Author: Yiping Huang, Peking University and ANU
On September 29, the US House of Representatives passed the bill to punish China for its undervalued currency. For the bill to become actual policy, it requires endorsement by the Senate and approval by the president. So, with mid-term elections due for the House and the Senate on November 2, the currency tension between China and the US might ease somewhat temporarily.
Treasury Secretary Tim Geithner indicated during a Ways and Means Committee hearing before the House of Representatives that he would use the upcoming G20 Summit in Seoul to pressure China to accelerate pace of renminbi appreciation. There are some obvious benefits of using a multilateral framework such as G20 Summit for resolving a currency dispute. But a ‘Plaza Accord II’, if that’s what Geithner had in mind, might be a dangerous way to go.
Agenda for the Seoul Summit
Many government officials from G20 members have been busy for the past months defining a proper agenda for the G20 Summit in November. This is critical because otherwise the gathering would be a waste of the leaders’ precious time. More importantly, the relevance of G20 as an institution depends on its ability to solve global problems. Since inception of the G20 Summit, its legitimacy has frequently been questioned.
To be fair, the G20 already has a long list of items proposed for discussion among leaders in Seoul in November. Many are a direct extension of the efforts fighting the global financial crisis. They include creation of a policy framework supporting strong, sustained and balanced growth around the world, restructuring of the financial regulatory framework and reform of the International Monetary Fund (its voting power and governance structure).
For sure the leaders would again have to discuss the issue of exit from expansionary fiscal and monetary policies. The Toronto Summit actually had an agreement on this but its implementation was complicated by worsening of the sovereign debt crisis in Europe and risks of a double-dip recession in the world economy. Continuation of excessively loose monetary and fiscal policies, however, could be poisonous for future growth.
Other issues proposed for discussion by experts and policymakers are the Doha Round of WTO Trade Negotiation, anti-corruption, climate change and marine environment protection. These are all important subjects. The Doha Round, in particular, could play a vital role in containing trade protectionism and ensuring an open and free trade system. The difficulty, however, is that the leaders might not be able to deliver concrete results in the short term.
As the host of the Seoul Summit, the Korean government has also added two items to the agenda: global financial safety net and development. But it isn’t clear yet if Korea intends to build a financial safety net completely independently of the reform efforts for the financial regulatory system and the IMF. Certainly, development of low-income countries is important both politically and economically. But what can G20 leaders deliver on all this in Seoul?
Rebalancing of the global economy
One area where the G20 can play an important role is global rebalancing. From its beginning in Washington in late 2008, the G20 Summit repeatedly stressed the importance of rebalancing as a way of both reducing financial risks and supporting sustainable growth. So far, however, we have seen very limited action from respective governments. This is understandable since global leaders have been busy containing financial and economic risks.
There is a wrong-headed perception among some experts and officials that the global imbalance problem is fundamentally a problem between the US and China. If that is the case, then the task of rebalancing should be left to these two countries and the G20 would have little to contribute. This is not consistent with the facts. True, China accounts for a large part of the global surplus. But similarly, Japan, other East Asian economies and oil exporters also contribute significantly to the overall surplus.
The global imbalance is a global issue. Resolution of it is better effected through multilateral frameworks. It certainly helps reduce risks of direct confrontation between the worlds’ two largest economies. The multilateral approach is also more likely to root out the core problem. For instance, even if China is forced to eliminate its current account surplus, the global imbalances may continue if other surplus countries do not do the same. The US might simply shift its borrowing from China to others.
But how should G20 deal with global rebalancing? The approach hinted at by Geithner through forced appreciation of renminbi is likely to be dangerous and unproductive. It might amount to a ‘Plaza Accord II’ as proposed by Bill Clines of the Peterson Institute of International Economics. In essence, a ‘Plaza Accord II’ would require currency appreciation and fiscal expansion in surplus countries but currency depreciation and fiscal contraction in deficit countries.
