New Economist

Three myths about yuan revaluation

The latest Economist cover story and leader, America's fear of China, explains why bashing China over trade is not a good idea. But the more interesting piece is inside: Lost in translation. It argues that "If China sharply revalued the yuan, as American politicians are demanding, it could actually hurt the United States and help China." It's a long piece that is worth reading. Below I excerpt the section which claims that the standard arguments for a revaluation are based partly on a series of myths (emphasis added).

The first myth is that there is overwhelming evidence that the yuan is grossly undervalued. China's large bilateral trade surplus with America proves nothing. It largely reflects Asia's changing supply chain. Much of what America buys from China today once came from Japan, South Korea and Taiwan. China now imports components from these countries, assembles them and exports the finished goods to America. Knock out these and America's bilateral deficit with China shrinks by more than half. Even so, China's overall current-account surplus is also huge. The surge in its foreign-exchange reserves, to over $1.2 trillion, also suggests that the yuan is undervalued: without those massive purchases of dollars, the currency would have risen.

However, not all economists agree that the yuan needs to be sharply revalued. At one extreme is Morris Goldstein, of the Peterson Institute for International Economics, who argues that the yuan is undervalued by 40% or more against the dollar and should immediately be revalued by 10-15%. In the other corner many highly respected economists, including Robert Mundell, an economics Nobel prize-winner, and Ronald McKinnon, of Stanford University, strongly argue against a big appreciation of the yuan.

Economists find it devilishly hard to define the “correct value” for a currency. On purchasing-power parity (PPP), the yuan is clearly undervalued against the dollar. Perhaps by as much as 50%. But PPP is not useful for determining the optimal exchange rate between two countries of such different levels of income. It is natural for average prices to be lower in poorer countries because wages are lower. As countries get richer and their productivity rises, their real exchange rates appreciate. And although the depreciation in the yuan's real trade-weighted value since 2002 looks perverse, this follows a real appreciation of 50% between 1994 and 2001 (see chart 1).

A study by two IMF economists, Steven Dunaway and Xiangming Li, found that estimates for the undervaluation of the yuan ranged from zero to nearly 50%, depending on which method was used. Another recent study, by Yin-Wong Cheung, Menzie Chinn and Eiji Fujii, concluded that using conventional statistical methods it is hard to prove that the yuan is much undervalued. Such uncertainty may partly explain why America's Treasury Department has so far ducked labelling China as a currency manipulator in its twice-yearly report to Congress. Another reason is that it is loth to give ammunition to the protectionist lobby.

Myth number two is that the sharp increase in China's trade surplus is due to an explosion in cheap exports. Until 2004 China's surplus was relatively modest, but it soared over the next two years (see chart 2). Jonathan Anderson, chief Asia economist at UBS, points out that export growth actually slowed between 2004 and 2006 (see chart 3). The main reason for the bigger trade surplus was a sharp slowdown in the annual real growth rate in imports, from more than 30% in early 2004 to less than 15% last year.

The entire increase in China's trade surplus since 2004 has come from trade in heavy industrial materials and equipment. China used to import increasing amounts of steel, aluminium, chemicals and machinery, but import growth collapsed after 2004 when the government started to tighten policy, causing a sharp slowdown in construction, one of the biggest importers of machinery and materials. At the same time China continued to invest heavily in metals and equipment, creating substantial excess capacity, so import growth remained relatively weak last year. Mr Anderson argues that imports should recover as overcapacity is used up.

The third fallacy is that imports from China destroy jobs and harm the American economy. It is hard to see how China can be blamed for job losses when America's unemployment rate (4.5%) is close to its lowest for decades. Trade with China may affect the composition of jobs in America, but it has little impact on total employment. It is true that some workers are harmed by trade with China, just as there are some losers from all international trade. But the American economy overall is better off, so in theory there is ample room to compensate any losers.

Trade with China helps, not harms the average American. Thanks to imports from China, prices are lower and real incomes higher. Commentators often refer to the “cheap” yuan as being an unfair subsidy for Chinese exporters. But it is a moot question who exactly is subsidising whom. Not only do cheap imports subsidise American consumers, but China's large purchases of Treasury bonds also hold down American interest rates, thereby subsidising home buyers. Suppose that overnight the yuan rose by 30%, what would happen? American interest rates would rise as China needed to buy fewer Treasury securities and prices at Wal-Mart would increase. If consumer spending and imports then collapsed, this would certainly reduce America's trade deficit, but in a much more painful way than most Americans have in mind.

