An Alternative Take on China’s Exchange Rate

An interesting argument appeared in the Financial Times by Yukon Huang, a senior associate at the Carnegie Endowment and former country director for the World Bank in China. Mr Huang takes issue with the allegations, most forcefully voiced by the Nobel prize winning economist Paul Krugman, that global trade imbalances have been caused by China’s suppression of its exchange rate. His arguments are well structured and worth reading in full at this link to the FT, because he looks back over 30 years to the time of Deng Xiaoping, the architect of China’s reforms, to explore the causes of China’s considerable success in achieving such rapid growth.

The thrust of Mr Huang’s argument is that Deng followed many of the theories of “new economic geography that Mr Krugman was developing at that time. These showed how economies of scale and declining transport costs encourage concentration of production in certain places, and in turn lead to new trade patterns. Specifically Deng is credited with identifying and implementing the three “Ds of this new economic theory. China increased the “density of economic activity by concentrating production in a few coastal cities geared to exports. It cut the “distance between markets through an expansion of transport services and finally it reduced barriers to the movement of goods, helping to eliminate “divisions.

This deliberately unbalanced growth in Mr Huang’s opinion generated huge economies of scale and encouraged some 150m migrant workers to gravitate to the booming commercial centers around Guangzhou, Shanghai and Beijing. Over time, high-technology and export industries relocated to the coast and resource-based and domestically oriented industries established a presence in the interior.

We would not dispute for one moment that this concentration and specialization pushed 500m people out of poverty and led to annual gross domestic product growth of 10%. The share of GDP that was traded surged from 10% in 1979 to more than 70% today. This extraordinary transformation was the result of a complex set of policies, of that we would agree but not Mr Huang’s conclusion that exchange rates played only a minor role. He makes the point that when China finally did allow the renminbi to appreciate from 2005 to 2008, its trade surpluses grew bigger rather than smaller, suggesting that other factors “ notably savings and investment rates “ were, and continue to be, (in Mr Huang’s opinion) the primary determinants of China’s trade balances.

Although he makes some sound observations concerning the evolution of China’s trade balances he also completely ignores many other points. His argument suggests China was and is a free market responding to market forces when in fact it is closer to a command economy with many major corporations either still state owned or at least heavily state influenced. Bank lending, interest rates and virtually all infrastructure investments are at the direction of the state.  He paints China as a benign victim of global forces when in fact the current trade pattern is very much of its own design.

Mr Huang specifically says “Given the fragile global economy, China’s major concern is to maintain rapid growth and lessen the inequality that came with its original unbalanced growth. Arguably China’s only concern for the rest of the world is that it will continue to buy China’s goods if costs rise, hence the stubborn unwillingness to allow the exchange rate to find its own level.  The damage the last 30 years have done to western manufacturing in transferring jobs from west to east is immense and irreversible, and nearly all of China’s current wealth is as a result of that transfer. Mr Huang argues that given time the growth of the interior relative to the coastal regions will re-balance the economy and boost internal consumption making the country less reliant on exports. That may be but how long will it take? Another ten years? Meanwhile China grows to become the world’s largest economy on the back of manufacturing destruction elsewhere? An artificially suppressed exchange rate will certainly not hasten internal consumption or the objective of balancing the trade surplus, it will merely perpetuate the low wage environment that has allowed China to rise so far so fast.

While we cannot agree with all of Mr Huang’s arguments and in particular his conclusions, the article is well written and makes an interesting contribution to the debate.

–Stuart Burns