Bretton Woods system

What is WTO? China and the WTO: Questions/issues General Agreement on Tariffs and Trade (GATT, 1947-1994) What is WTO? 1947, Geneva, 23 (including China), now 148+ Most Favored Nation Principle (MFN) National Treatment Principle (NT) What are WTO’s rules and principles? Why did China want to enter? The World Trade Organization (WTO, 1995-) It deals with the rules of trade between nations at a global or near-global level. = GATT + Dispute settlement mechanism + others What had China promised? Why are there still trade frictions? © HKU ECON 0602 Larry QIU 3/153 © HKU ECON 0602 Larry QIU 4/153 Rules are set through negotiations NT MFN =

= 3% F D 3% ? Annual renewal © HKU ECON 0602 Larry QIU 5/153 Larry QIU © HKU ECON 0602 6/153 WTO/GATT negotiation rounds 120 predicted duration of Doha round The Sixth WTO Ministerial Conference, Doha Round was held in Hong Kong, China from 13 to 18 December 2005. Successful? Agreed to extend the talk 100 d ra n (m n s) u tio o th January 1, 2005? 39 months http://www. wto. org/english/thewto_e/minist_e/m in05_e/min05_e. htm Tokyo 60 regression line 40 Kennedy 20 Geneva 0 7/153 Torquay Geneva II 0 Larry QIU April 1, 2010: 102 months Dillon Annecy © HKU ECON 0602 Uruguay 80 © HKU ECON 0602 30 60 90 Larry QIU 120 number of participants

150 8/153 China’s WTO accession Agreement and implementation Bind all tariffs. The average tariff for industrial goods will fall to 8. 9% and to 15% for agriculture. Most tariff cuts will be made by 2004; all cuts will occur by 2010. Why enter? MFN status renewed every year DSB helps Implementation: tariff-rate quotas introduction How to enter? WTO re-entry (1986) Requirements (laws and policies to confirm with WTO rules) Negotiations (2/3 members’ support) Result? Dec 11, 2001 Limit subsidies for agricultural production to 8. 5% of the value of farm output and will not maintain export subsidies on agricultural exports.

Implementation: only in corn and cotton exports Within three years of accession, grant full trade and distribution rights to foreign enterprises (with some exceptions, such as for certain agricultural products, minerals, and fuels). Implementation: ok Conditions and promises (next slide) © HKU ECON 0602 Larry QIU 9/153 Agreement and implementation (cont’d) © HKU ECON 0602 Larry QIU 10/153 Agreement and implementation (cont’d) Provide non-discriminatory treatment to all WTO members. Foreign firms in China will be treated no less favorably than Chinese firms for trade purposes.

Dual pricing practices will be eliminated as well as differences in the treatment of goods produced in China for the domestic market as oppose to those goods produced for export. Price controls will not be used to provide protection to Chinese firms. Implementation: VAT export rebate Implement the Trade-Related Aspects of Intellectual Property Rights (TRIPs) Agreement upon accession. Accept a 12-year safeguard mechanism, available to other WTO members in cases where a surge in Chinese exports cause or threaten to cause market disruption to domestic producers. Implementation: textile export case Fully open the banking system to foreign financial institutions within five years.

Joint ventures in insurance and telecommunication will be permitted (with various degrees of foreign ownership allowed). Implementation: Restrictions and higher demand Implementation: new laws, but weak implementation © HKU ECON 0602 Larry QIU 11/153 © HKU ECON 0602 Larry QIU 12/153 Check China’s Implementation By the end of 2006, the U. S.

