Why China's Exporters Are Complaining Loudly

The Shanghai stock market had a good day today – its last trading day before the May holiday and the very long four-day weekend. The SSE Composite is up 4.84% and trading volume was up substantially too. What seemed to propel the market today was a bunch of companies reporting good earnings, especially the banks – three of the Big Four reported very healthy first quarter earnings growth, perhaps a consequence of January’s huge jump in loans. There are also more rumors about things the government might do to keep the market from falling.

Meanwhile it seems the fight over the currency is intensifying. Chinese Academy of Social Sciences economist Li Yang, formerly a member of the PBoC monetary policy committee and currently an advisor to the powerful NDRC, was reported by Market News International to have said in a lecture today that the government should stop allowing the RMB to appreciate because of the pain it is bringing to export companies. He said that the RMB is currently at a “balanced level,” and elaborated: “One important factor to decide whether we're at a balanced level is that our companies are making losses on this appreciation. So we shouldn't move it any more.”

I am not sure I understand his reasoning. I have seen very little in the academic literature that suggests that a currency has reached an equilibrium level when some of its exporters are losing money. I would have thought that any definition of equilibrium would have focused instead of the level of the trade surplus, the amount of central bank intervention, the growth rate of exports, or on any of a number of other factors that suggest that RMB is still not near an equilibrium level, but I suspect that Li’s argument actually has more to do with the terms of the debate within China than with economic reasoning.

There is a very deep, and reasonable I think, concern that a significant slowdown in the exporting sector might not be matched by a sufficiently large increase in domestic consumption in the short term, and so the result may be that China will not grow fast enough to absorb new entrants into the labor market. If we see slower growth in fixed asset investment on top of that, the reduction in Chinese growth may be significant and may have adverse unemployment consequences – something the government does not want to have to deal with, especially right now. I think there is a lot of pressure from exporters, provincial leaders and Ministry of Commerce officials to reduce the appreciation rate as a way of making life easier for Chinese exporters. They are worried about its impact on growth, even though this probably reflects an excessive focus on the dollar – as has been pointed out many times, the RMB is not appreciating in general; it is only appreciating against the dollar.

By the way, and to support the argument that it is not the rising RMB that is hurting Chinese exporters, Gene Ma of ISI-CEBM sent me an interesting piece today. In it his team argues that “the main driver behind China’s narrowing trade deficit is not slowing exports, but the changing terms of trade. In particular, prices of imports are rising much faster than exports.” They also note that China’s export engine is moving northward. “The share of the Pearl River Delta in total exports fell from 47% in 1995 to 30% today. The share of the Yangtze River delta rose from 20% to 40%.”

What this suggests to me, as I have discussed often on this blog, is not so much that China’s exports are getting clobbered. It suggests that China is evolving – very naturally I might add – so that its export performance is shifting as a consequence of development differentials across the country. China itself is not losing out to other countries as much as exporters in the Pearl River Delta think. China’s export competitiveness, instead, is shifting north. If you keep your eyes to firmly focused on the performance of the southern exporters, it would be easy – but of course very mistaken – to conclude that something awful is happening to China’s export capability. It isn’t. Not yet, anyway.

I do think however that we may be seeing a gradual, and very positive, shift in the importance of exports to China. I am currently reading a very interesting April 29, 2008, report by Credit Suisse called “China: the Beginning of the End of an Era.” In the report the authors say:

We think the end of an era in terms of China’s mighty export industry has just begun. Current conditions will likely go beyond the cyclical slowdown caused by the US recession, in our view. After years of currency appreciation, wage increases, and material cost surges, we think the Chinese export sector has started to crack. The introduction of the Labor Contract Law this year is probably the straw that broke the camel’s back.

As part of their argument they note:

China’s private consumption is seemingly on the rise, led by service consumption and rural consumption. The “one-child generation” is emerging as an influential new force that may redefine Chinese consumer behavior. Our projections show China leapfrogging the US as the world’s largest consumer market before 2020.

If they are right, and their argument is certainly plausible, we may be at the beginning of a process of rebalancing the Chinese economy away from the export sector and towards the domestic market. This is obviously a very healthy and necessary part of China’s long-term development, but it is worth noting that there is no reason to expect the process itself to be an easy one. I have mentioned several times before on my blog how it took the very deep and painful crisis of 1798 to turn the US economy away from its dependence on exports towards a healthier domestic focus. China’s refocus may also come with a difficult adjustment period. Part of the reason for the fight over the appreciation of the RMB is, I suspect, the reluctance to pay the cost of this adjustment.

