The US economist Herbert Stein once said that if something cannot continue forever, it will not. In the case of imbalances between China and the West, however, the cut-off point still looks to be a long time in the future.
Five years ago, many people warned that excess spending in the West and undervalued exchange rates in Asia were producing unsustainable imbalances. From 2005 to 2008, China’s bilateral surplus with the US increased by 41 percent, and its trade surplus with Europe more than doubled. After falling in 2009, China’s surplus with the US and Europe increased by 32 percent and 16 percent respectively last year.
Someone who fell asleep in August 2008 and woke up last year would probably never guess that there had been any interruption whatsoever in China’s burgeoning imbalances with the West.
These surpluses are generated primarily within East Asian production networks. Multinational corporations in Japan, South Korea and elsewhere ship sophisticated parts and components to China for assembly and re-export to developed countries. The China Customs Agency classifies this type of trade as “processing” trade. Last year, China ran deficits of more than US$100 billion in processing trade with East Asia and surpluses of US$100 billion with Europe and US$150 billion each with the US and Hong Kong. Its global surplus in processing trade last year totaled US$322 billion.
While rebalancing is not taking place in processing trade, it is occurring in “ordinary trade” (China’s other major customs regime). Ordinary exports are produced using Chinese factors of production, and ordinary imports are intended for China’s internal market. China’s balance in ordinary trade shifted from a surplus of US$38 billion in 2005 to a deficit of US$48 billion last year.
Researchers at the Centre D’Etudes Prospectives et D’Information, analyzing China’s ordinary trade using data up to 2007, found that Europe (especially Germany) exported large volumes of automobiles and other consumer goods to China.
Moreover, East Asian countries exported increasing quantities of parts and components and capital goods to foreign-owned enterprises in China that produce for the local market.
By contrast, the share of ordinary US exports to China shrank, suggesting that China’s rebalancing is likely to be associated with continued large bilateral surpluses with the US.
Subsequent data indicate that this pattern is continuing. Last year, China’s ordinary-trade balance recorded a US$71 billion deficit with East Asia and surpluses of US$44 billion and US$23 billion with the US and Europe respectively. Europe’s ordinary exports to China increased from US$85 billion in 2009 to US$115 billion last year.
By contrast, the US’ ordinary exports to China increased more slowly, from US$50 billion in 2009 to US$64 billion last year. Thus, firms in East Asia and Europe are benefiting more than firms in the US from increasing demand in China.
According to China Customs Statistics, the US’ combined bilateral deficit in processing and ordinary trade last year totaled US$186 billion. However, this understates the size of the deficit, because the lion’s share of China’s processed exports to Hong Kong are trans-shipped to advanced economies (which means that Europe’s bilateral deficit is significantly higher as well).
By contrast, US data treat goods coming from China via Hong Kong as being exported from China, yielding a bilateral trade-deficit figure of US$273 billion, up from US$203 billion in 2005.
Many researchers warned in 2005 that imbalances between the US and East Asia were unsustainable, saying that they were driven by excess spending in the US and undervalued exchange rates in East Asia. Excess spending was fueled by deterioration in the US fiscal balance, from a surplus of 2 percent of GDP in 2000 to a deficit of 4 percent of GDP in 2004. Undervalued exchange rates in Asia were supported by accumulated reserves of almost US$1 trillion in China, plus hundreds of billions of dollars elsewhere in the region.
Since 2005, US budget deficits have increased by another 6 percent of GDP, while China’s external reserves have increased by US$2 trillion. It is likely that at some point investors will be unwilling to continue lending to the US at low interest rates, and that China will regard continued reserve accumulation as a bad investment. At that point, the US trade deficit will shrink.
If imbalances between the US and China are thus unsustainable, it makes sense for policymakers to pursue a soft landing. In the case of the US, this requires recognizing that the government faces a budget constraint. For China, it means redirecting saving away from reserve accumulation toward cash-strapped small and medium-size enterprises, as well as much-needed investments in education, healthcare and affordable housing.
Willem Thorbecke is a senior research fellow at the Asian Development Bank Institute and a consulting fellow at Japan’s Research Institute for Economy, Trade and Industry.
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