Is Chinese Mercantilism Good or

Bad for Poor Countries?

Dani Rodrik

CAMBRIDGE – China’s trade balance is on course for another bumper surplus this
year. Meanwhile, concern about the health of the US recovery continues to mount. Both
developments suggest that China will be under renewed pressure to nudge its currency
sharply upward. The conflict with the US may well come to a head during Congressional
hearings on the renminbi to be held in September, where many voices will urge the Obama
administration to threaten punitive measures if China does not act.

Discussion of China’s currency focuses around the need to shrink the country’s trade
surplus and correct global macroeconomic imbalances. With a less competitive currency,
many analysts hope, China will export less and import more, making a positive
contribution to the recovery of the US and other economies.

In all this discussion, the renminbi is viewed largely as a US-China issue, and the interests
of poor countries get scarcely a hearing, even in multilateral fora. Yet a noticeable rise in
the renminbi’s value may have significant implications for developing countries. Whether
they stand to gain or lose from a renminbi revaluation, however, is hotly contested.

On one side stands Arvind Subramanian, from the Peterson Institute and the Center for
Global Development. He argues that developing countries have suffered greatly from
China’s policy of undervaluing its currency, which has made it more difficult for them to
compete with Chinese goods in world markets, retarded their industrialization, and set
back their growth.

If the renminbi were to gain in value, poor countries’ exports would become more
competitive, and their economies would become better positioned to reap the benefits of
globalization. Hence, Subramanian argues, poor countries must make common cause with
the US and other advanced economies in pressuring China to alter its currency policies.

On the other side stand Helmut Reisen and his colleagues at the OECD’s Development
Centre, who conclude that developing countries, and especially the poorest among them,
would be hurt if the renminbi were to rise sharply. Their reasoning is that currency
appreciation would almost certainly slow China’s growth, and that anything does that must
be bad news for other poor countries as well.

They buttress their argument with empirical work that suggests that growth in developing
countries has become progressively more dependent on China’s economic performance.
They estimate that a slowdown of one percentage point in China’s annual growth rate
would reduce low-income countries growth rates by 0.3 percentage points – almost a third
as much.
To make sense of these two contrasting perspectives, we need to step back and consider
the fundamental drivers of growth. Strip away the technicalities, and the debate boils
down to one fundamental question: what is the best, most sustainable growth model for
low-income countries?

Historically, poor regions of the world have often relied on what is called a “vent-for-
surplus” model. This model entails exporting to other parts of the world primary products
and natural resources such as agricultural produce or minerals.

This is how Argentina grew rich in the nineteenth century, and how oil states have become
wealthy during the last 40 years. The rapid growth that many developing countries
experienced prior to the crisis was largely the result of the same model. Countries in Sub-
Saharan Africa, in particular, were propelled forward by the growing demand for their
natural resources from other countries – China chief among them.

But this model suffers from two fatal weaknesses. First, it depends heavily on rapid growth
in foreign demand. When such demand falters, developing countries find themselves with
collapsing export prices, and, too often, a protracted domestic crisis. Second, it does not
stimulate economic diversification. Economies hooked on this model find themselves
excessively specialized in primary products that promise little productivity growth.

Indeed, the central challenge of economic development is not foreign demand, but
domestic structural change. The problem for poor countries is that they are not producing
the right kinds of goods. They need to restructure away from traditional primary products
to higher-productivity activities, mainly manufactures and modern services.

The real exchange rate is of paramount importance here, as it determines the

competitiveness and profitability of modern tradable activities. When developing nations
are forced into overvalued currencies, entrepreneurship and investment in those activities
are depressed.

From this perspective, China’s currency policies not only undercut the competitiveness of
African and other poor regions’ industries; they also undermine those regions’ fundamental
growth engines. What poor nations get out of Chinese mercantilism is, at best, temporary
growth of the wrong kind.

Lest we blame China too much, though, we should remember that there is little that
prevents developing countries from replicating the essentials of the Chinese model. They,
too, could have used their exchange rates more actively in order to stimulate
industrialization and growth. True, all countries in the world cannot simultaneously
undervalue their currencies. But poor nations could have shifted the “burden” onto rich
countries, where, economic logic suggests, it ought to be placed.

Instead, too many developing countries have allowed their currencies to become
overvalued, relying on booming commodity demand or financial inflows. And they have
made little systematic use of explicit industrial policies that could act as a substitute for
undervaluation.

Given this, perhaps we should not hold China responsible for taking care of its own
economic interests, even if it has aggravated in the process the costs of other countries’
misguided currency policies.

Dani Rodrik is Professor of Political Economy at Harvard University’s John F.

Kennedy School of Government and the author of One Economics, Many Recipes:
Globalization, Institutions, and Economic Growth.