Much has been made of China's trade surplus and the role of currency in creating it. But the trade imbalance, as it has for decades, is the result of a relatively low-cost labor supply and limited domestic consumer spending. The reality is that China's trade surplus will last for many years to come.
Thirty years after the start of its open-door policies, China is one of the most trade-dependent countries in the world. In 2008, its total trade volume was $2.5 trillion, or 57% of its GDP, second only to Germany among large economies. Inspired by the success of its East Asian neighbors, China adopted an export-led growth model in the mid-1980s. Chinese exports are still labor-intensive--as its comparative advantage lies in its abundant labor supply.
Even today, after years of rapid economic growth, China still has a huge rural supply of workers. Agriculture only contributes 11% to China's national GDP, yet the countryside makes up 55% of its population and 40% of its total labor force. The current global financial crisis has led millions of workers to migrate back to the countryside from urban areas, adding to the pool of workers there.
Even today, after years of rapid economic growth, China still has a huge rural supply of workers. Agriculture only contributes 11% to China's national GDP, yet the countryside makes up 55% of its population and 40% of its total labor force. The current global financial crisis has led millions of workers to migrate back to the countryside from urban areas, adding to the pool of workers there.
Meanwhile, China's fast-declining fertility rates are creating a "demographic dividend." Smaller family size means that working family members don't need allocate as much income to others. The "dependency ratio" for the country as a whole is low: Currently, one working person in China only needs to support 0.4 non-working persons; in the U.S., the same figure is 0.66.
Comment On This StoryCombined, China's large rural workforce and low dependency burden limit consumer spending. Consumption only accounts for 48% of GDP in China, compared with 70% in India and the United States. China has a relatively small domestic market, and exports become an inevitable choice to expand growth.
The impact is clear in global trade imbalances. The surplus countries--China, Germany, Japan, Russia--have a comparative advantage in manufacturing and resource industries and report persistent surpluses; the deficit countries--noticeably the United States, the United Kingdom and Australia--have a comparative advantage in finance but trade deficits. The surplus countries export goods to the deficit countries, and the deficit countries export financial services to the surplus countries.
In an ongoing study of 39 countries for the period 1990-2006, Jianwei Xu and I examined various factors contributing to China's trade surplus with the United States. We found that China's disadvantage in finance vs. manufacturing can explain 40–50% of China's trade surplus with the United States. China's low dependency burden can explain another 24%. By contrast, the undervaluation of the yuan vs. the dollar explains less than 2%. That is, China's trade surplus with the United States is better explained by its low cost labor supply and limited consumer spending than the value of its currency.
The implications of our analysis are three-fold. First, so long as trade imbalances are a product of labor imbalances, the trade surplus will not be corrected so long as the global division of labor remains unchanged. And so long as the status quo brings gains to all parties, there is no impetus for change.
Second, the so-called "dollar hegemony"--or predominance of the dollar in international trade--is not the cause of imbalances, either. Even if the dollar did not dominate world trade and finance, there would be imbalances as long as countries stick with their comparative advantages. The "dollar hegemony" only attracts excessive liquidities to the United States.
Third, promoting the yuan as a settlement currency will not solve China's problem of external imbalances. Nor will moderate adjustments of the yuan's exchange rate against major currencies. A sharp revaluation may be required to reduce China's current account surplus to a reasonable level. Yet that would probably lead to large swings in the yuan's value, a result China would not like to see.
China will continue its export-led growth model over the next decade primarily because the long-term factors affecting its position in the international division of labor--especially its comparative advantage in manufacturing, reserve of labor in the countryside, and a low dependency ratio--will not change quickly.
The costs of China's export-led growth model are high--underutilizing its burgeoning foreign reserves is the most serious. China has to go through significant structural changes to rebalance its economy. Among them, improving its financial sector, accelerating the pace of urbanization, and establishing a more complete social security system.
Yang Yao is the deputy director of the China Center for Economic Research and deputy dean of the National School of Development at Peking University.
Link to Forbes: http://www.forbes.com/2009/09/25/trade-surplus-labor-china-leadership-yao.html
