Determinants of China's trade balance

Integrating economic, political and socio-cultural considerations, this thesis identifies the key determinants of China's trade balance with a view to drawing policy implications that can assist in correcting China's excessive trade surplus.\ud \ud China's economic reforms and open-door policy over the past three decades have led to its fast economic growth and concomitant rapid trade expansion. While China's trade was largely in balance (a modest surplus) from the early 1990s to the early 2000s, a large and persistent trade surplus has emerged since 2004. The surplus has now been widely regarded as excessive and harmful to China's macroeconomy, for the following reasons. (1) A large and persistent trade surplus could lead to problems of domestic excessive liquidity and high inflation; leaving limited room for the Chinese government to use monetary and fiscal policies to manage its macroeconomy. (2) An over-reliance on external demand could leave the Chinese economy vulnerable to external shocks. (3) The large trade surplus could worsen China's trade relations with its trading partners. All of these could affect China's sustainable economic growth. A sustainable growth of China's economy, however, is crucially important not only for China itself due to the employment pressure resulting from the huge population but also for the rest of the world given that China has been one of the major economic engines, contributing to economic growth elsewhere around the globe. Hence, it is utterly imperative for China to curtail the excessive surplus in order to lessen any potential large-scale damages to the Chinese economy. To reduce the surplus, understanding its determinants is essential. So far, there is still a dearth of comprehensive examination of key determinants that have resulted in China's excessive trade surplus. This study is an attempt to fill this void.\ud \ud Many factors can affect the balance of trade of a developing country like China where peculiar circumstances exist. They can be economical, political, or even social and cultural. Available studies on China's trade balance tend to focus largely on economic factors. This study, embracing a multi-faceted view, examines not only economical, but also political, social and cultural factors that may affect China's trade balance. Such a comprehensive analysis generates valuable insights into the mechanism by which China's trade balance may have been affected. It was also invaluable for the design and conduct of empirical analysis for this study, which focused on verifying the relations between trade balance and a number of important economic variables.\ud \ud For the empirical analysis, an integrated multi-channel approach was developed, building on existing trade balance literature. The main channels included in this approach, through which economic determinants may affect the balance of trade, include: the supply-side channel, the demand-side channel and the relative price effect. The empirical investigations were carried out to assess how some key economic determinants, as identified from earlier comprehensive analysis, affect China's trade surplus at both aggregate and disaggregate levels. To better measure the impact of productive capacity and the relative price effect on trade balance, this study augmented the conventional model of trade balance by incorporating the variables of FDI and labour cost into the econometric analysis.\ud \ud The econometric modelling with aggregate data reveals the existence of long-run equilibrium between trade balance and domestic income, foreign income, exchange rate and FDI. The results suggest that changes in China's trade balance are chiefly dominated by income movements at home and abroad. FDI has a short-run impact on China's trade balance but the long-run effect is not significant. Real effective exchange rate, which represents the relative price effect, does not seem to have a significant impact on China's trade balance in both the long and short run.\ud \ud Using disaggregate data, the actual level of China's bilateral trade balance with its major trading partners is re-estimated using Hong Kong's re-export data. Four major variables: FDI, exchange rate, relative income and relative unit labour cost are incorporated into the econometric model. The results reveal two new significant determinants of China's trade balance: labour cost and FDI. The low labour cost has a much greater impact on China's trade surplus, followed by FDI. The impact of the exchange rate, though important, but again not as critical as many others have claimed. The impact of income on China's trade balance is also presented but not as significant as revealed in the aggregate analysis.\ud \ud This study makes the following important contributions to the trade balance literature. (1) It emphasises the importance of analysing trade balance determinants by going beyond economic factors and also including political, social and cultural factors for countries like China where peculiar situations prevail. (2) It proposed a multi-channel and multi-perspective conceptual framework for better identifying economic factors that may affect a country's trade balance. (3) It adds to the understanding of empirical relationships between key economic determinants and trade balance with findings from econometric modelling using both aggregate and disaggregate data.\ud \ud The findings of this study have important implications for China to curtail its excessive trade surplus. The most effective way to reduce China's trade surplus is to boost the disposable income of Chinese consumers, especially those low-income consumers, so that they can afford to consume more. To induce higher domestic consumption, innovative policy instruments have to be devised to channel more income to ordinary consumers, especially those low-income consumers, through significantly increased investments to improve social security, to provide low-cost education and health care, and to provide other public goods that help ordinary people to reduce their cost of living. In the meantime, measures have to be devised and effectively implemented to ensure wage-earners obtain an equitable share of the income they generate.\ud \ud In addition to boosting ordinary people's income, directly and indirectly, some other measures should also be considered in order to reduce China's trade surplus. In terms of FDI, it probably no longer makes any sense for China to provide incentives to attract any inflow FDI (especially, those low value-adding processing trade and heavy polluters). Instead, policy incentives may be used to attract inward FDI that are technologically intensive and advanced so to help China to protect its environment, develop renewable energy, and produce high-valued products. Further, it will also be useful for China to relax exchange rate control. The Chinese yuan should be allowed to float more freely against other currencies; letting the market forces have a major play in determining the value of the yuan