Should Latin America Fear China Should Latin America Fear China? This presentation is partly based on my paper of the same title, available at: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=612441 Eduardo Lora Research Department Inter-American Development Bank November 5, 2004

Should Latin America Fear China? Why is China raising fears? Know your competitor: China´s strengths and weaknesses China: Friend or Foe? Trade and FDI effects on Latin America

China’s population represents 20% of the world’s population… Total World Population (%) 5 10 15 20 Japan UEM U.S.A. Latin America China Source: World Bank

...12% of the world’s economy (%) World GDP 2002, PPP USD 5 10 15 20 Korea Canada Russia United Kingdom Germany Japan China U.S.A. Source: IMF

LAC’s economic growth rates are minute compared to China’s GDP per capita annual growth 1990-2002* -0.04 -0.02 0.02 0.04 0.06 0.08 Haiti Venezuela Paraguay Jamaica Ecuador Honduras Colombia Suriname Uruguay Nicaragua Bolivia Brazil Guatemala Mexico Argentina Peru Belize El Salvador Costa Rica T & T Panama Dom. Rep. Guyana Chile China Source: IDB calculations based on the World Bank´s World Development Indicators Online. *Calculations made with 1995 US constant dollars data.

China´s economy may be as large as the U.S. in 10 years Economic size (% world GDP) 5 10 15 20 25 China U.S.A. Latin America Share 2002 Share 2010 Forecast assumes constant growth rates and equal to the past decade Source: BBVA

China is rapidly gaining importance in world trade China’s trade (% world trade) 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 5.0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 Source: World Trade Organization (W.T.O.)

China´s export growth rate is astonishing China: 34.1% (2003I-2004I) Latin America: 8% (2003) Brazil: 21% (2003) Colombia: 9% (2003) Mexico: 2.5% (2003)

China´s export basket has become very diversified Number of manufactured products exported to the US 1972 6,136 goods 2001 13,242 goods 100 90 80 70 60 50 40 30 20 10 OECD Latin China OECD Latin America China America

China may be taking over the industry in the rest of the world Manufacturing Added Value Growth Rates, 1990’s 2 4 6 8 10 12 Sub-Saharan Africa Industrialized LAC World MENA South Asia Developing East Asia China Source: Lall, et all. 2004. Latin America Industrial Competitiveness and the Challenge of Globalization. Washington D.C: IDB

China has overtaken LAC in FDI Net Foreign Direct Investment - 10 20 30 40 50 60 70 80 90 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 US Dollars in Billions China LAC Source: Eclac for LAC and World Bank: WDI and the Economist for China

China is the #1 destination for worldwide foreign direct investment... Foreign Direct Investment (2002 US dollars) 10 20 30 40 50 60 India Malaysia Poland Singapore Switzerland Japan Mexico Brazil United Kingdom U.S.A. Germany LAC France China Source: Unctad 2003. World Investment Report La encuesta de AT Kearney se realiza mediante encuestas a grandes inversores y se refiere exclusivamente a la Inversión Extranjera Directa. Esta encuesta recoge las perspectivas de inversión para los próximos años. China, desde 1998, aparece sistemáticamente entre los tres destinos más atractivos para la IED. U.S.A. es el otro país que aparece regularmente entre los tres primeros. Esta encuesta, al referirse exclusivamente a la IED, está relativamente poco contaminada de los vaivenes de los mercados financieros.

Confidence Index of Foreign Direct Investment (FDI) 2003 ...and it is the country that generates the most confidence among investors Confidence Index of Foreign Direct Investment (FDI) 2003 China U.S.A. Mexico Poland Germany India United Kingdom Russia Brazil Spain France Italy Czech Republic Canada Japan Thailand Hungary South Korea Australia Taiwan Vietnam Hong Kong Malaysia Turkey Indonesia 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 (1) (2) (9) (11) (4) (15) (3) (17) (13) (7) (5) (6) (14) (8) (12) (20) (16) (21) (10) (24) (33) (18) (42) (29) (31) Lower Confidence Higher Confidence ( )= 2002 Source: A.T. Kearney Same position Increased Decreased

Should Latin America Fear China? Why is China raising fears? Know your competitor: China´s strengths and weaknesses China: Friend or Foe? Trade and FDI effects on Latin America

China vis-à-vis Latin America China’s Strengths Market size Macro stability Labor costs Infrastructure China’s Weaknesses Economic regulation Corporate governance Financial sector Common Problems Rule of law Education

