Part 1 Global Economic Trends and Challenges Chapter 1 Structural Change in the Economy of Emerging Countries 【Key Points of Part 1

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Part 1 Global economic trends and challenges Chapter 1 Structural change in the economy of emerging countries 【Key points of Part 1. Chapter 1】 *Although the expansion of investments in China and other emerging countries led the global economy amid the slowdown in advanced countries after the global economic crisis, excess debt has arisen as a result of capital investment-driven economic growth. In addition, excess capacity is becoming increasingly prominent. *The gap between production facility capacity and actual production is prominent in such sectors as steel, chemicals and liquid crystal displays, with producer and export prices falling. Due to the combination of the excess capacity and the global economic slowdown, trade restrictive measures, which have been decreasing internationally, are starting again to increase in these sectors. *Resource-producing economies recorded accelerated growth due to the expansion of demand for resources in emerging countries, but they are experiencing economic slowdown because of a steep fall in resource prices caused by an increase in supply due to such factors as the global economic slowdown and the shale revolution. *While the Chinese government is implementing structural reforms to shift from an investment-driven economy to a consumer-driven economy and is upgrading its industries, resource-producing countries such as Saudi Arabia are also starting structural reform initiatives. *In terms of production, China’s presence is growing. Whereas Japan, the United States and Germany were previously major export sources of value added in final demand for other countries, China’s weight as an export source of value added is increasing.

Section 1 Emerging countries’ growth led by investment expansion and deepening of economic relationship 1. Growth of emerging economies through expansion of investments As a premise of the analysis of the challenges faced by emerging countries today, this white paper will first look back at the history of the economic growth and industrialization of developing countries since the 1970s. Since the 1970s, developed countries have increased technology transfers to and investments in developing countries in pursuit of labor force and resources against the backdrop of their own abolition of the fixed exchange rate system and liberalization of the movement of capital and of policy changes in some developing countries. Consequently, some developing countries, mainly the Republic of Korea (ROK) and ASEAN countries, have succeeded in industrialization through foreign direct investments and exports of goods. At first, those countries were mainly engaging in labor-intensive light industries, but in recent years, they have increased their presence in the high-technology sector, including semiconductors, in addition to such sectors as electrical and electronics equipment and automobiles. As a result, emerging and developing countries have achieved sustained growth and have until now continued to record economic growth at a faster pace than developed countries until the global economic crisis, although their economies temporarily slowed down due to the Asian currency crisis in 1997,

1 among other factors1 (Figure I-1-1-1-1).

Figure I-1-1-1-1 Growth rate of emerging countries and percentage within the global economy

(%) (%) 50% 8%

40% 6%

30% 4%

20% 2%

10% 0%

0% -2%

Difference between growth rates in developed and emerging countries (right axis)

Percentage of emerging countries within global nominal GDP

Note: Difference between growth rates in developed and emerging countries are based on the growth rate spread of real GDP between those countries. Source: IMF World Economic Outlook, April 2016.

For example, the ROK achieved economic growth mainly based on exports in its long period of growth called the “Miracle on the Han River.” Despite a temporary slowdown due to the Asian currency crisis, the ROK has achieved such economic growth as to put the country in the 11th place in the world in terms of economic size and 31st place in terms of per-capita nominal GDP in 2015. Likewise, Southeast Asian countries have achieved remarkable economic growth accompanied by a rise in the export ratio against the backdrop of the expansion of Japanese and other foreign companies’ production networks (Figures I-1-1-1-2 and I-1-1-1-3).

1 Here, the classification of the World Economic Outlook (IMF) is followed. 2

Figure I-1-1-1-2 Export ratio of ROK and Southeast Asia and real GDP per capita (2005, $) (ROK) (%) 30,000 60%

25,000 Real GDP per capita 50% Export ratio (right axis) 20,000 40%

15,000 30%

10,000 20%

5,000 10%

0 0%

(2005, $) (Southeast Asia) (%) 3,000 90% 80% 2,500 Real GDP per capita 70% Export ratio (right axis) 2,000 60% 50% 1,500 40% 1,000 30% 20% 500 10% 0 0%

Note: GDP per capita is a value obtained by dividing real GDP by population, and export ratio is an export rate of goods and services in relation to GDP of each year. Source: United Nations Main Aggregates Database

Figure I-1-1-1-3 Changes in inward direct investment from abroad to ASEAN

(bn. $) (bn. $) 140 2,000 1,800 120 1,600 100 1,400 Asian currency 80 1,200 1,000 60 800 40 600 400 20 Global economic crisis 200 0 0

(year)

World total (right axis) China (reference) ASEAN

Source: UNCTAD

Since the second half of the 1990s, the presence of China—which has grown by taking advantage of the progress in its reforms and initiatives to open up to the outside world, the end of the Cold War and its accession to the WTO—has rapidly expanded. In the 2000s, China overtook Japan and developed countries in Europe to become the global No. 2 in terms of economic size, with its share in the global GDP rising from 3.6% in 2000 to 13.4% in 2014 (Figures I-1-1-1-4, I-1-1-1-5 and I-1-1-1-6).2 The size of China’s annual growth is almost equal to the growth of the United States, and its annual growth is equivalent to the creation of an economic area equal in size to the economy of Thailand or Taiwan (Table I-1-1-1-7). Furthermore, some Chinese provinces have a country-size scale: for example, the economic size of the Guangdong province is larger than that of Indonesia.

2 Individual countries’ GDP growth rates are from dollar-based data included in the World Economic Outlook (April 2016) (IMF). 4

Figure I-1-1-4 Long-term trend of GDP in China

(PPP) (bn. $) 25,000 20,000 18,000 20,000 16,000 [Economic situation in 2015*] 14,000 Nominal GDP: 10,982.8 bn. $ 15,000 GDP per capita: 14,107 $ (PPP) 12,000 7,990 $ (nominal) 10,000 10,000 8,000 Beijing Olympics (2008)

6,000 Nominal GDP GDP GDP per capita 5,000 WTO membership (2001) 4,000 Southern Tour Lectures (1992) 2,000

0 0

1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 1980 (year) Deng Xiaoping Jiang Zemin Hu Jintao Xi Jinping

Nominal GDP (right axis) *Nominal GDP in Japan (2015): 4,123.3 bn.$ GDP per capita (PPP, left axis) GDP per capita: 32,486 $ (nominal) 38,054 $ (PPP)

Source: World Economic Outlook Database, IMF (Apr. 2016)

Figure I-1-1-1-5 Changes in real GDP growth rate of China (year-on-year rate)

(%) 18 Southern Tour WTO membership Economic Beijing (IMF outlook) Lectures (1992) (2001) 16 reform (1978) Olympics (2008)

14 Average growth rate 1978-2015: 12 9.6% 10

2 Tiananmen Square Asian Financial Global Economic Incident (1989) Crisis (1977) Crisis (2008)

1985 1996 2007 1978 1979 1980 1981 1982 1983 1984 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021

(year) Source: National Bureau of Statistics of China, CEIC database and World Economic Outlook Database, IMF (Apr. 2016)

Figure I-1-1-1-6 Changes of GDP scales in major countries (tn. $) 25 China GDP: IMF outlook 2005 5th in the world surpassing France 2006 4th in the world surpassing UK 20 2007 3rd in the world surpassing Germany 2009 2nd in the world surpassing Japan

15 USA

China 10 Global Economic Crisis (2008) China’s WTO membership (2001) Japan 5

0 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 (year) USA China Japan Germany UK France India Italy Brazil Canada

Note: Decline in Japan’s GDP in and after 2013 is due to currency exchange rate. Top 10 countries for 2015 are indicated. Source: World Economic Outlook Database, IMF (Apr. 2016)

Table I-1-1-1-7 Impacts of Chinese economy 1. Annual increment of Chinese economy (bn. $) GDP (2014) GDP (2015) Increment China 10,430.7 → 10982.8 552.1 USA 17,348.1 → 17947 598.9 * Increment of Chinese economy surpasses GDP in Thailand (395.3 bn. $ in 2015) and Taiwan (523.6 bn. $). 2. One province in China is comparable to one country GDP in Guangdong province 1,170.0 bn. $ (2015) * Largest economic scale in China GDP in Indonesia (2015) 859.0 bn. $ * Largest economic scale in ASEAN Note and source: GDP of each country is based on World Economic Outlook Database (Apr. 2016), IMF. GDP of Guangdong province is announced in RMB by National Bureau of Statistics of China and converted into

6 dollars.

In terms of exports, while Japan, the United States and Germany suffered declines in their global shares, China, serving as the “world’s factory,” increased its global share from 4.1% in 2000 to 13.4% in 2014, and its export items range widely, from light industry products such as textiles through to machinery (Figures I-1-1-1-8 and I-1-1-1-9).

