Monday, April 25, 2005

Lau and Stiglitz: China's Alternative to Revaluation

by Calculated Risk on 4/25/2005 07:40:00 PM

In a Financial Times commentary, Lawrence Lau and Joseph Stiglitz argue that an export tax would be a better choice for China.

"If China were to contemplate a revaluation, it should consider as an alternative the imposition of a tax on its exports. Export taxes are generally permitted under WTO rules. Indeed, China has already moved in a limited way in this direction on textiles. There are several reasons voluntary imposition of a tax on its exports may be preferable to a renminbi revaluation. Both would have similar effects on Chinese exports - they would make them appear more expensive to the rest of the world. Because of this similarity, an export tax would provide an empirical answer to the question of whether a revaluation would work. But it would do this without some of the significant costs attendant on revaluation.

One of the advantages of an export tax is that, unlike a revaluation, it would not lead to financial losses for Chinese holders of dollar-denominated assets, such as the People's Bank of China or commercial banks and enterprises. China's central bank currently holds about $640bn (£334bn) in foreign exchange reserves. Assume that only 75 per cent is held in dollar-denominated assets. A renminbi revaluation of 10 per cent would result in a loss of $48bn or about 400bn yuan for the central bank.

Another cost of revaluation would be possible further deterioration in the distribution of income, including increasing the already large rural-urban wage gap. Revaluation would put downward pressure on domestic Chinese agricultural prices; an export tax would not. An export tax, by contrast, would have a beneficial side effect: it could generate substantial government revenue for China. Given the high import content of Chinese exports to the US, a 5 per cent export duty would be equivalent to a currency revaluation of some 15-25 per cent, generating about $30bn-$42bn a year.

Finally, an export tax would not reward currency speculators. It may even discourage the speculation that has complicated macro-economic management of China's economy. If potential speculators can be convinced that China would rather impose an export tax than revalue, less "hot money" will flow into China. By contrast, nothing encourages speculators more than a "victory", especially where, as here, it is likely to do little to correct the underlying problems."
It seems a 5% export tax would just increase the US trade deficit with China and might lead to more inflation in the US. I'll be interested in Setser and Roubini's views on this proposal!