The west is wrong to obsess about the renminbi
By Michael Spence 2010-01-26 China is being pressed to revalue its currency. It is a mistake to become obsessed by this. What the global economy needs is for China to grow and for its current account surplus to fall.
Some (inside and outside China) see this as a static zero-sum game for global market share. This is unhelpful. The main issues are growth and the restoration of global demand. The latter is in short supply because of the rise in US savings, caused by the crisis but likely to persist. China has a big contribution to make – in the order of a third of the deficit in global demand. Its high growth figures and rebounding trade, with imports outgrowing exports, suggest the crisis policies are working. But they may have to be reined in to avoid overheating, inflation and asset bubbles. Further, surpluses serve no strategic purpose in a developing country that is fully financing its investment.
The singular focus on the exchange rate appears based on the assumption that it is the key cause of the surplus and the main policy instrument for removing it. The reality is more complex. Reducing the surplus in China involves deep structural change, much as reducing the US deficit does. The high savings in China are embedded in the structure of the economy. The government controls too much income directly and through ownership of the state-owned enterprises. Household income at 60 per cent of gross domestic product is way below international norms and household saving at 30 per cent of disposable income is high. This puts household consumption in the range of 40-45 per cent of GDP. A significant change in both these ratios is needed to sustain growth, make better use of the now large domestic market and guide the structural change in the economy associated with the middle-income transition, and to reduce the surplus without damaging growth.
Without these structural changes, if the currency were floating and convertible (no capital controls), the outcome is most likely to be continued high savings, a trade surplus matched by an outflow of private savings to foreign investments and slow growth. Exchange rate appreciation by itself will not get rid of the surplus.
Rapidly rising domestic demand is essential to sustaining high growth in China. The traditional export sectors are in decline anyway. Incomes are rising. Comparative advantage is shifting to high value-added sectors. Domestic demand and new export sectors are needed to drive growth and guide the structural transformation of the economy, much of which is in the complex middle-income transition. In this dimension, China's economic interests and global ones are aligned. The excess savings are in the order of 10 per cent of GDP. That needs to turn into household consumption.
It is understood within China that an appreciating currency is needed to sustain pressure for structural change on the supply side. Insufficient appreciation will cause the structural shifts to stall. That will impact productivity growth and incomes.
There are vested interests in China in the status quo. The crisis may have temporarily strengthened their hand. They too tend to hold a static zero-sum version of the issue. Pressing for exchange rate appreciation strengthens their hand. But this resistance is temporary. No one thinks that the transition to advanced country incomes in the next two decades will be built on export-oriented, relatively low value-added, labour-intensive, manufacturing-processing industries.
Will an appreciating currency leave the large rural population few options to advance as labour-intensive exports decline? It is a concern inside China. At this stage of growth, neither a pegged exchange rate nor subsidies are desirable. The export-led manufacturing sector – a big employer in earlier stages of growth – will not be the main source of jobs in the future. That will come instead from the domestic economy, the growing middle class and services they consume.
So China's growth will require structural change, a shift to the domestic market, the elimination of the current account surplus and an appreciating currency. To be fair, one can view the exchange rate as a trigger for deeper structural reform. The problem is the signal being sent. A narrow focus on the exchange rate signals an incomplete understanding of the complexity of the transition. It plays into the hands of the zero-sum proponents inside and outside China.
The writer received the 2001 Nobel memorial prize in economics and chairs the Commission on Growth and Development