Figure I-1-1-1-8 Share of major countries within global export (%) 16

14 China USA 12

6 Japan

(year) China USA Germany Japan ROK Note: Top 5 countries of export value (2014) in the world are indicated. Source: UN Comtrade (downloaded on Nov. 30, 2015).

Figure I-1-1-1-9 Share of major export products of China within global export (%) 50

30 Footwear Electrical machinery

20 Clothing 10 Overall

Footwear (HS64) Clothing (HS61, 62) Furniture (HS94) Electrical machinery (HS85) Iron and steel (HS73) Machinery (HS84) Precision instruments (HS90) Overall Plastics (HS39) Vehicles (HS87)

Source: UN Comtrade.

China’s economic growth is driven mainly by gross fixed capital formation, including capital investment, which accounted for just over 40% of the whole GDP in 2014. This is higher than the levels seen in major advanced countries in their periods of high growth. For example, in the case of Japan, the ratio of gross fixed capital formation to GDP peaked at 36.4% in 1973 (Figure I-1-1-1-10) (Figure I-1- 1-1-11).

Figure I-1-1-10 Trend in China's GDP composition by demand

60%

50% 44.0%

40% 37.9% 30%

20%

10% 13.5% 0%

Export Import Household consumption Government expenditure GFCF

Note: Among the major developed countries, the ratio of gross fixed capital formation (GFCF) to GDP peaked in Japan (1973, 36.4%) and Germany (1971, 30.0%). Source: UN National Accounts Aggregate Database.

Figure I-1-1-1-11 Years when the percentage of investment to GDP peaked in major countries

50% 44.6%

40% 36.4%

30.0% 30% 24.9% 24.4%

20%

10%

0% China 2013 Japan 1973 Germany 1971 UK 1974 USA 1979

Note: Years when the ratio of GFCF to GDP peaked during the period between 1970 and 2014 Source: UN National Accounts Aggregates Database.

A similar expansion of capital investment is observed to some degree in other emerging and developing countries, including Singapore, Malaysia and Thailand, too. However, investments in China have a huge impact on the entire world because of the size of the country’s economy, accounting for around a quarter of global investments in 2014. In comparison, final consumption in China, which

is comprised of consumption in the household and government sectors, has been relatively slow in expanding and China’s share in global final consumption is only around 10% (Figures I-1-1-1-12, I- 1-1-1-13, I-1-1-14 and I-1-1-1-15).

Figure I-1-1-1-12 Gross fixed capital formation (GFCF) and final consumption in China (ratio to the world total)

World total 24.4%

Proportion 9.3% of China

GFCF Final consumption

Source: UN National Accounts Main Aggregates Database

Figure I-1-1-13 Household consumption and gross fixed capital formation (GFCF) in Singapore (ratio to the world total)

(%) 0.6 Ratio of the household consumption to the world total 0.5 Ratio of GFCF to the world total

0.4

0.3

0.2

0.1

Asian currency crisis Global economic crisis 0.0

(year)

Source: UN National Accounts Main Aggregates Database

Figure I-1-1-1-14 Household consumption and gross fixed capital formation (GFCF) in Malaysia (ratio to the world total)

(% 0.008 Ratio of the household 0.007 consumption to the world total 0.006 Ratio of GFCF to the world total

0.005

0.004

0.003

0.002

0.001 Asian currency crisis Global economic crisis

0.000

1992 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 (year) Source: UN National Accounts Main Aggregates Database

Figure I-1-1-1-15 Household consumption and gross fixed capital formation (GFCF) in Thailand (ratio to the world total) (%) 1.2 Ratio of the household consumption to the world total 1.0 Ratio of GFCF to the world total

0.8

0.6

0.4

0.2

Asian currency crisis Global economic crisis 0.0

(year)

Source: UN National Accounts Main Aggregates Database

It is the development of the free and open trade and investment systems that has been institutionally supporting the economic growth of emerging and developing countries, and the World Trade Organization (WTO)—which was established in 1995 through the reorganization of the General Agreements on Tariffs and Trade (GATT)—is the symbol of that.3 The WTO has expanded since then by bringing in new members, China in 2001 and Russia and other former East Bloc countries in 20124 (Table 1-1-1-16).

3 Reflecting the recognition that the protectionism that became pervasive in the 1930s was a cause of World War II, the General Agreement on Tariffs and Trade (GATT), which was based on the underlying principle of the provision of most favored nation treatment and national treatment, was put into effect in 1948 with the aim of achieving multilateral trade liberalization. The GATT signatory countries realized substantial tariff reductions and developed trade-related rules concerning non-tariff matters through eight rounds of multilateral negotiations including a few of those countries. In 1995, GATT was reorganized into the World Trade Organization (WTO). 4 For the history of the round negotiations after WTO was established, see Part III, Chapter 1, Section 2. 12

Table I-1-1-1-16 New WTO member countries and regions since 2001 2001 Lithuania, Moldova, China 2002 Taiwan 2003 Armenia, Macedonia 2004 Nepal, Cambodia 2005 Saudi Arabia 2007 Vietnam, Tonga 2008 Ukraine, Cape Verde 2012 Montenegro, Samoa, Russia, Vanuatu 2013 Laos, Tadzhikistan 2014 Yemen 2015 Seychelles, Kazakhstan Source: UN National Accounts Main Aggregates Database

Around the time of the end of the Cold War, regional economic integration initiatives accelerated. The European Union was established in 1993, following the Asia-Pacific Economic Cooperation (APEC, established in 1989) and the North American Free Trade Agreement (NAFTA, concluded in 1992). Subsequently, the euro, a common currency, was introduced in Europe in 2002, representing a further evolution of the economic integration and resulting in a rapid expansion in trade within the region (Figure I-1-1-1-17).

Figure I-1-1-1-17 Trend in export value by destination from EU (tn. $) (tn. $) 7.0 100% 90% 6.0 80% 5.0 70% 60% 4.0 50% 3.0 40%

2.0 30% 20% 1.0 10% 0.0 0% 1990 1995 2000 2005 2010 2014 Ratio to the world Ratio to EU region Ratio of EU region (right axis)

Source: Global Trade Atlas

Efficiency improvement in distribution of goods due to the diffusion of Information and Communication Technologies and containers has also supported economic globalization. The penetration rate of the Internet has risen rapidly in developed countries since the 1990s and in China since the 2000s. In Japan, the penetration rate of the Internet5 was 90.6% in 2014 (Figure I-1-1-1-18). Meanwhile, looking at the usage of containers in exports from Japan, the volume of container cargoes has roughly doubled, indicating that the diffusion of containers has contributed to the efficiency improvement in distribution of goods. As a result, the ratio of the distribution cost to sales in the whole of Japan, which was 6.13% in 1995, improved to 4.90% by 2014 (Figures I-1-1-1-19 and I-1-1-1-20).

5 The figure indicates the penetration rate of Internet for household use. The penetration rate of the Internet for business use is presumed to be growing at a similar or faster pace compared with the penetration rate of the Internet for household use. 14

Figure I-1-1-1-18 Internet usage in major countries

(%) 100

90 Germany 80 USA 70 Japan 60 China 50 40 30 20 10

2014 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Source: World Development Indicators, World Bank.

Figure I-1-1-1-19 Change in volume of container cargoes and volume index related to the exports from Japan

10 9 8.7 8 7 6 5 4.5 4 3 2 1 0 Volume of container cargoes (export) Volume index (export)

Note: Magnification from 1972 to 2013 Source: Nationwide Flow Survey of Export-Import Container Cargos, Ministry of Land, Infrastructure, Transport and Tourism and Trade Statistics, Ministry of Finance

Figure I-1-1-1-20 Ratio of the distribution cost to sales in Japan (%)

(%) 7 6.58 6.5

5.5

4.5 4.7

Source: Survey Report on "Distribution Cost for 2014, Japan Institute of Logistics Systems"

From these results, between 1990 and 2014, the value of global trade increased by a factor of 5.4, outward foreign direct investment stocks grew by a factor of 10.9 and such investment on a flow basis expanded by a factor of 5.6 rapidly (Figure I-1-1-1-21). As the global economic structure changed, the ratio of outward foreign direct investment stocks to GDP and the ratio of the value of exports of goods to GDP expanded 31.8% and 24.6%, respectively, while international transfer of technologies proceeded, mainly from developed countries to emerging countries (Figure I-1-1-1-21).

Figure I-1-1-1-21 Trends in export value, outward direct investment stock and patent royalty in the world (ratio to nominal GDP)

Exports value of goods in the world (bn. $) 20,000

x5.4(1990-2014)

10,000

Outward direct investment stock in the world (bn. $) 40,000

20,000 x10.9(1990-2014)

0 1980 1982 19841986 1988 19901992 1994 1996 19982000 2002 20042006 2008 20102012 2014

Patent royalty received by OECD member countries (mil. $)

500,000 x14.8(1990-2014)

0 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013

Ratio of export value of goods, outward direct investment stock and patent royalty in the world to GDP

31.8% 35% 0.008

30% 0.007 0.006 25% 0.005 20% 0.004 24.6% 15% 0.003 10% 0.002

5% 0.001

0% 0 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 2012 Receipts of patent royalty, ratio to GDP (OECD member countries, right axis) Outward direct investment stocks, ratio to GDP (world) Exports value of goods ratio to GDP (world)

Source: WTO Statistics Database UNCTAD STAT OECD Stats IMF World Economic Outlook Database Oct 2015, WTO Statistics Database, OECD Stats, UN National Accounts Main Aggregates Database, UNCTAD STAT.