-China Business Council surveyed its members and reached the following conclusions Three general commitments and their implementations 2. Reforms promoting free trade (e. g. , tariff reduction) Implementation: very good, or even ahead of schedule 1. Reforms facilitating foreign business (e. g. retailing, local-content-requirement) Implementation: very good, almost full implementation (banking sector slower)

3. Reforms improving the transparency and predictability of China’s laws (e. g. , in foreign language) Implementation: good in laws but not so good in enforcement, especially in IPR protection © HKU ECON 0602 Larry QIU 13/153 Larry QIU 14/153 AUGUST 28, 2009, WSJ Chinese Tire-Import Spat Puts Obama in TradePolicy Pickle Trade frictions Recent trade frictions between China and the U. S. Dumping and antidumping in the world Is China’s antidumping retaliatory? © HKU ECON 0602 © HKU ECON 0602 Larry QIU 15/153

President Barack Obama has until Sept. 17 to rule on a U. S. International Trade Commission recommendation that the White House put a 55% tariff on low-grade car tires imported from China. The ITC's finding followed a complaint by the United Steelworkers that a flood of cheap Chinese tires in recent years had cost more than 5,000 union jobs. © HKU ECON 0602 Larry QIU 16/153 SEPTEMBER 14, 2009, WSJ China Strikes Back on Trade Beijing Threatens U. S. Chicken, Car Parts After Washington Slaps Stiff Tariffs on Tires SEPTEMBER 24, 2009, WSJ Paper Is Next Front in China Trade Fight PITTSBURGH

-- Three paper companies and the United Steelworkers filed an antidumping case Wednesday against China and Indonesia, making good on the union's threat to protect other U. S. industries after winning a recent trade decision against China. BEIJING -- China said Sunday it would review complaints about U. S. exporters' pricing of chicken and auto products after Washington's move to slap punitive sanctions on Chinese tire imports, raising tensions in a trade dispute ahead of two planned meetings between the countries' leaders. © HKU ECON 0602 Larry QIU 17/153 Larry QIU © HKU ECON 0602 18/153 Antidumping (AD) proliferation SEPTEMBER 27, 2009, WSJ

China Launches Probe into U. S. Chicken Imports During 1995-2006, 42 countries launched 3044 AD filings against 98 countries Developing © HKU ECON 0602 Larry QIU 19/153 © HKU ECON 0602 Larry QIU 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 400 350 300 250 200 150 100 50 0 1991 The ministry said Sept. 13 that it was examining complaints from domestic companies that some chicken-product imports were being dumped in the Chinese market and benefiting from subsidies, after the U. S. said it would impose duties of 25% to 35% on Chinese tire imports for the next three years. AD filings by reporting countries 1990 BEIJING

-- China's Ministry of Commerce said Sunday it is formally starting to investigate some "unfair" imports of chicken products from the U. S. , advancing a case it had first flagged two weeks ago. d eveloped 20/153 Asymmetry for a country as a plaintiff (X) and as a defendant (Y) 600 Change in the pattern of AD users (by level of development) China Y 90 80 70 60 50 40 30 20 10 00 200 Korea United States Taipei Japan Indonesia Thailand India Devel o pi ng © HKU ECON 0602 0 Devel o ped Larry QIU 100 200 EU 300 400 500 X 21/153 © HKU ECON 0602 Larry QIU 22/153

Question Examples: Before 1993, China exported about 1 million color TVs to EU each year, but after imposition of AD duty (44%), exports fell to 30,000 in 1999. In 1994, US imposed a 377% AD duty on Chinese garlic, which soon disappeared from the US market. In 1991, China exported more than 2 million bicycles to EC market. Beginning in 1993, EC levied 30. 6% AD duty.

Chinese bicycles have been almost entirely driven out of the market. © HKU ECON 0602 Malaysia South Africa Mexico Canada Turkey Poland Argentina Chile Czech New Zealand Venezuela Australia Bulgaria and Tobago Lithuania Philippines Pakistan Latvia Rica Israel Colombia Guatemala Egypt Uruguay Peru Trinidad Slovenia Ecuador Costa Paraguay Jordan Nicaragua 0 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 Brazil 1990 0. 0. 0. 0. 0. 0. 0. 0. 0. 0. 400 AD f i l i ngs i ni t i at ed by l evel of devel o pm ent Larry QIU What is dumping? What is anti-dumping? Why is China subject to so many AD investigation? 23/153

© HKU ECON 0602 Larry QIU 24/153 X The Economics of Dumping and AD Definition of dumping: selling a product at a price below the fair value. Based on cost Based on price Based on third-country reference Why will a firm practice dumping? Price $80? Cost $50 ? Cost $110? International price discrimination Reciprocal dumping in markets with monopoly Business cycle and capacity Predatory dumping Price $100 The welfare analysis of dumping © HKU ECON 0602 Larry QIU 25/153 v © HKU ECON 0602 Larry QIU 26/153 X Antidumping and the WTO Why anti dumping?

