The Rebalance author Mercy Kuo regularly engages subject-matter experts, policy practitioners and strategic thinkers across the globe for their diverse insights into the U.S. rebalance to Asia. This conversation with Fabio Ghironi – Paul F. Glaser Professor of Economics at the University of Washington, NBER Research Associate, CEPR Research Fellow, Euro Area Business Cycle Network Fellow, Officer of the Central Bank Research Association and Director of CBRA International Trade and Macroeconomics Program, and holder of several editorial appointments – is the 53rd in “The Rebalance Insight Series.”
Assess China’s economic reforms with regard to currency and the structure of the economy.
China has been undergoing a transformation from an emerging country that relies disproportionately on an export- and investment-led model of growth to a mature industrial economy in which domestic consumption represents a larger share of aggregate demand. As in past experiences of other countries, this has been associated with slowing growth. This growth slowdown has come in conjunction with an increasingly worrisome situation in the Chinese banking sector. The choice to turn to the extension of bank credit as the strategy to prop up growth has resulted in a debt-to-GDP ratio that is now well above 250 percent. Artificially inflated property values, weakly performing firms, and loosely regulated lending imply that Chinese banks are saddled by massive amounts of non-performing loans.
As capital flowed out of the country, Chinese authorities allowed the renminbi exchange rate to move more than in the past in response to market forces. This was instrumental to pursuing entry of the renminbi in the SDR basket, but Chinese policymakers have been trying to walk a very narrow path between allowing some weakening of the currency to bolster growth and using reserves in an effort to prevent even larger depreciation. The focus should now be on cleaning up the banking sector before any further effort to internationalize the currency. Failure to do that could spell disaster for China’s economy and beyond.
How would you evaluate the Chinese government’s management of the recent turmoil in China’s equity and capital markets and impact on international investor confidence?
Unfortunately, the experience of the last year is not very encouraging, with poor coordination across different authorities and regulators resulting in a government that struggled to keep up with events rather than providing effective guidance. This clearly had a negative impact on investor confidence. Until the problems in China’s banking sector are resolved—which will require accepting failures and growth below target—delaying opening of the capital account will be crucial to prevent the situation from deteriorating even more rapidly. But the government must show the resolve to rein in the debt bubble it has tried to ride.
Legislative passage of the Trans-Pacific Partnership (TPP) and Transatlantic Trade and Investment Partnership (TTIP) is facing obstacles on both sides of the Pacific and Atlantic. Taking a long-term view, how might passage of both or either affect the global economy?
TPP and TTIP represent opportunities for a large share of the global economy to achieve further integration by removing still existing trade barriers and by harmonizing market rules according to standards of best practice. Liberalization of trade in services will be especially beneficial for the most advanced countries, which are in a position of comparative advantage in that sector. The less advanced partners will benefit significantly from enhanced market access for their manufactured products. By extending far beyond reduction in traditional trade barriers, TPP and TTIP are structural reforms with wider and deeper reach than traditional trade deals. They would promote a more efficient allocation of resources within and across countries—across firms and sectors in each country. The productivity effects of such reallocations will be especially valuable to lift the global economy out of its persistent doldrums. The fact that TPP includes provisions against currency manipulation and for enhanced macro policy cooperation will also be beneficial. To be sure, there will be “losers” in each country, and policies should be in place to reduce the costs for them. Moreover, for the full range of benefits from these treaties to materialize, it will also be important that they become vehicles for engagement of outsiders—such as China—rather than instruments for antagonizing. I return to this below.
Explain the implications of the European Union’s decision not to grant China “market economy status.”
The EU’s decision is part of an ongoing row over trade practices. China is accused of “dumping” products in export markets, by selling them at prices below the price charged in the domestic market or even below production cost. This strategy has become especially apparent in sectors such as steel. The decision not to grant China “market economy status” makes it easier for countries to use retaliatory tariffs: If China were granted such status, use of tariffs would require countries to reference prices in the Chinese market to establish that “dumping” is happening. As long as China does not have “market economy status,” countries can use prices in a third country for comparison, making it easier to argue for retaliatory tariffs. In the current political climate in Europe (and in the U.S.), heightened attention is placed on the consequences of unfair trade practices, and the EU’s decision did not come as a surprise. The outcome of the Brexit referendum is likely to cause EU policymakers to pay even more attention to the consequences of perceived unfair practices in the foreseeable future, as distributional consequences of economic policies take center stage in discussions.
How should the next U.S. administration manage the impact of China’s economic reforms on the U.S. and its allies in Asia and Europe?
The keyword is “engagement.” If he were the next president, Mr. Trump’s plan of imposing huge tariffs on Chinese products would be disastrous for everyone. The next U.S. administration should support China’s efforts to reform and open its markets through a strategy of active engagement. While the rhetoric of President Obama’s administration is positioning TPP as a tool to reaffirm U.S. leadership “against” a rival China—a useful political strategy to marshal support for the agreement—I think a big potential benefit of TPP is that it would create a framework that could actually facilitate engaging China in more cooperative policymaking—both in terms of trade and macroeconomic policy. Continued engagement in the economic sphere will be the best way to ensure cooperative progress in areas of concern outside the economic realm. Whether or not TPP is ratified, no one stands to gain from economic war between the U.S. and China.