Nothing focuses people’s mind on China more than its accumulated foreign exchange reserves. China’s reserves rose a record $178 billion in the second quarter of the current year to $2.132 trillion, and are growing. Starting from a low of $1.6 billion in 1978, just before Deng Xiaoping launched the reforms after the demise of Chairman Mao, reserves grew steadily every year except for the five years — 1985, 1986, 1989, 1992 and 1999. To some at least, like the mercantilists of yore, reserves constitute one of the indicators of a nation’s strength.
Mercantilism was a school of thought that called for maximising exports and minimising imports. Before the early part of the last century, for a country with an adverse balance of payments, gold and silver were the main instruments of squaring off a deficit in receipts vis-à-vis payments. Between the 16th and the 18th centuries, the strength of a nation was often judged by the amount of gold and silver that it possessed. Thus, the mercantilists encouraged policies to acquire gold and silver by maximising exports and minimising imports.
Reserves grow only when the central bank purchases the extra foreign exchange resulting from the excess of exports over imports and/or net capital inflows. Data on balance of payments available from 1982 show that, China managed to maintain a current account surplus in all but five of the 26 years until 2008. This surplus was modest around $22 billion per year in the six years ending in 2001. After WTO accession in 2001, it grew explosively from $17 billion to $426 billion in 2008. China also got a substantial amount of foreign direct investment (FDI). Starting with less than $500 million in 1982, FDI steadily increased to about $3.5 billion in 1991, $40 billion annually in the early 2000s, and further to a peak of over $121 billion in 2007. Even after declining moderately, in the following year, it remained as much as $94.3 billion! Almost the entire amount of the impressive reserve accumulation of China can be explained by its large current account surplus and FDI inflows.
With the large reserve accumulation and an explosive export growth, China has been described as mercantilist by some observers. Is China really a mercantilist?
The twin pillars of mercantilism are maximising exports and minimising imports. China has indeed followed a policy of promoting exports. This year, China may have already overtaken Germany to become the world’s biggest exporter. In the first six months of 2009, China exported goods worth $521.7 billion, while Germany chalked up $521.6 billion. Export-led growth has been the cornerstone of the economic policy of many countries in the past, most notably Germany and Japan after the War and the East Asian Tigers (Hong Kong, Singapore, Taiwan, South Korea) in more recent times. But, some China observers argue, what needs focus is whether China is minimising imports.
Tariff barriers have been low in China, especially in the post-WTO accession period since December 11, 2001. It took almost a decade-and- a-half for China to gain accession to WTO. In this long accession period, China was asked to take on a host of trade reforms and commitments as a precondition for admission to WTO. These included substantial tariff reductions and dismantling of most non-tariff barriers. For example, import tariffs on pork had to come down from 20 per cent to 12 per cent, on barley from 114 per cent to just 3 per cent, and on automobiles, from 100 per cent to 25 per cent.
There were, however, apprehensions about the impact of WTO accession on the Chinese economy: Gains from such accession would accrue mostly to foreigners, Chinese workers would lose their jobs and angry mobs of displaced workers would destabilise the regime in Beijing, some observers argued. But defying all such doomsday predictions, China emerged stronger from the WTO accession! Trade as well as current account balances improved, and soon there were allegations of a mercantilist China snatching jobs from other countries, most notably the US.
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High tariffs have not been the main source of worry about mercantilist China. The concerns have been mostly about workers’ overall remuneration and exchange rate policy. The current account surplus reflects an excess of domestic savings over domestic investment. As much as half of China’s savings are from the corporate sector and this is explained by natural monopolies, particularly in the natural resource sector such as oil, high commodity prices and low wages. Corporate profitability also went up after the post-liberalisation smashing of the “iron rice bowl” of lifelong secure jobs and social welfare under the centrally-planned economy. Under the planned economy, housing, healthcare and pension were provided by the enterprises. While China’s savings ratio increased from 37.5 per cent in 1998 to 49.9 per cent in 2007, underneath, the ratio of the corporate sector disposable income to the national disposable income increased from 13 per cent to 22.5 per cent, and the share of the government disposable income to the total increased by 2 percentage points.
In China, the share of wages in GDP declined from 53 per cent in 1998 to 41 per cent in 2005. After the smashing of the “iron rice bowl”, Chinese households have also had to save relatively more to provide for the non-existent social security.
The second concern about mercantilism in China has been its exchange rate policy. For example, the Fair Currency Coalition in the US, an industry-agriculture-worker alliance to support the US economy against currency misalignment by any trading partner, has been consistently complaining about the undervalued renminbi. According to one estimate, the Chinese renminbi was undervalued to the extent of an average of 35 per cent relative to the US dollar between September 2006 and February 2008. The renminbi, per US dollar, according to this view, should be valued at around RMB 5 rather than RMB 6.82. Under Section 301 of the Trade Act of 1974, the Fair Currency Coalition in the US has been petitioning the US Trade Representative (USTR) about China’s predatory currency undervaluation and manipulation which constitutes an illegal export subsidy violating WTO rules and discouraging imports into China. The USTR has rejected the petition several times in the past.
Some argue that the relation between the US and China has become a delicate one. Just as the US as a debtor is too big to fail for China the creditor, China as a creditor is too big to annoy for the US. After all, China holds over $750 billion in US treasury bills, and roughly 65 per cent of China’s $2.2 trillion reserves are in dollar assets.
The author is an executive director, Asian Development Bank (ADB), Manila. The views expressed here are personal and do not reflect those of ADB