David Dollar, Senior Fellow, Foreign Policy, Global Economy and Development, John L Thornton China Centre, Brookings Institution, has the following to say in his brief dated 4 October 2016 for the initiative Election 2016 and America's Future -
- Trade with China has led to the loss of American manufacturing jobs, reduced real wages for semi-skilled workers, and devastated some communities dependent on low-end manufacturing jobs. These negative effects have naturally given rise to protectionist sentiments in the U.S. presidential campaign and given trade in general a bad name.
- China pegged its currency, the yuan, to the U.S. dollar at a rate of 8.3:1 in 1994. This was a reasonable and not unusual choice for a developing economy. The problem is that China had rapid productivity growth that required some appreciation over time. China is fortunate that the dollar was appreciating in the late 1990s so that the yuan appreciated with it in trade-weighted terms. China’s mistake was in following the dollar down in the first half of the 2000s. This resulted in trade-weighted depreciation, just as Chinese productivity really took off. It was at this point that China developed a very large trade surplus that rose above 10 percent of GDP. Pegging the currency to the dollar in the face of a large trade surplus requires the central bank to accumulate reserves, and China’s reserves over this period rose to a global high of $4 trillion.
- China shifted off the peg to the dollar in 2005, and over the past decade has allowed significant appreciation of its currency—about 20 percent against the dollar since 2005. The trade-weighted appreciation is more significant (above 40 percent) because the dollar has trended upward over the decade. As a result of this new currency policy, China stopped intervening in the foreign exchange market to accumulate reserves. In fact, for the past year China has been selling reserves to keep the value of its currency high. Its $4 trillion stockpile of reserves has declined to $3.1 trillion. In the face of this new currency policy, China’s trade surplus initially declined. But now it has started to rise again, and one factor is the shift of SOE investment outward. There are also net private outflows of capital, though it is hard to measure these exactly. The growing net capital outflow from China is threatening to take China’s trade surplus back to levels that pose problems for the global economy.
- A second and related problem is that China’s policy towards foreign direct investment is highly asymmetric. China is now encouraging its firms to invest abroad in virtually all sectors. Meanwhile, according to an OECD measure of investment restrictiveness, China is the most closed of major economies. It is significantly less open than other emerging markets such as Brazil, India, Mexico, or South Africa.
- The growth of the U.S. economy slowed significantly between the 1990s and the 2000s. It would be hard to attribute any significant part of the slowdown to China. While the large trade gap with China is annoying, it is still small compared to the U.S. economy: For example, the $467 billion of imports in 2014 represented less than 3 percent of the U.S. economy. And although the share of manufacturing in employment has been on a slow but steady decline since the 1950s, the share of manufacturing in GDP has been stable. This pattern reflects the relatively faster productivity growth in manufacturing compared to services.
- What distinguishes the 2000s from the 1990s is that overall employment growth has been so slow. In thinking about how to deal with China, there is a risk that that issue will distract from more important considerations about how to make U.S. output and employment grow more quickly. The slowdown in U.S. growth can be attributed to a multitude of factors, including the aging population, under-investment in education, under-investment in infrastructure, and the financial crisis that emanated from Wall Street.
- While protectionism is tempting, it is almost certain to backfire and cause more economic harm to the United States.
- Inducing China to become a more normal trading and investing nation will require a mix of carrots and sticks from the next administration, a policy that could be characterized as “responsible hardball".
- As a departure from current policy, the most promising option would be imposing new restrictions on Chinese state enterprises purchasing their competitors in the United States until China opens up reciprocally.
- If the TPP is implemented, South Korea and ASEAN members could be attracted to join. It has the potential to spur new supply chains among a group of countries that have to some extent harmonized their regulations on investment, environmental protection, and labor standards. The TPP could be a positive incentive for China to reform.
- The United States can also use leverage over China’s desire to be granted market economy status in order to negotiate significant reductions in excess capacity in steel and other heavy industries.
David Dollar doesn't attempt to make a case for condemning China as a "currency manipulator". He also stresses that the United States' growth slow-down is due to internal structural factors which cannot be blamed on China. Nevertheless, he faults China on continuing to peg the RMB to a weakening dollar at a time when China's productivity took off. He also seems to imply that China's recent trend of outward direct investment (ODI) is largely driven by monopolistic state-owned enterprises protected unfairly by China's domestic policies. The truth, however, is more complex.
While it makes good economic sense for the RMB to float freely at some point, this cannot be switched on overnight without a robust and mature financial infrastructure able to withstand the massive ebb and flow of the globalized financial markets.
As for outward investments, it is true that the state-owned enterprises are leading the way in large energy and infrastructural deals in developing countries. However, Chinese acquisitions in advanced countries are increasingly spearheaded by non-government commercial enterprises. Spencer Lake, Global Head of Capital Financing at HSBC, wrote in the Financial Times (30 June, 2015), noting that private investors are becoming the main driving force of China's ODI, targeting agriculture, technologies, high-end manufacturing, consumer goods, real estate, services and brands. Wanda's recent acquisition of the AMC and Legendary cinema chains in the United States is a case in point.
Bearing in mind these complexities, while a “responsible hardball" in pushing against China may serve to hasten China's much-needed state-owned-enterprise reform* and pry open more market opportunities for Western businesses, it begs the question whether it could deliver the silver bullet to turn around the United States' structural economic malaise.
*To understand the complexity of state-owned-enterprise reform, its relation to China's debt explosion, state control over excess capacity, and the imperative of maintaining 6.5% annual growth rate until 2020, visit a Petersen Institute for International Economics (PIIE) panel discussion on 5 October, 2016 “China’s State-Owned Enterprise Reform Process” with speakers including Nicholas R. Lardy. Click here
Visit an article in the Financial Times of 11 October "China approves debt-for-equity programme" on how China attempts to address her massive, unsustainable debt problem. Click here According to the FT article, "Chinese companies have accumulated about $18tn in debt, an amount equivalent to 170 per cent of gross domestic product. The State Council said it would also encourage mergers, bankruptcies and debt securitisation to help reduce leverage across the corporate sector."
Visit also an article in the South China Morning Post of 27 September Why China’s debt is not worth losing any sleep over, just yet. Click here .The article points out that China's total debt ratio of approximately 255% of GDP is still far from being the world’s highest. As for SOEs, not only liabilities but assets should also be included. As for local governments, infrastructural projects should not be treated in the same way as commercial debt, as long-term socio-economic considerations are involved. "What really matters is not total debt per se, but the debt-to-equity ratio, on both the microeconomic and macroeconomic levels. A high debt-to-equity ratio encourages moral hazard and reckless risk-taking, and potentially leads to financial instability. While China should definitely work to lower its overall debt-to-equity ratio, the total debt outstanding per se is still manageable".
