Is Chinese Mercantilism Good or Bad for

Poor Countries?
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CAMBRIDGE Chinas trade balance is on course for another bumper surplus this year.
Meanwhile, concern about the health of the US recovery continues to mount. Both
developments suggest that China will be under renewed pressure to nudge its currency sharply
upward. The conflict with the US may well come to a head during Congressional hearings on
the renminbi to be held in September, where many voices will urge the Obama administration
to threaten punitive measures if China does not act.

Discussion of Chinas currency focuses around the need to shrink the countrys trade surplus
and correct global macroeconomic imbalances. With a less competitive currency, many
analysts hope, China will export less and import more, making a positive contribution to the
recovery of the US and other economies.

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In all this discussion, the renminbi is viewed largely as a US-China issue, and the interests of
poor countries get scarcely a hearing, even in multilateral fora. Yet a noticeable rise in the
renminbis value may have significant implications for developing countries. Whether they
stand to gain or lose from a renminbi revaluation, however, is hotly contested.

On one side stands Arvind Subramanian, from the Peterson Institute and the Center for Global
Development. He argues that developing countries have suffered greatly from Chinas policy
of undervaluing its currency, which has made it more difficult for them to compete with
Chinese goods in world markets, retarded their industrialization, and set back their growth.

If the renminbi were to gain in value, poor countries exports would become more
competitive, and their economies would become better positioned to reap the benefits of
globalization. Hence, Subramanian argues, poor countries must make common cause with the
US and other advanced economies in pressuring China to alter its currency policies.

On the other side stand Helmut Reisen and his colleagues at the OECDs Development
Centre, who conclude that developing countries, and especially the poorest among them,
would be hurt if the renminbi were to rise sharply. Their reasoning is that currency
appreciation would almost certainly slow Chinas growth, and that anything does that must be
bad news for other poor countries as well.

They buttress their argument with empirical work that suggests that growth in developing
countries has become progressively more dependent on Chinas economic performance. They
estimate that a slowdown of one percentage point in Chinas annual growth rate would reduce
low-income countries growth rates by 0.3 percentage points almost a third as much.

To make sense of these two contrasting perspectives, we need to step back and consider the
fundamental drivers of growth. Strip away the technicalities, and the debate boils down to one
fundamental question: what is the best, most sustainable growth model for low-income
countries?

Historically, poor regions of the world have often relied on what is called a vent-for-surplus
model. This model entails exporting to other parts of the world primary products and natural
resources such as agricultural produce or minerals.

This is how Argentina grew rich in the nineteenth century, and how oil states have become
wealthy during the last 40 years. The rapid growth that many developing countries
experienced prior to the crisis was largely the result of the same model. Countries in Sub-
Saharan Africa, in particular, were propelled forward by the growing demand for their natural
resources from other countries China chief among them.

But this model suffers from two fatal weaknesses. First, it depends heavily on rapid growth in
foreign demand. When such demand falters, developing countries find themselves with
collapsing export prices, and, too often, a protracted domestic crisis. Second, it does not
stimulate economic diversification. Economies hooked on this model find themselves
excessively specialized in primary products that promise little productivity growth.

Indeed, the central challenge of economic development is not foreign demand, but domestic
structural change. The problem for poor countries is that they are not producing the right
kinds of goods. They need to restructure away from traditional primary products to higher-
productivity activities, mainly manufactures and modern services.

The real exchange rate is of paramount importance here, as it determines the competitiveness
and profitability of modern tradable activities. When developing nations are forced into
overvalued currencies, entrepreneurship and investment in those activities are depressed.

From this perspective, Chinas 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.

Lest we blame China too much, though, we should remember that there is little that prevents
developing countries from replicating the essentials of the Chinese model. They, too, could
have used their exchange rates more actively in order to stimulate industrialization and
growth. True, all countries in the world cannot simultaneously undervalue their currencies.
But poor nations could have shifted the burden onto rich countries, where, economic logic
suggests, it ought to be placed.
Instead, too many developing countries have allowed their currencies to become overvalued,
relying on booming commodity demand or financial inflows. And they have made little
systematic use of explicit industrial policies that could act as a substitute for undervaluation.

Given this, perhaps we should not hold China responsible for taking care of its own economic
interests, even if it has aggravated in the process the costs of other countries misguided
currency policies.

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