The types of goods traded have also changed over the years, with trade growing in capital goods and parts which are necessary for emerging countries for their exports. For example, the value of imports of raw materials and parts by China from the rest of the world grew by a factor of 30 between 1990 and 2013. By production process, the value of imports of materials increased by a factor of 106, whereas the value of imports of processed goods expanded by a factor of only 22. This indicates that China is not limited to simple assembly in terms of production process but is also expanding into the processing of imported materials (Figures I-1-1-1-22 and I-1-1-1-23).

Figure I-1-1-1-22 Import value in China by production process (bn. $) (bn. $) 1,800

1,600 Capital goods 1,400 (x14)

1,200 Parts (x34) 1,000

800 Processed goods (x22) 600

400 Materials 200 (x106)

1987 2001 1985 1989 1991 1993 1995 1997 1999 2003 2005 2007 2009 2011 2013

Consumer goods Capital goods Parts Processed goods Materials

Note: Values on the right side of the figure stand for magnifications from 1990 to 2013. Source: RIETI TID Database.

Figure I-1-1-1-23 Share of import value in China by production process

70% 60% 50% 40% 30% 20% 10%

1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 Materials Processed goods Parts Capital goods Consumer goods

Source: RIETI TID Database.

The expansion of energy demand in emerging countries since the 2000s brought about an upsurge in crude oil prices. Between 1990 and 2014, the volume of global consumption of primary energy

19 increased by a factor of 1.6. While the volume of consumption in the OECD member countries in the same period grew by a factor of 1.2, the volume of consumption in non-OECD member countries increased by a factor of 2.1 (Figure I-1-1-1-24).

Figure I-1-1-1-24 World primary energy consumption (100 mil. oil conversion tons)

(100 mil. oil conversion tons) 140 Changes 1990-2014: 120 1.6 times (world total) 1.2 times (OECD) 100 2.1 times (non-OECD)

20 World total OECD non-OECD

1978 2012 1970 1972 1974 1976 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2014

Source: BP Statistical Review of World Energy June 2015.

Oil-producing countries recorded a huge current account surplus, which has been allocated for overseas investments as “oil money” (Figure I-1-1-1-25). Against the backdrop of the rise in resource prices, investments in the resource sector grew. For example, production of shale oil has increased steeply in the United States in recent years. Investments in resource-producing countries such as Brazil, Saudi Arabia and Russia also became active, leading to rapid economic growth in these countries (Figure I-1-1-1-26).

Figure I-1-1-1-25 Current account of OPEC member countries

(bn. $) 600

500

400

300

200

100

-100

-200

1980 2008 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2010 2012 2014 Saudi Arabia Qatar UAE Kuwait Iran Venezuela Nigeria Ecuador Angora Iraq Algeria Libya Indonesia

Source: IMF World Economic Outlook Database October 2015.

Figure I-1-1-1-26 Long-term trend of GDP in Brazil

(Unit: bn. US$) (Unit: US$) 3,000 IMF estimation 20,000 18,000 2,500 16,000 2,000 14,000 12,000 1,500 10,000 8,000 1,000 6,000 500 4,000 2,000 - 0

Lula’s first cabinet Lula’s second cabinet Rousseff’s first cabinet (2003-2006) (2007-2010) (2011-present ) Nominal GDP (US$) [left axis] GDP per capitaperson (PPP) (US$) [right axis]

Source: IMF WEO, October 2015.

These economic trends led to changes in the industrial structure around the world. In other words, as production bases shifted to emerging countries, the ratio of gross fixed capital formation to GDP rose in emerging and developing countries but declined in developed countries. However, in emerging countries, final consumption did not grow as fast as gross fixed capital formation, so developed countries continued to be the main consumer regions even in terms of this trend (Figure I-1-1-1-27).

Figure I-1-1-1-27 World share of emerging and developed countries in final consumption and investment

Investment ratio to GDP 35%

30%

25%

20%

15%

1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 2012 1970 Final consumption ratio to GDP

85% 80% 75% 70% 65%

60%

1985 1970 1973 1976 1979 1982 1988 1991 1994 1997 2000 2003 2006 2009 2012

Emerging and devceloping countries Developed countries

World share of emerging and other countries in investment

60%

50% "Investment" far exceeds "consumption" 40%

30%

20%

10%

1973 1970 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 2012 World share of emerging and other countries in final consumption Wold share of emerging and other countries in investment

Source: United Nations National Accounts Main Aggregates Database.

2. Global imbalance and global economic crisis In the 2000s, developed countries, including the United States and southern European countries, continued to be the main consumer regions, supporting the global economy on the consumption side. As a result, in the period leading to the global economic crisis, capital inflows into and current account deficits in these countries expanded, resulting in the global imbalance, which refers to the extreme polarization between countries recording current account surpluses and those recording current account deficits (Figure I-1-1-2-1).

Figure I-1-1-2-1 Trends of current account in major countries in the world Trend of current accounts in major countries in the world

(bn. US$) 1500

0 Amount Amount of the current account

-1500

1986 2000 2014 1980 1982 1984 1988 1990 1992 1994 1996 1998 2002 2004 2006 2008 2010 2012 USA Southern Europe UK China Japan Germany Central, Eastern and Northern Africa Other developed countries Other developing countries

USA

200 0 -200 -400 -600 -800

-1000

1990 1982 1984 1986 1988 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 1980 23

Southern Europe

100 0 -100 -200 -300

-400

2014 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 1980

Note: Southern Europe includes Spain, Portugal, Italy and Greece. Source: IMF World Economic Outlook Database October 2015.

In the United States, consumption expanded due to significant growth in the value of credit provided in the 2000s, and massive amounts of imports of goods from China and other emerging countries increased the U.S. current account deficit (Figure I-1-1-2-2). The current account deficit was covered by financial inflows from countries recording current account surpluses, such as China and Japan (Figures I-1-1-2-3 and I-1-1-2-4). However, in 2008, subprime loans, which originated against the backdrop of expectations for higher housing prices, turned into nonperforming loans because of a drop in housing prices, thereby becoming a factor of the global economic crisis.

Figure I-1-1-2-2 Debts in the non-financial sector in USA (ratio to GDP) 120 300 Lehman Brothers Bankruptcy 100 250 US household debt expanded rapidly 80 200

60 150

40 100

20 50

0 0

1992 1970 1971 1973 1975 1977 1978 1980 1982 1984 1985 1987 1989 1991 1994 1996 1998 1999 2001 2003 2005 2006 2008 2010 2012 2013

Total Governmental sector Household sector Corporate sector

Source: BIS total credit statistics

Figure I-1-1-2-3 Bank sector’s receivables from USA in major countries (tn. $)

(tn. $) 6 Others Germany UK France 5 Switzerland Netherlands Japan 4

0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Note: Data for 2010 has some missing values partially (France). Source: BIS Consolidated banking statistics.

Figure I-1-1-2-4 Holdings of U.S. bonds by foreign countries and shares of Japan and China

(bn. US$) 45% 7,000

40% 6,000 35% 5,000 30% 25% 4,000 20% 3,000 15%

2,000 countries 10% 5% 1,000

0% 0

Holdings Holdings of U.S. bonds by foreign

2002 2008 2014 2000 2000 2001 2002 2003 2004 2004 2005 2006 2006 2007 2008 2009 2010 2010 2011 2012 2012 2013 2014 2015

Holdings of U.S. bonds by foreign countries Japan China

Source: US Department of Treasury

In Europe, as the policy interest rates in the euro area, which were nominal interest rates, were unified, real interest rates declined in Spain and other countries where the inflation rate was high because of strong economic conditions, providing an additional economic boost. While consumption expanded, accompanied by an increase in borrowings due to credit expansion, products were exported from Germany and other countries, leading to the expansion of the imbalance between countries recording

25 current account surpluses and those recording current account deficits within Europe as well as outside the region. In terms of finance, banks in Germany and other countries provided loans in pursuit of high nominal interest rates in southern European countries, which covered their current account deficits with such loans. In 2010, confidence in government bonds issued by southern European countries crumbled, resulting in the euro crisis (Figure I-1-1-2-5).