UPDATE: Greg Mankiw links to and posts an excerpt from a 22 May Wall Street Journal article on the yuan by Matthew J. Slaughter

Doing research in China: constraints, conformity and self-censorship

Hong Kong-based economics professor Carsten A. Holz asks an important question in this month's Far Eastern Economic Review: Have China Scholars All Been Bought? Of course, you know the answer:

Academics who study China, which includes the author, habitually please the Chinese Communist Party, sometimes consciously, and often unconsciously. Our incentives are to conform, and we do so in numerous ways: through the research questions we ask or don’t ask, through the facts we report or ignore, through our use of language, and through what and how we teach.

Foreign academics must cooperate with academics in China to collect data and co-author research. Surveys are conducted in a manner that is acceptable to the Party, and their content is limited to politically acceptable questions. For academics in China, such choices come naturally. The Western side plays along.

China researchers are equally constrained in their solo research. Some Western China scholars have relatives in China. Others own apartments there. Those China scholars whose mother tongue is not Chinese have studied the language for years and have built their careers on this large and nontransferable investment. We benefit from our connections in China to obtain information and insights, and we protect these connections. Everybody is happy, Western readers for the up-to-date view from academia, we ourselves for prospering in our jobs, and the Party for getting us to do its advertising. China is fairly unique in that the incentives for academics all go one way: One does not upset the Party.

What happens when we don’t play along is all too obvious. We can’t attract Chinese collaborators. When we poke around in China to do research we run into trouble. ...China researchers across different disciplines may not all be equally affected. Economists and political scientists are likely to come up against the Party constraint frequently, and perhaps severely. But even sociologists or ethnographers can reach the forbidden zone when doing network studies or examining ethnic minority cultures.

Holz does not pull any punches, likening the Communist Party to the mafia. The examples he gives of 'doing research' are both fascinating and horrifying. Hat tip: China Challenges

Sriperumbudur: India's Shenzhen?

If you build it, will the investors come? Bloomberg columnist Andy Mukherjee ask whether Sriperumbudur in India's Tamil Nadu state may be India's answer to Shenzhen. If so, it will need political will and administrative savvy, he writes:

There's much optimism in India about the transformation of a small hamlet of paddy fields and wetlands in the south of the country into a global electronics hub. Local media say India may have found its equivalent of China's Shenzhen, or at least a miniature version of it.

It's indeed possible that Sriperumbudur in India's Tamil Nadu state may start churning out as many mobile phones in three years as Shenzhen in southern China does now. That won't be a mean feat, considering Shenzhen makes one out of eight handsets sold anywhere in the world.

The question is whether India has the political will and the administrative savvy to take Sriperumbudur to its full potential. It took a leader of Deng Xiaoping's foresight, and the might of China's command-and-control economy, to create Shenzhen. Who will bat for Sriperumbudur, which sends one lawmaker to the 545-member parliament, in democratic India?

The globalisation of managerial pay

While many complain about globalisation in the West, in developing economies it is seeing rewards for managerial and professional staff take off. Andrew Taylor reports in the Financial Times that Pay to ‘race ahead’ in Asia and E. Europe

The pay gap between professional staff and managers employed in emerging Asian and eastern European economies and those working in more mature markets is narrowing rapidly after taking inflation into account, according to research published on Monday.

Forecasts of wage increase in more than 50 countries, published by global consultants Hay Group, reveals that real pay, after allowing for local cost of living, is predicted to race ahead in Asia and eastern Europe this year compared with the “developed old economies” of western Europe and the US.

Faster wage growth reflects “the wealth creation being generated by rapid economic acceleration in China, India, the former Eastern Bloc and the Baltic states,” says Hay.

...According to Hay’s research, the real pay of senior mangers in China is forecast to rise by “an impressive” 8.9 per cent this year. Earnings of professional staff after adjusting for inflation are predicted by 7.9 per cent administrative workers and by 7.8 per cent for professional staff.

Extremely high pay rises in India last year also look set to continue in 2007 with real earnings of senior managers forecast to rise by 6.9 per cent, it says.

