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China, International Trade and Global Supply Chain

  • Xiaojiang Zhang
Chapter

Abstract

Global supply chain has fundamentally changed international trade structure. China’s rapid ascendance in the last couple of decades in global economic order can be largely attributed to its successful integration into the global manufacturing supply chain. Many of today’s essential goods are produced by international supply chains that integrate material processing, production technology, participating labor and delivery network across different geographical locations. The current state and future direction of supply chains are relevant for analyzing global and Chinese economic condition and therefore important for applying suitable trading and investment strategies regarding China.

Global supply chain has fundamentally changed international trade structure. China’s rapid ascendance in the last couple of decades in global economic order can be largely attributed to its successful integration into the global manufacturing supply chain. Many of today’s essential goods are produced by international supply chains that integrate material processing, production technology, participating labor and delivery network across different geographical locations. The current state and future direction of supply chains are relevant for analyzing global and Chinese economic condition and therefore important for applying suitable trading and investment strategies regarding China.

6.1 Major International Supply Chains

Computer and communication technology supply chain is the most important global supply chain at work. Fast changing, with high risk and high margin, this supply chain is largely organized around design technology providers in the US, production technology and equipment provider in Japan, Korea, Singapore, Taiwan (China), and manufacturing process provider in China, Korea.

Automotive and parts supply chain remains important for its sheer size in terms of both values created and the amount of labor employed. While US and China provide two largest auto markets, Germany and Japan are the strongest international supply chain players in this area of technology complexity.

Electric equipment and appliance supply chain requires competitive capabilities on cost control and operations management. Advanced economies have largely exited this area for its low margin and relatively high environment cost. Important for providing employment for less skilled labor from populous countries, the chain is heavily concentrated in China, Mexico other emerging market countries.

Textile supply chain is more sensitive to labor cost input and is more mobile than the electric and appliance supply chain. It moved from Japan and other Eastern Asia countries/regions to China, and now in the process of moving to other emerging countries as wage and other costs in China grew.

Aerospace products remain to be the pinnacle of modern manufacturing technology. This supply is dominated mostly by US and to less extent the European Union.

For the past 30 years these major global supply chains moved manufacturing process, good and wealth around the globe, changing fortune of many countries. While they lifted many from poverty in emerging countries, it also brought with it structural dislocation in both advanced economies and developing countries for its uneven cost benefit distribution. To decipher the current state and future direction of macro economic condition of various countries including China, it is important to analyze supply chain’s impact using relevant countries’ trade and other statistics, based upon which policy makers are also trying to address their constituents concern and finding possible remedy to influence the future direction of economy.

6.2 Electronics and Electric Supply Chains

At the top of electronics and electric supply chain, the US has the largest and also one of the most innovative economies often takes the leading position in international supply chains. Large companies including Apple, IBM, Oracle, Microsoft, Boeing and Intel dominate the global technology landscape. Its export strength in aerospace is a prime example of technology system integration at the highest level.

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Even though US economy remains technologically competitive, the effect of global supply chain is under heavy scrutiny in the US, especially regarding large trade deficit. Many associated the manufacturing employment loss to the enduring merchandise (goods) trade deficit. One of the alternative possible explanations suggests the export of US dollars as the reserve currency by definition would inevitably lead to US trade deficit. Any possible policy solution to the US merchandise trade deficit would have large international economic ramification and significant impact on investment outlook.

The US international trade pattern has two important characteristics. First the size of US international trade is moderate by international comparison relative to the size of its GDP. That is one of the reasons US market is able to withstand large event shock during time of international turbulence, as was the case during the Asian Financial Crisis in the 1990s. Second the size of US trade deficit includes large goods merchandise deficit and sizable service surplus. Based upon data published by US Bureau of Economic Analysis, US trade on goods in 2015 was 761.5 billion in deficit, and trade on service was 263.9 in surplus. That made US total trade number at −497.6 billion in red for 2015.

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The US total goods and services deficit-to-GDP ratio is relatively modest when large US GDP is taken into account. This ratio came down significantly after 2008 financial crisis, as US trade on goods took hit during the crisis, and service export sector continued its growth, especially within the Other Personal Travel segment. The relatively modest deficit to GDP ratio suggests the issue at the heart of US trade deficit, the discussion upon which could influence the future direction of US international trade relationship including Sino-US trade relationship, is more centered upon certain economic dislocation caused by global supply chain versus the size of trade deficit.

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One of the economic dislocations, the US manufacturing job had endured two large losses since 1996. One caused by the burst of dot-com bubble and the other caused by the 2008 financial crisis. While education and health services employment grew, the population severely impacted by manufacturing job loss was a different population group from those in education/health care services and policy remedy was called for to help improve their economic situation.