Figure I-1-1-2-5 Trends of current account in EU 28 (bn. US$) Trends of current account in EU 28

(bn.US$) 600

400

200

-200

-400

-600

1982 1998 1984 1986 1988 1990 1992 1994 1996 2000 2002 2004 2006 2008 2010 2012 2014 1980

Germany

400 300 200 100 0

-100

1984 1982 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 1980

Netherlands

100

-50

1980 2006 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2008 2010 2012 2014 1982 Source: IMF World Economic Outlook Database October 2015.

After the euro crisis, the number of countries recording current account surpluses increased within the EU because of austerity measures implemented by individual countries. For example, Spain led the economic growth in the euro area by expanding consumption from the second half of the 1990s onwards while debts in the household and corporate sectors grew. As a result, from the beginning of the 2000s, Spain’s current account deficit expanded rapidly. After the euro crisis, Spain experienced economic slowdown due to the disposal of non-performing loans and swung into a current account surplus (Figures I-1-1-2-7, I-1-1-2-8 and I-1-1-2-9). In 2008, among the EU28, there were only seven countries recording current account surpluses: Germany, Sweden, the Netherlands, Austria, Denmark, Finland and Luxemburg, but in 2014, the number increased to 21 countries, including Italy, Spain, Greece and Portugal (Figure I-1-1-2-6).

Figure I-1-1-2-6 Changes in current accounts of EU 28 before and after global economic crisis (bn. $) Current account of EU 28 as of 2008 (bn. $)

Germany Sweden Netherlands Austria Denmark Finland Current account surpluses Luxembourg Malta Current account deficits Estonia Slovenia Cyprus Latvia Czech Republic Belgium Croatia Slovakia Lithuania Hungary Bulgaria Ireland Romania France Portugal Poland Greece Italy UK Spain 300 200 100 0 -100 -200 (bn. $)

Current account of EU 28 as of 2014 (bn. $)

Germany Netherlands Italy Sweden Denmark Spain Ireland Belgium Hungary Slovenia Luxembourg Austria Greece Portugal Czech Republic Croatia Malta Lithuania Slovakia Bulgaria Current account surpluses Estonia Romania Latvia Current account deficits Cyprus Finland Poland France UK 400 300 200 100 0 -100 -200 (bn. $)

Source: IMF World Economic Outlook Database October 2015.

Figure I-1-1-2-7 Debts in the non-financial sector in Spain (ratio to GDP) 160 350 Total（right axis) 140 Governmental sector 300 120 Household sector 250 Corporate sector 100 200 80 150 60 100 40 20 50

0 0

1982 1983 1984 1985 1987 1988 1989 1990 1992 1993 1994 1995 1997 1998 1999 2000 2002 2003 2004 2005 2007 2008 2009 2010 2012 2013 2014 1980 Source: BIS total credit statistics

Figure I-1-1-2-8 Changes of real GDP growth rate in Spain 10%

-5%

1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 1980 Source: IMF World Economic Outlook Database October 2015

Figure I-1-1-2-9 Trends of current account in Spain (bn. US$)

(bn. $) 50

-50

-100

-150

-200

1992 1982 1984 1986 1988 1990 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 1980 Source: IMF World Economic Outlook Database October 2015.

3. Expansion of economic relationships between emerging countries The economic growth of emerging countries and the deepening of the global value chain brought about the expansion of economic relationships between emerging countries. Particularly notable are changes in China’s economic relationships with its neighboring countries because of its rapid economic growth after the global economic crisis. For example, the number of countries whose largest trading partners are Japan, the United States or Europe has declined, while the number of countries whose largest trading partner is China has increased (Table I-1-1-3-1). This paragraph analyzes the effects of the expansion of economic relationships between emerging countries on the production networks that have been established mainly by developed countries.

Figure I-1-1-3-1 Geographical distribution of the largest trading partners among Japan, USA, EU15 and China

Yellow: Japan is the largest trading partner of 4 regions Red: China is the largest trading partner of 4 regions Blue: EU15 is the largest trading partner of 4 regions Green: USA is the largest trading partner of 4 regions *4 respective regions are marked with their own colors regardless of amount of the trade.

Source: Global Trade Atlas

(1) Changes in production networks in East Asia, ASEAN and other regions (A) Expansion of final demand in China It has been said that in East Asia and ASEAN, international division of production has developed in close collaboration with Japanese companies’ overseas business expansion. Specifically, intermediate goods have been exported from Japan and the ROK to China and ASEAN, while final goods assembled in China and ASEAN through trade with ASEAN and between China and ASEAN have been exported from there to the United States and Europe.6 This structure has been gradually changing in line with China’s economic development, and this change has accelerated particularly since the global economic crisis. Regarding the export of value added, an indicator of which countries’ demand is finally met by exports of goods and services from individual countries through cross-border production networks, Japan and the United States were the world’s two largest final demand regions in the 1990s through the 2000s, but since the global economic crisis, the situation has changed, with China becoming the largest final demand region for the ROK, Taiwan, Thailand, Malaysia and Australia (Table I-1-1-3-2).

6 White Paper on International Economy and Trade 2014 31

Figure I-1-1-3-2 Geographical distribution of the largest final demand providers to exports of goods and services in respective countries and regions

Yellow: Japan is the largest provider of final demand Red: China is the largest provider of final demand Blue: Germany is the largest provider of final demand Orange: France is the largest provider of final demand Green: USA is the largest provider of final demand Brown: Russia is the largest provider of final demand Grey: Other country than above mentioned is the largest provider of final demand * Each country is excluded to be the largest provider of final demand of itself.

Source: OECD Tiva.

For the whole of ASEAN, the United States was still the largest final demand region in 2011, but China has increased its presence as a final demand region. For example, in 2009, China became a larger final demand region for ASEAN than Japan7 (Figure I-1-1-3-3).

7 The share of direct exports to China from individual ASEAN countries also rose. The rise is prominent in Myanmar and Laos in particular. 32

Figure I-1-1-3-3 Final demand destinations of value-added exports by ASEAN and geographical distribution (1,000 mil. $) 1,200

1,000

800

600

China surpasses Japan (2009) 400

200

0 1995 2000 2005 2008 2009 2010 2011 Japan USA China

(Geographical distribution as of 2011)

Yellow: Japan is the largest final demand provider Red: China is the largest final demand provider Blue: Germany is the largest final demand provider Orange: France is the largest final demand provider Green: USA is the largest final demand provider Brown: Russia is the largest final demand provider Grey: Other country than above mentioned is the largest final demand provider * Each country is excluded to be the largest final demand provider of itself.

Source: OECD Trade in Value Added Database

Presumably, one factor behind this is that exports to China, mainly of resources, have grown due to

33 the expansion of private consumption associated with a rise in the income level within the country and the effects of economic stimulus measures taken by the Chinese government and growth in construction demand since the global economic crisis. In 2009, the share of foreign value added in relation to construction demand in China in a foreign country’s GDP, which is an indicator of the cross-border spillover effects of real estate investments in China, was high mainly in resource-producing countries, including Brunei (1.65%) and Malaysia (1.07%)8 (Figure I-1-1-3-4).

Figure I-1-1-3-4 Share of foreign value added in relation to construction demand in China (2009)

1.2%

1.0% Others Services

0.8% Construction Metals Chemicals Mining 0.6%

0.4%

0.2% demand demand China in being 100%

Ripple effect by country with Ripple effect by country with the construction 0.0%

Source: OECD Trade in Value Added

As a result of a shift of final demand regions from developed countries to China, it can be assessed that East Asian countries’ economic conditions are becoming increasingly prone to being influenced by the conditions of the Chinese economy, including construction demand.

(B) A rise in China’s position as a producer and changes in the global value chain Provided above was an overview of changes in economic relationships between emerging countries from the viewpoint of final demand. As a result of China’s economic growth, changes have occurred in the division of production. As described above, the expansion of the global value chain was led by direct

8 In 2009, domestic value added accounted for 89.3% of the overall value added in relation to construction demand in China, while foreign value added accounted for the remaining 10.7%. The share of value added in relation to construction demand in China in a foreign country’s GDP is high in resource-producing countries as mentioned in the main text. Meanwhile, in terms of the size of value added, Japan is the largest provider of value added (1.06%), followed by the United States (0.82%) and ASEAN (0.82%). 34 investments by companies from developed countries, including Japan, so although the nominal value of exports from emerging countries increased, the largest value was added by developed countries in most cases. For example, in terms of the value of imports of goods by the United States, China surpassed Japan in 2002, with the value of U.S. imports from China staying higher than the value of imports from Japan since then, but the value of U.S. imports of value added from Japan remained higher than the value of such imports from China until around 20069 (Figure I-1-1-3-5).

