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The author is a is a senior associate at the Carnegie Endowment for International Peace
As China and its trading partners continue to argue bitterly over manufacturing overcapacity and global trade, much of the discussion appears to be adversarial in nature.
Excess Chinese capacity in certain industrial sectors is a point of contention. Another problem is excess Chinese savings caused by suppression of domestic demand. These two issues are very different, but analysts and policymakers on both sides seem to be confusing them.
In the former case, Beijing has targeted certain industries it believes are strategically important, such as electric vehicles and solar panels, and implemented policies aimed at giving Chinese manufacturers a long-term competitive advantage in those sectors. There is nothing particularly Chinese about this strategy. Most major economies also employ measures to support or protect favored sectors.
Because these measures come at the expense of foreign manufacturers, they often provoke widespread outrage, but much of this reaction is self-serving. Comparative advantage, which determines the benefits of trade, means that some countries are able to produce certain goods more efficiently than others. Ultimately, the purpose of trade is to concentrate production in those countries that have a comparative manufacturing advantage.
However, comparative advantages only arise in the exchange of goods and not in their production. This is where the problem of excess Chinese savings arises. China’s structurally high domestic savings rate is the result of a decades-long development strategy that effectively transfers income from households to subsidize the supply side of the economy – the production of goods and services. Because of these transfers, household income growth long lagged behind productivity growth, leaving Chinese households unable to consume much of their output.
Some of these subsidies are explicit, but most take the form of implicit and hidden transfers. These include targeted loans, an undervalued currency, labor restrictions, weak social safety nets and overinvestment in transportation infrastructure. These various policies automatically force Chinese people’s savings. By effectively exporting excess savings through subsidizing the production of goods and services, China is able to externalize the resulting demand deficit.
The fact that China dominates certain manufacturing sectors is consistent with free trade and comparative advantage. It is excessive savings that is a problem for the global economy – and it should be noted that many countries besides China are behaving similarly, including Germany and Japan. The problem is that these excess savings represent a suppression of domestic wages and therefore domestic demand in order to achieve global competitiveness.
This is a classic trade policy in which unemployment – the result of a lack of domestic demand – is exported through trade surpluses. These surpluses have to be absorbed by trading partners, usually in the form of higher unemployment, higher budget deficits or higher private household debt.
For this reason, the political implications of the two issues are very different. The problem of excess savings can exacerbate the problem of excess capacity. Countries with trade deficits try to protect their economies from the excess savings of demand-deficit countries. This may take the form of restrictions on trade or capital inflows.
Beijing will undoubtedly continue to protect and support industries it considers strategically important, as will the US, the EU and the rest of the world. This will inevitably lead to conflict, increasing protectionism and widespread overcapacity in some sectors. In a well-functioning global trading system, countries produce goods in which they have a comparative production advantage and then exchange them for goods in which they do not have one. This means that the global economy is doing better, even if individual sectors are suffering.
However, if the purpose of exports is to externalize the problem of weak domestic demand, things can only get worse for the global economy, as John Maynard Keynes noted at Bretton Woods. The world must solve the problem of excess savings and unbalanced trade, even as individual countries separately compete for excess capacity and comparative advantage.