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China may become Germany's top export customer by 2016; Global rebalancing favours US net exports - - US becomes cheap production location
By Michael Hennigan, Founder and editor of Finfacts
May 4, 2010 - 6:53:09 AM
Table 1: Bilateral and regional German export performance -- Average volume per month in €bn, seasonally adjusted Source: Deutsche Bank Research
China may become Germany's top export customer by 2016 as German exports to the emerging giant are expected to keep the impressive momentum of 19% per annum growth in 1991-2008 period. Meanwhile global rebalancing, with the world recovery being led by emerging economies, strong growth is seen as favouring US net exports as US has become a cheap production location.
Deutsche Bank Research economists, Steven Schott and Jochen Möbert, say that the global economic downturn following the financial crisis led to dramatic slumps in exports in Germany. As the world economy begins to recover, bilateral trade relations are now developing in very different ways. While exports to emerging markets are rising strongly again, deliveries to developed markets are picking up only very hesitantly.
Before the global recession the German export engine was running at full speed. In 2008, total German exports reached a new record high at €981.8bn. In bilateral trade record figures were reached, too. For example, deliveries to France - -Germany's No 1 export market - - rose to an average €7.8bn per month (9.5% of total exports). At the end of 2008, the shock wave triggered by the Lehman crisis hit the real economy. With a slight delay, German exports nosedived in H1 2009 (-21% compared with 2008). Exports to France fell by more than 13% to €6.7bn per month. Exports to the US, previously Germany's second largest export partner, even dropped by over 20% to €4.6bn per month in the same period. Deliveries to other major trade partners such as the Netherlands, the UK, Italy and Spain also plunged. Beside the slump in exports to industrial countries, deliveries to emerging markets also declined. Exports to India dropped 13%, to Brazil 29% and to Russia even in excess of 35% (H1 2009 compared with 2008). Only exports to China were nearly unchanged during this period.
Deutsche Bank Research said by passing large-scale fiscal rescue packages, the governments of all the large industrial countries and major emerging markets managed to cushion the deep and synchronous economic downturn. Germany’s export sector benefited from the subsequent recovery of the world economy. Having registered only relatively small declines during the crisis, exports to China rose quickly by more than 13% in the recovery phase. With an average monthly volume of €3.2bn, exports to China even reached a new all-time high in H2 2009. At 30% and 22%, respectively, exports to Brazil and India are also showing strong double-digit increases and are back at pre-crisis levels. The large industrialised countries - - first and foremost the US and France - - have yet to stage an equally strong recovery. Germany's exports to France, for instance, only rose by 2.4% in H2 2009 (compared with H1 2009). Exports to the US, by contrast, even fell once again by more than 6% compared with the crisis months. Sluggish US demand is in part the result of the weaker dollar exchange rate, but also of feeble private consumption. In particular, high household debt, the higher unemployment rate and a return to higher savings rates of around 5% are standing in the way of quick recovery.
As the individual countries fared differently both during the slump and in the recovery phase, country rankings have also changed. The US lost its second place and now ranks fifth behind France, the UK, the Netherlands and Italy. China, by contrast, moved up from eleventh to eighth place and continues to make headway. Nonetheless, the US and the European countries will remain Germany’s main export markets over the next few years. Pre-crisis growth in exports to these countries, however, was already weaker - - at 4% to 6% p.a. from 1991 to 2009 - - than the increase in exports to the emerging markets. The crisis simply reinforced an already existing trend. Over the next few years exports to China will likely keep up their impressive momentum (+19% p.a. between 1991 and 2009). China’s share in German exports of currently about 5% could thus double in just six years.
Exports to other emerging markets have also increased markedly over the last twenty years. Germany’s eastern neighbours Poland (15% p.a.) and the Czech Republic (13% p.a.) both boasted double-digit annual growth rates. Moreover, exports to the countries referred to as the "next eleven" (South Korea, Mexico, Turkey, the Philippines, Egypt, Indonesia, Iran, Pakistan, Nigeria, Vietnam and Bangladesh) also grew by approx. 12% annually. Thanks to their population total of roughly 1.3bn (with South Korea's population being the smallest at 49m and Indonesia's the largest at 237m) exports to these countries enjoy considerable growth potential. The countries’ huge catch-up potential, particularly in infrastructure and manufacturing, implies that their share in Germany's exports could rise substantially from the current 4.6%.
