Paul Van Den Noord

China is running a large current account surplus and the US an equivalent deficit. US lobbies think nominal appreciation of the Chinese currency vis-a-vis the US dollar will resolve this. However, what matters for rebalancing is real, not nominal, appreciation of the Chinese currency and this is driven by economic fundamentals, not exchange rate policy. The fact that real appreciation is slow in China must serve an economic purpose, which is that China is in a transition from a rural to an industrial economy and needs to absorb massive labour supply. At the early stages of development of the Chinese economy domestic demand could not be the engine, but exports could. This requires strong competitiveness and is underpinned by a flat Philips curve associated with abundant labour supply. The low real exchange rate serves the same role as the “infant industries” industrial policies in advanced economies in the past.

That said, as the Chinese economy matures, a shift to domestic demand will (have to) occur and this will involve a real appreciation of the exchange rate. This must, however, be an orderly process. Nobody is served by a run on the dollar (although it might happen) and nobody is served either by outright protectionism. Instead what is needed is a set of coherent structural policies that accommodates and facilitates the adjustment. This means that structural policies in China (and in some other emerging economies running current account surpluses) should be focused on creating better social safety  so as to reduce the incentives for (excessive) saving, and to develop its financial markets so that it would be less in need of the US to act as their banker. Structural policies in the US should, in contrast, be targeted at easing the incentives for dis-saving built into the tax system ( such as the mortgage interest deduction). Also in Europe imbalances are serious and require appropriate structural policy responses – not least since in the euro area nominal exchange rate adjustment is not a (realistic) option in the first place.

The OECD sees it as its role to promote such structural policies, notably in the framework of the G20 deliberations. We hope to demonstrate (see attached PowerPoint, parts of which I may or may not use, dependent on the time available) that such policies can hit three birds with one stone, i.e. to raise growth prospects in advanced countries, facilitate fiscal consolidation in these countries and ease the global imbalances. Whenever there are important spillover effects of policy (positive or negative), there is a role for international organizations, and in this case the OECD is, in our view, particularly well placed.