Chinese wages, yuan appreciation, and global rebalancing

In the past couple weeks, the two big stories out of the Chinese economy have been reports of labor unrest and rising wages, and the news a few days ago that China would slowly allow the appreciation of its currency.  The former is an important development in the path toward a more stable post-crisis global economy; the latter, though welcome, is largely a political sideshow.

First to the news about wages.  Increasing the wage share in the Chinese economy is probably the single best way to address global imbalances (the other needed change is an increase in US savings rates, but this might have to wait until after the recovery is solidified).  The reason is simple: in any economy, final household consumption can be thought of as the result of two ratios: first, out of total GDP, how much income flows to households in the form of wages and other transfers, less taxes; second, of total household income, how much is spent on consumption vs. saved.

When looking to explain China’s low consumption, most commentators have focused on the second of these two ratios: they picture the thrifty Chinese family, squirreling away all of its income to pay for their children’s education and future health expenses.  Now if you believe this story, the only way to increase Chinese consumption is to convince Chinese households they no longer need to save as much — in other words, to build a resilient and wide-reaching social safety net and quality public schools (something we’re still struggling with here in the US) and induce a cultural shift away from saving toward spending.  A difficult task indeed.

But the good news is, that story isn’t really true, or at least isn’t the whole story.  Chinese household savings is high, but it’s not thaaaat high.  As the graph below shows, Chinese household savings increased during the 1990s, but between 1999 and 2006 was pretty much flat, bouncing around just below 25 percent; certainly high by US standards, but not so much by Asian standards.  It’s edged up a little in the past few years, but only to about 27 percent — still well below India’s rate, yet you rarely hear people complaining that Indian households save too much.

So Chinese final household consumption is low not because household savings rates are too high, but because Chinese household income is too low.  The upside of this is the fact that increasing Chinese consumption doesn’t require complex institution building and cultural shifts; all it takes is getting more money to households.  And with growing pressure to increase wages, it looks like soon they will be.  (For more see this recent paper for Brookings here, and for a more academic take see here.)

So where does the Chinese currency fit in here?  Well, the short answer is, it doesn’t.  Structural forces in the Chinese economy, like the total wage share, are far more important than small adjustments in the exchange rate.  A slow, gradual appreciation of the yuan is ultimately in both China’s and the global economy’s interest, but it’s not going to have nearly the impact you’d expect based on the political rhetoric in both China and the US.  I don’t really understand how the exchange rate got to be such a loaded political issue, where the US looks weak if it can’t force China to appreciate its currency, and China looks like its bowing to foreign interference if it takes minimal steps to bring its exchange rate more in line with its competitiveness.

Which brings me to the last point I’ll make, which is that there is some real benefit of China’s recent decision to inch the yuan upwards, but it has little to do with any actual economic forces.  Thanks to this week’s announcement, now a) the G20 can focus on real problems, like Europe’s mess, rather than getting locked in a debate over the yuan, and b) hopefully the rhetoric in both China and the US will be toned down, and the likelihood of a trade war between the world’s two most powerful economies during a very fragile global recovery will decrease.  So at least some good will come of it.


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