The exchange rate delusion

IF one looks at the trade patterns of the global economy's two biggest players, two facts leap out.
One
is that, while the United States runs a trade deficit with almost
everyone, including Canada, Mexico, China, Germany, France, Japan, South
Korea and Taiwan, not to mention the oil-exporting countries, the
largest deficit is with China.
If trade data were re-calculated
to reflect the country of origin of various components of value-added,
the general picture would not change, but the relative magnitudes would:
higher US deficits with Germany, South Korea, Taiwan and Japan, and a
dramatically lower deficit with China.
The second fact is that
Japan, South Korea and Taiwan all relatively high-income economies have a
large trade surplus with China. Germany has relatively balanced trade
with China, even recording a modest bilateral surplus in the post-crisis
period.
The United States has a persistent overall trade deficit
that fluctuates in the range of 3%6% of gross domestic product (GDP).
But, while the total reflects bilateral deficits with just about
everyone, the US Congress is obsessed with China, and appears convinced
that the primary cause of the problem lies in Chinese manipulation of
the yuan's exchange rate.
One problem with this view is that it
cannot account for the stark differences between the United States and
Japan, and Germany and South Korea. Moreover, the real
(inflation-adjusted) value of the yuan is now rising quickly, owing to
inflation differentials and Chinese wage growth, particularly in the
country's export sectors. That will shift the Chinese economy's
structure and trade patterns quite dramatically over time.
The
final assembly links of global value-added chains will leave China for
countries at earlier stages of economic development, such as Bangladesh,
where incomes are lower (though without producing much change in the
balance with the United States).
A somewhat more sensible concern
might be that the dollar's reserve currency status causes it to be
“over-valued” with respect to every currency, not just the yuan. That
could create additional pressure on the tradable part of the US economy,
and thus might help to explain why the US tradable sector has not
generated net employment for two decades.
But, in order to
explain performance relative to Japan and Germany, one would have to
argue that the euro and the yen have been undervalued, which makes no
sense.
In fact, the employment generated by the tradable sector
has been in services at the upper end of the distributions of
value-added per person, education and income. As a result, growth and
employment in the tradable sector have gone separate ways, with healthy
growth and stagnant employment.
In Germany, by contrast, the tradable sector is an employment engine. The same is true of Japan.
The
US economy's distinctive features for at least a decade prior to the
crisis that began in 2008 were an unsustainably high level of
consumption, owing to an illusory wealth effect, under-investment
(including in the public sector), and savings that fell short of the
investment deficiency. That excess household and government consumption
fuelled the domestic economy and much of the global economy as well.
In
several European countries that now confront fiscal and growth
challenges, the pattern was somewhat different: most of the excess
consumption and employment was on the government side. But the effect
was similar: an unsustainable pattern of income and employment
generation, and lower productivity and competitiveness in these
economies' tradable sectors, leading to trade deficits, stunted GDP and
weak job creation.
One could argue that the euro has been and
still is overvalued, and that this has hindered many eurozone economies'
productivity relative to non-eurozone countries. But the relative
productivity deficiencies within the eurozone are more important for
growth and have nothing to do with the exchange rate.
Excessive focus on currencies
The
focus on currencies as a cause of the West's economic woes, while not
entirely misplaced, has been excessive. Developing countries have
learned over time that real income growth and employment expansion are
driven by productivity gains, not exchange rate movements. This, in
turn, requires public and private investment in tangible assets,
physical and telecommunications infrastructure, human capital and
skills, and the knowledge and technology base of the economy.
Of
course, it is possible for a country's terms of trade to get out of line
with income and productivity levels, requiring a rebalancing. But
resetting the terms of trade is no substitute for tackling the
structural underpinnings of productivity.
None of this is
peculiar to developing countries. Under-investment has long-term costs
and consequences everywhere. Excess consumption merely hides these costs
temporarily.
In the United States, productivity deficiencies
have led to a pattern of disconnection from global supply chains. So the
challenge for America is not only to restore productivity, but also to
restore its links to the main currents of world trade.
China's
growth and, more generally, that of the major emerging economies
provides a substantial potential tailwind. That is certainly true
nowadays for Germany, Japan and South Korea. The United States and
others can take advantage of it as well, but only if productivity
relative to income levels in specific areas of potential competitiveness
begin to rise.
As long as America's economic policy remains
focused primarily on deficits, domestic demand, exchange rates and
backsliding on trade openness, its investment deficiencies will remain
unaddressed. That means that its employment and income distribution
problems will remain unaddressed as well.
The good news is that,
at a deep level, incentives across advanced and developing countries are
aligned. The emerging economies would like nothing more than the
restoration of sustainable patterns of growth in the advanced economies,
and are prepared to be cooperative players in that process. But
focusing on these countries' exchange rates is not the right way to go
about it. - Project Syndicate
●Michael Spence, a Nobel
laureate in economics, is professor of economics at New York
University's Stern School of Business, distinguished visiting fellow at
the Council on Foreign Relations, and senior fellow at the Hoover
Institution, Stanford University. His latest book is The Next Convergence The Future of Economic Growth in a Multispeed World ([You must be registered and logged in to see this link.]