This is generally believed: Antidumping procedure Tariff substitution (protectionism) Domestic firms initiate and file a partition Evidence on dumping Evidence on damage caused by dumping Exporting country’s response Government’s decision Antidumping duty: level and duration -WTO trade liberalization process Safety-valve argument -insufficient safeguard mechanisms Strategically used or even abused -no strong control by WTO AD agreement The role of the Dispute Settlement Mechanism

© HKU ECON 0602 Larry QIU 27/153 © HKU ECON 0602 Larry QIU 28/153 Novel Chinese AD regulation China’s AD law 1995 An interesting questions Korea, Russia & Canada In general, there is no legal basis for “retaliation” in the use of antidumping actions. Article 56 : “Where any country (region) takes discriminative anti-dumping measures on the products exported from the People's Republic of China, the People's Republic of China may, upon the actual circumstances, take corresponding measures against the country (region)”.

© HKU ECON 0602 Larry QIU 29/153 Question #1: What factors determine China’s use of AD investigations: is it retaliatory? Answer: GDP, exchange rate, import penetration, retaliation (AD club, tit-for-tat, etc) Question #2: Is there any difference between China and the US? Answer: No. Larry QIU © HKU ECON 0602 30/153 China and the WTO: Answers Why China and the US comparison? Different country types What is WTO?

-China-new/developing -US-traditional/developed Significant AD users and/or targets 1947, to achieve global freer trade What are WTO’s rules and principles? MFN, NT, DSB -China launched 133 AD filings, among the top 5 new users-India(457), Argentina(219), South Africa(200), Brazil(134)

Most recent trade frictions: -China faced 536 AD filings, top 1 in the world -US launched 373, top 1 among developed countries Export quotas on rare earth export -US faced 175 AD filings, among the top 3 in the world- 95%, electronics, US>Japan>EU China(536),Korea(229) Re-entry, MFN, DSB Why China wanted to enter? Trade liberalization, market opening What China had promised? Export Subsidy: Why are there still trade frictions?

© HKU ECON 0602 Larry QIU 31/153 © HKU ECON 0602 Larry QIU Dumping and antidumping 32/153 Topics CEPA: Questions/issues China and the WTO China’s FTA: CEPA What is FTA? What is it?

Is it consistent with the WTO rules? An economic analysis of FTA Sino-US trade imbalance China’s exchange rate Export and employment © HKU ECON 0602 Larry QIU Free Trade Agreement Is CEPA consistent with WTO’s rules? How do China and Hong Kong benefit from CEPA? 33/153 © HKU ECON 0602 Larry QIU 34/153 © HKU ECON 0602 Larry QIU 36/153 China WTO: 2001-2002 China’s FTAs: CEPA (Closer Economic Partnership Arrangement) January 1, 2004. CEPA II: Jan 1, 2005. CEPA III: Jan 1, 2006. 273+713 (ALL) tariff free for HK products to China, while others still subject to as high as 35%. 18+8+23 HK services sectors entering China earlier than

other countries under China’s WTO promise. Agreements on investment trade, financial services and Zero Tariff tourism. Easy to operate http://gbcode. tdctrade. com/gb/www. tdctrade. com/econforu m/tdc/chinese/tdc051101c. htm © HKU ECON 0602 Larry QIU 35/153 Examples of FTAs China’s first FTA (free trade agreement). More than 10 now Debate in HK (2003) for the first one (the following two issues) Two questions (answer it later) Violating WTO’s MFN principle?

