Fri, Apr 01, 2011 - Page 9 News List

Change in China’s economic policy brings unknown knowns

By Martin Feldstein

China’s new five-year plan will have important implications for the global economy. Its key feature is to shift official policy from maximizing GDP growth toward raising consumption and average workers’ standard of living. Although this change is driven by Chinese domestic considerations, it could have a significant impact on global capital flows and interest rates.

China’s high rate of GDP growth over the past decade has, of course, raised the real incomes of hundreds of millions of Chinese, particularly those living in or near urban areas. In the same way, the funds that urban workers send to relatives who remain in the agricultural sector have helped to raise their standard of living as well.

However, real wages and consumption have grown more slowly than China’s total GDP. Much of the income from GDP growth went to large state-owned enterprises, which strengthened their monopoly power. In addition, a substantial share of China’s output goes abroad, with exports exceeding imports by enough to create a current-account surplus of more than US$350 billion over the past year.

China now plans to raise the relative growth rate of real wages and to encourage increased consumer spending. There will also be more emphasis on expanding -service industries and less on manufacturing. State-owned enterprises will be forced to distribute more of their profits. The rising value of the yuan will induce Chinese manufacturers to shift emphasis from export markets to production for markets at home, just as the government plans to spend more on low-income housing and to expand healthcare services.

All of this will mean a reduction in national saving and an increase in spending by households and the Chinese government. China now has the world’s highest saving rate, probably close to 50 percent of its GDP, which is important both at home and globally, because it drives the country’s current-account surplus.

A country that saves more than it invests in equipment and structures (as China does) has the extra output to send abroad as a current-account surplus, while a country that invests more than it saves (as the US does) must fill the gap by importing more from the rest of the world than it exports. A country with a current-account surplus has the funds to lend and invest in the rest of the world, while a country with a current-account deficit must finance its external gap by borrowing from the rest of the world. More precisely, a country’s current-account balance is exactly equal to the difference between its national saving and its investment.

The future reduction in China’s savings will therefore mean a reduction in its current-account surplus — and thus in its ability to lend to the US and other countries. If the new emphasis on increased consumption shrinks China’s savings rate by 5 percent of its GDP, it would still have the world’s highest saving rate. However, a 5 percentage point fall would completely eliminate China’s current-account surplus. That may not happen, but it certainly could happen by the end of the five-year plan.

If it does, the impact on the global capital market would be enormous. With no current-account surplus, China would no longer be a net purchaser of US government bonds and other foreign securities. Moreover, if the Chinese government and Chinese firms want to continue investing in overseas oil resources and in foreign businesses, China will have to sell US dollar bonds or other sovereign debt from its portfolio. The net result would be higher interest rates on US and other bonds around the world.

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