SA–China relations did not just start with trade. History proves that there is political interest between China and SA. In SA, Beijing supported the Pan-African Congress (PAC); this was because the USSR had already secured relations with the ANC, thus precluding closer ANC-China relations (Grimm et al. 2014).

According to Grimm et al. (2014), in 1999, President Mandela made the first state visit to China after the formal diplomatic relationship had begun and in 2000, President Jiang Zemin visited South Africa; at that time, the two heads of state signed the Pretoria Declaration on the Partnership between the PRC and the Republic of South Africa which, for the first time, highlighted enhancing the partnership from both sides. All these political relationships created a foundation for the development of the bilateral relations.

South Africa has a significant impact on China’s economy. The support from South Africa has provided China with a base in the international community and international organisations and agencies. According to Niu (2011, cited in Grimm et al. 2014), China’s approach to SA is sometimes seen as China’s Africa strategy in the broader context: South Africa, albeit just one state among 54 African countries, arguably provides China’s African engagement with legitimacy. Hence China’s invitation to South Africa to join the BRIC club in 2011. Many Chinese officials have shown that China is willing to deepen their bilateral relations with SA (Niu 2011, in Grimm et al. 2014).

For China, SA is the most significant trade partner on the continent and bilateral trade makes up nearly 20% of China’s total trade with the continent (Shinn & Eisenman 2012:349–350, in Grimm et al. 2014).

It is clear that the relations between SA and China are strengthened by the multilateral relations they hold. According to Molepolle (2015), the relations between China and SA at a multilateral level include the Forum on China-Africa Cooperation (FOCAC), G20, World Trade Organization and the G77.

Alden and Yushan (2014), highlight that, in 2012, the outgoing Chinese President Jintao stated that China and SA shared common interests in many international affairs, and that China hoped to cooperate with SA in the United Nations (UN), G20, BRICS and other international forums to reinforce the collective voice of developing countries and propel the international political and economic order into a more fair and reasonable direction. The mutual support between China and SA has been given concrete meaning through four multilateral forums, namely the UNSC, the FOCAC, BRICS and the G20.

Alden and Yushan (2014) show that SA worked together with China under the UNSC. This was a security council that tried to maintain peace in African countries. Alden and Yushan gave the case of Zimbabwe and sanctions as an example of where SA worked cooperatively with China to block Western inspired sanctions. Of particular significance from a South African perspective was the experience of working with China on African security, which for one diplomat involved with the SA mission underscored the willingness of the Chinese to genuinely seek out, consult and integrate South African (and African) views in formulating UNSC positions (Alden & Yushan 2014).

According to Alden and Yushan (2014), SA is also in a multilateral relationship with China through the FOCAC forum. With regard to FOCAC, SA involvement in the FOCAC process has from the outset been marked by a desire to ensure that African, or at least South African, perspectives are incorporated in the ministerial meetings (Alden & Yushan 2014). Meanwhile, Alden and Yushan show that South African officials in China, for example the ambassadors, are regularly lauded by Chinese officials as being the most active of delegates among the African ambassadors based in Beijing.

In an effort to upgrade to the comprehensive strategic partnership between China and SA, China invited SA to join the BRIC group (Xiong 2012). In 2006, this group officially became a diplomatic political entity called BRIC; SA officially joined in 2011 and the acronym was extended to BRICS. According to the Global Sherpa, cited in Provincial Treasury (2013), the formation of BRICS is an effort by its members to foster cooperation in order to meet global challenges, especially those faced by emerging economies. These countries’ collaboration is aimed at meeting the economic needs of this century which include infrastructure development, consumption and increased trade (Provincial Treasury 2013).

