China contemplates change

Oct 17th 2005
From The Economist Global Agenda

As China forecasts another year of GDP growth above 9% and America’s treasury secretary tries again to persuade Beijing to revalue the yuan, China's government does seem to be preparing to change its approach to economic growth. However, its main concern is not American policymakers but China's poor

ONE could practically hear the teeth gnashing and the garments being rent in Washington and Brussels. On Tuesday October 11th, China’s planning agency announced that GDP had grown at an annual rate of 9.4% in the first nine months of 2005, causing it to raise its forecast for the full year to 9.2%, from 8.8%. The agency also predicted a record trade surplus of $79 billion for this year, more than twice last year’s, even though the export growth rate has slowed somewhat. With workers in the West already up in arms about low-wage competition from China, news that the peril to the east is growing even faster than expected is the last thing politicians in the developed world wanted to hear.

In recent months, those politicians have been battling assiduously to keep China’s good fortune from spilling too far into their domestic markets. The European Union has only recently resolved the “Bra Wars” contretemps, in which Chinese-made clothes piled up at European customs points thanks to import quotas imposed at the beginning of the summer, and retailers facing empty shelves howled for relief. The United States, too, has been pressuring China over textiles. Last week, as John Snow, the American treasury secretary, visited Beijing, negotiators worked furiously to reach an agreement on Chinese textiles. American manufacturers have been pushing for the kind of comprehensive quota agreement that the EU reached with China. But on Thursday, the American negotiators reported that they had once again failed to reach a deal on the touchy issue.

Americans have also been pressuring China because of its currency, which some on Capitol Hill claim is undervalued against the dollar by as much as 40%. This makes China’s goods irresistibly attractive to American consumers, who have been on a buying binge thanks to low interest rates (in turn helped by China’s stockpiling of US Treasuries), running down savings and taking on debt to finance their spending. Figures released on Thursday showed that surging shipments of clothing and textiles pushed America's imports from China to a record $22.4 billion in August.

Mr Snow used his visit to press the case for a looser currency peg. Though China revalued the yuan in July, pegging it to a basket of currencies rather than only the dollar, it has moved only a couple of percentage points against the American currency, far too little to hold back the flood of imports into the United States. On Tuesday, Mr Snow said that while he applauds steps towards a more liberal currency regime, America wanted to encourage China to “move forward” on the issue. Speaking to reporters on Thursday, China's finance minister, Jin Renqing, rebuffed Mr Snow's demands: “Using revaluation of the renminbi [yuan] to resolve global imbalances, particularly the imbalances of certain countries, is impossible and also unnecessary,” he said.

Mr Snow is treading reasonably cautiously for now. Speaking before the meetings took place, he said he did not want to threaten China with trade sanctions over the issue, and the Treasury has delayed its bi-annual report, which will contain its assessment of China’s currency situation, until the results of last week's visit could be incorporated. On Monday October 17th, after the meetings, Mr Snow said the talks had convinced him that China was committed to moving to a more flexible currency regime, and was currently “seriously engaged” in laying the groundwork by putting the reforms into place that would make such a move possible.

But many in Congress are pushing for bolder action. Recently, Chuck Schumer, a New York senator, told Mr Snow that he would expect the Treasury report to label China a “currency manipulator” unless the yuan is allowed to fluctuate more. Mr Schumer is also co-sponsoring a bill to slap tariffs of 27.5% on Chinese imports unless China revalues, which has substantial support in Congress. The growing protectionist sentiment among America’s legislators has had little obvious effect on the Chinese, who continue to resist fiercely any appearance of caving in to American demands. At his Monday news conference, Mr Snow called the tariffs “ill-conceived”, but gave a warning that Congress would take action if more progress was not made on liberalising the currency regime.

This is not the first time the Chinese have stood their ground. In the late 1990s, many saw the yuan as overvalued. But China resisted pressure to devalue in order to avoid exacerbating the Asian financial crisis. It is also worth noting that while China does benefit in some ways from an undervalued currency now, it has opened its markets to a greater extent than some other Asian countries during rapid, export-led development.

Addressing inequality

Nonetheless, China’s leaders may finally be readying themselves for a change in the mercantilist, growth-at-any-cost model that has prevailed for decades. The Communist Party leaders’ annual meeting on economic policy ended last Tuesday with word of a strategic shift: from now on, there will be more emphasis on redressing the inequality and social disruption that market reforms have left in their wake.

The most immediate worry for China’s leaders is social unrest. Last year, the government documented more than 70,000 demonstrations, attended by some 3m protesters. The government is caught in a bind. It needs the export sector to continue booming, in order to absorb surplus labour from the countryside and moribund state-owned companies. But it is aware that the rapid growth of recent years has opened fractures that could grow even wider.

If China can heal some of those rifts with a greater focus on rescuing those left behind by the new prosperity, this may in turn take some of the pressure off the government to subsidise export workers through currency management. It may also help China to develop domestic demand that can take up the slack when America’s appetite for cheap goods falters, as it inevitably must given the paucity of its national savings.

But though details are sketchy, it seems improbable that China’s move towards more balanced economic growth will be anything like the kind of radical leap that foreign observers would like. There are some brands of wealth redistribution that would make foreign investors very jittery, such as higher taxes. Hu Jintao, China’s president, is still consolidating power; even if he had a radical vision of a China less dependent on the cravings of the American consumer, it would have to wait until his command of the party was firmer. More importantly, it would have to wait until Chinese consumers became sufficiently confident in the social safety-net and the provision of affordable health care and education that they were willing to save less and spend more. But where is the money for pensions and the like going to come from?

And though the rising tide of China’s economy undoubtedly has the power to lift all boats, there are worrying rigidities in the system, caused by the under-development of its financial system and the fact that economic reform has not been accompanied by political reform. Officials rightly fret that further economic changes could undermine the stability of the party’s rule. Amid all the talk of addressing the wealth gap, the party’s plenum reiterated a commitment to rapid growth by restating a goal of raising China’s GDP to double its 2000 level by 2010. As long as China’s expansion remains export-driven, western politicians may just have to learn to live with a new and unpredictable economic power.

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