Making Room for China in the World Economy

As it comes out of the crisis, the world economy faces two apparently conflicting demands. On the one hand, achieving global macroeconomic stability and preventing a protectionist backlash will require that we avoid large current account imbalances of the type that the world economy experienced in the run-up to the crisis. On the other hand, returning to rapid growth in the developing nations will require that they resume their conquest of global market share in tradable goods. The challenge of meeting both demands is epitomized by the contentious US-China bilateral relationship. American (and European) policy makers blame China for an undervalued renminbi, which they argue is the root cause of China’s huge trade surplus. Chinese leaders resist the pressure, fearing that appreciation will undercut the competitiveness of Chinese goods in world markets, hurt exports, and damage growth. The Western answer to this concern is that China needs to replace foreign demand with domestic demand as the engine of growth. But if growth depends primarily on the supply of modern manufactured products and other tradables as opposed to services and non-tradables, as I will argue here, the Chinese position has more force than critics give it credit. The conventional fix for China’s current account surplus, consisting of a combination of expenditure expansion and currency appreciation, will shift the structure of the economy away from tradables and towards non-tradables. This may be good for macroeconomic balance in China and elsewhere, but it will almost certainly have adverse effects on China’s growth—perhaps large enough even to endanger the country’s social and political stability. Making Room for China in the World Economy