from Follow the Money

Spence on China

January 5, 2007

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Michael Spence has a Nobel prize in economics, a series of very prestigious academic appointments, friends on the Harvard faculty and access to the opinion page of the Wall Street Journal.

I, obviously, don’t have comparable qualifications -- or comparable access to the Wall Street Journal's oped page.  

But I do try to follow the data coming out of China closely.  I probably shouldn't say this, but it sure seemed to me that Dr. Spence got a few key facts wrong in his Wall Street Journal oped

Spence writes: “In 2005, China’s trade surplus was $50 billion.”    That seems off.  The IMF reports a $134.2b goods surplus in 2005 (BoP basis) and a $9.4b services deficit, for a combined goods and services surplus of $124.8.   See Table 2 of the Article IV.   The simple (customs) goods trade surplus for China in 2005 was around $100b.  Google it.  It doesn't take long to find an article kind of like this.

Spence argues that “In fact, China’s trade surplus isn’t all that large.  It is well under 5% of China’s GDP, smaller in percentage terms than the US trade deficit.”   

That also seems off.   Look at the data on China's current account surplus – a slightly broader measure of China’s external surplus than the trade surplus.  China’s 2005 current account surplus was $161b, or 7.1% of its GDP – and its 2006 surplus is now estimated by the World Bank to be $222b, or 8.5% of China’s GDP.   Both the 2005 and 2006 Chinese surpluses are larger as a percent of China’s GDP than the US current account deficit is as a percent of US GDP.    

If you just look at China's trade surplus (BoP basis), it works out to around 5.5% in 2005 and probably 6.5-7% of China's GDP in 2006 -- numbers comparable to the US trade deficit. Spence’s graph shows China’s trade surplus through 2004.   That seems a bit misleading to me: China’s trade surplus ballooned in 2005 and 2006, just when the graph ends.   Spence's argument worked through 2004.  It no longer does. 

Here are two graphs – based on the latest customs data (the BoP data the IMF reports is a bit different, but the trend is the same).   The first shows China’s overall exports and imports (using rolling twelve month sums) -- the gap between the two is China's goods trade surplus over the preceding 12 months.


spence_1

The second shows China’s overall trade surplus, looking at both the monthly data and the rolling twelve month sum. 

spence_2

The rest of Spence’s article didn’t drive me absolutely crazy – as he notes, a gradual increase in US savings relative to US investment and a gradual fall in Chinese savings relative to investment and a “further lowering of the market-determined value of the dollar” will all be part of the overall adjustment process.    I am not sure if the PBoC-determined value of the dollar is part of the lowering of the market-determined value of the dollar or not, but in my view it certainly would help global adjustment if the RMB didn't depreciate along with the dollar.  

I deeply believe that the debate on China would be greatly facilitated if we dealt with China as it is, not as it used to be -- and the data presented in major financial dailies reflected China as it is now, not China as it used to be. 

In 2006, China will export nearly $1 trillion of goods – up from around $266b back in 2001.    The increase in China’s exports in 2007 – if current trends continue – will exceed China’s total exports in 2001.  Its current account surplus has soared, going from 1.3% of GDP in 2001 over that period to at least 8.5% of GDP in 2006 (and that is probably too low given the recent data for November).   China’s saving rate has gone from around 35% of GDP in 2001 to around 50% of GDP in 2006.  (My data are IMF estimates, apart from the 2006 current account surplus estimate, which comes from the more up –to-date World Bank quarterly). 

Those are all huge changes.  The argument that China’s overall trade surplus is a myth is two years out of date.  The myth now is that China’s doesn’t run a big global surplus.  

The real debate on China now isn't about whether China runs a surplus or not.  It is over the connection between China's exchange rate policy and the recent surge in its savings rate and associated surge in its global surplus.  Martin Wolf has highlighted this better than anyone.  Wolf writes:

I do not think China’s savings are driving the real exchange rate and the current account but rather the other way round. I think the same is true in the US, too … .

China has a more or less fixed nominal exchange rate. It also has a target of very low inflation. The two together determine the real exchange rate. At this real exchange rate, there exists a current account surplus and corresponding savings rate that delivers satisfactory levels of activity. Now suppose that the current account surplus suddenly shot up one year, because of greater than expected export capacity. China’s authorities would be concerned about overheating. So what would they do? They would tell local authorities and state-owned enterprises to invest less. They would tell banks to advance less credit. They would sterilise the reserve accumulation. These policies would generate the surplus of savings over investment needed to accommodate the current account surplus without either excess or inadequate demand. The real exchange rate tail wags the savings dog.

Exactly the same thing applies to the US, but in reverse. “ Emphasis added.

Right now, it is possible to argue, as Martin Wolf does, that China's savings surplus stems from its exchange rate policies -- with the rise in the savings surplus coming as China pushed the RMB down v. a host of currencies when the dollar depreciated.    It is possible to argue, as Ronald McKinnon does, that China's savings and current account surplus has nothing to do with China's exchange rate policy (though I am curious how Dr. McKinnon explains the post-2002 surge in Chinese exports).  It is possible to argue, as Dr. Buiter and a host of others do, that China should be running a 10% of GDP current account surplus at this stage of its development, and should be saving 50% of GDP and investing 40% of GDP (though I am curious why Dr. Buiter thinks China's equilibrium savings surplus rose recently).  It is possible to argue that China should be saving and investing less and still running a large current account surplus.   It is even possible to argue that China should be investing less -- and if that means an even larger current account surplus, so be it.

But I don't see how it is possible to argue that China doesn't really have a current account surplus right now. Even the Chinese Academy recognizes China has a large and growing surplus.  The data has sort of spoken.

China alone now accounts for about 1/5 of the world’s current account surplus (depending on how you account for Europe -- I treat the Eurozone as a block, not as a set of seperate countries).  China is clearly is an important contributor to overall imbalances – not the only one, but an important one.  It is possible to argue that this imbalance is not worth worrying about, but not that it doesn't exist.

Sorry about the rant.  When I saw numbers that I didn't recognize at the beginning of Spence's argument, it kind of got in the way of his broader argument -- at least for me.

Update: I am with Delong on this, not with folks like Spence, Roach and (at least occasionally) Roubini.  I don't think the US savings and investment gap is independent of the willingness of China and the petrostates to finance the US at low rates.  If China let its exchange rate move significantly and reduced its current account surplus, the US wouldn't ended up borrowing the same amount from other countries.  It would end up borrowing less.

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