How to square the U.S.-China circle
Three is a nice long article in the New York Times by David Leonhardt, in which we learn, among other things, that Tim Geithner is actually an old China hand. Which should come in handy as he tries to right the bilateral imbalance between the two countries that has clearly become unsustainable.
Most writing on this subject, the Leonhardt piece included, concludes that the Chinese end of the solution lies in stimulating consumption demand in China, and reducing that country's ridiculously high saving rate. But the discussion typically ignores an important issue: the secret of China's growth is that it has made a rapid transition into producing tradables (mainly manufactures). If the correction in China's trade balance comes at the expense of slowing down this process of structural change, it will also result in a reduction in the economy's longer-term growth rate. This would be a bad bargain for China, and it is an important reason why the Chinese authorities have resisted a significant appreciation of their currency (which, in the absence of other compensating policies, would have the effect of reducing the profitability of investment in tradables).
So if growth in China relies on continued structural change in the direction of tradables, but the international context no longer allows a large external surplus, must the world have to choose between global macro stability and Chinese growth? Is there any way out of the conundrum?
Actually, there is, but we need to think a bit out of the box. The economics of the situation is actually pretty simple. If China wants a larger supply of tradables than the market equilibrium produces, it can achieve this by directly subsidizing the domestic production of tradables (through tax incentives or rebates or reduction in the cost of inputs), while letting the real exchange rate appreciate to equilibrate the external balance. Direct subsidies don't tax the domestic consumption of tradables the way that currency undervaluation does. Presto! We have both the structural change China needs, and the external balance the world economy requires.
Put differently, if China gives up the exchange rate as an instrument of industrial policy, it will need a substitute. Explicit industrial policies are the obvious substitute. Across the board spending by China on infrastructure and other things doesn't quite achieve the required goal, unless the spending is targeted on projects that disproportionately reduce the costs of producing tradables.
There are of course small details to worry about, such as the WTO's Agreement on Subsidies. But we do need to think creatively about squaring the circle in question, and I cannot come up with any other alternative.
If you want to read more about this, here's a paper that explains the argument in greater detail.
Read more at Dani Rodrik's Weblog
So you've found a new way for the Chinese to undervalue their labor which allows them to continue amassing wealth at the cost of jobs everywhere else - particularly in America.
How sweet.
Then there's the matter of Chinese industrial pollution which now exceeds America's and is growing exponentially (according to a recent Krugman article). Since the Chinese refuse to do anything about it (again according to Krugman) we can also dispossess America's rich to pay for the needed scrubbers. Public service, you know.
Seems to me that everyone would be better served if the Chinese were allowed to burn America's "progressives" instead of coal. We'd all feel SO much better.
May 16, 2009 12:16 PM | Reply | Permalink
You write of China:
"Direct subsidies don't tax the domestic consumption of tradables the way that currency undervaluation does."
Direct subsidies tend toward oversupply. So, not only would the Yuan get stronger and go further with a rescission of Chinese currency policy, but Chinese goods in China would become cheaper because of oversupply. Assumedly that would increase domestic Chinese demand for Chinese goods and bring new consumers into the market. Perhaps it would also increase Chinese demand for manufacturing infrastructure items. But what goods are you talking about? Doesn't that make all the difference in terms of the effects of trade balances taken together with currency balances?
Would the stronger Yuan would make Chinese goods more expensive to foreign buyers and thus create manufacturing opportunities for Western companies in their home markets? What goods would this be true for, and which would it not apply to, if I'm on target?
Correct me wherever I'm missing pieces of the puzzle here.
May 16, 2009 12:22 PM | Reply | Permalink
strike the second "would" in first sentence second paragraph.
May 16, 2009 12:26 PM | Reply | Permalink
First, China runs a smaller overall trade surplus with the world than it does with the United States. It runs a deficit with countries that supply it with commodities, such as coal, iron ore and crude oil, and it also imports significant capital goods from developed countries. Therefore, its ability to turn from exporting to internal consumption is limited - it has to pay for its imports.
Second, the paper give insufficient weight to US global economic policy. The rise of Japan 1950-1973, Korea (actually the "Asian Tigers") 1973-1990, and China 1990-2005 is at least partly due to US policy. Japan benefited from Korean War spending and on Washington's encouraging US companies to source goods from or make direct investments in Japan to develop it as a counterweight to the USSR in Asia during the Cold War. When Japanese companies began to successfully compete with US companies, there was a shift of Washington policy to redirect economic integration to the Asian Tiger economies. Later, when China began to open up, US companies flooded into the Guangdong province. This had the blessing of Washington, since it created a democratic capitalism beachhead adjacent to Hong Kong and it helped the competitiveness of US multinationals by giving them an even lower cost manufacturing base.
It would appear that this policy continues to shift, and that during the Bush administration Washington encouraged US companies to shift their focus to India in order to bolster India's development as a partner in the War on Terror.
China is now the target of negative commentary, as were the Asian Tigers prior to the 1997 Asian Financial Crises or as was Japan prior to the Financial Crisis of 1990. However, China's reserves (and Japan's) are big enough, and the US is now weak enough, that it is unlikely that Washington and Wall Street will be able to engineer a crises in China.
May 17, 2009 2:59 PM | Reply | Permalink
Merrill, thanks for some food for thought. US global economic policy when applied to China has long involved some gambling addiction. The gamble was that the Chinese regime and its core nationalists would acquiesce to democratic government with checks, balances, individual legal rights, and free markets. It hasn't happened except perhaps for certain privileged populations.
May 17, 2009 10:24 PM | Reply | Permalink
This article actually sounds pretty knowledgeable, but then –- as most China-policy articles do -– it heads for a “solution” that isn’t going to work.
Oh, it makes the usual mistakes (stimulating personal spending is not going to work in time to help out in this crisis, but is a great idea for the NEXT crisis), and the usual misunderstandings (excess savings are actually corporate, not personal), but on the whole, not bad.
It even notes that its own solution, letting the Renminbi appreciate while subsidizing exports is ILLEGAL under the rules of the World Trade Organization. Which, in the end, makes me wonder why the article was even written, let alone reproduced here.
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Mike7Woodson,
Yes, a stronger Chinese currency would make exported products more expensive in US dollar terms. To make it even easier to understand, just consider how many extra dollars it would take to fill up that Wal-Mart shopping cart. $40? $200?
Think of it as a tax hike on people who have to shop at those places. The congressman ordering out of the FAO Schwarz catalogue isn’t going to care, is he?
As for “creating manufacturing opportunities for Western companies,” that would be companies in Western India, Western Brazil, Western Mexico, Western Indonesia, Western . . . well, you get the idea.
Manufacturing for mass consumption in America is dead. Get used to it.
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Merrill,
You’re right about post-1950 US policy. Japan, Korea, China, et al, did everything we told them to do, and they did it really well.
Now, it seems, we don’t like them doing what we told them to do, and changing the rules just because the other guy starts to pull ahead just isn’t fair.
May 17, 2009 10:02 PM | Reply | Permalink
Manufacturing for mass consumption may be dead in the US for the speculative future, however, as other developed nations begin taking US market share away in intellectual property driven innovation markets, every kind of work that can be lured into hard hit areas will likely be entertained. It all depends how many non-manufacturing jobs go overseas as to how desperate people will be for any kind of work. If anyone has a crystal ball on that prediction, I'd be interested to hear of it.
May 17, 2009 10:30 PM | Reply | Permalink