Through the BRICS grouping, SA has managed to work together with China. Regarding BRICS and global issues, the various summit declarations highlighted the fact that the BRICS countries shared similar needs, for example, for the democratisation of international institutions and an approach to climate change that took into account developing countries’ interests (Alden & Yushan 2014). On controversial foreign policy issues such as Libya (and later Crimea), while no conformity of position was expected, disagreements were expressed behind closed doors and not for the world to hear, to retain the image of BRICS unity; regular consultation, such as the meeting of BRICS foreign ministers at the Hague in the midst of the Ukrainian crisis in early 2014, reinforced this approach (Alden & Yushan 2014). These issues contributed towards a stronger relationship between SA and China.

Finally, as the only African member of the G20, the South African government has a privileged position to work with other leading economies in shaping a coordinated response to the global financial crisis (Alden & Yushan 2014).

It can be concluded that currently SA’s participation in BRICS is to a certain degree implicitly reliant on and intertwined with its bilateral relationship with China. South Africa and China’s relationship became strong after the formation of their bilateral relations. The relations at a bilateral level were created for example as a result of the Bi-National Commission (BNC) and its committees. Xiong (2012) shows that since the formal establishment of relations in 1998 and the creation of the BNC in 2001, trade and investment between China and SA have grown exponentially.

According to Xiong (2012), in December 2001, the president of SA inaugurated the first plenary session of the BNC where separate talks were held between the ministries and departments of foreign affairs, economic cooperation and trade, science, technology, energy and tourism. Since the inception of the Pretoria Declaration, there have been four BNC meetings from 2001 to 2010 (Xiong 2012). At the end of the second BNC meeting in 2004, the joint communique issued announced that the South African customs union would enter into free trade negotiations with China, further reintegrating the commitment to enhance south-south cooperation to safeguard the rights and interest of the developing world in multilateral forums such as the World Tarde Organization (WTO) and the UN as well as mutual support for FOCAC and the New Partnership for Africa’s Development (NEPAD) (Xiong 2012). According to the previous president of SA both countries shared common perspectives on the restructuring of the UN, the reform of the global trading system, and enhanced south-south cooperation, hence similar diplomatic sentiments were reiterated in subsequent BNCs with the business and investment forum growing a larger presence (Xiong 2012). Although the BNC was clearly a mechanism to process and organise the dialogue for technical cooperation, its existence provides both the countries a coordinated opportunity in which to hone, revise and further develop bilateral relations on specific issues.

China and SA seek to increase trade between one another. Both governments seek to further solidify and coordinate bilateral engagements through forming the comprehensive strategic partnership in 2010, which may be assumed to be one of the determining factors in the prelude to SA’s invitation into BRICS at China’s insistence (Xiong 2012). From 23 to 26 August 2010 China and SA further developed bilateral relations by upgrading to adopt a comprehensive strategic partnership.

According to Alden and Yushan (2014) the rapid growth in trade has been the result of a combination of the burgeoning bilateral friendship and of global factors, and these include China’s joining the WTO in 2001 and, with Pretoria’s formal recognition of China’s market economy status, its upgrading to a strategic partnership in 2004.

In 2005, negotiations to create a free trade agreement (FTA) – reportedly initiated by Beijing – began with SA’s DTI and hence the proponents of the FTA with China argued that it would help SA to correct the trade imbalance, improve employment and draw new sources of investment into the mining sector while others pointed out that it would offer more economic gains to SA and China while disadvantaging the other Southern African Customs Union countries, whose existing exports already enter China duty free, or nearly so (Alden & Yushan 2014). It was the latter concerns, coupled with the anticipated outcry by the trade unions aligned with the ANC, that caused the issue to languish and drop off the agenda; more recently; however, the FTA has again become a talking point between Beijing and Pretoria (Alden & Yushan 2014).

Alden and Yushan (2014) show that China became the largest bilateral trading partner of both SA and the Southern African region, overtaking countries such as the US. In 2013, the president of China visited SA in March and both countries signed the Terms of Reference for the Joint Inter-Ministerial Working Group, the purpose of which was to supplement mechanisms and coordinate the implementation of major projects and bilateral agreements (Alden & Yushan 2014).