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The deficit in the manufacturing areas, which includes computer and communications equipment, apparels, automotive and parts and some other manufacture sectors, was often suggested as the root cause for the loss of manufacturing jobs, while others have also argued that the loss could also be partially caused by technological improvement, US production moving to higher environmental standard or export of US dollar as the reserve currency.

From the traded merchandise type perspective, the largest source of US trade deficit was concentrated within a few goods segments including Computer and Electronic Products, Oil and Gas, Transportation Equipment, Apparel, Electrical Equipment, among many other traded merchandise categories.

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From the traded merchandise geographical origin perspective, the majority of US merchandise trade deficit was encountered during its trading with a few large trading partners that are all manufacturing powerhouses. Besides China, Germany, South Korea and Vietnam also increased their respective surplus over the recent years, with Germany and South Korea for their technological strength and Vietnam for being the alternative low cost manufacturing hub to China. US deficit to Japan was stable. US merchandise deficit to the rest of the world excluding countries mentioned above actually shrank.

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The continuous US trade deficit with China had attracted attention from US policy makers. US trade deficit with China was concentrated in the following areas: foremost was Computer and Electronic Products category, with Electrical Equipment and Appliances category being the distant second, followed by apparel, leathers and others. Services category has been a continuous source of surplus for US.

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As large as it is, China’s share of the source for US computer and electronic products import has peaked in recent years. Rising labor, real estate and other costs, and the general maturing nature of the existing US market, limited market segment growth potential. At the same time, Countries including Mexico and Vietnam have gained their manufacturing prowess.

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A detailed look at US deficit with China within Computer and Electronics category showed that most of the deficit was in computer equipment and communication equipment. In this area China is part of an expansive supply chain took off from the beginning of this century powered with core technologies provided by global giant including Microsoft, IBM, Google, Intel, NVIDIA and Samsung.

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An example is the semiconductor area that is strategic for some of the global giants to be able to rapidly deploy application of new technology with economically affordable cost for consumers around the world amid volatile demand. Positioned within 4 segments, including equipment, materials, semiconductors and electronic end equipment, the top 20 companies in this semiconductor industry chain are from US, Japan, Korea, Taiwan (China), with the top 7 based upon 2013 revenue being Intel (US), Samsung (Korea), TSMC (Taiwan, China), Qualcomm (US), Micron (US), SK Hynix (Korea), Toshiba (Japan). Here US provides technology design and specification, US, Japan, Korea, Singapore and other places provide high-end technology equipment and components, and China provides mid to low level components and labor. As goods flow within the manufacturing chain, about 217.7, 230 and 242 billions USD worth of integrated circuit are imported into China respectively for 2014, 2015 and 2016 based upon data published by China Customs. Besides being the manufacturing hub that supplies sufficient amount of mobile labor essential for volatile consumer demand, China also provides a substantial market for testing new technologies. While computer-related growth plateaued, with artificial intelligence expected to play a bigger role in daily life, this supply chain could morph into another important area with potentially explosive growth. The segment investment risk involves fast technology turnover that could render past large investment useless and for the size of investment loss, substantial macro impact for involved countries and companies. Another possible investment risk comes from the large structural imbalance this supply chain brings to the international and respective domestic economies, which if not properly addressed, could lead to severe policy reaction. There could also be large investment reward associated with these risks as Chinese technology companies gaining their competitive edge based upon a large consumer base.

The technology flow pattern could be approximated by Mach and Elec trade flow statistics reported by World Bank. Data suggested China was the final destination for international machinery and electrical equipment trade, with other countries/regions being either the supplier or conduits for these traded equipment.

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One player gaining significant technological edge was Korea, Rep. Over the resent years it has built up considerable amount of surplus with US, China and HK China, while being able to reduce its deficit with Japan.

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Relative to Computer and Electronics Equipment category that is often high value-added and produced with fully distributed global supply chain, US deficit in Electrical equipment, appliance and components category is much smaller. Out of this category, Electric Lighting Equipment and Household Appliances are overall low margin manufacturing business where Mexico is also a strong market player taking advantage of its geographical proximity to large US market and the size of its labor market.

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The household appliance and electric lighting equipment production is concentrated in China, while Mexico is also showing competitiveness in this low margin business that is sensitive to labor and transportation cost. Continuously manufacturing migration to China, Mexico and some eastern European countries could be expected, assuming no major change of existing business environment.