Why China likes it? HK: Zero tariff on China’s import. One country Gradualism Graduate to become strong banks by like HSBC © HKU ECON 0602 Larry QIU 37/153 European Communities (EC)

North America Free Trade Agreement (NAFTA) CEPA (China-HK), China-Singapore,…, China-ASEAN (Jan 2010) Future: Asia Pacific Economic Cooperation (APEC), China-Australia, Other forms Customs union Common market Economic union © HKU ECON 0602 Larry QIU 38/153 CEPA: FTA Welfare Analysis? Trade creation and Trade diversion Goods I: FTA Free flow Efficiency cost Goods II: CU Production Factors: CM Policies: EU = Tariff ?

HK = © HKU ECON 0602 Larry QIU 39/153 © HKU ECON 0602 Larry QIU 40/153 Made in HK? :Free trade on commodity FTA vs. MFN Article XXIV in GATT Why allow them? Rule of origin 30% or above value added in HK, including R&D and design. Company not necessarily located in HK Back to the two questions Trade creation vs. trade diversion Partial success Stepping stone or stumbling block? Non-member’s incentives ?? ?? ? ??

No trade Some FTA Global free trade Larry QIU © HKU ECON 0602 41/153 © HKU ECON 0602 Larry QIU 42/153 HK services? Can I bring i-pad and i-phone to China? News report 20% Tax Personal use – Register in HK Chinese citizen: 5,000 yuan tax free Foreign visitor: own use Smuggling ?? – Operation in HK for more than 3-5 years – Pay HK tax Business: Import Tariff free? – Employ above 50% local (HK) workers CEPA, rule of origin. Is i-phone HK product?

Why different for personal use and for international trade? Common: US-Canada border, Switzerland-Germany border Tax system (value added tax, sales tax, etc) – Any country’s company China case: Value added tax (17%) on imports Proof of origin © HKU ECON 0602 Larry QIU 43/153 © HKU ECON 0602 Larry QIU 44/153 X China’s other FTAs CEPA: Answers ASEAN (Association of Southeast Asia Nations)

Australia, New Zealand, Norway Thailand, Singapore Macao etc What is FTA? trade creation and trade diversion An economic analysis of FTA Is CEPA consistent with WTO’s rules? Taiwan ASEAN + 3 © HKU ECON 0602 Regional trade arrangement Inconsistent with MFN, allowed by WTO, How do China and Hong Kong benefit from CEPA? Special case Larry QIU 45/153 Topics © HKU ECON 0602 Larry QIU 46/153 Trade deficit: Questions/issues China and the WTO China’s FTA: CEPA What is the problem? How serious is it?

Sino-US trade imbalance What are the reasons? Is it a problem? China’s exchange rate Export and employment © HKU ECON 0602 Larry QIU 47/153 © HKU ECON 0602 Larry QIU 48/153 The problem Size and discrepancy U. S. Exports, Imports, and Balance of Trade with China, 1983-2005 It is quite incredible that while the negotiations of China’s accession to the WTO are greatly influenced by the deficit that the US runs in its trade with China, the actual size of the US-China bilateral trade deficit is not actually known!

It has also been brought out about RMB This session is to look at the problem and get some idea about the problem. Two basic questions Why large surplus/deficit? Why large discrepancy? Larry QIU © HKU ECON 0602 49/153 Larry QIU © HKU ECON 0602 50/153 Even sign is different Year US Data China Data 1988 1989 1990 1991 1992 1993 1994 1995 1996 -3. 5 -6. 2 -10. 4 -12. 7 -18. 3 -22. 7 -29. 5 -33. 8 -39. 5 © HKU ECON 0602 3. 3 3. 5 1. 4 1. 8 .3 -6. 3 -7. 6 -8. 6 -10. 5 Larry QIU Discrepancy