According to the Presidency (2014), SA has signed several strategic agreements with the government of the PRC which aim to strengthen bilateral relations, trade cooperation and create sustainable investment opportunities between the two countries.

According to the Presidency (2014) the following agreements were signed:

One of the traditional trade theories is mercantilism. This theory shows that national wealth is reflected by the country’s holding of precious metals and trade is a zero sum game (Appleyard et al. 2010:18). A zero sum game is one in which one country benefits at the expense of its trading partners (a zero sum game is a game such as poker where one person’s winnings directly match another player’s losses) (Appleyard et al. 2010:19).

Appleyard et al. (2010:19) explain that the acquisition of precious metals thus became the means for increasing wealth and well-being and the focus of emerging European nation states, and hence a strong army, strong navy and merchant marine, as well as a productive economy were critical to maintaining and increasing the power of the state. This theory shows how countries used to trade. Trade was done by the use of power; rich nations tried to benefit at the expense of poor nations. It also shows that trade is not a mutually benefitial process. According to Levich (2001), the theory of mercantilism states that the world only contained a fixed amount of wealth and that to increase a country’s wealth, one country had to take some wealth from another, through having a higher import or export ratio. So, this tendency, to export more and import less and to receive in exchange gold (the deficit is paid in gold), is called mercantilism (Levich 2001). However, David Hume and his price specie flow model and Adam Smith and his invisible hand challenged the basic tenets of mercantilism.

According to Appleyard et al. (2010:22), David Hume and the price species flow mechanism challenged the mercantilism views of long-time trade surplus. He argued that the accumulation of gold by means of trade surplus would lead to an increase in the money supply and therefore to an increase in prices and wages and the increase would reduce the competitiveness of the country with a surplus (Appleyard et al. 2010:22). Hume argued that one country could not maintain a trade surplus for a long time since this surplus leads to an increase in money supply, which will increase domestic prices and hence lower exports and raise imports (Appleyard et al. 2010:22). This theory is important to this research, since it shows the automatic adjustment of the trade disequilibrium within a country. The theory states that a trade surplus (or deficit) automatically produces internal repercussions that work to remove that surplus (or deficit) (Appleyard et al. 2010:22). Therefore, upon engaging in trade, a nation will end up with a zero trade balance.

Adam Smith also critisised the mercantilism views and stated that a nation’s wealth is reflected in its productive capacity and trade is a positive sum game (Appleyard et al. 2010: 24). A positive sum game occurs when both countries benefit from their trade. Appleyard et al. (2010:24) indicates that Smith concluded that countries should specialise in and export those commodities in which they have an absolute advantage and should import the commodities in which the trading partner has an absolute advantage. Each country should export those commodities they produce more efficiently because the absolute labour required per unit was less than that of the prospective trading partner. According to Kilic (2002), if a country or individual is absolutely more efficient at the production of a good than another country or individual, then we say that they have absolute advantage in the production of that good. This theory shows that both countries engaging in trade will benefit from that. This theory is important to this research because it shows that trade is determined by the set of natural resources that a country has. These natural resources will determine the country’s absolute advantage. Moreover, as the country start trading, this model will show how commodities will flow to and from one country.

According to Appleyard et al. (2010:24), it is clear that Adam Smith argued that countries could trade, based on an absolute advantage in the production of only one set of commodities that the two countries are to exchange. Therefore, absolute advantage forms the basis of trade. The question is what if only one country has absolute advantage for both goods? According to Smith in that case there is no basis for trade because trading in these circumstances has no mutual benefits (Appleyard et al. 2010:26).

