Economic Competitiveness of the EU in the Light of Growing Trade Expansion from China - Essay Example

? Conjectural View on Emergence of China and Economic Competitiveness of the EU Executive Summary The report will try to shed light on the topic “Is the further emergence of China going to threaten the economic competitiveness of the European Union (EU)?” In the first part, the report will try to understand the competitive threat for EU in context to trade deficit, labour cost advantage in China, Dumping practices by China, Intellectual property rights violation, protectionism by Chinese government to save the domestic industry and create barrier for EU companies and value chain up gradation by investing capital in the field of research and development by Chinese government. Throughout the report, the study will try to understand the competitiveness of China in terms of both macro and micro economic theories. Important assumption in this paper will be backed by statistics and industry data. In the last part, the study will try to recommend suitable actions to European Commissioner and Head of Member State in order to improve its competitiveness in sustainable manner. Table of Contents Table of Contents 3 Introduction 4 Trade Deficit between EU and China 4 Low Labour Cost Advantage of China 7 Effect of “Dumping" 10 Intellectual Property Rights Violation 11 Protectionism and Expenditure on R&D in China 12 Recommendations & Conclusion 14 Reference 16 Introduction This report will use conjectural view on the topic “Is the further emergence of China going to threaten the economic competitiveness of the European Union (EU)?” in order to prepare a report which is backed by empirical evidences and data. The report has been created by taking into consideration the stake of European Commissioner and Head of Member State hence objective of the report is to recommend measures which can be implemented by European Union (EU) to address the challenges posted by the emergence of China. The report will include issues like, 1- trade deficit between EU and China, 2- low labour cost advantage of China, 3- effect of “Dumping" on overall competitiveness steel industry of EU, 4- Intellectual property rights violation of China and how it may destroy EU competitiveness, 5- Protectionism in China and 6- value chain up gradation by China. These topics are pertinent in context to overall measurement of competitiveness of EU. The study will try to understand the competitiveness by taking into consideration of the emergence of China. However, it is not possible to consider all the above mentioned aspects in accordance to their merit due to space restriction. This can be referred as the major limitation of this report. Trade Deficit between EU and China International trade between EU and China has been increased in last decade, for example, export of EU to China has been increased by 110 billion euro during the year 2000 to 2011 (Eurostat, 2012). However, import from China to EU has been increased by 173 billion euro in the same period of time (Eurostat, 2012). The trend is showing that balance of trade is declining for EU and dependency on Chinese export is increasing. Export and import deficit of EU in context to China can be depicted in the following manner. (Source: Eurostat, 2012) Although the trade deficit between for EU has been decreased from 75 billion euro to 67 billion euro in the first six month of 2012 but still the amount of deficit is large enough to impact the competitiveness of EU. After the economic recession, the trade deficit between EU and China has been improving but still the difference is large enough to affect the economic strength of EU nations. According to the above table only Germany and Finland have trade surplus to china while other European countries have trade deficit with China. However, Germany and Finland were unable to convert the trade deficit into trade surplus prior to recession. Careful analysis of the chart shows that growth rate of export from EU nations to China has been outpaced the growth rate of import from China. For example, export volume of Greece to Chine has been doubled in the five year tenure from 2007 to 2012. Declining trade deficit for EU might not ensure the fact that competitiveness of EU would increase in future course of time because EU needs to incorporate massive improvement in its industrial sector in order decrease its dependency on China. Although Greece has increased its export to China but still its import from China is ten times higher than its export (Norris, 2011). Same is the condition for majority of European countries hence it can be said that improving the competitiveness of EU by decreasing bilateral trade deficit with China will not be an easy task. According to macro economic theories, a country can maintain equilibrium by balancing the large trade deficit with one country with large trade surplus with other country. But the story is not same for EU nations when it comes to trade deficit with China. For some EU countries magnitude of trade deficit is large enough to cover a significant percentage of gross domestic