Should the economic development described continue, the emerging markets - - first and foremost the BRIC countries, the countries of Eastern Eurpe as well as some of the “next eleven” economies -- will increasingly gain in importance for Germany’s export industry over the coming years. Hence, China could make second place in three years' time and even overtake France as Germany's main export market in 2016. By then, Poland should also have forced its way into the top 5 group. In addition, German exporters will focus more on countries like Russia, India, Brazil, South Korea, Mexico and Turkey in future. But thanks to their geographical proximity the EU countries will also remain major export markets for Germany.
Insight on how the White House plans to bolster exports, with Fred Hochberg, Export-Import Bank of the US:
Richard Berner, a Managing Director, Co-Head of Global Economics and Chief US Economist at investment bank Morgan Stanley, says this time it's different. In virtually every post-war recovery, the US has led the global economy out of recession. But it is different this time: Asia excluding Japan, other emerging markets and their suppliers are at the front of the pack. In contrast, thanks to lingering housing and consumer headwinds, the US is somewhere in the middle. As a result, MS expects strong global growth will boost US (net) exports and add materially to growth in US output this year and next. Specifically, MS believes net exports (difference between exports and imports as an addition or subraction from US growth) will add about 0.3% to growth this year, in contrast with the typical drag on US GDP as imports rebound in recovery. Upside risks to non-US growth mean a larger boost is increasingly likely.
Berner says two factors support that outlook: First, consumer and business demand in the rapidly growing economies have become key factors driving their growth. The MS global team estimates that overall growth in China, India, ASEAN (Asian tarding alliance), Latin America and Canada will average about 8.3% this year and 7.0% in 2011. Growth in private domestic demand will likely account for between 65% and 95% of this growth, depending on the country. For example, MS's Marcelo Carvalho just raised his 2010 outlook for Brazilian growth from 5.8% to 6.8%, with most of the boost coming from consumer and government spending. And the Asian team raised their outlook for ASEAN growth in 2010 from 5.1% to 6.1%. Second, MS projects that US exporters will be increasingly leveraged to that fast-growing pie as their share of exports to those regions increases, especially in capital goods and consumer and business services.
Obstacles to improvement in net exports: Berner says to be sure, there are headwinds to the contribution to US growth from net exports. First, weakness in European and Japanese growth will likely hobble overall overseas demand. Most important, the sovereign credit crisis in the euro area means that even the tepid outlook for European growth this year of just 1%, with domestic demand contracting, is subject to significant downside risks as higher funding costs and fiscal austerity depress consumer and business demand. If the crisis escalates to curb the availability of trade credit, such impairment might further hobble US exports. In Japan, domestic demand is likely to be flat at best, while exports are the primary driver of Japanese growth. Another headwind facing US exporters is the lower price levels in many faster-growing economies; global consumers may be able to source many goods more cheaply at home. Finally, rising US imports might partly offset export gains in time-honoured cyclical fashion.
Tailwinds: Asian (and Americas) consumers and a cheaper US dollar: MS believes two global tailwinds will swamp those headwinds. The share in US exports of goods and services delivered to Asia ex Japan, Latin America and Canada has risen significantly in the last decade, thanks in part to these countries' faster growth. Despite the global recession, the share of US goods exports going to those destinations rose from 69% of the total to 73% over the past five years, while the share of US services exports going to those economies also rose 4 percentage points to 46% over that period.
In addition, the dollar's ongoing decline on a real effective basis has given US exporters a competitive edge in those markets. Measured by the Fed's real effective trade-weighted exchange rate index relative to other important trading partners, the dollar has declined by nearly 18% over the seven years ended in March. At the same time, local currency appreciation in those fast-growing trading partners has improved their terms of trade, thus boosting real incomes and fueling their demand and import growth.
