy; a Case of China - Essay Example

Essay on an emerging market economy; a case of China. Insert Insert Insert Executive summary China has had a rapid economic growth in the last three decades since the initiation of economic reforms in the year 1979. This fast rate of economic growth has caught the worlds attention, and China is now a strong emerging economy almost closing the gap between it and the United States of America. It has become a major world economic power. There has been a tremendous improvement in the macroeconomic indicators over the past decade. From 2004, the Chinas GDP has been growing steadily at the rate of between 9.9% and 10%. There has also been a positive growth in net export, increase foreign reserves and of great significant increase in the outward Foreign Direct Investment. In the past decade, the country has benefitted from FDI and also had some negative spillovers as an emerging economy. Some of the benefits include the generation of exports and imports, labor mobility, horizontal and vertical integration, creation of more employment opportunities, capacity building of human capital and increase in Gross Domestic Investment among others. The costs which may occur as a result of FDI between emerging and advanced economy are such as crowding out of local firms, the foreign investors may gain the larger market share in the economy thus making local firms less productive. The net effect of FDI is positive in emerging economies, but negative in developed economies. Introduction There have been several economic research and policy studies conducted on various emerging market economies in the world. An emerging market economy can be defined as that market economy which is growing from a small market economy towards the level of advanced economies in the world. In China, there has been a constant economic growth in the last decade which has seen a significant positive deviation in the countys economy towards those advanced economies such as the United States of America. China is the highest populated country in the world with highest labor force endowment. This significant reform in the Chinas economy can be attributed to the economic reforms and trade liberalization which was initiated 35years ago. The fast rate in which Chinas economy has risen in the last three decades has caught the world attention and described by economists as the greatest in the present economic times. From the time the reforms were initiated in 1979 to 2014, there has been an increasing trend in the countrys Gross Domestic Product at a rate of about 10% annually. Prior to the reforms, the countrys GDP was estimated below 6.7%, but this grew to about 12% in 2014. The economic reforms also helped to improve the balance of trade and balance of payment in the economy. China has since become a net exporter especially to the African countries (Loren et al., 2014). The unemployment rate in China has significantly reduced from the time the economic reforms were initiated. The Chinese government has been giving priority to the employment issue. In 2005, the population of China was estimated at 1.3 billion. At that time, the total urban employed population was 273.31 million while rural employed population was approximated at 485 million. There is annual employment growth rate of about 10 million which has come as a result of restructuring of the economic sectors. It should however be noted that the emergence of the economy of China to second worlds super power has caused certain economic concerns in the world especially USA. There are those who argue that the Chinese policy makers are using unfair trade practices such as weakening their currency value intentionally and using non-efficient policies and strategies such as producer subsidies to flood markets with cheap goods. Even though the growth in the China economic status is vital in realizing socio-economic stability in the country, the government should be worried about what the strategies used could cause in the long run. China is using distortive economic policies where the growth is over-dependent on export and fixed investment. There is low consumer spending in the countrys economy as the country has a very serious discrepancy in income of its citizens. The government needs to move with speed to come up with policies that can improve consumer demand in the economy before the tremendous growth witnessed in the economy is hurt. This paper is going to discuss industrial structure of the Chinese market economy, look at the trend of selected macroeconomic indicators in the past decade and draw conclusions. The paper will also discuss the effects of Foreign Direct Investment between an emerging economy and an advanced economy such as USA. This paper will finally discuss the reasons that could lead to differences in mode of entry strategies of foreign direct investment between emerging markets and developed markets. The industrial structure of chinas economy The China industrial structure can be examined by first of all considering the Gross Domestic Expenditure (GDE) of the country. From reports of research on the domestic consumption in China for the last decade, it was established that only 35% is the household consumption rate which is far much below the international consumption standards (Herd S., Dougherty R. 2007). This could be attributed to those challenges which the population faces that lower their propensity to consume as they are forced to save for precautionary reasons among other reasons such as low labor income (Yu et al, 2009). When private consumption is very low in the country, it is more likely to reduce the rate of economic growth or can cause recession in the countrys economy. According to Keynes, this can be solved by heavy investment, a strategy employed by China. In the economic study involving time series data on the countrys GDP in 2011, it was found that China invests 50% of its GDP and a 5% surplus from outside the country up to the Lehman shock in 2008. This reliance on the external demand and very low internal demand is blamed on the bad economic policy. China deliberately devalued its currency in 1994 which has since made its export prices to compete in the world trading markets. Chinas foreign exchange policy is likely to create serious economic problems in the future that could seriously affect the tremendous growth witnessed in the past three and a half decades. Deliberate devaluation of the currency creates high inflation rate. This decreases the purchasing power of the citizens within the country whereas foreigners with a stronger currency have more effective demand (Yu, Miaojie. 