Morgan Stanley: China does not rely much on export led growth

Sometimes you read something and it makes you stop, because it is at odds with your existing sense of how the world economy is working. Drossos and Kinbrough’s argument that China does not rely on a cheap currency to fuel an export-led growth model had that effect on me. They are making a comparative argument -- other countries rely more on undervalued currencies and current account surpluses for growth than China. But the basic point, even upon reflection, still seems off.The hard part of their argument to swallow is this: China’s exports to the US are on track to rise by 30% this year, or by a bit less than $50 billion -- the increase alone is about 3% of China’s GDP (though this will be partially offset by the imports China needs in order to export). China’s exports to the US are on track to double since 2000, rising from $100 billion to around $200 billion by the end of 2004, while overall US imports have gone up by only 20%. Nouriel and I are looking at data on exports to the US as a share of GDP, and China is among the countries that is most dependent on the U.S. market. That sure feels like export led growth.

Moreover, the entire Bretton Woods two hypothesis (see Nouriel’s blog) hinges on the argument that an undervalued exchange rate and rapid export led growth is so central to China’s overall economic prospect that they will incur all the costs associated with funding the United States deficits and sterilizing massive reserve buildup to maintain an undervalued exchange rate for some time.

One argument against the "export led growth" argument is that China’s overall trade is roughly in balance. That argument always struck me as a bit at odds with the facts. A 3% or so of GDP current accout surplus (2003) is not "roughly in balance." The IMF estimates that China will --despite a massively negative commodity price shock and an overheated domestic economy -- still run a current account surplus of 2.5% of GDP this year. 2.5% is not 5%, but it is not zero either. Moreover, as Morris Goldstein has emphasized, China’s underlying current accout surplus (in 2003) was around 5% of GDP, not 3% -- a cyclical credit driven bubble was driving the surplus down. Compare that surplus with the deficit that China could run given its ability to attract FDI, and you get a gap of 7, even 8% of GDP. That is not small. There is a reason why China’s 2004 reserve accumulation is likely to exceed $100 billion.

Remember, when South East Asia was in the midst of a comparable property and investment bubble in 94, 95, and 96, large current account deficits were the norm. The surprise -- given the scale of the adverse oil/ commodity shock and China’s own position in its economic cycle -- is that China is still running a 2.5% of GDP current account surplus.

The other argument that could be made against an export-led growth thesis is that China’s imports are increasing quite rapidly (the pace of growth has tailed off a bit recently, but from a very high pace). That is no doubt true. But it also does not counter an manufactured export led growth argument. China’s exports are also growing fast, and part of the increase in imports is linked to the surge in exports: Chinese exports have a large imported component, both of things like computer chips and imported raw materials (see, among other things, my post on DeLong).

Of course, that is not the entire story. China’s imports are also growing because of a surge in demand for raw materials (and to a lesser extend capital goods) linked to China’s rapid growth. While some growth is linked to china’s emergency as an exporting powerhouse, some is also linked to an overall dyanmic created by rising income (accelerated by rapid lending growth). But even here, the observed surge in imports is overstated a bit by higher commodity prices, whether for oil, cooper, iron ore or soybeans. My bet is that if you looked at China’s 2004 import and export volumes, its export volumes are grow faster than its import volumes, DESPITE a massive domestic boom in China that is driving up import volumes (and contributing the overall run-up in commodity prices). If that is true, China’s overall trade surplus is falling slightly this year only because of an adverse move in import prices.

China may not rely on export led growth quite as much as Malaysia or Taiwan, but still ...