Friday, 2 December 2011

The Renminbi and Poor-Country Growth

China’s current account surplus over the recent two decades can be well explained by structural savings determinants.  Song, Storesletten and Zilibotti (2010)[1] have have stressed the role of rising corporate savings due to reallocation within the manufacturing sector from low- to high-productivity companies. Wei (2010)[2] explains rising China’s household savings with gender-imbalances. Still, large appreciations do impact the current account and - in developing countries -  do depress growth (Keppler, Reisen, Schularick and Turkisch, 2011)[3], as evidenced by data over the past fifty years.

Renminbi effective exchange rate index, 2008 - 2011
Source: BIS

The graph documents the appreciation of the renminbi (RMB) in nominal (red dashed line) and real (blue solid line) effective exchange rate (REER) based on broad BIS effective exchange rate indices, comprising trade weights with 58 economies. Mostly due to positive inflation differentials with its trade partners, China’s currency has appreciated by 18 percent compared with its trade partners[4]  since 2008.  

What does the recent RMB appreciation mean for low- and middle-income countries countries? That, indeed, is a question rarely raised, and opinions rather than hard evidence have been provided. Subramanian (2010)[5] seems to envisage a static world economy where “higher tradable goods production in China results in lower traded goods production elsewhere in the developing world, entailing a growth cost for these countries”. While China’s undervaluation has boosted its long-run growth rate (by more than 2 per cent, according to Rodrik, 2008[6]) by allowing greater output of tradable goods, Subramanian juxtaposes the other poor countries as “emerging market victims” of China’s exchange rate policy. Rodrik (2010)[7] agrees: “China’s currency policies not only undercut the competitiveness of African and other poor regions’ industries; they also undermine those regions’ fundamental growth engines. What poor nations get out of Chinese mercantilism is, at best, temporary growth of the wrong kind.” Rodrik is concerned that countries in Sub-Saharan Africa, in particular, have been propelled forward merely by the growing demand for their natural resources from other countries – especially from China.

So is the recent RMB appreciation good news for other poor countries?   Now, with the RMB having gained in real effective terms by more than a quarter since mid 2005 (see graph), poor countries’ exports surely have become more competitive, which should speed growth if Subramanian and Rodrik are correct. “The Renminbi and Poor-country Growth”, a new publication[8], suggests the contrary – provided RMB appreciation will produce a slowdown in China’s growth as predicted by Kappler et al (2011) for the group of developing countries.

To analyse the impact of China’s growth (slowdown) on a broad group of poor  countries, the paper looks  at the relationship between China’s growth rate and those of 115 developing and emerging countries for the period between 1990 and 2009. The analysis distinguishes net oil and raw material exporters from net importers, and low- income from middle-income developing countries. The impact of China’s growth on these four country groups can be quantified using a fixed-effects model, which allows to analyse a cross-section of developing countries over time.

Some results of the series of panel regressions  deserve to be noted, including by politicians:

1.       The impact of China’s growth on both the low- and middle-income countries has grown significantly in the 2000s. The results show that a one per cent change in China’s growth rates will result in a change around 0.34 per cent in the same direction in the low-income countries. As for the middle-income countries, the corresponding growth association is 0.66 per cent.
2.       Similar to Levy Yeyati (2009)[9], the impact of OECD countries is found to have significantly decreased over the same period for the low-income countries with a coefficient close to zero (0.03 per cent to be precise). As for the middle-income countries though, there has not been a significant decrease in the impact of OECD growth in the 2000s.
3.       The results of the export-based analysis show that the China impact is not limited to exporters of oil and raw materials. On the contrary, the increasing growth association with China in the 2000s is a robust finding that pertains to non-oil developing countries. Consequently, China’s strengthening growth engine role for poor countries is not merely driven by the its demand for oil and other raw materials. This finding is supported by growing evidence of the remarkable rise of manufactured exports from Sub-Saharan Africa to China and other emerging countries and by foreign direct investment from emerging countries that has reached Africa’s non-oil countries (in proportion to their respective GDP) not less than it reached oil and raw material producers; by contrast, OECD-country imports from Africa remains as biased towards oil as the FDI flows from OECD to Africa.[10].

The trade patterns of growing countries tend to be quite dynamic. If factors are being accumulated at differential rates, the composition of output can change quite quickly. Rybczynski effects suggest that China’s skill-intensive output is rising disproportionately. Unlike low-income countries that do not compete directly with China anymore, advanced and middle-income manufacturing exporters compete directly with China in manufacturing exports. As a result, they are likely to gain the most from RMB revaluation. China’s average export prices (unit values) place substantial downward pressure on these countries’ prices; by contrast, there is little and melting evidence for price competition between China and low-income countries[11]. Table 3 summarises the discussion and the potential growth impact of renminbi for low- and middle-income countries[12].

