China as the Fastest-Growing Countries - Essay Example

?China China is one of the fastest growing countries in the world. It is a country that is emerging from tight controls, where the government throughits arms controlled economic activities such as setting up prices of various commodities, fixing foreign exchange rate and regulating the international trade. China has benefited immensely from the international trade. According to Bradsher (2010), China is one of the countries that enjoys trade surplus and high level of foreign exchange reserves in the world. In 2009, China had a trade surplus of $198 billion with the rest of the world. United States of America is one of the key trading partners with China. However, there has been controversy surrounding China and its trading partners. China is blamed for not opening fully its vast domestic market to other foreign trading partners through its currency devaluation, fixed exchange rate regime and tighter import regulations. China has to make painful decisions on whether to allow its currency to appreciate or not. In addition, it has to choose from maintaining its fixed currency exchange rate regime or adopting a flexible exchange range regime. By studying its economy and listening to the concerns of its trading partners, China will be in a position to make decisions that best suit its interest as well as those of its trading partners. If China chooses maintain a devalued RMB, it will generate more wealth at the expense of its trading partners. Why China chooses to keep its currency artificially low compared to it trading partners. There are many reasons why China would wish to maintain artificially low currency as compared with those of its trading partners, especially against the dollar of the United States of America. According to James (2010) China wishes to maintain artificially low RMB exchange rate to other currencies of major trading partners in its interest. Federal Reserve (1999) revealed that a country devalues her own currency when it does not have sufficient foreign reserves or unwilling to spend foreign exchange reserves to maintain its exchange rate to foreign currencies. China is among the richest countries with high level of foreign exchange reserves in the world. However, it seems China has different ambitions and is unwilling to spend its foreign exchange reserves to keep RMB at a rate appropriate against the dollar. There are many genuine and valid reasons, which make China keep its currency artificially low. The first reason why china wants to maintain its devalued currency is because it wishes to maintain high levels of exports. By keeping its currency low, China is able to make its currency cheaper in relation to other major currencies. As a result, it makes its products and services cheaper to customers (consumers) in foreign countries. This will ensure that China continues to exports a lot of goods and services to other countries. China’s currency devaluation approach is consistent with foreign exchange theory that stipulates that that the lower the currency in relation with those of other trading partners, the lower the prices of exports hence a country will be able to export more. Higher exports as compared to imports will enable China to generate trade surpluses and build even more reserves of foreign currencies. The second reason why china wants to keep its currency low is to discourage its domestic consumers from purchasing imported goods and services. China’s artificially low currency will make foreign goods and services more expensive as compared to similar goods and services produced in China. Devaluated currency discourages imports and China will be able to control quantity and value of imports entering its borders. When a country increases consumption of domestic goods and services, it keeps its factories running (Saccomanni, 2008). Therefore, the country is able to maintain its employment levels and even increase employment rates with increase in domestic consumption. Furthermore, by reducing the number of imports, China will be able to prevent incidences of current account deficits. The third reason why China intends to maintain a devalued currency is to avoid implementing unpopular fiscal revenue generating as well as spending policies. Such unpopular fiscal generating revenues include higher taxation. Taxation rates will be revised upwards to generate more revenues to purchase foreign exchange reserves, which will be used to sustain currency’s exchange rate if the RMB will be gaining value faster than its trading partners. This is a scenario that is likely to hit China because of its growing wealth generated from high levels of exports. The unpopular fiscal spending habit is deficit financing that makes a country borrow loans from development partners, a road that China does not wish to take. China must also understand the challenges it faces by adopting RMB devaluation. By choosing devaluation, China can jump start own inflation. In addition, devaluation can be perceived as a sign of economic weakness and a country can receive poor credit rating. Poor credit rating may dampen investors’ confidence towards a country and may hamper the flow of foreign direct investments. If China fails to keep its currency at an appropriate level, it may promote successive devaluations. Trading partners will be concerned that China’s devaluation might negatively hurt their domestic export industries and trading partners may also opt for devaluation to offset negative effects that China may generate by keeping its currency artificially low. For example, the trade deficit between United States and China has been brought about by artificially low RMB exchange rate against the dollar. Successive devaluation may exacerbate economic difficulties and create global financial instability. In addition, it does not contribute to economic recovery of trading partners and discourages balanced global economy. Should China adopt a flexible exchange rate? There are various factors that China must consider first before making a decision to adopt a flexible exchange rate. A flexible exchange rate refers to a currency system that allows supply and demand forces in the market to determine it exchange rate. According to Barth et al (1994), it is important to consider four factors before a decision on whether to adapt fixed or flexible exchange regime can be reached. They include prevailing economic disturbances, economic