What Rebalancing?

TOKYO – The American economist Herbert Stein once said that if something cannot continue forever, it will not. In the case of imbalances between China and the West, however, the cut-off point still looks to be a long time in the future. Five years ago, many people warned that excess spending in the West and undervalued exchange rates in Asia were producing unsustainable imbalances. From 2005 to 2008, China’s bilateral surplus with the United States increased by 41%, and its trade surplus with Europe more than doubled. After falling in 2009, China’s surplus with the US and Europe increased by 32% and 16%, respectively, in 2010. Someone who fell asleep in August 2008 and woke up in 2010 would probably never guess that there had been any interruption whatsoever in China’s burgeoning imbalances with the West. These surpluses are generated primarily within East Asian production networks. Multinational corporations in Japan, South Korea, and elsewhere ship sophisticated parts and components to China for assembly and re-export to developed countries. The China Customs Agency classifies this type of trade as “processing” trade. In 2010, China ran deficits of more than $100 billion in processing trade with East Asia and surpluses of $100 billion with Europe and $150 billion each with the US and Hong Kong. Its global surplus in processing trade in 2010 totaled $322 billion. While rebalancing is not taking place in processing trade, it is occurring in “ordinary “trade (China’s other major customs regime). Ordinary exports are produced using Chinese factors of production, and ordinary imports are intended for China’s internal market. China’s balance in ordinary trade shifted from a surplus of $38 billion in 2005 to a deficit of $48 billion in 2010. Researchers at the Centre D’Études Prospectives et D’Information Internationales, analyzing China’s ordinary trade using data up to 2007(http://www.cepii.fr/anglaisgraph/workpap/summaries/2011/wp2011-03.htm), found that Europe (especially Germany) exported large volumes of automobiles and other consumer goods to China. Moreover, East Asian countries exported increasing quantities of parts and components and capital goods to foreign-owned enterprises in China that produce for the local market. By contrast, the share of ordinary US exports to China shrank, suggesting that China’s rebalancing is likely to be associated with continued large bilateral surpluses with the US. Subsequent data indicate that this pattern is continuing. In 2010, China’s ordinary-trade balance recorded a $71 billion deficit with East Asia and surpluses of $44 billion and $23 billion with the US and Europe, respectively. Europe’s ordinary exports to China increased from $85 billion in 2009 to $115 billion in 2010. By contrast, America’s ordinary exports to China increased more slowly, from $50 billion in 2009 to $64 billion in 2010. Thus, firms in East Asia and Europe are benefiting more than firms in the US from increasing demand in China. According to China Customs Statistics, America’s combined bilateral deficit in processing and ordinary trade in 2010 totaled $186 billion. But this understates the size of the deficit, because the lion’s share of China’s processed exports to Hong Kong are trans-shipped to advanced economies (which means that Europe’s bilateral deficit is significantly higher as well). By contrast, US data treat goods coming from China via Hong Kong as being exported from China, yielding a bilateral trade-deficit figure of $273 billion, up from $203 billion in 2005. Many researchers warned in 2005 that imbalances between the US and East Asia were unsustainable, noting that they were driven by excess spending in the US and undervalued exchange rates in East Asia. Excess spending was fueled by deterioration in the US fiscal balance, from a surplus of 2% of GDP in 2000 to a deficit of 4% of GDP in 2004. Undervalued exchange rates in Asia were supported by accumulated reserves of almost $1 trillion in China, plus hundreds of billions of dollars elsewhere in the region. Since 2005, US budget deficits have increased by another 6% of GDP, while China’s external reserves have increased by $2 trillion. It is likely that at some point investors will be unwilling to continue lending to the US at low interest rates, and that China will regard continued reserve accumulation as a bad investment. At that point, the US trade deficit will shrink. If imbalances between the US and China are thus unsustainable, it makes sense for policymakers to pursue a soft landing. In the case of the US, this requires recognizing that the government faces a budget constraint. For China, it means redirecting saving away from reserve accumulation towards cash-strapped small and medium-size enterprises, as well as much-needed investments in education, health care, and affordable housing. Willem Thorbecke is a Senior Research Fellow at the Asian Development Bank Institute and a Consulting Fellow at Japan’s Research Institute for Economy, Trade and Industry. Copyright: Project Syndicate, 2011.www.project-syndicate.org