Rising renminbi, not inflation, holds key

By Mark Williams (China Daily)
Updated: 2011-05-05 13:37
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China's struggle with rising prices is reverberating around the world. Domestic inflation is the highest in nearly three years. Wages are increasing at a double-digit annual pace. It is no wonder that many are asking whether the era of China as a low-cost producer for the world is at an end.

The thought makes some nervous. Cheap imports from China have helped keep price pressures low in many countries. But higher wages and rising export prices in China may actually benefit its trading partners and would arguably leave the country better off as well. Continued rapid wage increases would help shift more of China's income into the pockets of its workers.

This, in turn, would support the development of a more sustainable, consumption-oriented model of economic growth. The United States and Europe would see their trade deficits with China shrink as Chinese goods became less competitive and as their exports to China picked up, providing a boost to employment.

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But a close look at recent developments reveals that expectations of such a shift are premature. China's inflation has mainly affected food prices. That matters to Chinese consumers who spend a significant share of their income on food. But food products make up a tiny fraction of what China sells to the rest of the world. Whether or not China is exporting inflation or becoming less competitive depends on what is happening to prices of goods that it exports.

We need to be careful when measuring export price inflation. The usual approach is to track the price of the "average" export. But this can be deeply misleading, particularly for a country like China. Its exports are far more sophisticated today than a few years ago, both because China has become the preferred base for companies assembling goods made from high-tech components produced elsewhere and because Chinese enterprises have increased their own technical abilities. The fact that average prices have risen tells us nothing about what has happened to prices of individual goods.

What we need is a measure that compares like with like and adjusts for the changing composition of China's exports through time. Fortunately, the US government does just that when it calculates the price of US imports from China. This measure is not a perfect guide to China's overall export since US purchases may not be exactly the same as those for the rest of the world. But it should be pretty close.

US figures show that the renminbi price of China's exports to the US is actually about 2 percent lower today than a year ago and that, in fact, prices have been falling at that rate or faster for most of the last five years.

How can this be when wages are rising so fast? Simple. China's firms are becoming much more productive, too. Each worker is taking home more pay but the wage bill for each crate of goods sold has been flat or falling. In fact, productivity has risen so rapidly that export prices in US dollars have increased only 8 percent since 2005, even though the renminbi has risen more than three times as fast.

The upshot is that China remains firmly entrenched as the world's low-cost producer despite current inflation troubles and rapidly rising wages. But there are two other ways in which China and global inflation are entwined.

The first is through China's role in pushing commodity prices higher. Given its current momentum, China's economy should be able to take these cost increases in its stride. Not so with other major economies where recoveries are already faltering. In these places, high commodity prices are eating into the disposable incomes of workers who are already rattled by high unemployment levels. High commodity prices may also prompt policymakers to raise interest rates earlier than they would otherwise have done.

The second link is through Chinese policymakers' reaction to domestic inflation concerns. Senior figures have been dropping hints over the last few weeks that officials will allow the renminbi to revaluate faster to limit the pass-through from high global commodity prices to the domestic economy.

Measured in dollars, US imports from China today cost only 3 percent more than a year ago. But if policymakers follow through, the price that foreigners pay for Chinese goods will rise by more in the months ahead. Anyone worried about China exporting inflation should be watching the renminbi rather than the current level of China's consumer price inflation.

The author is a senior China economist at Capital Economics, a London-based independent macroeconomic research consultancy.

Rising renminbi, not inflation, holds key