Saturday, August 7, 2010

Chinese Mercantilism

I will start with an apology that it is so long since my last post, which is due to my having been busy with my 'real' work. There were a host of subjects that I would like to cover, but the subject that grabbed my interest was China.

One story about China of particular note was an Economist article on the situation of labour in China. The increasing cost of labour in the coastal areas is creating ever more incentive for the movement of less skilled work into inland China, and that this will see/and is the result of the coastal provinces continuing their steady rise up the value chain. This process has been ongoing, and will allow (in principle) for China to maintain economic growth for a long time yet, all the while without losing the ability to compete in the lower value added industries on which its initial success was founded.

For the rest of the world, this ability to manage a transition from low value added to high value added whilst retaining the former, presents an ongoing problem for competitors. This is the key difference between the emergence of China and countries like Japan, South Korea and Taiwan; the depth of China's labour market. This depth will allow China to compete in every segment for a long while yet, allowing an ever greater dominance of Chinese exports.

Another aspect of the Economist article that was interesting was the concentration of strikes in China in foreign enterprises, reflecting points I made a long, long time ago. The point in question was the way in which China seeks to bring in foreign investment, methods and technology, whilst at the same time weighting the dice against the foreign companies. In the case of strikes, the authorities seem very willing to look on (and take no action) in the case of strikes in foreign companies, but far less willing to tolerate stikes within domestic enterprises. In a post I made a long time ago, I pointed out the many ways in which China sought to disadvantage foreign companies, and it seems the policy is ongoing.

Although in some respects investing in business in China is a risky choice, China is managing to weight the dice even further in their favour. A while ago, I discussed rare earth metals, and that China (which is the dominant producer) was seeking to restrict exports. This is a recent article on the subject:

The United States Magnetic Materials Association (“USMMA”), a trade association representing domestic high performance magnet producers and suppliers, today warned of impending shortages of rare earth materials needed to support domestic manufacturing in support of emerging green technologies like wind generation, hybrid vehicles, and new battery development, high-tech consumer products like mobile phones, PDAs, MP3s, and national security and defense systems.

Late last week, China, the world’s largest rare earths producer, announced new plans to cut rare earth export quotas by 72 percent for the second half of the year. According to China’s Ministry of Commerce, foreign shipments will be capped at 7,976 metric tons, down from 28,417 tons for the same period last year.

In restricting exports, until such time as alternative sources can be brought on stream (15 years according to the US government), China is effectively forcing companies that use rare earth metals to set up operations in China. In so doing, they will rapicly accelerate the process of manufacture of high-tech devices and the importation of other technologies. All the while this is taking place, despite discussion of RMB revaluation, the RMB remains undervalued. The head of the IMF China mission recently had this to say:

WASHINGTON (Dow Jones)--China's currency is "substantially" undervalued despite Beijing's recent decision to appreciate the yuan, the head of the International Monetary Fund's mission to China said Wednesday.

China has held up the IMF staff report for the fourth year running, objecting to the fund's characterization of its currency and pressing the board to omit its finding.

"The RMB remains substantially below the level that's consistent with current fundamentals," said IMF China Mission Chief Nigel Chalk, referring to the renminbi, another name for the yuan, on a conference call with reporters.

Under pressure from Beijing, the IMF board was at odds how to define China's exchange rate. "Several directors agreed that the exchange rate is undervalued," the IMF said in a notice posted late Tuesday evening. "However, a number of others disagreed with the staff's assessment of the level of the exchange rate, noting that it is based on uncertain forecasts of the current account surplus."

What we are really seeing is yet more of China's strategy of mercantilism, in which they continue to seek any advantage that they can get, without any regard to the concept of free and fair trade. Of course, the most interesting point about China's mercantilism is the resultant strength of China's export machine. In a recent article in the Telegraph, Edmund Conway illustrates the essential problem that is confronting the Western economies:

[Mervyn King]Sitting at a summit listening to his fellow central bankers and finance ministers go round the table and explain how they would escape from the economic doldrums, he realised, with both horror and amusement, that they all had precisely the same plan: export their way out.


In other words, the US and UK's plans to focus on exports as a source of growth in the future are dependent on the world's big exporters – and specifically China – suddenly discovering an appetite for those American and British goods. Fail in this and a double-dip recession is almost assured.


