As fears grow of a recession in the United States, investors are pinning their hopes on China. Many think the mainland's economy has developed sufficiently to allow its growth to 'decouple' from slowing US demand. The effect is already visible in financial market fund flows. Last week alone, investors withdrew more than US$5 billion from US stock funds. At the same time they pumped US$731 million into mainland, Greater China and Hong Kong country funds and another US$519 million into Asia ex-Japan equity funds, according to data research company EPFR Global. Unfortunately for the bulls, their belief that the mainland will be largely immune to a global slowdown may be misguided. According to a new paper by Li Cui, senior economist with the Asia and Pacific department of the International Monetary Fund, as the mainland economy has evolved, it has become more, not less, exposed to external demand. In the past, many China-watchers have argued that the mainland's economy is insulated from external business conditions because it is mostly driven by domestic demand, with the contribution of exports to growth being relatively small. Their reasoning is based on the argument that mainland exports are largely assembled from imported components, with little value added by mainland factories. Under this model, any decline in demand for mainland exports would be offset by a drop in mainland demand for imported components. As a result, the mainland's net trade surplus - and its contribution to growth - would hardly be affected by an external slowdown. But the IMF paper points out that this picture of mainland trade no longer holds true. In recent years, the mainland has invested heavily in its capacity to manufacture sophisticated components and capital goods at home and to raise the value added by domestic manufacturing (see charts). As a result, the mainland now relies less on imports to support its export industries. Import growth has slowed relative to export growth, and the trade surplus has blown out, helping to fuel the economy's feverish expansion. One consequence of all this investment is that as mainland exports have become more sophisticated, the close correlation between exports and imports has broken down. According to the IMF paper, that means 'external shocks may have more potent effects on the mainland's trade balance and the domestic economy, because a slowdown in exports may not be offset by a commensurate decline in imports'. That is not the only problem. Demand for low-value exports, like cheap toys and textiles, is not greatly influenced by downturns in the international business cycle. But demand for the higher-margin goods the mainland is now exporting is more closely linked both to the health of external economies and to the relative value of the yuan. As the yuan strengthens, demand for the mainland's higher-value exports may weaken. As a result, the IMF paper concludes, 'China has become more vulnerable to external shocks, such as a real exchange rate appreciation or a slowdown in external demand, than is generally assumed'. That is not the end of the world. A drop in growth rates could be good for the mainland economy. But it does mean the mainland may not turn out to be quite the safe haven investors are hoping.