The World Banks shows just how a large a policy shift Martin Wolf (and Nick Lardy) are proposing for China
The World Bank estimates that net exports contributed 3.3 percentage points to China’s growth in q1, “broadly the same as in the second half of 2006 and higher than expected.” And from the accompanying figure (Figure 1), it sure seems like net exports contribution to growth is going up over time – not down.
I don’t know, but just maybe the RMB is undervalued in real terms? Big current account surplus. Large and growing contribution from net exports to growth. Merchandise exports up 30% y/y in the first four months of the year. Strong growth in Chinese exports to Europe (I don't need to mention that the RMB hasn't been stable against the euro over time), very rapid reserve growth …
That is why Martin Wolf’s eminently reasonable policy suggestions imply a very large change in Chinese policy. Right now, Chinese policy tends to restrain domestic demand growth to keep the economy from overheating while net exports contribute heavily to growth. Wolf – echoing Nick Lardy – thinks China should stimulate domestic demand to offset the potential drag on growth from a stronger RMB.
Wolf’s policy course makes sense to me. I increasingly suspect that China’s ability to hide the long-term costs associated with using the balance sheet of its central bank to provide a de facto subsidy to its export sector contributes to China’s ability to sustain its current policy regime. The benefits are visible (strong contributions from exports to growth, strong export growth, limited pressure on the least efficient tradables sectors because of the protection offered by an undervalued exchange-rate) and front-loaded, the costs are hidden and back-loaded.
But I still suspect that China is likely to respond to signs that the economy is over-heating – whether rising share prices or rising food prices – by taking administrative steps to try to curb lending, not by allowing much more RMB appreciation. That effectively means more of the same, not something new.
The World Bank makes another important point: a surplus from the processing trade is still a surplus. Sure, foreign firms get some of the profits – but that should show up in the balance of payments. Suppose a US firms sets up shop in China, importing some components from abroad, buying some components in China and exporting the finished product. China still exports more than it imports. That is positive for its balance of payments. The profits from this operation do go to the foreign investors – but that should show up in the income balance, which is part of the current account.
The World Bank’s Beijing team looked at the data, and found that the profits foreign firms operating in China earn aren’t big enough to offset the surplus on the processing trade. The Beijing office notes: “these profits appear modest, compared to the size of the trade surplus” before concluding “the economic impact of the trade surplus does not seem to depend much on the source.”
True. From a balance of payments point of view, China isn’t the same thing as Chinese firms. US firms operating in China who export more from China than they import into China from the rest of the world contribute to China’s trade surplus, not to the United States' trade surplus!
As usual there is much more in the World Bank Quarterly – including a discussion of the pace of RMB appreciation (slow through April, though it clearly picked up in May), China’s ongoing efforts to sterilize its rapid reserve growth (the central bank seems not to have done as much sterilization as it should have in January and February … ) and a long discussion of rising grain prices …
I fully agree with your analysis, unfortunately your solution (and Lardy and Wolf) is to suggest a mere structural transformation of the Chinese political economy (domestic demand or consumption driven growth) which (for a long list of reasons) is simply not going to happen. Political decision makers here doubtless realize the rmb is undervalued, realize the costs, know how many jobs will disppear if they revalue and choose to do nothing. My guess is the Americans will get them out of this mess by erecting tariffs. What jumped out at me in the WB report was the box on grain prices.
My biggest worry here is how difficult I think it will be to spur domestic demand in China to promote the kind og growth they have now. At least this will take some time which means that growth would have to go down on the back RMB appreciation. Now, I am not talking ageing here since this will take at least 20 more years to ripple through the system but even institutionally it will be difficult to get those thrifty households out of the box.
This does not I think merit currency manipulation and clearly the likes of China and Brazil should not at this point in their growth cycle be running high external surpluses. Incidentally, in relation to all this about reserve accumulation in which the US sees the big emerging markets becoming its biggest creditors I also read a recent piece in the Economist about sovereign wealth funds.
So, not only is China the biggest creditor in the US but also a major asset holder too. However, what also strikes me with these sovereign wealth (is this btw what you guys Voldemort in China’s case?) is that at some point in the future all this reserve accumulation will become zero sum, I mean where the hell is the yield going to come from? Here of course ageing comes in in the long run since pension funds are fast joining the party as well as private retail investors in local low yield environments (Japan anyone?) …
Re: Exchange rate and the RMB denominated portion of exports here is a comment on the contribution of local costs to export end price equals… 15% X 25%
http://app1.chinadaily.com.cn/fortune2005/ft050517p9n.pdf
Or the supply type of assets which will be available for purchase, along with limits to the amount and type of control that may, or may not, accompany ‘ownership’:
“…Big institutions… which have been pouring billions of dollars into hedge funds and other alternative investment vehicles, have become “disenchanted” with returns on traditional investments such as bonds and commercial real estate, said Michael Metz, chief investment strategist at Manhattan-based money management firm Oppenheimer & Co. So “money is almost forced to go into equities, which is a shrinking universe,”… With initial public share offerings by companies failing to make up for the shares sucked out of circulation by privatizations, buybacks and other deals, the U.S. stock market is experiencing its first two-year period of “declining net share issuance” in 15 years, according to Jeffrey N. Kleintop, chief market strategist for LPL Financial in Boston. He estimated that the supply of public shares overall has dropped by as much as 3 percent…”
http://www.newsday.com/business/ny-bztop5234027may29,0,5148518.story?coll=ny-business-print
How difficult would it be for China to set up a simple direct payment Social Security system?
