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How will China’s external current account surplus evolve in the coming years?

Louis Kuijs's picture

How China’s current account surplus will evolve in the coming years is one of the key questions on the economic outlook, both for China itself and for the global economy. China’s increasingly competitive manufacturing sector will continue to power ahead, to expand exports and to gain global market share. At the same time, China’s domestic economy should continue to grow rapidly, thereby drawing imports. However, how this will on balance play out with regard to the current account surplus is less certain. It will largely depend on how much progress is made with rebalancing the economy.

China’s export volumes have continued to rise very rapidly in recent years.An increasing array of manufacturing sectors is becoming more competitive internationally, including many types of machinery and equipment. Competitiveness is boosted by technological catch up, movement up the value chain, and economies of scale as well as by traditional strengths such as infrastructure and the business climate. Reflecting these factors, labor productivity growth in manufacturing has remained solid, thus helping containing unit labor costs despite respectable wage growth.

Some have argued that China is losing its competitive edge because its export prices are rising. However, that is an incorrect inference. Higher raw commodity prices mean export prices are rising all over the world—not just in China. Prices of US imports from China are now rising at the same pace as those of US imports of manufactured goods from developed countries. But those of US imports of manufactured goods from other emerging markets and developing countries are rising faster. On this price metric, the most we can say is that China’s competitiveness is improving at a slower pace than before.

In all, China’s exports have continued to strongly outpace world trade. Their global market share rose from 7.4% in 2007 to an estimated 9.6% in 2010, and this trend has continued in the first 4 months of 2011.

In addition to the strength of gross exports, the value added content of exports has continued to rise. This is because of deeper supply chains in the processing sector and a rising share of normal (non processing) exports, which have a higher value added content. Thus, in value added terms exports have grown even somewhat faster than headline exports. In several parts of the world, China’s strong export performance is causing economic and sometimes also political friction.

There is another side to China’s external trade story. China’s domestic economy grew even faster than exports since 2007 and China’s imports surged alongside domestic demand. As a result, imports strongly outpaced exports, with import volumes 34% higher in 2010 than in 2007, in real terms, compared to a 24 % increase in export volumes. This has basically driven the decline in the current account surplus from 10.1% of GDP in 2007 to 5.1% in 2010, leading to external rebalancing simply because China grew much faster than the rest of the world. In the first 4 months of this year, import volume growth eased but to a still steady pace.

China’s external terms of trade have moved around a lot in recent years, because of swings in raw commodity prices. However, on average, the terms of trade worsened only 4 % between 2007 and 2010, which only had a modest impact on the current account, compared to the volume effect.

For 2011 as a whole, with export and import volumes both expected to grow at lower double digit rates and the terms of trade declining somewhat further, the current account surplus is likely to fall further, to 3.5-4 % of GDP.

The reduction in the current account surplus has of course been influenced by the global crisis. This depressed global demand and led China’s government to implement a large and effective stimulus which boosted domestic demand.

Looking ahead, whether the recent trend towards a lower external surplus will be sustained in the coming years remains to be seen.Exports should continue to expand strongly and gain global market share. Imports should also continue to grow rapidly on the back of continued solid growth of China’s domestic economy. However, it is unclear how these 2 factors would on balance work out with regard to the current account surplus. Whether the domestic economy and imports will outpace exports in the coming five years depends in large part on China’s policies, especially on progress with rebalancing.

If China’s domestic demand growth remains much stronger than elsewhere and significant rebalancing takes place towards a larger role for services and consumption the external surplus may remain contained. However, such progress with rebalancing requires substantial policy adjustment and reform in a range of areas, including pricing of inputs into industry, public finances, the policy setting for private and service sector companies, and the exchange rate. In the absence of such policy adjustment, exports are likely to start outstripping imports again, as they did before 2008, especially if the global economy—and thus demand for China’s exports—does well.

Recent patterns of investment across sectors suggest rebalancing is not yet entrenched, even though the current account surplus has come down. Prior to 2008, investment was particularly strong in sectors that export a relatively large share of output. At the time of the recent global crisis and China’s stimulus that pattern seemed to shift, with investment growth particularly strong in sectors producing more for the domestic market. However, since 2010 the investment pattern has shifted back again, resembling the pre-crisis pattern.

