| The Making of China’s Trade Deficit BEIJING – China registered a monthly trade deficit of $7.2 billion in March 2010 , its first since April 2004. And yet , at around the same time , the United States Congress issued its loudest call ever to classify China as an exchange-rate manipulator , accusing Chinese leaders of maintaining the renminbi’s peg to the dollar in order to guarantee a permanent bilateral trade surplus . China’s March trade deficit indicates , first of all , that it is incorrect to claim that Chinese economic growth depends mainly on exports . Exports are an important part of the Chinese economy , and any global market fluctuation or external shock will certainly have an impact on overall growth . But , like any other large economy , China’s economy is driven by domestic consumption and investment . Indeed , China’s exports fell by 16 % year on year in 2009 , owing to the global financial crisis and recession . Nevertheless , annual GDP grew by 8.7 % , thanks to 16.9 % growth in consumption ( measured by gross sale of consumer goods ) and a 33.3 % surge in fixed-investment demand . Moreover , although China’s “ trade dependency ” is now reckoned to be 70 % of GDP , that figure is greatly distorted by the fact that Chinese exports require massive imports of materials and parts . The net value added of total Chinese foreign trade accounts for only about 15 % of GDP . Thus , net exports contributed 10.8 % to China’s overall GDP growth rate , or only about 1.1 percentage point of 9 % growth in 2008. Compare that figure to Germany , where net exports accounted for 64 % of growth in 2008. Similarly , the figure was 33 % in Japan , 28.6 % in Korea , and 20 % in the Philippines . Clearly , China is nothing special in this regard . To be sure , China’s domestic consumption is not as high as it should be , standing at 49 % of GDP in 2008 , with household consumption accounting for only 35 % . Such figures have led many observers to believe that overall domestic demand must be low , leaving China dependent on external markets for growth . But domestic demand , which determines imports , consists not only of consumption , but also of fixed-asset investment . Indeed , rapid growth in investment may translate into high import growth and trade deficits . That is exactly what is happening in China now . Some people may argue that investment growth without consumption growth will result in overcapacity and eventually lead to recession . Perhaps . But we need to remind ourselves that housing investment accounts for about 30 % of China’s total fixed investment , with much of the rest directed toward infrastructure – that is , long-term , durable public infrastructure investments – including subways , railways , highways , urban public facilities , and the national water system . Moreover , one can easily imagine that import demand would soar further if the US and the European Union lifted their bans on exports of high-tech products to China . In that case , the trade deficit recorded in March could be at least 40 % higher . The renminbi’s exchange rate , then , is really a secondary factor in China’s external account . Put another way , the global imbalance could be corrected more efficiently by addressing other , more fundamental factors . The fundamental factors underlying the US external imbalance are large fiscal deficits and low household savings , owing to excessive financial leverage . The fundamental factors on the Chinese side are high corporate and household savings , together with some distortion of resource/utility prices . Indeed , the current situation indicates that a significant adjustment in exchange rates may not be needed at all in order to redress global imbalances . If that is true , and China shouldn’t worry about the renminbi’s exchange rate , should it worry about its economy overheating ? After all , its previous trade deficits in the era of reform – such as in 1992-1996 and 2003-2004 – all occurred at times of overheating . But there are differences between now and those earlier periods . For example , when rapid investment growth in 2004 led to overheating , world markets were booming . At that time , both domestic investment and exports required immediate tightening . Today , by contrast , although domestic investment is growing very strongly , external demand has not recovered to its previous levels . The result is the March trade deficit , caused mainly by exceptionally high annual import growth ( 65 % ) coupled with relatively low export growth , which reached a nominally impressive 24 % only because of the sharp decline recorded in the base period . Such a single-factor situation is easier to deal with than the double-factor situation of 2004 , and because the high investment demand has been mainly stimulus-related this time , policymakers can handle it in a more timely fashion if they perceive a problem . That said , the ratio of capital formation does require careful monitoring . The last time China saw such high growth in domestic investment , the savings rate was not as high as it is now . The problem currently is that a trade deficit has emerged at a time when the national saving rate is as high as 51 % . That means that investment is extremely high – and that , despite the high share of infrastructure investment , there is an urgent need to manage the potential risks . |