If current trends continue, China may emerge as the world's largest economy by 2020.

Discuss the possible implications of such a development for

(1) The world trading system.

(2) The world monetary system.

(3)The business strategy of today's European and U.S. based global corporations.

(4)Global commodity pricesAnswer:

The world trading system would clearly be affected by such a development. Currently China enjoys a somewhat privileged status within the World Trade Organization as a developing country. Such a rise to eminence, however, would clearly force it to become a full and equal member, with all the rights and responsibilities. China would also be in a position to actively affect the terms of trade between many countries. On the monetary front, one would expect that China would have to have fully convertible and trading currency, and it could become one of the benchmark currencies of the world. From the perspective of Western global firms, China would represent both a huge market, and potentially the home base of some very capable competitors. Finally, commodity prices would probably fall.

a) The world trading system

The impact of one economys growth on the world economy is transmitted through its impact on the terms of trade - which depends on the bias of its growth. (Hicks 1953, Corden 1956, Bhagwati, 1958). In Chinas case there appears to have been a strong export bias, so that Chinas growth has most likely caused an improvement in the terms of trade for its trade partners (Amiti and Freund 2008, Harris et al 2010).

An extensive literature exists trying to assess the quantitative implications of these two effects on trade flows, (Ahearne et al. 2003, Lall and Albaladejo 2004;; Roland-Holst and Weiss 2005, Coxhead 2007, Eichengreen et al. 2007, Athukorala 2010, Hanson, and Robertson 2010). Overall the evidence is mixed. For example Lall and Albaladejo (2004) find evidence of strong competitive effects but Hanson, and Robertson (2010) find that, for the countries with the most similar trade patterns to China, its growth represents only a small negative shock in export demand. Eichengreen et al. (2007) find positive effect on the exports high income Asian economies that are significant exporters of capital goods, and a strong negative effect on low income Asian countries that are dependent on the production and exports of consumer goods.

Athukorala (2010), however, argues that these studies fail to take account of the complex Asian production networks. He finds that Chinas exports to third country markets have had complementary effects on Asian exports due to the effect of components trade, and that the impact of Chinas growth on Asia is overwhelmingly positive. Another limitation of this gravity literature is that it is focused on trade flows only. To that end Wood, and Mayer (2011) use on a factor content approach, familiar from the trade-wage literature, to examine at the impact of Chinas emergence on industry composition in other countries. They argue that an upper estimate of the effect of a world with China, relative to one without out it, would be to increase the world share of basic skilled workers by approximately 10%. They find that this would reduce the output shares of other countries primary and manufacturing sectors by only up to 1-3.5%, with the Asian economies being the most severely affected.

In contrast Autor et al (2012) assess the impact of Chinas import penetration on USA manufacturing, focusing on not just wage effects but also regional employment effects. They find that the rising exposure to Chinese import competition explains between 33-55% of the U.S. manufacturing employment decline between 1990 and 2000. This is a dramatic contrast with much of the earlier trade wage literature that found minimal effects on wages from trade in the USA, though this can be accounted for the fact that China is now much larger than it was when most of trade-wage studies were undertaken.b) World monetary

China does not allow its currency to float and therefore must make large-scale purchases of dollars to keep the exchange rate within certain target levels. Although the renminbi (RMB) has appreciated against the dollar in real terms by about 40% since reforms were introduced in July 2005, some analysts contend that it remains highly undervalued. Chinas undervalued currency makes its exports less expensive, and its imports more expensive, than would occur under a floating exchange rate system. In order to maintain its exchange rate target, the government must purchase foreign currency (such as the dollar) by expanding the money supply. This makes it much more difficult for the government to use monetary policy to combat inflation. Many economists argue that Chinas industrial policies have sharply limited competition and the growth of the private sector, caused over-capacity in many industries, and distorted markets by artificially lowering the costs of various factor costs (such as capital, water, land, and energy) below market levels in order to promote targeted industrial sectors. Such policies have come at the expense of other (non-industrial) sectors of the economy, such as services.

c) the business strategy of European and US global corporations

Chinas rapid economic growth and emergence as a major economic power have given Chinas leadership increased confidence in its economic model. Many believe the key challenges for the United States are to convince China that it has a stake in maintaining the international trading system, which is largely responsible for its economic rise, and to take a more active leadership role in maintaining that system; and that further economy and trade reforms are the surest way for China to grow and modernize its economy. For example, by boosting domestic spending and allowing its currency to appreciate, China would import more, which would help speed economic recovery in other countries, promote more stable and balanced economic growth in China, and lessen trade protectionist pressures around the world. Lowering trade barriers on imports would boost competition in China, lower costs for consumers, and increase economic efficiency. However, many U.S. stakeholders are concerned that Chinas efforts to boost the development of indigenous innovation and technology could result in greater intervention by the state (such as subsidies, trade and investment barriers, and discriminatory policies), which could negatively affect U.S. IP-intensive firms. Failure by China to take meaningful steps to rebalance its economy could increase tensions with its trading partners, especially if Chinas share of global exports continues to increase rapidly, and if that increase is viewed as being the result of nonmarket policies that give Chinese exports an unfair competitive advantage. Some economists contend that some economic rebalancing by China appears to have taken place in recent years, noting that Chinas current account surplus as a percent of GDP declined from a historical high of 10.1% in 2007 to 2.5% in 2013. In addition, private consumption as a percent of GDP has risen annually from 2011 to 2013. However, many economists contend that much of the reduction in Chinas current account surplus may largely the result of sluggish global demand for Chinese products, rather than a significant change in Chinese economic policies. In July 2012, the IMF stated that, although the fall of Chinas current account surplus was a welcome sign, the external rebalancing was achieved at the cost of rising internal imbalancesnamely the high rate of investment spending, which, the IMF assessed, would be difficult to sustain.In addition, gross fixed investment as a percent of GDP grew each year from 2011 to 2013, and continues to be the dominant source of Chinas GDP growth.d) Global commodity prices

Chinas unusually fast growing commodity intensity likely reflects the rapid expansion in the tradable export sector and large-scale fixed asset investmentparticularly since 2000 (Yu,

2011). Both activities are commodity intensive. For example, Ye (2008) estimates that just over of Chinas copper usage is accounted for by infrastructure investment and construction, with accounted for by consumer and industrial goods. It is beyond the scope of this paper to assess the root causes of Chinas structure of economic growth and the high commodity intensity that results, but previous studies have highlighted the role of structural factors and domestic policy distortions (IMF, 2011a).

Chinas role in international commodity trade only matters to the extent that it affects the relative distribution of supply and demand of different commodities across countries. For example, Chinas strategic policy decision to strive for self-sufficiency in key grains but rely on imports of oilseeds has likely had major implications for global agricultural trade patterns.

In terms of broad commodity groups, China has come to play a dominant role in base metals markets and, to a somewhat lesser extent, agricultural raw material markets. In contrast,

China has not yet assumed a large role in global food and energy markets although its share of world imports is rising gradually.

At higher frequencies, Chinas influence on commodity markets will mainly reflect the business cycle, seasonality, and unanticipated transitory changes in its supply-demand balance. In general, we should expect unanticipated shocks to have a larger impact (all else equal), since market participants may be able to adjust commodity inventories to smooth out the effects of anticipated fluctuations in supply and demand. As a result, this paper considers the effect of unanticipated demand shocks and also leaves aside supply-side spillovers which may be important in some cases.

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