Subscribe Feed (RSS)China isn’t losing its competitive edge
December 1st, 2008 by Michael Pettis | Filed under Consumption and production, Currency regime, Policy, Trade protection.The stock market had a decent day today, with the SSE Composite rising 1.25% to close at 1895. Bad news about manufacturing was overshadowed by an announcement that the government will expand a plan to subsidize household appliance purchases by farmers. That helped appliance manufacturers, who led the market up. I suspect that we will see an increasingly worried government propose more of these consumption-boosting measures, although for now there is not enough information to gauge how effective these will be.
The release of the proposal to boost consumption by helping farmers buy appliances came on the back of a string of related proposals by government officials. According to Friday’s South China Morning Post:
Zhang Ping, the director of the National Development and Reform Commission, yesterday gave a bleak outlook for the world’s fourth-biggest economy, a day after the central bank cut interest rates by the biggest margin in 11 years. ”The global financial crisis has not bottomed out yet and the impact is deepening in China,” Mr Zhang told a briefing. “Some domestic economic indicators point to an accelerated slowdown in November.”
The government might cut interest rates and lower banks’ reserve requirements further, National Bureau of Statistics officials, led by spokesman Li Xiaochao, wrote on the Ministry of Finance’s website. The government might also raise the threshold for personal income taxes to exempt more people and further stabilise the yuan, the officials said.
Any such measure is good news, although as I have written often in earlier posts, the sheer size of the global adjustment will make it very difficult for China to create sufficient domestic expansion. Meanwhile news from the manufacturers continues to get grimmer. Today two separate Purchasing Managers’ Index numbers were released, one by the China Federation of Logistics and Purchasing (the “official” one) and one by CLSA. Both of them showed record contractions in export orders, output and new orders, suggesting that manufacturing is contacting at a faster pace than most expected. On a slightly more positive note, Dong Tao of Credit Suisse thinks we “may be getting close to a bottom in this cycle, cushioned by orders from government projects and the near ending of inventory de-stocking.”
The most interesting news recently, however, was related to a speech President Hu made yesterday at the weekend’s Politburo meeting. According to today’s People’s Daily, besides warning “that the global financial turmoil will make it harder for China to maintain the pace of its economic development in the near future”, he said, in a widely noted comment, that “with the spread of the global financial crisis, China is losing its competitive edge in the world market as international demand is reduced.”
What exactly does this mean? It is worth noting that this has come in the context of recent RMB weakness. According to a Bloomberg piece today, “China’s yuan fell by the most in seven weeks, three days before U.S. Treasury Secretary Henry Paulson visits Beijing for trade talks, on speculation the central bank wants to weaken the currency to spur the economy.” Meanwhile calls for depreciation of the RMB are getting more common, and more and more commentators are beginning to wonder if we might not see a conscious strategy of RMB depreciation.
Several people have pointed out that even with the RMB’s weakness against the dollar, the surge in the dollar against the euro has meant that the RMB has strengthened on a trade-weighted basis. This may be true, but it seems to me that the meaningful exchange rate is the dollar/RMB rate (most of Asia is effectively dollar bloc), and the dollar/euro exchange rate does little more than determine how the trade deficit shifts between the US and Europe.
So to get back to President Hu, what exactly does it mean that China is losing its competitive edge? China has better infrastructure than most developing countries, and it has never been strong in technological or management innovation, and its financial system has always been poor at allocating capital, so which “edge” is China losing? If this means that labor costs are getting too high, this comment is worrying because actually I think rising wages are necessary to China’s long-term adjustment (whether they will have the much-needed short-term effect in increasing consumption is doubtful). I hope this isn’t a prelude to constraining wage increases.
But I think the biggest worry is that this may be a hint that the RMB has appreciated too much. The one thing that China absolutely cannot afford to do, in my opinion, is to fix its “competitive edge” by lowering comparative costs via RMB depreciation. Maureen Fan of the Washington Post asked me last night what I thought of this comment, and my response was:
Chinese exports aren’t being priced out of the market. The problem is a contraction in global demand, and all export economies are going to lose sales. If China tries to “regain” competitive edge by subsidizing exports – for example, by depreciating the currency – that could make global conditions worse by increasing overcapacity, when what we really need is to increase global demand.
