[MUSIC] How has international trade affected China's economic development? In this presentation, I want to first talk about the controversy over China's trade practices. Has China tried to unfairly benefit from trade by supporting its exporters and manipulating its exchange rate? Next I want to talk about different ways in which trade contributes to development, first, through comparative advantage. How does comparative advantage result in greater efficiency of production in China? And, who are the winners and losers from trade? Next I want to talk about how trade influences productivity growth in the future. So talk about some of the dynamic impacts of trade on growth. And finally I want to talk about how China can maintain it's international competitiveness as wage costs increase and factor prices change. And what is the government role in this process? So is China manipulating an exchange rate? The issue has become quite prominent because China has had fairly substantial trade surpluses with the United States. And this has been blamed in the US for the loss of US manufacturing jobs. And some recent research has suggested that regions in the US that import an increasing amount of Chinese goods often see more problems for workers in terms of higher unemployment, lower wages, the need for more government assistance. The accusation has been that the Chinese currency is undervalued. Meaning, that if the right exchange rate was six RMB per dollar, China has set it at eight RMB per dollar, which makes Chinese goods cheaper when they're sold in the US. And this is a price that US producers have difficulty competing with. Now there's also accusations that for certain goods in certain periods, China has dumped their excess production on to the world market in the US and other countries. So they just charge very low prices. Even below the cost of production. And this, of course, is not something that other countries can compete with. Especially in areas where China has state firms that are producing kind of at capacities which are really above what the market probably should dictate. Now coming back to the exchange rate issue, if we look at the US dollar RMB exchange rate over time, we can see that it was held fixed at a bit over eight RMB per dollar since 2000. Earlier it had been lower in the 1990s and then, starting in 2006, that has gradually appreciated. So, to the benefit of US producers, the RMB has actually become stronger over time in nominal terms and also in real terms if we account for the difference in inflation in the two countries. Now compare that to the Euro where actually there has been a devaluation of the Chinese currency in the 2000s. But then as for the dollar since 2010, since the financial crisis, we've seen a gradual appreciation of the Chinese currency and the Japanese exchange rate has been relatively steady. If we look at the patterns in China's bilateral trade balance with different parts of the world measured as a share of China's GDP, we can certainly find evidence, as seen in the green line that China's trade surplus with the United States increased during the 1990s and early 2000s. And then, started to fall following the great financial crisis. A similar pattern holds for the rest of the world, not including Asia. But for Asia, the blue line, we see a very different pattern. We see that in the late 90s and early 2000s, China increasingly went into deficit with other Asian countries, somewhat offsetting the pattern with the US and other parts of the world. And then, this also started to reverse, so, China went increasingly into surplus in the most recent period, even with Asia as well. So, that in the most recent period, we see that China is now in trade surplus with all different regions of the world, which is contrast to earlier experience. Now China has made some strong arguments for why it is not manipulating it's currency. So the first is a matter of strategy. China's goal is not to manipulate the exchange rate. Its goal is to keep the currency exchange rate relatively stable to the dollar to provide a stable production environment for Chinese producers, and to commit to a non-inflationary monetary policy. In fact, if you look at what China did during the Asian financial crisis, when many other currencies in Asia were being depreciated as money was flowing out due to the crisis. There was a lot of pressure for China at the time to also devalue it's currency to stay competitive with these other Asian countries but it didn't. It resisted that temptation, the US and other developed countries were encouraging China not to devalue its currency as well because that would just make the global economic shock of the Asian financial crisis even worse. And so China resisted and kept the yuan stronger, so this showed that it wasn't trying to take every opportunity to devalue its currency. Also you can see that China has kept very low tariffs on imports and the amount of imports is also increased quite dramatically in China. So it's clearly not being protectionist. And this is even at the prevailing exchange rates. If China was trying to devalue the exchange rate then this would actually hurt Chinese imports. But we still see a big increase in Chinese imports. And of course another argument to explain surplus is from China and the US is that this simply reflects a movement of production from Hong Kong, Taiwan, other Asian countries to China through foreign invested firms. So the surplus that used to be coming from those countries have just been shifted over to China but doesn't really represent a global change in the trade going to China. And of course, if the US was not importing these goods from China, then chances are they might be importing those goods from some other country that has comparative advantage in the same types of goods. It's not as if US manufacturers would be the ones replacing the kind of lost Chinese exports if you tried to reduce those imports to the US. China has also argued kind of related to the first point that frequent exchange rate adjustments really create speculation. People think the Central Bank is going to alter the exchange rate, then they're going to start to speculate and move money in and out of China based on that speculation. Okay, now in addition to these issues of Chinese openness to foreign trade, there's also the issue about foreign openness to Chinese