Transmission of China's Shocks to the BRIS Countries

• Published date: 01 September 2017
• Author: Mustafa Çakir,Alain Kabundi
• DOI: http://doi.org/10.1111/saje.12164
• Date: 01 September 2017

TRANSMISSION OF CHINA’S SHOCKS TO THE

BRIS COUNTRIES

MUSTAFA C¸AKIR*AND AL AIN KABUNDI

†,‡

Abstract

This paper investigates the effects of China on the BRIS countries, namely Brazil, Russia, India

and South Africa. We identify Chinese supply and demand shocks and assess their transmission

to BRIS in a structural dynamic factor model framework estimated over the period 1995Q2-

2009Q4. The findings show that Chinese supply shocks are more important than its demand

shocks. Supply shocks produce positive and significant output responses in all BRIS countries.

And while these supply shocks have a permanent impact on the BRIS countries, the effects of

demand shocks are short-lived. Both supply and demand shocks are transmitted through trade

rather than financial linkages. However, the responses of the BRIS countries are heterogeneous

and therefore require country-specific policy responses.

JEL Classification: C33, E32, F40, O57

Keywords: Dynamic factor model, supply and demand shocks, sign restrictions, BRIS

1. INTRODUCTION

Increasing economic integration among countries, especially through trade and financial

flows, has been one of the most remarkable events in the world over the past two deca-

des. Many emerging economies have gained in prominence as their economic activities

now have significant ripple effects in other countries, including the developed ones (Akin

and Kose, 2008). As far as geopolitics is concerned, five emerging economies – Brazil,

Russia, India, China and South Africa (BRICS) – are rapidly becoming integrated and

increasingly import ant to the world economy (C¸akır and Kabundi, 2013a, 2013b).

These countries intend to strengthen their multilateral cooperation by way of the alliance

of the BRICS group. China is the dominant actor in this emerging group.

This paper is closely related to that by Eickmeier and K€uhnlenz (2017). But unlike

these authors, who focus on the role of Chinese supply and demand shocks on global

inflation dynamics, the current study emphasises the overall effects of Chinese supply

and demand shocks on BRIS countries. The reason for assessing the effects of China’s

shocks to BRIS is based on the fact that, in general, China has become the first trading

partner of many countries, but in particular of the BRIS countries (Siklos and Zhang,

* Corresponding author. Assistant Professor, Department of Economics, Istanbul Sabahattin

Zaim University, Halkalı, Istanbul, Kucukcekmece 34303, Turkey. E-mail: mustafa.cakir@izu.

edu.tr

†

Research Department, South African Reserve Bank, Pretoria 0001, South Africa

‡

Department of Economics and Econometrics, University of Johannesburg, Economic

Research Southern Africa (ERSA), South Africa

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C2017 Economic Society of South Africa. doi: 10.1111/saje.12164

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of Economics

2010).

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China has become an economic powerhouse and has contributed to economic

recoveries after meltdowns. Even after the subprime crisis in the United States (US),

which triggered a global financial crisis in 2008, coupled with weak global economic

growth, China’s economy grew by 9.1% in 2009. Its growing importance as an assembly

platform for the exports of manufacturers, a destination for foreign investment as well as

a consumer of imported technology, raw materials and industrial goods is not a one-time

shock. Rather, it is an ongoing process that continually shapes the balance of global sup-

ply and demand (Eichengreen and Tong, 2006).

The empirical framework used is somewhat related to Eickmeier (2007), Kabundi

and Nadal De Simone (2011) and Eickmeier and K€uhnlenz (2017). It involves the iden-

tification of these shocks using a structural dynamic factor model instead of the tradi-

tional vector autoregressive (VAR) model. The rationale for adopting this framework is

motivated by the fact that the factor models can handle many variables and hence turn

the curse of dimensionality, commonly observed in small VAR, into the blessing of dimen-

sionality. The analysis includes 161 quarterly series of BRICS countries observed from

1995Q2 to 2009Q4. In addition, we adopt the sign restrictions identification strategy

instead of short- or long-term restrictions techniques, which appear to be too restrictive.

This identification is based on the IS-LM framework, which is commonly used in mac-

roeconomics. Supply and demand shocks are identified in such a way that they explain a

larger proportion of the Chinese gross domestic product (GDP). In so doing, we are

confident that these shocks have their origin in China instead of the other BRICS coun-

tries. We then assess their effects on a set of BRIS variables.

There is a great deal of literature on China’s economic influence on other countries.

Studies in this area have been conducted at different levels. On a regional level, Jenkins

and Edwards (2006) examine the effects of China and India on sub-Saharan Africa, look-

ing at the channels through which the growth of the Asian drivers is affecting sub-

Saharan Africa. Lederman et al. (2009) conducted another related study that focuses on

the effects of the emergence of China and India on Latin America. Jenkins et al. (2008)

investigate the effects of China on Latin American trade and foreign direct investment

(FDI) flows, and the results demonstrate that there are winners and losers in the region,

both at country and sector level.

On a country level, Jenkins (2012) analyses the economic effects of China’s re-

emergence on Brazil and finds that Brazil has benefited from trading with China in the

short run, especially from the high prices of primary commodities, but it has lost export

markets to China in manufacturing Rangasamy and Swanepoel (2011) investigate the

effects of China on South African trade and inflation, and the results suggest that the

effects of China on the South African trade balance are positive but, in terms of inflation,

the paper does not provide any convincing empirical results that inflation in China leads

to domestic price increases. More recently, Edwards and Jenkins (2013) undertook a sim-

ilar study looking at the effects of China’s imports on the manufacturing industry,

1

China’s annual real GDP growth rate has averaged around 10% over the past two decades. Its

share of global output in 2012 stood at 8.7% measured by current prices, making it the second-

largest economy after the US (International Monetary Fund, 2012). As Perkins (2005) notes, this

annual growth rate could be sustained in the range of 8–10% a year for the next couple of decades.

As a strategic power that is intent on rivaling the US, China is projected to surpass the US in 2030

to become the world’s largest economy (Maddison, 2006).

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C2017 Economic Society of South Africa.