Views on U.S.-China Trade Imbalance

Views on U.S.-China Trade Imbalance

 (By Xu Hongcai, Presentation in the 21st Session of World Model United Nations Conference in Vancouver)

Good afternoon, everyone!

Today, I am very honored to be here, the beautiful Vancouver, to participate in the World Model United Nations Conference. My name is Xu Hongcai, the visiting scholar at University of British Columbia. I am working in China Center for International Economic Exchanges, namely CCIEE, which is one of most important think-tank in China. Last year CCIEE hosted the Second Global Think-Tank Summit in Beijing. This message is also featured on the United Nations website.

My presentation title is “my view on U.S.-China trade imbalance”, which consists of five parts. First is introduction. Second is to analyze the reasons of bilateral trade imbalance. Part three is the views of some experts on RMB exchange rate. Part four is the solutions for U.S.-China trade imbalance. Last part, I will give three policy proposals to the United States.

First of all, please look at part one: introduction. In the past couple of years, China has been criticized by the United States Congress for "manipulating" its currency in order to maintain its advantage for exports, and thus preserve its trade surplus. A popular view has argued that China's trade surplus was the source of today's huge global economic imbalance. So, China should be responsible for the unemployment of the United States, and even for the global financial crisis of 2008. What is your answer? My answer is NO! China has refused to accept the blame and quickly appreciate its currency. Why?

In fact, China’s trade surplus reached $155.1 billion in 2011, a decrease of 15.9% compared to $184.5 billion in 2010, and its trade surplus to GDP ratio dropped to 2.3% in 2011 from 3.2% in 2010. By the way, in February this year, China had a trade deficit of $31.49 billion. In recent years China has actively expanded imports of hi-tech products and resources in order to promote trade balance. Considering the huge trade surplus has increased domestic liquidity, fueled inflation, and added to pressure on the appreciation of RMB, in the next five to ten years China will continue to seek trade balance. In this place, some people have really misunderstood China.

In 2011, German trade surplus reached $202 billion. So, the global largest trade surplus country is not China. If considering trade surplus to GDP ratio, Germany reaches about 6%, Russia is about 10%, China is also not the most imbalanced country. Why does the United States strongly blame China? I remember, six years ago, some people said that China’s RMB should appreciate 20%~40%, even though in the past six years China’s currency has appreciated more than 30%. Especially, in today’s Hong Kong market RMB Non-Deliverable Forwards (NDFs) has started its depreciation. Facing new situation, they have still claimed that RMB should appreciate 20%~40%. That is terribly ridiculous.

Now, let me analyze the reasons of U.S.-China trade imbalance. First, from the demand end, China’s current account surplus has increased since 2002. Its export has been boosted by outside demands from irrational exuberance led by American property bubble such as asset securitization, and the soaring price of global energy and resources. The primary cause is Fed’s over-easing monetary policy after 9.11.

Second, from the supply end, there are two elements. The first is China’s entry into WTO in 2001. Hereafter, so much international capital has flowed into China, resulting in a fast surplus growth for processing trade. Another element is that China had tailored its economic institutions to meet WTO rules and thus successfully improved its supply efficiency.

Third, from economic structure, China’s trade surplus exists only in its processing trade. In its general trade, China is actually experiencing a trade deficit. The reasons are China’s dual economic structure and cheap labor force. The economic structure in China and America is different. China’s trade surplus is a result of insufficient domestic demand. To dig further, that is achieved at the sacrifice of workers’ interests. The processing trade takes up 50% of China’s foreign trade. In this process, China only earns quite limited amount of “processing fee”. Most of the benefits go to transnational corporations.

For the United States, the trade deficit is a result of insufficient saving and overspending by government and households. American national saving ratio has decreased to less than 1% from 13% during the 1990s. On the one hand, U.S. has spent a great deal of money on war and the development of advanced weapons. On the other hand, overspending becomes a popular practice. Particularly, Wall Street spends money recklessly.

So, U.S. should increase savings and restrict governmental expenditure in order to decrease its fiscal and trade deficit. China should adjust income distribution in order to increase its domestic demand.

Lastly, it should be noticed that the proportion of China’s current account surplus to GDP is actually dropping. The trade surplus to GDP ratio in China has gradually increased since 2001, and reached the peak about 8% in 2008. Thereafter, it has declined gradually. In 2011, that is 2.3% which is lower than 4% accepted by the international standard.

To sum up, in the process of globalization, China provides lower price commodities for global consumers. As a result, the citizens of import countries have enjoyed lower living costs and inflation rate. World economy has also enjoyed a sustainable development. In my opinion, China’s huge contribution should be recognized and commended by international community.

In part three, let me introduce some views on RMB Exchange Rate. First, Peterson Institute for International Economics believes that RMB is underestimated by at least 20% to 40%. Nobel Prize winner Paul R. Krugman has supported this argument and argued that China has been manipulating RMB exchange rate for trade surplus, which imposed a great threat to the economic recovery for other countries.

