A better solution for the problem of accommodating China's rapid growth

In his latest Project Syndicate article, "Making Room for China", Professor Dani Rodrik proposes an excellent idea for enabling the national economies of the world to accommodate the rapid growth of China. We analyze the implications of his proposal, by first assuming ideal circumstances in the geo-political arena. For this purpose, we consider China's imports, exports and domestic consumption using three different measuring units -- the total volume, the value in dollar terms and the value in yuan terms.

Professor Rodrik's proposal is that the World Trade Organization (WTO) relaxes its rules for China. As a result, over the course of the next few years, the Chinese government enacts a system of subsidies and other incentives to encourage its domestic industry. Presumably, these subsidies and incentives are directed towards keeping the price levels of those goods that China exports stable in dollar terms, and they do not directly affect wage levels (in yuan terms) of China's domestic consumers. Simultaneously, the Chinese government allows the Renminbi-yuan to appreciate in value against the dollar. Moreover, this appreciation against the dollar would also reverse the depreciations of the yuan against the other currencies of developing countries. Recall that these depreciations of the yuan had resulted from the dollar's recent depreciations against these other currencies, with the yuan pegged against the dollar.

The expected net effect on China's exports from these twin factors of industrial encouragement policy and currency appreciation is that these two factors would cancel each other out. Specifically, the total volume of China's exports follows the same growth path over the next few years that it would follow if there would not be any change in the dollar-yuan exchange rate and in China's industrial policy. Moreover, the value of China's exports in dollar terms as well as the value in yuan terms would also have followed the same growth path as the one that would have resulted with no change in the dollar-yuan exchange rate and in China's industrial policy.

On the other hand, the net effect on China's imports is a different story. Because of the yuan's appreciation against the dollar, foreign goods would be cheaper in China's domestic markets. Some high quality foreign goods that are used for business investments, construction, entertainment and health do not have direct substitutes among locally produced goods. Examples of such goods include heavy machinery, software, hi-tech gadgets, foreign cuisine, travel abroad and pharmaceuticals. Moreover, commodities like oil, metals and other inputs for industrial production would be cheaper. The import of these goods would increase more than otherwise, when measured in terms of volume as well as in dollars, even if in terms of yuans, the increase in spending on these imports would only follow the existing trend.

Next, to understand the implications of Professor Rodrik's proposal for China's domestic consumption, we classify the Chinese income-earners into three categories. The first category comprises of agricultural workers. These people reside predominantly in the rural areas. Their incomes are very low, and their consumption is only at the level of subsistence. Neither their incomes nor their consumption behavior would be affected, in any significant way, by the marginal changes in the exchange rate or industrial policy that are proposed by Professor Rodrik.

The second category comprises of the millions of workers who have recently migrated, say in the last five years, from the rural areas to the cities. These people have left behind their traditional jobs in agriculture. They are now invariably employed as factory-hands, semi-skilled laborers, skilled technicians, supervisors and in other jobs that require comparable skills. They are currently undergoing the process of 'learning-by-doing' in an industrial setting, in marked contrast to their earlier slow rhythm of agricultural work. Their income levels are showing rapid increases. Their expenses now are far higher than what their former rural lifestyles had accustomed them to. For example, rent, food and daily commute incur large expenses in the cities, whereas in the villages these facilities are practically free.

However, the consumption behavior of these people still displays a large degree of caution. These people spend only on what they think is essential. They are highly cost-conscious shoppers. The consumption of foreign goods would increase among these people, to the extent that some foreign-made goods are cheaper, than equivalent domestically produced goods, as a result of the yuan's appreciation. One would suppose that this situation would benefit China's neighboring developing countries that export low cost goods to China. However, it does not seem possible that when the whole of China's annual imports is considered, that this substitution of cheaper foreign goods, as a result of exchange rate changes, would be a major influential factor.

The third category of income-earners has had first hand experience of China's industrialization for many years now. These people form the upper levels of China's middle class. They are employed as factory managers, businessmen, bureaucrats, politicians, company executives and other positions holding comparable social status. They have the financial means to make down-payments on apartments, cars, motor-cycles, house-hold appliances and other durable goods. For these people, foreign goods add variety and luxury to their consumer experience. Cost-consciousness is not the deciding factor when its comes to consumption of foreign goods among these people.

