China’s Rebalancing Act

Perhaps most important, China must now export more manufactured goods to finance imports of energy and mineral products. The worsening terms of trade have been a major factor contributing to the decline in the current-account surplus in recent years.

Nevertheless, despite the merits of its analysis, the IMF underestimates China’s progress in rebalancing. In my view, China’s rebalancing is more genuine – and more fundamental – than the Fund recognizes, and the prediction of an eventual rebound in China’s external surplus/GDP ratio will most likely turn out to be wrong.

First, the roughly 30% real exchange-rate appreciation since 2005 must have had a serious impact on exporters, reflected in the bankruptcy – as well as the upgrading – of many enterprises in coastal areas. Though the market shares of Chinese exports seem to have held up quite well, this is attributable to price-cutting in foreign markets, which is not sustainable. Over time, real exchange-rate appreciation will cause a shift in expenditure, making China’s rebalancing more apparent.

Second, China’s wage levels are rising rapidly. According to the 12th Five-Year Plan, the minimum wage should grow by 13% per year. Together with real appreciation, the increase in labor costs is bound to weaken the competitiveness of China’s labor-intensive export sector, which will be reflected in the trade balance more clearly in the coming years.

Third, China has made significant progress in building its social-security system. The number of people covered by basic old-age insurance, unemployment insurance, workers’ compensation, and maternity insurance has risen substantially. Moreover, universal medical insurance is emerging, and a comprehensive system for providing aid to students from poor families has been established. As a result, the motivation for precautionary saving has been weakened somewhat, while some researchers have found statistical evidence that the consumption rate is rising, which is supported by China’s emergence as the world’s fourth-largest importer of luxury goods.

Finally, the worsening of China’s terms of trade will play an even more fundamental role in reducing its trade surplus in the future. Given weak demand, which may be prolonged, Chinese exporters must accept increasingly thin profit margins to maintain market share. However, China’s large size and low per capita income and capital stock imply continued rapid growth in its demand for commodities. Thanks to supply constraints, China’s import bill for commodities and metals is likely to offset its processing-trade surplus in the near future.

In short, as long as China’s government is not so unnerved by the slowdown in output growth that it changes its current policy stance, the current-account surplus is more likely to continue to fall relative to GDP than it is to rebound in 2013 and thereafter. In fact, such an outcome is not only likely, but also desirable. After all, faced with infinite quantitative easing, being a large net creditor means being in the worst position in today’s global economy.

Yu Yongding was President of the China Society of World Economics and Director of the Institute of World Economics and Politics at the Chinese Academy of Social Sciences. He has also served as a member of the Monetary Policy Committee of the People’s Bank of China, and as a member of the National Advisory Committee of China’s 11th Five-Year Plan.

Copyright: Project Syndicate, 2012.

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