It’s about Hu, not yuan
By Yinghua Zhu and Marc ChandlerThe Russian despot Vladimir Lenin was a big fan of Frederick Taylor, an American whose scientific management principles revolutionized the labor process by boosting output, albeit often at the cost of worker dehumanization. Taylorism is not about capitalism per se, it is about efficiency, and apparently good communists can respect that.
As Taylorism was adopted by the Soviet Union, so too, it appears, “Fordism” may be coming to China. Fordism refers to a type of political economy that recognizes, despite great disparities in power between workers and owners/management, workers need to earn high enough wages to purchase the goods that are being created in order to complete the production cycle.
The financial impact of the Euro’s decline over the past six months has prompted European officials to dial back their calls for Chinese yuan appreciation (Figure 1). While the U.S. Treasury appears to be embracing a multilateral effort (e.g., via the IMF and G20), many in the U.S. Congress are preparing to escalate their case for yuan appreciation, perhaps (if it is not too cynical) as the November mid-term elections approach.
Unfortunately, the focus on bilateral exchange rates makes for poor economics and poor policy and investment strategy, even if it plays well in Peoria. The large U.S. trade deficit with China (and its larger trade deficit with the rest of the world) is not simply a function of exchange rates, but is rather a result of investment, savings, consumption patterns, and corporate strategies, which include the division of labor brought about by globalization.
Value-added Although many pundits refer to China as the “factory of the world,” it might better described as the “assembler of the world.” While last year China was the world’s biggest exporter, it was also one of the world’s biggest importers. China does not simply import raw materials and commodities; it also imports parts and semi-finished goods, which it then assembles.
Those imported raw materials and commodities are largely invoiced in U.S. dollars, as are the parts and semi-finished goods. The cost of these inputs is estimated to be about 25 percent of the price of the finished good. Another quarter of the price can come from the value-added in the assembly work, which is the only part that is sensitive to the value of the yuan.
The other 50 percent of the price of the imported Chinese good is incurred locally in the U.S. for storage, shipping, and marketing. Of course, each of those middlemen also earn a profit. The fact that only a small part of the price of the Chinese-made goods is impacted by the value of the yuan means that nearly any reasonable currency appreciation will be insufficient to balance the accounts.
Some U.S. politicians like to cite extreme estimates that the yuan is as much as 40 percent undervalued vs. the dollar. But the discrepancy between U.S. and Chinese manufacturing wages represents an even more profound gap. Chinese manufacturing wages are about 3 percent of manufacturing wages in the U.S.
The impact of a 40-percent appreciation of the yuan on the price of a Chinese good would be limited to the increased cost of the value-added component of that good — that is, the wages of the Chinese manufacturing worker. Everything else being equal, it would raise the price of a Chinese-made good by 10 percent. However, Chinese manufacturing wages would still be only 4.2 percent of U.S. wages, and the imbalance would remain. A sharp appreciation of the yuan would also reduce import prices, and therefore likely offset the impact on wages.
Experiences in other countries, such as Japan and Germany in the 1970s, suggest a strengthening currency will make the life of many low-cost manufacturers difficult, and in these circumstances whether a country can upgrade its value-added would be a key factor to determine its future competitiveness.
For the complete article, see the September 2010 issue of Active Trader magazine. Click here to subscribe.
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