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Thursday, 16 September 2010

Is Chinese Mercantilism Bad for Poor Countries?

Yes. According to Rodrik. China's undervalued currency has prevented developing countries from restructuring away their economies from low value primary goods to China-like high value manufacturing. The answer lies in these countries recognise inherent weakness of their current approach and consider using their exchange rates more actively in order to stimulate industrialization and growth (i.e. competitive devaluation that shifts the "burden" onto rich countries) :

China’s trade balance is on course for another bumper surplus this year. Meanwhile, concern about the health of the US recovery continues to mount. Both developments suggest that China will be under renewed pressure to nudge its currency sharply upward. The conflict with the US may well come to a head during Congressional hearings on the renminbi to be held in September, where many voices will urge the Obama administration to threaten punitive measures if China does not act.

Discussion of China’s currency focuses around the need to shrink the country’s trade surplus and correct global macroeconomic imbalances. With a less competitive currency, many analysts hope, China will export less and import more, making a positive contribution to the recovery of the US and other economies.

In all this discussion, the renminbi is viewed largely as a US-China issue, and the interests of poor countries get scarcely a hearing, even in multilateral fora. Yet a noticeable rise in the renminbi’s value may have significant implications for developing countries. Whether they stand to gain or lose from a renminbi revaluation, however, is hotly contested.

On one side stands Arvind Subramanian, from the Peterson Institute and the Center for Global Development. He argues that developing countries have suffered greatly from China’s policy of undervaluing its currency, which has made it more difficult for them to compete with Chinese goods in world markets, retarded their industrialization, and set back their growth.

If the renminbi were to gain in value, poor countries’ exports would become more competitive, and their economies would become better positioned to reap the benefits of globalization. Hence, Subramanian argues, poor countries must make common cause with the US and other advanced economies in pressuring China to alter its currency policies.

On the other side stand Helmut Reisen and his colleagues at the OECD’s Development Centre, who conclude that developing countries, and especially the poorest among them, would be hurt if the renminbi were to rise sharply. Their reasoning is that currency appreciation would almost certainly slow China’s growth, and that anything does that must be bad news for other poor countries as well.

They buttress their argument with empirical work that suggests that growth in developing countries has become progressively more dependent on China’s economic performance. They estimate that a slowdown of one percentage point in China’s annual growth rate would reduce low-income countries growth rates by 0.3 percentage points – almost a third as much.

To make sense of these two contrasting perspectives, we need to step back and consider the fundamental drivers of growth. Strip away the technicalities, and the debate boils down to one fundamental question: what is the best, most sustainable growth model for low-income countries?

Historically, poor regions of the world have often relied on what is called a “vent-for-surplus” model. This model entails exporting to other parts of the world primary products and natural resources such as agricultural produce or minerals.

This is how Argentina grew rich in the nineteenth century, and how oil states have become wealthy during the last 40 years. The rapid growth that many developing countries experienced prior to the crisis was largely the result of the same model. Countries in Sub-Saharan Africa, in particular, were propelled forward by the growing demand for their natural resources from other countries – China chief among them.

But this model suffers from two fatal weaknesses. First, it depends heavily on rapid growth in foreign demand. When such demand falters, developing countries find themselves with collapsing export prices, and, too often, a protracted domestic crisis. Second, it does not stimulate economic diversification. Economies hooked on this model find themselves excessively specialized in primary products that promise little productivity growth.

Indeed, the central challenge of economic development is not foreign demand, but domestic structural change. The problem for poor countries is that they are not producing the right kinds of goods. They need to restructure away from traditional primary products to higher-productivity activities, mainly manufactures and modern services.

The real exchange rate is of paramount importance here, as it determines the competitiveness and profitability of modern tradable activities. When developing nations are forced into overvalued currencies, entrepreneurship and investment in those activities are depressed.

From this perspective, China’s currency policies not only undercut the competitiveness of African and other poor regions’ industries; they also undermine those regions’ fundamental growth engines. What poor nations get out of Chinese mercantilism is, at best, temporary growth of the wrong kind.

Lest we blame China too much, though, we should remember that there is little that prevents developing countries from replicating the essentials of the Chinese model. They, too, could have used their exchange rates more actively in order to stimulate industrialization and growth. True, all countries in the world cannot simultaneously undervalue their currencies. But poor nations could have shifted the “burden” onto rich countries, where, economic logic suggests, it ought to be placed.

Instead, too many developing countries have allowed their currencies to become overvalued, relying on booming commodity demand or financial inflows. And they have made little systematic use of explicit industrial policies that could act as a substitute for undervaluation.

Given this, perhaps we should not hold China responsible for taking care of its own economic interests, even if it has aggravated in the process the costs of other countries’ misguided currency policies.

1 comment:

  1. We Zambians should not let Rodrick or any other economist persuade us that a stronger yuan, and therefore more expensive Chinese goods would benefit us. We would continue to buy Chinese clothing and other goods, from which our people benefit greatly, but at higher prices.

    How about encouraging a generally weaker kwacha through a change in the exchange rate? This would make our export crops like cotton, coffee and tobacco more competitive in foreign markets, and would thereby boost agricultural earnings.

    Would a 'devaluation' of our Kwacha make sense in general terms? Most certainly! Inflation in Zambia has for several years been at least three times inflation in the United States, yet with little reduction in the exchange rate. The Kwacha has owed its 'strength' to a combination of artificial factors - aid, debt forgiveness and high copper prices. Far better to live in the real world and let our farmers make good earnings from exports.

    Let us not worry about the dollar/yuan exchange rate. This political football is of little concern to Zambia.


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