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).
