Part II
In Part I of this article we reviewed the evolution of trade and financial ties between China and Latin America in the last fifteen years, and how a close and intense trade and financial relationship was forged, and assessed the benefits, costs and problems that came along with this new partnership. What I intend to do now is look to the future and try to determine how this connection will evolve as China’s economic growth slows and goes through fundamental structural changes towards a rebalancing between the internal market and the services sector vs. manufacturing and construction.
The initial consequences of these trends were a collapse in the price of commodities, which represent the main exports of most of Latin America’s countries, and a deep recession in many of them as the sequel of the sharp fall in their terms of trade – the ratio of their export prices over their import prices.
Lower growth in China impacts Latin America
There is a general consensus that as the Chinese economy decelerates, with a rate of growth estimated for 2016 slightly above 6% but projected to reach 4.8% in 2020 (www.tradingeconomics.com), their demand for Latin America’s commodities will also shift, affecting more negatively the exporters of raw materials associated with construction like iron ore and copper –Chile, Peru, Ecuador and Bolivia), and far less those associated with the sale of foodstuffs — Argentina.
The World Bank has estimated that for each percentage point that China’s economy slows down, commodity prices fall by 6%, with a lag of two years.[1] But as the terms of trade tend to deteriorate for Latin America, there are mounting pressures for the depreciation of their national currencies, which in turn make them more competitive, something that would help Mexico, in essence an exporter of manufactures, compete better in the US market vis-à-vis China’s exports to that country.[2]
The other key element is the sharp increase in real wages in China compared with those of Latin American countries. China’s real minimum wage has more than doubled in the last decade while those of Latin America grew by far less – Brazil’s rose by almost 50% — and Mexico’s remained flat. Also the real exchange rate of China has appreciated sharply, almost 60% in the last decade in relative terms compared to an average of Latin American nation’s currencies, despite the fact that the People’s Bank of China has poured close to half a trillion dollars in the foreign exchange markets as the result of sizable capital outflows and also as an attempt to prevent additional appreciation of the yuan.
Another interesting element that will affect China’s connection to Latin America is the Trans Pacific Partnership (TPP), as it comes closer to a successful conclusion, despite the protectionist rumblings in many countries (and especially loud ones in the US presidential campaign), China’s trade with key Latin American nations could be severely disrupted. Mexico, Chile and Peru are all part of TPP and there could be sizable trade diversion from China’s exports to them. This is not only towards mainly Malaysia and Vietnam, but also towards Japan and Singapore.
Has China become a full-fledged “market economy”?
Additionally, there is the issue of China’s negotiated deadline for the country being defined as “market economy” at the end of this year, as was stated in its access protocols to the World Trade Organization (WTO) in 2001. This means that the ease of nations to impose countervailing duties on China’s exports deemed to be dumped, would be severely reduced from its current status. A strong global debate is now ongoing about whether China has fulfilled its obligations to phase out the non-market elements of its economy.
Many experts consider that China has not fulfilled its commitments to liberalize its economy, with market forces determining supply, demand and prices in most productive sectors. In their opinion, China is far from reaching this goal, and they enumerate[3] the following elements to prove that it is still very much a centrally controlled system:
- 71 detailed five-year government plans directing and managing the overall economy;
- 22 national industrial sectoral plans.
- The absence of effective markets for land, labor, capital, energy and other factor of production;
- The absence of rules to assure real competition, bankruptcies and market exit mechanisms;
- The subordination of markets to state planning at the whim of the authorities;
- The state fully controls all industry associations;
- The state imposes all sorts of restrictions to investment in China, and abroad by Chinese people and corporations.
Latin America initiated more anti-dumping investigations and adopted more steps against China’s exports than any other region of the world in the last fifteen years, with the steel industry being the most notorious case. China today accounts for around 50% of the world’s steel market as both consumer and producer, and most of its mills are state-owned. The slowdown of China’s economy and its shift in direction away from construction has increased oversupply, threatening the steel industries of the rest of the world. It is estimated that just the spare capacity in China’s steel industry is larger than the total European steel industry. Today even with an easier path to impose countervailing duties, Latin America’s imports of Chinese steel continue to grow and local production keeps on falling.
If China were to be granted market economy status in December, the possibilities of using anti-dumping procedures would become far more complicated than they are now, which could have devastating consequences for Latin American economies.
