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China’s Vanishing Trade Imbalance

Eduardo Porter
Tuesday, 1 May 2012 | 10:54 PM ET

America’s economic imbalance with China has been a singular concern of policy makers for more than half a decade. Senators Charles E. Schumer and Lindsey Graham wanted to punish China for pegging the exchange rate to the dollar in 2005 — arguing that its policy of cheapening the currency to subsidize exports was fueling a huge trade surplus that cost America jobs.

Nanjing street shopping district.
Grant Faint | The Image Bank | Getty Images
Nanjing street shopping district.

Their bill never passed. But reducing China’s surpluses has remained at the top of the bilateral agenda ever since.

Something unexpected has happened to China’s economy, however. Its surplus with the rest of the world has largely disappeared.

China’s imbalance with the United States is still likely to take center stage when Treasury Secretary Timothy F. Geithner sits down to the fourth round of the U.S.-China Strategic and Economic Dialogue this week. But he will have a harder time making the case that America’s trade deficit is somehow China’s fault.

China’s current-account surplus — the broadest measure of its trade relations, which tracks how much more China exports in goods and services than it imports — has plummeted. In 2007 it amounted to more than 10 percent of the entire Chinese economy.

By last year it had shrunk to about 2.8 percent. And the International Monetary Fund estimates it will decline to 2.3 percent of the nation’s output in 2012, the smallest since 2001.

The United States’ current-account deficit has shrunk, too, to 3.1 percent from 5.1 of American gross domestic product. Senator Schumer and colleagues nonetheless continue to attack China for its cheap currency. Last October the Senate passed a bill, which has yet to pass the House, to let American companies seek duties on Chinese imports to compensate for what is said to be an undervaluation.

Mitt Romney has promised that if he becomes president he will declare China guilty of currency manipulation, something which the Obama administration has declined to do and which would pave the way to slapping duties on Chinese exports.

But to hear leaders in Beijing, the problem is solved. In March, China’s premier, Wen Jiabao, said the Chinese currency may “have reached its equilibrium level.” China's currency manipulation is undisputed. The government tightly controls the exchange rate to preserve the competitiveness of Chinese exports. The manipulation has been at the core of a strategy that led China’s merchandise exports to quintuple from 2000 to 2010, increasing its share of world exports by about 0.75 of a percentage point a year, according to the I.M.F .

Still, there is reason to think that China’s economic strategy may be turning a corner. While its current-account surplus with the United States, $318 billion last year, was somewhat bigger than it was in 2007, China actually ran a big deficit with the rest of the world. China’s vast takeover of world markets may be running out of steam.

“The rapid growth of China’s export market share during the past decade was the result of a variety of factors that have largely run their course,” noted the I.M.F.’s World Economic Outlook, published in April. These include cheap labor, multinationals’ outsourcing of production to China, a huge jump in productivity and China’s 2001 entry into the World Trade Organization, which limited the ability of other countries to stop its exports.

There is scattered evidence. China’s wages have been rising over the last decade — about 10 percent a year in real terms, according to Nicholas R. Lardy of the Peterson Institute for International Economics. The combination of climbing Chinese wages and transportation costs has led American companies, including General Electric and Master Lock, to reassess their global production lines and move some production back to the United States.

Though China has only slowly loosened its grip on the exchange rate, the appreciation is greater than it might appear at first sight. Nominally, China’s renminbi has risen 8 percent against the dollar since June of 2010. But factoring in China's higher inflation, it has gained about 13 percent. And it has appreciated about 40 percent in real terms since 2005.

This is making a difference. The I.M.F. forecasts that China’s surplus will rebound gradually to 4.25 percent of the country’s output by 2017. But it noted that if the renminbi continues to gain — either through faster appreciation or sustained higher inflation — the surplus will be smaller.

Skepticism is warranted, of course. It is too soon to know whether these changes really mean China is turning a page in its development strategy. The I.M.F.’s central forecast is that China’s share of world markets will keep growing at the same rate as in recent years.

An important reason the surplus shrank in China is that the global recession clipped consumer spending in its main export markets in the United States and Europe. China’s own reaction to the global contraction — a huge buildup of roads, rail and other public infrastructure alongside a wave of cheap lending for private investment in construction and other projects — sucked in imports rapidly.

These factors are unwinding. What is more, the investment boom could help Chinese companies gain share in new, high-tech markets where they did not compete before. In the wind energy industry, for example, China now has about 6 percent of world exports, up from almost zero five years ago.

Still, China has not adopted many of the reforms that economists suggest are needed to lay the groundwork for a new phase of development that relies less on exports to other countries and depends more on the spending of the Chinese themselves. To do this, wages and incomes must rise.

The government must bolster the social safety net — providing better pensions and health care to Chinese families so they do not have to save every last penny in case of a rainy day. And interest rates on bank deposits — which the government keeps artificially low to reduce its borrowing costs and provide cheap credit to industry — must rise too, so consumers can get a return on their savings.

Despite these uncertainties, the goal of a more balanced Chinese economy is closer than it has been in at least a decade.

Some effects of the global recession will linger. Exports of machines and equipment to the United States, accounting for 10 to 15 percent of China’s export growth early in the last decade, will not recover until the American housing market does. And China’s terms of trade will get worse as the price of energy and the other raw materials it imports keeps rising even as the electronic devices and other machines it exports keep getting cheaper.

China has already saturated markets in many of the low-tech goods it makes — toys, for example. And gaining new markets in higher-tech goods against established rivals is likely to become increasingly difficult.

And weird as this may seem for a country of 1.4 billion people, China is looking at a labor shortage down the road that will start increasing wages ahead of productivity growth, eroding China’s competitive edge. Its working-age population is expected to peak and start shrinking within five years, partly as a result of the one-child policy that depressed birthrates and accelerated the aging of the population.

China’s backward farm economy will continue shedding workers for a few years, adding to the urban labor force. Still, Chinese factories on the coast are having a harder time drawing workers from the agricultural hinterland in the west. That is partly because rising food prices are raising farm incomes. And it is partly because living conditions are grim in Chinese cities, where workers must make do without a social safety net.

Whether China’s economy stays on a more balanced keel is important for the entire world, which is struggling with weak consumer demand after a deep recession. It is also important for China — whose reliance on exports to drive employment and growth is distorting the economy, repressing consumer demand, feeding a surge in unproductive investment and loading banks with dubious loans.

China’s economy is in a peculiar spot. Its surplus has shrunk drastically, but without any of the reforms needed to transform China into more of a consumer economy that relies less on exports. In fact, household consumption has fallen consistently as a share of the economy since the early 1990s.

This path leads nowhere good. Further investment booms may continue to shrink China’s trade surplus. But they come at a high cost: more resources wasted on empty buildings and unused roads.

Fortunately, China’s leaders appear to understand the need to change. The 12th five -year plan begun last year is centered on the goal of raising family incomes, shifting to an economy more reliant on the production of services and building the kind of safety net that gives the Chinese people the confidence to spend some of their vast savings.

If these reforms are actually made, China could be on a more sustainable path of economic growth that would increase the well-being of regular Chinese. And American senators would have to blame somebody else for the nation’s trade deficit.

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