China Needs a U.S. Lesson: Alberto Alesina and Luigi Zingales

Tear down this Chinese wall.

In his famous 1987 speech in Berlin, U.S. President Ronald Reagan delivered the exhortation to Soviet leader Mikhail Gorbachev: “Tear down this wall.” Contrary to everybody’s expectation, the wall started to come down only two years later.

It is about time to give the same directive to communist China. The Chinese wall is metaphorical, but equally hideous: It limits freedom of expression, assembly and movement. It prevents the Chinese from pursuing their happiness and choices freely. If there weren’t enough moral and humanitarian reasons to make that exhortation, here is an economic one: The lack of freedom in China is the main cause of imbalances in the world.

It is well-known that the Chinese trade surplus, or the excess of its exports over its imports, is the counterpart of too much saving, which leads to unfair advantages and possibly deflationary pressure on a global scale.

The causes of this imbalance, and the potential remedies, are disputed. The prevailing view is that it is due to China’s undervalued currency. By keeping the yuan artificially low, the argument goes, the Chinese are dumping underpriced products on Western markets, wiping out the competition unfairly. It is incumbent upon the Chinese government, the reasoning continues, to stop manipulating its currency and let it strengthen.

Cost Advantage

This theory doesn’t explain two facts. First, the Chinese cost advantage in the products they export exceeds the 20 percent to 30 percent difference that a stronger yuan could achieve. In this situation, a currency revaluation may mean Americans will pay more for Chinese imports, without reducing the amount imported by very much. The dollar’s real effective exchange rate is now almost as low as it has ever been since the end of the Bretton Woods currency-exchange system.

Why then does China export so much more than it imports? The answer comes from simple accounting. For every country, the current account is equal to the difference between the income produced and the sum of domestic investment and consumption. When a country consumes and invests less than it produces, it is bound to have a current-account surplus.

In the case of China, a country that grows 9 percent a year and invests 43 percent of its gross domestic product, it is hard to argue that it invests too little. But it is very easy to argue that it saves too much: 54 percent of GDP versus an average of 33 percent among developing countries and 17 percent among Organization for Economic Cooperation and Development economies. So China’s surplus is due to its excessive saving, not to its undervalued currency.

Citizen Preferences

How can we deem Chinese savings excessive? In a free country, the aggregate consumption-saving decision is the result of individual choices, which reflect the preferences of its citizens. It would be very paternalistic of us to argue that savings are excessive.

The point, though, is that China isn’t a free country and the economic decisions of Chinese aren’t driven by market forces. They are influenced by political decisions made by a small self-appointed elite. This group has decided that the accumulation of claims on the rest of the world is more important than the standard of living of the current generation.

The excess savings don’t reflect the will of the Chinese people. Most of it doesn’t come from household savings, but from the corporate sector, especially government-owned enterprises.

American Steaks

At the same time, Chinese wages are kept low by preventing labor from organizing and limiting the flow of information. Not only does this provide an unfair advantage to Chinese producers, but it prevents Chinese workers from having the resources to buy American steaks and iPods.

A redistribution of income would benefit the Chinese people and the world alike. Income inequality in this workers’ paradise is among the highest in the developing world. In addition, some more generous social-security system -- now almost non-existent -- for Chinese families would lower their precautionary savings.

The U.S. government should stop bashing China for its currency policy, while the Federal Reserve engages in massive quantitative easing. It’s hypocritical and leaves the Chinese with an easy way to respond. Instead the U.S. should regain the high ground and lecture them on what’s best in America: freedom.

Accusing communist China of keeping workers’ salaries artificially low and not being pro-workers would embarrass the nation’s government. Learning from Reagan, we can stand on our beliefs. If we do, the Chinese wall will come down sooner than we expect.

(Alberto Alesina is a professor of economics at Harvard University. Luigi Zingales is a finance professor at the University of Chicago Booth School of Business. The opinions expressed are their own.)

To contact the writer of this column: Alberto Alesina at aalesina@harvard.edu Luigi Zingales at luigi.zingales@chicagogsb.edu

To contact the editor responsible for this column: James Greiff at jgreiff@bloomberg.net

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