China's Three Paths to Rebalancing

Source: Getty
Op-Ed Wall Street Journal
Rebalancing in China means by definition that the household consumption share of GDP must rise, and the only effective way to do this is by raising the household income share of GDP.
Related Media and Tools

 After rising for seven years, the yuan has dropped 1% against the dollar in 2012, setting off intense speculation about Beijing's intentions. The threat of a weaker yuan and the competitive devaluations it might inspire is raising worries in a world already struggling with low demand.

These worries are justified. Beijing urgently needs to rebalance its economy away from excessive reliance on investment toward more domestic consumption. Some Chinese policy makers evidently believe that by boosting China's competitiveness abroad, a weaker yuan will provide some relief from the sharp slowdown associated with rebalancing.

There is, however, a lot more to Chinese competitiveness than the exchange rate. In fact, three mechanisms explain the relatively low price of Chinese exports, all of which transfer income from Chinese households to subsidize Chinese producers.

The currency regime is certainly one of them. An undervalued currency spurs exports by subsidizing costs for local manufacturers. These subsidies are effectively paid for by Chinese households in the form of artificially higher prices for imported goods.

The second mechanism does the same thing, but with a different set of winners and losers. Chinese workers' wages have grown more slowly than productivity for most of the past three decades, which means that until two years ago workers received a steadily declining share of what they produce. Manufacturers benefit because wages are effectively subsidized. The more labor-intensive production is, the greater the subsidy.

The third mechanism, and by far the most important, is artificially low interest rates. These reduce household income by reducing the return on household savings, and increase manufacturing competitiveness by lowering the cost of capital, with more capital-intensive producers benefitting the most.

All these subsidies goose economic growth, but they distribute the benefits in different ways—to local producers, employers, or borrowers. They also distribute the costs in different ways—to households as importers, as workers or as savers.

These three mechanisms cause the economy to grow faster at the expense of households. That's the root of China's unbalanced economy: household income has grown so much more slowly than the economy that household consumption over the past three decades has collapsed as a share of GDP.

Rebalancing in China means by definition that the household consumption share of GDP must rise, and the only effective way to do this is by raising the household income share of GDP. But for all the noises Washington and others make about revaluing the currency, this isn't the only way. There are two other mechanisms at Beijing's disposal.

Consider who exactly wins and loses with each mechanism. Yuan appreciation will disproportionately help urban households—for whom import costs tend to be important. And it will disproportionately hurt manufacturers to the extent that their production inputs—mainly labor, land, logistics and raw materials—are priced domestically.

Raising Chinese wages will help household income too. It will disproportionately help low-paid workers, while disproportionately hurting labor-intensive manufacturers who tend to be small and medium enterprises.

But the best way to rebalance is raising interest rates. Of all the three mechanisms, this is the most important one, since it strikes at the heart of the imbalances generated by China's investment-led growth model.

By skewing the financial system, Beijing has managed to distort the whole economy which is built on that system. If the government hikes the cost of capital, the winners will be every saver, whose higher income will then allow him to consume more. The losers are the large capital-intensive companies, usually state-owned enterprises, who for too long have treated the banks as ATMs.

This mechanism can change incentives for everyone. For the sake of more sustainable and equitable long-term growth, it is almost certainly better if Beijing raises interest rates. Higher interest rates will reduce the incentive to invest in economically dubious projects that benefit local elites, and will force a more efficient allocation of Chinese savings.

Which path of rebalancing China chooses in practice will reflect domestic priorities and political maneuvering, though the good news is they'll all broadly have the same impact. Each path is painful, and they all ensure that China's export costs will rise and its foreign competitiveness will go down. In return, its domestic market will become a bigger source of demand. The world should not, in other words, be overly concerned with what happens just to the exchange rate.

This article was originally published in the Wall Street Journal.

End of document

About the Asia Program

The Carnegie Asia Program in Beijing and Washington provides clear and precise analysis to policy makers on the complex economic, security, and political developments in the Asia-Pacific region.




In Fact



of the Chinese general public

believe their country should share a global leadership role.


of Indian parliamentarians

have criminal cases pending against them.


charter schools in the United States

are linked to Turkey’s Gülen movement.


thousand tons of chemical weapons

are in North Korea’s possession.


of import tariffs

among Chile, Colombia, Mexico, and Peru have been eliminated.


trillion a year

is unaccounted for in official Chinese income statistics.


of GDP in oil-exporting Arab countries

comes from the mining sector.


of Europeans and Turks

are opposed to intervention in Syria.


of Russian exports to China

are hydrocarbons; machinery accounts for less than 1%.


of undiscovered oil

is in the Arctic.


U.S. government shutdowns

occurred between 1976 and 1996.


of Ukrainians

want an “international economic union” with the EU.


million electric bicycles

are used in Chinese cities.


of the world’s energy supply

is consumed by cities.


of today’s oils

require unconventional extraction techniques.


of the world's population

will reside in cities by 2050.


of Syria’s population

is expected to be displaced by the end of 2013.


of the U.S. economy

is consumed by healthcare.


of Brazilian protesters

learned about a massive rally via Facebook or Twitter.


million cases pending

in India’s judicial system.

1 in 3


now needs urgent assistance.


political parties

contested India’s last national elections.


of Egypt's labor force

works in the private sector.


of oil consumed in the United States

is for the transportation sector.


of Chechnya’s pre-1994 population

has fled to different parts of the world.


of oil consumed in China

was from foreign sources in 2012.


billion in goods and services

traded between the United States and China in 2012.


billion in foreign investment and oil revenue

have been lost by Iran because of its nuclear program.


increase in China’s GDP per capita

between 1972 and today.


billion have been spent

to complete the Bushehr nuclear reactor in Iran.


of Iran’s electricity needs

is all the Bushehr nuclear reactor provides.



were imprisoned in Turkey as of August 2012 according to the OSCE.

Stay in the Know

Enter your email address to receive the latest Carnegie analysis in your inbox!

Personal Information
Carnegie Endowment for International Peace
1779 Massachusetts Avenue NW Washington, DC 20036-2103 Phone: 202 483 7600 Fax: 202 483 1840
Please note...

You are leaving the website for the Carnegie-Tsinghua Center for Global Policy and entering a website for another of Carnegie's global centers.