= US - China -6. 8 -9. 7 -11. 8 -14. 5 -18. 6 -16. 5 -21. 9 -25. 2 -29. 0 51/153 US data China data Discrepancy = US-China 1997 -49. 7 -16. 4 -33. 3 1998 -56. 9 -21. 1 -35. 8 1999 -68. 7 -22. 5 -46. 2 2000 -83. 8 -28. 7 -55. 1 2001 -83 -28. 1 -54. 9 2002 -103. 1 -42. 7 -60. 4 2003 -124 -58. 6 -65. 4 2004 -162 -80. 3 -81. 7 2005 -202. 30 -114. 2 -88. 1 2006 -234. 10 -144. 2 -89. 9 2007 -258. 50 -163. 3 -95. 2 2008 -268. 00 -170. 9 -97. 1 2009 -226. 88 -143. 4 -83. 5 © HKU ECON 0602 Larry QIU 52/153 How large is it?

Discrepancy is larger than Japan’s surplus! Question 1: Why large Sino-US trade deficit? Answer 1: FDI FDI: Motorola © HKU ECON 0602 Larry QIU 53/153 © HKU ECON 0602 Larry QIU 54/153 Question 1: Why large Sino-US trade deficit? Answer 2: Processing trade and world production fragmentation. More export Production fragmentation Processing trade: Nike, Gap © HKU ECON 0602 Larry QIU 55/153

© HKU ECON 0602 Larry QIU 56/153 Another example: iPhone Who export Barbie doll ? Counted wrongly solely china $. 65 materials $1 Mattel Inc. Plastic & hair Taiwan $. 40 paint Models pigments, molds Labor $. 35 for labor $. 10 services Cotton cloth $10 2 dolls are sold /sec worldwide !!! $2 HK Value Chain and implication for net trade? $. 50 packaging & other services Business, Gov’t & Macroeconomics 57/48 Another example Consequence: switching trade flows Shares of total US imports by country and country group 1990 ($491 b) China: 3% 2005 ($1,662 b) NICS: 5. 2% ASEAN: 5. 5% ??

China: 14. 6% Canada: 18% Canada: 17. 2% Rest of the world: 19. 3% EU: 17. 8% EI-15: 20% 59/153 Mexico: 10. 1% Japan: 18% Larry QIU Japan: 8. 3% NICS: 10. 2% © HKU ECON 0602 ASEAN: 5. 9% Mexico: 6% Rest of the world: 20. 9% © HKU ECON 0602 Larry QIU 60/153 Question 1: Why large Sino-US trade deficit? Why large overall trade deficit/surplus? Let us look at the Sino-US trade deficit in the context

of the overall US trade deficit. In 2006, China accounted for only 26% of the US trade deficits. Answer 3: Macroeconomic imbalances in the two countries It is the overall trade deficit/surplus, not just bilateral © HKU ECON 0602 Larry QIU 61/153 © HKU ECON 0602 Larry QIU 62/153 A tale of two countries Over a span of several years, a country (US) with a floating exchange rate can run an ongoing overall trade deficit for only one reason:

A domestic imbalance between saving and investment. China’s situation is just the opposite. National income identity S/Y Net domestic saving = S-I = [Y-(C+G)]-I C/Y = X-M = international lending I/Y Y=GDP, C=private consumption, I=domestic investment S/I G=government consumption, S=saving, X=export, M=import (X-M)/Y If not large deficit with China, it will be with some other countries

© HKU ECON 0602 Larry QIU china: save a lot, consume less, large trade surplus 63/153 © HKU ECON 0602 Larry QIU 64/153 © HKU ECON 0602 Larry QIU 65/153 © HKU ECON 0602 Larry QIU 66/153 © HKU ECON 0602 Larry QIU 67/153 © HKU ECON 0602 Larry QIU 68/153 © HKU ECON 0602 Larry QIU 69/153 © HKU ECON 0602 Larry QIU 70/153 71/153 © HKU ECON 0602 Larry QIU 72/153 Question 1: Why large Sino-US trade deficit? Two wrong arguments

(1) China blocks US exports Not convincing. US exports to China increased more than to other countries. © HKU ECON 0602 Larry QIU Question 1: Why large Sino-US trade deficit? Two wrong arguments (2) The Chinese government lowers the RMB value The Morrison and Labonte Report (2010) If China can continue its combination of lowcost labor and rapid productivity gains, which have been reducing export prices in yuan terms, its exports to the United States are likely to continue to grow regardless of the exchange rate regime, as evidenced by the 21% appreciation of the RMB from 2005 to 2008 which did not lead to any reduction in the trade deficit over that period.

