Throughout 2010, China was criticized by the US Congress (and many others) for “manipulating” its currency in order to maintain an advantage for exports, and thus preserve its trade surplus. China’s behaviour, it was alleged, was the source of today’s huge global imbalance.
China, however, refused to accept the blame and declined repeated US demands to undertake a large revaluation. The exchange rate of the renminbi against the dollar rose only around 3% between June and the year’s end. According to an analysis used by some US economists and politicians, the low rate of currency appreciation, combined with Chinese export growth of 31% in 2010 over 2009, should have increased China’s trade surplus by a wide margin.
In fact, China’s trade surplus decreased by 6.4% in 2010 compared with 2009. And that decline follows a 30% drop in China’s trade surplus in 2008, owing to the global financial crisis and subsequent recession. Overall, China’s trade surplus has decreased by 36% in absolute dollar terms, and has dropped by more than half (53%) in proportion to GDP over the past two years. So, the ratio of China’s current account surplus to gross domestic product (GDP) is down to 4.6%, significantly below the peak of 11.3% reached in 2007.
These data demonstrate conclusively that the “exchange-rate-centred” theory of trade imbalance does not match reality. China’s economy over the past two years has become much more balanced in its external trade relationships, despite there being no significant exchange-rate adjustments.
The reason, of course, is the strong increase in Chinese domestic demand. Total sales of consumer goods increased by 14.8% in 2010 and domestic fixed investment grew by 19.5%, both in real terms. As a result, in dollar terms, import demand grew by 38.7%, outpacing export growth of 31%. Simply put, if a country can improve its domestic balance, it will become more balanced externally, regardless of how little the exchange rate changes.
Can China reduce its trade surplus further while continuing to maintain its policy of “gradual appreciation” of the renminbi? Such an outcome is quite likely in the next years, during the period of the new five-year plan.
To begin with, several significant fiscal/taxation reforms are now under way or in the pipeline, such as an increase in the collection of state-owned firms’ dividends and a hike in the resource tax on industries such as oil and coal mining, in order to reduce corporate savings. There will also be cuts in personal income tax in the next few years in order to increase households’ disposable income.
In the new plan for 2011-2015, some binding targets are set for the social safety-net reforms. The social-security system will finally provide universal coverage, including the rural population and migrant workers in China’s cities. More public funds will be available for rural education and rural healthcare. More public services will be provided to newly urbanized rural migrants. All of these changes will increase household consumption in both the short and long term.
When all of these reforms are realized, China’s national savings rate may be reduced to 45%, from 51% currently. That will have a very significant effect in terms of reducing the current account surplus, which reflects net national savings.
Moreover, the Chinese government, at both the central and local levels, will remain keen to continue infrastructure investments aimed at further urbanization and industrialization. An ambitious plan for a national high-speed train system has been set forth. All major urban areas, including some tier II cities, are building public transportation systems to include more subways and light-rail networks.
Other urban facilities will also be in strong demand, because China’s urban population will continue to increase massively in the foreseeable future. Given that the urbanization ratio is still low, at 48%, a relatively high investment in infrastructure may be sustained for a long time. Those investments will drain most of the country’s domestic savings and sustain high demand for imports.
So, it seems likely that China’s current account surplus will dip below 4% of GDP before long—and probably go even lower, if not turn into an outright deficit. In other words, China could easily reach the target set by the “indicative guidelines” for reducing global imbalances by 2015, as proposed by US officials at the Group of 20 ministerial meeting in Seoul in November.
The key question is: what is going on with the US, which, after all, represents the other side of the great imbalance? The US current account deficit has been narrowing in recent quarters, thanks to export growth. That is good news. Moreover, it happened without much downward exchange-rate adjustment so far, owing to the weakness of the euro and some other key currencies.
The monetary easing undertaken by the US Federal Reserve raised expectations of a devaluation of the dollar that might help exports. But domestic savings remain low in the face of persistently high levels of public debt. Again, the fundamental cause of the global imbalance can be found in domestic structural problems on both sides. Exchange rates will play only a secondary role in rebalancing.
Fan Gang is professor of economics at Beijing University and the Chinese Academy of Social Sciences, director of China’s National Economic Research Institute, secretary-general of the China Reform Foundation, and a former member of the monetary policy committee of the People’s Bank of China.
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