May, 2023
China’s economic boom has been impressive but there have been some grave policy errors. Amongst them, a more prominent one is allowing, and to a large extent forcing, persistent large trade surpluses. I will later try and link this to India, so stay tuned.
A trade surplus is when exports exceed imports. Seems benign, doesn’t it? But as
@michaelxpettis explains, China’s burgeoning trade surplus is not a symptom of manufacturing prowess but instead a consequence of the great difficulty it has had in rebalancing its domestic economy.
Rebalancing the economy in a way where domestic consumption starts contributing more to GDP and reducing debt. Consumption as a % of GDP has been historically low in China because the government has actively suppressed it by keeping wages low and fixing the exchange rate.
However, suppressing consumption isn’t necessarily bad, and it essentially is what allowed China to build manufacturing and infrastructure capacity in the 80s by directing huge new gains as investments into these areas.
But wage growth hasn’t kept pace with GDP growth, resulting in stagnant-ish consumption as a % of GDP. With stagnant consumption rates comes lower demand for goods, including imports, resulting in consistent trade surpluses. This is the link between consumption and surpluses.
The Chinese saw this in the mid 2000s but knew rebalancing consumption required deeper social reforms and compromises they weren’t willing to make - things like wage laws and safety nets. The easier short term fix was focusing on increasing investment as a % of GDP.
They started investing heavily in property investment and infrastructure on the heels of debt but there’s only so much an economy can productively absorb. The incremental investments in these areas were hardly yielding anything, but debt was soaring. Enter things like Evergrande.
China is faced with this problem now - low consumption, of which trade surpluses are an after effect, and high debt. It can’t effectively stimulate consumption, and it will need to reign in on debt. This is where China let trade surpluses run amok because they have no fix.
In April, imports fell 7.9% YoY and exports rose 8.5 % YoY. The trade surplus was $90B in April, a record for April. But a country can only run a trade surplus until and unless there are other countries willing to run a deficit. This is where things are getting messy for China.
Major economies such as the US who funded China’s surpluses by running large deficits themselves are changing course with their own industrial policies. By the way, this phenomenon is why the US dollar is the de facto currency of trade, but more on that later.
Emerging economies such as India who also contribute significantly to China’s surplus are rapidly working on reducing their deficits. Moreover, interest rates will ultimately slow global demand. For China to run surpluses of nearly 5% of its GDP, the rest of the world must run deficits equal to an astonishing 1% of its collective GDP. This is not sustainable and will eventually reduce China’s trade surplus. At that point, China will be faced with low consumption, low investment given the need to reduce debt and low surpluses.