There is one fascinating piece of information that comes from the report that gives a sense of the scale of the demographic adjustment that China is undergoing: “Thirty-five years ago, for every one hundred people, representing new labor worldwide, thirty came from Chinese. Today, the number declines to thirteen and is projected to be only three in thirty-five years.” Wow! This is a huge slowdown in the rate of growth of the working population – one of the inevitable consequences of the one-child policy.

One other thing worth noting that has nothing to do with trade: According to today’s China Daily a senior official from the NDRC, Xu Zhimin, director of the NDRC's economic operations department, said that the government will not increase the price of refined oil or electricity until inflation is brought under control. The NDRC has reportedly wanted for a while to deregulate the price of energy and resources, but they are too worried about inflation to do so now.

Needless to say, if you believe the inflation problem is largely a problem of expectations, they may be right to postpone deregulation. If you believe it is a monetary problem, however, freezing prices of electricity will only cause the momentary pressure to show up in other kinds of inflation.

Comments

[ChandlerLutz]

Michael, Great Article. I really enjoyed it....

I don't pretend to be an expert on China, but I believe that China's export market is and will be a victim of their own success. Since, the Chinese government has kept their currency artificially low it has engendered the rise of many lower quality production goods. If the government lets the currency rise, these exporters will face severely decreasing margins. On the other hand, if the government maintains the current currency rates it may impede China's transformation into a producer of higher quality goods like Japan experienced after WWII. I'm not sure if there exists a graceful solution to this dilemma....Your thoughts?

[paultaut]

Another self serving article...

And another floater for the Chinese Gov.,

Considering the lack of commentry, it looks like Mr. Pettis has lost some credibility.

The Chinese Gov. can cut tax rates for those complaining...Chinese companies are already pricing a 6.6 rate on goods 3 months out.

[flatman]

Look the Chinese have been very smart about this. Through a cheap currency and cheap labor they have used exports to develop a broad spectrum of industries that export to developed countries. Along the way it means they have built the latest factories, trained a workforce and started to build a middle class. As that middle class evolves they will have the industry to support it and not be at the mercy of the developed world. Ideally that could mean that they will be less reliant on exports. As that happens they will let the currency appreciate and since by that time they have killed off domestic manufacturing in the developed world - they will still be able to export.

[John Egan]

Good article... It was interesting to hear a repeat of what I've read recently that the manufacturing growth is towards the North, which can explain a lot about bottlenecks in transportation and lack of available coal in the East.

Thx jegan ;-)

[whidbey]

The article is good, but largely wrong. The problems are chiefly internal, largely political and the dispute is over distributional effects of GCP within the state. The problem are largely insoluable. The US is the most critical export and China wants nothing to happen to that outlet. In the meanwhile they need more jobs, more markets and something to buy with the dollars. I know, I lve there.

[mysaug]

what he is saying is that stability (jobs)is number one concern so protecting IP, commitments to WTO like opening up their markets to products AND sevices, dropping domestice content laws, etc are out the window. They joined WTO and got to live with both positives and negatives. Having a few hundred million living on $3 a day is not our country's problem, they need to deal with it but can not violate WTO agreements. Why we put up with this I do not know.

[fatcat]

the fact remains that the us consumer is jammed..that means they buy less product for a long while..guess who suffers...chicom.

[continuum]

Mr. Pettis, I did a correlation study on USD/XYZ exchange rates and the quarterly trade balances with corresponding countries going back 7 years. I was quite surprised to find that the correlation is -0.04, meaning 0. What I realized afterwards are that

1. US economy is highly intertwined with the rest of the world. Except for a small number of products that we either import & consume or originate & export, we import the lower end of value chain and export the higher end.

2. Trade balance is the aggregate result of a huge number of factors, of which exchange rate is but one.

The popular soundbite of exchange rate driving trade balance is great for political consumption, but it's intellectually dishonest to make that automatic link without detailed analysis of the two economies (and in the global context, not just bilateral).

Chinese economy is not unlike US's on the above two points, except that import-valueadd-export portion is probably even bigger. Remember 97? Virtually all export competitors of China's had their currencies massively depreciated in a matter of months or even days. Somehow Chinese trade didn't suffer any significant or lasting impact. And the reason is very simple -- as pointed out above.

Of course there're some exporters and interest groups in China complaining. But if my analysis/guesstimate above is correct, the Chinese economy overall wouldn't be significantly impacted by CHY appreciation (within certain limit of course). By the same token, Americans who've been crying for CHY appreciation in hope of improving bilateral trade balance would be sourly disappointed and severely discredited -- as the facts over the past 1/5 yrs have already shown.

To me, it's plainly political posturing by interest groups on both sides.

[paultaut]

continuum...

A much better explanation than the article which started this thread.

If the American consumer is going to buy anything during a recessive environment it will be lower priced items...aka Chinese.