Ricardian comparative advantage challenged these statements made by Smith that there is no trade if one country has an absolute advantage in the production of both commodities. This theory does make it clear that even if a country is absolutely more or less efficient in the production of all commodities, a basis for trade still exists if there is a difference in the degree of relative efficiency across commodities (Appleyard et al. 2010:39). A comparative advantage exists whenever the relative labour requirements differ between two countries; this means that, the internal opportunity cost of the two commodities is different for the two countries prior to trade and both countries may gain if they undertake to trade using this base (Appleyard et al. 2010:33). Ricardian comparative advantage demonstrated that countries could trade using the basis of comparative advantage and gains from trade (Appleyard et al. 2010:40). According to Kilic (2002), if a country or individual is relatively more efficient in the production of a good than another country or individuals then we say that they have comparative advantage in production of that good. David Ricardo’s theory gave solutions to Adam Smith’s shortfalls. This theory is important to this research because it encourages a theoretical discussion of what determined trade in the past decades. This theory also shows the flows of commodities between two countries, triggered by the comparative advantage principle. The theory also shows that trade is a mutually beneficial transaction, where all parties engaging in trade come to benefit.

The Heckscher-Ohlin theory also supported the Ricardian comparative advantage theory. Heckscher-Ohlin assumes that relative factor intensities are different across commodities and that these differences are consistent across countries, which leads to pre-trade price differences (Appleyard et al. 2010:1310). The theory suggests that the country with abundant capital will be able to produce relatively more of the capital-intensive good, while the country with abundant labour will be able to provide to produce relatively more of the labour intensive good (Appleyard et al. 2010:133). The Heckscher-Ohlin theory states that a country will export the commodity that uses relatively intensively its relative abundant factor of production and it will import the good that uses relatively intensively its relatively scarce factor of production (Appleyard et al. 2010:135).

The Heckscher-Ohlin theory states that countries trade because of differences in the factor abundance and the factor intensities of the goods they produce (Markusen 2005:3). The differences determine which countries have comparative advantage over others. In a case where country (A) is capital abundant and country (B) is labour abundant, this is represented by: [(K/L)*A > (K/L)*B].

K represents capital factor, L represents labour factor, A represents country A and B represents country B.

The inequality shows that the ratio of capital to labour in country A exceeds the ratio of capital to labour in country B. Therefore, Appleyard et al. (2010:128) argues that if the inequality is like that, then country A will produce and export capital-intensive goods while importing labour-intensive goods from country B. This model is important to this research because it explains the basis for trade. It modifies Ricardo’s comparative advantage theory and shows the flows of commodities between two countries.

The new trade theory shows that trade happens not because of comparative advantage but the principal motives for trade are scale economies, imperfect competition and product differentiation (Markusen 2005:3). The new trade theories divert from the traditional theory assumptions that there were constant returns to scale, perfect competition and homogenous products.

The theory of intra-industry trade assumes that because of intra-industry specialisation, each country will import some products even in industries in which it is a net exporter, and vice versa; that is, there will be intra-industry trade (Krugman 1983:344). Countries that export and import items in the same product classification are engaging in intra-industry trade (IIT) (Appleyard et al. 2010:186). According to Appleyard et al. (2010:185) IIT was also an aspect of the Linder theory, since it argues that one country can have a comparative advantage and a comparative disadvantage regarding same product due to product differentiation. This theory helps us to show if any trade agreements between China and SA are effective. The effectiveness of trade agreements is shown by the presence of IIT.

The other model is the Krugman model. This model rests on two features, that is, economies of scale and monopolistic competition (Appleyard et al. 2010:187). Appleyard et al. (2010:187) shows that in Krugman, labour is assumed to be the only factor of production and the economies of scale (which are internal to the firm) are incorporated into the equation for determining the amount of labour required to produce given levels of output by a firm, as shown here: L = a + bQ.

L stands for labour needed by a firm, a represents a constant (technologically determined) number, Q represents the output level for the firm and b specifies the relation at the margin between the output level and the amount of labour needed.

