Op-Ed Contributors

Behind China's trade deficit

By Fan Gang (China Daily)
Updated: 2010-04-30 07:52

Focus on yuan misguided; investment and domestic consumption, not exports, are engines of economy

China registered a monthly trade deficit of $7.2 billion in March this year, its first since April 2004. Yet, at around the same time, the United States Congress issued its loudest call ever to classify China as an exchange-rate manipulator, accusing Chinese leaders of maintaining the yuan's peg to the dollar in order to guarantee a permanent bilateral trade surplus.

China's March trade deficit indicates, first of all, that it is incorrect to claim that Chinese economic growth depends mainly on exports. Exports are an important part of the Chinese economy, and any global market fluctuation or external shock will certainly have an impact on overall growth. But, like any other large economy, China's economy is driven by domestic consumption and investment.

Indeed, China's exports fell by 16 percent year-on-year in 2009, owing to the global financial crisis and recession. Nevertheless, annual GDP grew by 8.7 percent, thanks to a 16.9 percent growth in consumption (measured by gross sale of consumer goods) and a 33.3 percent surge in fixed-investment demand.

Moreover, although China's "trade dependency" is now reckoned to be 70 percent of GDP, that figure is greatly distorted by the fact that Chinese exports require massive imports of materials and parts. The net value added of total Chinese foreign trade accounts for only about 15 percent of GDP.

Thus, net exports contributed 10.8 percent to China's overall GDP growth rate, or only about 1.1 percentage point of the 9 percent growth in 2008. Compare the figure to that of Germany, where net exports accounted for 64 percent of growth in 2008. Similarly, the figure was 33 percent in Japan, 28.6 percent in South Korea, and 20 percent in the Philippines. Clearly, China is nothing special in this regard.

To be sure, China's domestic consumption is not as high as it should be, standing at 49 percent of GDP in 2008, with household consumption accounting for only 35 percent. Such figures have led many observers to believe that overall domestic demand must be low, leaving China dependent on external markets for growth.

But domestic demand, which determines imports, consists not only of consumption, but also of fixed-asset investment. Indeed, rapid growth in investment may translate into high import growth and trade deficits.

That is exactly what is happening in China now. Some people may argue that investment growth without consumption growth will result in overcapacity and eventually lead to recession. Perhaps. But we need to remind ourselves that housing investment accounts for about 30 percent of China's total fixed investment, with much of the rest directed toward infrastructure - long-term, durable public infrastructure investments including subways, railways, highways, urban public facilities and the national water system. Moreover, one can easily imagine that import demand will soar further if the US and the European Union lifted their bans on exports of high-tech products to China. In that case, the trade deficit recorded in March could be at least 40 percent higher.