China and the Global Economic Recovery, Keynote Address by Anne O. Krueger, First Deputy Managing Director, IMF
January 10, 2005
China and the Global Economic Recovery
Keynote Address by Anne O. Krueger
First Deputy Managing Director
International Monetary Fund
At the American Enterprise Institute Seminar
January 10, 2005
Thank you Desmond. I'm very pleased to be here. China's role is increasingly important in the world economy, and its growing role raises questions for the country itself and the world. I am only sorry that I will not be able to stay for the whole of the discussion.
Before discussing one of the brighter aspects of the Asian economies, I want to say something about the recent tragic events in Asia. The scale of the disaster that struck Indonesia, Sri Lanka, India, Thailand, and several other countries, is difficult for us to comprehend. The number of those who lost their lives is shocking. Those who survived but who have lost loved ones, most or all of their possessions and their livelihoods are being counted in the millions. The extent of the destruction that the tsunami left in its wake is incomprehensible.
The international response has been unprecedented, both at the official and, in a particularly striking way, at the individual level. The challenge now is to help those in the countries affected, in the first instance by providing humanitarian relief. But they will also require outside assistance as they seek to rebuild their lives. This will be a long-term effort and it will be important to maintain the current momentum.
From the first day of the crisis, the IMF has made clear its readiness to assist the affected countries in maintaining macroeconomic balance and we have already responded to requests for assistance from some countries.
Short- and medium-term relief is vital, of course. But over the longer term, maintaining the pace of global economic growth will be an important factor in helping the countries worst affected by the tsunami crisis to rebuild what has been destroyed. In this context, Asia's economic dynamism and resilience will be important. And the Chinese economy is a key part of that dynamism.
The theme of today's seminar is China's role in the global economy. I want first to sketch key aspects of China's changed role in the world economy. I then want to look ahead, and suggest some of the issues that I think will confront China and its global economic partners in the next few years: whether China can achieve the much-debated soft landing; the extent to which the Chinese authorities should modify current exchange rate policy; China's role in world trade, especially in the wake of the expiration of the Multi-Fiber Agreement; and the need for structural economic reforms.
Let me start by putting our discussion in context. We are all familiar with the rapid pace of Chinese economic growth in recent years. It has been spectacular: real GDP grew by 9.7 percent a year on average from 1990 to 2003. And as of now, the pace of growth shows little sign of abating—I will return to the issue of the so-called soft landing later. And this rapid growth has had a significant impact, both within China and around the world.
We are all aware of the extent of the changes that have taken place in recent years—both in China itself and in China's impact on the rest of the world.
Rapid growth has had a dramatic impact on the lives of millions of Chinese citizens. Tens of millions of people have escaped poverty in China in the past decade or more.
Yet it is important to remember that this was an economy starting from a very low base. Per capita incomes remain relatively low by international standards, even after more than doubling in nominal terms and almost doubling in PPP terms in the past decade or so. The actual numbers (less than $1,000 a head on the World Bank Atlas method and about $4,000 on a ppp basis) underline the point that China is still markedly poorer than many of its neighbors, and dramatically poorer than Hong Kong. It is classed by the World Bank as a lower middle income country.
This is an economy with much catching up to do. Continued rapid growth will be essential if poverty rates in China are to be reduced further. The challenge for the Chinese authorities is to ensure that growth rates are sustainable over a long period.
Yet even now, China's sheer size, coupled with its rapid growth, makes it a major player in the global economy. In nominal terms, China currently accounts for almost 4 percent of world output—not much more than in 2000, incidentally—more than one and a half times bigger than Canada. Measured on a ppp basis, China's share of global output has risen from close to 11 percent in 2000 to a shade over 13 percent in 2004. On that basis it dwarfs Canada—and France, Italy and the UK; and is almost twice as big as Japan. Indeed, on the ppp basis it is the third largest economy if we count the euro area as a single economy.
China's share of world trade has grown more rapidly. In 1990, its share of world exports was 1.9 percent; that grew to 4 percent in 2000 and 6 percent by 2003. China's share of world imports grew from 1.5 percent in 1990, to 3.6 percent in 2000 and 5.7 percent by 2003.
China and the global upturn
Rapid growth in China has clearly been an important factor in underpinning the current global upturn. The global recession of 2001-02 was relatively modest and short-lived by historical standards; and the global recovery has been strong. The outlook remains relatively benign in spite of continuing geo-political tensions and a significant rise in oil prices.
Of course, the U.S. economy continues to be an important engine of global growth. But China's contribution to global and particularly Asian growth in recent years has been increasingly significant: in part because of the two factors I have already mentioned: the exceptionally strong pace of growth; and the growing importance of China in the world economy.
