Thursday, 30 December 2010

Why China's trade surplus is a strategic opportunity

The economic growth in China over the last 20 years has been one of the biggest forces for reducing global poverty, as tens of millions of people have gone from subsistence farming to industrialised production jobs. The wealth that has been created from this trend has transformed China, and now cities such as Shanghai and Beijing are catching up with Hong Kong and Singapore in their level of development. The growth in China looks set to continue, with the economy forecast to surpass the USA’s in size within the decade, according to a new interactive tool published by The Economist.

During its period of growth, China has benefitted from being a low cost economy by exporting manufactured products to the rest of the world. Now, its low levels of domestic consumption have been brought into the spotlight by the sovereign debt crisis. “How can developed countries deal with their trade deficits while China runs such a large surplus?” is the question Western politicians and economists are asking. China’s ability to export is propped up by its cheap currency, which results from the Chinese government selling Yuan and buying US-dollar denominated Treasury Bonds.

Some American economists decry this as manipulation of the Chinese currency, at odds with a free-market philosophy of world trade (this is a view I see as rather hypocritical: as long as the Chinese government is buying Treasury bonds on the free market it is up to them how to spend their Yuan). However it is clear that a lot of tension is building up in the system. If the Chinese government stops buying Treasuries, the Renminbi will appreciate against the dollar, which devalues all the bonds the Chinese government already holds. Furthermore, Chinese exports would become less competitive in the global marketplace, potentially damaging its economic growth. And the US will find it harder to finance its budget deficit, likely to cause serious problems for its domestic economy.

The only thing that will sustain China’s growth is a rebalancing of China’s economy toward domestic consumption. This will cause a large shift in the nature of the goods and services most in demand. It presents both local and foreign companies with a great opportunity for growth. Capitalising on this shift in consumption from developed to developing countries should be high on the list of strategic priorities of any multinational corporation.

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