Latin America’s Response to the growth of China and India: overview of research findings and policy implications

Daniel Lederman, Marcelo Olarreaga, Guillermo Perry 08 August 2007

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China's and India's fast economic growth during the past decade is paralleled only by their growing presence in policy discussions throughout the Latin America and the Caribbean (LAC) region. The success of these Asian countries is looked upon with admiration, but there is also concern about the effects that growing Chinese and Indian exports may have on the region’s manufacturing and services sector. China and India’s growing share in world markets is often blamed for the poor performance of the private sector in LAC.

Part of the frustration in LAC can be attributed to the region’s loss of economic importance vis à vis the two Asian economies, in spite of a broad range of reforms in the region that started in the mid-to-late 1980s. In 1980, LAC’s economy was twice as large as those of China and India, which jointly represented 3% of world GDP. Today China is the sixth largest economy in the world, when measured in terms of GDP, and India the tenth. Together they account for 6.4% of world GDP, while LAC’s economy is 20% smaller.

China and India’s fast economic growth was accompanied by their rapid integration into world markets, while LAC lagged behind. Similar trends can be observed in inward flows of foreign direct investment (FDI) and trade in services and innovation.

Empirical research on China & India’s impact

A superficial look at these trends would suggest that China and India’s growth has been pushing LAC countries out of world markets, and that is probably why defensive strategies dominate policy discussions in the region. However, China and India’s rapid growth could have actually been helping LAC economies.

In our recent CEPR Policy Insight number 10, we review the research conducted by the World Bank (the underlying research will be published as an edited volume titled “Latin America’s Response to China and India”). Here we briefly review the highlights of our Policy Insight. The research seeks to disentangle these forces and assess how the overall growth of trade, FDI and innovation in China and India has affected LAC, and how LAC firms and governments have adjusted.1

The commodity price link

The main findings of the study indicate that the growth of China and India is not a zero-sum game and there is evidence of positive effects for LAC economies associated with China and India’s greater presence in world markets. Indeed, the correlation between Chinese, Indian, and LAC growth is positive and has been rising since the early 1990s. This has been driven mainly by demand externalities and higher prices for commodities, where LAC’s comparative advantage naturally lies.

Indeed, our study found that there has been a significant increase in the correlation between the price of commodities exported by LAC and China’s industrial production index. This was especially the case with metals and minerals (driven by copper and, since 2004, by iron ore and zinc) as well as beverages (driven by coffee). The correlation between Chinese industrial output and the world price of crude oil is also large and increased from 0.81 at the beginning of 2000 to 1.88 by the end of 2005. Sugar prices have also benefited from the growth of China and India, whereas the price of soybeans and wheat shows a strong and rising correlation with the Chinese production index until late 2004, but has been declining since then. Similar patterns are observed in the correlation between Indian industrial output and world commodity prices, with the exception of mineral and metals.

These results are not surprising given that China and India’s share in world markets for most of these commodities has more than doubled between 1990 and 2004 and is currently as high as 25% of world consumption. Even though the absolute level is still small for some commodities (e.g., petroleum), the rapid increase in Chinese and Indian imports has had a significant effect on prices.

Negative spillovers in some industries

However, if at the aggregate level Chinese and Indian growth is good news for the region, some industries and firms in some countries appear to be negatively affected. This seems to be the case, for example, with industrial and electrical machinery, electronics, furniture, textiles and transport equipment, mainly in Mexico and to some extent in Central American countries. However, the study found that most of the deterioration in the relative position of Mexican exports in third markets relative to China’s and India’s has more to do with domestic supply-side conditions than with declining demand for Mexican products as a consequence of rising competition from China and India.

Growing imports from China and India have an impact on manufacturing unemployment and factor adjustments costs in LAC, as expected, but its economic significance is marginal. This, of course, does not mean that addressing the high unemployment in the manufacturing sector of some LAC countries, as well as the high factor adjustments costs faced by LAC firms, is not a priority.

Services is a sector where India in particular has outperformed LAC in terms of export growth. However, LAC exports of services to the United States are still seven times larger than exports of services by China and India combined. In addition, there is very weak evidence of India’s exports of services to the U.S. substituting for LAC exports to the U.S., except perhaps in business professional and technical services, legal services and industrial engineering. In the other five service sub-sectors considered, there is either no impact or a positive impact on LAC exports to the U.S.

More generally, LAC’s specialisation pattern is changing in favor of natural-resource- and scientific-knowledge-intensive industries, and part of this change can be attributed to the rapid growth in China and India. There is evidence that in some countries, China and India may be pushing LAC economies toward low-wage, unskilled, labour-intensive sectors (e.g., the apparel sector in Haiti and Nicaragua). In other countries and sectors, however, firms are adjusting by moving toward higher quality and skilled-intensive products (e.g., apparel in Costa Rica and Dominican Republic) as competition from China and India intensifies.

Policy implications

The higher correlation between the business cycles in LAC and the two Asian economies is mainly driven by demand spillovers, largely explained by the high correlation between Chinese and Indian industrial output and world commodity prices. This suggests that the commodity boom currently benefiting LAC is heavily dependent on the continuing growth of the two Asian economies. Economic fragilities in China and India, or changes in consumer preferences, should therefore be closely tracked by LAC economies with a large share of their economy attached to natural-resource-intensive products.

The research results also suggest that some regional development priorities need to be strengthened. To help firms adjust towards higher quality and scientific-knowledge intensive products, adequate focus needs to be put on improving education policies to help workers acquire the necessary skills. Support for private sector innovation, both patentable and non-patentable, should also be strengthened to help firms adjust towards scientific-knowledge intensive sectors. Also, in order to exploit the synergies in innovation patterns between LAC and India, governments may want to consider scaling up scientific exchange programs.

Policies to facilitate rural development and manage natural-resource-based industries should also be given more importance in order to respond to the higher prices for commodities.

One area where some LAC countries seem to have been underperforming is bilateral exports to the two Asian economies. Export promotion activities or free trade agreements could help. In terms of FDI promotion via specialised agencies, a change of course does not seem necessary as LAC has benefited from growing FDI to China and India.


1 All background papers are available at www.worldbank.org/lac.

 

 

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Topics:  Global economy

Senior Economist, Development Economics Research Group, World Bank

Professor of Economics, University of Geneva; and Research Fellow, CEPR

Chief Economist of the Latin America and Caribbean Region at the World Bank

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