November 10th 2007

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Articles from this issue:

COVER STORY: Farmers' protest in Canberra over national water plan

EDITORIAL: Howard and Rudd - the Coke vs. Pepsi election?

RURAL CRISIS: Crocodile tears and hand-wringing over drought

CANBERRA OBSERVED: Why voters have turned on John Howard

INTERNATIONAL TRADE: China's aggressive trade strategy pays off

FOREIGN INVESTMENT: Risk for Australia in dependence on China

PUBLIC AFFAIRS: Overdue steps to ensure open government

STRAWS IN THE WIND: Victoria's hospital fiasco / Shooting fish in a barrel / Misreading America

POLITICAL IDEOLOGIES: How family-friendly is the free market?

DRUGS POLICY: Illicit drugs and the federal election

REPRODUCTIVE HEALTH: Exposing the abortion-breast cancer link

OPINION: A Rudd election win will be a disaster

OBITUARY: A Labor Party statesman remembered - Hon. Kim Edward Beazley Snr. AO (1917-2007)

AS THE WORLD TURNS: Christian foster-parents face deregistration / Marital status and poverty - study

BOOKS: CREATORS: From Chaucer to Walt Disney, by Paul Johnson

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China's aggressive trade strategy pays off

by Colin Teese

News Weekly, November 10, 2007
China has been able to increase its exports and accumulate massive foreign-exchange reserves by ignoring free-market orthodoxy and ruthlessly pursuing its national self-interest, reports former Australian senior trade negotiator Colin Teese.

United States pressure is mounting on China to relax its iron grip on the Chinese currency. This is not altogether surprising, given that the US economy could be heading towards a downturn - some even hint at the possibility of recession.

But that's not the only thing driving the US preoccupation with the value of the Chinese currency. Behind it all stands multilateral trade theory - or, rather, not so much "theory" as dogma built around the notion of market-based, non-interventionist economic and trade policies.

The opposite view is the extreme interventionists' belief that individual countries are best served by bilaterally balanced trade flows. That is to say, each trading country would seek to limit the value of its purchases from any given trading partner to the value of its exports to that same country. This thoroughly protectionist position is now largely discredited. And no wonder. It suffers from the obvious weakness that bilateral balancing can sometimes seriously limit overall trade flows to the disadvantage of all countries participating in international trade.

Overall balance

Imbalances in the value of trade between individual countries are not necessarily harmful, so long as individual countries are able to achieve overall balance. Under such a system it is perfectly acceptable to run a trade deficit with one or more trading partners, providing that these deficits are offset by surpluses with other partners.

Under this arrangement no country would be disadvantaged, and the possibility exists for overall trade flows to be larger than they would otherwise be. Thus was given rise to what became known as a "multilateral balancing" system of international trade, although it was probably unfortunate that it was marketed as a "theory of international trade".

Thinking economists always recognised, right from the start, that, in practice, perfect "multilateral balancing" would be difficult to achieve year in year out. Individual national economies, even in the developed world, were hardly ever growing at the same pace. On the other hand, it made no sense to hold back growth in international trade to the pace of the slowest-growing economies.

Almost inevitably, such economies, at the beginning of their growth phase, would need more imports than could immediately be funded from exports. Capital imports from more developed economies became the obvious means of funding imports not covered by export income. Providing always that the imported capital was used for productive purposes rather than consumption, it was a healthy outcome.

But there was always one obvious flaw in the system. As sceptics pointed out, it did not deal with the problem of the successful exporters in developed economies consolidating their price advantages into permanent and unshakable market power. The theorists dismissed the criticism: they maintained that the system was self-correcting, so long as governments did not attempt to influence the relative value of their currencies.

How? If a country's exchange rate is not "managed" by its government, as that country's exports increase, extra demand for the currency by potential buyers of such exports will push up its value, and so the exchange rate. Paying more for the currency means paying more for goods from that source. In other words, the country's exports will become less competitive than before. And the more exports increase, the more the currency rises, and the more the exporting country loses its competitive edge.

That's the theory of what should happen. The only problem is it never does - not because the mechanics of the idea are flawed, but because the governments of newly-emerging economies won't allow it to happen.

However unpleasant it is to recall, economic history tells us that governments with economies growing on the back of exports always intervene for as long as they can to hold down the value of their respective currencies. If we look back to the start of the industrial revolution, we see that Britain did it - and only committed itself to the virtues of free trade after its industrialisation was consolidated. So did the United States.