Not convincing. Undervalue to all currencies © HKU ECON 0602 Larry QIU 73/153 © HKU ECON 0602 Larry QIU 74/153 Inport less Question 2: Why such a large discrepancy? Share of China’s Exports via HK (%) 60 Answer: The role of Hong Kong. Two issues are involved: First, the accounting of the Chinese good shipped to the US via Hong Kong; Second, the measurement of the value added by Hong Kong traders to these good. 50 40 30 20 10 0 86 90 91 92 93 94 95 96 97 98 99 © HKU ECON 0602 Larry QIU 75/153

© HKU ECON 0602 Larry QIU 0 1 76/153 China’s calculation US calculation The US Commerce Department records Hong Kong re-exports of Chinese products to the US as US imports from China, but Hong Kong re-exports of US products to China as US exports to Hong Kong, not China. This overstates US trade deficit. © HKU ECON 0602 Larry QIU 77/153 Before 1993. The Customs General Administrations of China recorded the re-exports from Hong Kong to the US as China’s exports to Hong Kong, rather than to the US. Since 1993.

China has gradually modified this approach to identify the final destination of its export to Hong Kong and treat the exports from China to the US via Hong Kong as China’s exports to the US. Larry QIU © HKU ECON 0602 78/153

Direct trade vs. re-export However, China is not able to identify all of the goods leaving its country and destined for the US via Hong Kong as exports to the US. $9 $7 This understates the US trade deficit. $6 $1 $8 HK $2 $1. 3 $1. 5 HK exports services: $2. 3 to US and $0. 5 to China © HKU ECON 0602 Larry QIU 79/153 © HKU ECON 0602 Larry QIU 80/153

The value-added of Hong Kong’s re-exports Calculation US calculation: $9 ? $7 ? $8 – $1. 3 = ? $7. 3 (deficit) China’s calculation (before 1993): $9 ? $7 = $2 (surplus) China’s calculation (since 1993): $9 ? $7 ? $6 + $2 = ? $2 (deficit) The US counts the total value of goods from Hong Kong, that originated in China, as Chinese exports, so that it is implicitly ignoring the value added in Hong Kong. For this reason, the trade deficit with China reported by the US is overstated. More accurate: $9 ? $7 ? $6 – $1 + $1. 5 = ? $3. 5 (deficit) US deficit: ? $7. 3 < ? $3. 5 < ? $2 © HKU ECON 0602 Larry QIU 81/153 Larry QIU

© HKU ECON 0602 82/153 Revised numbers Year US Data Thus, in order to estimate the “true” value of the deficit, it is necessary to compute the value-added in Hong Kong on goods shipped from China to the US, and also in the reverse direction. China Data While the markup or value-added on Hong Kong

re-exports of Chinese goods to the US fluctuates every year, the average markup is 29 percent of the re-export value. The markup on Hong Kong re-exports of US products to China is lower. © HKU ECON 0602 Larry QIU 83/153 © HKU ECON 0602 -. 7 -2. 6 -6. 3 -7. 7 -11. 7 -14. 7 -20. 3 -21. 6 -. 5 -2. 1 -5. 3 -6. 9 -11. 0 -12. 9 -14. 6 -15. 6 (-33. 8) 1988 1989 1990 1991 1992 1993 1994 1995 (-8. 6) Larry QIU Discrepancy = US - China -. 3 -. 4 -1. 0 -. 7 -. 7 -1. 7 -5. 6 -6. 0 (-25. 2) 84/153 Is this a serious problem? First, all serious observers acknowledge that, just as the official Chinese data grossly underestimate China’s surplus with the US, the US data substantially overstate that imbalance.