It was also significant, though, because of weaknesses in Europe and Japan. As an engine of regional growth, it is clear that China has overtaken Japan. With Japan barely growing in recent years, the buoyancy of the Chinese economy has been crucial for other Asian economies. Trade between China and the Asian economies has grown rapidly. Getting on for one fifth of Korea's exports now go to China, for example and Korea now accounts for a tenth of all Chinese imports.
China is important for Japan, too: Japanese exports to China have grown much more rapidly than total Japanese exports.
For the ASEAN five countries—Malaysia, Thailand, Singapore, Indonesia, and the Philippines—China has also become an increasingly important market: in 1995, China accounted for 2.6 percent of ASEAN five exports. In 2003, that figures had risen to 6.7 percent. And the share of India's exports going to China has more than quadrupled over the same period, from less that 1 percent in 1995 to 4.5 percent in 2003.
And with growth in the euro area continuing to be sluggish at best, the impact of Chinese growth has extended well beyond Asia. Since 1995, the share of Brazilian exports going to China has more than doubled from 2.6 percent in 1995 to 6.2 percent in 2003. Argentina has seen the share of total exports going to China rise six-fold in the same eight-year period from 1.4 percent to 8.4 percent; and double since 2001.
China's commodity imports have grown rapidly. In 1990, China was not a soybean importer: last year estimates suggest its imports represented more than a third of total world imports. China's imports of cotton represented nearly a quarter of world imports in 2004, compared with about 7 percent in 1990. Chinese steel imports represented something over 10 percent or world steel imports last year, more than double the share in 1995. Oil imports are still relatively small—about 3.4 percent of total world oil imports: but in 1990 China's oil imports were only half of one percent of world oil imports.
Looking ahead: a soft landing?
So the contribution Chinese growth has made to the global economic recovery thus far is clear and positive. But few think the current pace of growth is sustainable; and the challenge for China's policymakers is to ensure a smooth adjustment to growth rates that can be sustained over the medium term without fuelling inflationary pressures, attaining a soft landing but avoiding a sharp slowdown.
Last year, as you know, the Chinese authorities took a number of steps intended to moderate the pace of growth and achieve the soft-landing: these largely took the form of administrative controls, including on bank lending, but in late October they also announced a modest rise in interest rates. So far, though, there have not been clear signs of growth moderating to a level that can safely be viewed as sustainable. In the third quarter, growth picked up in fixed investment, industrial production and retail sales. There continue to be bottlenecks, especially in the energy and transport sectors.
It is therefore too soon to be confident that the much talked-about soft landing has, as yet, been successfully engineered: the jury is still out. Experience has taught us that achieving an orderly transition to more moderate, and sustainable, growth rates is, at best difficult. It is a matter of striking the right balance between doing too little, and failing to check growth and inflationary pressures; and doing too much, with the risk that the economy judders almost to a halt.
Chinese policymakers are understandably anxious to avoid too sharp a slowdown. They are hardly alone. China's contribution to Asian and global growth has been such that policymakers—and exporters—fret about an ill-timed fall-off in demand from Asia's largest economy.
As I've said, I think it is still too soon to be sure that the landing will be a soft one. But I also think that the fears of a hard landing tend to be overdone—for two reasons.
In the first place, the impact of a hard landing on China's neighbours is likely to be less than many have suggested. In the middle of last year, the Fund conducted a simulation to assess the likely impact on the rest of Asia in the event of a sharp slowdown. The calculations suggest that a decline in the investment growth rate of 5.5 percentage points—in China, investment accounts for over 40 percent of GDP—would lead over time to a 4 percent point fall in GDP and a 10 percent fall in imports, relative to what would otherwise have been the case.
The Fund's calculations suggest that such a relatively sharp fall in Chinese imports would have a relatively small short-term impact, reducing world GDP (at PPP exchange rates) by perhaps one third of a percent in the first year; that figure might rise to three quarters of a percent after several years, with most of the longer-term impact in Asia (the bulk would be in China itself).
The impact for some Asian economies might be significant. But such a shock should be manageable given the fairly robust outlook for the region as a whole. The United States and EU are still important export markets for Asian economies. A substantial drop in the growth of exports to China would still leave countries in the region with relatively robust export growth rates provided that growth momentum in industrial markets is sustained in the U.S. and gradually improves in Europe.
Beyond Asia, a hard landing in China would have only a small impact. In spite of recent rapid growth, trade shares with China are lower for countries outside of Asia. For example, preliminary estimates for the United States and the Euro area point to a decline in GDP of less than 0.1 percentage points even over the longer term.
The second mitigating factor for the hard landing scenario is the likely response of the Chinese authorities. Thus far they have displayed great caution in trying to bring about the smooth adjustment that we all regard as optimal. This suggests very strongly that policymakers would respond promptly to any sign of a dramatic slowdown. It is difficult to imagine that any drop in growth would be sustained for more than a quarter or two without a response from the authorities. The Fund's analysis takes no account of possible policy responses.