The reality is that just as the US and UK are in most need of demand from Chinese consumers for their goods, Beijing is facing an economic crisis of its own, and is resorting to its most reliable weapon: exporting the hell out of it.
This is the problem writ large. China will do anything to keep economic growth going and, as long as they do so, their export policy will hinder any possibility of rebalancing of trade, and will continue to see the hollowing out of Western productive capacity, increasingly including higher added value goods and services. The most puzzling aspect of this is that, despite lots of noise from China's competitors, the noise just remains that; noise. It never translates into substantive action, in particular from the US.

For the underlying reason for the lack of action, the answer must lie in the reliance of the US government on Chinese funding of deficits. It is a spiral of decline, in which the purchase of treasuries by China holds down the value of the RMB, China uses the low valuation to support exports, the exports depress and destroy productive capacity in the US, and the US needs to borrow more money from China, to make up for their poor economic performance. The more money they need to borrow, the more fearful the US government becomes about taking action to halt the spiral. As I have long argued, China must be confronted, but in order to do so, the US must take the pain that will follow such action.

And such action will indeed be painful....but the potential extent of the pain just keeps growing. That is the nature of the spiral.


None of this is to say that all is perfect in the Chinese economy. For example, as I posted a couple of years ago, the Chinese construction boom has been spurred by the purchase of apartments that have been left empty, and which have been purchased as speculative investments. This trend has (finally) been noted by several analysts, and suggests that a severe bubble is in place.

I have also been looking at some of the HSBC reports on China, and they have made interesting reading. China, due to the opaque nature of the government, is a country where you feel that analysis is somewhat like trying to read tea leaves for the signs of the future. One interesting report was that there are some problems on the horizon for China's local government, with this from an HSBC (1):

New Century Weekly – a financial newspaper in China – reported this week that a recent China Banking Regulatory Commission (CBRC) investigation had found that of the RMB7.7trn extended to local financing vehicles as part of stimulus funding, 23% (or RMB1.8trn) went towards projects that may ultimately have problems in servicing their loans.
The problem was that, as part of the Chinese fiscal stimulus, local governments were forced to borrow from banks to fund infrastructure projects, and these loans are now going sour. It seems that, even in a country like China, where there is a strong need for new infrastructure, fiscal stimulus presents risks that (to use a cliche) bridges will be built to nowhere.

There are plenty of other signals that suggest that the dragon may not be as fit as it appears, and it will be interesting to see how China fares in the coming year. As I have mentioned the opacity of China is such that analysis of what is taking place is never easy.

(1) HSBC Research, 29 July, 2010, China Economic Spotlight,


  1. You state:

    The increasing cost of labour in the coastal areas is creating ever more incentive for the movement of less skilled work into inland China, and that this will see/and is the result of the coastal provinces continuing their steady rise up the value chain. This process has been ongoing, and will allow (in principle) for China to maintain economic growth for a long time yet, all the while without losing the ability to compete in the lower value added industries on which its initial success was founded.

    You have clearly misstated the argument of the Economist article. In fact, the article argues that China faces serious labour problems in the future, and in particular will experience significant upward pressure on wages that will uncut competitiveness in international markets:

    These are the 3 crucial points in the Economist article:

    (1) China’s population is aging and there will be less surplus labour willing to move from the countryside:

    The workshop of the world, in other words, is ageing. As China’s villagers grow older, coastal factories will have to offer higher wages to tempt them to migrate. One-sixth of non-migrants say they are too old to go, even though they are under 40. The end of surplus labour is not an event, but a process. And that process may already be under way.

    I have already made a similar point in past comments here.

    (2) The shift of some manufacturing to inland China is hindered by poorer infrastructure there and will not stop upward pressure on wages:

    The redrawing of China’s industrial map may, therefore, contribute to a rebalancing of its economy. The rise of the inland provinces will push up demand for labour, even as China’s baby-bust reduces supply. As a consequence, wages will rise at the expense of profits and China’s workers will take home a greater share of the national cake.

    (3) The rise in demand for, and rising price of, Chinese non-tradable goods and services (both on the coast and inland) will make exports less competitive:

    Higher consumer spending will increase demand for services, such as housing, retailing and haircuts, which consumers favour, and which cannot be traded across borders. The rise in their price will have much the same effect as a stronger exchange rate, making Chinese goods pricier relative to internationally traded commodities.

    These processes are all good news for the West, because the rebalancing of development in China to more development in the countryside and inland is precisely what is required to allow wages to rise. This will mean that there will be less surplus labour to keep the urban manufacturing wage so low.

