PRINTED BY: XXXXXXXXXX. Printing is for personal, private use only. No part of thisbook may be reproduced or transmitted without publisher’s prior permission. Violators will beprosecuted.Is China a...

PRINTED BY: [email protected]. Printing is for personal, private use only. No part of thisbook may be reproduced or transmitted without publisher’s prior permission. Violators will beprosecuted.Is China a Neo­Mercantilist Nation?PageChina’s rapid rise in economic power (it is now the world’s second largest economy) has been builton export­led growth. The country takes raw material imports and, using its cheap labor, converts 156them into products that it sells to developed nations. For years, the country’s exports have beengrowing faster than its imports, leading some critics to claim that China is pursuing a neo­mercantilist policy, tryingto amass record trade surpluses and foreign currency that will give it economic power over developed nations. Thisrhetoric reached new heights in 2008 when China’s trade surplus hit a record $280 billion and its foreign exchangereserves exceeded $1.95 trillion, some 70 percent of which are held in U.S. dollars. Observers worry that if Chinaever decides to sell its holdings of U.S. currency, this could depress the value of the dollar against other currenciesand increase the price of imports into America.Throughout 2005–2008, China’s exports grew much faster than its imports, leading some to argue that China waslimiting imports by pursuing an import substitution policy, encouraging domestic investment in the production ofproducts such as steel, aluminum, and paper, which it had historically imported from other nations. The trade deficitwith America has been a particular cause for concern. In 2011, this reached a record $295 billion. At the same time,China has long resisted attempts to let its currency float freely against the U.S. dollar. Many claim that China’scurrency is too cheap, and that this keeps the prices of China’s goods artificially low, which fuels the country’sexports.So is China a neo­mercantilist nation that is deliberately discouraging imports and encouraging exports in order togrow its trade surplus and accumulate foreign exchange reserves, which might give it economic power? The jury isout on this issue. Skeptics suggest that going forward, the country will have no choice but to increase its imports ofcommodities that it lacks, such as oil. They also note that China did start allowing the value of the yuan (China’scurrency) to appreciate against the dollar in July 2005, albeit at a slow pace. In July 2005 one U.S. dollar purchased8.11 yuan. By January 2012, the one dollar purchased 6.38 yuan, a decline of 21 percent. As a result, China’s tradesurplus has started to contract as export growth has slowed and imports have increased. In 2011, the surplus was$155 billion, down substantially from the $290 billion in 2008. While this suggests that China’s trade surplus mayhave peaked for now, it is still a cause for concern in many developed nations, and particularly the United States.Sources: A. Browne, “China’s Wild Swings Can Roil the Global Economy,” The Wall Street Journal, October 24, 2005, p. A2; S.H. Hanke, “Stopthe Mercantilists,” Forbes, June 20, 2005, p. 164; G. Dyer and A. Balls, “Dollar Threat as China Signals Shift,” Financial Times, January 6, 2006,p. 1; Tim Annett, “Righting the Balance,” The Wall Street Journal, January 10, 2007, p. 15; “China’s Trade Surplus Peaks,” Financial Times,January 12, 2008, p. 1; W. Chong, “China’s Trade Surplus to U.S. to Narrow,” China Daily, December 7, 2009; A. Wang and K. Yao, “China’sTrade Surplus Dips, Taking Heat of Yuan,” Reuters, January 9, 2011; and Aaron Back, “China’s Trade Surplus Shrank in ‘11,” The Wall StreetJournal, January 11, 2012.Zero­Sum GameA situation in which an economic gain by one country results in an economic loss by another.LEARNING OBJECTIVE 2Summarize the different theories explaining trade flows between nations.The classical economist David Hume pointed out an inherent inconsistency in the mercantilistdoctrine in 1752. According to Hume, if England had a balance­of­trade surplus with France (it exportedmore than it imported) the resulting inflow of gold and silver would swell the domestic money supplyand generate inflation in England. In France, however, the outflow of gold and silver would have theopposite effect. France’s money supply would contract, and its prices would fall. This change in relativeprices between France and England would encourage the French to buy fewer English goods (becausethey were becoming more expensive) and the English to buy more French goods (because they werebecoming cheaper). The result would be a deterioration in the English balance of trade and animprovement in France’s trade balance, until the English surplus was eliminated. Hence, according toHume, in the long run no country could sustain a surplus on the balance of trade and so accumulate goldand silver as the mercantilists had envisaged.The flaw with mercantilism was that it viewed trade as a zero­sum game. (A zero­sum game is onein which a gain by one country results in a loss by another.) It was left to Adam Smith and David Ricardoto show the shortsightedness of this approach and to demonstrate that trade is a positive­sum game, or asituation in which all countries can benefit. Unfortunately, the mercantilist doctrine is by no means dead.Neo­mercantilists equate political power with economic power and economic power with a balance­of­trade surplus. Critics argue that many nations have adopted a neo­mercantilist strategy that is designed tosimultaneously boost exports and limit imports.2 For example, critics charge that China is pursuing aneo­mercantilist policy, deliberately keeping its currency value low against the U.S. dollar in order to sellmore goods to the United States and other developed nations, and thus amass a trade surplus and foreignexchange reserves (see the accompanying Country Focus).Absolute AdvantageIn his 1776 landmark book The Wealth of Nations, Adam Smith attacked the mercantilist assumption thattrade is a zero­sum game. Smith argued that countries differ in their ability to produce goods efficiently.In his time, the English, by virtue of their superior manufacturingPage157