A BIG export-oriented economy is booming but its trading partners are livid. Year after year, they point out, it runs large current-account surpluses. The country regards itself as an export powerhouse whose goods are prized abroad. Others castigate it for mercantilism. Some argue that it subsidises its exports unfairly by giving exporters credit at cheap rates and by keeping its currency artificially undervalued. Pressure builds on the country to revalue its currency and boost domestic consumption, which makes up an unusually small share of its GDP.
Today this description makes you think of China, or perhaps Germany. But as research published in the IMF’s latest “World Economic Outlook” makes clear, plenty of other countries have been in a similar situation: Japan in the early 1970s, West Germany in the late 1960s, and South Korea, Japan or Vietnam in the years leading up to 1988. The Chinese current-account surplus in 2008 was 21% of the combined total for surplus countries. Germany in 1967 and Japan in 1971 both had a fifth of the world’s total surplus, too. Today’s surplus countries can take some comfort from the fact that they are not historical anomalies.
That these surplus economies of the past resemble China or Germany today is not the only reason they are interesting. It turns out that they also did much as these countries are now being exhorted to do, altering their economic policies to reverse their persistent surpluses. Some relied in the first instance on allowing their exchange rate to appreciate, as America would like China to do (though fiscal or monetary adjustments often followed). Others turned to fiscal and monetary stimulus to boost domestic demand, a policy Germany is now being urged to follow by some of its euro-zone peers. Yet others used labour-market or financial-sector reform to boost domestic demand. By poring over countries’ current-account statistics and changes in economic policy, IMF economists have identified 28 instances of such “policy-induced surplus reversals” over the past half-century. They then examined those episodes for clues about the possible impact of similar moves by today’s surplus countries.
Less may be more
Changing course certainly worked as far as restoring external balance was concerned. On average, the surplus narrowed by 5.1 percentage points of GDP. The contribution of net exports to GDP growth fell by 1.6 percentage points, mainly because imports increased sharply whereas exports were on average unchanged. Oddly enough, however, shifting out of surplus did not affect growth appreciably in either direction (see chart). The IMF economists reckon that it was a few tenths of a percentage point higher in the three years after countries started tackling their surpluses than in the three preceding years, but this difference is so small that it is well within the statistical margin of error.
That is because increased contributions to growth from private consumption and investment, which boosted expansion by an additional 1.0 and 0.7 percentage points respectively, were enough to offset the declining contribution of net exports. Economic growth simply came from different sources. Foreign demand was replaced by local demand. Likewise, fewer workers were employed in the parts of the economy that produced goods for sale abroad, but just as many more found work making things that were consumed within the country’s borders. On average, there was “full rebalancing”.
All this might suggest that China has little to fear from a revaluation of the yuan. But that conclusion is slightly tempered by another of the fund’s findings. Countries that engineered a reversal primarily by revaluing their currency fared differently from those that relied on fiscal or monetary stimulus. Growth declined in the former case and rose slightly in the latter. Once again, neither effect was large enough that it lay outside the margin of error. But the economists find that, all else being equal, a 10% appreciation in the exchange rate reduces GDP growth by around one percentage point. Given actual exchange-rate movements, the IMF reckons that if the only thing surplus countries had done was to let their currencies rise, then growth might have ended up declining by between two and four percentage points.
Countries do not, however, tend to rely on only one tool to get rid of their surpluses. That the declines were much smaller on average was because the effects of the appreciation were offset by demand-boosting fiscal, monetary and structural policies. For instance, South Korea and Taiwan in the 1980s, which are two of the surplus countries of the past that look most like China today, also significantly liberalised their domestic financial sectors when they let their currencies rise. In some countries that had exchange-rate appreciations exports moved up the value chain: this also helped. These countries did not so much export less after they revalued as export different, more expensive things. But they saved less and consumed and imported more, contributing more to global demand.
A separate analysis, published as part of the Asian Development Bank’s (ADB) latest “Asian Development Outlook”, also indicates that Asia’s exports may be less sensitive to exchange-rate movements than a study of history may suggest. This is because many production processes are now separated into stages that are carried out in different countries. This means that a greater share of Asian trade—32% of exports from Asia’s developing economies in 2007, up from 13% in 1992—is now made up of trade in parts and components. The ADB’s economists find that trade in parts is much less sensitive to changes in the real exchange rate than trade in finished products. If China revalues, it may need to worry even less about a collapse in its exports than past experience implies.
There are, in any case, other benefits to reducing current-account surpluses than just satisfying miffed trading partners. In many cases of past rebalancing, an undervalued exchange rate also led to excessive growth in money supply, making it harder to tame inflation. The desire to regain control over monetary policy was one of the reasons South Korea let the won rise in 1989 and Taiwan allowed its currency to appreciate in 1988. If China revalues the yuan in 2010 it may be for similar reasons.
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