Figure I-1-1-3-5 Shares of Japan and China in nominal value of imports and imports of value added in USA

25%

20%

15%

China surpasses Japan in imports China surpasses Japan of value added (about 2006) 10% in nominal value of imports (2002)

2000 1995 1996 1997 1998 1999 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Japan (nominal value) China (nominal value) Japan (value added) China (value added)

Note: There is no value added data except for 1995, 2000, 2005, 2008, 2009, 2010 and 2011, and value added during the period without data is assumed to change at the same rate. Source: Global Trade Atlas, OECD TiVA

As indicated above, until recently, for many countries around the world, the largest trading partners in terms of the value of their imports of value added concerning final demand were developed countries, particularly, Japan, the United States and Germany. However, since the global economic crisis, the number of countries with China as their largest trading partner in terms of the value of their imports of value added has increased around the world. For example, in 2011, China and Thailand were the only major countries with Japan as their largest trading partner in terms of their imports of value added (Table I-1-1-3-6).

9 At around this time, the largest importer of value added from the United States was presumably Canada. 35

Figure I-1-1-3-6 Geographical distribution of value added creators to final demand of respective countries

Yellow: Japan is the largest creator of value added Red: China is the largest creator of value added Blue: Germany is the largest creator of value added Green: USA is the largest creator of value added Brown: Russia is the largest creator of value added Grey: Other country than above mentioned is the largest creator of value added *Each country is excluded to be the largest creator of value added of itself.

Source: OECD TiVA

In line with an improvement in Chinese companies’ production capabilities, changes can be observed in the composition of importers and exporters in China. From the second half of the 1990s onwards, the share of foreign companies in exports from China continued to rise consistently until it peaked in 2005, since when it has declined. In 2015, the share was down to 44.1%, similar to the level around 1998 (Figure I-1-1-3-7).

Figure I-1-1-3-7 Share of foreign companies in imports and exports in China

(%) 65

60 Exports Imports

55 49.4 50

45 44.1 40

(year)

Source: General Administration of Customs, CEIC database.

One aspect of this trend is a change in ASEAN’s position in the global value chain. First, regarding the source of value added to the nominal value of exports of goods and services from ASEAN, the share of value added by Japan is declining while the share of value added by China is rising. In the second half of the 1990s through around 2000, the share of value added by Japan in the value of exports from ASEAN was around 10%. However, as China caught up with Japan, the shares of value added by the two countries were almost equal in 2011. Moreover, the composition of traded goods has also changed. Although ASEAN’s exports to China are still composed mainly of intermediate goods (processed goods and parts), the share of parts has declined since the global economic crisis while there has been an uptrend in the shares of processed goods that are close in nature to raw materials10 and of raw materials (Figures I-1-1-3-8 and I-1-1-3-9).

10 The share of raw materials has recently been declining. 37

Figure I-1-1-3-8 Share of value added in exports in manufacturing industries from ASEAN (Japan and China)

12% 10.6% 9.7% 10% Japan China 8% 7.4% 6.3% 5.7% 6.0% 6% 5.5%

5.1% 4% 4.9% 4.8% 4.7%

3.4% 2%

0.6% 1.3% 0% 1995 2000 2005 2008 2009 2010 2011 Source: OECD Trade in Value Added Database

Figure I-1-1-3-9 Change in composition of export items from ASEAN to China

70% Materials Processed goods 60% Parts Consumer goods Capital goods 50%

40%

30%

20%

10%

1990 2001 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Source: RIETI TID

These trends indicate that Japanese companies’ role in the division of production in ASEAN is changing and also that apart from existing production networks established mainly by companies from developed countries, the economic integration of China and ASEAN is developing independently. Presumably, the reasons for this include not only the growth of Chinese companies, including state-

38 owned enterprises and private companies, but also institutional factors, such as the Chinese government’s support for Chinese companies’ overseas business expansion and the conclusion of the China-ASEAN free trade agreement. In line with improvements in China’s technological capability and production capacity, there are also signs of change in trade between China and the ROK. After the establishment of diplomatic relations between the two countries in 1992, their trade relationship was initially vertical, with the ROK mainly exporting light industry products to China while importing primary goods such as resources and agricultural products from there. Regarding foreign direct investment, small and medium-size enterprises from the ROK mainly invested in small-scale, labor-intensive light industries in China, such as textiles and clothing, in order to take advantage of low-cost labor there. From 2002 onwards, following China’s accession to the World Trade Organization (WTO), foreign direct investments from the ROK in China11,12 increased rapidly. However, at that time, ROK companies operating in China imported a large proportion of parts and materials necessary for their production from the ROK, leading to exports of raw materials, intermediate goods and capital goods to China for ROK companies operating there13 (Figures I-1-1-3-10 and I-1-1-3-11).

11 The manufacturing industry is the largest recipient of outward foreign direct investments from the ROK, and the investments in the industry are mainly made in such sectors as electronics, automobiles and steel. Investments are also actively made in the mining sector in order to secure resources. By region, Asia is the largest recipient of foreign direct investments from the ROK, followed by North America and Europe. 12 The ROK has been steadily attracting inward foreign direct investments from abroad, with the ratio of such investments to GDP staying above 10% since 2000. The amount of inward foreign direct investments in the ROK in 2015 (on a declared basis) was a new record high of approximately 21 billion dollars, up 10.0% compared with the previous year. By sector, investments in services, particularly financial services and insurance, increased significantly, while investments in the manufacturing sector declined. By country/region, investments from the United States, China and the Middle East grew markedly, whereas investments from Japan and Europe decreased. 13 Mukoyama, H.,“Tsuyomaru Kankoku no Chugoku tono keizai kankei” (March 2014). 39

Figure I-1-1-3-10 Change in value of outward direct investment in ROK (by industry, flow)

(mil. $) 30,000

Others 25,000 Real estate and rental Finance and insurance 20,000 Wholesale and retail Mining 15,000 Manufacturing

10,000

5,000

Source: Korea Eximbank and CEIC database.

Figure I-1-1-3-11 Changes in value of outward direct investment in ROK (by country and region, flow) (mil. $) 35,000

30,000

25,000

20,000

15,000

10,000

5,000

0 (year)

USA China Hong Kong Japan Vietnam Singapore Indonesia Thailand Central America Europe Middle East Pacific

Source: Korea Eximbank and CEIC database.

After peaking in 2007, foreign direct investments from the ROK in China slowed down. In addition, as ROK companies operating in China proceeded with local procurement of intermediate goods, the ratio of procurement of intermediate goods from the ROK declined. In 2005, the ROK accounted for 4.0% of value added to the value of exports of goods and services from China, but in 2011, the share

40 fell to 2.7%14 (Figure I-1-1-3-12). As for the composition of exports from the ROK to China by type of goods, the share of intermediate goods (parts and processed goods) was 76.8% in 2013, down around 10% compared with 2000. According to one estimate, a rise of 1% in China’s self-sufficiency rate of input of intermediate goods would result in a decrease of 8.4% in exports from the ROK to China, which in turn would lead to a decline of 0.5% in the ROK’s GDP.15

Figure I-1-1-3-12 Share of foreign value added creation in exports of goods and services in China 9% 80%

8% 70%

7% 60% 6% 50% 5% 40% 4% 30% 3% 2% 20% 1% 10% 0% 0% 1995 2000 2005 2008 2009 2010 2011 Within China (right axis) Japan ROK

Source: OECD Trade in Value Added Database

It is said that a sense of crisis is growing in the ROK about China’s catching up. 16 China’s technological capability is improving and production capacity is expanding in the area of intermediate goods, such as semiconductors, panel displays, petrochemicals, and steel, which are the ROK’s main industries. In China, it has become possible to produce many types of parts and materials, leading to a

14 However, as a result of increases in production and sales by Chinese companies in China and abroad in the electronics sector, exports of intermediate goods to China remained robust afterwards. In 2015, integrated circuits, liquid crystal devices, auto parts and semiconductors were among the main intermediate goods items exported to China. 15 Hyundai Economic Research Institute, “Effects of the Rise in the Chinese Economy’s Self-Sufficiency Rate on the ROK Economy” (July 2015). 16 Regarding the nine major ROK industries’ competitiveness relative to China, the Korea Institute for Industrial Economics and Trade (KIET), a government-affiliated think tank, provided the following assessments: the ROK is inferior to China regarding steel, textiles and clothing; competition with China is intensifying regarding shipbuilding, petrochemicals, communication equipment, home electronics and liquid crystal displays; the ROK maintains a slight advantage concerning general machinery and semiconductors; ROK companies maintain an advantage regarding automobiles (Korea Institute for Industrial Economics and Trade, “Current Status of China’s Catching Up and the ROK Industries’ Competitiveness” (October 2014). 41 rise in the self-sufficiency rate, and as a result, China’s dependence on imports from the ROK has been declining.17 Concerning China-ROK trade, there is also a high degree of similarity between the two countries’ import and export product items. In 2015, integrated circuits, liquid crystal devices, wireless communication equipment and semiconductors were among the major export and import items for both countries (Table I-1-1-3-13). Concerning the two countries’ trade with the rest of the world, too, there is much overlap between their import and export items.18 The Spearman’s rank correlation coefficient19 was calculated to look at the similarity between China and the ROK in the composition of export items, and in 2014 the correlation coefficient concerning China and the ROK was 0.803, higher than the correlation coefficients for Japan and China (0.768) and Japan and Germany (0.664), meaning that there is a higher degree of similarity in the composition of export items of China and the ROK (Tables I-1-1- 3-14 and I-1-1-3-15).

