Nottingham University March 3 rd 2010

1. China’s Role in the World EconomyMartin Wolf, Associate Editor & Chief Economics Commentator, Financial Times Nottingham University March 3rd 2010

2. China in the World Economy • The presentation will address five issues: • China’s strategic interests; • Natural resources and the global environment; • Trade; • Finance; and the • Balance of payments.

3. 1. China’s strategic interests • China is a developing country and is likely to remain a relatively poor country for decades, in terms of incomes per head. • But, by virtue of its size, it has a gigantic impact. Indeed, it is on its way to becoming a superpower. • As a result, it is one of the few countries – arguably one of two or three (if the European Union is viewed as one) – that must take account of the impact of its actions on the world economy. • China cannot just “import order”. It must “export order”, too.

4. 1. China’s strategic interests • How then should China define its interests, while taking account of its impact on the world in which it finds itself? • China’s interest, I would argue, lies in maintaining a stable, peaceful and co-operative global political and economic environment. • Only such an environment would be able to support and adapt to China’s rapid economic development. • How should China, as one of the world’s leading powers, seek to achieve that objective?

5. 1. China’s strategic interests • I would argue that this interest will be best secured via a rules-governed, institutionally-based global system, on lines created by the US after the Second World War. • China’s objective should be to strengthen and develop that order, not overthrow it. • The alternative is a world of power politics: • Such a world has proved highly unstable in the past; • China has to recognise that in such a world, there is a big risk that other powers might “gang up” against it; • In such a world, development will be much more difficult.

6. 2. Natural resources and the global environment • China is already the world’s largest consumer of natural resources and the world’s biggest emitter of greenhouse gases. • Its impact on global resource markets and the global environment, already enormous, is sure to grow further in the decades ahead. • Its specific interest with respect to raw materials is secure access at the lowest possible prices. • Its dominant policy seems to be to invest in raw material supplies abroad.

7. 2. Natural resources and the global environment IMPORTS OF THE “WORKSHOP OF THE WORLD”

8. 2. Natural resources and the global environment IMPORTS OF THE “WORKSHOP OF THE WORLD”

9. 2. Natural resources and the global environment COMMODITY PRICES SOAR

10. 2. Natural resources and the global environment COMMODITY PRICE DIVERGENCE

11. 2. Natural resources and the global environment • The advantage of this policy is preventing the formation of cartels against China. • But the policy will not necessarily increase security: • Raw material supplies located in other countries can be expropriated, at will, as has frequently happened; • The principal risk is the variability of price, rather than physical supply; • Governments of exporting countries have an interest in securing the maximum price of exports, whoever notionally owns the supply;

12. 2. Natural resources and the global environment • These risks can be managed only by securing direct control over the governments of supplying countries; • But any such policy risks creating a strategic rivalry with other countries that are also dependent on imported materials; and, at worst, • This might even lead to open conflict. • It might make sense for China to complement a policy of investing in raw material supply with a policy of promoting free trade in resources themselves. • That should allay suspicion that China is trying to achieve a privileged position, at the expense of others.

13. 2. Natural resources and the global environment • On climate change, China has clearly conflicting interests. • As a rapidly growing developing country, China’s interest lies in ensuring that cuts in emissions fall elsewhere and that it is more than adequately compensated for any cuts it is forced to make itself. • But if it sticks to this position, it is likely to find that no cuts are made at all, which might ultimately be very damaging to China.

14. 2. Natural resources and the global environment THE GREAT EMITTER

15. 2. Natural resources and the global environment • Thus, it is going to be necessary to make commitments. This should at least promote a desirable improvement in energy efficiency. • If China accepts some quantitative limits, these will be globally tradable. • That could be a source of revenue for China (and China’s businesses) in the early years of the regime, though in the longer run China will have to buy emissions permits, rather than sell them.

16. 3. Trade • China ranks with the European Union and the US as one of the world’s biggest trading entities. • Trade has also played a dominant role in China’s development, as well. • As a global player, China needs an open global economy. Purely regional arrangements will not satisfy China’s needs. • This makes China the natural defender of the multilateral, rules-based global trading system in the 21st century.

17. 3. Trade • It is important, for this reason, that its own policies be compatible with WTO rules, in all respects, and that it also fully obey rulings against it by the WTO. • It is also important for China to use WTO procedures, to manage disputes with other trading powers. • It is, finally, important for China to play an energetic role in securing the completion of the Doha round of multilateral trade negotiations. • Subject to the above, China can also play a productive role in ensuring an open set of trading arrangements in the Asia-Pacific region.

18. 3. Trade EXPORTS OF THE “WORKSHOP OF THE WORLD”

19. 4. Finance • China will ultimately become the centre of the global financial system. • Already China’s gross savings match those of the US in size. • Its interests lie in: • Securing a domestic financial system that promotes its own development; and • Promoting a stable global financial system that supports a rapidly growing and reasonably stable world economy. • As a leading member of the Group of 20 China is in a good position to secure these aims.

