Tomas Palley on China

[michael perelman <michael@xxxxxxxxxxxxxxxxx>]

Am I wrong in thinking said Palley is mistaken by putting too much
emphasis on currency manipulation? How much manufacturing would return
to the United States if China would increase its currency by 100%? Would
we start seeing shoes and textiles manufactured in United States? At
best, the outsourcers would be inconvenienced by moving to Burma or some
other low-wage country.

Partially implicit in his piece seems to be the idea that China is the
creature of US outsourcers. But the 35% figure in the article is pretty
amazing.


www.thomaspalley.com

Exchange Rates, Labor Standards, and Democracy: Why China Must Change
Copyright Thomas I. Palley

For the past five years the global economy has been flying on one engine.
That engine is the U.S. consumer who has been on a consumption binge
financed by borrowing, in turn backed by a housing price bubble. This
situation poses the threat of a serious hard landing when that engine
eventually stalls, as it must. Ever inflating house prices and rising
debt-to-income levels are not sustainable. And as the late Herbert Stein,
Chairman of President Nixon’s Council of Economic Advisers, wryly observed:
“If something cannot go on forever, it will stop.”

This view, regarding the global economy’s excessive dependence on the U.S.
and the financial fragility of the U.S. economy, is not just held by
progressive economists. It is also shared by Wall Street. Thus, Stephen
Roach, Chief Economist for Morgan Stanley, recently wrote in the Financial
Times (November 4, 2005): “there is now about a forty percent probability of
a hard landing in the next twelve months.” And in a research brief, Roach
singles out China as being particularly dependent on the U.S.: “China’s
export prowess is balanced on the head of a pin – a pin made in America.
Fully thirty-five percent of Chinese exports go to the United States.”

Roach’s Wall Street warnings are sobering. But they miss a more profound
point, which is that the global economy has been heading in the wrong
direction, hollowing out the middle class in America while failing to create
a big enough middle class in the developing world. That hollowing-out
process has long been visible in U.S. statistics on wages and family income
distribution, and it has been rendered keenly concrete by Delphi Corp.’s
recent bankruptcy filing. It is only because of successive stock market and
housing price bubbles, combined with a massive increase in consumer access
to credit, that the hollowing-out has not been worse.

A major cause of these dangerous trends is the flawed structure of the
global economy. Spurred by our own policy makers, the International Monetary
Fund, and the World Bank, developing countries have adopted an export-led
approach to manufacturing growth and development. This approach has two
critical features. First, countries rely on selling in foreign markets
rather than their own domestic markets. Second, countries use under-valued
exchange rates to subsidize their products, thereby making them
hyper-competitive. China exemplifies this model, exporting over half of its
manufacturing output and having an exchange rate that is up to forty percent
undervalued.

The focus on export-led growth has distorted the global economy. First, it
has created the global financial imbalances that Wall Street is so
apprehensive about, as manifested in the record U.S. trade deficit. Second,
U.S. manufacturing has been undermined by unfair competition subsidized by
under-valued currencies. This in turn has accelerated the hollowing of
America’s middle. Third, export-led growth promotes the global
race-to-the-bottom since countries look for international competitive
advantage however possible. Consequently, workplace standards, wages, and
the environment are all subject to persistent retrograde pressures, impeding
the development of a middle class in developing countries.

The implication is that the global economy must shift from export-led
development to domestic market-led development. In an export-led world,
higher wages undermine employment. In a domestic market-led world, higher
wages can promote employment. This is where labor standards and unions
enter. The challenge is to establish a system that has wages rising with
productivity so that workers can buy what they produce, rather than dumping
it on world markets. Setting wages by government edict does not work, as
evidenced by the former socialist economies. Instead, labor standards and
unions are the way forward, since they provide a decentralized mechanism
that links wages and productivity through bargaining. History supports this.
Every country that has ever made the transition to developed industrialized
status has traveled this route.

China is the poster-child for export-led manufacturing growth. It has the
most under-valued exchange rate, the worst labor repression, and is by far
the largest developing country exporter. As such, China is the gravitational
attractor for the race to the bottom. Other countries must change too, but
they can only do so if China changes so that none lose relative competitive
advantage. If China revalues its exchange rate, other East Asian countries
can also do so. Likewise, if China raises wages, so too can others.

One area where China is showing leadership is its stated commitment to
increase social spending. This will be good for China’s citizenry, and it
will also contribute to incomes and domestic demand in China which will be
good for the global economy. However, there is also a problem that is unique
to China. Labor standards and trade unions are key to domestic market-led
development, but China’s political system prevents them. That creates an
additional political roadblock that must be solved. Democratic reform in
China is not a nicety. It is a necessity for the global economy to work.

--

Michael Perelman
Economics Department
California State University
michael at ecst.csuchico.edu
Chico, CA 95929
530-898-5321
fax 530-898-5901