February 2007

China's Economic Rise: Opportunity or Threat?

How to deal with China’s ever-growing trade surplus has become one of the key economic policy challenges confronting the United States. The importance of this issue was highlighted by the recent high-level visit to Beijing of U.S. Treasury secretary Henry Paulson and Federal Reserve chairman Ben Bernanke.

At this event, panelists discussed the global economic implications of China’s trade surplus and examined the policy options available to the United States in working with China to address its trade imbalance, including the possibility of encouraging China to adopt a more flexible exchange-rate policy. Panelists discussed these and other issues on February 22 at AEI.

The Honorable Timothy D. Adams
Under Secretary of the Treasury for International Affairs

In September 2005, President Bush began an annual economic dialogue between the United States and China. In recent talks, the United States evaluated the role of both the private sector and of Congress in managing Sino-U.S. relations.

There are four goals we need to consider in relation to U.S.-Chinese economic relations. The first is an expansion of services in China to American firms. The second is the environment and energy and how they interact. We need to work with the Chinese to promote the use of nuclear power and other clean technologies.

The third goal is an examination of the composition of growth and the economy in China. There is currently too little consumption, too much investment, and too much reliance on exports. The last goal is innovation. If China wants to move up on the value chain, it has to improve its protection of intellectual property rights or risk stifling new innovation.

China could play a large role in the political debates in the 2008 U.S. presidential election, as our economic relationship with China is one of our most important. To manage the relationship well is a long term priority.

Anne Krueger
Former IMF first deputy managing director

Recent growth in China mimics the growth South Korea experienced in the 1980s and 1990s. With high growth rates of about 13 percent and a 75 percent rural population, Korea started in disequilibrium with growth. By 1997 the system failed and Korea began to see negative growth rates.

China has experienced successful growth, especially as it began to remove its trade barriers. Providing incentives for exports and encouraging foreign direct investment, it has used similar methods as Korea. But now its financial system has fallen behind other countries compared to the past.

China needs to fix its constrained financial system because it is not allocating credit well. China needs to create better assets for consumers who hold savings. As Chinese demographics continue to change, the saving and investment balance will also shift.

Morris Goldstein
Institute for International Economics

Chinese surplus growth and account balance surplus has grown from 1 percent of gross domestic product (GDP) in 2001 to 9 percent of GDP today. Instead of appropriately appreciating the real exchange rate, the yuan has decreased by 2 percent. With heavy market intervention, China manages to keep the value of the yuan from rising. The International Monetary Fund (IMF) cannot manipulate or implement policy to appreciate the exchange rate if China will not accept it.

China needs to start repairing its large undervaluation. They can do so by shifting expenditures to public spending such as health care and education. The exchange rate in China is important to the United States, so we should put forth a plan for fiscal consolidation in China. There is no doubt that a yuan appreciation would decrease the account surplus.

Stephen S. Roach
Morgan Stanley

China serves as a major low-cost goods supplier subsidizing the American consumer. Approximately 62 percent of Chinese exports are by foreign multinational companies operating within China. We have to be careful with imposing a currency fix on a transitional economy with a fragile financial system.

America’s deficit should not be blamed on China, especially when there is a lack of domestic savings and growth. Our saving rate of 1 percent and spending appetite causes our deficits. We cannot fix the external imbalance by shutting out China.

China is at the heart of the globalization debate. There is still a lot of poverty in the developing world--wages have gone to corporate profitability instead of labor--and there is a rise in income inequality. The globalization we are witnessing today is unique for two reasons: first because it is enabled by information technology, and second because it focuses on services rather than manufacturing.

Yusuke Horiguchi
Institute for International Finance

The United States should act through the IMF because China cannot be seen as bending to U.S. pressures. By working with the IMF and under a multilateral agreement, China can fix the account imbalance and reduce reliance on net exports.

The United States must combine increased national savings with a strong fiscal policy. China needs to play its part with the IMF and make a commitment to allow a more flexible exchange rate.

The basic fund argument is that greater flexibility will be good for China, because it will increase the effectiveness of monetary policy. The reality, however, is that a flexible rate will lead to enhanced prospects for the sustained stability of the financial system. China has huge reserves and a tremendous comparative advantage. A yuan appreciation is a critical factor in fixing the account imbalance. A bilateral agreement is the wrong solution. The IMF was created for this and a multilateral approach is feasible when the agency plays a critical role.

AEI intern Jenna Lally prepared this summary.