[bill stenner]

continuum does have some valid points. I havent followed currencies and am wondering as to how the overvalued Euro as compared to the US dollar is faring. With the Euro worth more and im just guessing at this point that the RMB is tied moreso to the US dollar.. then a sinking US Dollar will hurt Euro way worse because of higher buying power for Chinese goods. This I find far more fascinating because the Euros are screaming about a sinking US dollar yet no one has really looked at why. Realistically it would be in the Euros interest to buy into the US and bring it up to make it less of a target for cheap Chinese goods which of course would wreak havoc on their own manufacturing sectors in a double whammy kind of way. just wondering..

[sharpe_mind]

bill stenner- the Euro is so overvalued precisely because the RMB is so undervalued. China is forced to buy so many dollars because it keeps RMB undervalued, but it doesn't want to hold all its currency reserves in USD, so it buys enormous quantities of EUR every day. The reason EUR has been able to raise to what by any valuation indicator are ridiculous levels is because it is the best alternative to the USD for the reserves of Asian and Middle Eastern central banks. In fact the same goes for pretty much every flexible currency that doesn't face massive intervention, including GBP, CAD, AUD....the one exception being JPY, which nonetheless has been rising signficantly lately.

continuum, trade balances aren't the only factor one can use to explain a currency's value. Numerous other factors are important, including relative interest rates and structural savings/investment vs consumption levels. But the bottom line is that if the PBOC stopped buying USD tomorrow, CNY would rise tremendously. It would take a serious appreciation before China's private sector started sending its money abroad, as the lackluster reception of QDII and the small outward FDI show. Besides you probably need that very large appreciation to occur in the first place before corporate China would feel like sending money aboard was even worth fighting the CNY's continual appreciation.

paultaut- I agree 100%. Just look at the stock price of WMT, which accounts for an astounding 30% of foreign purchases in China and 10% of all US imports from China: ipezone.blogspot.com/2...

[sharpe_mind]

One other thing to mention about the recent noise made by China's exporters- it has all been from the very low end (textiles and toy producers) and all been in the Guangdong area. Considering that Shenzhen, just north of Hong Kong, was the very first Special Economic Zone (SEZ), and has been tremendously successful, it makes perfect sense that it should be the first one where wages rise to the point where the very low end is priced out (as higher value exports open up and take over). My suspicion is that part of the recent fervour has been Shenzhen's proximity to the Hong Kong press (which means the press has easy access to those complaining as well as a wide forum for airing their complaints), as well as the fact that many of the early established lower value added factories in Shenzhen are owned by Hong Kongers.

I'm in complete agreement with Mr. Pettis- the interior is picking up the lower end exports as the coast/south moves up the value chain. For example, China is starting to come up in heavier industry and capital goods, such as shipbuilding and autos, and the tertiary industry is growing strongly. Even so, exporter complaints may be beside the point and exactly what is needed. At this level of inflation, there _needs_ to be pain somewhere to bring inflation lower. If anything China has wanted to have its cake and eat it too. The very best thing for China would be pain concentrated in the export sector, as opposed to pain spread throughout the entire economy.

[M. Pettis]

Continuum, I think you are correct. It is pretty easy to point to currency levels and relative prices to explain trade, and it doesn't require much of a conceptual leap, so that is what people usually focus on, but there are other important factors, and in pegged countries the monetary impact of the currency regime is usually a major factor in determining trade flows in the short term.

In China, an undervalued currency requires a build-up of reserves, which means that it necessarily must export its savings. Of course a net export of savings must be the flip side of a trade surplus. I think this is also Sharpe_Mind's point.

But notice in this case that the level of the RMB does indeed have a very big impact on trade, not because of relative prices but for reasons that are very hard to explain to the Paultauts of the world and so tend to be ignored in the political posturing. Specifically, as the PBoC exports savings via the accumulation of reserves it also necessarily monetizes the net inflow on the trade and capital accounts.

This means that its monetary policy cannot be managed for domestic needs. In the case of China, monetary policy is excessively loose, which in a financial system like that of China's, where monetary expansion is channeled via the banking system into fixed asset investment, the consequence is usually an expansion of production that exceeds the expansion in consumption.

The result must necessarily be rapidly growing exports and a rising trade surplus. That I think is Sharp_Mind's point -- a currency adjustment can and will reduce the trade account, but only if it causes reserve accumulation to slow, and unfortunately the current currency regime actually causes reserve accumulation to grow even faster because of rising levels of hot money inflows.

This can go on as long as the rest of the world is able to absorb the growing Chinese trade surplus (via growing RoW trade deficits), but once we approach a limit there must be an adjustment. Those, I think, are the big questions for China: are we approaching the limits and, if so, how will we adjust.