I have written about this a lot in previous postings, so I won’t rehash all my arguments, but the problem China is facing is not that its exports are less competitive but rather that the US economy has to shift towards higher household savings, and the inevitable corollary is a significant reduction in household consumption. This means that the US imports must decline (and European imports are likely to decline too, by the way), or to put it another way, that foreign exports to the US (and Europe) must decline. If China tries to maintain its export growth in the face of contracting global demand, it inevitably means that someone else must bear more than 100% of the full cost of the necessary adjustment, and I find it hard to believe that other countries, especially net importing countries, will accept this with much good grace.
Currency depreciation – even failure to continue appreciating the currency – along with any other export-boosting measures, will almost certainly lead to a significant rise in trade tensions, and as I have argued many times before, a trade war will hurt current-account surplus countries far more than it will hurt deficit countries. In fact as I see it (and will write in a future entry) this crisis will come in two stages. In the first stage, countries with excess debt-fueled consumption get hit, and as a consequence they are forced to cut consumption and raise savings.
In the second stage, countries with excess debt-fueled production get hit as they fail to accommodate their excess production to the cut in global consumption. Countries like China should be wary about production-boosting measures (Smoot-Hawley-with-Chinese-characteristics, I call them) and should focus largely on consumption-boosting measures. The more they do, the less the chance of international trade constraint and the faster they get through the crisis – but make no mistake, this will not be an easy process no matter what they do.
Tags: Competitive edge
Dear Professor Pettis,
thank you for your outstanding analysis of the involvement of the chinese economy in this crisis. I hope the members of the government read your blog and heed your advice.
The statement of chairman Hu does not sound too wrong since the reason he gives for the alleged loss of competitive advantage is indeed the lack of global demand, just as you point out too. If it were for a policy shift, the usual vocabulary of the government is much more “political”.
Looking around in the emerging economies all the currencies face depreciation, the yuan being no exception and maybe for just the same reason as the others: investors fearing a severe slowdown in these economies and flying for safety in the Dollar.
The speech of chairman Hu thus to me does not seem to indicate a policy statement towards a lower yuan.
I suppose the chinese government is aware of the long term non-viability of the present global imbalances, though it cannot be ruled out that they endavour to stretch these as long as possible for short term profit and lack of alternatives.
Your advice is the more important to be heard.
http://www.ecipe.org/files/WSJErixonSally.pdf
A meaningful comments about the new protectionism.
The other Asian currencies have fallen a lot vs. the USD. China competes with other Asian countries for exports to US and Euro markets and that is the lost edge President Hu is refering to I suspect.
Not actually related to this article but to your letter to editor in the Asia Wall Street Journal. As far as I know, you are the first to pick up on the point that increased savings rate by US consumers will help keep the US$ at its current level and maybe even appreciate over time. And I have also come to the same conclusion and agree with you wholeheartedly. The savings rate has now moved to 2.4% (vs 1% in Sep) and if this continues, this will be a substantial boost to the US$ though probably a big negative for US exporters. Though you don’t like it, I suspect the Chinese will depreciate the RMB over time since they have always done what has been to their best interest. And although depreciating the currency would not help a lot, as it is a demand issue as you points out, it is still a incremental benefit nonetheless.
Have you looked at the likely range of export decline? I have yet to dig into the data but I wonder if the low value added /basic goods manufactured by China might be able to withstand the crisis similar to a Wal-Mart in a recession.
Rmb devaluation is not good expansionary policy
Dec.1 Rmb had sharpest drop in years by dip 0.5ppt to lower band limit of 6.8850. NDF fell harder across board
This is very interesting move, Economically monetary conditiions need to be eased aggressively to counter the deflationary recession risk just like in 1998, however whether Rmb depreciation is prefered and good way is dubious.