2010). Statistics of macroeconomic indicators in China from the year 2004 to 2013 According to reports from various studies conducted in the Chinese economy within the reference period stated, most of the macroeconomic indicators have had minimal changes with most of them showing a steady trend. In this paper, last decade data on GDP, inward and outward Foreign Direct Investment, Balance of Trade, unemployment, inflation and Balance of Payment to draw conclusions. In the last decade, China has had a steady increase in the net export as its trade with the world. In 2004, china had a total import of approximately Mio € 450,849 and a total export of Mio € 26,398. From that time, there has been a continued decline in import growth rate up to -6.5% in 2009. From 2009, the import growth rate has been positive but in a decreasing rate up to 5.5% in 2013. In contrast, there has been an increasing trend in the total export from 2004 to 2013. The export growth was however affected negatively in 2009 and 2010 when China was a net importer. The export growth rate by 2013 was at 11.6%.These findings are according to statistics from IMF. The Gross domestic Product has also shown a steady increasing trend in the last decade. The annual GDP of China has grown steadily in average from the time of the initiation of reforms according to time series data. The overall growth rate has been estimated at about 9.9%. This growth was however affected by world economic slowdown in 2008 and declined to 9.6% from 14.7% in 2007. It should be noted that according to time series data from the World Bank in 2013, there has been a significant decrease in unemployment rate in the country; consequently this has led to increased inflation in the country (Nicholas Stern. 2013). When the rate of unemployment is reduced, it affects the prices that become very high. These high ratio increases rate of inflation. This phenomenon is explained well with Phillips curve. For the last decade, the unemployment rate in China has reduced at approximate rate of 0.48%. The Chinese government policy makers in 1994 came up with a policy to deliberately devalue their currency so as to increase exports of their commodities to the world market especially to advanced economies as USA. This policy has led to increasing in foreign currency reserve in the country for the last decade (IMF 2006). In Foreign Direct Investment, China has had an increase in outward FDI to Africa and Asia countries in the past decade. China has become a source of outward FDI, which grew from about 4 billion in 2004 to about 68 billion in 2013. The FDI inflows have significantly reduced in the past decade. It can be concluded that in the last decade there have been a tremendous improvement in the major macroeconomic indicators in the republic of China. Costs and benefits which can be realized when emerging markets and developed ones invest in each others country. Several economic and policy studies have shown that when two countries with different development levels invest in each other, there are some gains and losses as well. This paper is going to discuss the effects of FDI between emerging and a well-advanced market economies. An example of a more developed economy in the world today compared to China is the United States of America. It should be noted that the rapid economic growth which has been witnessed in China since the initiation of economic reforms has increased Chinese-USA ties in terms of investments and trade. There are several costs and benefits which come with any economic strategy. As shown in the data collected in the last decade on macroeconomic indicators, it can be evident that emerging economies benefit more from FDI. There are a number of Costs and Benefits of FDI between developed and emerging economies To discuss the benefits, one would ask, why are multinational firms investing in emerging market economies? Research on the impact of FDI on host economy has shown that there is a more complex influence as a result of the interaction between foreign and local investors, individual firms and institutions. According to economic studies it has been found that FDI helps to increase capital accumulation and advancement of technology which in the long run increases economic growth rate at an increasing rate. It has been proved that technology advancement and capital accumulation has a multiplier effect on investment hence acceleration of economic significance. China has had the largest share of FDI from USA to emerging economies in the recent years. For example in 2004, it got up to US$ 61 billion followed by Korea and Brazil. The danger of imported capital is that it is later paid back to the exporter through profit remittance or project discontinuation. It, therefore, means that the country with capital inflow pays for the cost of capital. FDI creates more employment opportunities especially in the emerging economies like China with a high labor endowment, but fewer job opportunities. Through FDI, opportunities may also open