Making Room for China
Dani Rodrik
CAMBRIDGE – China’s undervalued currency and huge trade surplus pose great risks to the world economy. They threaten a major protectionist backlash in the United States and Europe; and they undermine the recovery in developing and emerging markets. Left unchecked, they will generate growing acrimony between China and other countries. But the solution is not nearly as simple as some pundits make it out to be.
Listen to what comes out of Washington and Brussels, or read the financial press, and you would think you were witnessing a straightforward morality play. It is in China’s own interests, these officials and commentators say, to let the renminbi appreciate. After all, the Chinese economy can no longer rely on external demand and exports to sustain its remarkable growth, and Chinese consumers, who are still poor on average, deserve a break and should be encouraged to spend rather than save.
This story casts China’s policymakers in the role of evil and misguided currency manipulators, who, inexplicably, choose to harm not only the rest of the world, but their own society as well. In fact, an appreciating renminbi would likely deal a serious blow to China’s growth, which essentially relies on a simple, time-tested recipe: encourage industrialization. Currency undervaluation is currently the Chinese government’s main instrument for subsidizing manufacturing and other tradable sectors, and therefore promoting growth through structural change.
Before it joined the World Trade Organization in 2001, China had a wider range of policy instruments for achieving this end. It could promote its industries through high tariffs, explicit subsidies, domestic content requirements on foreign firms, investment incentives, and many other forms of industrial policy. But WTO membership has made it difficult, if not impossible, to resort to these traditional forms of industrial support. China’s tariffs declined precipitously in the late 1990’s, and many of the other inducements were also phased out. Currency undervaluation has become a substitute.
It is not just China that benefits from a competitive currency. There is a strong positive relationship across all developing countries between currency undervaluation and economic growth. But this relationship is much stronger in China, presumably because the productivity gap between the rural, traditional parts of the economy and the modern, industrial sectors is so huge.
The trouble with currency undervaluation is that, unlike conventional industrial policy, it spills over into the trade balance. It acts as a subsidy on the production of tradable goods (which is desirable), along with a tax on their domestic consumption (which is incidental and undesirable). Indeed, China’s current-account imbalance, which had remained moderate until the current decade, began its inexorable rise in 2001 – precisely when the country joined the WTO.
Given that WTO rules tie China’s hands on industrial policy, how much of a growth penalty would the Chinese economy suffer if the renminbi were to appreciate? My estimates, crude as they are, suggest a steep trade-off. An appreciation of 25% – roughly the extent by which the renminbi currently is undervalued – would reduce China’s growth by somewhat more than two percentage points. This is a significant effect, even by the standards of China’s superlative growth performance.
Most importantly, a slowdown of this magnitude would put China below the 8% growth threshold that its leadership apparently believes is necessary to avert social strife. No one knows where the 8% figure really comes from, and many experts believe that China’s society and polity are capable of handling much lower growth. But, even if political implications are put aside, it would be a tragedy if the most potent poverty-reduction engine the world has ever known were to experience a notable slowdown.
To be sure, other countries that relied on exports to grow rapidly – such as Germany, Japan, and South Korea – eventually had to let their currencies appreciate. But China is still a very poor country, at barely one-tenth the income level of the US. It has a huge reservoir of surplus labor in the countryside. In addition, China must live with restrictions on its industrial policies that none of these other countries, in pre-WTO days, had to abide by.
So we are left, it seems, with two equally unappetizing options. China can maintain its currency practices, but at the risk of large global macroeconomic imbalances and a major political backlash in the US and elsewhere. Or it can let its currency appreciate, at the risk of inducing a growth slowdown and political and social unrest at home. It is not clear that advocates of this option have fully comprehended its potentially severe adverse consequences.
There is, of course, a third path, but it would require re-writing the WTO’s rules. If China were allowed a free hand with industrial policies, it could promote manufactures directly while allowing the renminbi to appreciate. This way the increased demand for its industrial output would come from domestic rather than foreign consumers.
It is not a pretty solution, but it is the only one. The great advantage of industrial policies is that they enable growth-promoting structural change without generating trade surpluses. They are the only way to reconcile China’s continued need for industrialization with the world economy’s requirement of lower current-account imbalances.
Dani Rodrik, Professor of Political Economy at Harvard University’s John F. Kennedy School of Government, is the first recipient of the Social Science Research Council’s Albert O. Hirschman Prize. His latest book is One Economics, Many Recipes: Globalization, Institutions, and Economic Growth.