trade. And the Chinese also sometimes complain that there are non-tariff barriers in the US and Europe. That there are these safeguard provisions if exports from China to those countries increase too fast, those countries have the right to safeguard their markets by kind of limiting the amount of Chinese exports. And this is actually part of some of the agreements, but does hurt Chinese exporters. And finally, there's a lot of controversy over what should be the right labor and environmental standards for less developed countries like China compared to advanced countries, and how this affects international trade. Now, if we think about how trade should affect development, in theory, we know that if we do a simple analysis that consumers will certainly benefit from lower prices of imports but can be hurt by higher prices of exports. And the flip side is that producers often benefit of course from higher prices of exports but can be hurt by lower prices of imports if they are producing for the domestic market or if they rely on imported inputs. So some people will definitely be made better off and some worse off when the economy is more integrated into the global markets. But there should be some net gain to trade and these are called kind of efficiency triangles which capture the gains from trade. To see this more clearly, let's try a very simple supply and demand diagram for a good that's produced in China. So, first assume there's no trade and there's just the domestic market with a demand curve, the consumer demand and a supply curve, what produces are willing to produce at different prices. Well, we know that the intersection of these curves determines the amount of production and consumption of this good, and the market price in a world of Autarky. So, this is the PA on this figure. Now, if we introduce a world price that is higher than the domestic price, this will lead to intersection points of that price that are now at different points on both the demands curve and the supply curve. And where the world price intersects the supply curve will determine the amount of production by Chinese firms and that's going to be this QSW, the quantity supplied. But the intersection point with the demand curve is going to be determining how much Chinese consumers are going to consume of the goods, so that's going to be the quantity demanded. And now there's a difference between the quantity supplied and the quantity demanded and that difference is exactly the amount of goods that are being exported from China to the rest of the world. Well, what are the benefits and gains of trade? In a world of Autarky, using the Autarky price, Economists usually calculate consumer surpluses and producer surpluses. Where consumer surpluses are the difference between the demand, the value that consumers put on the good and the actual price they have to pay. And the production surplus is the difference in the price that firms earn and the actual cost of producing, and so those are kind of net gains to producers and consumers in the market, based on the equilibrium market price. Now if you shift to the world price, how do these triangles change? Well at that price, the consumer surplus shrinks. Because this is an exported good, a good where the world price is above the domestic Autarky price, consumers facing higher prices are going to be less well off, but producers gain quite a bit. In fact the gain to producers is even more than the loss to consumers. So the net gain to the economy is this triangle, which is the efficiency triangle that reflects the gains from trade. Now in addition to those benefits in cost of trade, we can think more dynamically about how trade outcomes today may affect the productivity of producers in the future. So there is a lot of research in economics that shows that in China and elsewhere, exporting does promote productivity as domestic producers interact in more sophisticated markets that demand higher quality goods, and also can learn things from their customers about the way to produce goods of better quality. There's also evidence that using imported inputs can increase the quality of exported products. Because it allows you to produce, again, higher quality goods being able to import higher quality materials and components. And there's also evidence that competition plays a very important role in creating incentives for innovation and thus productivity grow. So by allowing imports to come in or foreign firms to come in and compete with domestic firms, this puts a lot of pressure on Chinese firms to continue to innovate and increase productivity. And the imported capital also can directly raise productivity by increasing the possible things that domestic producers can produce competitively. Now, what about China's international competitiveness today? There's a real question about what the role of government should be when comparative advantage is changing over time. And the thing that's happening in China that's most salient here is that wages have been going up very fast. So the relative cost of labor to capital has grown and for China to adjust its production to that new comparative advantage really requires that new industries develop, and that industries are upgraded. Moreover, there have been a lot of thinking by some of the economists that sometimes it's good to support certain sectors of the economy because they provide new technology and benefits to other sectors of the economy that they don't internalize. And that could justify government support of those sectors. And so the question is, what should be the role of industrial policy? How active should the government be in China or elsewhere to help support rising sectors or sectors that put China in the right kind of direction in moving up the value chain and taking advantage of kind of the dynamics of comparative advantage? Some people like Justin Lin, the former chief economist of the World Bank argue very forcibly that the government should play a leading role, but others are very critical of this. An economist named Zhang Weiying has been publicly debating Justin on this issue, saying the government should not try to pick winners and losers. It should stay out of that game and just support the market. And this is a debate that has occurred for many years in many different country contexts, but is still a very live debate in China today.