Chinese investment in Latin America favored populist regimes
The nature of Chinese investment in Latin American countries varies enormously in nature and size. Its investments in Brazil are designed to overcome protectionist nature of its economy, which force foreign nations to invest locally since otherwise they would be unable to sell their products in those markets. As the result, China’s investments in Brazil are widely diversified but relatively inefficient since their manufacturing plants also are subject to restrictions and duties on the imports that are allowed to make, forcing them to consume less competitive, domestically produced inputs. This pattern of forcing foreign investors to invest locally if they wanted to serve those markets was the rule all over Latin America until the mid-1980s, when the debt crisis forced many of the region’s countries, led by Chile and Mexico, to abandon their inward-looking protectionist development models and embrace freer markets and globalization.
That was never the case of Brazil, which for the most part continued with the old import-substitution paradigm, as other nations in the region that liberalized for a time, only to make dramatic reversals back to protectionism, as it happened in Argentina, Venezuela, Bolivia and Ecuador. These nations created, along with the Marxist regimes in Cuba and Nicaragua, an axis of populist-managed (mismanaged seems more appropriate) bloc that heralded that populism was back in force, and that it would continue to extend to the rest of the region.
Of course, that did not happen and when the good old days of the Biblical Fat Cows (in this case the years of extremely favorable terms-of-trade) ended. One populist regime after another were no longer able to keep the fantasies of improved well-being of their populations financed with public deficits and external loans. Many of these loans came from China. As their economic recessions evolved into economic and political crises, the populists were thrown out of office, as in Argentina and in Brazil, by election and presidential impeachment proceedings, respectively, or are slowly but surely descending into chaos, as in Venezuela.
In many respects China became the lender of last resort to most of the populist regimes in Latin America, with Venezuela accumulating a skyrocketing debt of $56.3 billion with the Asian giant. This amounted to 45% of its GDP! It is unlikely that China will collect on many of these debts. With the political neutering of socialist president of Chile, Michelle Bachelet, and the victory of market-friendly Mauricio Macri in Argentina in December and Pedro Pablo Kuczynski in Peru only last week, the alliance of solidly market-friendly nations in Latin America widened, which will pose a challenge for China that had put most of its bets with the populist regimes which are dwindling.
Conclusions
It is clear that both China and Latin American nations have to review their economic, trade and financial relationship as part of a broader strategic association towards the future. So far it has been a haphazard, convoluted, collection of bilateral agreements and deals between China and the nation-states of Latin America and that is not likely to change anytime soon. CELAC[4] does not have the mandate, the resources or the necessary human capital to play a defining role in a bilateral relationship between China and Latin America as a whole. It is worth remembering that virtually all attempts for Latin American integration, including the leaden albatross of Mercosur, have failed dismally,[5] and the new relationship with China will not change this situation.
Also progress in huge Chinese investments in Latin America, like the ambitious twin-ocean railway, a $50 billion deal that plans to link ports in a Brazilian coast in the Atlantic and a Peruvian seashore in the Pacific, spanning 3,500 kilometers of rugged or virgin terrain in the Amazon basin, and crossing the Andes mountain range, one of the most cumbersome in the world, are not as easily built in Latin America as in an authoritarian China, where the central government can manage environmental and indigenous preoccupations in an effective way, like it did in the Three Gorges Dam. This will be far more complicated in Latin America.
[1] Commodity Markets Outlook, World Bank, January 2016.
[2] The reasons for the Mexican peso sharp depreciation of 23% in the last year, have more to do with speculative trades and hedging in foreign exchange markets than with the fall on commodities prices.
[3] Professor Dr. Markus Taube, “China is not a market economy: state planning and subsidization are in China’s DNA,” June 2015, Aegis Europe.
[4] The Community of Latin American and Caribbean States to which we alluded in part 1 of this article.
[5] This curse might change with the Trans-Pacific Alliance, a relatively new grouping of market-oriented Latin American economies made of Chile, Colombia, Mexico and Peru that has been making fast progress towards much faster trade opening and coordination in myriad of economic and regulatory issues.
Manuel Suarez-Mier is a Washington, DC-based independent consultant on economic and financial issues. He has taught economics and international finance at various universities in the US and Mexico and was Director of the Center for North American Studies at American University 2014-2015. His numerous posts include chief of staff of the Governor of the Bank of Mexico. He also was Mexico’s top economic diplomat in Washington at the time of the negotiations of the North American Free Trade Agreement (NAFTA) between the US, Canada and Mexico.