Now, as mentioned above, the income levels (in yuan terms) of all three categories of domestic consumers in China are not directly affected by the changes in the foreign exchange rate or the domestic industrial policy. Even so, the drop in prices of foreign goods due to the appreciation of the yuan would lead to much larger increases in the consumption of foreign goods in the third category of consumers. Thus total consumption of foreign goods would show marked increase in volume than they would show without Professor Rodrik's proposal. There would be a proportionate increase in the value of the foreign goods consumption in terms of dollars. However, the value in yuan terms would show a milder increase because of its appreciation against the dollar.

In summary, China's total imports in dollar terms would show an accelerated increase, mainly due to (i) changes in consumption behavior among the third category of consumers, in proportions that are significantly larger than the proportion of yuan appreciation, and (ii) increased usage of high quality foreign goods in business investment, construction, entertainment and health, that is proportionate to the yuan appreciation. Recall from above that China's exports would remain largely unaffected by Professor Rodrik's proposal. Consequently, China's trade surplus would shrink at a faster pace than otherwise. Moreover, since the increase in imports is directed towards the larger than normal increase in consumption among the third category consumers, the production of domestic goods is not affected. Hence, China's annual GDP would continue on a 8%+ growth path, as per the current trend.

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Now, for the caveats. The trouble with Professor Rodrik's proposal is that there is no effective way to monitor this exchange between the China and the Western powers. The Western powers would like to have the yuan appreciated against the dollar. So, as Professor Rodrik proposes, say they agree to relax some of the WTO rules. But then, what if political pressure from the party bigwigs in the different regions of China prevents any significant appreciation in the yuan? Resisting the yuan's appreciation against the dollar could turn out to be an issue of national pride for China's middle class that is rapidly becoming highly sensitive about national pride and cultural identity.

Secondly, the Chinese government has announced its intention to promote the yuan as a currency of wide international use within the next decade or so. In that case, it would not be so easy for the Chinese government to control the exchange rate value of the yuan. As long as the only users of the yuan in international currency markets were the exporters from China, all the Chinese government had to do was to collect the dollars from these exporters' revenues from abroad and give them a proportionate amount of yuans in return. This would have held the yuan-dollar exchange rate fixed. But if major economies in Asia and currency traders elsewhere come to use yuan in large quantities, then the movement of the yuan-dollar exchange rate would be far more unpredictable.

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Finally, we provide a better solution for the accommodation of China's rapid economic growth among the other nations of the world. The first point to note is that global imbalances are a matter of direct concern only for policy-makers. The common people are not directly affected by these imbalances. They are far more concerned about their employment and their income levels. Thus the large trade surpluses that China runs up by exporting goods to the developed countries affects the political situation only to the extent that it leads to unemployment and income stagnation for workers in the advanced countries. We address these issues directly in our solution.

The rapidly growing Chinese economy is capable of absorbing a few million workers from America who could then join the third category of consumers in income levels and standards of living. Millions of Americans could be employed in China as teachers of the English language, sports coaches, political and media consultants, skilled factory workers, mid-career managers, hi-tech engineers, fashion designers, company executives and so on. Besides there is a huge craze among Chinese consumers for American goods -- American food, fashion clothing, Hollywood movies, etc. So there is a demand for Americans working as 'cultural ambassadors' in China.

Historically, thousands of Chinese workers had migrated as early as the mid-nineteenth century to build the railroads in America. They had settled down in the China-towns across various cities in America. On the other side, Cancun in China has had settlements of Western traders for nearly two centuries. Elsewhere in China, missionaries from Western countries have preached Christianity for more than a century. During the Boxer Rebellion, local Chinese fanatics had murdered missionaries. It is important to prevent such dangerous mis-understandings during the current phase of globalization. If high unemployment persists for long in the developed countries, there would be a spontaneous global migration among workers in the rich countries to China. The role of the governments is to anticipate and facilitate this migration, and provide for the safety of these millions of people who would have migrated in search of employment and better standard of living.

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