Second, Professor McKinnon argues that wage growth has two great advantages: first, Chinese wage would become closer to those in the developed countries, thus reducing protectionist pressures; second, the higher wage would increase labor’s share in China’s GDP. In this light, household disposable income and domestic consumption can be increased and China’s economy will rely less on export.

Third, Stephen Roach, the former chief economist of Morgan Stanley, points out that U.S. has a trade imbalance relation with 90 countries in the world, and forcing RMB appreciation does no good to U.S., by which the biggest victim is the middle-class in the United States. Professor Michael Spence, a Nobel laureate in economics, supports Roach’s view.

Fourth, Engel, the senior researcher of the Federal Reserve Bank of the United States, points out that the proper control of exchange rate and reduction of exchange rate fluctuation is helpful to stability of global economy.

Fifth, Professor Stiglitz thinks that the adjustment of RMB exchange rate against U.S. dollar will not have a material impact on U.S. trade, and its contribution to the job creation in U.S. is very limited. The short term exchange rate adjustment will even result in a speculative fluctuation in foreign exchange market.

Sixth, Blanchard, the Chief Economist of IMF, holds that forcing RMB appreciation will provide little help to American economy. The job opportunity in the United States mostly depends on service sector. It is terribly unrealistic to solve the unemployment problem in America by suppressing China’s manufacturing industry.

So, there have been such different opinions of RMB exchange rate. In my view, America Congressmen should listen to different voices.

In part four, I want to discuss the solutions for U.S.-China trade imbalance. In my view, the real exchange rate should include the relative prices of production factors such as wage, commodities, land, and resources. I provide three solutions as follows.

The first solution: allowing one time substantial appreciation of nominal RMB exchange rate while keeping the wage at a low level. Therefore, the prices of China’s commodities measured by foreign currencies will rise, resulting in its exports and trade surplus will be drastically reduced. But, this solution has huge negative impacts on China, leading to unemployment and the economic stagnant. Generally, because of the lower profit in labor intensive enterprises, a moderate appreciation of exchange rate would make these enterprises financially troubled and decrease the resident income and consumption.

The second solution: allowing the real exchange rate to rise, in other words, let China’s production price such as wage, land, rents, and resources all grow. Meanwhile, making sure the nominal exchange rate remains unchanged. As a result, the product prices and exporting costs will rise. Thus China’s trade surplus will be reduced.

The third solution: implement the policy of “gradual wage increase and gradual exchange rate appreciation”, which is also called “double gradual policy”. But, China’s wage increase and the exchange rate appreciation of RMB should be controlled in an acceptable scale in order to maintain a stable and sustainable economic development. Nominal exchange rate adjustment and relative price increase will lead to the increase of production costs among domestic enterprises. Thus, the Chinese trade surplus will gradually drop.

To sum up, the operational costs of the first solution are tremendous and it looks like “big bang”. Second solution is not feasible in recent global context. Only the third one is a rational and practical choice. Now, in the Hong Kong market, NDFs have started to fluctuate both ways. This tells us RMB is possibly near a balanced level. So, next step, China will step up exchange rate reforms, especially in increasing the flexibility and two-way fluctuations of RMB exchange rate.

Last part is my policy proposals to the United States. In the beginning of this year, in his State of the Union address, President Obama argued that U.S. should not increase the market share of its products in China; Chinese products should be blocked from entering into U.S.; and the RMB exchange rate should appreciate fast, for the purpose of retaining some jobs for Americans.

In my view, this obviously doesn’t make sense. In China, everybody knows the ancient story of Great Yu Controls the Waters of Yellow River. Yu's father, Gun, spent nine years building a series of dikes to block flood water, but failed. Great Yu created a lot of channels to guide water, thus succeeded. Maybe, President Obama should study China’s traditional philosophy.

By the way, over the next decade, China will increase its total import to $10 trillion. Facing such huge opportunity, the country that holds more share of market, will develop faster and increase its employment. The United States has restricted on Chinese import of hi-tech products. Evidently, this policy will give a lot of business opportunities to Japan and Germany.

Undoubtedly, the present biggest challenge in the United States is to create the employment. But, it is impossible to solve this problem if America goes back to the traditional reindustrialization, and the labor and resource intensive industries, such as textiles and toys. Everyone understands this violates the objective rules. The United States should highlight its competitive edges on the knowledge and technology intensive industries.

So, I want to give three proposals to the United States. First, relieve the restrictions on hi-tech products export to China, which can take higher profits, and increase American employment in service sector.

Second, expand Chinese FDI in rebuilding infrastructure, including airports, ports, expressways and high speed railway.

Third, in new energy and environmental industries, the United States combines its hi-tech superiority with China’s low labor costs in order to achieve low carbon and sustainable economic development.

In chief, the United States should promote bilateral trade cooperation, and strengthen the mutual trust, thus jointly share the achievements of China’s economic development.

Thank you for attention.