Is China cheating?
Foul play! How else, says the US, could China undercut American producers in so many areas? For decades America seemed to dominate manufacturing, so U.S. officials focused on liberalizing trade in manufactured goods. They put little effort into creating a level playing field for farmers, since they knew America couldn't compete in agriculture.
Now, China is out-competing everyone, racking up huge trade surpluses with the US. So America's Treasury Secretary accuses China of deliberately keepings its exchange rate low, and calls for China to let market forces determine the value of the renminbi. The IMF's departing Chief Economist, Ken Rogoff, warns that the surpluses put global stability at risk.
For those who recall East Asia's crisis of five years ago, much of this seems to run counter to what was said then. China was urged not to float its currency. Until Argentina's peso imploded, fixed exchange rates were fine. The U.S. Treasury welcomed government intervention in exchange rate markets, and encouraged the IMF to support such interventions with mega-billion dollar loans to crisis countries. If China had let its currency float back then, it would have depreciated in value, deepening the crisis.
Countries were warned: avoid trade deficits and build up reserves, because they are the key frontline defense. East Asia's countries followed that advice, and for a good reason: they had seen the consequences of a lack of reserves.
East Asia's governments knew then that the IMF's policies would deepen their downturns, but they were helpless to resist. The IMF had the money they needed. China and Malaysia, lucky enough not to have to turn to the IMF or brave enough to set their own course, did what every textbook said you should do: they pursued expansionary monetary and fiscal policies. China's economy continued to grow at 7 percent; Malaysia had the shortest and shallowest downturn.
To understand what is at stake, a few basic economic points need to be spelled out. First, international trade is based on the principle of comparative advantage; countries export goods in which they have a relative advantage and import goods in which they have a relative disadvantage. By and large, America now has a relative disadvantage in manufacturing, while China has a relative advantage. China should be exporting manufactured goods to the US.
Secondly, if a country invests more than it saves, it will need to borrow, and the counterpart to that borrowing is a trade deficit. America's burgeoning trade deficit is a result of the Bush Administration's unprecedented mismanagement. Tax cuts that America could ill afford turned a huge fiscal surplus into a massive deficit; rather than saving, America's government is borrowing, much of it from abroad. That, not China's exchange rate policy, is the culprit.
In fact, China's overall trade surplus today is actually small, around 1 percent of its GDP. Of course, the Bush Administration wants to shift the blame, but neither China, nor anyone else, should be fooled. This is reminiscent of what happened twenty years ago, when President Reagan engineered huge tax cuts that were supposed to pay for themselves, but which incited huge fiscal deficits, which in turn led to huge trade deficits. Back then, Japan was blamed!
The harsh truth is that neither the IMF nor the Bush administration really believes in free markets. They interfere with markets when it suits their purposes. The Bush Administration supported bailouts for airlines, unprecedented subsidies for agriculture, and tariff protections for steel.
The IMF is right: there is a real risk of global instability, but the underlying cause is massive U.S. borrowing from abroad, which began under President Reagan. This turned the U.S. into a huge debtor. If, someday, America's creditors decide that they want to hold fewer dollars, it could set off large exchange rate movements, causing global instability.
Why hasn't the IMF sternly criticized these deficits? Why should the richest country in the world live beyond its means while the IMF scolds poorer countries for smaller transgressions?
This problem is compounded by the global reserve system, which sees most countries demanding U.S. dollars, effectively to bury them in the ground. The system requires the reserve currency country (the US) to be a massive debtor?to the point where others lose faith. But to solve deep-seated problems with the global financial system, we need to go beyond the complacency that has long marked the G-7 and the unilateralism that defines the current U.S. administration.
China is right to have ignored America's demands. Floating the exchange rate would expose the country to instabilities that would lead to a host of further problems, particularly the country's shaky banking system. A higher exchange rate would undermine job creation and would contribute to deflation, which China is successfully combating.
China is fortunate to have the freedom to follow its own views. Its huge foreign currency reserves give it the freedom to ignore the IMF and the U.S. Treasury. In the end, this may be the most compelling reason for why China should continue to run trade surpluses. Once again, China has shown its mastery of basic economic principles. Others in the region only wish that they could have acted similarly.
Joseph E. Stiglitz, a Nobel laureate in economics, is professor of economics at Columbia University and was chairman of the Council of Economic Advisers to President Clinton and Chief Economist and senior vice president at the World Bank. - Ed.
2003.10.08
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