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There is embedded efficiency in producing household appliances in China and Mexico, for the production quantity required to satisfy existing domestic demand is already large. In this low margin business segment, besides labor cost, the efficiency provided by scale of production is also important. While the investment reward in this area could be modest compared with high tech area, as large household appliance makers improve on their production skills and have business prospect supported by solid domestic and international demand, the downside risk is limited.

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Within the much smaller area of Electrical Equipment, where Germany, Japan and US are all very competitive market players, China is slowly expanding its footprint with technological improvement.

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Supported by solid demand and improvement on production capability, investment risk and reward in Electrical Equipment and Component area is comparable to those in household appliance area.

6.3 Automotive Supply Chain

Compared with other important supply chains including Computer Electronics and Household Appliance, automotive supply chain puts particular emphasis on just-in-time production management to cut inventory cost and hence requires precisely integrated production delivery process. Germany, Japan and US lead global automotive manufacturing supply chain. One of the large change over the past two decades was the German auto manufacturers’ successful integration of mid European industries from Poland, Czech, Slovakia and Hungary into their manufacturing supply chain, with very broader economic ramification. The integration had both expanded market in Europe for German auto products and lowered the manufacturing cost of German industries. Therefore the core strength of Euro, which is heavily dependent upon German economic vitality, is on a much solid foundation. The increased investment from Germany to Poland illustrated the supply chain integration.

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The investment from Germany to Poland had increased substantially since Poland joined the European Union in 2004. Investment from Germany to Spain kept up with investment from Spain to Germany, while investment from Germany to Italy did not keep up with investment flow from Italy to Germany.

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As a result, the net investment from Germany to Poland increased. In comparison, German net investment to Italy had decreased substantially. This change of direction for net investment flow within Europe is fundamental to the current mid Europe economic strength and southern European economic difficulty.

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Czech, Hungary, Poland and Slovakia together have a combined population of more than 60 million, and a combined GDP roughly about a quarter of German GDP. The German net investment and subsequent supply chain integration in Mid Europe region has lowered German auto manufacturing cost by tapping into a less expensive and well educated labor force. As German technology investment improved the manufacturing skill level and efficiency within these four countries, these countries have also gained importance as US automotive product providers.

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The European auto supply chain’s impact was global. Currently two largest automotive markets in the world are the US and China market. In 2015, 4.0 million vehicles under different German brands were sold in China, and German surplus in Vehicle and Auto Parts with US reached $28.7 Billion. German auto and parts supply chain, including related electronics and chemicals business, had a stabilizing effect on German and mid European economies during large economic shocks in Western Europe, including Brexit, referendum and elections in Italy and France. The amount of real economic impact would be larger when German-affiliated auto production and export from Mexico were taken into calculation.

For China’s capital market, the main effects of German auto supply chain strength were the followings: (A) a stable European economy translated into a stable external market for various European-bound export industries; 2nd the strength of Euro economy was often underestimated, which translated into incorrect estimate for pace of European economic recovery and ECB interest rate policy. These are important factors for export industry analysis and domestic monetary liquidity forecast.

The other strong automotive supply chain leader is Japan. Japan has been a strong technology supplier on the global stage for both electronics and automotive industry. Based upon trade data from Japan Ministry of Finance, the largest source of country’s trade surplus with a single trading partner is the US.

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Within US Japan bilateral trade, the largest source of Japan trade surplus with US was the automotive sector. This shows both the competitiveness of and the country’s heavy dependency upon automotive industry.

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For US auto market, one of the relatively recent developments was the increase in auto manufacturing activities in Mexico and accelerated growth of US auto deficit with Mexico. Many of the production activities were resulted from auto-related investment from global automakers. The rapidly gained competitiveness of Mexico manufacturing base and this large auto deficit are becoming concerns for US policy makers for auto industry’s importance in US economy.

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For China auto market, the competitiveness of global automotive supply chain especially those led by automakers from Germany and Japan is evident as well. Passenger vehicle market is often sub-categorized into three sections including car, SUV and MPV. In the year of 2016, foreign brands took 80.7% of the car section and 41.8% of the SUV section in China, based upon number of vehicles sold data published by China Auto-stats. When the value of vehicles sold is accounted for, since foreign brands usually occupy the higher end on the value chain, the relative strength of global auto supply chains in China is even larger.

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The ratio of cars sold under domestic brands versus total number of cars sold in China had shown a declining trend, from 29.11% in 2011, 22.42% in 2014, to 19.3% in 2016, as customers demanded better cars and foreign manufactures were responding by moving into compact and subcompact car segment. The falling ratio suggested the technology gap between existing supply chain leaders and market followers was actually widening at least for now.

