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In our empirical approach, we first carefully estimated a common economic activity factor from a range of real indicators of Chinese economy following Fernald, Spiegel and Swanson. In terms of the Chinese data, the quality of the reported output figures has long been under scrutiny and so we used a range of economic indicators for China including industrial production index, electricity production, real retail sales, consumer expectation index, rail freight traffic, real estate investment —residential building, total loans, fixed asset investment and floor space started — and commodity building to estimate the common economic activity factor. Similarly, we estimated an economic activity factor for the US.
In the second step of our empirical framework, we assessed dynamic effects of an unanticipated one standard deviation negative shock to the economic activity factor of China and the US on 12 commodity-exporting nations: Argentina, Australia, Brazil, Canada, Chile, Colombia, Indonesia, Malaysia, Mexico, Peru, Russia and South Africa. We separately estimated a seven-variable domestic dynamic vector auto-regressive (VAR) system for each of these countries to assess the impact on output measured by industrial production, country-specific commodity price index, exchange rate and net export to China (or the US) while also controlling for domestic prices and short-term monetary policy instruments over the period January 2000 to September 2015. In each of these country-specific VAR, we use the China and the US economic activity factors as exogenous shocks.
The main conclusion of our paper is summarised in Figure 1 where we rank the countries in terms of aggregate output impact of an unexpected negative shock to China over the horizon of 12 months after the shock. The top three countries with most negative real effect of a China shock are Brazil, Russia and Argentina. Australia ranks fifth out of the 12 nations, evidently the only advanced economy to suffer a severe implication. Still the overall magnitude of the impact is relatively small but long lasting for Australia. The countries to be least impacted include Canada, Mexico and somewhat surprisingly, Indonesia.
Financial variables of all the countries suffer, commodity prices and stock prices decline and the exchange rate depreciates. The countries that suffer more in terms of aggregate output are the ones whose exports to China are hit harder in comparison. Thus, the transmission of the China shock to the real economy is via the direct trade channel.
For comparison, we present our results for the US shock for all the countries in Figure 2. The Australian economy shows no significant real impact for the US shock mirroring the Canadian economy for the China shock. On the other hand, both Canada and Mexico, little affected by China, show strong vulnerability to the US shock. In fact, the effect of a negative US shock on the Canadian economy is much larger in magnitude compared to the impact of a negative China shock on the Australian economy.
Our overall results strongly echo Gauvin and Rebillard who show that emerging economies are on average more vulnerable to a slowdown in China than advanced economies. The magnitude of the real effects on Brazil and Russia, for example, far outweighs that on Australia. This possibly reflects a more diversified economy with a sizeable service sector among the advanced countries.
Our results also strongly suggest that emerging economies are quite diverse in terms of their possible vulnerability to China. Even within Latin America, Brazil and Argentina are a lot more exposed to a China shock than Colombia and Chile. What explains such heterogeneity among emerging economies is subject to further research.
Finally, we find that some countries are more sensitive to developments in China than to shocks in the United States. Importantly for policymakers, Australia is a prominent example of such a country.