The policy focus in the coming years is key but hard to predict. Recent years have not seen a steady sequence of rebalancing-oriented reform. The 12th 5 Year Plan has rebalancing as a key objective. But the other major objective is industrial upgrading and moving up the value chain. The plan suggests the government should lead this effort, even though in most market economies the role of the government would largely be to provide an enabling framework, with most of the upgrading left to the corporate sector. Industrial upgrading is actually already happening. If on top of that the policy focus in the coming years is going to be more on industrial upgrading than on rebalancing we will on balance see more emphasis on industry and investment rather than services and consumption. This would drive up the current account surplus again over time. On the other hand, given the robust outlook for domestic demand, with a policy focus on rebalancing the current account surplus should remain contained. Thus, the relative emphasis on these 2 policy objectives in the coming years will be a key determinant of the current account trend.

Comments

Submitted by Anonymous on
Thank you, Mr. Kuijs, for summarizing your analysis of China's CA surplus. Maybe you are writing for a Beijing audience but I find your assessment here in subsance as well as tone overly optimistic about the prospects of rebalancing. i recognize you have been studying and writing on the matter for several years and therefore wanted to publicly and respectfully venture the following critical comments: First, China's imports consist largely of commodities and supplies that fuel exports rather than consumer goods manufactured abroad. It is still an investment-led export subsidizing model. Externally, the US recovery has already reversed the recesson-induced move to rebalancing in the bilateral account, which is the centerpiece of China's surplus and the global imbalances now distorting economies of Mexico, Brazil, etc. Internally, the evidence I have seen only supports the notion that, notwithstanding official doctrine advocating China's economic adjustment, the prevailing political support lies with advocates of status quo policies favoring export manufacturing. The recent effective stimulus is an interesting fact, but consumption of foreign exports is still effectively taxed very sustantially by the currency peg. In sum then, China's investment-led export subsidizing model meets a reanimated US market, enriching and politically bolstering the already favored industrial interests. That is my read of your analysis and it points to the likelihood of political solutions. I'm interested to hear if and where you and others would agree with, object to, or qualify my comments. I also think we should be preparing the US media and political class for an intelligent discussion of the global and US-China imbalances - a tall but worthy task! Thank you. Matthew Lieber, Ph.D. Visiting Professor, Beloit College lieberm@beloit.edu

Submitted by Anonymous on
Thank you, Mr. Kuijs, for summarizing your analysis of China's CA surplus. Maybe you are writing for a Beijing audience but I find your assessment here in subsance as well as tone overly optimistic about the prospects of rebalancing. i recognize you have been studying and writing on the matter for several years and therefore wanted to publicly and respectfully venture the following critical comments: First, China's imports consist largely of commodities and supplies that fuel exports rather than consumer goods manufactured abroad. It is still an investment-led export subsidizing model. Externally, the US recovery has already reversed the recesson-induced move to rebalancing in the bilateral account, which is the centerpiece of China's surplus and the global imbalances now distorting economies of Mexico, Brazil, etc. Internally, the evidence I have seen only supports the notion that, notwithstanding official doctrine advocating China's economic adjustment, the prevailing political support lies with advocates of status quo policies favoring export manufacturing. The recent effective stimulus is an interesting fact, but consumption of foreign exports is still effectively taxed very sustantially by the currency peg. In sum then, China's investment-led export subsidizing model meets a reanimated US market, enriching and politically bolstering the already favored industrial interests. That is my read of your analysis and it points to the likelihood of political solutions. I'm interested to hear if and where you and others would agree with, object to, or qualify my comments. I also think we should be preparing the US media and political class for an intelligent discussion of the global and US-China imbalances - a tall but worthy task! Thank you. Matthew Lieber, Ph.D. Visiting Professor, Beloit College lieberm@beloit.edu

Professor Lieber, thanks for your comments. What I tried to do--but I am not sure it worked--was to write what has happened so far and to make the point that, at least in my view, the question is not whether China's exports and imports will grow--they will--but what will on balance happen to the current account. I argue that this will depend on China's policies in the coming years. You think I am too optimistic. I set out not to be. I tried to write that only with a set of rebalancing oriented policies will China's current account surplus remain contained. But that does not seem to have come over well. Thanks for pointing that out. You write that the bilateral US-China (im)balance is "the centerpiece of China's surplus. I actually do not agree. Bilateral (im)balances don't necessarily mean much, especially not if they are affected by multinational production networks. Also, the US nowadays buys only 1/6th to 1/5th of China's exports. Macroeconomically it is the total (im)balances that matters. I think China and the US both need to look at their external (im)balance with the rest of the world and to ensure these remain contained. We seem to agree that China will only see this happen if substantial policy adjustments are made. Like you I sense this is not easy, including because of political and political economy reasons. By the way, similarly, political and political economy reasons also may end up holding up progress with needed reforms in the US.

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