structural characteristics, risks commonalities that a country is subjected to and objectives a country under consideration wishes to pursue. Therefore, China as a country must weigh costs and benefits, study its macroeconomic environment, consider its objectives as well as the impact to its international trade and relations. First China should consider benefits and costs of adopting a flexible exchange rate. There are a number of benefits associated with adopting a flexible exchange rate. Through a flexible exchange rate regime, the trade between China its trading partners will be automatically adjusted/ stabilized in line with changing economic conditions. As result, the balance of payment will be adjusted slowly, continuously and smoothly rather than largely and occasionally. Large and occasional changes could be disruptive to the trading systems. By adopting a flexible exchange rate regime, China will be able to eliminate the risk of policy mistakes that could have been made had China used monetary and trade policies to rectify its trade when economic environment changes. Through flexible exchange rate, China will be able to free its internal policies from unnecessary constraints caused by currency devaluation or revaluation. This will enable China to concentrate on solving important issues such as inflation and unemployment instead of using monetary and fiscal policy to defend the exchange rate. In addition, under flexible exchange rate, China will not have to spend money on exchange reserves needed to defend its currency or cause misunderstanding with other trading partners by keeping its currency artificially low. Instead, money that could have been used to spend on purchasing defending currencies could be employed to other constructive ventures. If China adopts a flexible exchange rate, it will be able to automatically equalise its prices with those of different countries without fear of inflation. This is because China’s currency will be able to appreciate with rising international prices and thus will not be affected by rising import prices. Furthermore, China will be able to pinpoint where it comparative advantage lies and concentrates its efforts there because exchange rates will be at or close to the equilibrium (Salvatore, 1995). There are costs that China will incur by adopting a flexible exchange rate regime. China’s exports have increased significantly over the years because it has a fixed exchange rate regime. This is because it has made it products and services cheaper to both domestic and foreign customers. If it adopts a flexible exchange rate regime, its exports may reduce because prices Chinese products will also increase. The current China exporters fear that if China adopts a flexible exchange rate, their product will no longer be competitive in the international markets. Secondly, by adopting the flexible exchange rate regime, the value of 8.28 renminbi will be very unpredictable (Arnold, 2008). Thus there will be risk of loosing by engaging in international trade. The second factor to be considered is China’s macro-economic environment. China is the largest producer of red meat, rice, cotton, tobacco and wheat. It is also the leading producer of coal and has extensive deposits of iron-ore. China faces a number of economic disturbances. This includes international pressure to allow its currency to appreciate, especially from its key trading partners United State of America. China’s population is rapidly increasing against its resources, with many people living in rural China. Consequently, China is undertaking an urbanization program, under which people are relocated to urban centers. It is estimated that over two hundred million Chinese people have been moved from rural to the urban dwellings officially or non-officially. In addition, Chinese people are known to be serious savers of the money they receive. In fact China is one of the countries in the world with high country’s saving rate. This saving culture depress consumption and Chinese government is developing polices that will encourage its people to spend. This is in order to boost demand for domestic products to sustain its domestic industries and employment rates. China as a country has less degree of mobility of factors of production. When a country has less degree of mobility of factors of production, it follows that a country should adopt a flexible exchange rate and vice versa. Demand for crude oil and petroleum is increasing in China. Therefore, China has to import increasing quantities of petroleum to meet domestic growing demand. The third factor to consider is the China’s international trade. China has been liberalizing its economy since 1978. As a result, China has experienced high levels of economic growth and development. Initially, China exported light industrial products, food, chemical products, native products and animal by-products. However, since 2000, it exports machinery, automobiles and electronic items. Machinery and electronics from China accounts for more than half of Chinas products. China is currently opening its markets to the rest of the world slowly. Chinese economy has solidly recovered, growing very fast, stable and vast with over 1.3 billion people. China is one of the few lucky countries that have managed to maintain trade surplus over the years. Bradsher (2010) revealed that China had a trade surplus worth $198 billion in 2009. However, OECD (2011) stated that the current account surplus of China is reducing. Elwell (n.d.) stated that trade between China and USA has grown substantially from $4.9 billion in 1980 to $343 billion in 2006. China is also a growing US export market. China’s rapid population and development needs make China attractive to the United States’ products and services. China imports semiconductors, electronic components, aircrafts and parts, scrape metal and waste, grains, oilseeds, resins as well as synthetic rubber and fibers from United States. In 2008, China managed to exports goods and services worth $1.4 trillion (free on board). According to Harrigan and Deng (2008), trading pattern between China and the world takes the form of Heckscher-Ohlin. This is because China has abundant skilled and unskilled labour. As a result, it has comparative advantage in producing goods and services that are labour intensive. According to Xinhuanet (2010), China is increasingly trading with African countries. China imports from