PBOC governor Zhou xiao chun commented possible Rmb depreciation once, I guess PBOC are testing the water in terms of market positioning and expecation to see: how much room they could push Rmb lower without 1) causing shocks to China’s macro stability 2) triggering regional competitive devaluation and 3) raising political pressure from US-EU on trade. 3) Furthermore, the 2 months time window before Obama adminstration provide some window.
In my view, this is very delicate balancing act and dangerous play as Rmb stability is most important anchro of macro stability.
* Rmb devaluation against USD is not necessary as trade surplus are surging on dropping commodity;
* Small Rmb-USD depreciation probabaly can not help exporters as the pressure is demand recession not relative competitiveness, Korean won devalue by 35% but Korean export still plunged 20-20% y-y.
* Marginal devaluation say to 7.0-7.5 range is destabilizing and can be replaced with bigger VAT rebate.
* Rmb devaluation will put big pressure on domestic economic confidence which government is trying hard to maintain.
Judging by the fragile state of economic confidence, vulnerable asset markets and risk of capital outflow, Aggressive fiscal expansion and domestic easing is/should be better policy mix, this aggressive expansionary policy should be complemented and anchored with tightly managed Rmb-USD for stabilization.
We continue to expect stable Rmb exchange rate in 2009
Pettis: Currency depreciation – even failure to continue appreciating the currency – along with any other export-boosting measures, will almost certainly lead to a significant rise in trade tensions.
I’m not sure that it will, as most jobs in the U.S. are increasingly dependent on trade. For that to change, you’ll need a large and very painful readjustment in the structure of the U.S. economy. The reason that you have as large a trade deficit as you have in the first place is that the politics of trade and employment in the United States is very different in 2008 than it was in 1985.
The one thing that you need to think about is why are there not more calls for protection in the United States, and the answer is that the vast majority of people in the US see themselves going out of work if you don’t have trade with China. You ask people in the United States what happens if there is a trade war with China, and outside of a few industries like textiles, the answer is going to be “I lose my job.”
Pettis: The US economy has to shift towards higher household savings, and the inevitable corollary is a significant reduction in household consumption.
That’s assuming constant wealth and productivity which is not a good assumption. One effect of moving factories from the US to China is that you get huge gains in productivity due to comparative advantage. If you reduce the volume of trade, you will end up decreasing productivity which will throw you into a downward cycle. You have to look at productivity and comparative advantage because that explains why people move factories to China in the first place.
Long run, you boost savings by boosting incomes and you boost incomes by boosting productivity.
Right now you have positive savings rates because of precautionary savings, but if you have insufficient demand leading to unemployment, then savings rates are going to turn very sharply negative. Also it is pointless to boost savings if those savings aren’t going to be invested in something useful.
The other thing that I don’t understand is why people assume that the “optimal situation” between US and China is one in which you have zero trade deficits when no insists that this is the optimal situation between New York and New Jersey or even between France and Germany. My guess is that if you use some simple comparative advantage arguments, you’ll end up finding that impose an international trade constraints actually reduces total wealth generation.
Twofish said: “The other thing that I don’t understand is why people assume that the “optimal situation” between US and China is one in which you have zero trade deficits when no insists that this is the optimal situation between New York and New Jersey or even between France and Germany.”
That kind of argument is typically the one I hope not to hear here. But I expected it. It displays the current credo i-e long-term external deficits make sense.
History has told us the story more than once that comparative advantage argumentation is valid as long as the system is balanced.
Trade requires two parties and overall balance. Any alternative would end up badly. For both parties.
Deficits between New York and New Jersey are a joke. And you know it of course.
Deficits between France and Germany are built up within the Eurozone… And I can tell you that intra-Eurozone imbalances are already a tough issue here in Europe. We shall be running into a wall concerning the Italian public debt and the whole Spanish one “across” the board in 2010 or 2011.
Deficits between US and China are another species. Not only they harm the US on the long run but they will hurt China as well. China certainly does not understand it. Nor can it or will it. For some obvious reasons including historical ones.