Empirical evidence in two forms: Richard Berner says statistical relationships illustrate these points. MS estimated the parameters of a simple relationship to explain growth in US exports as a function of growth in non-US GDP, plus changes in the real exchange rate and non-oil imports (the last variable represents the influence of ‘round-trip' trade on exports). The estimated elasticity of real exports with respect to non-US GDP alone is about 2 - implying that, other things equal, 5% growth abroad will yield 10% growth in US exports. The elasticity of exports with respect to the real effective exchange rate implies that the 5% depreciation in the broad trade-weighted dollar over the past 30 months will add another 3.5% to exports. Those estimates are consistent with the view that US real merchandise exports will grow by roughly 10% over the four quarters of 2010.
Incoming data hint that the MS view of exports may be conservative. In March, the ISM (Institute of Supply Management ) export orders index rose to 61.5%, the highest level since 1989. If sustained, that level would be consistent with 13-15% real export growth, significantly higher than the 9.7% MS expects for 2010. Non-defense capital goods orders and shipments are both up 7% annualized in the three months ending in March - which hints at strength in overseas deliveries of capital goods as well as domestic investment outlays.
On Monday, the ISM reported that the New Export Orders Index registered 61% in April, 0.5 percentage point lower than the 61.5% in March. This was the 10th consecutive month of growth in the New Export Orders Index.
Global capex revival? Berner says it's worth noting that global rebalancing of the sort MS envisions involves the potential for a significant upswing in capital spending, including in infrastructure, not just in EM economies but also in the developed world. As MS London colleague Joachim Fels likes to describe it, there is a lot of spare capacity, but it's in the wrong places and the wrong sectors.
That fits the MS script in three ways: First, an export-driven US recovery may require new growth in US supplying industries, including small and new businesses. Second, some of that investment will likely come in the form of foreign direct investment (FDI). Global investors will likely begin looking to strategic corporate US assets rather than US sovereign debt. Third, there is the time-honoured ‘accelerator' mechanism: Global companies have reduced their older and less-productive capacity, and gross investment is rising simply to maintain the capital stock; in addition, they are replacing it with more productive capital. Those factors should benefit US capital goods producers exposed to global markets.
Import surge temporary: On the other side of the ledger, slower growth in US final demand seems likely to restrain imports. Imports have recently jumped, but MS believes that much of the rise has reflected a significant swing in inventories as companies liquidated them more slowly. Between June 2009 and February 2010, real imports jumped by US$18.3 billion (16%), while the swing in real manufacturing and trade inventories (the change in the change in the stocks) was more than triple that magnitude (US$61 billion) over the same period. The magnitude of such changes likely will slow, as will the rise in imports.
Empirical evidence on imports supports that outlook: Richard Berner says a simple relationship explaining the growth of real non-petroleum imports depends on the growth in consumer and equipment investment outlays, swings in inventories (which wash out over two quarters), the growth of exports (to capture and control for ‘round-trip' trade), and the real effective exchange rate. The elasticity of imports with respect to the domestic final demand components is 1.1, suggesting that moderate gains in demand will be associated with similarly moderate growth in imports. The model also suggests that the 5% decline in the dollar over the past 30 months will trim some 4 percentage points from what would otherwise be the growth in non-petroleum imports.
Criteria for sustainable rebalancing: In the MS view, this shift from US domestic to overseas demand marks the beginning of a long and beneficial process of rebalancing for the US and global economies. Ultimately, as noted above, it involves a shift in production venues through FDI back to the US, which has become a relatively cheap place in which to produce.
The biggest risk to this outlook is that contagion from the sovereign credit crisis would spread from Europe to other markets and economies. While the MS baseline view is that the combination of IMF and EU assistance will buy time for the peripheral economies in Europe to regain market confidence and implement aggressive fiscal restraint, that outcome is far from clear to the economists.
More broadly, Richard Berner says three policy initiatives are critical to assuring the sustainability of US and global rebalancing: Fiscal exit in many developed market (DM) economies is needed to reduce the internal gaps between saving and investment that give rise to external imbalances. Improved exchange rate flexibility in the EM world, paced by the likely revaluation of the Chinese renminbi this summer, should facilitate the adjustment process and serve as an adjunct to monetary policy in Asian and Latin American economies where inflation risks are rising. And preventing protectionism from shutting markets should foster increased confidence that the benefits from globalization will outweigh its adjustment costs.