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Unlike the US automotive market, the amount of direct automotive imports into China and export from China remained modest. Vehicles sold in China under German and Japanese brands are mostly manufactured in China, hence bilateral automotive trading data with China does not directly exhibit the competitiveness of German or Japanese automotive industry in China’s market.

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From 2009 to 2015, compared against large increase of phone import from China, motor vehicle parts import from China to Japan only increased slightly again illustrated China playing the role of final market but not an intermediary export base for international auto supply chain.

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The Japanese economic recovery after 2008 financial crisis was relying heavily on success of Japan auto industry, with 3.79 million vehicles sold in China under Japanese brands in 2016, and Japanese surplus in Vehicle and Auto Parts with US reaching 46.6 billion in 2015 by report US Census data.

In summary, the current operating models in China by international automotive supply chain from Germany, Japan, US and Korea Rep are to focus on manufacturing or making final assembling of vehicles in China for auto sales in China. These leaders have so far not incorporated China as an exporting base into their global manufacturing supply chain the same way Mexico was set up to be. The understanding of this business model helps us to conduct analysis on China capital market investment from several perspectives. The first is regarding automotive industry’s importance for US, Germany and Japan, China is more of a final consumer versus a global supplier, hence the current global auto trade conflict risk for China domestic auto industry is limited. The second point is since German, Japanese, American and Korean automotive supply chain leaders all have extensively integrated local supplier into their production network and therefore have established large domestic economic presence, their sales data can be useful for both analyzing the state of Chinese domestic auto consumption level, future trend and domestic auto makers’ growth prospect. The third is automotive industry including international suppliers forms a large part of China consumer market, producing more than 23 million vehicles in 2016. The statistics of the international auto suppliers in China provides a context for both analyzing and assessing domestic economic health regarding GDP, commodity price, inflation and other macro matters.

6.4 Chemicals and Pharmaceutical Manufacturing

Another global supply chain that is often considered having significant entry barrier is the chemical industry. Based upon World Bank data, US and Germany are the main leaders in the area of global chemical business. Belgium, Netherlands and Japan are also established players in the segment. Though emerging countries including China made strides in areas including basic chemicals, the entry barrier remains high for newcomers for a couple of likely reasons. First chemical manufacturing process itself is technology and capital intensive. Second the volatile commodity price and long investment cycle requires large amount of knowledge and resources for careful planning to weather capital investment risk. Third the patent law implementation regarding chemical and manufacturing process protection can also complicate an investment decision.

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While US has a very large chemical industry and market, over the years it has also built up trade deficit in this segment with some countries including Ireland, Germany, Switzerland, Israel and India. Germany and Switzerland have been traditionally strong players in pharmaceutical manufacturing business. Ireland enlarged its market presence partly because of its favorable corporate tax policy. On the export side, US chemicals also had slowdown in export to emerging economies in various chemical subcategories.

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From the perspective of chemical product type, US trade deficit in chemical area is mostly concentrated in pharmaceutical subcategory. Surplus in Resin, synthetic rubber and fiber reflects US strength in industrial chemical production involving technology complexity.

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Within the important pharmaceutical and basic chemical area, US export was stagnant while import has increased.

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Specifically regarding international pharmaceutical business, Ireland has a favorite corporate tax policy put in place. Germany, Switzerland and UK have been traditional strong players in the pharmaceutical industry. India acts as an efficient low cost production site. All five countries that had surplus with the US have certain entrenched competitive advantage in the high margin segment.

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German competitiveness in chemical manufacturing area is illustrated by its large and increasing surplus with the US, most of which is concentrated in pharmaceutical and basic chemical areas.

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German pharmaceutical surplus to US is roughly 30% of German global pharmaceutical surplus, suggesting the large surplus to US is possibly due to the very large US market demand for high quality medical and pharmaceutical products.

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UK, long after ceding its top position in international trade to the US and giving up imperial preferential system in order to join the European Economic Community in 1973, has nevertheless managed to remain competitive in the very high-end segment of the manufacturing business, exemplified by aircraft engines and pharmaceutical production. It is an important player in global chemical industry and runs a sizable surplus with US on pharmaceuticals.

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When analyzing UK chemical industry more broadly based upon data published HM Revenue and Customs, within the chemical category, UK ran a sizable surplus in pharmaceutical area, and a smaller surplus in organic chemicals area.

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UK’s largest trade surplus by country in 2015 was with US, a large part of it was related to pharmaceutical products within the chemical category. Its largest deficit was with Germany and China.