Market Size Matters Attraction to FDI oriented to home market Scale economies in production, transportation and commercialization Ease to develop new industrial clusters

Macroeconomic Stability Country Risk Ranking 1 2 3 4 5 6 Argentina Haiti Nicaragua Ecuador Honduras Paraguay Jamaica Venezuela Bolivia Uruguay Guatemala Rep. Dom. Brazil Peru Colombia El Salvador Costa Rica Panama T & T Mexico Chile China Source: IDB calculations based on “the Global Competitiveness Report 2003-2004 and the WEO 2003” * Scale (median) / Scores (simple average) * A component of the macroeconomic environment index

China’s country risk is low… Low public and external debt levels Low inflation rates Huge international reserves Strong external current account High savings levels and investment coefficients High expected growth rates

Gross Minimum Wages and Average Wages for China Average wages in China are lower than minimum wages in most of the LAC countries Gross Minimum Wages and Average Wages for China (2001 current dollars) 20 40 60 80 100 120 140 160 180 200 Uruguay Argentina Nicaragua Brazil Honduras China Salvador Peru Bolivia Colombia Mexico Paraguay Venezuela Chile Costa Rica Panama

Effective labor costs are a fraction of those in LAC Cost of the Labor Force Including Benefits: Clothing, 2002 (US$/Hr) 2.45 2.7 0.38 0.39 0.68 0.88 0.92 0.98 1.48 1.49 1.58 1.65 0.5 1 1.5 2 2.5 3 India Bangladesh China(inner-land) China(costal) Nicaragua Colombia Honduras Guatemala El Salvador Dominican Rep. Mexico Costa Rica Source: USITC (2004).

Key infrastructure costs are low Electricity Cost, 2002-2003 (US$ cent/KWh) 17.14 14.21 11.72 11.7 9.74 8.11 8.04 6.84 5.07 5 10 15 20 China Colombia El Salvador Costa Rica Dominican Rep. Nicaragua Honduras Guatemala Mexico Source: IDB calculations

…the infrastructure investment pace is impressive 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 0% 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% GDP Percentage Transportation Telecommunications Electriricity

China vis-à-vis Latin America China’s Strengths Market size Macro stability Labor costs Infrastructure China’s Weaknesses Economic regulation Corporate governance Financial sector Common Problems Rule of law Education

The economic regulation in China is a nightmare Regulation Quality Index - 1.20 0.70 0.20 0.30 0.80 1.30 1.80 2.30 T&T Mexico Panama Uruguay Jamaica Brazil Peru Belize El Salvador Colombia Guatemala Bolivia Dom. Rep. Honduras Guyana China Nicaragua Venezuela Paraguay Ecuador Argentina 1998 2002 Chile Aart Kraav , y Massimo Mastruzzi , descrito en “Governance Matters III: Governance Indicators for 1996 " Source Daniel Kaufmann,

Minority shareholders are unprotected Protection of shareholders 1 2 3 4 5 Haiti Bolivia Honduras Guatemala Nicaragua Paraguay Argentina China Venezuela Ecuador Panama Colombia El Salvador T&T Mexico Peru Uruguay Costa Rica Jamaica Brazil Rep. Dom. Chile Source: The Global Competitiveness Report 2003-2004

Auditing and accounting standards are dreadful 1 2 3 4 5 Paraguay Haiti Honduras Bolivia China Nicaragua Argentina Ecuador Venezuela Uruguay Rep. Dom. Panama Peru Colombia Mexico Brazil Chile Jamaica T&T Source: The Global Competitiveness Report 2003-2004 Costa Rica El Salvador Guatemala

…and the bankruptcy law is ineffective Effectiveness of bankruptcy law 1 2 3 4 5 6 Haiti Honduras Ecuador Guatemala Bolivia El Salvador Nicaragua China Panama Paraguay Argentina Rep. Dom. Venezuela Uruguay Jamaica T&T Mexico Costa Rica Peru Brazil Colombia Chile Source: The Global Competitiveness Report 2003-2004

Corporate governance will not improve A means to support SOEs Access to capital Corporatization of the largest SOEs SOEs serve political objectives State control over key sectors State control over investments abroad Social security (holdings)

China’s savings rates are some of the highest of the world LAC National Savings Rates* 2 9 30 20 34 40 47 60 5 10 15 25 35 Eeastern Europe Developed Middle East Africa Rest of Asia East Asia China Source: The Global Competitiveness Report 2002-2003 *Naional Savings Rate as GDP Percentage, 2001

