Global Trends by Martin Khor

Monday 22 March 2010

Promoting global economic recovery

Blaming China's currency for United States' economic woes is counter-productive.  A new report on the global economy suggests the US should solve its over-consumption while Germany, Japan and China should boost their domestic consumption to spur global demand and economic recovery.

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For the past few weeks, there has been a shrill attack on Chinese economic policy emanating from United States' Congress members and economists.   According to them, China's policy of linking its currency to the US dollar has undervalued the yuan, led to China's large trade surplus and is a major reason for America's economic problems. Some economists even try to blame this for the imbalances in the world economy.

This blame game is now going beyond the rhetorical or the academic realm.  If the US Treasury labels China as a country practising currency manipulation in a report on 15 April, it could trigger actions in the Congress to slap on an import surcharge on Chinese goods.  The economist Paul Krugman, one of those urging actions to “take on China”, is suggesting a hefty 25% surcharge.

Such drastic measures could trigger a trade war, which nobody needs today when the global economy is trying to find its feet following the worst recession in 60 years.

A recent report of the South Centre by its Special Economic Advisor Yilmaz Akyuz (formerly Chief Economist of UNCTAD) throws interesting light on the global economic imbalances, the situation in the major countries, and what needs to be done.

The report, “Global economic prospects: The recession may be over but where next?” recognises that the US economy (that has high household debt and trade deficit) has to adjust, and its over-consumption problem has to be tackled. 

But this adjustment will cause its own problems for many developing countries as it may result in increased interest rates (which is bad for indebted countries) and a higher dollar (exerting a downward pressure on currencies in developing countries in deficit, and on commodity prices).

So far, the US and China have adopted the strongest policy response to the crisis with big fiscal stimulus packages and aggressive easing of monetary policy.

In China, there has been a high growth in exports, and this in turn accounted for one third of Chinese GDP growth in the years before the crisis.

But in the debate on the global economy, attention has focused on the US-China relation, to the neglect of the role of Germany and Japan, according to the report.

These countries, like China, have been having large current account surpluses (7.5% of GDP in Germany and 4.8% in Japan, before the crisis).  They also have large trade surpluses with the US ($50 billion for Germany and $75 billion for Japan).

The overall trade surplus of China (11% of GDP) and its trade surplus with the US ($270 billion) is higher.  “However the contribution of Japan and Germany to global demand and growth is much smaller than China's and their reliance on exports is much greater,” says the report.

Firstly, the real domestic value of China's trade surplus with the US is actually lower than the gross figure because there are a lot of imported components in Chinese exports.  Thus in 2005, the trade surplus of China with the US was $172 billion in conventional terms, but it was only $40 billion in value-added terms (the amount after deducting the import content of the exports of both counties).

In the same year Japan's surplus with the US was $85 billion.  Since the foreign content of Japan's exports is lower than the foreign content of US exports, in value added terms Japan's surplus with the US turns out to be higher than China's surplus with the US.

Secondly, and more importantly, “Japan and particularly Germany have been siphoning global demand without adding much to global growth,” says Akyuz.  During 2002-07, exports grew 25 times faster than domestic demand in Germany and 8.5 times in Japan while the figure is less than 3 for China.

While exports contributed 34% to GDP growth in China, they contributed 50% to Japan's GDP growth and 143% to Germany's growth in 2002-2007.   In other words, even if there had been no export growth in China, the GDP would still have enjoyed high growth, but without export growth Germany's GDP would have fallen by about 1% a year during 2002-07.

The paper cites under-consumption as a major problem in Germany and Japan.  In Germany, there has been high unemployment and stagnant wages because of an over-focus on price stability.  In both countries, the share of wages has fallen, thus suppressing consumption.

These two advanced countries need to increase their contribution to global demand (and thus to the global recovery) by expanding their domestic consumption through faster wage growth.  Their increased domestic demand and higher growth is needed to spur more imports and reduce their trade surplus, which would contribute to other countries' exports and GDP growth.

China, through its high growth and its reliance on both its own domestic demand and exports, has contributed relatively more than the two industrial countries to global growth, the report implies. 

However, China obviously also needs to adjust.  It cannot rely as much as previously on exports due to the expected adjustment in the US and the slowdown in Europe, and it thus has to generate domestic demand through significantly increasing its consumption, whose share of GNP fell from 55% in the late 1990s to 36% at present.

Under-consumption is thus a major problem.  Consumption has to grow faster than both national income and investment in China in the future.  The significant fall in the share of wages would need to be reversed. 

Akyuz suggests a combination of policies promoting higher wages, elimination of the gap between wage and productivity growth, increased budgetary transfers especially to rural households, and increased public spending on health, education and housing in order to reduce household precautionary savings.

However, even if China maintains its high GDP growth by switching from exports to domestic demand, it cannot be expected to become the locomotive for global growth.  This is because there is a lot of imported inputs going into China's exports, whereas imports make up only 8% of China's domestic consumption.  

“Consequently, a $100 shift in the composition of aggregate demand from exports to domestic consumption would reduce Chinese imports by some $40,” says the report.  This has serious implications especially for South-east Asian countries which supplies a lot of the parts and components to China for its exports.

As for exchange rates, the paper says that it is an important issue in the adjusting of global trade imbalances, but currency movements do not create additional demand for the global economy.  Thus they alter relative growth rates rather than raising the overall global growth.

“Briefly, currency movements cannot address the problem of global under-consumption associated with sluggish wages,” says Akyuz. 

A depreciation of the dollar against the Chinese currency could reduce Chinese exports and its trade surplus with the US, but would not solve the under-consumption in China nor bring an increase in domestic demand to offset the decline in exports.  It could even aggravate the under-consumption problem.  Thus the exchange rate is not an appropriate instrument to address the under-consumption problem and excessive reliance on exports in China.      

The paper adds it is not clear how dollar depreciation against the Chinese currency would address the root cause of the US problem of over-consumption.  It is unlikely to produce significantly faster growth of exports to China.  Even if it reduces China's exports to the US, this may be replaced by imports from other developing countries as long as US consumers continue to live beyond their means.

Akyuz notes that the US has run current account deficits in the past four decades regardless of the strength of the dollar against the currencies of its main trading partners, blaming Germany in the 1970s, Japan in the 1980s and now China.  The yen has been rising against the dollar during this period but this had no impact on the surplus of Japan with the US.

Thus, concludes the paper:  “The solution should be sought primarily in national policies designed to address problems of over-consumption in the US and under-consumption in surplus countries.”