for more jobs from local suppliers. The positive effect of FDI will also be increased the labor mobility. However, for more employment opportunities to be created it may warrant crowding out of local firms and industries which are more labor intensive in their production. This would happen when local firms are taken over by a foreign investor. Accessibility to the export market is a benefit realized by FDI in emerging economies. FDI in emerging economies helps to create more export, but at the same time generates imports. As a result, there is a minimal net effect in the trade balance by FDI. It reduces certain trade restrictions between two countries and, as a result, there is better access to the world export market. Foreign Direct Investment allows stronger currency to circulate in the local economy which is as a result of increased export of commodities. This will help in strengthening of the local currency against world exchange rates. Increase in Gross Domestic Investment. FDI in itself is an investment and thus it increases the Gross Domestic Investment. However, this increased investment requires funding either domestically or with capital inflow and this will in a turn increase cost of international borrowing. It leads to horizontal and vertical spillover to the local industries. Inward FDI is aimed at accelerating technological advancement, growth in the economy. There is increased interaction between local and foreign firms that results in proper integration in the channel of distribution thus enhanced productivity of local firms. The local firms also gain from vertical linkages in the value chain through knowledge transfer down the supply chain. FDI promotes the creation of human capital through capacity building and labor mobility. Trained workforce may be absorbed by the local firms or set up individual businesses that help to improve livelihoods. However, local firms and industries may also realize negative spillover effects as a result of foreign investment. These could be as a result of crowding out effects; foreign investors in the long run may gain bigger market share at the cost of local firms. This may lead to excess supply and hence low profits as a result of poor sales. Some foreign firms may also decide to import inputs that hurt the local supplier base (Nicholas Stern. 2013). In conclusion, according to Meta-analysis carried out on the FDI data, there is a negative net effect on developed economies, but a positive though very minimal net effect on emerging economies. These positive effects help in improving the economic growth of emerging economies like China. However, there is need to address the negative spillover effects to avoid hurting local firms. Reasons that might cause a difference in the available entry strategies for FDI between developed and emerging markets. The level of development in different countries has made the behavior of FDI differ broadly among countries. This level of development has been one of the reasons that determine the mode of entry of FDI. Emerging economies use strategies such as cross-border mergers and acquisition. The difference in the entry strategy may be caused by the countries different strategies in asset exploitation and augmentation (Frankel F.R. 2005). The asset availability in the country may determine its competitive advantage. Technological capabilities of the firm and the global experience also affect the type of entry strategy. Firms in developed countries may have more advanced technology than in emerging markets. Financial muscles of a firm may determine whether to use acquisition strategy or mergers. In conclusion, more advanced economies use different strategies that are likely to benefit them more in their inward or outward FDI. They have better technological capabilities, well trained human capital and high-value capital accumulation. References Frankel F.R. (2005), Indians Political economy: 1947-2004, Oxford, Oxford University Press Galbraith J.K., Krytynskaia L. (2004), Wang Q., ‘The Experience of Rising Inequality in Russia and China during the Transition, European Journal of Comparative Economics, GGDC (2009), Total Data Base, Groningen Growth and Development Center, available at: http://www.eco.rug.nl/ggdc Herd S., Dougherty R. (2007), ‘Growth Prospects in China and India Compared, European Journal of Comparative Economics, June 2007 IMF (2006), ‘Asia rising: patterns of economic development and growth, World Economic Outlook, Washington D.C. Loren Brandt, Debin Ma, Thomas G. Rawski. 2014. From Divergence to Convergence: Reevaluating The History behind Chinas Economic Boom†. Journal of Economic Literature 52:1, 45-123. [Abstract] [View PDF article] [PDF with links] Nicholas Stern. 2013. The Structure of Economic Modeling of the Potential Impacts of Climate Change: Grafting Gross Underestimation of Risk onto Already Narrow Science Models. Journal of Economic Literature 51:3, 838-859. [Abstract] [View PDF article] [PDF with links] Yao, Yang and Miaojie Yu. 2009. Labor, demography, and an export-oriented growth model in China. Journal of Comparative Economic Studies, 5 Dec. 2009, pp. 61–78. Yu, Miaojie. 2010a. Trade, democracy, and the gravity equation. Journal of Development Economics 91(2), pp. 288–300. Yu, Miaojie. 2010b. "Processing Trade, Firm Productivity, and Tariff Reductions: Evidence from Chinese Product" SSRN Working Paper. Available at http://ssrn.com/abstract= 1734720. Yu, Miaojie. 2011. "Moving up the Value Chain in Manufacturing for China," edited by Yiping Huang and Juzhong Zhuang, "Can PRC escape the middle-income trap? Structural transformation and policy options". ADBI, forthcoming. Yu, Miaojie. 2011b. "Patterns of Trade, Comparative Advantage and Productivity in the ASEAN-China-India Region." Available at http://ssrn.com/abstract=1854907.JCGE | Read More