They could draft something within a year I think. A very low overhead, simple system, similar to the US..
If the Chinese workers have no social insurance and fear disability/old-age poverty, they will continue saving 50% of their income which will migrate to the export sector eventually.
If they did this, as well as universal health care, it would spark much more consumption, which would naturally encourage the RMB to appreciate because of the inflation relief it would provide. And the US wouldn’t have to prod for it.
Hank Paulson should be pressing them on the social insurance issues, and appreciation would come naturally I think.
- and it would also have the advantage of not seeming manipulative or aggressive, simply asking them to take care of people and develop social insurance programs, and giving them assistance in designing them.
Instead of rapid currency appreciation which caused so many problems for Japan in the 80s which they are very weary of repeating.
The Japan analogy has been applied a bit too freely I think. China today isn’t Japan of the 80s. Japan of the 60s and 70s appreciated in real terms w/o causing itself trouble. Korea also let its real exchange rate appreciate without causing itself trouble in the 70s and 80s — and its trouble in the 90s was linked to an excess of s-term debt more than real appreciation. korea also has appreciated in the 00s (especially in 05/06), without following Japan into bubble land and trouble.
China itself appreciated in real terms from 95-02 — remember, the dollar itself appreciated then.
There are plenty of examples of real appreciations that didn’t lead to stagnation. And as importantly, there is a strong argument that the source of japan’s bubble was loose monetary policy that attempted to sustain higher growth than was possible after japan’s catch up phase had ended (and also to offset yen strength), not yen appreciation. if that is the case, china is dead set on following japan’s example in the worst way, tho its loose monetary policy is a by product of an effort to avoid yuan appreciation, not a by product of an attempt to offset yuan appreciation.
Setting up a social security system financed by dividends from the SOEs (At least in the short-term) would be a two-fer. Less business savings, and a social safety net that might encourage consumption …
Speaking of safety nets:
“…a large chunk of tradable Chinese shares are held by state firms and government agencies according to the China Economic Quarterly… Chinese population is estimated to own around 7% of shares vs about 50% for Americans. It’s difficult not to think of the phrase “Size Matters” when it comes to the potential for equities should this percentage rise….” - Andrew Busch Update, June 1, 2007
Knowing the objectives, risk tolerance and depth of the majority shareholders’ pockets matters too. Let them buy shares…
Am I the only one wondering why the World Bank may still be providing assistance to China?
“…Mr. Zoellick also suggested that the international community must rethink having the bank provide loans to countries like China that have access to global capital markets and possess huge foreign exchange reserves. The bank, he said, could move more into providing technical assistance to these countries…”
http://www.nytimes.com/2007/05/31/washington/31zoellick.html?ref=business
If such policies are successful in making China consume more of its output at home, are the Americans going to consume less? If so, which Americans, and how?
the Americans who need, and are loosing their own social safety nets?
RE — the answer to your question is yes. the mechanism is some combination of higher prices on Chinese goods and higher interest rates, as there will be less Chinese savings to finance the uS deficit. Either that or the US consumes the same but pays more (higher rates), inducing more savings elsewhere by crowding out investment elsewhere. the global current account has to balance.
And if only 7% of shareholders are Chinese citizens, the SOE isn’t exactly ’selling’ when it lists - and seems to be in a very good position to profit from the increase in the shareprice:
“The Chinese state is consistently missing out on billions of dollars of potential revenue because it sells companies at far less than what the market thinks they are worth, the World Bank said… ‘After the IPO, on the day those stocks get listed, very often there is a big increase in prices,’ Bert Hofman, the bank’s lead economist for China, told reporters as it released its quarterly update on the Chinese economy. ‘…it actually means if it is state property, that the government could have made a lot more money from the IPO, but it didn’t.’…” http://www.forbes.com/afxnewslimited/feeds/afx/2007/05/30/afx3768250.html
Methinks transfer pricing plays a role here. Tax planning, y’know:
The [World Bank] Beijing office notes: “these profits appear modest, compared to the size of the trade surplus” before concluding “the economic impact of the trade surplus does not seem to depend much on the source.”
To my knowledge, neither the World Bank or the IMF provided a lot of assistance to the developement of China.
China keeps the bank running:
“But even before that vote was taken, the bank had received a warning from China, the agency’s second-biggest customer, that it might halt future borrowings if Wolfowitz doesn’t rein in its anticorruption investigative practices.
Making loans to developing countries is central to the bank’s very reason for existence — so the threat to quit borrowing is a blow at its mission, and to the job security of some 26,000 World Bank bureaucrats, staffers and consultants around the world.
“The bank is desperate to keep its best clients,” Lerrick said. “Its status and power are at stake.”