Copyright: Project Syndicate, 2009.
www.project-syndicate.org
For a podcast of this commentary in English, please use this link: http://media.blubrry.com/ps/media.libsyn.com/media/ps/rodrik38.mp3
You might also like to read more from Dani Rodrik or return to our home page.
|
|
manfredkissling 03:09 15 Dec 09
I think Chinese central planners think they can short-cut corners, outsmart the system and put their growth on steroids. In the short term, it seems they are -the same way the Soviets did back in the 50's and 60's- however in the long term the manipulation of the markets will bear a huge cost to them. Time will tell.
tvselvakumaran 12:33 24 Dec 09
A better solution for the problem of accommodating China's rapid growth
In his latest Project Syndicate article, "Making Room for China", Professor Dani Rodrik proposes an excellent idea for enabling the national economies of the world to accommodate the rapid growth of China. We analyze the implications of his proposal, by first assuming ideal circumstances in the geo-political arena. For this purpose, we consider China's imports, exports and domestic consumption using three different measuring units -- the total volume, the value in dollar terms and the value in yuan terms.
Professor Rodrik's proposal is that the World Trade Organization (WTO) relax its rules for China. As a result, over the course of the next few years, the Chinese government enacts a system of subsidies and other incentives to encourage its domestic industry. Presumably, these subsidies and incentives are directed towards keeping the price levels of those goods that China exports stable in dollar terms, and they do not directly affect wage levels (in yuan terms) of China's domestic consumers. Simultaneously, the Chinese government allows the Renminbi-yuan to appreciate in value against the dollar. Moreover, this appreciation against the dollar would also reverse the depreciations of the yuan against the other currencies of developing countries. Recall that these depreciations of the yuan had resulted from the dollar's recent depreciations against these other currencies, with the yuan pegged against the dollar.
The expected net effect on China's exports from these twin factors of industrial encouragement policy and currency appreciation is that these two factors would cancel each other out. Specifically, the total volume of China's exports follows the same growth path over the next few years that it would follow if there would not be any change in the dollar-yuan exchange rate and in China's industrial policy. Moreover, the value of China's exports in dollar terms as well as the value in yuan terms would also have followed the same growth path as the one that would have resulted with no change in the dollar-yuan exchange rate and in China's industrial policy.
On the other hand, the net effect on China's imports is a different story. Because of the yuan's appreciation against the dollar, foreign goods would be cheaper in China's domestic markets. Some high quality foreign goods that are used for business investments and construction do not have direct substitutes among locally produced goods. Examples of such goods include heavy machinery, software, hi-tech gadgets, foreign cuisine, travel abroad and pharmaceuticals. Moreover, commodities like oil, metals and other inputs for industrial production would be cheaper. The import of these goods would increase more than otherwise, when measured in terms of volume as well as in dollars, even if in terms of yuans, the increase in spending on these imports would only follow the existing trend.
Next, to understand the implications of Professor Rodirk's proposal for China's domestic consumption, we classify the Chinese income-earners into three categories. The first category comprises of agricultural workers. These people reside predominantly in the rural areas. Their incomes are very low, and their consumption is only at the level of subsistence. Neither their incomes nor their consumption behavior would be affected, in any significant way, by the marginal changes in the exchange rate or industrial policy that are proposed by Professor Rodrik.
The second category comprises of the millions of workers who have recently migrated, say in the last five years, from the rural areas to the cities. These people have left behind their traditional jobs in agriculture. They are now invariably employed as factory-hands, semi-skilled laborers, skilled technicians, supervisors and in other jobs that require comparable skills.They are currently undergoing the process of 'learning-by-doing' in an industrial setting, in marked contrast to their earlier slow rhythm of agricultural work. Their income levels are showing rapid increases. Their expenses now are far higher than what their former rural lifestyles had accustomed them to. For example, rent, food and daily commute incur large expenses in the cities, whereas in the villages these facilities are practically free.
However, the consumption behavior of these people still displays a large degree of caution. These people spend only on what they think is essential. They are highly cost-conscious shoppers. The consumption of foreign goods would increase among these people, to the extent that some foreign-made goods are cheaper, than equivalent domestically produced goods, as a result of the yuan's appreciation. One would suppose that this situation would benefit China's neighboring developing countries that export low cost goods to China. However, it does not seem possible that when the whole of China's annual imports is considered, that this substitution of cheaper foreign goods, as a result of exchange rate changes, would be a major influential factor.
The third category of income-earners have had first hand experience of China's industrialization for many years now. These people form the upper levels of China's middle class. They are employed as factory managers, businessmen, bureaucrats, politicians, company executives and other positions holding comparable social status. They have the financial means to make down-payments on apartments, cars, motor-cycles, house-hold appliances and other durable goods. For these people, foreign goods add variety and luxury to their consumer experience. Cost-consciousness is not the deciding factor when its comes to consumption of foreign goods among these people.