products (GDP) of the country. For example, in 2010, United Kingdoms’ trade deficit with China was almost 5% of its GDP (Norris, 2011). According to economists, China should appreciate its undervalued currency in order to create a fair business environment for EU nations (Norris, 2011). In 2001, China entered the World Trade Organization and since then, the world has seen exceptional growth rate of international trade between China and EU nations (Scott, 2012). Extensive dependency on Chinese manufacturing export has not only decreased export capacity of majority of EU nations but also piled up foreign debt for these countries. However, the condition of trade deficit between EU and China is completely opposite in context to exports and imports of services. During the period of 2009 to 2011, EU nations have exported service worth of 25.1 billion euro whereas China has exported 17.5 billion to hence trade surplus for EU was almost 7.5 billion. Service verticals like royalties & license fees, consultancy service, computer & information services and transportation services contribute up to a significant portion in the trade surplus between EU and China. (Source: Eurostat, 2012) Now, it can be said from the above diagram that competitiveness of EU in the service sector has not been topple by emergence of China but competitiveness of EU in manufacturing sector has been threatened by the emergence of China. There can be numerous reasons behind the dominance of China in the field of exporting such as low cost labour force, intellectual property right violation, "Dumping" effect and many others. Low Labour Cost Advantage of China According to the research work of Ceglowski and Golub (2005), emergence of China as the largest exporter in the world is not a miracle but the result of deploying human resources at lowest possible cost. Ceglowski and Golub (2005) have showed that, employers need to pay $15 to $30 per hour to factory workers in order to use them in manufacturing process whereas in China, factory workers get $1 per hour. Low labour cost has automatically helped Chinese manufacturers to reduce the manufacturing cost and export the material to developed countries at low price. Ceglowski and Golub (2005) has pointed out that there is strong correlation exist between low wages for Chinese labour force and undervalued currency. Chinese currency Yuan has been depreciated by Chinese government in the regular interval during the period of 1990 to 2005. However, effect of currency devaluation by Chinese government to the overall competitiveness of the China is beyond the scope of this paper hence the study will only concentrate on the effect of low cost advantage of China on competitiveness of EU. According to Cox and Koo (2003) and Golub and Hsieh (2000), relative unit labour costs should be used to measure the competitiveness of a country. Now the study will use the concept of Long Run Average Costs (LRAC) in order to understand the cost advantage of China in comparison to EU. (Source: Katzner, 2006) According to the curve, average cost of production decreases in long run with the increase in production. This might be due to the fact, overall cost (including variable cost and fixed cost) increases at slower pace in comparison to rise in total production quantity, as a result average production cost decreases. But such kind of proposition can reveal the truth behind the export dominance of China in partial manner. China has used decreased the manufacturing cost by not only using the concept of economies of scale but also deploying cheap labour forces. Otherwise it will not be possible for China to maintain the cost advantage in long term manner in a world where capital resources are mobile and production process is footloose across countries. In such context, China has used low priced non-tradable inputs or labours as a way to decrease the cost of manufacturing and exporting goods. The study will use relative unit labour costs (RULC) to show the low labour cost advantage of China. Let, (Source: Ceglowski and Golub, 2005) Li-labour employed by the country for manufacturing goods, VAi- value added by the labour forces and ai- marginal productivity. Suppose all the other factor of production remain constant for China and EU, hence marginal productivity between two countries will be decided by the variation in Li. If cost of labour is the only factor in production cycle then average cost of production will be equal to ULCi or unit labour cost. (Source: Ceglowski and Golub, 2005) Wi- wage of labour and e- exchange rate between China and EU In such context competitive advantage of EU (j) and China (i) will be decided by the bilateral relative unit labor costs. (Source: Ceglowski and Golub, 2005) RULCij can be decomposed as follows (Source: Ceglowski and Golub, 2005) Value of Euro is higher than the value of Chinese currency; hence exchange rate of Euro is greater in China. According to the equation, China’s competitiveness over EU is dependent on three factors such as 1- labour productivity in China in comparison to labour productivity in EU nations, 2- wage of the labour