China Radio: Deficits Can Be Good
We tend to think of the word “surplus” as something good, and “deficit” as bad. That’s certainly true in the United States, where budget and trade deficits have been concerns for years. But it’s also true in China, where recurring trade surpluses are seen as a sign of economic strength.
So it’s understandable, then, why a few readers seem to have misinterpreted my comments on China’s trade deficit for the month of March, in which I suggested the deficit may be “a blip on the radar screen” — part of a regular cycle rather than a lasting trend. They assumed I was saying China’s economy will be just fine despite running a deficit, and will soon get back on track. In fact, what I was saying is that many economists look at the March trade deficit as a hopeful sign that China may be restructuring its economy away from an overdependence on exports, towards more vibrant domestic consumer demand, but that it’s too early to draw that (positive) conclusion, given the seasonality of China’s exports and the likely composition of its surging imports (raw materials and components, rather than finished consumer goods).
I made this point a little more clearly in an interview I gave on China Radio International (CRI) a couple days ago, along with Peking University economist Cao Heping (you can listen to the report or read the transcript here):
In fact, [Professor Cao] goes on to suggest the deficit may not actually be a bad thing.
“For the rest of the world it’s good news because it can help China to contribute a little bit more towards the global recovery.”
Patrick Chovanec agrees with this point of view, suggesting that many international observers will see the deficit as a sign of reform within the Chinese economy.
“Many people are looking at this and hoping to see a trend towards rising consumption in China, particularly rising consumption of imports and more balanced trade, not just because it would benefit the US or Europe but because it would represent a significant structural adjustment for China to a more sustainable growth path in the future.”
It’s too early to say whether the trade deficit reported in March is a result of external factors or evidence of a more profound change in the Chinese economy.
It’s an important point I wanted to clarify here, not just because it cuts against reflexive impressions and popular misconceptions, but because it cuts to the core of the challenges currently facing the Chinese economy. There is widespread consensus, not just among economic commentators, but among China’s leadership, that China needs to move from an export-driven growth model to a domestic-demand driven model. You hear this mantra frequently repeated in the Chinese media. Yet there seems to be little practical realization of the real changes this implies for China’s economy. For the past thirty years, the Chinese, from high to low, have had a mindset that says “exports good, imports bad,” and “capital inflows good, outflows bad.” Thirty years ago, when foreign exchange was hard for the Chinese to come by, that mindset made sense. Today, China is drowning in foreign currency that it wants to earn, but doesn’t want to spend. The export-driven model has been a great success in bringing China to this point, but now China has outgrown it. Trade surpluses are no longer fueling much-needed investment, they’re fueling overinvestment, underconsumption, and inflation.
That’s why movement towards more balanced trade — even a deficit — would be a positive sign for China. A deficit would give China the opportunity to draw down on its massive foreign currency reserves, in order to improve real living standards rather than merely pile up dollar-denominated IOUs. But as I said, it’s too early to say whether that’s really happening or not. Time, and perhaps more revealing data, will tell.