China and the world economy
From T-shirts to T-bonds
Jul 28th 2005
From The Economist print edition
Beijing, not Washington, increasingly takes the decisions that affect workers,
companies, financial markets and economies everywhere
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GLOBAL tremors in the currency, bond and commodity markets greeted China’s
announcement that the yuan will no longer be pegged to the dollar. No longer is
it just Washington that has the power to cause shockwaves. For many people, the
tremors reflected the view that China is the root cause of America’s trade
deficit, and that the revaluation is a partial cure.
In fact, that view is wrong on several counts. China is not the main cause of
the American trade deficit. On the other hand, China is behind almost everything
else going on in the world economy. For China is beginning to drive, in a new
and pervasive way, economic trends that many countries assume to be domestically
determined.
Americans like to slap the 単ade in China?label on their huge trade deficit.
Yet not only is China’s forecast current-account surplus of around $100 billion
this year only a fraction of America’s likely deficit of $800 billion, but, as
chart 1 shows, most of the increase in America’s trade deficit has come from
outside China. The main cause of America’s trade deficit is a lack of domestic
saving, not unfair Chinese competition. The deficit is thus made in America, not
made in China.
As for last week’s revaluation, the announcement marked a significant break with
the past. China has long been under pressure to revalue its currency from
countries that claim the undervalued yuan gives Chinese exporters an unfair
advantage. After pegging the yuan to the dollar for a decade, China has shifted
to a managed float against a basket of currencies, with an initial revaluation
against the dollar of 2.1%. Nobody is yet sure how this will work. It may be
just a token move aimed at warding off American protectionism. Or it could be
the first of several revaluations, marking the end of the so-called 遅evived
Bretton Woods system? under which China and other Asian countries have bought
billions of dollars in foreign-exchange reserves to hold their currencies steady
against the greenback.
Either way, the tiny revaluation by itself will have little impact on America’s
huge trade deficit. Indeed, even if the yuan is allowed to rise by another 5-10%
over the next 12 months, as many economists expect, that would hardly make a
dent in the deficit. Nevertheless, it is still an important change in China’s
exchange-rate regime, representing a step towards a market-based system. And, as
such, it could have implications for the dollar, bond yields, and American
consumer spending.
To view China’s global impact mainly in terms of its exports and its trade
surplus is to misunderstand, and to underestimate, the profound forces behind
China’s growing influence. Everyone knows that most TVs and T-shirts are made in
China. But so, in some ways, are developed countries’ inflation rates, interest
rates, wages, profits, oil prices and even house prices镥r at least they are
strongly influenced by what happens in China.
Of course, China is not the only fast-growing emerging economy that is making
waves around the world. But China really does loom much larger: its contribution
to global GDP growth since 2000 has been almost twice as large as that of the
next three biggest emerging economies, India, Brazil and Russia, combined.
Moreover, there is another crucial reason why China’s integration into the world
economy is today having a bigger global impact than other emerging economies, or
than Japan did during its period of rapid growth from the mid-1950s onwards.
Uniquely, China combines a vast supply of cheap labour with an economy that is
(for its size) unusually open to the rest of the world, in terms of trade and
foreign direct investment. The sum of its total exports and imports of goods and
services amounts to around 75% of China’s GDP; in Japan, India and Brazil the
figure is 25-30% (see chart 2). As a result, the dragon’s awakening is more
traumatic for the rest of the world.
Doubling the world’s workforce
Most analysis of China’s growing importance focuses on its rising share of
global output and exports. That, in turn, fuels fears that China is stealing
production and jobs from the rest of the world. But this misses half the story.
It is true that China’s trade surplus has increased sharply this year镎ainly
because the government’s efforts to cool fixed investment have cut back imports.
But over the past decade, China’s imports have risen at the same pace as its
exports. So China is giving a big boost to both global supply and demand.
China’s impact on the world economy can best be understood as what economists
call a 断ositive supply-side shock? Richard Freeman, an economist at Harvard
University, reckons that the entry into the world economy of China, India and
the former Soviet Union has, in effect, doubled the global labour force (China
accounts for more than half of this increase). This has increased the world’s
potential growth rate, helped to hold down inflation and triggered changes in
the relative prices of labour, capital, goods and assets.
The new entrants to the global economy brought with them little capital of
economic value. So, with twice as many workers and little change in the size of
the global capital stock, the ratio of global capital to labour has fallen by
almost half in a matter of years: probably the biggest such shift in history.
And, since this ratio determines the relative returns to labour and capital, it
goes a long way to explain recent trends in wages and profits.
In America, Europe and Japan, the pace of growth in real wages has been
unusually weak in recent years. Indeed, measured by the growth in income from
employment, this is America’s weakest recovery for decades. According to Stephen
Roach, an economist at Morgan Stanley, American private-sector workers’ total
compensation (wages plus benefits) has risen by only 11% in real terms since
November 2001, the trough of the recession, compared with an average gain of 17%
over the equivalent period of the five previous recoveries (see chart 3). In
most developed countries, average real wages have lagged well behind
productivity gains.
The entry of China’s vast army of cheap workers into the international system of
production and trade has reduced the bargaining power of workers in developed
economies. Although the absolute number of jobs outsourced from developed
countries to China remains small, the threat that firms could produce offshore
helps to keep a lid on wages. In most developed countries, wages as a proportion
of total national income are currently close to their lowest level for decades.
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