Since 2001, when China became a member of the World Trade Organization, the Asian giant has become a much more significant trade and investment partner to Latin America. Trade between the two has multiplied by 21 times since 2002. In contrast, trade between Latin America and Europe only grew twofold, and between the continent and the US threefold. Last year, China’s total exports to the region amounted to $130 billion while imports added up to $104 billion, according to UN data.
China has already emerged as Latin America’s principal banker. Between 2005 and 2015, China Development Bank and the Export-Import Bank of China lent the region $125 billion, almost double the amount lent by the IMF and the World Bank combined. Around 78% of Chinese loans were destined for Argentina and the member states of the trading and political bloc Alba, which includes Venezuela, Ecuador, Bolivia and Cuba.
China’s total stock of foreign direct investment in the region is estimated to add up to around $100 billion and has doubled in the last decade.
However, the relationship between China and the region is lop-sided. China is much more important to Latin America for growth than the other way around, creating economic imbalances and political asymmetries.
China’s imports from Latin America only account for 6% of the country’s total, according to HSBC. But those exports to China have been one of the main motors of Latin America’s economic growth. The slowdown in the Chinese economy (HSBC forecasts it will expand by 6.7% this year against 6.9% last year and 9.3% in 2011) is having a profound effect on Latin American exporters.
Chinese imports from the region have centered around a narrow range of commodities, especially copper, soybeans, iron ore and oil. These factors make the region vulnerable to any dramatic shifts in China’s economy and its growth model — like the ones we are currently witnessing.
“Latin America’s relationship with China is a work in progress,” says Larry Birns, director of the Council on Hemispheric Affairs (COHA), a Washington DC-based think tank. “The rise of China means that Latin America has become a lot less economically dependent on the US. Yet, the relationship is highly unequal. Latin America does not enjoy high visibility in China.”
During the past two years, China’s leadership has decided to switch from a growth model based on massive investment — mostly led by the state — in infrastructure to one centered around middle-class consumption, the services sector, and the promotion of a knowledge economy. This new model is more driven by market forces.
The country’s leaders concluded that the old model was unsustainable, based as it was on a staggering investment rate of up to 45% of GDP, which was leading to an accumulation of debt at an annual rate of more than 15% of income.
China has reconciled itself to a slowdown in its trend rate of growth. In the period covered by the 13th five-year plan (2016-2020), this is expected to be no lower than 6.5% a year. This is still high by Western standards but much lower than the rate of 10% seen before 2008 and 7% witnessed until recently.
The Chinese authorities view the new model as more sustainable in the long term. However, the knock-on effects to Latin America are clear. Weaker Chinese demand — and the consequent lower commodity prices — has forced Latin America’s commodity-exporting countries to undertake difficult policy adjustments.
A quick look at some of the figures shows how significant China is to Latin America. China imports 40% of global production of soybeans; some 75% of its supplies come from Brazil and Argentina. It buys a third of the iron ore sold on world markets and a fifth of the copper, with a high proportion coming from Latin America. Between 2000 and 2013, Latin America’s trade with China rose 27% a year, a period when the region’s trade with the world expanded by just 9% a year, according to COHA.
Brazil is the Asian giant’s biggest trading partner in the region, with China accounting for more than 40% of Brazilian exports and imports. The Latin American nation sends chiefly iron ore and soybeans, which together comprise 70% of its exports to China.
However, China’s economic slowdown is exposing underlying fragilities in Latin America’s economy.
Towards a new relationship
The message is clear: Latin America must up its game if it is to take advantage of myriad opportunities stemming from China’s new normal model.
“The future now lies in the digital economy and the industrial internet, for which universalization of broadband and lower cost to access cloud-computing services are crucial,” says Mario Cimoli, officer-in-charge of the international trade and integration division at the UN’s Economic Commission for Latin America and the Caribbean, ECLAC.
One of Latin America’s biggest problems, traditionally, has been the so-called middle-income trap. The region has lost its competitive edge in the export of manufactured goods because its wages are on a rising trend. However, it has been unable to keep up with more developed economies in the high-value-added market.
Cimoli see a fostering of the region’s digital economy as a partial solution to this issue and as a way of integrating Latin America with China, as the Asian giant’s middle class expands and the services sector becomes more important there.