Real pay in eastern Europe is also rising “at a rate far above that in the west,” The biggest rises this year are expected in Bulgaria where average real increase of 6 per cent are predicted for managers, professional staff and administrative workers.

Scott Marlowe, general manager for Hay in the Czech republic says: “While wages are growing from a much lower level for manual and administrative workers, pay levels for managers are closer to western standards.

...Salary increases in western Europe by comparison are forecast to be much “ much more moderate” this year. Real pay rises for managers, professional and administrative staff are expected to average less than 1.5 per cent in Germany, Italy, Spain and France and just 1.5 per cent in Britain.

US workers are also expected to fare worse “with predicted increases of just 1.4 percent across all three categories. ...“Much like their colleagues in Europe, American employees cannot look forward to stellar pay rises in 2007.”

A classic example of supply and demand at work. This will not only reduce the brain drain in those countries, it also increases the rewards for human capital - which can be no bad thing.

China vs. India - part 2

The Economist's latest Economics Focus compares China and India. The piece, Reading the tea leaves, concludes that "India's boom may be less impressive than it seems":

India has been swept by optimism that its economy can do as well as China's. A recent article in the Economic Times claimed that the growth in India's total factor productivity (TFP), the efficiency with which inputs of both labour and capital are used, had accelerated, whereas China's had slowed owing to wasteful investment. As a result, the article boasted, rising productivity—the main driver of long-run economic growth—is now running neck and neck in the two economies. Close inspection of the numbers, however, reveals that China remains well ahead.

Both India and China have large populations, low incomes and rapidly rising GDP, yet the composition of their growth has been quite different. A recent paper* by Barry Bosworth and Susan Collins, of the Brookings Institution in Washington, DC, explores the sources of expansion in both countries, breaking down total GDP growth into increases in inputs of labour and capital, and gains in TFP. In the period 1993-2004, China's GDP grew by an average of 9.7% a year, India's by 6.5%. Employment increased faster in India than in China, but this was more than offset by a much slower rise in output per worker: only 4.6% a year, compared with 8.5% in China. This reflected both stronger capital investment in China and much faster growth in TFP, which increased at an annual rate of 4% against India's 2.3% (see left-hand chart). Contrary to the popular claim that China's TFP growth has slowed, the authors find that it has accelerated from a pace of 3.6% in 1978-93.

These figures challenge the conventional wisdom that China's growth is more dependent than India's on investment than on efficiency gains. Over the past decade TFP has in fact accounted for a bigger slice of GDP growth in China than in India. Thanks to economic reforms, India's TFP growth has improved from its paltry 0.2% a year in the 1960s and 1970s before the economy was opened up, but it is still much slower than in China. Worryingly, the figures also show that India's TFP grew more slowly in 1999-2004 than in 1993-99. Since 2004, TFP growth has probably spurted (the figures are not yet available), but this may reflect a cyclical boom.

The relative performance of the two countries varies by sector (see right-hand chart). In agriculture, China has enjoyed much faster productivity growth. Indeed, India's TFP growth in farming has fallen since 1993, dragging down overall TFP growth because agriculture still employs a large share of the population. In 1978 it accounted for 71% of workers in both India and China. Now the respective figures are 57% and 47%. India therefore has huge scope to sustain rapid growth by shifting workers from agriculture to more productive jobs in industry and services.

According to conventional wisdom, Chinese workers have shifted largely from farming to factories, whereas India's growth has been driven largely by services, from call centres to writing software. In fact, jobs in services have expanded more strongly in China than in India. Since 1993 the rate of increase of China's service-sector jobs has been four times that in industrial jobs and has exceeded that in India. China's real output of services has not only grown almost as fast as its industrial output, but also faster than India's services.

Indeed, a larger proportion of workers is employed in services in China than in India. However, the share of services in GDP is much smaller in China (33%, against India's 50%), because Chinese industry is so much more productive. India's industrial workforce, including small firms in the informal sector, has been growing much faster than China's—by 3.6% a year since 1993, against only 1.2% in China—but its industrial output has lagged behind China's because its productivity has grown more slowly. This is due in part to rigid labour laws, which prevent the most efficient use of workers, and to a lack of modern infrastructure. Since 1993, China's industrial TFP has grown by an annual average of 6.2% compared with a measly 1.1% in India—barely any faster than before the economic reforms of the early 1990s.

