by Arvind Subramanian, Peterson Institute for International Economics
Op-ed in the Financial Times
April 9, 2012
© Financial Times
Remember that issue with the Chinese currency? As markets await this week’s economic data releases from Beijing, it is easy to be complacent over its mercantilist exchange rate policies. Now concern is shifting to whether China has a hard landing ahead.
Foreign exchange reserves have stabilized at about $3.2 trillion. The renminbi has appreciated by about 30 percent against the US dollar since 2005. Despite all this, however, the renminbi problem is still not a thing of the past.
The good news is that there is an opening for the reformist wing of the current Chinese leadership to follow the model of Deng Xiaoping’s protégé and former Prime Minister Zhu Rongji to look abroad to address the problem. It should do so, for the benefit of China and the world.
Leave aside the question of whether the world’s fastest-growing and still-poor economy should be running such large (if shrinking) current account surpluses. The self-insurance motive for building reserves was met at least a trillion dollars ago. Even the desire for export-driven growth has become less attractive because of the overinvestment, inefficiency, and corruption associated with the range of policies supporting mercantilism.
But policies remain mercantilist. By how much? One way of assessing the competitiveness of the Chinese economy is to compare Chinese prices with those of other countries, taking into account that richer countries tend to have higher prices. If a country’s prices are lower than what might be expected given its standard of living, its currency is undervalued (and vice versa). This is the purchasing power parity method for assessing currency valuation.
My calculations suggest that the renminbi remains substantially undervalued, by about 30 percent against the dollar. The mercantilist juggernaut is alive and well.
Unsurprisingly, China’s partners have been exercised by the policies underlying such undervaluation. Discussions are afoot in several international forums—the International Monetary Fund (IMF), the G-20, and most recently in the World Trade Organization (WTO)—to define standards for mercantilist exchange rate policies and to find effective ways of enforcing them.
Not all these attempts reflect rich country grievances. In fact, China poses competitive problems for other developing countries, because it is these countries that are China’s main competitors. In recent research with Aaditya Mattoo of the World Bank and Prachi Mishra of the IMF, we show that China’s exchange rate has a substantial effect on the exports of other developing countries that compete with China in third-country markets. For example, a 10 percent appreciation of the renminbi could increase exports of competitors by between 2 and 6 percent.
How can China definitively address the renminbi problem? The reformers within China are aware that the answer lies in opening up the capital account and freeing up interest and exchange rates. The opposition to reform remains substantial, however, and the leadership transition later this year appears to have sharpened the divide over economic reforms.
But, emboldened (or liberated) by the prospect of relinquishing power later this year, the reformers are increasingly asserting the case for change. The reform-imbued World Bank China 2030 report bearing the government’s imprimatur, the recent moves to open the capital account, and, most striking of all, premier Wen Jiabao’s call to break the monopoly of the state banks, all reflect the new-found zeal for reform.
China’s reformers need all the help they can get to overcome the domestic opposition. It might seem counterintuitive to suggest that a strong, powerful, and fiercely nationalistic country such as China can get help from the outside. But there is a recent historical precedent. About a decade ago, Mr. Zhu shrewdly used accession to the WTO as a way of furthering domestic and external liberalization, often against public and political opinion.
Today’s reformers can similarly harness the lever of international cooperation to help liberalize China’s exchange rate and financial sector policies. The right forum for and design of cooperative efforts will need to be worked out. But how fitting and effective it would be for Mr. Zhu’s protégé, Mr. Wen, to turn to the same source of help at the same twilight stage of his professional career—and for the same laudable reason of pushing through reform.
Working Paper 12-19: The Renminbi Bloc Is Here: Asia Down, Rest of the World to Go? October 2012
Policy Brief 12-7: Projecting China's Current Account Surplus April 2012
Book: Sustaining China's Economic Growth after the Global Financial Crisis January 2012
Book: Eclipse: Living in the Shadow of China's Economic Dominance September 2011
Op-ed: For a Serious Impact, Tax Chinese Assets in the United States October 13, 2011
Op-ed: Taxing China's Assets: How to Increase US Employment Without Launching a Trade War April 25, 2011
Op-ed: Why the World Needs Three Global Currencies February 15, 2011
Policy Brief 10-26: Currency Wars? November 2010
Op-ed: Obama Has to Tell Beijing Some Hard Truths November 29, 2010
Congressional Testimony: Correcting the Chinese Exchange Rate September 15, 2010
Policy Brief 10-20: Renminbi Undervaluation, China’s Surplus, and the US Trade Deficit August 2010
Op-ed: Chinomics: Yes, China Does Need that Infrastructure June 23, 2010
Policy Brief 10-16: Deepening China-Taiwan Relations through the Economic Cooperation Framework Agreement June 2010
Congressional Testimony: China's Exchange Rate Policy and Trade Imbalances April 22, 2010
Op-ed: New Imbalances Will Threaten Global Recovery June 10, 2010
Policy Brief 10-7: The Sustainability of China's Recovery from the Global Recession March 2010
Congressional Testimony: Correcting the Chinese Exchange Rate: An Action Plan March 24, 2010
Paper: Submission to the USTR in Support of a Trans-Pacific Partnership Agreement January 25, 2010
Peterson Perspective: A Growing US-China Rift January 6, 2010
Book: China's Rise: Challenges and Opportunities (hardcover) September 2008
Paper: China Energy: A Guide for the Perplexed May 2007
Speech: Is China a Currency “Manipulator”? January 28, 2009
Congressional Testimony: China's Role in the Origins of and Response to the Global Recession February 17, 2009
Book: US-China Trade Disputes: Rising Tide, Rising Stakes August 2006
Book: Debating China's Exchange Rate Policy April 2008
Congressional Testimony: A Muscular Multilateralism to Engage China on Trade September 21, 2011
Peterson Perspective: Legislation to Sanction China: Will It Work? October 7, 2011
Book: The Future of China's Exchange Rate Policy July 2009
Working Paper 11-14: Renminbi Rules: The Conditional Imminence of the Reserve Currency Transition September 2011