Now, as mentioned above, the income levels (in yuan terms) of all three categories of domestic consumers in China are not directly affected by the changes in the foreign exchange rate or the domestic industrial policy. Even so, the drop in prices of foreign goods due to the appreciation of the yuan would lead to much larger increases in the consumption of foreign goods in the third category of consumers. Thus total consumption of foreign goods would show marked increase in volume than they would show without Professor Rodrik's proposal. There would be a proportionate increase in the value of the foreign goods consumption in terms of dollars. However, the value in yuan terms would show a milder increase because of its appreciation against the dollar.
In summary, China's total imports in dollar terms would show an accelerated increase, mainly due to (i) changes in consumption behavior among the third category of consumers, in proportions that are significantly larger than the proportion of yuan appreciation, and (ii) increased usage of high quality foreign goods in business investment and construction, that is proportionate to the yuan appreciation. Recall from above that China's exports would remain largely unaffected by Professor Rodrik's proposal. Consequently, China's trade surplus would shrink at a faster pace than otherwise. Moreover, since the increase in imports is directed towards the larger than normal increase in consumption among the third category consumers, the production of domestic goods is not affected. Hence, China's annual GDP would continue on a 8%+ growth path, as per the current trend.
*******************************************************************************************************
Now, for the caveats. The trouble with Professor Rodrik's proposal is that there is no effective way to monitor this exchange between the China and the Western powers. The Western powers would like to have the yuan appreciated against the dollar. So, as Professor Rodrik proposes, say they agree to relax some of the WTO rules. But then, what if political pressure from the party bigwigs in the different regions of China prevents any significant appreciation in the yuan? Resisting the yuan's appreciation against the dollar could turn out to be an issue of national pride for China's middle class that is rapidly becoming highly sensitive about national pride and cultural identity.
Secondly, the Chinese government has announced its intention to promote the yuan as a currency of wide international use within the next decade or so. In that case, it would not be so easy for the Chinese government to control the exchange rate value of the yuan. As long as the only users of the yuan in international currency markets were the exporters from China, all the Chinese government had to do was to collect the dollars from these exporters' revenues from abroad and give them a proportionate amount of yuans in return. This would have held the yuan-dollar exchange rate fixed. But if major economies in Asia and currency traders elsewhere come to use yuan in large quantities, then the movement of the yuan-dollar exchange rate would be far more unpredictable.
*******************************************************
Finally, we provide a better solution for the accommodation of China's rapid economic growth among the other nations of the world. The first point to note is that global imbalances are a matter of direct concern only for policy-makers. The common people are not directly affected by these imbalances. They are far more concerned about their employment and their income levels. Thus the large trade surpluses that China runs up by exporting goods to the developed countries affects the political situation only to the extent that it leads to unemployment and income stagnation for workers in the advanced countries. We address these issues directly in our solution.
The rapidly growing Chinese economy is capable of absorbing a few million workers from America who could join the third category of consumers in income levels and standard of living. Millions of Americans could be employed in China as teachers of the English language, sports coaches, political and media consultants, skilled factory workers, mid-career managers, hi-tech engineers, fashion designers, company executives and so on. Besides there is a huge craze among Chinese consumers for American goods -- American food, fashion clothing, Hollywood movies, etc. So there is a demand for Americans working as 'cultural ambassdors' in China.
Historically, thousands of Chinese workers had migrated as early as the mid-nineteenth century to build the railroads in America. They had settled down in the Chinatowns across various cities in America. On the other side, Cancun in China has had settlements of Western traders for nearly two centuries. Elsewhere in China, missionaries from Western countries have preached Christianity for more than a century. During the Boxer Rebellion, local Chinese fanatics had murdered missionaries. It is important to prevent such dangerous mis-understandings during the current phase of globalization. If high unemployment persists for long in the developed countries, there would be a spontaneous global migration among workers in the rich countries to China. The role of the governments is to anticipate and facilitate this migration, and provide for the safety of these millions of people who have migrated in search of employment and better standard of living.
*******************************************************
Missourian 07:21 11 Dec 09
What exactly is meant by the WTO rules on industrial policy? If they -- whatever they are -- were effective at all wouldn't they have slowed China's breakneck development to date?
In fact, the weakness of the exisiing rules on subsidies in particular are a central part of the problem. Indeed, any trade-based rule is likely to be increasingly less relevant, the more China relies on growth that's led by domestic consumption. In effect, the WTO gives China nearly absolute freedom to deploy its trillions of dollars of slush funds as it deems fit, especially so long as there is no direct link to exports.
A better argument would have been that China needs to abandon its beggar-thy-neighbor currency policy and the US needs to adopt a smart industrial policy. The WTO wouldn't be much of a constraint for the US either, so long as it relied on generally available incentives (expense new investment, tax consumption rather than income) instead of piling on new subsidies for favored technologies and business groups.