  2. Also, on the issue of the flood of migrant workers from the countryside to the cities:

    an unlimited supply of labour is not a natural phenomenon given by China’s population structure, as is so often assumed. Rather, it is a consequence of the government’s rural-agricultural policies which, intentionally or unintentionally, bankrupt the countryside and generate a continuous rural exodus …. Over the last twenty years, the Chinese government has largely concentrated investment in the urban-industrial sector, particularly in coastal areas, with rural and agricultural investment lagging behind. State-owned banks have also focused their efforts on financing urban-industrial development, while rural and agricultural financing were neglected. In the last two decades, rural per capita income has never exceeded 40 per cent of the urban level .... The result of this urban bias has been relative economic stagnation in the countryside and a concomitant fiscal stringency on the part of rural local governments. From the 1990s onwards, the deterioration of agricultural incomes and the demise of collective rural industries—the township and village enterprises which used to be vibrant generators of employment in the early stages of market reform—forced most young labourers in the countryside to leave for the city, creating a vicious cycle which has precipitated a rural social crisis. China’s agrarian sector was not only neglected, however, it was also exploited in support of urban growth. A recent study has found that there was a sustained and increasing net transfer of resources from the rural-agricultural to the urban-industrial sector between 1978 and 2000, both through fiscal policy (via taxation and government spending) and the financial system (via savings deposits and loans).

    Hung Ho-Fung, America’s Head Servant?

    The punitive fiscal policies imposed on the Chinese rural population is examined in Huang Jikun, Scott Rozelle and Wang Honglin, ‘Fostering or Stripping Rural China: Modernizing Agriculture and Rural to Urban Capital Flows’, The Developing Economies, vol. 44, no. 1, 2006, pp. 1–26.

  3. "and the US needs to borrow more money from China, to make up for their poor economic performance."

    It doesn't, and it isn't. US dollars are only of real value to US citizens. Ultimately if you take payment in dollars you have to buy something real from the US to get rid of them.

    There will be at some point a relative revaluation of the Western currencies against the eastern ones. At that point it will be the people owning assets or liabilities denominated in the Western currencies that will take the hit.

    The first country to realise that exporting is not going to help and who then stops the needless borrowing in their own currency will end up being the winner.

    Just like in 1971 when the currencies free floated, we're waiting for a paradigm shift to get us out of this death spiral.

  4. A quick reply to your comments LK, but will leave it to the article to speak:

    "The interior has demographic depth: Anhui alone has a population of 62m, about three-quarters of Vietnam’s (although about a fifth of its labour force already works outside its borders). Provinces farther west are even bigger: Sichuan has 82m people. How far upriver might Chinese manufacturing travel? Over 2,500km from Shanghai, where the brown Yangzi meets the greener waters of the Jialing river, the city of Chongqing is flourishing. It is the centre of a municipality of 28m people, run directly by the central government. The municipality’s GDP grew by over 19% in the year to the first quarter"


    "A number of economists believe China has reached a turning-point in its development, having exhausted its supply of surplus labour. Others think this conclusion premature. Calculations by Mr Knight, Deng Quheng of the Chinese Academy of Social Sciences and Li Shi of Beijing Normal University imply there are still 70m people in China’s villages who might be expected to leave in search of work, given their age, family obligations and so forth."

    Note: this is about migrant labour, not labour. Labour in villages still might move into manufacturing if local.

    As for the total workforce, take a look at a Chinese farm, and consider how much labour is locked up in inefficient farming...there is plenty more labour stored up....youth may be declining, but look at the chart again, the total workforce may decline very slowly, but that does not mean that there is not untapped capacity within the workforce that will not outstrip the shrinkage.

    I will now await the deluge in response to my reply....

    As a general note, I am not mis-stating the article, but interpreting the information.....or I would just give up on the blog and leave it to the Economist....

  5. Excellent analysis. I enjoyed it.

    I'd be interested in an article covering what, precisely, you would do if you were the American president. How would you go about "confronting the Chinese."

  6. Yes, the article says this:

    A number of economists believe China has reached a turning-point in its development, having exhausted its supply of surplus labour. Others think this conclusion premature. Calculations by Mr Knight, Deng Quheng … and Li Shi … imply there are still 70m people in China’s villages who might be expected to leave in search of work, given their age, family obligations and so forth."

    But you fail to quote the remarks directly following this that contradict it:

    Mr Knight and his co-authors suggest that the labour market may still be “segmented”, so that a surplus of labour in the countryside can coexist with shortages on the coasts. China’s land policies and its household-registration system, or hukou, may be partly to blame. Villagers risk losing family plots if they do not tend them. At the same time, they cannot enroll their children in city schools or benefit from many other public services until they have been officially acknowledged as permanent urban residents. That can take years. Policy aside, people over 30 are much less likely to shoulder their bindle stick and seek their fortunes. Having risen for the past decade, the number of Chinese aged 15 to 29 will fall quite sharply after 2011 …. The workshop of the world, in other words, is ageing etc.

