[Mb-civic] FT.com US has little to teach China about steady economy >By Joseph Stiglitz

[Michael Butler]

FT.com      
 
US has little to teach China about steady economy
>By Joseph Stiglitz
>Published: July 26 2005 19:18 | Last updated: July 26 2005 19:18
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Joseph Stiglitz will answer questions on China, the US and the global
economy in a live debate from 3pm BST on August 2. Send questions in advance
to ask at ft.com. Answers will appear at www.ft.com/stiglitz

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As excitement over China¹s revaluation has died down ­ including jubilation
by some of the speculators, who have at last earned an (albeit modest)
return ­ it is time for a calmer assessment about what it does and does not
mean for China, for the US and for the global economy.

There remains considerable uncertainty. Though China has demonstrated a
willingness to adjust its exchange rate, we do not know what will follow;
will the total adjustment over the next couple of years be 10 per cent or 40
per cent? The speculators, surely, will be betting on more. And as China
wisely sterilises these inflows, we can expect a continuing build-up of
reserves, with this being used by speculators and their allies as an
argument for further revaluation. But China will, hopefully, see through
this.

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The key question is how the appreciation will affect global imbalances,
China¹s trade surplus and the US trade deficit and what, if any, will be the
knock-on effects. America¹s trade deficit of $700bn is nine times China¹s
trade surplus. China¹s economy has been going gangbusters; rapid growth with
little inflationary pressure. The revaluation will hardly make a dent. Even
larger revaluations are not likely to do much to the global imbalances.

First, we do not know accurately the size of China¹s surplus because, in an
attempt to circumvent exchange controls, there is over-invoicing of exports
and under-invoicing of imports ­ part of speculative flows. The large import
content of China¹s exports, particularly to America, mean that China¹s
competitiveness will be little affected. Economists disagree about whether
the import content for exports to America is 70 per cent or 80 per cent but,
whatever the number, it means that the effective appreciation was almost
certainly under 1 per cent. In the case of a larger revaluation, Chinese
companies would probably respond to the loss of competitiveness by cutting
margins, reducing further the effect of the revaluation. This revaluation ­
even if followed by further moderate ones ­ is likely only to slow the
rising tide of China¹s exports slightly.
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op chart 26_07>But whether this, or a succession of revaluations, eliminates
China¹s trade surplus will have little effect on the more important problem
of global trade imbalances, and particularly on the US trade deficit. Much
of China¹s recent gains in textile sales, for instance, after the end of
quotas last December, came at the expense of other developing countries.
America will once again be buying from them, and so total imports will be
little changed.

More fundamentally, the trade deficit equals capital inflows, and capital
inflows equal the difference between domestic investment and domestic
savings. That is why, normally, when the fiscal deficit goes up (so domestic
savings goes down), the trade deficit goes up. Neither President George
W.?Bush nor John Snow, the US Treasury secretary, has explained how China¹s
revaluation will change these basic equations. Unless domestic investment
goes down or domestic savings go up, the trade deficit will persist,
unabated. The trade deficit could diminish but if it does, it will not be a
pretty picture. Domestic investment, for instance, could go down if we
succeed in getting our wish and China¹s trade surplus disappears; with China
no longer using the money from its trade surplus to fund our huge fiscal
deficit, medium- and long-term interest rates would rise. The economic
downturn, and the decrease in investment, would be compounded if the
increase in interest rates pricked the housing bubble.

There is a myth of mutual dependence: China needs to export goods to the US,
which needs China¹s money to finance its deficit. But China could easily
make up for the loss of exports to America ­ and the wellbeing of its
citizens could even be improved ­ if some of the money it lends to the US
was diverted to its own development. China has huge investment needs. If its
government is going to lend money, why not finance its own development? Why
not fund increased consumption at home, rather than that of the richest
country in the world, to pay for a tax cut for the richest people in the
richest country, or to fight a war which most view as anathema? But the US
could not so easily make up for the gap in funding without large increases
in interest rates, and these could play havoc with the economy.

op chart 26_07>There is a second myth: that China would benefit from letting
its exchange rate float freely, letting market forces set the price. No
market economy has foresworn intervening in the exchange rate. More to the
point, no market economy has fore?sworn macroeconomic interventions.
Governments intervene regularly in financial markets, for instance, setting
interest rates. Some market fundamentalists claim that governments should do
none of this. But today, no country and few respectable economists subscribe
to these views. The question, then, is what is the best set of interventions
in the market? There is a high cost to exchange rate volatility, and
countries where governments have intervened judiciously to stabilise their
exchange rate have, by and large, done better than those that have not.

Exchange rate risks impose huge costs on companies; it is costly and often
impossible to divest themselves of this risk, especially in developing
countries. The question of exchange rate management brings up a broader
issue: the role of the state in managing the economy. Today, almost everyone
recognises that countries can suffer from too little government intervention
just as they can suffer from too much. China has been rebalancing and, over
the past two decades, markets have become more important, the government
less so. But the government still plays a critical role. China¹s particular
blend has served the Chinese well. It is not just that incomes have been
rising at an amazing 9 per cent annually, and that high rates have been
sustained for more than two decades, but the fruits of that growth have been
widely shared. From 1981 to 2001, 422m Chinese have moved out of (absolute)
poverty.

op chart 26_07>The US economy is growing at a third the pace of China¹s.
Poverty is rising and median household incomes are, in real terms,
declining. America¹s total net savings are much less than China¹s. China
produces far more of the engineers and scientists that are necessary to
compete in the global economy than the US, while America is cutting its
expenditures on basic research as it increases military spending. Meanwhile,
as America¹s debt continues to balloon, its president wants to make tax cuts
for the richest people permanent. With all this in mind, China¹s leaders may
not feel they need to seek advice from the US on how to manage either the
exchange rate or the economy.

Sources for charts: IMF; EIU; ADB

The writer is University Professor at Columbia University and was awarded
the Nobel Prize in economics in 2001
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