Global imbalances, the renminbi, and poor-country growthHelmut Reisen, 1 November 2010
Discussions on how best to move towards a more balanced world economy have frequently ignored how proposals to redress these imbalances will impact poor countries. Highly publicised global imbalances in the current accounts of the balance of payments – embodied in deepening US current account deficits since the mid-1990s and sizable Chinese foreign exchange reserve accumulation since the early 2000s – have drawn much attention to the question of renminbi misalignment. A rapid appreciation of the renminbi would involve substantial risks not only for China’s growth but also for global and poor-country growth.
Many studies purport to measure the degree of renminbi undervaluation using various theoretical constructs, but most have ignored the exchange-rate implications of the fact that China is still a poor country. The Harrod-Balassa-Samuelson (HBS) effect can be used to explain the real exchange rate by a country’s relative productivity level. Figure 1 shows percentage deviations of the renminbi from the cross-country regression line from 1990 to 2007, using two PPP (purchasing power parity) concepts, based on International Comparison Program (ICP) and Penn World Tables (PWT) data. Regardless from the measure, the degree of implied undervaluation has increased since the early 2000s. Until China loosened its dollar peg in June 2010, there had been a recent accentuation in the degree of undervaluation, largely driven by China’s superior GDP growth.
Figure 1. China: HBS-implied misalignment, 1990 to 2007
Percentage deviation of market rate from PPP rate
Source: Garroway, Hacibedel, Reisen and Turkisch, 2010
Renminbi appreciation and China’s growth
Stellar growth performance in China has been accompanied by a stable path of real exchange rates. Large fluctuations of real effective exchange rates can undermine incentives to invest in non-traditional sectors (Williamson 2000). Figure 2, which relates the PPP estimate of the real exchange rate (US = 1) to the logarithm of the corresponding countries’ per capita GDP, shows a striking association between exchange-rate stability and income convergence. Figure 2 suggests that sustained growth benefits from an exchange rate that is not only competitive but also stable. The smooth real exchange rate path in high-growth China and India contrasts with the experiences of Brazil, Indonesia, and South Africa, where income convergence has been slower over the last two decades.
Figure 2. Individual adjustment paths between 1990 and 2008
Source: Garroway et al. 2010
The Harrod-Balassa-Samuelson framework predicts that the renminbi is bound to appreciate in inflation-adjusted trade-weighted terms as long as China grows faster than the advanced countries. It is hard to forecast the effects of renminbi appreciation on China’s future growth rate. Much will depend on the scale and speed of currency appreciation, the counterfactual growth effects of policy status quo of pegging the renminbi to the US dollar, and whether the real appreciation occurs through nominal appreciation or through positive inflation differentials with trade partners. But development economists should nevertheless be concerned about a potential slowdown triggered by currency appreciation, not least because China has contributed to global growth in general and to poor-country growth in particular in the 2000s
China is still well described by a dualistic framework that assumes a large subsistence agricultural sector containing surplus labour existing side-by-side with a growing and dynamic capitalist, urban tradables sector characterised by rising productivity. In the absence of perfect financial markets, a competitive exchange rate is a powerful policy instrument to incentivise resources (including subsistence labour) to move from low- to high-productivity sectors.
China, the new locomotive for low-income country growth
The effects of China’s growth on other countries may be positive or negative depending on the similarity of their trade patterns. There has been concern among some developing countries (with labour-intensive industries) that China’s growth was having a detrimental effect on their terms of trade, while exporters of oil and industrial metals would benefit in the short term (but might suffer from resource-curse effects over longer periods).
Similar to Levy-Yeyati’s (2009) analysis for emerging countries, Garroway et al. (2010) analyse the impact of China’s growth on a broader group of poor countries. We estimate the relationship between China’s growth rate and those of 122 developing and emerging countries for the period between 1990 and 2009. The 1990s represent a highly volatile period particularly for the emerging and developing economies with several financial crises, while the 2000s can be considered a more tranquil period for the developing countries with enhanced integration of the global economy, a rising profile of China in the world economy (with WTO membership since 2001), and high global liquidity.
