Is China Rebalancing?

China’s trade surplus featured prominently during the 2012 presidential debates. Governor Romney accused China of currency manipulation, while President Obama touted increases in U.S. exports to China and emphasized his administration’s role in initializing fair trade cases against the country.

A May 2012 International Monetary Fund (IMF) research article, “An End to China’s Imbalances?” reports that the Chinese exchange rate has appreciated 14.75 percent in real terms from April 2008 to December 2011. Meanwhile, China’s trade surplus has declined sharply, from nine percent of GDP in 2007 to three percent of GDP in 2011. The authors, Ashvin Ahuja, Nigel Chalk, Malhar Nabar, Papa N’Diaye, and Nathan Porter, suggest that the trade surplus will continue to decline or persist at a low level, reflecting the experience of export-oriented growth in Japan. They speculate that China’s trade surplus will remain below five percent of GDP over the next five years.

The IMF report raises an important question: Will China decrease its trade surplus by increasing consumption of foreign products? It may be too early to say. Many factors contributed to the reduction in China’s trade surplus, including weak global demand, surging labor costs, and stronger Chinese imports. The authors explain, “The evidence increasingly points to a rising domestic imbalance as growth become increasingly dependent on very high levels of investment.” In other words, the Chinese government has shifted the country’s external imbalances to a domestic imbalance.

China’s tremendous increase in imports of capital or investment goods is particularly noteworthy for American policymakers, given their efforts to improve the competitiveness of U.S. manufacturers. Another IMF research report, “Regional Economic Outlook: Asia and Pacific Managing Spillovers and Advancing Economic Rebalancing,” finds that China is increasingly importing minerals and machinery to stimulate infrastructure and industrial development. The Chinese government’s 2008-2009 economic stimulus package and recent social housing projects further contributed to the import surge. For example, the government accelerated the construction of a high-speed railway network, as well as the inland relocation of manufacturing facilities in traditional industries.

Despite the country’s increase in imports, the authors find that Chinese consumption has declined from approximately 63 percent of GDP in 1992 to 48 percent of GDP in 2010. Imports of consumer goods have grown at a much slower pace than imports of capital goods, such as machinery and equipment, which are tied to China’s exports sectors.

Even if the Chinese economy transforms from investment to consumption led growth, rebalancing domestic demand may not lead to a large increase in consumer good imports from the United States. Chinese exporters have attempted to transform their operations from processing manufacturing to higher-end manufacturing, producing goods typically manufactured by Germany, Japan, and the United States. The regional economic outlook report suggests, “The investment may lead to capacity building in a range of manufacturing areas in which China has previously not had a foothold.” If this investment successfully strengthens Chinese industries’ competitiveness with higher-quality and creative products, the trade imbalance may be more sustainable.

Of course, the United States is still a clear leader in high-end manufacturing sectors and has many competitive advantages in crucial technologies. Meanwhile, Chinese exporters are still facing various difficulties in increasing their manufacturing capacities, including insecure intellectual property rights, low marginal return of capital, and corruption. These obstacles, however, may bring little comfort to U.S. policymakers, given China’s remarkable growth in productive capacity. In the green energy industry, for example, China has increased its share of global capacity from 16.5 percent in 2009 to 22.75 percent in 2010, overtaking the United States as world leader in wind energy capacity. Ongoing social and political problems are unlikely to retard Chinese industrial competitiveness forever. Thus, rather than being overly concerned with the exchange rate, the next U.S. president should focus on promoting and increasing the competitive advantages of U.S. industries.

Feature Photo: cc/Fear_Through_The_Eyes