Despite rebalancing, exports still vitally important to China
A more precise measure of external demand reinforces the scale of its contribution to growth, and that's why a lot hinges on trade numbers
Tomorrow Beijing will release China's trade figures for June.
The outlook is grim. After exports grew by less than 1 per cent in May - a far cry from the 20 per cent growth rates China was recording just two years ago - analysts are forecasting another lacklustre performance.
Confronted with weak external demand, especially from recession-hit Europe, it seems China's formidable export machine has stalled.
Yet most China-watchers are untroubled. These days, they explain, China's economy is all about investment and domestic demand. Exports now make up only a tiny share of China's gross domestic product, and they contribute even less to economic growth.
That might sound like a strange thing to say, given that in the first quarter of this year China's export shipments were worth an impressive 27 per cent of the country's GDP.
But that 27 per cent figure represents gross exports. When they say that exports are relatively unimportant, economists are looking at net exports, or exports minus imports. And in the first quarter of the year China's net exports equalled just 2.2 per cent of GDP, down from levels of more than 8 per cent during 2007.
Economists look at net exports because that's the accounting measure they use when calculating GDP. The trouble is that while the net export number might be handy for doing sums, it doesn't actually tell us very much about how important external demand is in driving China's economy.
Unfortunately, the figure for gross exports isn't much use either. In an economy where all the value of all exports was produced domestically, then gross exports would give a good idea of external demand.
But real supply chains don't work like that. Chinese factories import flash memory chips from Japan, displays from Korea and processors from the United States, which they then assemble into smartphones for sale around the world. So although the face value of China's exports may be high, the value added by China's factories is often relatively low.
But although gross exports aren't much help in gauging the true importance of external demand, net exports don't work either. If all China's imports were components destined for re-export, the net figure would do the trick. But they aren't. Imports are also consumed domestically, not least by Chinese buying their own smartphones.
To estimate the real contribution of external demand, we would have to account for the proportion of China's imports destined for re-export after assembly. Although these processing imports have fallen relative to China's total imports over recent years, as the first chart shows, they still make up a sizeable share of China's overall inbound goods trade.
In an attempt to do exactly that, Xing Yuqing and Manisha Pradhananga at the Asian Development Bank Institute have come up with a measure of external demand which strips out China's processing imports.
Then, for good measure, they have factored in an allowance for foreign direct investment into China, which remains driven largely by external, rather than domestic, demand.
They found that although the share of external demand in China's GDP has fallen from its high of 28 per cent reached in 2007, in 2011 it still accounted for 22 per cent of overall economic output.
As the second chart shows, that's 10 times as great as the share implied by the net export figure commonly used by economists.
Xing and Pradhananga conclude that despite efforts to rebalance the economy towards domestic consumption, China is still heavily dependent on demand from the rest of the world, and that its growth remains highly vulnerable to external shocks.
In other words, if tomorrow's trade numbers are as dismal as many analysts expect, it will be an ominous sign indeed for China's growth outlook.