Imagine there is one very rich person in country A. He is capable of making tons of things through his own labor. Each year he exports so much to another country B. He makes a handsome profit out of it. There is no doubt that you suspect this young man is causing a potential trade surplus of country A. Absolutely, you are right. That is what we see in data. However, data are damned by fickle accounting standards. What if I suddenly tell you that young fellow has been revealed to be a citizen of country B instead? Then what he sells to country B is no longer exports (As Rachel correctly points out, from a GDP perspective it is still exports, but not from a GNP perspective. See the technical addendum for a discussion and justification)! If that is the only trade taking place, there is no trade surplus at all! This story shows how sensitive our Current Account (CA) deficits (you can think of this as trade deficit, properly defined) number are to citizenship definition.
Back to China. Many of the super wealthy are thinking of migrating out (for lots of reasons, sometimes for better education opportunities for their kids, which is linked to the story I told in the previous blog, but many times because what they earned is semi-legal via corruption). If this takes place, and there is indeed evidence it is beginning to take place, we could witness a big capital flow that will wipe out all the trade surplus accumulated in previous years. By that time, not only will appreciation pressure on
RMB disappear, but also there might be depreciation pressure.
Technical Addendum:
I have been sloppy about trade surplus and CA surplus. For one thing I wish not to introduce too much technicalities, and for another, I think CA account is the proper definition of trade account. Trade account, too narrowly defines what is trade. In some sense, CA surplus is the trade surplus with respect to GNP, but trade account is trade surplus with respect to GDP. GNP, in my opinion is a more appropriate measure, but in most cases, there is little difference between GDP and GNP.
In general it is the large CA surplus that is disturbing. If country A earn huge trade surplus, but that is balanced out in its equally gigantic payments on foreign investment, it is no big deal, it is just a very different trade structure in that country B exports its capital service.
In China's case, most people ascribe the CA surplus to trade surplus. What this blog aims to illustrate is that such a large trade surplus is not incompatible with a balanced CA account, if proper adjustment is made. The important piece here is not net factor payment, however, it is rather capital account, namely cash transfers, which will take place when citizenship changes. Capital account has been completely out of discussion since it is generally unimportant, but what I argue here is it is illuminating to consider this channel in China's case.
RMB disappear, but also there might be depreciation pressure.
Technical Addendum:
I have been sloppy about trade surplus and CA surplus. For one thing I wish not to introduce too much technicalities, and for another, I think CA account is the proper definition of trade account. Trade account, too narrowly defines what is trade. In some sense, CA surplus is the trade surplus with respect to GNP, but trade account is trade surplus with respect to GDP. GNP, in my opinion is a more appropriate measure, but in most cases, there is little difference between GDP and GNP.
In general it is the large CA surplus that is disturbing. If country A earn huge trade surplus, but that is balanced out in its equally gigantic payments on foreign investment, it is no big deal, it is just a very different trade structure in that country B exports its capital service.
In China's case, most people ascribe the CA surplus to trade surplus. What this blog aims to illustrate is that such a large trade surplus is not incompatible with a balanced CA account, if proper adjustment is made. The important piece here is not net factor payment, however, it is rather capital account, namely cash transfers, which will take place when citizenship changes. Capital account has been completely out of discussion since it is generally unimportant, but what I argue here is it is illuminating to consider this channel in China's case.
In terms of GDP, what that rich person (or his firm located in country A) sells to country B would still be exports (but not in terms of GNP) even after the citizenship change. When we speak of trade surplus, do we refer to goods and services leaving one territory for another, or do we rather mean wealth being transferred from one country to another?
ReplyDeleteFor US-based multinationals, the profits may go to the home country (the US) instead of staying in China, although they will face a higher corporate tax if they were to be remitted back home. Even if these profits were to stay in China, they remain in the hands of the capital owners. The example I had in mind was Apple's assembly lines in China. Even if Apple's products are labeled "made in China", the edge-cutting technology and development phase remain in capital-abundant countries, and Apple chooses to assemble in China only because labor is extremely cheap there. Therefore, China gains very little from this kind of vertical integration since the value-added is extremely low.
By the way, some of your arguments ring a bell, and I assume we've been inspired by the same person.
Wish I could be taking field courses in international, but I still have the first-year classes to get through. You are ahead of the game, and I hope to learn a lot from you! :D
I have updated the blog with a slightly more detailed discussion, thank you for pointing out my sloppiness. As for the point on transfer pricing. Yes, lots of money will flow to Apple US, but it does not contradict what I said. Allow me to discuss this in a more structural way. Suppose Apple sells all its products for 100 million. The cost of manufacturing (in China) is only 0.1 million and the cost for R&D (in US) is 50 million (apparently I am assuming market power, which is not unjustified here). So there is 49.9 million of profits, and a sensible way of distributing the 49.9 m is that most of it (49.9*50/50.1) will go to Apple US. That is my benchmark. What I conjecture is that lots of it actually remain in China. Even if 9.9m goes to China, this is what I consider transfer pricing. in data, however, you do see most money (in this case 90m) is remitted back home in the presence of transfer pricing.
DeleteI was sloppy in distinguishing between current account (CA) surplus and trade surplus. Allow me to clarify that.
ReplyDeleteIn general it is the large CA surplus that is disturbing. If country A earn huge trade surplus, but that is balanced out in its equally gigantic payments on foreign investment, it is no big deal, it is just a very different trade structure in that country B exports its capital service.
In China's case, most people ascribe the CA surplus to trade surplus. What this blog aims to illustrate is that such a large trade surplus is not incompatible with a balanced CA account, if proper adjustment is made. The important piece here is not net factor payment, however, it is rather capital account, namely cash transfers, which will take place when citizenship changes. Capital account has been completely out of discussion since it is generally unimportant, but what I argue here is it is illuminating to consider this channel in China's case.
In international class, we have only focused on very old theories, like ricardian model, and HO model (which is fun in itself but not too relevant for the topics I have been thinking about). Nothing new, trade imbalance is out of sight. In general, I found the current work on international things quite uninspiring, almost all the literature focuses on currency as the sole determinant of trade imbalances. the only paper I encountered that offers an alternative is by a little-known economist in University of Melbourne that talks about intertemporal explanation of trade imbalance. I took it seriously, and formalized with a model, which I then calibrated with data on China and it does explain about 30% of trade imbalance in china in benchmark case. Unfortunately, no one talks about it. I am curious where you have seen similar approaches to international trade, I am eager to find some economists who would work in similar directions.