Source: Bloomberg
The International Monetary Fund’s reduced medium-term forecast for China’s current-account surplus of about 4 percent of gross domestic product is belated recognition of recent developments. The adjustment may still turn out to be too high, but good luck telling that to U.S. politicians.
America’s trade deficit with China hit a record $295 billion last year. Protectionist sentiments are running high, with recent U.S. complaints filed with the World Trade Organization and passage in March of a countervailing tariff bill. Such measures have been accompanied by a familiar chorus calling for a major revaluation of the yuan to counteract China’s alleged currency manipulation intended to keep its exports cheap.
But to focus on China’s currency is to miss the real story behind the country’s trade surplus.From China’s perspective, admonitions that the yuan is substantially undervalued seem illogical. China’s current- account surplus has declined steadily from 10 percent of GDP five years ago to less than 3 percent last year and is projected by some to decline even further. Moreover, officials in Beijing are perplexed that after they allowed the yuan to appreciate by almost 30 percent since 2005, critics still say the currency is undervalued, as if nothing had happened. (China also recently widened the yuan’s trading band, suggesting that it is now more confident about the stability of its value.)
Trade’s Bigger Picture
Much of the confusion comes from focusing on the still huge U.S.-China trade imbalances, rather than looking at the trade picture from a global perspective.
The truth is that China’s surpluses are not driving America’s deficits. This is illustrated by differences in the timing of changes to both countries’ trade balances. The U.S. trade gap began increasing in about 1998 and peaked around 2005. China’s trade surpluses only began increasing around 2005 and peaked in 2008. This suggests that U.S. deficits and China’s surpluses are not directly related but actually reflect country- specific circumstances.
Three phenomena largely explain the emergence of China’s trade surpluses: surging American consumption and fiscal deficits that fueled import demand; a maturing East Asian production network centered on China; and the ratcheting-up of China’s savings rates.
The origins and consequences of the increase in U.S. consumption followed by growing fiscal deficits are well known. This part of the story has little to do with China but reflects U.S. political gridlock.
The role of the Asian production-sharing network began decades ago as Japan moved portions of its production base to Southeast Asia. China became central to that network with its 2001 accession to the WTO, which offered easier access to Western markets. At the same time, a massive infrastructure program strengthened China’s competitive position.
Despite substantial real wage increases of about 12 percent annually in China, labor productivity rose even more rapidly, making it profitable for multinationals to use the country as the assembly plant for the world. In that respect, the U.S. trade balance with China is really a regional, rather than a bilateral, issue.
Hiding Behind China
Processing exports (those with a high import content, facilitated by low import tariffs) now account for about half of China’s trade volumes but are responsible for the entirety of its surplus. Eighty percent of the value added for these components, however, is sourced elsewhere.
This relationship is captured in the swelling trade surpluses of South Korea, Japan and Taiwan with China. Together, they rose from $30 billion in 2000 to more than $200 billion in 2010. In other words, China’s trade surplus with the U.S. originates largely from this North Asian trio.
When U.S. President Barack Obama welcomed Lee Myung Bak, his counterpart from South Korea, to Washington last year, he commented approvingly that South Korea’s trade with the U.S. was in balance -- “as it should be.” What Obama should have done was congratulate Lee by noting that South Korea, along with several others, has been able to avoid U.S. criticism by hiding its trade surpluses behind the Great Wall of China.
Indeed, rather than complaining about China’s exports of relatively labor-intensive products, Americans should ask themselves why their country isn’t able to produce the high- tech, capital-intensive components coming to the U.S. from the North Asian trio via China. These activities command the skills and salaries more appropriate for American workers.
The trade balance is, of course, the difference between what an economy saves and invests. In that respect, the increase in household savings rates in China has had a significant impact on its surplus.
While many suggest that Chinese household savings rates rose because of welfare concerns and demographic shifts, the major determinant has gone unrecognized. Rapid urbanization and the movement of some 250 million migrant workers into coastal cities have changed the savings dynamics in China. Restrictive policies have denied these workers formal residency rights and thus repressed their consumption instincts. Consequently, in some cities, migrants’ savings rates are as much as twice that of established residents. And soaring wages in recent years have led to a sharp increase in savings and, in turn, amplified China’s large trade surpluses.
These surpluses only began to decline when China’s stimulus program after the 2008 financial crisis drove up investment rates. But such high investment rates -- at more than 45 percent of GDP, the world’s highest -- aren’t sustainable; instead, consumption needs to increase as a share of GDP.
Although official accounts don’t yet reflect this transition, it has already started: Rural incomes have been increasing faster than urban incomes, and rural households have lower savings rates. In addition, as more migrant workers move inland due to lower living costs and better job opportunities, they will also spur consumption.
Granting formal residency rights to migrant workers -- which is now under consideration -- would give consumption an even bigger boost, and lead to a surge that would eliminate China’s trade surpluses even as investment rates decline.
Financial markets typically focus on exchange rates in analyzing the prospects for China’s trade. But in so doing, they often discount the power of structural shifts that would moderate global trade imbalances in mutually beneficial ways and ease the push by China and the U.S. toward more protectionism.