The potential growth impact of renminbi appreciation on developing countries
Impact channel
Growth effect
Price effect
Total effect
Country group

Low-income, oil & non-oil
Middle-income, oil & non-oil
Source: See discussion in text based on own estimates; Rodrik (2008); Levy-Yeyati (2009) and Fu et al. (2010).

Considering the evidence on the lack of export competition between China and poor countries and their dependence on China’s growth for their own growth performance, the growth impact for poor countries of a sudden and perhaps ‘excessive’ renminbi appreciation would be likely to be negative. The growth impact on middle-income countries would be ambiguous, as the negative engine effect of a slowdown in China’s growth might be compensated through increased competitiveness that resource-poor middle-income countries would enjoy as a result of an appreciated renminbi. By extension, therefore, not just China but likewise other poor countries – in particular those which now have a low index of export similarity with China – have a vested interest in China’s exchange rate to remain conducive to growth.

If China continues to converge towards advance-country per capita income levels, either higher real wages or real appreciation of the Chinese currency will continue to speed China’s structural upgrading. This would further soften the price pressures on low-skilled goods and on low-income countries. At the same time, technological upgrading in China would move China’s price impact from the middle-income countries to the high-income economies. Prosperity in China and other large emerging countries will improve export opportunities for the remaining developing countries, which can lead to accelerating global growth, supported by a demographic transition with a drop in fertility and young age dependence[13]. China’s initial opening may have hurt some developing countries in the 1990s, but its sustained growth improves the long-term prospects of low-income developing countries.

[1] Song, Z., Storesletten, K., and F. Zilibotti (2010), The “Real” Causes of China’s Trade Surplus,, 2 May.
[2] Wei, S-J (2010), The Mystery of China’s Savings,, 6 February.
[3] Kappler, M, H. Reisen, M. Schularick and E. Turkisch (2011), The Macroeconomic Effects of Large Currency Appreciations, OECD Development Centre Working Papers No. 296.
[4] In an earlier VoxEu article, I had estimated the renminbi to be undervalued by 12 percent relative to the Balassa-Samuelson benchmark that allows for differences in per capita incomes;  Reisen, H. (2009), How to assess the renminbi’s undervaluation,, 17 December.
[5] Subramanian, A. (2010), It is the poor who pay for the weak renminbi, , Financial Times, 3 February.
[6] Rodrik, D (2008), “The Real Exchange Rate and Economic Growth”, Brookings Papers on Economic Activity, Vol. 2.
[8] Garroway, C., Hacibedel, B., Reisen, H. and E. Turkisch (2011), “The Renminbi and Poor-country Growth”, The World Economy, Vol 34, Issue 11, November
[9] Levy Yeyati, E. (2009), On emerging markets decoupling and growth convergence,, 7 November.
[10] For detailed evidence,  see the African Economic Outlook 2011,
[11] Fu, X, Kaplinsky, R., and J. Zhang (2010), “The Impact of China’s Exports on Global Manufactures Prices”, Universty of Oxford. SLPTMD Working Paper 32.
[12] This is obviously a very broad summary of likely effects which does not do justice to country situations. For example, the net growth effect for resource-rich middle-income countries is likely to resemble the negative impact that a real effective appreciation of the renminbi would have on lowincome countries. However, the empirical evidence presented in the literature reviewed does not allow further country disaggregation.
[13] See Chamon and M., Kremer, M. (2009),  Economic transformation, population growth and the long-run world income distribution, Journal of International Economics, Vol79.1., September.

Wednesday, 16 November 2011

“Growing Like China” - Less State-Led Development than Transition

A perennial issue among development economists is whether and how China’s growth experience can be emulated by other poor countries. China’s success is referred to by many shades of ideology, from pure market to statist. My reading on the subject makes me question to what extent China is unique or what elements of its growth story can serve as a model to others. To be sure, Justin Lin – the Chinese Chief Economist of the World Bank - has studied the very issue since long.
 I have come, admittedly quite late, across a great paper in the American Economic Review (Feb 2011) that models and calibrates China’s outstanding and stable growth performance which started in 1992, when Deng Xiaoping opted for an acceleration of reforms: “Growing Like China”, by Zheng Song, Kjetil Storesletten, and Fabrizio Zilibotti. The paper presents a growth model consistent with China’s output growth, sustained returns on capital, reallocation within the manufacturing sector, and its large trade surplus.
The model is populated by two kind of firms – private and state-owned. Private firms use more productive technologies, but due to financial imperfections they must finance investments through internal savings. State-owned firms have low productivity but survive because of better access to credit markets. High-productivity firms outgrow low-productivity firms if entrepreneurs have sufficiently high savings. The downsizing of financially integrated firms forces domestic savings to be invested abroad, generating a foreign surplus. A calibrated version of the theory accounts quantitatively for China’s economic transition. Workers have shifted in increasing numbers from state-owned enterprises to private firms. In the chart, the solid blue line represents the results from the model over a long time period; the dashed red line shows a very similar rising trend in actual data from 1998 to 2007 in the share of total employment in private firms.

