Henry Liu’s Proposal on Shifting China’s Export towards the Domestic Market – Part 1

Henry Liu has written a series of long articles on Shifting China’s Export towards the Domestic Market.
He is one writer that does his research very well. His background and understanding of Chinese language, culture and history, as well as excellent grasp of world’s politics, economy and history,  makes his writing on China stand out from many writers on the topic.
 
Excerpts from his first article:    Part I: Breaking Free from Dollar Hegemony
 
Breaking Free from Dollar Hegemony
 
A first step in this redirection of policy focus on domestic development is for China to free itself from dollar hegemony.  This can be done by legally requiring payment of all Chinese exports to be denominated in RMB to stop the unproductive role of exporting for dollars that cannot be spent domestically without incurring heavy monetary penalty. Such a policy affects only Chinese exporters and can be implemented unilaterally by Chinese law as a sovereign nation, without any need for international coordination or foreign or supranational approval. Importers of Chinese goods around the world will then have to acquire RMB from the Chinese State Administration for Foreign Exchange (SAFE) to pay for imports from China. RMB exchange rate and Chinese export prices can the be coordinated according to Chinese domestic conditions. Import prices denominated in RMB can then be more rationally linked to Chinese export prices. Foreign trade for China then will benefit the RMB economy rather than the dollar economy. There will be no need for the People’s Bank of China, the central bank, to hold dollar reserves.
 
China’s economic growth since 1980 has been driven by export of low-price manufactured goods with a dysfunctionally low wage scale. To correct the imbalance of trade that has been giving China trade surpluses of dubious financial or economic benefit, China needs to raise wages, not to revalue its currency. Raising Chinese wages to the level of other advanced economies will redress the current inoperative terms of international trade that now benefits only the dollar economy to benefit the Chinese RMB economy. This low-wage-driven growth has distorted the progressive purpose of Chinese socialist society by reintroducing many of the pre-revolution socio-economic defects common found under market capitalism, such as income and wealth disparity, market-induced chronic unemployment, inequality of opportunities, collapsed social safety nets resulting from privatization of the part of the economy best handled by the public sector, rampant corruption from a collapse of societal morals and excessive influence of money in the political process, uneven regional development and environmental deterioration of crisis proportions. 
 
The current export-led growth of China can be expected to be seriously hampered by a protracted slowdown in the importing economies. Despite China’s image as an export juggernaut, Chinese per capita merchandise export in 2006 was $1,655, some $135 lower than global per capita merchandise export of $1,780. This is because Chinese wages are substantially lower than the average of all export economies, while the prices of raw material are the same for all buyers in the global market. A fall in world demand for exports would hit China harder than other export economies by pushing already too low Chinese wages further down just to keep Chinese export factories running. Also, since China’s trade dependency has increased steadily over time, importing inflation through the export sector to the domestic sector, China’s economy would be hit proportionally harder by a downturn in export than it was during the previous global recessions, unless current policy to reduce trade dependency is accelerated.
 
Exports are measured by gross revenue while GDP is measured in value-added terms. The rules of input-output macroeconomics requires import inputs to be subtracted from exports in value-added terms, and then convert the remaining domestic content into value-added terms by subtracting inputs from other domestic sectors to avoid making the denominator for the export ratio much bigger than GDP. Normally, this would reduce the export to GDP ratio. But China’s domestic input is excessively low due to low wages and rents, tax subsidies and weak environmental regulations. Thus such input adjustments have little impact on the trade to GDP ratio.
 
In recent years, China has been shifting from exports with a high domestic content, such as toys, to new export sectors that use more imported components, such as steel and electronics, which accounted for 42% of total manufactured exports in 2006, up from 18% in 1995. Domestic content of electronics is only a third to a half that of traditional light-manufacturing sectors. So in value-added terms, exports have increased less than gross export revenues. This is not a comforting development because it turns the export sector into a re-export sector, benefiting the domestic economy even less.
 
China’s current-account surplus amounted to 11% of GDP in 2007. This means its entire GDP growth was from the export sector, and its economy produced far more than it consumed domestically. This surplus production was shipped overseas for fiat dollars that cannot be spent in the RMB economy while Chinese workers could not afford the very products they produced at low wages. Thus under dollar hegemony, while China has become the world’s biggest creditor nation, it suffers from shortage of capital needed by its still undeveloped economy, particularly in the vast interior, and had to depend on foreign capital even in the coastal regions when the export sector is located. In recent years, Chinese policy has encouraged higher domestic consumption, yet since 2005, net exports have contributed more than 20% of GDP growth.
 
Some analysts have suggested that China’s GDP growth would stay at 9% from strong domestic demand. Yet this demand comes mostly from severe income disparity. China’s exports to other emerging economies are now bigger than those to the US or the EU. Asia and the Middle East accounted for more than 40% of China’s export growth in 2007, North America for less than 10%. But Chinese trade with other emerging economies was at a deficit, with China importing more, such as oil and other commodities, than the oil-exporting small economies could absorb more low-price Chinese goods for their small population, and poor emerging economies cannot buy more from China because they do not have sufficient amount of dollars to buy more. If Chinese exports are denominated in RMB, trade with these poor economies would explode with balance because their exports to China can also be denominated in RMB to pay for imports from China denominated in RMB. 
 
Export for dollars presents a diminishing return problem for all exporting economies because of dollar hegemony. For China, it is a problem of crisis proportions. Since global trade is denominated in dollars, China’s economy faces capital shortage despite its new role as the world’s biggest creditor nation. China is forced to accept foreign direct investment which accounts for over 40% of GDP, despite China’s chronic trade surplus and huge foreign exchange reserves of upwards of $1.8 trillion and growing. Weaker export growth could lead to a sharp drop in foreign direct investment because exporters would need to add less capacity. While over half of all foreign direct investment in China is in infrastructure and property, such investment is still mostly related to export, facilitating expatriate managers housing, foreign company offices in commercial buildings, power plants to supply export factories and highways linking production areas with shipping terminals. Only sovereign credit can redress China’s problem of uneven regional development caused by excessive dependence on foreign investment.  
 
July 28, 2008
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About kchew

an occasional culturalist
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