Coming to more recent history, before China we have the examples of Germany after World War II and, a little later, Japan. Governments of both countries held their exchange rates down by intervention to ensure that their exporters maintained their newly-won competitive advantage for as long as possible.

When it became no longer possible to maintain a totally unjustified low exchange rate, it was only allowed to increase slowly. Moreover, simultaneous with such relaxation - as Japan, for example, became less competitive because of rising wage-rates and advancing standards of living - they began investing overseas to maintain their competitive advantage.

Because they mostly retained majority ownership of the manufacturing industries they set up off-shore, they continued to gather to themselves the same or greater national benefit from the return on these investments as if they had continued to manufacture at home. Over the years, both Germany and Japan have benefited enormously from such foreign investment income.

We can expect China will follow that example. It will resist all demands to relax control over its exchange rate. Over time, internal economic considerations will require that the government allow the exchange rate to rise. But China will decide the timing and pace of change.

Investing in the West

Meanwhile, we should expect it will begin investing its surpluses in productive capacities elsewhere. In the process, it will begin to accumulate foreign exchange from such investment. These accumulations we can assume will more than balance any losses which might arise from the consequence of having to allow the value of its currency to rise.

China will follow this well-trodden path because it is the proven route to economic wealth and power. We can already see signs that it is paying off.

Interestingly, Australia has never been able to do this. Or, more accurately, it has never tried.

There are a number of reasons for this. Free-marketeers will insist that is because we persisted with heavily protected industries which could not compete internationally. Unfortunately, that is a wholly distorted picture. First, our exporters of manufactures have never enjoyed the luxury of an exchange rate kept low by government intervention.

In part this is because, over the past quarter-century, successive Australian governments have chosen to deny our exporting manufacturers the benefit of an exchange-rate managed to this end. Instead, the movement in our exchange rate has become the plaything of the fluctuations in minerals commodity prices. Manufacturing exports are paying the price, and free marketeers are the first to applaud this consequence of government policy.

It is the firm belief of that group that nothing should be allowed to stand in the way of our minerals exports. Minerals, they insist, are the only area in which we enjoy a natural advantage. Manufacturing - and agriculture, for that matter - should only flourish if, like minerals, they can compete, unaided, against international competition.

It should be noted that this strategy towards the management of our international economic relations with the rest of the world has not been followed by any other developed country. Indeed, all of the developed economies have totally ignored this approach. The fact of their success should have been an example for us.

Instead, that successful model is one we have, under the influence of free marketeers, preferred to reject. It is of course true that, since we fully embraced the economic model of deregulation some 25 years ago, we have achieved a measure of economic prosperity. But even that was achieved only after 10 years of considerably difficult economic adjustment.

Moreover, the longer-term economic losses and gains have been distributed unevenly. Despite what we are told to the contrary, real unemployment - along with other negative economic indicators - is still reflecting the consequences of deregulation. And the levels of economic well-being we are now experiencing result primarily from excessive borrowing for consumption and, more recently, from a boom in minerals exports.

Economic history surely warns us that well-being, thus driven, is unsustainable. At some stage mineral demand and prices will turn down - as they always do. And we will be compelled sooner or later to repay our debts.

How then, the more prudent among us may dare ask, will growth and prosperity - even as now measured - be sustained?

Interestingly, China and its continued growth strategy, based on cheap exports and a managed currency, are tied into our economic future. It is, after all, single-handedly driving the high minerals prices upon which we so heavily depend. So we have a vested interest in China continuing to resist the US and to maintain its low exchange-rate and thereby sustain its flow of cheap exports.

Our interest is obvious enough. But what about the US? Would it really help the US, in present circumstances, if the cost of Chinese exports were forced up by some minor move upward in the value of the yuan? Would it help deal with the US trade deficit? Probably not. It could even make it worse, if the only result was that import volumes from China remained unchanged but prices went up.

Chinese imports

What about US employment? Would a higher-value yuan allow US-based manufacturers to compete with Chinese imports? Hardly - since US wage rates are about 20 times greater.

The kind of change the US thinks it wants could actually make things worse.

Remember, at the moment China is using part of its trade surpluses to fund the US deficit. If its export income declines, its ability and incentive to do this will certainly be diminished. What we wish for is not always what we should get.

Our own Prime Minister's experience with his workplace relations agenda can no doubt attest to that.

- Colin Teese is a former deputy secretary of the Department of Trade.

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