    Some other studies of this:

    [China’s] country’s villages still contain perhaps 70m potential migrants. Other rural folk might be willing to work closer to home in the growing number of factories moving inland. But the supply of strong backs and nimble fingers is not infinite, even in China. The number of 15- to 29-year-olds will fall sharply from next year.

    The rising power of the Chinese worker

    On growing power of labour:

    Wave of strikes bring Chinese workers a step nearer new rights

  7. While it's not exactly on the topic of China, I just found this book: The Enigma of Capital: And the Crises of Capitalism by David Harvey
    Summary: Since the moment the deeply unsettling financial disaster erupted in September 2008, a crisis of confidence has gripped the economic mind. Experts of all stripes, from Alan Greenspan on down, were at a loss to explain what had happened.
    David Harvey saw this moment coming. A legendary scholar and critic of capitalism, he has been warning of problems for decades. Now, in The Enigma of Capital, Harvey provides a sweeping and brilliantly clear explanation of how the disaster happened, and how we can avoid another like it. Unlike other commentators, Harvey does not focus on subprime loans or mortgage securitization as the root cause of the calamity. Instead, he looks at something that reaches far deeper into the heart of capitalism--the flow of money through society. He shows how falling profit margins in the 1970s generated a deep transformation. With government assistance, capital was freed to flow across borders, and production moved to cheaper labor markets, depressing workers' incomes in the West. But as more and more money moved out of the laboring classes and into the pockets of the wealthy, a problem arose--how could the workers afford to buy the products which fueled the now-global economy? To solve this problem, a new kind of finance capitalism arose, pouring rivers of credit to increasingly strapped consumers. Moreover, these financial institutions loaned money to both real-estate developers as well as home buyers--in effect, controlling both the supply and demand for housing. But when the real-estate market collapsed, so did this financial edifice, an edifice that dominated our economy.
    We cannot afford to simply shore up this financial system, Harvey writes; we need to undertake a radical overhaul. With this landmark account, he offers a richly informed discussion of how we can turn our economy in a new direction--fairer, healthier, more just, and truly sustainable.

  8. This is for Lord Keynes and a little off the main topic but re-visiting a long argument on this board. Re whether austerity will work - you have long said that it will lead to debt deflation and pointed to Ireland as an example. Well it seems like the mainstream media are finally agreeing with you.

    This from the Telegraph: ''Less clear is whether it can work. The budget deficit seems stuck at 14pc of GDP, and unemployment has risen to 13.7pc. The severity of the slump is eating away at the tax base. Critics say the country is chasing its tail.
    Under the deflation, nominal GDP has contracted by almost 20pc. Yet the debt stock has risen. Ireland is uncomfortably close to a debt-deflation trap along the classic lines described by Irving Fisher in the 1930s.'' Very interesting.


  9. SuzySmith,

    The concept of "debt deflation" will appear more and more in analysis of the stagnation and double dip recessions that many countries will probably experience in the coming years.
    Without a proper understanding of debt deflation, no commentator can give sensible analysis of the current problems.

    Some resources:

    There is certainly a good deal of truth in
    David Harvey's analysis, but I would wary of his Marxist framework. Marxists are overly fixated on the alleged "falling rate of profit" thesis, an idea that has little empirical support. In my opinion, Post Keynesian analysis is a far superior explanation of the fundamental causes of the 2008 financial crisis.

  10. There's a good article here that explains why it is ridiculous to posit purely economic prescriptions for what are historical phenomena:

    Unless the day arrives when we can magic oil out of nowhere, our narrative of endless, pain-free progress will have to be abandoned.

  11. A Real Black PersonAugust 18, 2010 at 7:36 AM

    I see your and raise your

    and raise you

    Some of the responders on the second link assume that things will be bad all around the world following an a complete social and economical collapse. As intergrated as the global economy is, the rest of the world can adapt to a world where the American market has disappeared.

    Gareth Cheeseman, you will find some commenters here reluctant to admit or even accept that the human race is fast approaching very clear limitations because they they may be well-educated and highly mobile. If things turn sour in the mother country, there's always a lucrative job offer waiting in some developing country. It's hard to get upset about declining resources when one is first in line to use what's still available.


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