So though a hard landing cannot yet be ruled out, the consequences may be less dramatic than most commentators have argued.
Far more important in the longer-term will be a shift away from reliance on administrative controls as an instrument of economic policy. The more rapidly the authorities are prepared to move towards market mechanisms, the greater will be the benefits for the Chinese economy and its future growth prospects. Letting markets work more freely will make it easier to achieve rapid and sustainable growth in the future and reduce the need for intervention to avoid overheating. In the longer term, there is no good substitute for price incentives that for delivering the appropriate economic signals.
The modest rise in interest rates in October was a welcome move in this direction, suggesting that the authorities are ready to rely increasingly on market signals to achieve a behavioral response. It was also a welcome sign that the authorities are serious about their commitment to restrain inflationary pressures.
The exchange rate
Using monetary policy as a counter-inflationary tool, though, is made more difficult by the current exchange rate regime. And there is a large body of opinion that argues for an immediate shift to a floating exchange rate regime. The continuing reliance on a fixed exchange rate has been the source of some tensions between China and some of its economic partners.
There is no doubt that greater exchange rate flexibility would be desirable, and would be in China's own interest. It will undoubtedly make the pursuit of an independent monetary policy much easier. The Fund has consistently argued that the Chinese authorities should move gradually towards greater flexibility; and the authorities themselves have accepted this as a broad objective, without specifying a timetable.
But it is essential that greater flexibility be accompanied by a readiness to tackle structural problems in the banking system. The problem of non-performing loans is certainly not one peculiar to Chinese banks. But in spite of moves made to reform the banking system, NPLs remain a problem: and the overinvestment that might accompany continued rapid growth in the economy as a whole could create new NPL problems in due course.
Good progress has already been made on bank restructuring and reform. But the momentum needs to be maintained if a smooth adjustment to greater exchange rate flexibility is to be achieved.
Trade and the MFA
Exchange rate policy is not the only area of potential tension in China's relationship with the global economy. The past year or so has seen a great deal of speculation about the likely impact of the much-delayed ending of the Multi-Fiber Agreement. Some exporting countries have been afraid that competition from China would inflict considerable damage on their domestic industries.
There is no doubt that this is an area where China has a competitive edge in many cases. Removal of textile and clothing quotas and the eventual unrestricted access to this export market are widely expected to bring considerable benefits for Chinese producers.
In the short-term the impact on the Chinese economy is likely to be relatively small, however, and the main benefits for China are likely to accrue over the medium and longer term. There are signs that the Chinese authorities favor a gradual transition: from January 1st, export taxes have been levied on selected categories of textiles and clothing.
And many assessments of the consequences of ending the MFA take no account of the dynamic responses that we might expect, such as reforms to improve competitiveness in other exporting countries. Nor do they assess the impact of changes in exchange rate flexibility.
China is an economy undergoing rapid transformation. Its rapid growth has brought great opportunities and challenges—both for China and for the rest of the world. Some producers see Chinese competition as a threat. They worry about losing market share, about the impact on their markets from highly competitive Chinese exports. That's as familiar a refrain as it is an understandable one.
But China's growth has brought immense new opportunities for exporters—of primary commodities, of manufacturing inputs and of finished goods. China is contributing to the growth of world trade, not displacing it from elsewhere.
And competition from Chinese exports has benefited consumers across the world as well. Let us not forget that competition is one of the great benefits that freer trade brings, even when it forces some painful restructuring for those firms unused to it.
But China, too, is undergoing major and sometimes painful restructuring. It is a large and populous country. It has a cumbersome and inefficient bureaucracy, especially at the local level and in state-owned enterprises. Many of its citizens still live in abject poverty, and the gap between rich and poor has widened. It faces enormous demographic challenges as its population ages rapidly over the next few decades. Its banking system is saddled with bad debts that will, ultimately, have to be written off.
Chinese policymakers are seeking to maintain economic growth at levels that can have an impact on poverty while avoiding inflationary pressures that would ultimately hamper growth. And they are often relying on policy instruments that are at best unreliable in what is increasingly functioning like a market economy.
The challenges for China are not new, of course. The transition we are witnessing today started more than two decades ago. Adjustment is a relatively slow process even in small simple economies—and China is neither small nor simple.
What has changed is the extent to which all our economic fortunes are now linked with those of China. Its sheer size and its dynamism makes it increasingly important for global economic growth. With Japan's economy largely stagnant for much of the 1990s, China played a crucial part in sustaining and helping to fuel Asian economic growth. With European growth still lacklustre, the opportunities offered by Chinese growth are increasingly important for the world outside Asia. It is in all our interests that the Chinese economic miracle is sustained.