Another Reason for China to Go Slow on Yuan Revaluation

JUNE 29, 2011   the wall street journal

The U.S. and other of China’s largest trading partners have been arguing for years now that revaluing the yuan would be good for China’s economy. Sure, China might lose some jobs in the export sector as the yuan became more expensive in dollar and euro terms. But it would make up for that disadvantage by boosting the purchasing power of Chinese consumers — whose purchases would create jobs in other sectors of the economy, especially services.

A new International Monetary Fund report (pdf), however, warns China against expecting such a happy outcome.

A 10% increase in the value of the yuan,  adjusted for inflation, would reduce employment growth by 0.4 to 1.4 percentage points “across sectors except for agriculture,” calculate IMF economists Ruo Chen and Mai Dao.  Employment growth would slow not only in the export industry but in service industries too.

Why would appreciation cause an across-the-board slowdown in job growth? The authors say that services and manufacturing aren’t as distinct as they seem. The cost of exported manufactured goods includes a range of services, including banking, transport, retailing and energy. “Thus if  a real appreciation leads to a contraction in tradable sectors”—i.e., manufactured goods for export – “ the ensuing negative effect on demand for intermediate input can lead to a decrease in employment in non-tradable sectors as well.”

In other words, fewer jobs in the Chinese export toy business means fewer jobs in banks, trucks, utilities and wholesalers that supply the toy manufacturers.

The authors, who several times call their conclusion a “surprise,” say that they were looking at the short-term job effects. The work was conducted as part of the IMF’s annual review of China’s economy, which is due to be released in mid-July.

Over the longer term, some economists argue, China would be better off relying on domestic demand and service companies, rather than export companies whose fate is tied to the ups and downs of the U.S. economy. But, like all countries, China worries more about short-term employment effects than long-term theories about restructuring.

Currently, China is letting its currency rise about 0.5% a month against the dollar.  If China focuses even more on the job effects of its foreign-exchange rate policy, don’t expect a big change in the pace of change.

– Bob Davis