17 China is said to be raising the self-sufficiency of its major industries while reducing processing trade as part of its policy of upgrading the industrial structure (Hyundai Economic Research Institute, “Diagnosis and Outlook of Risks of Domestic and Overseas Economies” (November 2015). The share of processing trade in overall Chinese trade fell from 55% in 2000 to 35% in 2015 (calculated from the China Customs Statistics). 18 On a four-digit HS code basis, integrated circuits, liquid crystal devices, wireless communication equipment and auto parts are among major export items for both China and the ROK. 19 The rankings of product items in terms of export value in 2014 were compiled from data concerning the value of individual countries’ exports by product item (on a four-digit HS code basis), and the rank correlation coefficient was calculated based thereon. Spearman’s ρ (rho) takes a value between minus 1 and plus 1. The closer the value of Spearman’s ρ is to plus 1, the stronger is the positive correlation between the two countries’ rankings of export product items—which means the presence of a higher degree of similarity and a higher level of competition between their export product items. 42

Table I-1-1-3-13 Comparison of top 10 items of ROK imports from and exports to China Major export items from ROK to Major import items from China to China (mil. $) ROK (mil. $) 2000 2000 Mineral fuel 1,625 Coal 698 Thermionic tube, imaging tube for 1,231 Corn 660 television Cyclic hydrocarbon 670 Office equipment parts 412 Polycarboxylic acid 578 Computer 404 Ethylene polymer 518 Semiconductor 352 Office equipment parts 463 Mineral fuel 309 Cattle leather 436 Integrated circuit 269 Woven fabric of textile fiber 435 Transformer, rectifier 261 Integrated circuit 430 Frozen fish 248 Stainless steel flat rolled 420 Pig iron and spiegeleisen 242 products Overall 18,455 Overall 12,348

Major export items from ROK to Major import items from China to China (mil. $) ROK (mil. $) 2015 2015 Integrated circuit 24,270 Integrated circuit 8,649 LC device 15,308 Wireless communication device 8,472 Cyclic hydrocarbon 6,355 Computer 3,101 Wireless communication device 6,231 LC device 2,179 Automobile parts 5,410 Insulated electrical wire, cable 2,140 Alarm, siren 4,336 Semiconductor 1,897 Mineral fuel 3,311 Flat hot-rolled products 1,604 Semiconductor manufacturing 2,756 Steel structures 1,482 equipment Electric circuit components 2,735 Office equipment parts 1,111 Semiconductor 2,225 Printed board 1,103 Overall 137,124 Overall 90,250 Note: Items are classified according to HS 4-digit classification Source: Global Trade Atlas

Table I-1-1-3-14 Comparison of top 10 major export items in China and ROK (to the world)

Major export items in China (mil. $, %)

2014 2015 year on year Wireless communication device 195,317 213,412 9.3 Computer 163,421 137,303 -16.0 Integrated circuit 61,213 70,125 14.6 Lighting device 31,109 35,792 15.1 LC device 34,701 33,961 -2.1 Semiconductor 30,641 33,585 9.6 Furniture and components 28,442 29,172 2.6 Office equipment 31,233 28,918 -7.4 Automobile parts 28,477 28,285 -0.7 Travel goods, bag 27,130 28,270 4.2 Overall 2,343,222 2,280,541 -2.7

Major export items in ROK (mil. $, %)

2014 2015 year on year Integrated circuit 51,544 52,173 1.2 Automobile 44,821 41,721 -6.9 Petroleum product 48,818 30,622 -37.3 Wireless communication device 27,667 29,855 7.9

Automobile parts 24,265 23,053 -5.0 Vessel 21,836 21,570 -1.2 LC device 24,884 21,487 -13.7 Other than vessel for navigation 16,330 16,487 1.0 Cyclic hydrocarbon 10,601 8,317 -21.5 TV/radio parts 7,240 6,013 -16.9 Overall 572,665 526,757 -8.0 Note: Items are classified according to HS 4-digit classification Source: Global Trade Atlas

Figure I-1-1-3-15 Comparison of similarity of composition of export items between China and ROK (2014)

ROK

*Numbers stand for similarity of China Japan composition of export items (Max. value: 1)

Germany

Source: Global Trade Atlas. Spearman's rank correlation coefficient 휌 is calculated for composition of export items in respective countries for 2014 based on HS 4-digit classification.

China’s presence as a final consumption region and a creator of added value is growing not only for East Asian and Southeast Asian countries but also for other countries around the world, mainly resource- producing ones. The Chinese government is aiming to strengthen economic relationships with Asia, Europe and the eastern coast of Africa.20 Exports to these regions account for slightly higher than 50% of overall exports from China, while imports from there make up slightly lower than 60% of overall imports by China (Table I-1-1-3-16 and Figures I-1-1-3-17 and I-1-1-3-18).

20 Regarding these regions, Chinese President Xi Jinping proposed the New Silk Road Economic Belt (land-based portion of the New Silk Road) initiative during his visit to Kazakhstan in September 2013 and the 21st Century Maritime Silk Road (ocean-based portion of the New Silk Road) initiative in his speech in the Indonesian parliament in October of the same year. China refers to these two Silk Road initiatives collectively as the New Silk Road (One Belt, One Road) initiative. It is expected that improving connectivity with this region by developing infrastructure there—including roads, railways, ports, and communication and energy facilities—will contribute to exports from China by expanding flows of people, goods, funds and information and by promoting the region’s economies and industries. Although there is no clear definition of countries covered by the initiative, around 30 countries, including Turkey and Poland, signed a memorandum of understanding on the One Belt, One Road initiative in 2015, according to an announcement by the National Development and Planning Commission (February 2016). Meanwhile, according to a survey report commissioned by a Japanese private-sector think tank to the survey division of the Ministry of Commerce of China (Mizuho Research Institute, called “Full Picture of the New Silk Road Initiative as Revealed by a Chinese Think Tank—FY2014 Survey Commissioned to the Chinese Academy of International Trade and Economic Cooperation under the Ministry of Commerce,” the initiative, as broadly defined, covers a vast region that includes Central Asia, South Asia, Russia/CIS and Europe in the land-based portion and East Asia, Southeast Asia, South Asia, the Persian Gulf coast and the Red Sea and East Africa coast, with the total number of countries reaching as many as around 90. Described here are trade and investment relationships between China and the New Silk Road region as defined by the report commissioned by the Japanese think tank. 45

Table I-1-1-3-16 Major countries that have foreign economic relations with China (Asia, Europe and Africa) Central Asia Kazakhstan, Kirghiz, Tadzhikistan, Uzbekistan, Turkmenistan, Mongolia South Asia India, Pakistan, Bangladesh, Nepal, Bhutan, Sri Lanka, Maldives South-East Asia Vietnam, Thailand, Myanmar, Malaysia, Singapore, Indonesia, Philippines, Laos, Cambodia, Brunei, East Timor Middle East Afghanistan, Iran, Iraq, Syria, Jordan, Israel, Saudi Arabia, UAE, Oman, Kuwait, Bahrain, Qatar Central and Russia, Poland, Belarus, Czech, Slovakia, Hungary, Slovenia, Croatia, Eastern Europe Romania, Bulgaria, Serbia, Montenegro, Macedonia, Bosnia and Herzegovina, Albania, Estonia, Lithuania, Latvia, Azerbaijan, Georgia, Armenia, Ukraine Western Europe EU member countries Africa Egypt, Sudan, Ethiopia, Tanzania, South Africa Note and source: 1. Compiled focusing on the countries along the New Silk Road based on websites of The National Development and Reform Commission (NDRC), China Banking Regulatory Commission (CBRC) and other survey reports commissioned to the private sector. 2. Regions are classified for expedient.

Figure I-1-1-3-17 Trends of China’s exports to Asia, Europe and Coastal East Africa (bn. $) 2,500 (Exports) (Imports)

2,000

1,500

1,000

500

1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013

New Silk Road (land route) New Silk Road (sea route) Overall New Silk Road Overall exports

Note. Land and sea routes are aggregated from the countries that are considered to be included in the New Silk Road area. Overall does not meet total of land and sea routes as some countries are

overlapped both in land and sea routes. Source: Global Trade Atlas

Figure I-1-1-3-18 Changes of share of Asia, Europe and Coastal East Africa in China’s exports

(%) 70 (Exports) (Imports) 60 Overall 50

40 Sea route 30

10 Land route

Land route Sea route Overall

Note: Land and sea routes are aggregated from the countries that are considered to be included in the New Silk Road area. Overall does not meet total of land and sea routes as certain countries are overlapped both in land and sea routes. Source: Global Trade Atlas

Looking at the composition of China’s trade with these regions by type of goods, China imports raw materials (unprocessed resources such as crude oil and iron ore) and mainly exports processed goods (steel/metals chemicals, etc.) and consumer goods. Figure I-1-13-19 shows the type of goods that has the largest share in China’s imports from and exports to each trading partner. Regarding imports, the share of raw materials is the largest in imports from West Asia, the Middle East and the western coast of Africa. As for exports, the share of consumer goods is the largest in exports to Russia and many countries in Central Asia and Europe. Regarding trade with Southeast Asia and South Asia, the share of processed goods (steel/metals, chemicals, etc.) is the largest in both imports from and exports to many countries in these regions.

