Why U.S. Must Get Over Renminbi (Page 2 of 2)

Processing exports account for about half of China’s trade volumes but generate the entirety of its surplus. This trade – often exemplified by China’s exports of Apple’s iPads to the United States – typically depends on the import of high technology components made elsewhere and then brought into China for assembly and export to the West. Eighty percent of the value added for these components is generated elsewhere with China’s contribution concentrated in the lower technology components and labor assembly.

The particular country mix in processing trade is shown by the jump in the trade surpluses of South Korea, Japan and Taiwan with China which went from $30 billion to over $200 billion in the decade up to 2010. Thus, China’s trade surplus with the United States originates largely from this North Asian trio. And rather than complain about China’s exports of low tech – labor intensive products, the real question is why the United States isn’t able to produce the high tech- capital intensive components coming to the U.S. via China from the North Asian trio. These activities command the skills and salaries that would be more appropriate for American workers.

When President Barack Obama welcomed his counterpart from South Korea to Washington last year, he commented approvingly that South Korea’s trade with the U.S. was in balance – “as it should be.” What Obama should’ve done was congratulate President Lee Myung-bak by noting that South Korea, along with several others, has been able to avoid U.S. criticism by hiding its trade surpluses behind the Great Wall of China.

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Studies such as one done recently by a Federal Reserve Bank have shown that appreciation of the renminbi by itself would do very little to curb China’s trades surplus with the West, since much of the impact is negated by the lower cost of imports into China. Since exchange rates for the major East Asian countries are now closely aligned in their movements, it would take a more coordinated approach of the major East Asian countries to a make a difference. Only the domestic labor content is affected, and this is typically only a few percentage points of the cost.

More significant in its impact on trade balances has been the rise in household savings rates. Accounting identities tell us that the trade balance is the difference between what an economy saves and what it invests. The surge in China’s savings rates in excess of the rapid growth in investment explains the emergence of the huge trade surplus during 2005-08.

While many studies have suggested that Chinese household savings rates rose because of welfare concerns and demographics, the major factor has gone unrecognized. Rapid urbanization and the movement of some 250 million migrant workers into the major coastal cities have changed the savings dynamics in China. Restrictive policies have prevented these migrants from being given formal residency rights and thus repressed their consumption instincts. Consequently, migrant workers savings rates are as much as twice that of established residents in some cities, and as their incomes have soared, this has led to a sharp increase in household savings and in turn amplified China’s large trade surpluses.

These trade surpluses began to decline when China’s stimulus program drove up investment rates after 2008. But such high investment rates are not sustainable, thus consumption needs to increase as a share of GDP. For this to happen, the key is more rapid urbanization and lower household savings rates.

This has already begun. In the last two years there has been a modest increase in the share of consumption to GDP (which hasn’t yet shown up in the official accounts). This has occurred because recently rural incomes have been increasing faster than urban. Since savings rates are lower for rural relative to urban households this is reversing the historic decline in consumption as a share of GDP. In addition, as migrant workers move inland because of lower living costs and better job opportunities, this is also boosting consumption.

This process of rebalancing in favor of more consumption would be given a big boost if migrants were given formal residency rights. Since their abnormally high savings amount to 2-3 percent of GDP, this would lead to a surge in consumption that would eliminate China’s trade surpluses even as investment rates decline in the coming years.

Financial markets typically focus on exchange rates in analyzing China growth and trade prospects. But in doing so they miss the power of these kinds of structural shifts which would moderate global trade imbalances in ways that are far more beneficial to both China and the United States than the politically charged focus on appreciating the renminbi and actions that push both sides toward more protectionism.

Yukon Huang is a senior associate at the Carnegie Endowment and a former country director for the World Bank in China. This article was originally published by International Affairs Forum here.

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