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China’s Structural Change and the Impact on Korea’s Industrial Growth

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  • Author CHUNG. Sunghoon
  • Date 2016/09/22
  • Series No. KDI FOCUS No. 72, eng.
  • Language English
SUMMARY □ Until 2014, demand for durable goods was at the heart of China’s domestic market growth. This, combined with the expansion of global value chains(GVC), contributed significantly to the rise of Korea’s key industries, particularly that of heavy and chemical products, including electrical and electronic devices. Today, however, China faces two concurrent challenges, a slowdown in growth and a structural shift in domestic demand to services. As a result, a considerably large impact will likely be felt across the Korean heavy and chemical industries, the biggest beneficiaries of the rapid increase in China’s domestic demand. Under the circumstances, Korea’s policy makers and industrial entities need to enhance their understanding of the changes in the Chinese economy and develop preemptive countermeasures by reforming existing business structures. Additionally, researchers must provide more in-depth studies on China’s evolving domestic market.

- The rapid expansion in China’s domestic market was led by the demand for durable goods until 2014.

- China’s durable goods-led growth in the domestic market combined with the expansion of GVCs has contributed significantly to the growth of the Korean economy.

- Korea’s heavy and chemical industries were the biggest beneficiaries.

- However, China is currently faced with two concurrent challenges, slowdown in growth and changes in its industrial structure, which are also occurring in the domestic market.

- In fact, the shift in China’s domestic demand towards services is a natural phenomenon given its current economic structure and income level.

- China’s slow growth and the structural shift in domestic demand will deal a heavy blow to Korea’s key industries, whose growth has been largely attributed to China’s strong demand.

- If the series of recent events in China are regarded as an integral part of the shift in the industrial structure, it would be possible to predict the direction of China’s changes.

- Korea’s industries must be aware of the changes in the Chinese economy and develop countermeasures that include reforming business structures.

- Simultaneously, more in-depth studies are needed on the changes in China’s domestic market.

※ Written based on Chung, Sunghoon, “Global Value Chains and Impacts of China’s Structural Changes,” in Kyungsoo Choi (ed.), Structural Changes of the Chinese Economy and New Opportunities for Korea, Chapter 2, Research Monograph 2015-09, Korea Development Institute, 2015 (in Korean). (*The full text of Research Monograph will be released later on.)
KDI VOD Report
We still lack sufficient knowledge on the growth patterns of China’s domestic market, and how and to what extent it will affect Korea.
To gain further insight, this study identifies the various product categories in China’s domestic market and analyzes how the demand growth of each product influences the growth of Korean industries through the lens of global value chains(GVC).

This study examines the impact from the increase in China’s domestic final demand on the growth of Korean industries,
attempts to predict how China’s structural change will affect the industrial growth pattern,
and presents policy implications.

Firstly, let’s examine how the growth of Korean industries will be affected
by the growth in China’s domestic final demand.

China’s domestic demand increased ten fold from 1995 to 2014, jumping from 6 trillion to 62.3 trillion yuan.

To understand this remarkable growth, China’s domestic demand was divided into four product categories; non-durable goods, durable goods, utilities and construction, and services.

The demand by category shows that non-durable goods account for the largest share in 1995 and smallest in 2014, while the opposite is true for durable goods.

Then, what impact will this growth trend have on Korea’s GDP?

Our estimates find that, from 1995 to 2014, the impact from a 1% increase in China’s domestic final demand would be more severe for Korea, regardless of the product category.

However, the level varies across the board, with the impact from the demand for durable goods surging 11 fold.

Next, to examine the impact on Korea’s industries and economy as a whole,
the actual growth rate of China’s domestic final demand by
product in 2014 was applied to the estimation model.

The results show that Korea’s GDP would increase by 0.61% at the
aggregate level in 2014. This would account for 18.5% of the year’s real
GDP growth rate of 3.3%.

Notably, computers and electronic devices would increase by more than
2% and electrical equipment and petrochemical products by more than
1%, which is relatively higher than other industries.

In short, we find that the growth in China’s final demand was mainly driven by the demand for durable goods until 2014, and this resulted in Korea’s heavy and chemical industries benefiting the most, thanks to a tight production network.

But, China is currently faced with the dual problem of a slowing economy and a changing industrial structure, in which growth in the services industry has exceeded that of the secondary industry.

This, however, is not uncommon. In fact, many countries in the past have experienced a decline in the share of the secondary industry as GDP per capita reaches a certain level.
And, considering China’s current economic structure and income level, a similar phenomenon will also be likely.

Then, how will China’s service-based structural shift affect Korea’s
industrial growth pattern?

In order to predict how the shift will affect industries in Korea, the growth rate in China’s total domestic demand was set at 6% while a different rate was applied for each industry, for example, services at 7% and durable goods at 6%.

Under this scenario, Korea’s GDP at the industrial level would stall at 0.39%, pointing to a decrease of 0.22%p compared to 2014, with the heavy and chemical industries exhibiting a particulary larger decline than other industries.

Indeed, if China experiences a simultaneous slowdown in domestic demand as well as servitization,
not only will it deal a heavy blow to the overall growth of Korea’s industries,
but its key industries, whose growth has been largely attributed to China’s strong demand, will be hit particularly hard.

The slowdown in the growth of China’s domestic demand and the structural shift will exacerbate the recent oversupply problem faced by Korea’s heavy and chemical industries.
Accordingly, Korean industries must preemptively establish effective countermeasures which include business restructuring and policy makers need to provide Korean businesses with incentives to help them make more fundamental preparations.
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