Ask an Economist: The Value of the Yuan, part 2

C.P. Chandrasekhar

Triple Crisis Blog invited readers’ questions in advance of the April 24-25 IMF/World Bank meetings in Washingon. See all of the questions and answers here. A reader asked:

Q: There has been a lot of discussion recently about the over-valuation of the Chinese currency. How do we know how much it is overvalued? What would the implications be for US and Chinese workers if the government were to decide to devalue it?

Chandrasekhar: The argument really is that the Chinese currency is undervalued (because it is pegged to the dollar through central bank intervention) and needs to appreciate so as to make the dollar prices of Chinese exports higher and the RMB price of Chinese imports lower.

This is expected to reduce China’s exports and increase its imports and correct the imbalance in the form of current account surpluses in China and current account deficits in the US (for example).

One difficulty with the “under-“ or “overvaluation” argument is that it presumes that there is some equilibrium exchange rate at which the deficit or surplus on the current account of a country’s balance of payments would equal some predetermined and acceptable level of inflow or outflow of capital. However, in a world where capital flows are substantial and free, no such equilibrium exchange rate can be presumed to exist, since uncontrolled capital flows themselves tend to affect the exchange rate of a currency.

The real issue in the Chinese case is, however, different. Capital and technology are freely mobile across borders but labour is not. As a result, some developing countries are becoming locations for production of manufactures aimed at global markets because they have surplus labour and low wage costs.

These countries, then, are characterized by global productivity levels but low labour costs. This allows transnational and domestic firms located in China to outcompete US and other developed country manufacturers in their markets. What the demand for an appreciation of the Chinese RMB amounts to is that currency adjustment rather than labour flows should be used to correct for the low unit costs of production in China. If such appreciation does occur it would have negative consequences for Chinese workers. But it is unclear whether this would serve the interests of US workers, since capital would possibly just migrate to some other low wage developing country which would now become the leading exporter to the US.