So China is, since 1992, first and foremost about the transition to an economy with a shrinking share of state-owned enterprises and a strong rise in the share of private domestic firms in total employment (and in GDP); in 2007, that share hovered around more than 60 percent while it is now approaching 80 percent.

While these trends must be puzzling to advocates of ‘state-led development’, neoclassic economists will find it impossible to explain within their (closed-economy) neoclassical growth models that return to capital stayed constant in China over the growth period, despite heavy capital accumulation. And the high return to capital is difficult to reconcile with the observation that it did not lead to net capital inflows but went along rising foreign exchange reserves due to big foreign surpluses. No, these surpluses are NOT explained by an artificially undervalued renminbi – another reflex response typical of mainstream economists – but  are due to disparities among China’s firms in their relative productivity and access to credit.

Source: Growing Like China, AER Feb 2011

As state-led firms with privileged access to (development bank) finance are crowded out of the market by the more productive private firms, a larger proportion of domestic savings is invested in foreign bonds/assets (or in real estate in reality!) by the state-led firms as long as the private firms do not get easy access to that bank finance. The recent monetary tightening has effectively increased that disparity between privileged state firms and private firms; the latter need to pay skyrocketing curb market rates on informal credit markets (a repeat of Korea and Chinese Taipei earlier on).

Monday, 7 November 2011

Ways Round the Middle Income Trap

China's authorities are deeply worried at this stage about future growth prospects, labour-absorbing growth being the main legitimiser of the party's ongoing rule. The specific concern is that its rapid growth will soon slow down considerably and be trapped at middle income levels, as many in Arab, Latin American countries before, but also recently in Malaysia or Thailand. So I recently went the long way to the subtropical island of Hainan to give a keynote speech and debate at a policy panel  at the conference "Surmounting Middle Income Trap - China in the Next Decade", International Forum on China Reform, organised by China Institute for Economic Reform (CIRD), with GIZ and UNDP participation, inter alia.

 I learned that Chinese experts see the current state of China's economy and development very critically (indeed, in stark contrast to most foreign conference participants).  Capital waste and overinvestment, speculation of policy bank funds on the real estate market rather than on innovation, high curb rates for nonpriviledged borrowers such as SMEs, or the distribution scramble for land use and other resources were often cited examples of structural failures that were adding to the current cyclical headwinds. China's growth has so far been fueled by capital accumulation and dual-sector shifts, but this could end eventually as the country's saving rates is 1/2 of its income and as the young-age cohorts in the rural hinterland – the potential migrants to the urban high-productivity sectors - run thin, not least as a result of the one-child policy.

Prominent economists are fanning China’s growth concerns. The new buzz word is “Middle Income Trap”.   Eichengreen and co-authors[i], for example, produce evidence to suggest that rapidly growing economies slow down significantly, in the sense that the growth rate downshifts by at least 2 percentage points, when their per capita incomes reach around $17,000 US in year-2005 constant international prices, a level that China should achieve by or soon after 2015. But a look at the data would seem to suggest that escaping the “middle income trap” has not been a rare event recently.

Transitions from Middle-Income to Advanced-Country Levels
Growth Phase
in Transition
at Start
at End
in Years
Growth p.a.
in Transition

Czech Republic



Hong Kong SAR





New Zealand








Taipei, China


I have produced a table for all advanced countries (in the IMF WEO 2011 definition) that from 1980 went from middle income to advanced country status. The transition threshold is defined as in Foxley and Sossdorf[ii] for countries with a per capita income in terms of PPP (purchasing power parity)  below $15,000 from 1980 as reaching a per capita income of the last country awarded that category by the International Monetary Fund (IMF)—Portugal, with a per capita income of $23,000 in 2008.

The table has sixteen economies that found ways around the middle income trap over the last thirty years, none of them in Latin America or the Midle East. The majority of the countries belong to Europe and/or are (now) OECD members, so they are members of at least one of the two (Beta-)Convergence Clubs that the world has (cough, had?). While - except during the 2000s - poorer  countries did not grow faster on a global scale, they did when they belonged to either of the two convergence clubs. Some Asian countries did not need to be club member to make the transition, however.
The transition period and the transition speed has varied considerably among the sixteen countries, from five years to eleven, and from 3.6% to 9.5% per annum. The IMF estimates China to enter the transition threshold of ca $15,000_PPP/capita by 2015 or 2016. Despite the need to switch gradually to a new growth model, China has enough momentum to grow further, albeit at lower rates. My table suggests that China will enter the group of advanced countries as defined by the IMF between 2020 and 2027.

[ii] Foxley and Sossdorf (2011), “Making the Transition: From Middle-Income to Advanced Economies”, The Carnegie Papers.