China, for example, could easily repay its billions of dollars of outstanding loans tomorrow, Lerrick said. But the terms of borrowing have become so cushy — on some of those loans, for example, Britain even pays all the interest — that Lerrick said China “is happy to take the subsidy.”
http://www.foxnews.com/story/0,2933,261290,00.html
I’d like to raise a question, not directly related to this topic, but I think interesting in the context usually discussed in this blog (I hope the knowledge of posters here might provide some insight in other words). I raised the issue on Econbrowser, but I wonder whether people here might want to chime in.
Rather than paraphrase what I wrote over there, I’ll quote the relevant comments:
“It’s interesting to contrast US growth and German growth in the first quarter.
Personal consumption expenditures in Germany were strongly negative (mostly due to a VAT tax rise, but PCE wouldn’t exactly be strongly rising otherwise) while investment activity is brisk. In fact, German machine tools and plant equipment makers think this might be their best year since the late 60s! Capacity utilization is at 93%.
Meanwhile, in the USA, personal consumption expenditure is what kept the USA from recession territory while investment was pretty modest.
And all this despite what can only be called a pretty strong euro.
I guess my question is why have US manufacturers not benefited (much) more from strong global demand?”
Menzie Chinn:
“Iasius: There is some speculation that the rapid economic growth — in particular the resurgence in capital investment — has been centered in Europe, which draws most of its imports not from the United States, but elsewhere.”
“Menzie Chinn: “There is some speculation that the rapid economic growth — in particular the resurgence in capital investment — has been centered in Europe, which draws most of its imports not from the United States, but elsewhere.”
I guess my question was more related to the question of why this is occurring, not whether it is.
Is US manufacturing uncompetitive? And if so, what needs to be done?
This is related to my opinion that a significant part of the US trade deficit is not directly related to exchange rates or demand imbalances, but structural weaknesses of US industry that have escaped attention due to the otherwise strong US economy in the past years.”
Any comments?
iasius - would be interested in knowing if you may have read this link: http://app1.chinadaily.com.cn/fortune2005/ft050517p9n.pdf as shown further up on the comments page, and if may you find it to be helpful.
re: “From a balance of payments point of view, China isn’t the same thing as Chinese firms.”
The Bloomberg article Brad linked to in the previous post alternated between references to ‘foreign’ and ‘non-U.S.’ I was wondering if there may be a difference - ‘non-U.S.’ being not exactly ‘from the U.S.’, but not exactly from ‘foreigners’ either.
lasius — some “structural weaknesses” are XR rate related, in the sense that marginal new investment has gone to China and the like rather than the US, some are not. boeing in a sense under-invested several years ago (back when euro was weak) and isn’t in a position to sell all the planes the world wants now when dollar is weak. but it also looks to have made a couple of good calls — 777 is doing very well, 787 looks a better bet v. a380 right now and so on.
Re: Europe, Germany has specialized in capital goods production and right now there is tremendous demand for capital goods around the world. Europe also does much better in the Middle east and Russia than the US (pick your reason), and in eastern europe (europe’s periphery), lots of countries run current account deficits. all that has supported eurozone exports/ bop.
so I basically agree with menzie.
re: China daily — as a statement of Chinese views, it is helpful. As analysis,not so much. in order to be credible (in my view), you have to look at how Chinese trade with europe responded to the changes in the RMB/ euro and recognize that Europe’s share of chinese exports is rising (and us share falling) so the evolution of the RMB euro matters. The confusion of moves in the $/ RMB with moves in the broad real RMB is also a bit of problem, — and you need a theory about how Chinese trade responded to the RMB’s real depreciation from 02-04. i didn’t see much of that kind of analysis in the article. I think the imf’s analysis in the asian-pacific regional outlook is far better.
plus, i have trouble whenever i real “market playing a bigger role in XR determination” when the PBoC is intervening to the tune of $45b a month/ $2b a business day — and when the pace of rmb appreciations seems driven more by politics (pre-SED acceleration …) than anything else.
looking at the Busch quote about the participation of state entities in China’s stock market, if the state may think of itself as the market…
“if the state may think of itself as the market”
That is what happens during modern command economies. The traditional role of the state in ancient times wasn’t majorly different, but they understood the difference between State and Merchant. The State is overly worried about economics than being a spirtual leader.
thought spirtual leadership is religion’s domain…
>How difficult would it be for China to set up a simple direct
>payment Social Security system?
At least a decade, more likely two. People in developed countries tend to underestimate the difficulties in setting up a well run pension system. Just to give you two challenges. How do you collect the money when much of the economy is cash? How do you staff the system with clean honest officials that don’t take the money and run?
And the there is the question. Suppose there is a pension system in place. You’ve just changed the mechanism for pension, I don’t see how you’ve changed the cash requirements. Replacing the current system in which people put much into banks makes sense if you can argue that a centralized pension system will provide higher returns. However, there is no reason to believe that it will, and some good reasons to think that it won’t.
The existing government pension systems don’t give much confidence that they will work better. Existing pension systems have been centers of corruption and all sorts of funny business.
I’m also not sure that increasing spending in health and education will reduce “precautionary savings” but more spending on health and education has social good that is independent of its macroeconomic effects.