Chinese Mercantilism: The Long View
by Arvind Subramanian, Peterson Institute for International Economics
Op-ed in the Business Standard, New Delhi
January 14, 2011
© Business Standard
Chinese mercantilism will be high on the list of topics that US President Barack Obama will discuss when President Hu Jintao visits the US next week. Solutions galore have been offered to address China's undervalued exchange rate and the global imbalances that it has caused. But it is time to take a long view, backwards and forward, to draw lessons for dealing with China.
Start first with history and the parallels between Chinese mercantilism today and its counterpart of the early 1800s. Then, like today, China was running large trade surpluses and accumulating reserves, not in the form of dollars but silver. Then, like today, the deficit country was agitated by the imbalance and the resulting outflow of silver and threatened action. Unlike today, the action taken by the United Kingdom was effective and unconscionable. To redress the bilateral imbalance, the United Kingdom flooded the Chinese market with opium grown in India.
So successful was the policy that China's surplus turned into a deficit within a short period, the flow of silver was stopped, even reversed, and levels of opium addiction rose alarmingly. The resulting ban on opium by the then "drug czar," Governor Lin Zexu of Canton, led to the opium wars and inaugurated the "century of humiliation" for China that is etched in the collective Chinese DNA.
Saber-rattling by today's superpower, the United States, to redress the imbalance carries echoes of the humiliation inflicted by the then superpower, the United Kingdom. Dealing with China effectively requires a greater sensitivity to that history. That sensitivity should lead to the use of carrots rather than sticks to induce China's cooperation, and to an approach that is energetically multilateral, aimed at designing better rules, rather than aggressively unilateral, aimed at achieving particular outcomes.
A second lesson stems from one crucial difference between the two episodes of Chinese mercantilism. Back in the early 1800s, China was mercantilist and closed. The paradox is that today China is mercantilist but highly open. China's surplus in the earlier episode was a consequence of unquenchable foreign demand for China's tea combined with a closed-door policy that virtually extinguished Chinese demand for foreign products. Put simply, China exported a fair amount and imported very little. Today, China exports a lot—exports a lot more than it imports—but it also imports a lot.
Taking account of China's size and the regularity that large countries tend to trade less than small countries, China is an exceptionally big importer and trader. My calculations suggest that the degree of China's openness, measured in terms of trade outcomes, is far greater than anything achieved by the United States in the postwar period and resembles the levels of openness achieved by the United Kingdom at the height of its empire
Why is the fact of China's openness important? Chinese openness does not absolve Chinese mercantilism or eliminate its beggar-thy-neighbor consequences, especially for poorer countries such as India. But it is quite possible, albeit not inevitable, that Chinese mercantilism will pass. All the signs are that China has embraced the objective of internationalizing the renminbi and embarked on a process of achieving it.
Internationalization is proceeding in typically Chinese fashion—micromanaged, discretionary, and selective. One might call it interventionist liberalization. Not a day passes without some company, some country, some transaction having greater access to the renminbi. But renminbi internationalization cannot succeed without chipping away fundamentally at China's domestic financial repression and the undervalued exchange rate that underpin Chinese mercantilism. To be sure, this process will proceed much slower and messier than desired by outsiders and much faster than can be countenanced by some domestic interests within China. But the process has been set in motion and might prove difficult to reverse.
So, one reading, perhaps overly optimistic and naive, is that a China that moves away from mercantilism will be a China that is an exceptionally large and fair trader with strong stakes in maintaining an open trading and financial system. Post–World War II, the United States fashioned such a system out of enlightened self-interest. In contrast, China's stake in openness might be less enlightened but more direct and important because its rise to prosperity, on which is predicated the legitimacy of its government, will depend upon an open system.
In sum, the long view argues in favor of sensitivity about the past and a strategic forbearance about the future. Rather than confronting China and risking conflict, the United States and outsiders should nudge China along the path away from mercantilism that it seems to have embarked upon.
The problem, of course, is that the clamorous present and unhelpful Chinese actions on a whole swath of economic and political issues—natural resources, technology, energy, Tibet—demand a vigorous response from the world. The reality is that outsiders have limited recourse. A less lofty reason to embrace the long view is then simply to make virtue out of the cold necessity that the United States and others (including India) may no longer have effective means to force cooperation from a dominant China.
Niall Ferguson's Chimerica is thought to signify the mutual dependence between China and America. It seems to be as much about how each is beyond the influence of the other.