in China in comparison to wage of labour in EU at given PPP exchange rate and 3- exchange rate of Chine currency. Under the equilibrium condition, wages of Chinese labour is almost 30 times cheaper than the wages of labour in EU and exchange rate is 1 euro is equivalent to 7.97 Chinese Yuan. Hence, RULCij value for China is pretty much lower than EU. It is evident from the above economic calculation that low cost advantage in China has helped the country to improve its competitiveness over EU in terms of exporting goods and such advantage has ultimately increased threat for Economic Competitiveness of the EU. Effect of “Dumping" To understand the effect of dumping, it is very essential to understand the theoretical explanation of dumping. Dumping means that creating price discrimination by lowering the export price in comparison to domestic prices with an intention to separate the international market by costs such as transport or tariff costs. Due to dumping effect arbitrage becomes almost impossible which alternatively ensures the sustainability of existence of international price discrimination. According to economic theory, dumping is differentiated pricing behaviour for companies (Department for Business Innovation & Skills, 2012). In this case, China uses dumping policy to decrease the price of its export lower than its domestic price and EU steel industry import these materials from China at a price which can’t be matched by local players. Many of steel producers of EU have complained that Chinese exporters have used unfair means to reduce the price of steel exports which can not only destroy the competition in EU steel industry but virtually creates monopoly (Cendrowicz, 2009). In 2009, Eurofer (alliance of European steel manufacturers) has accused China for "irrational capacity extension" when it comes to exporting steel to EU nations. U.S. steel industry has already filed ant-dumping legal suit against China in order to decrease the flow of low priced exports from China. There is another part of this story; steel industry has been badly affected due to declining demand from heavy-engineering sectors, auto makers and shipbuilders (Cendrowicz, 2009). To deal with the competition, EU steel makers are decreasing the output, for example, Luxemburg-based ArcelorMittal (which is the biggest steel maker in the world) has chopped down the output by 50% in order to decrease the cost of production. Surprisingly in such dwindling condition OF demand in EU, Chinese steel companies have increased the production capacity from 1.2 million tons/per day to 1.4 million tons/per day. The reason behind such discursive action is that Chinese government is so desperate increase the employment rate in Steel industry and show a healthy gross domestic product (GDP) rate to international market. EU nations have accused that Chinese government uses varied techniques such as subsidizing steel companies, offering tax holidays and lower tax rates to stall companies and helping steel companies to access low cost resources in order to back the dumping practices of Chinese steel makers. Such biased and unethical government support system, China’s share in EU steel industry has been increased 10 times in last couple of years (Cendrowicz, 2009). Intellectual Property Rights Violation Unfortunate fact is that, China has failed to improve its reputation as a country where protection of Intellectual Property Rights (IPR) is of highest order. EU manufacturers have complained that trademark infringement, counterfeits of merchandises is common business problem in China (Dalsgaard, 2011). EU Customs have reported that they have identified more or less 115 million products violating intellectual property rights (IPR). (European Commission, 2012). These counterfeited products have not only created a grey market and affected the demand for products manufactured by EU manufacturers. However, more than 50% of the IPR violated products are contributed by Chinese manufacturers who are ripping the benefits of lenient IPR protection act of China. Medicines (24%), packaging goods (21%) and cigarettes (18%) are the most preferred products among Chinese players to counterfeit. Violation of IPR is not only affecting the demand of products manufactured EU companies but also affecting the domestic demand in China. Hence, Chinese government is trying to strengthen the legal framework in the country in order to decrease the scope of IPR violation. China is an export driven economy hence the country has the urge to lower the cost of production and export in bulk to improve the margin. In some cases, customers of China can get benefitted by accessing the low cost counterfeited products from China but these benefits are short term in nature. From the viewpoint of economists and social welfare sense, IPR violation is an optimal solution for a developing nation like China but same cannot be said when the same country has emerged as one of the economic powerhouse of the world (Cox and Sepetys, 2006). For EU nations, banking on IPR violated products will decrease the urge for innovation, which will definitely hamper