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Japan ran a pharmaceutical deficit with US while keeping a sizable deficit in the area of basic chemicals. This bilateral chemical trade pattern is quite different when compared with other industrialized countries regarding their respective trade relations to US in chemical business.

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US trading with China in chemical segment illustrated a traditional bilateral trade pattern between an existing player and a newcomer. US ran a surplus in Resin Synthetic Rubber area, and a deficit in less sophisticated basic chemicals area.

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The relatively low growth of US chemical import from China except basic chemicals again demonstrates the difficulty in overcoming technology difficulty by emerging countries. Similar to its competitiveness in the global appliance industry, China does have built-in advantages in basic chemical area, where the large amount of capital can be mustered, the technology barrier is relatively low and the demand for quantity is large in its domestic market. Even in this area, some difficulties exist and international corporations including BASF and others operated quite amount of production facilities in China.

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Another difficult area hence with potential growth opportunity is environmentally safer US pesticide and pesticide production technology export to China due to increased environmental awareness.

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Pharmaceuticals and Medicines area does not play a big role in US and China trading relationship and there are several possible reasons for that. One of the reasons was major difference in the patent protection. It is also difficult in making pharmaceutical products in China to meet western pharmaceutical standard.

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We also need to recognize that the healthcare industry in China is mostly a public-funded industry. Though the medical budgetary expenditure saw steady increase over the recent years, but as the economic growth moderates, the increase from the government spending on the medicine will inevitably also moderate.

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Regarding capital markets investment analysis for the chemical industry in China, its industry capability is still mostly on the beginning side of the learning curve hence it will less likely be subject to international trade conflict risk. Chemical export will continue to be mostly within low-end chemical area including pesticide, basic chemical and others. Growth on high-end chemical products and pharmaceutical products will be challenging. Opportunity for foreign capital and technology investment does exist. Growth prospect specifically within the pharmaceutical area will be moderate given the overall economic growth has moderated.

6.5 Apparel Sector

Apparel industry growth has peaked over the recent years. Rising labor cost and the value of CNY had eroded China’s competitive edge on textile production cost over other developing countries including Vietnam, Bangladesh and Mexico. While still important when domestic demand growth is taken into consideration, the overall growth potential in terms of export by China apparel sector is limited. This translates into an industry assessment with overall limited investment opportunity. Single credit opportunity can still be identified by focusing on niche player with successful reorientation from international demand to domestic demand with improved cost control measures.

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6.6 Agricultural Sector

International agricultural sector interacts with China mainly in the areas of grain import, soy import and seed technology-related import. Grains are the most important part of the agricultural sector for China. The country had traditional processed more wheat among major crops imported. More recent imports favored wheat and corn while domestic rice supply is abundant. For a large populous nation, food safety is a paramount national security issue hence being mostly self-sufficient on major crops will limit the import growth regarding grains segment.

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Meat import took off over the recent years as demand for protein diet enjoyed solid growth. The amount of both major crops and meat import themselves is not large enough to sway inflation index calculation.

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One of the agricultural areas with large quantity of import is soy. China imports very large amount of soy, mostly because availability of arable land and the yield advantage of foreign soy growers make foreign soy production much more competitive.

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Brazil had replaced US to be the largest soybean provider to China. These two combined provided about 70 million tons of soy to China. The soybean imported is used for direct food consumption, cooking oil and soy meal production. Soy mean is a major source of animal feed.

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One of the critical technologies in modern agricultural sector is the capability to genetically modify produce DNA to enhance yield and make them more adaptable in various natural environment, more pest-resistant and drought resistant, etc. Controversial in many corners of the world, its wide usage is a commercial reality and demand for GM seeds remains high. China imports significant amount of seeds from foreign countries and US dominates in this technology area. For China’s emphasis on food self-sufficiency, the relevance of seeds import for investment analysis is pertained to assessing whether seed technology plays significant role in a specific agricultural area and whether it gives or takes away competitive advantage of any industry leaders especially regarding merger acquisition opportunities.

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The amount of sugar and sweeteners import is large, with large amount of import coming from Brazil. The international market is competitive and the amount imported is not large enough to impact inflation and interest rate analysis in China.

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In summary, agricultural sector dependence on foreign production and technology is expected to grow because of continuously improved living standard, but at a very gradual pace for food security concern. Soy import will persist for international cost efficient and concern for domestic GM-related soy production. Investment analysis needs to be particularly focused upon regulatory change’s impact on land usage, price control and trend.

Copyright information

© Springer Nature Singapore Pte Ltd. 2018

Authors and Affiliations

  1. 1.BeijingChina

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