China crashes Cafta's party

Central American nations have long been trying to hook their economies to the US market, but they can't compete with China
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Workers at a Chinese factory
Workers in a garment factory in Beijing. Photograph: Elizabeth Dalziel/AP

I am writing from the Shanghai Forum, the annual event dubbed as Asia's version of the World Economic Forum in Davos. A major issue at the forum has been the need to alleviate China's impending labour shortage. The implications for Central America and other developing countries loom large.

It might seem inconceivable that a country with more than 1 billion people would have a labour shortage, but it's true. According to reports in the New York Times, the shortage is due to two factors: the increase in the levels of Chinese people going through higher education and getting absorbed into the emerging high technology, high value-added sectors of the economy; and the decrease in China's birth rate since its "one child" policy that began in 1977.

At the forum, Min Hua, director of the Institute of World Economy at Fudan University unveiled China's solution to the problem: the industrialisation of Chinese agriculture and the creation of scores of new cities to absorb the 800 million farmers who will migrate to those cities. That's right, China plans to move 800 million farmers to existing and newly created cities. If they mechanise the countryside and achieve similar productivity levels to the US, they say, China will only need 100 million people in the rural sector.

When the nations of Central America hear about this they will be shaking in their (Chinese) boots. For years these countries have been working to hook their economies to the US market, with a particular emphasis on clothing and apparel exports. Beginning in the 1980s, most Central American nations set up export processing zones that export textiles and clothing to the United States. By 2001, 87% of all El Salvadoran exports to the US were from such zones. For Honduras, 78%, and Guatemala and Nicaragua each export 63% of their exports to the US were from export processing zones.

The capstone of such efforts was the Central American Free Trade Agreement between the US, Central American nations (excluding Panama) and the Dominican Republic (Cafta, for short). Cafta, by lowering tariffs and locking in access to the US economy, was supposed to solidify Central America as a clothing hub. Then China crashed the party.

In 2001, both China and Central America sold approximately $6.5bn worth of clothing exports to the United States, with each holding approximately 12% of the US market for clothing. In 2004, the year before Cafta went into effect and after China's WTO entry was in full swing, Central American exports to the US reached $7.5bn and China's were still in the same order of magnitude at $10.7bn.

Yet since Cafta went into effect, Central American exports of clothing to the US have fallen by 25%. How could this happen? Clothing exports to the US from Central America in 2009 were down from $7.5bn in 2004 to $5.6bn but China's were up to $24.3bn – a 127% increase for China since 2004. The Central American share of US clothing imports has declined to 8.7%. China now holds 38% of the US import market for clothing.

News of a Chinese labour shortage was thus very welcome in Central America. Central American nations, as well as Vietnam, India, Sri Lanka and some others would stand to gain. Hundreds of millions of "new" low-skilled workers however, could seal Central America's fate.

As Roberto Porzecanski and I argue in our forthcoming book on China and the future of industrial competitiveness in the Americas, these trends are not reason to point fingers at China. Rather than bashing the Chinese, Central Americans, not to mention nations such as Mexico that have chosen a "low-wage export to the US through free trade agreements" development strategy, developing nations should look to learn from China.

Both China and the Americas have been globalising their economies for 30 years. China has adopted a strategic and gradual approach to globalisation where the government plays a key role, the Americas have practised the Washington Consensus of rapid trade and investment liberalisation and yanking the government from economic affairs. China has turned out to be the best globaliser in the developing world.

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