Figure I-1-1-3-19 Composition of China’s trade with Asia, Europe and Coastal East Africa by type of goods (goods with the largest share)

Imports of China (2014)

China

Primary goods Processed goods Parts and components Consumer goods Capital goods

Exports of China (2014)

China

Primary goods Processed goods Parts and components Consumer goods Capital goods

Note: Map is an approximate map. Source: UN Comtrade data obtained from World Bank WITS Database.

There is the view that these changes in the global value chain are not limited to East Asia but it may

48 be seen as a global phenomenon from the perspective of a slowdown in the growth of the volume of trade in goods across the world.21 For example, at the G20 trade ministers’ meeting held in 2015, this matter was discussed.22 Elasticity calculated by dividing the growth rate of the global volume of imports with the growth rate of real GDP has been declining as a long-term trend since the 1990s although going up and down steeply during the IT bubble period and the global economic crisis, for example. Since 2012, the growth rate of the volume of imports has tended to be lower than the growth rate of real GDP, so the ratio of the global trade volume to GDP has been declining.23 A change in vertical industrial integration worldwide has been cited as a background factor of such trends24 (Figure I-1-1-3-20).

Figure I-1-1-3-20 Relationship between global real GDP growth rate and volume of imports (elasticity)

7 6.4 6

4 3.5 3.5 3.1 3.2 3 2.4 2.5 2.6 2.2 2.3 2.1 2.0 2.0 1.9 2.0 2 1.6 1.7 1.4 1.2 1.0 0.8 1 0.6 0.7 0.0 0

-1

1992 1997 2002 1994 1995 1996 1998 1999 2000 2001 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 1993 Source: IMF World Economic Outlook and CPB World Trade Monitor.

21 Constantinescu, Mattoo, and Ruta (2015), The Global Trade Slowdown: Cyclical or Structural?, IMF Working Paper, WP/15/6, January 2015, (IMF). 22 Chairman’s Summary Meeting of G20 Trade Ministers, Istanbul, October 6, 2015. 23 However, the ratio of services trade to GDP has continued to rise. For further details, see Chapter 3, Section 1. 24 Constantinescu, Mattoo, and Ruta (2015). 49

(2) Overseas business expansion by Chinese companies, etc. (A) Overseas expansion by Chinese companies and foreign direct investment Since around the early 2000s, the Chinese government has called for active overseas expansion by Chinese companies. As a result, the value of outward foreign direct investments (FDIs) from China grew rapidly in the 2000s, and in 2014, it was very close to the value of inward FDIs in China (Figure I-1-1- 3-21). In 2014, China was the global No. 3 in terms of outward FDIs on a flow basis, after the United States and Hong Kong, and the global No. 7 in terms of outward FDIs on a stock basis (Figures I-1-1- 3-22 and I-1-1-3-23).

Figure I-1-1-3-21 Changes in direct investment in China

(bn. $) 160 (Overall) (Finance excluded) 140

120 Inward direct investment 100

40 Outward direct 20 investment

0 2006 2008 2010 2012 2014 2002 2004 2006 2008 2010 2012 2014 Inward direct investment Outward direct investment

Note: Statistics by Ministry of Commerce have reported overall including finance since 2006. Statistics excluding finance since 2002. Source: Ministry of Commerce of China and CEIC database.

Figure I-1-1-3-22 Outward direct investments in major countries (flow base)

(Trends) (bn. $) 450 400 350 300 250 200 150 100 50 0

USA Hong Kong China Japan Germany

Note: Top 5 countries and regions for 2014 are indicated. Source: UNCTAD website.

(2014)

(bn. $) 400 350 300 250 200 150 100 50

USA

Japan

China

Russia

France

Canada

Germany

Singapore Hong Kong Netherlands Note: Top 10 countries and regions as of the end of 2014 are indicated. Source: UNCTAD website.

Figure I-1-1-3-23 Outward direct investments in major countries (stock base) (Trends)

(tn. $) 7

0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 USA UK Germany Hong Kong France Japan China

Note: Top 5 countries and regions for 2014 are indicated with Japan and China. Source: UNCTAD website. (End of 2014)

(tn. $) 7

USA

Japan

China

France

Canada

Germany

Hong Kong Switzerland Netherlands Note: Top 10 countries and regions as of the end of 2014 are indicated. Source: UNCTAD website.

By region, Hong Kong was the largest recipient of FDIs from China, accounting for two-thirds of

China’s outward FDIs, followed by financial centers such as Luxemburg and the Cayman Islands (Figure I-1-1-3-24). Among other major recipients are the United States and Australia. By sector, leasing, business services, retailing, mining and financial services are the largest recipients of FDIs from China, followed by manufacturing (Figure I-1-1-3-25). The recipient sector of FDIs from China differed according to the recipient country/region. For example, business services, wholesaling, retailing, and financial services have large shares as recipients of Chinese FDIs in Hong Kong, while in Australia, the share of mining is large.

Figure I-1-1-3-24 Outward direct investment in China (by region)

(bn. $) 120

100

-20 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Hong Kong USA Luxembourg Virgin Islands Cayman Islands Australia Singapore UK Germany Indonesia Others Overall

Note: Top 10 countries and regions for 2014 are indicated. Japan is not shown as it was ranked 29th. Source: Ministry of Commerce of China and CEIC database.

Figure I-1-1-3-25 Outward direct investment in China (by industry)

(bn. $) 140

120

100

-20 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Lease and office services Wholesale and retail Mining Finance intermediation Manufacturing Real estate Transport and post Construction IC and IT services Agriculture and fishery Others Overall

Note: Top 10 industries for 2014 are indicated. Finance intermediation is not included before 2006. Source: Ministry of Commerce of China and CEIC database.

In many cases, Chinese companies procure foreign currency funds for overseas expansion in the Hong Kong stock market. In 2015, the Hong Kong Exchanges and Clearing attracted the largest number of initial public offerings in the world, outpacing the New York Stock Exchange. In the 2000s, the number of cross-border mergers and acquisitions (M&As) carried out by Chinese companies steadily rose. While M&A activities by companies from major Western countries, such as the United States and the United Kingdom, have remained sluggish since the slump after the global economic crisis, the number of Chinese M&As has increased, bringing China up to the global No. 7 in terms of the number of M&As in 2014 (Figure I-1-1-3-26).

Figure I-1-1-3-26 Cross-border M&A (acquisition) in the world (Trends)

(case) 2,500

2,000

1,500

1,000

500

0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

USA UK Canada France Japan Germany China

(2014)

(case) 2,500

2,000

1,500

1,000

500

USA

Japan

China

France

Canada

Australia

Germany Switzerland Netherlands Note: Top 7 countries for 2014 are indicated. Source: UNCTAD website.

Since 2011, the annual number of Chinese cross-border M&As has been increasing slightly at around 250. By nationality of M&A targets, companies in developed countries are the main targets. By country,

Chinese M&As have been mainly carried out in developed countries, and by sector, the share of resources and energy as M&A targets declined from the previous high level while the share of industrials, finance and consumer goods increased (Figure I-1-1-3-27).

Figure I-1-1-3-27 Cross-border M&A of China (by partner country and industry) Cross-border M&A by Chinese companies (completed)

350 303 300 264 255 251 245 250 200 150 100 50 0 2011 2012 2013 2014 2015

Targets by country (total of respective years)

350 293 300 250 230 186 200 158 150 96 100 78 78 60 44 50 34 33 28 0

Targets by industry

150 2011 2012 2013 2014 2015 111 97 100 90 89 88 89 75 74 71 75 56 61 61 49 50 44 40 31 34 23 24 10 7 8 4 7 0 Resource and energy Industries Infrastructure Finance Consumer goods 56

Note: Total from 2011 to 2015. Source: Thomson Reuters.

Regarding infrastructure investment, Chinese companies are acquiring port and airport service companies and shipping and aviation service companies through M&As around the world (Figure I-1- 1-3-28).