20. 5. Balance of payments • China is both the world’s fastest-growing emerging economy and the country with the largest current account surplus and so the world’s largest net capital exporter. • This has turned out to be a disruptive combination. • While one would expect the real exchange rate of the world’s most dynamic economy to soar, that has not happened.

21. 5. Balance of payments THE RISE OF THE IMBALANCES

22. 5. Balance of payments CHINA RISES TO THE TOP OF THE SURPLUS LIST

23. 5. Balance of payments CHINA EXPORTS A BIGGER SHARE OF GDP TOO

24. 5. Balance of payments CHINA’S MODEST REAL APPRECIATION

25. 5. Balance of payments • This outcome has been the result of intervening massively, to keep the exchange rate down, and acting, at the same time, to prevent the natural consequences for money and inflation. • Thus, the normal paths to global and domestic adjustment have been blocked. • High Chinese savings – even higher than the extremely high levels of domestic investment – and low household consumption also, of course, reflect the extraordinarily low share of household disposable income in China’s GDP and the high share of undistributed corporate profits.

26. 5. Balance of payments THE GREAT RESERVE ACCUMULATION

27. 5. Balance of payments CHINA’S SAVINGS EXPLOSION

28. 5. Balance of payments • One of the ways in which corporate profits are kept high is via the low rate of interest charged by banks. • This is also partly the consequence of the policy of keeping the exchange rate down. • More important, the ability to export surplus savings abroad, to support demand for Chinese production, has made it much easier for China to avoid desirable and necessary structural reforms, at home.

29. 5. Balance of payments • The needed reforms would benefit the Chinese people, by raising the living standards of today’s Chinese, and lowering the rate of investment in low return – and risky – foreign assets, particularly liabilities of the US government. • They would also help the world economy, because the high quality, safe foreign assets that China seeks do not, alas, exist. • That is one of the lessons of the financial crisis.

30. 5. Balance of payments • China insists that the US keep its currency a safe store of value. But one of the reasons the US currency is increasingly unsafe is the role of the US as the world’s borrower of last resort. • That is undermining the finances of the US Federal government: • Once the private sector stopped spending borrowing, the US government emerged as the ultimate spender and borrower; • This is because it is difficult to achieve a big enough swing in the US external accounts, in a world of structural surplus countries, notably China.

31. 5. Balance of payments • Whether or not one agrees with my view on the role of savings-surplus countries in causing the current crisis, it is widely accepted that rebalancing of world demand and current accounts is necessary to achieve a full exit from the crisis. • China’s decision to devalue the renmimbi, along with the dollar, is an obstacle to such an adjustment. For a huge surplus country to try to defend its surpluses in world of under-consumption is destabilising.

32. 5. Balance of payments THE REMNMINBI STABILISES AGAINST DOLLAR

33. 5. Balance of payments • What is needed now is a shift in policy. • This would involve: • A real appreciation of the currency; • Liberalisation of private capital outflow from China; • A redistribution of income, via taxation, dividends and higher interest rates, from corporations to households; • Development of safety nets for the population; and • Higher spending on public consumption.

34. 5. Balance of payments • These changes would be good for China and the world. • The policy of relying on external demand has run its course and now needs to be reversed. • China needs to become a source of net demand for the world. • Indeed, it is the natural large-scale net importer of capital (as the US was at a comparable stage of its development in the 19th century), not a net exporter.

35. 5. Balance of payments • Changes in China’s policies are not enough. • There also need to be large changes in the global monetary system, many of which have been identified by People’s Bank of China Governor Zhou Xiaochuan. • The reliance on a single national currency is inherently destabilising, because of the “Triffin problem” – excessive issuance undermines trust.

36. 5. Balance of payments • Reliance on a single currency makes it difficult for others to be large net borrowers, in a world of adjustable exchange rates, unless they are able to borrow in their own currencies (many cannot). • The solution is not a move to several national currencies, since that does not help the vast majority of countries.

37. 5. Balance of payments • The best solutions are two-fold: • A much large International Monetary Fund or similar insurance arrangement, to insure countries against the risk of a “sudden stop” in foreign lending; and • Issuance of Special Drawing Rights on a regular basis, particularly to developing countries, thereby allowing them to finance large ongoing current account deficits. • To make this happen, there also needs to be substantial reform of the governance of the IMF.

38. 5. Balance of payments • The big aim is to achieve a better balanced and more stable world economy. • It is crazy that stability has depended on irresponsible and excessive spending by the world’s richest consumers. • This process has, in any case, ended in crisis. • China can play a huge role – and it is very much in its interests to do so – in securing necessary reforms.