But ‘Plaza Accord II’ will probably be as ineffective as the original Plaza Accord which did not eliminate the global imbalances. For instance, the US current account surplus as share of GDP was 1.7 per cent in the 1980s, stayed at 1.6 per cent in the 1990s but surged to 4.7 per cent in the early 2000s. Princeton historian Harold James put it more bluntly: ‘The lesson of the past clearly indicates that a more sophisticated approach is required rather than exerting massive pressure for exchange rate adjustment and looser monetary and fiscal policy.’
‘Plaza Accord II’ is likely to be dangerous because it might force excessive on-off currency adjustment in surplus countries like China. Given the current state of the economy and the financial sector, drastic currency movements are likely to cause real difficulties. And any downturn of the Chinese economy today could risk growth and recovery from recession in many countries around the world, most notably East Asian economies and commodity exporters.
Coordinating structural reform
A better approach would be for G20 to focus on structural reform in key countries in which imbalance is a problem. And currency adjustment should be an important part of the, but not the entire, policy solution.
The G20 could play a role since it is able to look at experience in different countries. It can also coordinate the timing of the structural reforms in respective countries, since the reduction of a surplus in one country inevitably leads to, or has to be accommodated by, the reduction of a deficit in another country.
Take the example of China. The large Chinese current account surplus was derives mainly from distortions in factor markets, which repress costs of production and artificially improve the competitiveness of China’s manufacturing exports. Exchange rate misalignment is only a part of the picture of distortions. Elimination of the current account surplus requires liberalisation of the factor markets. Relying exclusively on currency adjustment to correct external imbalances would requires an out-sized appreciation, and that would be difficult for China to accommodate at this stage, both politically and economically.
Likewise, the exceedingly low savings rate in the US before the subprime crisis was caused by a number of factors. Simply depreciating the US dollar by a significant margin is unlikely to lift the savings rate materially. Such currency moves threaten to destabilise the economy and financial markets.
For the G20 to play a positive role in global rebalancing, it would have to depart from the earlier approach of the G7 focusing only on exchange rate and fiscal policy. Instead it should make efforts to encourage and coordinate more broad-based structural reforms in both surplus and deficit countries, consistent with what was agreed by G20 leaders in September 2009 in Pittsburgh, namely:
G20 members with sustained, significant external deficits pledge to undertake policies to support private savings and undertake fiscal consolidation while maintaining open markets and strengthening export sectors.
G20 members with sustained, significant external surpluses pledge to strengthen domestic sources of growth. According to national circumstances this could include increasing investment, reducing financial markets distortions, boosting productivity in service sectors, improving social safety nets, and lifting constraints on demand growth.
Rebalancing already happening
The good news is that global rebalancing is already happening. Both the current account deficit in the US and the surplus in China as shares of GDP have shrunk by half from their respective peaks before the crisis. Obviously, part of these adjustments must be cyclical, given global economic recession. But the bulk of the decline in global imbalances from 2007 to 2009 was a result of countries rebalancing export and import growth, and that is more likely to be sustainable.
Again, taking China as an example, recent adjustment of its external imbalance was, at least to some extent, a result of changes in domestic factor markets. Factor costs have been on the rise despite the global financial crisis. This is most evident in labour and resource markets due to changes in both policies and demand-supply conditions. During the past year, the government has begun to reduce price distortions for most resource products in order to improve economic efficiency. The upcoming labour shortage is already pushing up wages by close to 20 per cent a year.
PBOC deputy governor Hu Xiaolian recently argued that adjustment of fFactor prices are an important way in changing the renminbi’s real effective exchange rate. Such price adjustments are bound to have important impact on China’s trade composition. Rising wages, for instance, not only directly benefits consumption but also forces labour-using industries to move inland, another important positive factor for promoting domestic demand.
These are the policy issues that G20 leaders should focus on, with flexible exchange rate regime as a part of the broad structural reform package. The G20 can help identify some best practices, defining target ranges, setting time frames and laying out some types of disciplinary mechanisms (such as taxes on excessive surpluses and deficits). But it is better to leave decisions on choices of policy instruments and the pace of implementation to national governments.
Yiping Huang is professor of economics at the China Center for Economic Research at Peking University and in the Crawford School of Economics and Government in the ANU.
This is an article from the most recent edition of the East Asia Forum Quarterly: ‘Asia and the G20’.