Second, bilateral trade imbalances are far less important than global current account positions, and viewing all economic partners together (Barbie example). © HKU ECON 0602 Larry QIU 85/153 Third, and perhaps most important politically, 90% of US imports from China were previously imported from other countries and only 10% displace production in the US. China has in essence been seizing market share from other economies, especially HK and Taiwan, both of which have shifted much of their export production to China.

The US in fact now runs substantial bilateral surpluses with HK and the deficits with Taiwan have fallen sharply as a result. © HKU ECON 0602 Larry QIU 86/153 Trade deficit: Answers Forth, China takes the position that the domestic value added of Chinese exports to the US is low. many of Chinese exports are of the “material processing” and assembly type; the actual distribution of the benefits of the China-US trade, as measured by the respective domestic valueadded, may well be in favor of the US despite the bilateral imbalance of gross trade in favor of China.

The proportion of value-added to gross value in the “material processing” and assembly exports of China has been estimated to be between 10 and 20 percent. © HKU ECON 0602 Larry QIU 87/153 What is the problem? Large and persistent bilateral imbalance How serious is it? Serious: large and discrepancy FDI, fragmentation, RMB, HK What are the reasons? Is it a problem? Bilateral vs. overall imbalance

© HKU ECON 0602 Larry QIU 88/153 Topics RMB: Questions/issues China and the WTO China’s FTA: CEPA Sino-US trade imbalance China’s exchange rate Export and employment The RMB issue How to choose between fixed and flexible exchange rate systems?

What are the arguments (theories) for RMB revaluation What are the arguments (theories) against RMB revaluation My prediction and the aftermath Larry QIU © HKU ECON 0602 89/153 © HKU ECON 0602 Larry QIU 90/153 If RMB is undervalued: Effects on the US? The history: Yuan/USD exchange rate Japan and US pressure (2004 and today): If the yuan is undervalued, there are likely to be both benefits and costs to the U. S. economy.

RMB undervalued, Let it float freely 8. 7 1 dollar buy 6yen -> 1 dollar buy 8 yen 2. 1% 8. 28 8. 11 Fixed at 8. 28 6. 83 Benefits (depending on the economic situation) 17. 5% 6. 66 2. 5% Today 1994 1996 © HKU ECON 0602 4/2004 7/2005 Larry QIU 9/2008 Cheaper Chinese goods Dampens inflation (if there is high inflation)

Cheaper Chinese inputs Chinese purchase of US Treasury securities, lowering US interest rate, increasing investment 6/2010 91/153 © HKU ECON 0602 Larry QIU 92/153 Costs (depending…) Hurts US import-competing industries, employment US exports more difficult, employment Export deflation (if deflation in the US. Japan’s case) It benefits some US economic sectors and harms some others, but A Yale University study estimated that the sum effect of the 25% RMB appreciation was estimated to a negative effect on U. S. aggregate demand and output and result in a loss of 57,100 U. S. jobs—less than one-tenth of 1% of total U. S.

employment This is just like trade liberalization A country benefits from improvement in its terms of trade (export price / import price) – a general conclusion from international trade theory © HKU ECON 0602 Larry QIU 93/153 © HKU ECON 0602 Larry QIU 94/153 X RMB Analysis Fixed vs. Flexible Fixed vs. flexible exchange rate system IMF (International Monetary Fund), 1947 SDR (special drawing rights) Bretton Woods System:

Fixed Collapsed in 1973 (Nixon): Floating Is the yuan undervalued? Arguments for revaluation/flexible Arguments against revaluation/flexible My prediction and the aftermath © HKU ECON 0602 Larry QIU Fixed: stability Floating: efficiency Exchange rate stability Fixed to USD USD fixed to Gold US finance wars trade deficit other countries accumulate lots of USD All sell USD buy gold Managed float: market force combined with government intervention 95/153 © HKU ECON 0602 Larry QIU 96/153 X How to fix it?

