Abstract: In this paper, the author attempts to explain the current impressive growth of exports by breaking down the growth rate of export value into price effect and quantity effect. The author concludes that China’s current export boom mainly comes from price rise of export goods instead of higher external demand. Furthermore, the main reasons for higher price of exports goods are rapid increase of production and shipping costs. Profits of the manufacturing sector have not taken a turn for the better because of robust exports, but instead, the operation condition of some upstream sectors has deteriorated due to surging costs. The paper suggests that policies should focus both on the supply and demand side to alleviate the challenges businesses might face.
I. DISTINGUISH BETWEEN QUANTITY EFFECT AND PRICE EFFECT THAT BOOST EXPORTS
Since the outbreak of the pandemic last year, strong export has powered the recovery of the Chinese economy. Between this May and now, export value has maintained double-digit growth year on year (YoY), reaching a high of 25% in August. However, since April, YoY monthly growth of manufacturing profits has been on a rapid decline, plummeting to 6% in August, a record low since May 2020. This indicates that the recent export boom has failed to sustain the recovery in manufacturing profits.
The expansion of export value can be attributed to either an increase in quantity or price, or both. When demand is strong, the quantity and price of export goods will both rise, leading to the expansion of export value. But when demand stays the same, increase of export prices can also contribute to the same result. However, how much profits can a company generate not only depends on the final price of the export goods but also the company’s capacity to pass on costs to the downstream sector. Generally speaking, small and medium-sized enterprises (SMEs) located more downstream have weaker bargaining power and find it harder to completely pass increased cost to the demand side.
Expansion of export value due to cost increase would not improve and may even reduce the profitability of SMEs. Consider a case where with export volumn unchanged, increase of production costs leads to rising prices of export goods, which is manifested in the expansion of export value. In this case, as the size of orders and actual production of companies do not change, production costs rise along with product prices, meaning that profits will not change significantly.
Furthermore, due to weak bargaining power of SMEs, under most circumstances, increase in production costs could not fully pass on to the end products. For example, if production cost rises by 10 RMB while the selling price can only grow by 8 RMB, SMEs will have to bear the 2 RMB loss of profits. Although their export value rises, profits drop, making their business condition worse than before.
Therefore, it is critical to ascertain whether the main factor that boosts exports is quantity or price in order to understand the current state of exports and export companies.
II. PRICE INCREASE EXPLAINS MOST OF THE GROWTH RATE OF EXPORT VALUE IN JULY AND AUGUST
Based on the detailed statistics of export products released by the General Administration of Customs, 6383 products with complete data are selected. Then, we decompose the growth rate of total export value into quantity effect (export growth driven by the increase in quantity) and price effect (export growth driven by the increase in price). The result is presented in Figure 1.
As Figure 1 shows, from July 2020 to May 2021, quantity increase is the dominant factor that drives the growth of export value, with an explanatory power of over 70%. In comparison, price is a secondary factor that boosts growth of export value. Although the explanatory power of price effect rose in certain periods, like November and December 2020, it did not outweigh that of the quantity effect and even declined afterwards.
Since June 2021, quantity effect has declinined rapidly while the explanatory power of the price effect has surged. Over 60% of export growth rate in July and August 2021 came from the price effect. YoY growth rate of export value in August was 25%, of which 15 percentage points came solely from price increase. Take steel as a typical example, the price hike of steel alone can explain one percentage point of the 25-percentage-point rise in YoY national export growth in August, with a 4% explanatory power.
Changes on the supply side are the main reason for stronger price effect. As mentioned earlier, the explanatory power of the quantity effect for export expansion has declined sharply after June, which is in great contrast to the previous phase of expanding external demand. This demonstrates that price increase at this stage does not come from stronger demand of end products but is more likely attributed to surging production costs.
This is consistent with the rapid price increase of upstream products and shipping costs since early this year. Meanwhile, it can also explain the fact that profit growth of the manufacturing sector has slowed significantly. Since June 2021, profit growth of the manufacturing sector has declined, with only a 6 % growth rate in August compared to the same period last year.
Take steel and household appliance as examples. Steel price has risen by 60% from a year earlier. But since the beginning of this year, prices of iron ore and coke, upstream raw materials of steel production, have kept increasing in turns. In particular, iron ore price in this May nearly doubled compared to the same period last year. Although iron ore price fell sharply subsequently, coke price has risen rapidly by 120 % as of the end of September compared to the same period last year. Therefore, despite substantial YoY increase of steel price, raw material prices rose more significantly, resulting in little increase of profit margins per ton of steel.
Household appliances are one of China’s major export goods, accounting for about 7% of China’s export value. In July and August 2021, export value of household appliances grew at 25% and 33% respectively, whereas the export volume was roughly the same as last year, with an almost zero YoY growth rate. According to data released by the Ministry of Industry and Information Technology, the YoY monthly profit growth rate in July 2021 was -2.2% YOY, as compared to -1.68% in July last year, indicating that profit decline in the household appliances sector is not related to the base effect.
III. POLICY RECOMMENDATIONS
In summary, China’s current export boom mainly comes from price rise of export goods instead of higher external demand. Furthermore, the main reasons for higher price of exports goods are rapid increase of production and shipping costs. Profits of the manufacturing sector have not taken a turn for the better because of robust exports, but instead, the operation condition of some upstream sectors has deteriorated due to surging costs.
In the future, as the US phases out its fiscal subsidies and developed countries gradually resume production, external demand might begin to decline, which will lead to further decrease of export volume. Export volume is the order size of a business, which directly corresponds to its actual production condition and capacity utilization and affects the investment decision of the export company. Historical data show a stable correspondence between the YoY growth rate of exports and that of manufacturing investment, with the former leading the latter by roughly one year. This means that China’s manufacturing businesses might face double pressures of cost and demand, which will weigh on profits and investment of the manufacturing sector.
China should step up efforts on both the supply and demand side to address the difficulties likely to be faced by export businesses.
Supply side efforts should focus on improving the elasticity of supply in upstream sectors. Specifically, we need to cut back unnecessary administrative interventions in the supply of certain goods, restore market-based pricing, and relax import restrictions on some upstream products, so as to alleviate the upward pressure on commodity price.
On the demand side, macro policy should be proactive and anchored in China’s economic reality. It should aim to stabilize domestic aggregate demand, ensure smooth transition of macroeconomic operation into the next year and avoid large fluctuations in the economy.
Infrastructure investment should play a more important part in stabilizing aggregate demand. The restrictions on the types of projects allowed to be financed by special government bonds should be reasonably relaxed to facilitate the translation of funding into real changes on the ground. Prudent monetary policy should be more flexible, and the benchmark interest rate should be lowered to drive down market interest rates, reduce social financing cost, and stimulate the financing demand of the private sector.
This article first appeared on CF40’s WeChat blog in Chinese on September 30.