the long term economic growth for companies. For example, EU manufacturing companies can take help of their Chinese friends to counterfeit some patent protected products in order copy that products without incurring must cost but in long run this tendency will reduce the appetite of EU manufacturing companies to innovate new products and such tendency will negatively affect its competitiveness in the long run. Protectionism and Expenditure on R&D in China Recently, China and EU leaders have promised to engage in a deal which can degree of protectionism in China. Although the latest Chinese governments have stated that they will take steps to reduce trade protectionism in the country but there are enough concerns among EU companies that such steps might not be sufficient to maintain the equilibrium between world’s largest exporter and world’s second largest economy (Edwards, 2012). High value of foreign exchange reserve of the China has been showing that the country has performed exceptionally well in terms of exporting goods to EU nations. However, EU companies face multiple layers of bureaucracy, political pressure and protectionism for domestic companies in terms low tax rate, preferential treatment etc. Almost 50% of EU companies have reported that they face excessive protectionism in China (Edwards, 2012). Foreign companies face delay in getting permit, complex Foreign Direct Investment (FDI) policies, discursive action of government to create blockage in trade operation and many others. One of the major reasons behind the widespread discrimination for foreign companies is that their capital is not needed by China as it was needed during 1970-80’s. China has not joined World Trade Organization’s global procurement agreement which is the reason behind the discursive treatment to EU companies. It will not be right to state that competitiveness of China has only increased due to their protectionism, IPR violation, low labour cost, dumping and many others negative aspects of economics. China should be appreciated for their effort to move up in the value chain ladder by careful resource deployment. The country has invested huge amount of money in order to develop its value chain. The value chain up gradation of the country can be depicted in the following manner. (Source: United States International Trade Commission, 2010) According to the value chain model, in last 20 years, China has transformed itself from being a manufacturing based economy to a country which is capable of performing both upstream and downstream activities. China has used the concept of resource based advantage proposed by research scholars such as Rumelt (1986), Dierickx & Cool (1989) and Barney (1986) in order to improve its competitiveness. According to the industry reports, the country has increased its investment in improving the research and development activities in order to strengthen its domestic sector. The following model can be used to realize the extent of research and development expenditure (percentage of GDP) of Chinese government. (Source: Trading Economics, 2012) According to the above model, China spends almost 1.5% of its GDP to incorporate product innovation. Such huge amount of investment has helped the country to strengthen its value chain and create competitive threats for EU companies by decreasing the scope for manufacturing companies of EU to offer new products to international market. Recommendations & Conclusion Harsh fact is that there cannot be a single recommendation which can help EU nations to improve its competitiveness in overnight manner. It has been clearly shown through LRAC curve that low cost advantage of China cannot be depleted easily by EU manufacturers. However EU can use the concept of vertical specialisation (VS) to decrease its dependency on Chinese imports and give the domestic players some breathing space. In vertical specialisation model, EU needs to identify sectors which need immediate attention. EU needs to take strict actions against companies who are using IPR violation and counterfeiting activities in order to compete in the market. IPR violated products should be banned by EU nations in order to save the domestic players. However, EU needs to develop its resource capabilities in order to prevent Chine exporters to threat the nationwide competitiveness (Porter, 1991). To end this discussion, the study will strongly recommend to EU leaders to use antidumping law and trade quota in order to create a barrier for low cost Chinese exports. The proposed mechanism can work in the following manner. (Source: Carbaugh, 2010) According to the model, imposing trade quota will eradicate the price discrimination created dumping activities and limit the amount of Chinese import in EU. Area C (revenue effect) is showing that implementing anti-dumping measures will increase revenue for domestic players in EU and area D (consumption effect) is signifying that protectionism stance of EU leaders will decrease the demand of Chinese export across different nations of EU. Reference Barney, J. B., 1986. 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