Consequences of fixing Floating: International balance of payments The relative demand for the two countries’ goods and assets would determine the exchange rate: U. S. Fix: The government (central bank) buys and sells to fix the rate (open market operation): Thailand Easier by restricting market participants (convertibility,

free capital mobility): China Fix to a basket or a single currency: China Currency board system HK Monetary Authority HSBC, Standard Charters, Bank of China HK$7. 8/US$ © HKU ECON 0602 Larry QIU 97/153 RMB undervalue © HKU ECON 0602 Larry QIU 98/153 X 2. 65 Trillion FDI too China has become (since 2006) the world’s largest holder of foreign exchange reserve Maybe 72% of China’s reserves in US assets. Oct 2010

© HKU ECON 0602 Larry QIU Too much? 99/153 © HKU ECON 0602 Larry QIU 100/153 ******** Impossible Triangle Independent monetary policy USA ALL ? Free capital mobility RMB Analysis Fixed vs. flexible exchange rate system increase efficiency Is the yuan undervalued? Money supply and interest rate Arguments for revaluation/flexible Arguments against revaluation/flexible My prediction and the aftermath Fixed exchange rate system © HKU ECON 0602 Larry QIU 101/153 Arguments and Theories

© HKU ECON 0602 Larry QIU 102/153 Annual GDP growth rate comparison 14 1. The economic fundamental approach 12 10 Productivity, GDP, the basic value of a currency China’s relatively stronger economic growth over a long period of time 8 China US 6 4 2 0 94 95 96 97 98 99 0 1 2 3 4 5 6 7 © HKU ECON 0602 Larry QIU 103/153 © HKU ECON 0602 Larry QIU 104/153 Here it is 2.

The PPP approach The Economist conducts a worldwide survey of the prices of a “Big Mac” Foreign currency for international trade: international arbitrage leads to purchasing power parity One dollar should buy the same thing in the US and China http://www. oanda. com/products/b igmac/bigmac. shtml What is the thing? http://www. angelfire. com/id/SergioD aSilva/bigmacppp. html Larry QIU © HKU ECON 0602 105/153 © HKU ECON 0602 Larry QIU 106/153 2003 Some “Meaty” Evidence on PPP = Local price / $ price PPP Exch.

Rate Actual Exch. Rate 2. 32 1. 37 +69 262 2. 19 96. 7 120 -19 HK 11. 50 1. 47 4. 24 7. 80 -46 China 9. 90 1. 20 3. 65 8.

28 Problem with the Big Mac estimation Under/ Over Value 4. 59 Problem with PPP -56 Local Price $-Price USA 2. 71 2. 71 Switz. 6. 30 Japan © HKU ECON 0602 Larry QIU Non-tradable 94% of the value comes from services associated with the hamburger Not a good prediction, but it is related with the income level 107/153 © HKU ECON 0602 Larry QIU 108/153 X Price Levels and Real Incomes, 1996 An empirical regularity: When expressed in terms of a single currency, countries’ price levels are positively related to the level of real income per capita. Why? Nontradables tend to be more expensive (relative to tradables) in richer countries.

Why? Balassa-Samuelson theory: In poor countries, low labor productivity in the tradables sector, low wage rates, and so low price of nontradables. Larry QIU © HKU ECON 0602 109/153 X © HKU ECON 0602 Larry QIU 110/153 X Rich Poor wage > wage Big Mac Currency: 3. 65yuan/$ World Bank estimation: 4. 77yuan/$ Taking income levels into consideration, Jeffrey Frankel estimated that RMB was undervalued by 36% in 2000, and more in the next few years. price Non Tradable > price Non Tradable Other studies: various results. Similar Price Tradable © HKU ECON 0602 Larry QIU Tradable 111/153 © HKU ECON 0602 Larry QIU 112/153 3. The asset