Appleyard et al. (2010: 187) argue that the world market is characterised by the existence of the monopolistic competition market structure. In monopolistic competition, there are many firms operating, there are no barriers to entry and exit. In addition, firms earn zero amounts of profits in the long run. However, the output for these firms is not homogenous products. Appleyard et al. (2010:187) shows that the products differ from each other and each firm’s product possesses a certain amount of consumer brand loyalty. This product differentiation leads to advertising and sales promotion as firms attempt to differentiate their products in the minds of consumers (Appleyard et al. 2010:187).

To introduce international trade, suppose the home country is country X and the other country is country Y. Country Y is identical to country X in terms of its tastes, technology and other characteristics of factors in production (country Y might be identical in size) (Appleyard et al. 2010:188). Traditional theories could conclude that, with these same general supply and demand conditions (and hence relative prices), the two countries would have no incentive to trade with each other; however, Krugman (and Linder) would disagree (Appleyard et al. 2010:188).

Appleyard et al. (2010:189) show that when the two countries open up to trade, the important point to note is that the market size is being enlarged for each representative firm in each country, because there are now more potential buyers for every firm’s goods. When the market size is enlarged, economies of scale may come into play and production costs fall for all goods. If the firm being considered is in country X, the opening of the country to trade with country Y means that consumers in both countries are now consuming this product and country Y’s consumers now add country X products to their consumption bundles, just as country X’s consumers add country Y’s products to their consumption bundle.

As Krugman’s theory of trade patterns makes several very strong simplifications compared to the real world, it cannot be directly applied to empirics, as it is (Weckstrom 2013). However, this theory is useful to this research since it gives a more theoretical discussion that will assist us in understanding the international trade flows. It also explains the basis of trade if countries have economies of scale and if they are in a monopolistic competition market structure.

The Linder theory has also an important implication regarding trade. Linder is concerned only with manufactured goods. Linder implies that international trade in manufactured goods will be more intense between countries with similar per capita income levels than between countries with dissimilar per capita income levels (Appleyard et al. 2010:183). Trade, according to Linder’s theory, will occur in goods that have an overlapping demand (Appleyard et al. 2010:182). Linder’s theory is important to this research because it explains the composition and pattern of a country’s trade. Appleyard et al. (2010:183) show that the determination of the trading pattern by observing overlapping demands has important implications for the types of countries that will trade with each other.

The most important theory of trade that is relevant to the study is the gravity model of trade. According to Weckstrom (2013), the gravity model was first discovered in physics, when Newton found out that the gravity between two objects correlates with the masses of these objects and the distance between the objects. The same principle was found to work in international economics by Jan Tinbergen in 1962; he was interested in international trade flows that would prevail if no trade barriers were being used (Weckstrom 2013).

The Economic Watch (2010) explains that the gravity model of trade predicts the bilateral trade flows based on the economic sizes of (often using gross domestic product [GDP] measurements) and distance between two countries. The aim of this thesis is to predict the trade volume between SA and China and thereby use these results to test the trade balance hypothesis. Kowalski, Lattimore and Bottini (2009:35) show that in order to assess SA trade performance in a comparative framework, an econometric model based on the gravity model of international trade was developed.

The basic form of the gravity model is given as: F_sc = G (M_sM_c ÷ D_sc)

F_sc is the trade flow between SA and China, M_s and M_c are the GDP of SA and China, D_sc denotes the distance between SA and China and G is a constant.

Economic Watch (2010) argues that while the model in its basic form consists of factors that have more to do with geography and spatiality, the gravity model is used to test hypotheses rooted in purer economic theories of trade as well. The gravity model estimates the pattern of international trade. The gravity equation of international trade is often motivated using new trade theory models, which are models of increasing returns (Economic Watch 2010). Nowadays there is more trade between countries. The research uses this model to show trade flows between SA and China. It is important in modelling and understanding international trade flows.

