By Jaime Daremblum
It is the end of an era for China, and also for Latin America.
After expanding by at least eight percent, and often by double digits, for more than a decade, the Chinese economy is entering a period of slower growth. In 2012, it grew by only 7.8 percent, and the government's official growth target for 2013 is even lower (7.5 percent). Those numbers are obviously quite high by U.S. and European standards, but China is still a developing country with widespread rural poverty, and according to the New York Times, the Communist Party is hoping to relocate another 250 million people from the countryside to towns and cities by 2025. Chinese officials have long believed that eight percent annual GDP growth is the minimum required to ensure "social stability." Now they are dealing with a severe credit crunch, as years of debt-financed investment spending have left Chinese banks holding a massive quantity of bad loans, the value of which has now increased for seven consecutive quarters.
The good news, writes Ian Bremmer of Eurasia Group, is that China's new leaders (who assumed full power in March) appear "willing to begin undertaking modest economic reforms." Peking University finance professor Michael Pettis agrees, noting that the government of President Xi Jinping "seems determined to make the necessary changes, even at the expense of much slower growth." But rebalancing the Chinese economy -- making it less dependent on investment and more dependent on consumption -- won't be a quick or easy process. Pettis warns that, "if the economic rebalancing is managed well," average Chinese growth rates will probably stay at or below 3 to 4 percent. That would be a major change from the torrent growth China experienced over the past three decades.
It would also mean major changes for global commodity producers. Writing in the Wall Street Journal, renowned energy expert Daniel Yergin observes that the China-fueled commodity "supercycle" is over, and the export-driven economies that reaped huge benefits during the supercycle will have to adjust.
Many of those economies are located in South America. Starting in the early 2000s, China developed a voracious appetite for Argentine and Brazilian soy products, Brazilian iron ore, Chilean copper, Peruvian metals, Uruguayan beef, and Venezuelan oil. China's total trade with Latin America and the Caribbean reached about $260 billion last year, and the Asian giant is now the top trading partner of Brazil, Chile, and Peru. As political scientist Peter Kingstone has noted, "Brazilian exports to China grew at roughly four times the rate of total exports between 2000 and 2010." Over that same period, China's share of total Chilean exports nearly quintupled, to 24 percent. Last September, Peru's Foreign Trade Society reported that Peruvian manufacturing exports to China had increased by 387 percent in just seven years. Peruvian finance minister Luis Castilla has even said, "I light a little candle every day and pray that China's growth doesn't fall."
Unfortunately for Castilla, his prayers have not been answered: Chinese growth is falling, and it will have a significant impact on Latin America's biggest commodity exporters. How big an impact? Financial Times correspondent David Pilling cites a Nomura report, which estimated that if China's 2014 growth rate fell 1 percentage point below the Nomura baseline of 6.9 percent, Latin American growth would decline by half a percentage point. We can already see the effects of China's slowdown in Brazil, which grew by only 0.9 percent in 2012 and by only 0.6 percent in the first quarter of 2013 (after growing by 7.5 percent in 2010).
On the other hand, analysts Matt Ferchen and Alicia García-Herrero have shown that Latin American countries as a whole are actually less dependent on commodity exports in general, and China-bound exports in particular, than many people think. "Nevertheless," they wrote in a 2011 China Economic Quarterlyarticle, "the importance of China's perceived role in the Latin American economy means that a major drop in Chinese demand would badly damage economic expectations, especially as so many of the region's largest companies -- Brazil's Vale is a good example -- rely so heavily on the Chinese market." (Vale is a Brazilian multinational mining firm.)The story in Mexico is different. One cause of China's economic slowdown is the rapid growth of Chinese labor costs, which has dramatically reduced the competitive advantage that Chinese manufacturers once enjoyed over their Mexican counterparts. A Morgan Stanley analysis suggests that the Mexican-Chinese wage gap -- which was enormous a decade ago -- has virtually disappeared. Indeed, Bank of America Merrill Lynch economist Carlos Capistran calculates that average hourly wages are now roughly 20 percent higher in China than they are in Mexico. (In 2003, according to Capistran's figures, the wage gap was approximately 189 percent in the other direction.)
Mexico's relatively cheap labor costs are fueling its emergence as a manufacturing and export powerhouse: Global banking giant HSBC has projected that the United States will be importing more from Mexico than from China by 2018. The downside, of course, is that persistently sluggish wage growth is hindering the expansion of Mexico's middle class and making it harder for Mexicans to rise out of poverty. "We need to increase wages to become a true modern country," Mexican economist Luis de la Calle told the New York Times last year. According to Bureau of Labor Statistics data cited by the Times, total hourly compensation costs in Mexico are only two-thirds as high as total costs in Brazil.
Over the long term, all of the major Latin American countries need to diversify their economies and implement structural reforms. Luckily for Chileans, Colombians, Mexicans, and Peruvians, their countries are much further along in the reform process than Argentina and Brazil. (After 14 years of Hugo Chávez's destructive "Bolivarian socialism," Venezuela is in a category all its own.) In the Heritage Foundation's 2013 Index of Economic Freedom, Chile ranks seventh in the world, while Colombia (37th), Peru (44th), and Mexico (50th) all rank in the top 50, with scores well above the regional average for Latin America and the Caribbean. By contrast, Brazil ranks 100th, behind Gabon and Tanzania, and Argentina ranks 160th, behind Ecuador and Angola. We see a similar divergence in the World Bank's 2013 Ease of Doing Business Index, with Chile (37th), Peru (43rd), Colombia (45th), and Mexico (48th) all placing far ahead of Argentina (124th) and Brazil (130th).
Not surprisingly, the more liberalized economies (Chile, Colombia, Mexico, and Peru) -- all members of the so-called Pacific Alliance trade bloc -- are now in much better shape than the more statist economies (Argentina and Brazil). Thus, while the Chinese slowdown will affect all of Latin America's biggest countries, it will also highlight the growing divide between the economic reformers and the economic protectionists.
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