CHINA'S GROWTH MODEL

According to some preliminary estimates (link), China's trade balance is on the course for a significant surplus this year. IMF's annual forecast of current account balance predicted China's trade surplus at $334 billion in 2010 or roughly 6.2 percent of China's GDP. The IMF's medium-term forecast suggests a growing trade surplus by 2015 when the surplus is estimated at a little more than 8 percent of GDP.

Recently, Dani Rodrik questioned (link) the persistence of China's mercantilism based on persistently low exchange rate. The partial fixation of the exchange rate then stimulates export-led growth model and, consequently, results in a large trade surplus which translates into foreign exchange reserves, thus enabling China's central bank to foster exchange rate intervention to defended the targeted yuan exchange rate against the U.S dollar. The implications of China's growth model extend beyond the scope of effects on country's economic growth, investment and current account balance. China's export-led growth model has tremendously affected the macroeconomic performance of developing nations. The exports of developing nations in the European, Japanese and U.S markets basically substitute, not complement, China's exports to the markets of advanced countries. The persistent lack of the appreciation of renmimbi thus forced the economic policymakers of other developing nations to either adopt the same model of exchange rate intervention or lose the export share in developing countries. This intuition is underlined by the theoretical and empirical support.

In 2007, Hausmann, Hwang and Rodrik demonstated (link) that the pattern of specialization by developing countries predicts the subsequent economic growth, suggesting that the share of exports in advanced countries is highly positively correlated with the rates of economic growth. If China shifted the main source of economic growth from export-led model to domestic consumption, the renmimbi would have to appreciate considerably. Contrary to the assertion that China's exchange rate undervaluation hampers the economic growth, industrialization and development prospects of developing nations, the OECD recently stated that developing countries would be hurt significantly if the renmimbi exchange rate were allowed to appreciate. There is also an empirical support for the particular assertion. The OECD recently estimated (link) that, if China's output grew by 1 percentage point, the output of developing countries would decrease by 0.3 percentage point.

The empirics supports the argument I mentioned earlier - China's exchange rate misalignment inevitably hinders the growth prospects and industrialization of developing countries. The essential question in the course of economic development is what is the best model of growth for developing countries to boost industrialization and development frontiers.

One possibility is the so called surplus model. Historically, growth models of low-income countries were primarily based on exporting natural resources to the rest of the world. Countries such as oil-rich gulf states, Botswana and Argentina became wealthy. Such growth model heavily depends on export demand in other countries. The most notable failure of this growth model is that it doesn't encourage the diversification of economic activity. Thus, countries such as Libya have sustained relatively high levels of GDP but, at the same time, rather depressing domestic indicators. For instance, Libya's GDP per capita is at almost the same level as Chile's GDP per capita, but Libya's unemployment rate is 30 percent - almost three times the average unemployment rate in countries with the same level of GDP per capita. When foreign demand deteriorates, these countries experience the Dutch disease - an overheating economic activity and overvalued exchange rates that discourage investment, entrepreneurship and typically result in higher unemployment rates.

Industrialization and economic development mostly depend on domestic structural change based on the adopting the institutions of macroeconomic stabilization and the rule of law. China's exchange rate policy of renmimbi undervaluation is a failed temporary growth model that is set on the unsustainable course. Without shifting the major engine of growth from export-boosting exchange rate undervaluation to consumption-based growth, Chinese economy will no longer be able to sustain high productivity growth rates. Letting the renmimbi appreciate by free floating could significantly boost the potential for institutional change in China and other developing nations. Therefore, the systemic abuse of macroeconomic policy by exchange rate undervaluation would no longer be feasible and the costs of failed exchange rate regime for developing countries would diminish substantially.

RENMIMBI APPRECIATION: AN UPDATE

Here (link) is an article by Barry Eichengreen discussed in the previous post.

RENMIMBI APPRECIATION

Barry Eichengreen wrote a thorough defence of China's exchange rate policy response to the global demands for letting the renmimbi appreciate and thus stimulate the reduction of US trade deficit.

US Treasury Department recently launched a series of initiatives which labelled China as a currency manipulator and a true source of America's widening trade deficit and loss of manufacturing jobs. I pretty much disagree with this particular assertion. China maintains a fixed exchange rate of renmimbi against the US dollar (6.83 RMB/1 USD). True, it is a very difficult empirical task to estimate the true exchange rate of the two currencies due to the fixed exchange rate. If Chinese policymakers let the renmimbi to float freely in global currency market, estimating the real exchange rate would be an easier task.

Low exchange rate against the USD stimulated a large surplus of foreign currency reserves and a large trade surplus from a significant export advantage againist foreign exporters. China's low GDP per capita is pretty much associated with country's sizeable share of investment in national income. Gradually, as Chinese GDP per capita will grow, the share of investment in GDP will correspondingly decline.

The macroeconomic cost of renmimbi appreciation is a daunting empirical task. Earlier estimates suggest that Chinese annual growth rate might be lower by 1-1.5 percentage point. Renmimbi appreciation would also induce Chinese growth pattern shift from investment and export-driven growth to consumption-based growth. It is only a sheer guess whether Chinese policymakers will embrace lower economic growth and a shift towards domestic consumption as the main engine of growth.

However, it would be foolish to mark China as currency manipulator and an ultimate source of US trade deficit and manufacturing loss. The latter can be solely explained by a change in productivity structure which offshored many of America's jobs and created even more jobs at home. The only feasible means of reducing US trade deficit is to cut a galloping fiscal deficit which, according to Congressional Budget Office (CBO), is likely to exceed 10 percent of the GDP in the medium term. A move to free-floating renmimbi exchange rate would yield substantial benefits for the world economy. However, China did a great jobs at ignoring Western political demands without any reliance on sound economic analysis

CHINA'S EXCHANGE RATE AND AMERICAN JOBS

Here's a brief Sunday reading list on the issue of China's exchange rate and US manufacturing jobs.

Simon J. Evenett and Joseph Francois on whether Chinese currency revaluation will create net jobs for the US economy (link).

William R. Cline's discussion of estimating the effect of renmimbi appreciation on American jobs (link).

Abdul Abiad, Daniel Leigh and Marco E. Terrones's analysis of cost of reducing large current account surplus (link).

Paul Krugman's discussion of Chinese exchange rate policy (link) (link)

CHINA'S EXCHANGE RATE POLICY

Paul Krugman (link) and Greg Mankiw (link) analyze the costs and benefits of China's exchange rate policy.

ECONOMIC RECOVERY AND THE FUTURE OF EUROZONE

Martin Feldstein offers some interesting thoughts on whether the eurozone will survive the economic recovery (link).

CHINA'S CURRENCY AND ECONOMIC GROWTH

Dani Rodrik wrote a nice article on the future prospects of China's currency and its industrial policy (link).

CHINA'S CURRENCY POLICY AND YUAN REVALUATION

The Economist published a thorough discussion (link) of China's currency policy and reasons why yuan is unlikely to revaluate any soon.