…sustaining an also very high investment rate LAC Investment rate* 5 10 15 20 25 30 35 Middle East Africa Developed Eastern Europe Rest of Asia East Asia China Source: The Global Competitiveness Report 2001-2002 *Fixed Investmen as percentage of GDP, 2000

Capital markets play almost no role in the allocation of savings Local equity market access* 18 31 22 39 34 58 65 67 1 2 3 4 5 6 China LAC Rest of Asia Middle East East Asia Africa Developed Source: The Global Competitiveness Report 2002-2003 *Raising money by issuing shares on the local stock market is (1=nearly impossible, 7=quite possible for a good company) Eastern Europe

Savings feed the financial sector… Financial Deepening--M2 and Household Deposits 0% 20% 40% 60% 80% 100% 120% 140% 160% 180% 200% 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 M2 / GDP Household Saving Deposits / GDP

…but there is few credit for the private sector Ease of access to loans* 15 32 45 42 47 55 59 60 1 2 3 4 5 6 China LAC Rest of Asia Africa East Asia Middle East Developed Source: The Global Competitiveness Report 2002-2003 * How easy is it to obtain a bank loan in your country with only a good business plan and no collateral? (1=impossible, 7=easy) Eastern Europe

Banks are unsound Soundness of banks* 1 2 3 4 5 6 7 China Rest of Asia 13 36 51 54 55 65 1 2 3 4 5 6 7 China Rest of Asia Eastern Europe LAC East Asia Africa Middle East Developed Source: The Global Competitiveness Report 2002-2003 * Banks in your country are (1=insolvent and may require government bailout, 7=generally healthy with sound balance sheets)

There are several ingredients for a banking crisis Bad banking regulation Incentives toward excessive risk-taking Loans to state-owned companies Perception of state guarantee Lack of market control Bubble of assets prices Rapid credit growth Short-term capital flows... ...with a fixed exchange rate.

China vis-à-vis Latin America China’s Strengths Market size Macro stability Labor costs Infrastructure China’s Weaknesses Economic regulation Corporate governance Financial sector Common Problems Rule of law Education

The rule of law is weak and corruption is endemic in China Control of Corruption Chile Uruguay T & T Brazil Mexico Peru Panama Belize Rep. Dom. China Nicaragua 1998 Jamaica Colombia 2002 Guyana El Salvador Guatemala Argentina Honduras Bolivia Venezuela Ecuador Paraguay -1.40 -0.90 -0.40 0.10 0.60 1.10 1.60 2.10 Source: Daniel Kaufmann, Aart Kraav, y Massimo Mastruzzi, descrito en “Governance Matters III: Governance Indicators for 1996-2002"

Different symptoms, different origins Homicidal rates low (2,2 vs 13 in LAC) Crime and violence is not the problem Property rights are weak The judiciary is perceived as a branch of the Communist Party Law is a very new profession Judges lack formation and independence

Education levels like in LAC 1 2 3 4 5 6 7 8 9 10 1960 1965 1970 1975 1980 1985 1990 1995 1999 Africa Rest of Asia Middle East LAC East Asia Eastern Europe Developed China Panama Source: Barro Lee Years of education

Education levels are still low Higher Education Enrollment Rates Guatemala Nicaragua Costa Rica El Salvador Rep. Dom. Venezuela 5 10 15 20 25 30 35 40 45 50 Haiti T&T China Paraguay Honduras Jamaica Brazil Ecuador Mexico Colombia Peru Panama Bolivia Uruguay Chile Argentina Source: The Global Competitiveness Report 2003-2004

But this is changing fast Enrollment grew 29% in 2001 2,8 million new graduates in 2004, twice as in 2002… 3,2 million graduates expected for 2005

...and will widen the knowledge gap with LAC Knowledge Index for Latin America and Selected Countries, 1995 and 1998-2002 2 4 6 8 10 Latin America (1995) Latin America (1998-2002) China (1995) China (1998-2002) Korea (1995) Korea (1998-2002) Taiwan (1995) Taiwan (1998-2002) USA (1995) USA (1998-2002) Innovation Education Information Infrastructure Source: World Bank/KAM.