This world is getting into the world. Let us just hope it will be in slower motion… The pace is currently much too fast. Dangerously fast.
Francois: History has told us the story more than once that comparative advantage argumentation is valid as long as the system is balanced.
I don’t think that it does. Can you go into more detail about someone that has made this argument in detail.
Francois: Trade requires two parties and overall balance. Any alternative would end up badly. For both parties.
But if neither party objects to the terms there must be some balance. The thing that I keep asking is why is there no loud voices for protectionism at this point in the United States if the trade balance is supposed so unfavorable to the United States.
The United States as a whole must be getting some benefit from being able to run huge deficits with China, and walking around in the United States it seems obvious to me that enough people are gaining from Chinese trade that talking protection is political suicide.
Francois: Deficits between New York and New Jersey are a joke. And you know it of course.
No I don’t. Explain it to me.
Francois: Deficits between US and China are another species. Not only they harm the US on the long run but they will hurt China as well. China certainly does not understand it. Nor can it or will it. For some obvious reasons including historical ones.
I’d be very careful with the idea that “they just don’t understand.” Often there is something that they really do understand, that is speaker is missing. This is the reason that it’s useful for talking to people with different ideas since you need to defend some basic assumptions.
Being and working in the United States, one thing that is clear is that there is far less protectionist sentiment in the US than one might think because most people in the United States have jobs that depend on trade and the trade deficit. If you decrease Chinese imports, then a lot of people in the United States will lose their jobs, and it’s not clear to anyone that you will end up with higher paying jobs.
One thing that the US gets out of this deal is “free money.”
One interesting thing about all of this is that no major US politician has suggested that the way out of this mess is to restrict imports from China. Sitting in my apartment in NYC, it seems obvious why, and that is that restricting imports from China would (outside of a few selected industries like textiles) cause so much massive economic disruption that it’s political suicide to even suggest it right now. My own job depends critically on Chinese exports and looking around, so do most Americans.
“The one thing that you need to think about is why are there not more calls for protection in the United States, and the answer is that the vast majority of people in the US see themselves going out of work if you don’t have trade with China. You ask people in the United States what happens if there is a trade war with China, and outside of a few industries like textiles, the answer is going to be “I lose my job.””
Wrong, wrong, wrong.
I have never heard ANYONE say that without trade with China, they would lose their job. I have MANY times heard resentment about manufacturing gone to China, poor quality products, tainted food, etc. Not a week goes by that I don’t hear such complaints.
There is great resentment currently in the U.S. because globalization has meant stagnant wages, falling benefits, fewer jobs. American consumers are under stress because the job market has collapsed beneath them. What part of that is due to globalization, offshore outsourcing, China particularly, may never be quantifiable. But it doesn’t need to be.
There is a wave of mass layoffs coming. Krugman yesterday thought the official unemployment rate may top 10%.
If that happens, expect the China – US trade relation to come under extreme stress. The fact is Obama doesn’t owe his election to the economic actors who have profited from the China trade. They will be parties at the table but they will not determine policy. More important, in my view, will be the stressed American workforce. I’m sure his team will try to solve these problems without destructive protectionist measures but I don’t think that means status quo for China. It doesn’t even mean that protectionist measures are impossible or even unlikely.
Export demand for Chinese goods has collapsed. That puts pressure on sustainability of imports. The traditional approach (e.g. Thailand and Korea in 1998, Russia now in 2008) has been to strengthen the domestic currency with interventions that put a drain on Forex reserves. A stronger domestic currency keeps imports competitive in the face of dropping export demand. That ultimately leads to a collapse in confidence as the reserves drain out.
China’s approach to devalue the RMB tries to ensure that exports remain as competitive as before, or more competitive. This will show up in increasing dollar cost of imports against falling dollar value of exports. This will also lead to the same collapse in confidence as the reserves drain out.
lark: I have never heard ANYONE say that without trade with China, they would lose their job. I have MANY times heard resentment about manufacturing gone to China, poor quality products, tainted food, etc. Not a week goes by that I don’t hear such complaints.