My co-authors and I analyse China’s impact on long-run growth of developing economies in a fixed-effects panel that uses real GDP growth rates. Two interaction terms are included as explanatory variables in order to capture the impact of OECD growth and China’s growth in the second period. Developing countries are grouped by exports into oil- and non oil-exporters to explore how the changes in growth association differ across these two groups. This permits us to explore whether China’s rise as the new engine of growth was driven solely by the commodity linkage. Our main findings are:
1. The impact of China’s growth on both the low- and middle-income countries has grown significantly in the 2000s. So a slowdown of one percentage point in China’s annual growth rate would reduce low-income countries growth rates by 0.56 and middle-income growth rates by 0.36 percentage points.
2. The impact of OECD countries has significantly decreased over the same period for the low-income countries, with a coefficient close to zero, while it remained positive (0.3 percentage points) for middle-income countries.
3. The results for the non-oil developing economies show that the China impact is not limited to oil exporting developing countries, it is also a robust finding for non-oil countries. Consequently, China’s strengthening engine role for poor countries does not seem merely driven by the oil-exports channel.
China’s rapid growth and the attendant demand for other countries’ goods have had positive spillover effects to poor countries. Still, higher tradable goods production in China results in lower traded goods production elsewhere in the developing world – entailing a growth cost for these countries. Are these the poor countries, as suggested by Subramanian (2010)? The empirical evidence points to contrary conclusions. The exports of China were mainly concentrated on labour-intensive products in the early 1990s but since then a growing proportion of exports has become more capital- and skill-intensive. Technological upgrading in China has moved China’s price impact from the developing countries to the high-income economies (Robertson and Xu 2010). The real effective exchange rate of the renminbi has exerted no significant pressure on the export prices of low-income countries since the late 1990s (Fu et al. 2010).
Why are these new growth linkages important in the context of renminbi evaluation?
Rodrik (2008) reports panel regressions that suggest that the partial correlation between his index of (log) undervaluation and an economy’s annual growth rate is 0.026 for developing countries in general. A recent IMF study (Berg and Miao 2010) confirms Rodrik’s analysis by producing, with a dataset based on 181 country observations during eleven five-year periods from 1950-54 to 2000-04, empirical evidence that not only are currency overvaluations bad for growth but that undervaluations are also good for developing-country growth.
Moreover, Rodrik (2008) presents evidence that growth in large‚ dual economies such as China and India is especially supported by a competitive exchange rate. In the case of China, his estimate rises to 0.086, a much bigger number that he attributes to the large reservoir of surplus labour and the huge gap in the productivity levels of modern and traditional parts of the economy. This estimate implies that a 10% appreciation would reduce China’s growth by 0.86 percentage points.
By extension, a large Chinese appreciation would also imply a relative currency devaluation in other developing countries. The implied transfer of exportable production from China to other poor countries would mean lower global growth as it represents a transfer to countries that are less efficient to translate currency undervaluation into high growth. To be sure, these concerns ignore adjustment and substitution effects, but they serve to illuminate potentially high adjustment cost that a renminbi appreciation might entail for the world’s poor outside China, an aspect entirely neglected in current macroeconomic policy debates.
Berg, A and Y Miao (2010), “The Real Exchange Rate and Growth Revisited: The Washington Consensus Strikes Back?”, IMF Working Paper WP/10/58, International Monetary Fund, Washington DC, March.
Fu, X, R Kaplinsky and J Zhang (2010), “The Impact of China’s Exports on Global Manufactures Prices”, SLPTMD Working Paper Series No. 032 Department of International Development, Oxford University.
Garroway, C, B Hacibedel, H. Reisen and E. Turkisch (2010),"The Renminbi and Poor-Country Growth", OECD Development Centre Working Papers, No. 292.
Levy-Yeyati, E (2009), “On Emerging Markets Decoupling and Growth Convergence”, VoxEU.org, 7 November.
Reisen, H. (2009), “On the Renminbi and Economic Convergence”, VoxEU.org, 17 December.
Robertson, PE and JY Xu (2010), “In China’s Wake: Has Asia Gained from China’s Growth?”, The University of Western Australia, Discussion Paper 10.15.
Rodrik, D (2008), “The Real Exchange Rate and Economic Growth”, Brookings Papers on Economic Activity, Vol. 2.
Subramanian, A (2010), “New PPP-based Estimates of Renminbi Undervaluation and Policy Implications”, VoxEU.org, 16 April.
Williamson, J (2000), “Exchange Rate Regimes for Emerging Markets: Reviving the Intermediate Option”, Policy Analyses in International Economics 60, Peterson Institute for International Economics.