Africa have diversified from cotton and phosphate to crude oil, minerals, steel, copper, electronic items and chemical fertilizes. Furthermore, Africa has tremendously increased export of agricultural products such as oranges, wine, cocoa beans, coffee, olive oil and sesame to China. China is importing more from Africa as African exports are critical in promoting China’s economic development as well as improving lives of Chinese people. In a move to gain wider access to global market, China has agreed to undertake substantial import liberalization. In addition, China has been pushing for free trade agreement (FTA) with many East Asian economies. China is a processing hub, which also relies on imported raw materials, technology, capital goods and other intermediate goods from East Asian countries. The fourth factor to be considered is China’s international relations. International relation between China and rest of the world has improved significantly since China changed its international policies and began opening doors to international community. China is a member of many international bodies including World Trade Organization (WTO), which is instrumental in creating a balanced global trading system in the world. WTO encourages countries to trade with each other smoothly by solving trade related problems that one country may create for the others. China has written severally to the WTO asking the international body to intervene to help China trade effectively with other countries. This was because developed countries such as the United States of America and some members of the European Union did not welcome China’s products. They claim that China is dumping its goods to them and this has somehow hurt China’s export trade to developed countries. WTO has asked China to let its currency appreciate because it is hurting United States of America. Since 1998, China fixed its exchange rate at 8.28 renminbi against the US dollar. Bradsher (2010) revealed that China has been under immense pressure from United States of America to let it currency appreciate. Though China is under the influence of World Trade Organization and International Monetary Fund, it does not care because China does not borrow money from either of the two bodies. The United States of America threatened China with use of WTO dispute settlement procedures to push China to carry out its liberalization commitments. China is also a member of G-20. This places china in a very compromising situation because United States of America can use other G-20 members to ask China to let its currency appreciates against other currencies as influenced by demand and supply forces of the international trade. It is not a long before China is influenced by international bodies in which it is a member to respect its trading partners and let its exchange rate be flexible. Conclusion By observing some of the facts about China’s macroeconomic environment, its international trade and relations, objectives and weighing costs and benefits associated with adopting a flexible exchange regime, it is evident that China will be better off by adopting a flexible exchange regime. This is because Schmidt et al (2011) revealed that Goldman Sachs projected that China’s GDP will surpass that of the United States by 2039. This means that Chinese economy is going to grow even stronger. Chinese growth will be driven by its domestic consumption as well as exports. Its macroeconomic environment is stable and cannot be negatively impacted by a flexible exchange regime because China has to import more products and services from United States, other Asian countries as well as Africa to meet its needs. To do this, it has to developed good relations with trading partners by not involving it trade practices that grossly disadvantage is partners. There are very many benefits associated with adoption of a flexible exchange rate regime. Chief among them is the likelihood of improved relations between China and its key trading partner the United States of America. Thus, there will be more trade and China will have a moral authority to petition other developed countries to open market for its products. Furthermore, China is experiencing a lot of pressure from its trading partner the United States of America to revalues its currency. If United States of America solicits help from WTO, China is likely to obey and let its currency appreciate against the dollar since WTO has helped China before. China understands very well that if it allows its flexible exchange rate regime to flourish, it has to develop ways of making its product and service price competitive abroad. Luckily, China has a comparative advantage in terms of labour and will continue to be competitive in product and service pricing both in the international and domestic market. Accepting a flexible exchange rate regime is a small price to pay compared to many benefits it will reap in the process. References Arnold, AR 2008, Microeconomics, 9th edn, Cengage Learning, USA. Bradsher, K 2010, ‘China Uses Rules on Global Trade to Its Advantage’, The New York times, March 14, viewed, 25 March, 2011, . Elwell, KC, Marc Labonte, M & Morrison, MW, n.d., Is China a Threat to the U.S. Economy? Viewed, 25 March, 2011, . Federal Reserve 1999, Currency Devaluation and Revaluation, viewed, 25 March, 2011, . Harrigan, J and Deng, H 2008, China's Local Comparative Advantage, NBER Working Paper Series Working Paper 13963 National Bureau of Economic Research viewed, 25 March, 2011,. James, F 2010, Chinese Vow to Act on Artificially Low Currency, viewed, 25 March, 2011, . OECD 2011, Economic Survey of China 2010, viewed, 25 March, 2011, < http://www.oecd.org/document/43/0,3746,en_2649_34571_44477419_1_1_1_1,00.html>. Richard C. Barth, Chorng-Huey Wong, IMF Institute 1994, Approaches to exchange rate policy: choices for developing and transition economies, International Monetary Fund, Washington, D.C, USA. Saccomanni, F 2008, Managing international financial instability: national tamers versus global tigers, Volume 59, Edward Elgar Publishing, London. Salvatore, D 1995, Schaum's outline of theory and problems of international economics, 4th edn, McGraw-Hill Professional, New York. Schmidt, WS, Shelley, CM, Bardes, AB & Ford, EL 2011, American Government and Politics Today 2011-2012 Edition, 15 edn, Cengage Learning, USA. Xinhuanet 2010, China-Africa Economic and Trade Cooperation, viewed, 25 March, 2011, . Read More