Well then we know different people then. It will be interesting when push comes to shove and we start counting votes. The people I know are people in finance in NYC, software developers in Texas, and semiconductor designers in California. This opinions never make it to the press, they are lunch time conversations. Part of the reason people aren’t loud about being pro-China trade is that there is no point in complaining when you are winning.
So who do you know? Let’s count votes.
lark: What part of that is due to globalization, offshore outsourcing, China particularly, may never be quantifiable. But it doesn’t need to be.
Actually it does, because you need go convince people that the problems are due to globalization if you want to go China-bashing. I don’t think that the problem is globalization. I personally think that the problem is that the benefits of globalization have been unequally shared, and that government needs to be heavily involved to make sure that the economic gains from globalization get equally shared. This means low tariffs and high taxes on the super-wealthy.
lark: The fact is Obama doesn’t owe his election to the economic actors who have profited from the China trade.
Yes he does. You look at the groups of people that I just mentioned. Obama won in large part because he was able to out-technology McCain because of help from Silicon Valley and massively outspend McCain because of contributions from Wall Street. Those are the two most “pro-China” groups in the United States.
Also if you look at organized labor, two of the most active and vital unions in the US right now happens to be Pacific longshoremen and Teamsters. Think about that.
I voted for Obama because I was sick and tired of Bush era incompetence, I’m worried about keeping my own job, and because McCain came across as an economic idiot. The interesting thing is that now that Obama is in power, he really has to define “change” rather than just talk about it and that is going to lead to some interesting conflicts.
lark: They will be parties at the table but they will not determine policy.
Yes they will (or rather yes *we* will). Look at who Obama is naming to his cabinet. One thing that is interesting about Obama’s election is that it marks the ascent to power of political forces that have been dormant.
Google/Goldman-Sachs/MIT/Teamsters. This is the new governing coalition that Obama put together. Strange bedfellows, but that’s politics.
lark: More important, in my view, will be the stressed American workforce.
Sure. But the workforce isn’t what it was in 1985. You have investment bankers, software developers, and auto workers that are afraid of losing jobs. McCain’s strategy of “Joe the Plumber” and “bash Wall Street” failed very badly because he didn’t realize how the workforce has changed. Citicorp employs more people than GM.
It’s odd to see an investment banker as a “worker” but good politicians listen carefully and see beyond stereotypes. So rather than bashing bankers and mid-level managers, Obama was able to tap into this feeling in a way that McCain was not.
By the way, most Wall Street investment bankers don’t make multi-million dollar bonuses, and if you want to bash *upper* management and talk about more regulation, then you’ll get a lot of support.
lark: I’m sure his team will try to solve these problems without destructive protectionist measures but I don’t think that means status quo for China. It doesn’t even mean that protectionist measures are impossible or even unlikely.
But the type of protectionist measure is important. If Obama and the United Auto Workers thinks that tariffs on auto parts and textiles will help save American jobs, then sure I’ll go along with that. We are on the same team, and we need to be nice to each other. However, I *haven’t* heard the UAW or GM suggest that tariffs would be useful, and it’s likely to be the reverse since China is the only place in the world that buys Buick.
However, if Obama starts sounding like Lou Dobbs, then I (and a lot of other people) will turn against him in a big way.
The beauty of the internet is that you get to meet different people, and I’m just saying what things look like from my neck of the woods.
well, i dont think the recent depreciation is really a move intending to boost export sector. i think it is just a windowdressing gesture temperarily to show those unemployed export sector workforce that the government cares. the government is now really concerned about potential social unrest problems, which are now getting more and more serious. these unemployed export people have been putting a lot of pressure on the government, accusing it for killing them with currency appreciation. i recently heard several SOE CEOs say that they are worried that we will see real social problems coming out next year when companies’ profitability shrinks unemployment goes up and those who still have jobs are faced with a pay cut.