The Facts About China’s Currency, Chinese Subsidies……………..

Posted by- Aerospace Diary

Oct 6, 2011

Excerpts from-

The Facts About China’s Currency, Chinese Subsidies……………..

by Derek Scissors, Ph.D. The Heritage Foundation

There is great concern in the U.S. about Chinese currency policy costing American jobs. But over two decades, there has been no evidence that a weak yuan causes high American unemployment, writes Scissors.
Policymakers should focus on is other Chinese actions that do harm the entire global economy, particularly China’s market-distorting and anti-competitive subsidies.
Scissors explains why the U.S. must identify and measure Chinese subsidies as the necessary first step in reducing the damage they cause.

There is persistent concern in the U.S. that Chinese currency policy is costing American jobs. The main argument is that jobs are lost because China’s currency, the yuan, is weak- it is not worth enough as compared to the dollar, giving Chinese companies an unfair price advantage in international trade. 

There is no genuine evidence to support this claim. Over the past 20 years, U.S. unemployment has been low when the yuan is weak and high when the yuan is strong. It has been so because American, not Chinese, policies determine unemployment levels. The yuan is incidental. Congressional action to punish China for its exchange rate policy, such as that now being considered, will do nothing to create jobs in the U.S.

There are Chinese actions that do harm the U.S. These same policies also harm the rest of the world. The most damaging can be grouped under the mantle of subsidies. 

It is unwise to get into a battle of subsidies with the People’s Republic of China (PRC). Beijing has myriad ways to intervene in the market, starting with simply telling companies and banks what to do. The ability to order firms to act, using laws made at the whim of the Communist Party, is the heart of the biggest of Chinese subsidies: protection against competition through tight regulatory control of market entry and exit. 

State-Dominated Industries in China
The combined market share of importers, foreign firms based in the PRC, and Chinese private companies is not permitted to expand beyond a certain, often minimal position. There are other examples of regulatory favoritism but there is no greater subsidy than assured market share, in this case of a large market. Further, while SOEs are said to compete with each other, the competition can be difficult to recognize. Under the current government, a huge group of protected SOEs—very large and centrally controlled—and smaller but much more numerous provincial SOEs can never lose a competition because they are never permitted to go bankrupt. 

Traditional Subsidies

The second set of subsidies stems from a financial system rigged to boost SOEs. Access to domestic securities markets is heavily biased in their favor. Due to government-controlled interest rates, ordinary depositors now receive less on their savings than they pay in inflation—negative real returns. Banks gain from this low payout but themselves can only charge for borrowing at roughly equal to the rate of inflation. Banks also must place reserves at the central bank, the People’s Bank of China, at very low yields, costing revenue.

The warped financial system is the second force creating the imbalance between investment and consumption. The ability to borrow at no cost drives up investment. The return on saving is negative. Yet people must still save for housing, education, health, and retirement, so savings rates are high and consumption correspondingly limited. Here, too, Chinese subsidies do not just cause massive problems for competing firms, they weaken the global economy.

Land has become an important subsidy. Land is in principle state-owned, so that acquiring land for expansion is easy and comparatively cheap for most SOEs. The size of this subsidy is growing rapidly because land value in the PRC has soared in the past few years. China’s currency policy also acts as a subsidy, but not an important one for the U.S. The yuan is pegged to the dollar, so the dollar cannot fall against the yuan at the same speed it has against other currencies. This is what is meant by the yuan being “artificially weak.” 

Unfair Competition

China has multiple sources of genuine competitive advantage, but many firms do not profit from these. They are suppressed to ensure the dominance of SOEs, whose advantages are not market-based. When competing in the Chinese or global markets, private Chinese firms, multinationals based in the PRC, and foreign companies in home or third markets face an unbalanced fight.

Conclusion: First, Assess Subsidies

There is a long-running debate over where the U.S. should focus its efforts on encouraging China to resume market reform of its economy. The debate has caused American policy to be distracted and ineffective and it is past time for it to end. The yuan-dollar exchange rate is not important to the performance of the U.S. economy. Issues such as protection of intellectual property certainly matter but subsidies, when properly defined and understood, are the core problem. They block exports to China, distort imports from China, harm foreign companies operating in China, and unbalance the entire world economy. 

What to do first should also be an easy decision. No action will be successful until the U.S. has a reasonable and formalized understanding of the full set of Chinese subsidies, especially protection against competition. The evaluation should start as soon as possible. With that, multilateral and bilateral negotiations at least gain the prospect of being fruitful. If both the PRC and the WTO prove unable or unwilling to act to curb subsidies, the U.S. will then face the truly difficult decision of how best to limit their damaging effects.