Tue. May 24th, 2022

The author is a Professor of Finance at Peking University and a Senior Fellow at the Carnegie-Tsinghua Center for Global Policy

China last Friday reported the largest monthly trade surplus in its history. At $ 94.5 billion, it was the latest in nearly two years of record monthly surpluses even as Chinese consumption stagnated.

But while it may seem mere luck to China that its rising trade surpluses came just in time to balance stagnant consumption, it misunderstands the relationship between domestic consumption and trade. Contrary to many people’s beliefs, the country’s growing trade surplus is not a symptom of manufacturing prowess, nor is it evidence of a culture of frugality. Rather, it is a result of the great difficulties China has had in rebalancing its domestic economy and keeping its rising debt in check.

This is precisely because the conditions that explain stagnant domestic consumption also explain the rapid growth in Chinese exports relative to imports. This is incidentally true, not only of China, but of all countries that have persistent trade surpluses. Whether it is high-wage economies, such as Germany and Japan, or lower-wage economies, such as China and Vietnam, their international competitiveness is mainly based on the low wages their workers receive relative to productivity.

But it is precisely the low wages relative to productivity that limit the ability of their households to consume a significant portion of what they produce. In all these countries, households receive a lower share of the gross domestic product than among their trading partners, and therefore they also consume a lower share.

This is not always a bad thing. In the 1980s, the suppression of consumption allowed Beijing to direct large amounts of newly produced resources into much-needed investments. The result was rapid, sustainable growth as China built the infrastructure and manufacturing capacity it desperately needed.

However, that changed about 10-15 years ago, after China began investing as much in real estate development and infrastructure as it could absorb productively. This is when the debt used to finance investments rose faster than the economic benefits of that investment, which ultimately left the country with below the fastest growing debt burden in history.

Beijing has known the solution to this problem for years. To control the rising debt and the non-productive investment it finances, it had to rebalance the distribution of income with enough that growth would be driven primarily by rising consumption, as is the case in most other economies. But it requires a politically difficult restructuring of the economy in which a larger share of total revenue – as much as 10-15 percentage points of GDP – is transferred from local governments to Chinese households.

That’s why the trade surplus matters. In recent years, Beijing has sought to slow debt growth by reducing non-productive investment in real estate and infrastructure. This year, as we have seen with Evergrande, Beijing came down hard on the real estate sector.

If an increasing share of China’s total revenue went to ordinary households, the resulting reduction in investment by real estate developers could have been offset by an increase in consumption. But that’s not what happened. In the last two years, partly due to the Covid pandemic, wage growth has actually lagged behind GDP growth. The share that Chinese workers received from what they produce has decreased rather than increased, and with it the share that they are able to consume.

This is why China’s monthly trade surpluses have almost doubled in the last two years. Larger trade surpluses, driven by a declining domestic share of GDP, allow Chinese manufacturers to absorb weaker domestic demand without reducing output. Without these surpluses, Beijing would have had to increase debt even faster if it did not want factories to lay off workers.

Rising exports are usually a good thing, but for countries like China, rising trade surpluses are not. In this case, it is symptoms of deep and persistent imbalances in the domestic distribution of income. Until the country is able to reverse these imbalances, something that has proved very difficult politically, these huge surpluses are just the front of efforts by Beijing to control debt, and so it will continue.

It matters a lot to a world struggling with poor demand. For China to have surpluses of almost 5 percent of its GDP, the rest of the world must have a deficit equivalent to an astonishing 1 percent of its collective GDP. While Beijing is struggling with its growing debt and the difficulty of rebalancing domestic revenue, the rest of the world will have to continue to absorb China’s growing trade surpluses.

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