China watchers are waiting to see whether the country has engineered a soft landing, cooling down an overheating economy and achieving a more sustainable rate of growth, or whether Asia’s dragon will crash to earth, as others in the neighborhood have before it. However, some, particularly US politicians in this presidential election year, focus on only one thing: China’s trade balance.
True, not long ago the yuan was substantially undervalued and China’s trade surpluses were very large. That situation is changing. Forces of adjustment are at work in the Chinese economy, so foreign perceptions need to adjust as well.
China’s trade surplus peaked at US$300 billion in 2008 and has been declining ever since. Indeed, official data showed a US$31 billion deficit last month, the largest since 1998. It is clear what has happened. Ever since China rejoined the global economy three decades ago, its trading partners have been snapping up its manufacturing exports because low Chinese wages made them super-competitive. However, in recent years, relative prices have adjusted.
The change can be measured by real exchange-rate appreciation, which consists partly in nominal yuan appreciation against the US dollar, and partly in Chinese inflation. China’s government should have let more of the real appreciation take the form of nominal appreciation (US dollars per yuan). Because it did not, it has shown up as inflation instead.
The natural price-adjustment process was delayed. First, the authorities intervened in 1995-2005 and again in 2008-2010, to keep the US dollar exchange rate virtually fixed. Second, workers in China’s increasingly productive coastal factories were not paid their full value (the economy has not completed its transition from Mao to market, after all). As a result, China continued to undersell the world.
Then the yuan was finally allowed to appreciate against the US dollar — by about 25 percent cumulatively during 2005-2008 and from 2010 to last year.
Moreover, labor shortages began to appear, and Chinese workers began to win rapid wage increases. Beijing, Shenzhen and Shanghai have raised their minimum wages sharply in the last three years — by 22 percent on average in 2010 and last year. Meanwhile, another cost of business, land prices, rose even more rapidly.
As costs rise in China’s coastal provinces, several types of adjustment are taking place. Some manufacturing is migrating inland, where wages and land prices are still relatively low, and some export operations are shifting to countries like Vietnam, where they are lower still. Moreover, Chinese companies are beginning to automate, substituting capital for labor, and are producing more sophisticated goods, following the path blazed by Japan, South Korea, and other Asian countries in the “flying geese” formation.
Finally, multinational companies that had moved some operations to China from the US or other high-wage countries are now moving back. Productivity is still higher in the US, after all.
None of this is news to most international observers of China. However, many Western politicians (and, to be fair, their constituents) are unable to let go of the syllogism that seemed so unassailable just a decade ago: 1) The Chinese have joined the world economy; 2) their wages are US$0.50 an hour; 3) there are 1 billion of them; and 4) Chinese wages will never be bid up in line with the usual textbook laws of economics, so their exports will rise without limit. It turns out that basic economic laws eventually apply after all — even in China.
Like certain other aspects of the US-China economic relationship, China’s adjustment is reminiscent of Japan with a 30-year lag. Japan’s trade balance fell into deficit last year, for the first time since 1980. Special factors have played a role in the last year, including high oil prices and the effects of the March earthquake and tsunami disasters. However, the downward trend in Japan’s trade balance is clear. Even its current account showed a deficit in January.
This development has received relatively little attention in the US and other trading partners, which is curious, given that, two decades ago, Japan’s big trade surplus was the subject of intense focus and worry — just like China’s now. At the time, some influential commentators warned that the Japanese had discovered a superior economic model, featuring strategic trade policy (among other attractions), and that the rest of us had better emulate them. Either that, or the Japanese were “cheating,” in which case we needed to stop them.
Most economists rejected these “revisionist” views and argued that Japan’s current-account surplus was large because its national saving rate was high, which reflected demographics, not cultural differences or government policies. The Japanese population was relatively young, compared with other advanced economies, but was rapidly aging, owing to a declining birth rate since the 1940s and rising longevity.
That view has been vindicated. In 1980, 9 percent of Japan’s population was 65 or older; now the ratio is more than 23 percent, one of the highest in the world. As a consequence, Japanese citizens who 30 years ago were saving for their retirement are now dissaving, precisely as economic theory predicted. As the national saving rate has come down, so has the current-account surplus.
China faces a similar demographic trend and also a push to unleash household consumption in order to sustain GDP growth. As in Japan, the downward trend in China’s saving rate will show up in its current account. The laws of international economics still apply.
Jeffrey Frankel is professor of capital formation and growth at Harvard University.
Copyright: Project Syndicate
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