Should Latin America Fear China? Why is China raising fears? Know your competitor: China´s strengths and weaknesses China: Friend or Foe? Trade and FDI effects on Latin America

China imports more commodities every day... Commodities imports (% world trade) 25 20 Soybean Copper 15 10 5 Oil 87 89 91 93 95 97 99 01 -5 Source: I.M.F. WORLD ECONOMIC AND FINANCIAL SURVEYS. World Economic Outlook. Advancing Structural Reforms

...and exports more manufacturing products every day Commodities imports (% world trade) Selected good exports (% world trade) 25 30 20 25 Toys Soybean Copper 20 15 Textiles 15 10 10 Oil 5 5 Electronics Machinery 87 89 91 93 95 97 99 01 87 89 91 93 95 97 99 01 -5 Source: I.M.F. WORLD ECONOMIC AND FINANCIAL SURVEYS. World Economic Outlook. Advancing Structural Reforms

Mexico loses, Venezuela wins… and the rest fall somewhere in between Exports structure China Mexico Jamaica El Salvador Brazil T&T Uruguay Colombia Guatemala Argentina Honduras Peru Chile Paraguay Nicaragua Ecuador Venezuela 20 40 60 80 100 Food Commodities Fuels Minerals Manufacturing

Only Mexican and Brazilian exports compete strongly with China’s LAC-China Export Simmilarity Coefficient, 2001 . 03 .06 .09 .12 .15 .18 .21 Suriname Guyana Paraguay Venezuela Belice Chile Ecuador Uruguay Nicaragua Peru Bolivia Colombia El Salvador Panama Honduras Argentina Guatemala Costa Rica Brazil Mexico Source: Schott (2004). The relative competitiveness of China's exports to the United Staes vis a vis Other Countries in Asia, the Caribbean, Latin America and the OECD

However, in clothing and footwear things are far worse LAC-China Export Simmilarity Coefficient in Clothing, Footwear, Toys and Sc Eqpmt, 2001 4 8 12 16 20 24 28 32 36 40 44 48 52 56 60 64 68 72 Surinam Venezuela Mexico Argentina Chile Guyana Ecuador Costa Rica Belize Brazil Paraguay Peru Panama Colombia Uruguay Nicaragua Bolivia Honduras El Salvador Guatemala *Manufacturing products are: clothing, footwear, scientific equipment and toys Source: Schott (2004). The relative competitiveness of China's exports to the United States vis a vis Other Countries in Asia, the Caribbean, Latin America and the OECD

Transport costs may offset only a small part of the cost disadvantage Comparative Cost of Shipping, 2003 Total cost of shipping a container of 40 feet (in current US dollars) 500 1,000 1,500 2,000 2,500 3,000 3,500 4,000 4,500 Honduras Costa Rica Dominican Republic Mexico Guatemala Nicaragua El Salvador China Source: IDB calculations

Central America´s only real advantage is delivery time Average number of days in water traveling by ship 10 20 30 40 50 60 70 Mexico Honduras Colombia CBI China, Hong Kong, Taiwan ASEAN- India Source: IDB calculations

China and LAC attract FDI from different sources FDI Source Coincidence Index with China, 1997-2001 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 Panama Chile Venezuela Colombia Costa Rica Argentina Mexico Brasil Korea India Note: FDI Source Coincidence Index: SCICh,j = 1 – 0.5*Σ|Sharei,Ch – Sharei,j|. Calculated from OECD FDI flows from source countries (i countries) to China and Latin American countries and Korea. One less one half multiplied by the sum of the difference between the share of total flows from source country i going into China and the share of total flows from source country i going into country j. Source: OECD (2002)

...and for different sectors (except Mexico) FDI Sector Coincidence Index 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 Argentina LAC Brazil India Mexico Korea Note: FDI Sector Coincidence Index: SCIUS,j = 1 – 0.5*Σ|Sharei,US – Sharei,j|. Calculated from data from the Bureau of Economic Analysis for 2001, on FDI flows from the United States to host countries (j countries: China, India, Korea and Latin American countries). One less one half multiplied by the sum of the difference between the share of total flows form the United States in sector i going into China and the share of total flows form the United States in sector i going into country j (India, Korea and Latin American countries). Source: BEA (2001)

Are fears justified? Fears on export and FDI diversion are overblown... ...export and FDI losses may be important only for Mexico and some sectors in Central America ...but TOT effects are positive for the rest of LAC ...and LAC may attract important FDI flows from China However, never underestimate your enemy...

China may be a source of international financial instability Sudden stop Banking fears Loss of investor’s confidence Increase of Fed interest rates Contagion Increase of EMBI spreads If there were an Asian and an Enron effect... ...why not a Chinese effect?

My conclusion: China is more a friend than a foe... But beware!