* “Accounting for Growth: Comparing China and India”

Das (Wasted) Kapital

A new IMF paper by David Dollar and Shang-Jin Wei argues, on the basis of a large sample of firms, that China allocates its capital inefficiently. this claim has been made before, of course - but never with such hard evidence to back it up. Here is the abstract for Das (Wasted) Kapital: Firm Ownership and Investment Efficiency in China

Based on a survey that we designed and that covers a stratified random sample of 12,400 firms in 120 cities in China with firm-level accounting information for 2002-2004, this paper examines the presence of systematic distortions in capital allocation that result in uneven marginal returns to capital across firm ownership, regions, and sectors. It provides a systematic comparison of investment efficiency among wholly and partially state-owned, wholly and partially foreignowned, and domestic privately owned firms, conditioning on their sector, location, and size characteristics.

It finds that even after a quarter-of-century of reforms, state-owned firms still have significantly lower returns to capital, on average, than domestic private or foreign-owned firms. Similarly, certain regions and sectors have consistently lower returns to capital than other regions and sectors. By our calculation, if China succeeds in allocating its capital more efficiently, it could reduce its investment intensity by 5 percent of GDP without sacrificing its economic growth (and hence deliver a greater improvement to its citizens' living standard).

New book: China crisis?

Observer columnist, author and think tanker Will Hutton knows that controversy sells. So he's done his best to highlight the dark side of China's political economy in his a book to be published January 18: The Writing on the Wall: China and the West in the 21st Century (Little, Brown UK). The book is being serialised, with three excerpts published so far:

1. New China. New crisis: The Observer, Sunday January 7 - "In the last decade China has emerged as a powerful, resurgent economic force with the muscle to challenge America as the global superpower. But, in his controversial new book, Will Hutton argues that China's explosive economic reforms will create seismic tensions within the one-party authoritarian state and asks: can the centre hold?"

2. Power, corruption and lies: The Guardian, Monday January 8 - "To the west, China is a waking economic giant, poised to dominate the world. But, argues Will Hutton in this extract from his new book, we have consistently exaggerated and misunderstood the threat - and the consequences could be grave."

3. Low wage competition isn't to blame for western job losses and inequality: The Guardian, Tuesday January 9 - "US and British business culture is creating our widening pay gap, not the impact of sub-contractor economies like China."

His central thesis is neatly summarised in the second piece:

The west is unforgivably ignorant about China's shortcomings and weaknesses, which leads it vastly to exaggerate the extent of the Chinese "threat". China is certainly emerging as a leading exporter, but essentially it is a sub-contractor to the west. It has not bucked the way globalisation is heavily skewed in favour of the rich developed nations.

Its productivity is poor; it lacks international champions; its innovation record is lamentable; it relies far too much on exports and investment to propel its economy. To characterise China as an unstoppable force whose economic model is unbeatable and set to swamp us - the stuff of almost every ministerial and business lobby speech - is to make a first-order mistake.

Gripping stuff, which I'm sure will go down particularly well in America. Hutton overstates his case, of course. And he's no China expert. But he's a well known commentator and author and he writes better than 99% of those who do know better - so I'm sure it will sell well.

UPDATE: Torcuil Crichton of the Sunday Herald interviews Will Hutton about his book, and British politics: Great Will of China

Hutton's handling of the complex Chinese economic puzzle is refreshingly straightforward. China, as we all vaguely know, will be very important very soon. The economics of the 21st century will belong to China, much as the 19th came under British influence and the 20th closed under US dominance.

He details the fantasy that is communist doctrine, the endemic corruption of the state and the unsustainability of China's exponential growth. Within a decade it will be the world's second largest economy. The country is the single most important financier of the enormous US trade deficit. It competes for oil, water and military muscle. But though it looks like an unstoppable engine, it is not a market economy that we would recognise and it is on the verge of collapse.

 

Sitting in his office at the Work Foundation, the left-of-centre think tank he now heads, Hutton insists that "collapse" is too strong a word; convulsion might be better. "The question is, how will they make the transition from what they've got to where they need to be without very substantial convulsions?" says Hutton. "In the best case the Communist Party see the light and build plural institutions, which will mean losing monopoly control of the state. The next generation of leaders enact this or fight like tigers to resist it. If so we will see civil war in China or they may rally the country in a foreign adventure." 

Are China's poor better off?