It will require a major upgrade in network infrastructure and a reduction in access costs, a strengthening of the digital ecosystem, and a shift from the consumer internet to the industrial one.
For this to work, ECLAC says strong national policies and regional coordination are essential. This is fundamental to creating a digital common market in Latin America, which would lower cross-border barriers and make accessibility and the distribution of digital goods and services easier. This would boost the quality of supply and reduce access costs by taking advantage of economies of scale and of networking. The creation of such a digital common market can be based on national and regional institutional advances that are rarely present in other areas.
ECLAC’s Digital Agenda for Latin America and the Caribbean (eLAC2018) sets out a framework for these objectives to be met.
Clearly, China’s new model will shape its economic relations with Latin America region in the coming years.
Cimoli adds: “Latin America and the Caribbean should prepare to seize the opportunities and address the challenges arising from these shifts. The region must take advantage of the changes under way in China to diversify its export basket.”
The OECD’s forecasts about the number of future tertiary graduates in China underscore the fundamental changes that must take place in Latin America if it is to strengthen its commercial and investment bonds with the Asian giant in the future. China has around 50 million tertiary graduates today but that number is expected to multiply fourfold by 2030. Latin America has a similar 50 million today but its figure is only predicted to double.
One out of every two future students in China is expected to study sciences and technology, whereas only one in five Latin American students is predicted to do so. The services sector makes up 40% of Chinese GDP today but the World Bank forecasts that will rise to 48% by 2018.
This blueprint for the transformation of Chinese society has huge ramifications for Latin America — and indeed the rest of the world — because the Asian nation is expected to contribute one-third of the world’s future economic growth, according to the OECD. China is expected to overtake the US as the world’s biggest economy in real terms in about a decade’s time.
“Latin America must start to diversify its economy fast if it is to serve the needs of China’s rising middle class,” says Ángel Melguizo, head of the Latin American and Caribbean unit development center at the OECD. “Exporters need to identify new sources of growth in a more markets-led China. Opportunities are everywhere.”
A wake-up call
China’s shifting economy should be a wake-up call to Latin American leaders and an opportunity for the region to pursue a development strategy centered on a greater degree of productive diversification, upgrading, and integration.
Latin American firms — including small- and medium-sized enterprises that account for a high proportion of the region’s industry — must move up the supply chain and offer more value-added products.
Traditionally, Latin America has exported crude oil to China and left the refining to take place there. Similarly, it has exported soybeans and not soybean oil.
China’s rising middle class means myriad opportunities will exist for meat and fisheries exporters, for example. Advanced logistics is also a sector that is likely to expand rapidly in Latin America, including software tracking. New mineral sources will have to be identified and their transportation carefully thought through.
Professional services — including lawyers, accountants and architects — must prepare for the growing importance of China in Latin America. Mandarin has to become a much more important language option for young Latin Americans. Direct flights are needed between major Latin American and Chinese cities.
New trade agreements with China are key, and services must be included. Currently, only three Latin American countries have bilateral accords with the Asian nation: Chile, Peru and Costa Rica. Chile and Peru are both founding members of the Pacific Alliance, the forward-looking Latin American trading bloc. The association as a whole could attempt to strike deals with China.
The Trans-Pacific Partnership Agreement (TPPA) — a trade agreement among 12 Pacific Rim countries signed in February this year — could lead to a big boost in world trade. Its Latin American members include Chile, Peru and Mexico. China is not yet a signatory but is considering becoming one. However, doubts are growing as to whether it can be ratified — Peruvian President Pedro Pablo Kuczynski gives it a 30% chance of ever making it through the US congress, for example.
“The rise of the bundling of goods and services is an important trend,” says Douglas Lippoldt, global senior trade economist at HSBC. “For example, Mexico is expanding its automotive export sector in a big way, but that includes the development and integration of the software used in the vehicles.”
Evan Ellis, professor of Latin American studies at the US Army War College, agrees. “Traditionally, Latin America has only supplied China with relatively low-value-added goods and services. However, nowadays more technologically advanced Chinese firms are setting up shop in Latin America. There is more pressure on Latin American firms to move up the value chain.”
Increasingly, China is becoming the dominant trading and investment partner in Latin America. As Chinese imports slackened during the past few years, new vulnerabilities in Latin American economies were exposed. The region must embrace the digital and knowledge economies if it is to take full advantage of the new opportunities. LF