Why the Renminbi should not rise to address the imbalances

Recently I read an article written by Prof. Martin Feldstein in Financial Times on the need for Renminbi to rise to address the global imbalances (published on 29 October 2009). It is an interesting article, but I don't think it is the sustainable way to address the imbalances.

http://www.ft.com/cms/s/0/fd4b4852-c4db-11de-8d54-00144feab49a.html

The article discussed about one of the possible ways to address the global imbalances based on the external factors, but ignored the internal factors within China. The suggestion is just a short-term measure to address the global problem. Looking at the internal social structure within China, appreciating Renminbi could have a detrimental effect to the global economy.

The root cause of the imbalance actually lies in the relatively low domestic consumption within China, whereas the US and Europe produce high domestic consumption. If we analyse the article properly, the suggested measure (i.e. Renminbi appreciation) is also addressing this issue, but only through the monetary policy. It assumes that if the Renminbi appreciates, Chinese will be more likely to spend for foreign goods. This might be true in short term, but might not work well within the Chinese society, as the fundamental issues in China are not addressed.

Appreciating Renminbi would decrease the Chinese export. Looking at the fact that Chinese economy is heavily export-driven, this could affect the Chinese companies, which expand at a much faster pace than the social infrastructure reform in recent years. Chinese companies are generally not prepared for such a sudden change in monetary policy and could significantly affect their general business. As a result, the import for high technology goods from US or Europe will also reduces, which provides no contribution to reduce the global imbalances.

The more sustainable and critical issues that Chinese government should address currently should be: (a) creating a better social safety nets (e.g. social security system, healthcare system), (b) increasing the household income of the Chinese working class. Due to the inadequate social safety net, Chinese are generally reluctant to spend knowing that their future could be uncertain. The social safety net reduces the risk and uncertainties, and hence increase the willingness to spend. If we look at the European countries with well-established social safety net, the residents generally spend more because they know that their future is secured.

Secondly, Chinese working class generally has low wages compared to their counterparts in US or Europe, although Chinese companies may be achieving high revenue. The employment regulation is relatively flexible (i.e. companies are less restricted to lay off a worker in China than in US or Europe). Appreciating Renminbi may not shift the demand from manufacturing to services. This can be seen in the European labour market, where the cost is higher and the employment regulation is strict. A manufacturing company would hire a service company (e.g. outsourcing, consulting company) only if the benefit could be justified against the cost. If the labour cost is high and it is inflexible to lay off worker, the manufacturing company may consider hiring someone externally from the service company because they are aware of the higher cost to keep a worker for a longer period. Service industry in US or Europe hence takes advantage of this gap and nourishes.

Increasing the general wages of the Chinese working class and addressing the employment regulation provide far better effect than Renminbi appreciation. Firstly, Chinese working class will have more household income to be poured into the economy to address the global imbalances. Secondly, it helps shift the demand in China from manufacturing to services, encouraging a knowledge driven economy. Thirdly, it encourages Chinese companies to focus on the efficiency of their operations.

On the third point, I would like to elaborate more. On one hand, the focus on operational efficiency could compensate for the impact of labour wage increase on the company profit margin. A more efficient company could withstand the global competition, prepare them for the global arena and encourage Chinese industrial spending in the international economy. On the other hand, as improving operational efficiency also reduces the waste in energy consumption, it could also indirectly decrease the negative impact on the environment, which is critical for the world future growth.

In conclusion, appreciating Renminbi would only address the short-term symptom of the global imbalances, would not be sustainable and could be detrimental to Chinese economy (thus global economy). Fundamental issues concerning the Chinese society should be addressed first. The way forward should lie in the improvement in social safety nets, improvement in the working class income and improvement in the company operational efficiency.