Not everyone in China is benefiting from the economy's stellar growth, according to a new World Bank report. FT Beijing correspondent Richard McGregor reports that China’s poorest worse off after boom

China’s poor grew poorer at a time when the country was growing substantially wealthier, an analysis by World Bank economists has found. The real income of the poorest 10 per cent of China’s 1.3bn people fell by 2.4 per cent in the two years to 2003, the analysis showed, a period when the economy was growing by nearly 10 per cent a year. Over the same period, the income of China’s richest 10 per cent rose by more than 16 per cent.

“Preliminary analysis on Chinese data indicates that average income of the bottom decile went down slightly between 2001 and 2003, whereas all other income categories saw significant increases,” said Bert Hofman, the bank’s lead economist in China. “Our analysis suggests that a considerable number of people below the poverty line were hit by an income shock – they only kept up consumption by spending their savings.”

The findings challenge the basis of government policies aimed at narrowing the country’s politically sensitive wealth gap. ...China, which had relatively even income distribution in 1980 when it embarked on market reforms, is now “less equal” than the US and Russia, using the Gini co-efficient, a standard measure of income disparities.

...The fall in income for the poor cannot be explained by declining farm incomes, as food prices were rising at a faster rate than urban prices in December 2003. Over the period that the study covers, inflation was low and in one year, 2002, negative.

The findings challenge the basis of government policies aimed at narrowing the country’s politically sensitive wealth gap. Hu Jintao, China’s president, who came to power in 2002 and is likely to win a second five-year term next year, has made narrowing the gap between rich and poor a centrepiece of his administration’s economic policies.

China, which had relatively even income distribution in 1980 when it embarked on market reforms, is now “less equal” than the US and Russia, using the Gini co-efficient, a standard measure of income disparities.

The Wall Street Journal also reported the findings today: In China, Growth at Whose Cost? The story, by Andrew Batson and Shai Oster, points out that "the poorest of the country's 1.3 billion people are getting even poorer."

From 2001 to 2003, as China's economy expanded nearly 10% a year, average income for the poorest 10% of the country's households fell 2.5%, according to an analysis by the World Bank that has been presented to the Chinese government. Those roughly 130 million Chinese earn $1 a day or less, the World Bank's global benchmark for poverty.

Meanwhile, the nation's total income rose sharply, and other income groups saw gains, suggesting that the rich are getting richer at the expense of the poorest.

The reason for the income decline at the bottom isn't clear. The World Bank hasn't completed its analysis and its conclusions haven't been published. Even so, the data call into question an economic model that economists have held up as an example for other developing nations.

"This finding is very important. If true, it sheds doubt on the argument that a rising tide lifts all boats," said Bert Hofman, the World Bank's chief economist in China.

...The World Bank's Mr. Hofman says the bank's analysis shows the majority of China's poorest 10% appear to be only temporarily poor, thrown down by some setback like sudden illness, the loss of a job or the confiscation of land. That suggests that a basic social safety net, like medical insurance or unemployment benefits, could help move them back out of poverty. Only about 20% to 30% of the poorest appear to be long-term poor, and even they have some savings.

Unfortunately I have not been able to find the report on the main World Bank website, or their China website. If anybody can send me a link, I'd appreciate it.

UPDATE: Dave Altig at Macroblog has also posted on this report. He comments:

Temporary bouts of economic hardship are clearly a much different thing than persistent poverty traps.  And if, in fact, poverty is predominantly transitory, we should perhaps be more circumspect about declaring that a rising tide fails to raise all boats.

How are wages set in Beijing?

That is the question asked by José de Sousa and Sandra Poncet from the Université Paris 1, in a new working paper. Drawing on a sample of 29 Chinese provinces between 1995 and 2002, How are wages set in Beijing? (PDF) finds that most of the variance in the average regional wage rate is due to differences in access to markets and to immigrant labor.

Both market access and migration have statistically significant effects on the wage level. The magnitude of the immigrant labor access offsets the impact of market access and exerts a downward pressure on wages.

Climate change: wait, there's more...

As if the 600 page Stern Review on the economics of climate change were not enough to digest, Her Majesty's Treasury has also posted 36 commisioned pieces of supporting research online. Quite a few concern temselves with 'the China problem', some with the economics of adaptation, others with mitigation and abatement. Though many are clearly for the specialists, readers might find some of interest. The full list is over the fold...