According to Lipsey and Lancaster (1956–1957) in Snorrason (2012:15), the general theory of the second best states that if a constraint is introduced into a general equilibrium setting which prevents the attainment of one of the Pareto conditions, other Pareto conditions, although still attainable, are in general no longer desirable. Free trade means that there are no distortions in trade. Snorrason (2012:15) indicates that Pareto optimality is achieved exclusively under free trade so that other cases where there are distortions, for example tariffs, subsidies, taxes or monopolies, are suboptimal.

The theory of second best addresses this by stating that, in the presence of distortions, if not all the conditions for Pareto optimality can be satisfied, then the removal of some of the distortions does not necessarily increase welfare, nor does the addition of other distortions necessarily decrease it (Snorrason 2012:15). One suboptimal situation is replaced by another suboptimal situation and thus welfare may remain unaffected, increased or decreased. In a system with several distortions, the removal of any single distortion cannot be presumed to be improving welfare; thus, if an economy is prevented from attaining all the conditions for maximum welfare simultaneously, the fulfilment of one of these conditions will not necessarily leave the economy better off and this is the general theory of second best (Snorrason 2012:16).

The World Trade Report (2009:21) states that the main logic of the terms-of-trade (or traditional) approach is that countries that have market power (that can influence their terms of trade) cannot resist the temptation to act in their own interests. According to Jonhson (1954) in the World Trade Report (2009:21), in a situation where each country sets trade policy in an attempt to improve its terms of trade and increase national income, the result is a ‘non-cooperative equilibrium’ (known as Nash equilibrium) which is inefficient as the unilateral actions of countries cancel out one another. This situation, which is often referred to as a ‘prisoners’ dilemma’ driven by terms of trade, can be avoided through a trade agreement between countries allowing them to cooperate rather than act unilaterally (World Trade Report 2009:22). By cooperating in binding agreements to reduce their trade restrictions, countries overcome this inefficiency (Mayer 1981 in the World Trade Report 2009).

The commitment theory focuses on a domestic source of inefficiency. When setting trade policy, a government may be unable to make credible economic or political commitments to the private sector or the parliament (World Trade Report 2009:23). The lack of economic commitment leads to a so-called time-inconsistency problem and this is a situation where the decision of the government to implement a certain policy at some future time is not optimal when the future period arrives (World Trade Report 2009:23). In these models, the government wishes to use a discretionary trade policy to increase social welfare (for example, in response to unexpected events, or to allow temporary protection to an infant industry). However, the use of trade policy changes the behaviour of participants in the economy, that is, if agents anticipate the policy that the government will implement, they can react to it in a way that will reduce the impact that it has on them (World Trade Report 2009). This implies that the government will not be able to use a discretionary trade policy as intended, and this results in a socially inefficient trade policy.

The sequence of random variables is heteroscedastic if the random variables have different variances. On the other hand, a sequence of random variables with a constant variance are said to be homoscedastic. There are a number of formal statistical tests for heteroscedasticity. One such popular test is the white test for heteroscedasticity.

The test is useful because it has the secondary advantage of testing for specification bias which helps us assess whether the model is spurious or well fitted. After running the regression the residuals are obtained and then the test regression is established by regressing each product of the residuals on the cross products of the regressors and testing the joint significance of the regression. The null hypothesis for the white test is homoscedasticity and if we fail to reject the null hypothesis then there is homoscedasticity. If the null hypothesis is rejected then there is heteroscedasticity:

Reject H₀ if the white test result (n.R2~asyXdf2) is greater than the chi-square critical value.

The Lagrange Multiplier (LM) test centres on the value of the R² for the auxiliary regression. If one or more coefficients in an equation are statistically significant, then the value of R² for that equation will be relatively significant, while if none of the variables is significant, R² will be relatively low (Gujarati & Porter 2008). The LM test operates by obtaining R² from the auxiliary regression and multiplying it by the number of observations, T.

The test can be done by using the following identity: TR² ≈ X² (m).

In this identity, m is the number of regressors in the auxiliary regression (excluding the constant term), equivalent to the number of restrictions that would have to be placed under the F-test approach (Gujarati & Porter 2008).