from Follow the Money

Unhelpful –

November 13, 2008

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China has just increased its tax rebates on exports. While steps to support domestic Chinese demand help the world economy, steps by China – the country in the world with the largest current account surplus and (on a backward looking basis) still quite rapid export growth – to keep its exports up don’t.

Global demand is falling (Intel, Best Buy, Department stores sales are all telling the same story … ). Big importers can increase their market share through protectionism. Big exporters can increase their market share through export subsidies. Neither helps to address the real problem – the global shortfall in demand.

Monday’s excellent FT leader effectively argues -- diplomatically -- that the United States isn’t the only country that has lost a bit of economy and financial credibility over the past few years. It turned out that the US credit crisis wasn’t nearly as contained as the Fed and Treasury thought. And it turns out that the TARP isn’t really going to be used to buy troubled assets. But it also turned out that China never really carried through on its 2004 and 2005 and 2006 and even 2007 rhetoric that it planned to rebalance its economy.

Back in 2004 China’s leaders generally got the benefit of the doubt. Not necessarily about the quality of China’s economic data; as David Pilling notes, China’s data never has been all that credible. But most observers expected that China’s leaders would be able to deliver when they announced their plan to shift the basis of China’s growth away from exports and investment. Chinese policy makers generally had a pretty good track record of doing what they said they would do.

But four years after China indicated that it wanted to rebalance its economy, its economy looks more unbalanced than ever – its current account surplus is far far larger than in 2004, and investment accounts for a higher share of GDP than in 2004. The FT:

China’s growth to date has been phenomenal, but it was based on exports and investment, at the expense of consumption. China almost aimed to be a supersized South Korea: in 2005, capital investment made up more than half of China’s gross domestic product. The capital-intensity of its growth also meant profits grew strongly as a share of GDP. But employment growth has slowed since the 1980s, so workers have gained small benefit.

With an undervalued renminbi also making imports dear, the Chinese public has proved loath to spend. China has far too little dom­estic consumer demand. Where­as household consumption made up more than half of China’s GDP in the 1980s, it now contributes little more than a third.

In the absence of a domestic safety net, Chinese household savings have been as high as a quarter of disposable income. In addition, corporate and government savings have soared. Overall, China has been saving close to 60 per cent of GDP. This contributed hugely to the global savings imbalance. Some of the deepest roots of the current crisis lie in the plugging of western deficits with Asian savings.

The Chinese government recognises that it must build domestic consumer demand, but it is time for the leadership to put its money where its mouth is. Alas, the planned stimulus does not attempt to boost public and private consumption. It aims, instead, to keep the economy ticking over until it can start exporting again. This will not work.

Well said.

China never really adopted the kind of policies needed to reorient its economy in good times. And now -- barring a program of direct Chinese subsidies for US and European consumption that bypasses the US and European financial sector -- it looks like it will have to try to reorient its economy in bad times. It isn’t yet clear it can.

The failure to adjust when times were good is most obvious with China’s currency. China never let its currency move enough against the dollar back when the dollar was falling to generate a meaningful nominal appreciation of its currency against a basket of China’s trading partners. That was a mistake. It would have been far easier for China to adjust to a stronger RMB back when the both global economy and China’s domestic economy were strong that it is now. Ironically, the RMB’s current tight link to the dollar has produced a far larger nominal appreciation (against a basket of the currencies of China’s trade partners) than the period of controlled RMB appreciation against the dollar between mid 2005 and mid 2008 ever did.

Right now, the RMB is appreciating when both China’s domestic economy and the global economy is slowing. That isn’t helping China. But China’s policy makers made the bed they now have to sleep in. They could have allowed the RMB to appreciate meaningfully against a broad currency basket back when times where good. They didn’t. That constrains China’s options now that times aren’t as good. China will have a hard time explaining policy efforts directed at supporting its exports so long as it has a huge and growing trade surplus.

I certainly wouldn’t count the fiscal cost of larger VAT rebates on exports as part of China’s stimulus … it helps parts of China’s economy, but not the rest of the world.

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