Figure I-1-1-3-28 Acquisition of foreign logistic infrastructure by China transport-related cross-border M&A by Chinese companies

16 Acquisition completed

14 In process

0 Air freight Airlines Marine freight Land freight

Source: Thomson Reuters

Acquired company Country Hanjin New Port Co Ltd South Korea PT Kutai Nyala Resources Indonesia Kuantan Port Consortium Sdn Bhd Malaysia APM Terminals Zeebrugge NV Belgium Kumport SA Turkey Brazilian Dock Brazil Luka Rijeka dd Croatia Swissport International AG Switzerland Source: Thomson Reuters

(B) China’s economic cooperation provided mainly to resource-producing countries25 China’s share as a destination of exports from resource-producing countries, mainly in the Middle East and Central Asia, is increasing, and at the same time, the value of Chinese economic cooperation provided to such countries is growing (Figure I-1-1-3-29). Presumably, infrastructure built through Chinese economic cooperation projects, including roads and railways, invigorates flows of goods between resource-producing countries and China, while oil and natural gas pipelines thus constructed contribute to China’s acquisition of resources from abroad.26

Figure I-1-1-3-29 Share of China in exports in major resource-rich countries and Chinese economic cooperation (Share of China in exports in respective countries)

(%) (%) 25 100 Kazakhstan Saudi Arabia 20 80 Iraq Turkmenistan 15 60

10 40

5 20

0 0 2007 2008 2009 2010 2011 2012 2013

25 China’s economic cooperation with foreign countries or regions (as defined by China Statistical Year Book (National Bureau of Statistics of China)) may be different from cooperation provided to developing countries through ODA and other means as defined in Japan. China’s economic cooperation with foreign countries or regions is presumed to be a concept that includes foreign construction contracts and foreign labor service cooperation. 26 China also led the establishment of the Asian Infrastructure Investment Bank (AIIB) as a new financial institution intended to promote infrastructure investments in Asia. The AIIB was established in December 2015 with 57 countries as its founding members and formally started operation after holding a general meeting and a Board of Governors meeting in January, but Japan and the United States are not members of the institution. In addition, at the end of 2014, China established the Silk Road Fund (40 billion dollars), which is intended to promote co-development and co-prosperity with countries in the region covered by the One Belt, One Road initiative that it is advocating by investing in and providing loans for connectivity-related projects, including infrastructure and resource development and industrial and financial cooperation. This fund can make decisions on projects at China’s own discretion. According to a media report, in April 2015, a decision was made on the first project, which is an investment in the construction of a hydroelectric power station in Pakistan. 58

Source: Direction of Trade Statistics/Yearbook 2014, IMF.

(Value of Chinese economic cooperation offered to respective countries) (mil. $) 7,000 Kazakhstan 6,000 Turkmenistan

5,000 Saudi Arabia Iraq 4,000

3,000

2,000

1,000

0 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Source: Ministry of Commerce of China, CEIC database.

After the global economic crisis, the growth in Chinese economic cooperation slowed down, particularly in 2014, the most recent year for which relevant data is available, but in the 2000s, such cooperation was growing rapidly (Figure I-1-1-3-30). Between 2000 and 2014, the value of Chinese economic cooperation grew by a factor of 17, translating into the average annual growth of 22.4% over the 14-year period, and immediately before the global economic crisis, the annual growth was nearly 40%. By region, Asia and Africa are by far the largest recipients of Chinese cooperation in terms of value. In particular, Africa’s share in overall Chinese economic cooperation rose remarkably, from 13.1% in 2000 to 37.2% in 2014 (Figure I-1-1-3-31).

Figure I-1-1-3-30 Chinese economic cooperation (value of completed projects) (bn. $) 180 (%) 45.0

160 40.0

140 Growth rate (right axis) 35.0

120 30.0

100 25.0

80 Africa 20.0

60 15.0 World total 40 10.0

20 Asia 5.0

0 0.0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Asia Africa Central and South America Europe North America Oceania World total Growth rate (right axis)

Source: Ministry of Commerce of China, CEIC database.

Figure I-1-1-3-31 Share of Chinese economic cooperation (value of completed projects) by region

(Changes) (%) 70

60 Asia 50

40 Africa

0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Asia Africa Central and South America Europe North America Oceania

(2014)

Central and North Oceania South America 2% America 1% 9% Europe 5%

Asia 46%

Africa 37%

Source: Ministry of Commerce of China, CEIC database.

In 2014, the most recent year for which relevant data is available, Asia was the largest recipient region of Chinese economic cooperation, but by country, African countries (Ethiopia, Angola and Algeria) were the three largest recipients, followed by Saudi Arabia and Venezuela (Figure I-1-1-3- 32). Figure I-1-1-3-33 is a map indicating major recipients of Chinese economic cooperation in terms of value (the deeper the color is, the larger the value of economic cooperation is). While recipients of Chinese economic cooperation are scattered across the world, there are many recipients in Africa, Southeast Asia, South Asia and the Middle East in particular.

Figure I-1-1-3-32 Value of Chinese economic cooperation by major country (value of completed projects, 2014) (bn. $) 8 Asia Africa Europa Central and North Oceania South America America 6

Iraq

USA

India

Brazil

Russia

France

Algeria Nigeria

Angora Canada

Belarus Mexico

Ecuador

Pakistan Ethiopia

Vietnam

Malaysia Tanzania Australia

Bahamas

Germany

Indonesia

Singapore

Venezuela

Kazakhstan

Hong KongHong

Saudi Saudi Arabia

New Zealand New

Republic of the… Republic of Equatorial Guinea Equatorial Papua New Guinea NewPapua Source: Ministry of Commerce of China, CEIC database.

Figure I-1-1-3-33 Partner countries and regions for Chinese economic cooperation

Note: The deeper the color, the larger value of economic cooperation. Source: Ministry of Commerce of China, CEIC database.

Recently, economic cooperation in terms of the value of completed projects has been increasing in Kazakhstan, Turkmenistan and Ethiopia, and it has also been on an uptrend in Pakistan, Saudi Arabia, Iraq and ASEAN countries such as Indonesia (Figure I-1-1-3-34).

Figure I-1-1-3-34 Trends in Chinese economic cooperation by major country (value of completed projects) (Central Asia)

(mil. $) 3,500

3,000 Kazakhstan Turkmenistan 2,500 Kirghiz Uzbekistan 2,000 Tadzhikistan

1,500

1,000

500

0 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

(Africa)

(mil. $) 8,000

7,000 Ethiopia Tanzania Sudan Kenia 6,000 Egypt Mozambique 5,000

4,000

3,000

2,000

1,000

0 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

(South Asia)

(mil. $) 8,000 7,000 Pakistan India 6,000 Bangladesh 5,000 4,000 3,000 2,000 1,000 0 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

(Middle East) (mil. $) 7,000 6,000 Saudi Arabia 5,000 4,000 3,000 2,000 1,000 0 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

(ASEAN) (mil. $) 5,000

4,500 Indonesia Laos 4,000 Malaysia Brunei 3,500 Philippines Singapore 3,000 Thailand Vietnam 2,500 2,000 1,500 1,000 500 0 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

(Russia/CIS)

(mil. $) 1,800 1,600 Belarus 1,400 Russia 1,200 Georgia Azerbaijan 1,000 800 600 400 200 0 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Source: Ministry of Commerce of China, CEIC database.

Regarding Chinese economic cooperation projects, large-scale infrastructure and plant construction projects are increasing. Among recent specific examples27 of the progress made in Chinese infrastructure cooperation provided to other countries is a contract obtained by China for a high-speed railway project in Indonesia, which was reported by the media in September 2015. Among examples of cooperation for large-scale infrastructure projects in developed countries is an agreement reached at the U.K.-China summit in October 2015 on promoting the introduction of Chinese-made nuclear power stations in the United Kingdom. In 2016, there have been media reports about agreements signed with Saudi Arabia and Iran during Chinese President Xi Jinping’s visit to the Middle East on economic cooperation, including the construction of nuclear power stations and high- speed railways (Figure I-1-1-3-35).

27 There are no statistics concerning the breakdown of specific economic cooperation, so projects mentioned in recent media reports are cited here. 65

Figure I-1-1-3-35 Chinese foreign infrastructure cooperation projects reported recently

UK Nuclear power plant (Oct. 2015)

Laos High-speed railway Iran (started Dec. 2015) Nuclear power plant (2015) High-speed railway (Jan. 2016)

Saudi Arabia Indonesia Nuclear power plant High-speed railway (Jan. 2016) (Sep. 2015) Note: Map is an approximate map. Source: The sources such as newspaper reports.

Regarding the composition of exports of goods to recipients of Chinese economic cooperation, the share of capital goods has generally stayed large in line with infrastructure investments, although the share varies from recipient country to country (Figure I-1-1-3-36).

Figure I-1-1-3-36 Trends in composition ratio of imports from China by type of goods

Kazakhstan

(%) 60

0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Primary goods Parts and Components Processed goods Capital goods Consumer goods

Pakistan

(%) 60

0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Primary goods Parts and Components Processed goods Capital goods Consumer goods

Source: UN Comtrade.