Economics focus

Feb 17th 2011 | from the print edition

CHINAS inflation rate has become one of the worlds most closel watched n!mbers"
#his wee$s release showed that inflation rose to %"&' in (an!ar) !p from 1"*' a
ear earlier" #he increase was smaller than e+pected) b!t has not ,!elled fears that
as inflation creeps !p the -o.ernment will need to slam on the economic bra$es"
Some economists) howe.er) belie.e that China sho!ld welcome hi-her inflation as a
more effecti.e wa to rebalance its econom than a c!rrenc appreciation"
#he recent s!r-e in Chinese inflation has been dri.en mainl b food prices) b!t non/
food inflation has also risen to 2"0') its hi-hest rate since the series be-an in 2001"
1a-es are increasin- at a faster rate" For man ears Chinas lar-e pool of s!rpl!s
labo!r held a.era-e pa rises below the rate of prod!cti.it -rowth" 2!t as fewer
o!n- people enter the wor$force) wa-es are now risin- faster than prod!cti.it"
Arth!r 3roeber of 4ra-onomics) a 2ei5in-/based research firm) ar-!es that if hi-her
inflation reflects faster wa-e -rowth) this will help China) not h!rt it"
6conomists bro!-ht !p to belie.e inflation is alwas a bad thin- will cho$e on the
idea of welcomin- more of it) b!t the tr!th is that Chinas a.era-e inflation rate of
2' o.er the past ten ears has been !n!s!all low for a de.elopin- co!ntr 7see
left/hand chart8" #he optimal inflation rate in an emer-in- econom is often hi-her
than in the de.eloped world beca!se of somethin- called the 92alassa/Sam!elson
effect:" As low/income co!ntries catch !p with richer ones) faster prod!cti.it -rowth
in the tradable/-oods sector p!shes !p wa-es" Since labo!r is mobile) this in t!rn
leads to hi-her wa-es in the non/tradable sector) where prod!cti.it -rowth is
slower) so prices rise faster than in rich co!ntries" ;oreo.er) some of the was in
which inflation is tho!-ht to be harmf!l to -rowth) s!ch as disco!ra-in- sa.in- and
in.estment) hardl matter in China) where both loo$ e+cessi.e"
Indeed) a bit more inflation co!ld help to rebalance Chinas lopsided econom" Its
bi--est imbalance is too little cons!mption) lar-el beca!se wa-es ha.e fallen as a
share of national income" 1hen wa-es rise more slowl than prod!cti.it) an
econom prod!ces more than it can cons!me) res!ltin- in a c!rrent/acco!nt s!rpl!s"
If wa-es now o!tpace prod!cti.it) wor$ers share of the ca$e will rise) boostin-
cons!mption and helpin- to red!ce Chinas e+ternal s!rpl!s"
1a-e/dri.en inflation wo!ld also help to narrow Chinas trade s!rpl!s b p!shin- !p
the price of its e+ports" Con.entional wisdom sas that a stron-er !an wo!ld red!ce
Chinas c!rrent/acco!nt s!rpl!s" <et the empirical s!pport for this is wea$" In a
paper p!blished in 200&) ;en=ie Chinn of the >ni.ersit of 1isconsin and Shan-/(in
1ei of Col!mbia >ni.ersit e+amined more than 170 co!ntries o.er the period 1&71/
200*?) and fo!nd little e.idence that co!ntries with fle+ible e+chan-e rates red!ced
their c!rrent/acco!nt imbalances more ,!ic$l than co!ntries with more ri-id
re-imes"
In ad5!stin- c!rrent acco!nts) what matters is the real e+chan-e rate 7which ta$es
acco!nt of relati.e inflation rates at home and abroad8" ;o.ements in nominal
e+chan-e rates often do not achie.e the desired ad5!stment in real rates beca!se
the ma be offset b chan-in- domestic prices" For e+ample) the ens trade/
wei-hted .al!e is aro!nd 1*0' stron-er than it was in 1&@*" <et (apans c!rrent/
acco!nt s!rpl!s remains bi- beca!se that appreciation has been lar-el offset b a
fall in domestic (apanese wholesale prices) so e+porters remain competiti.e"
An alternati.e wa to lift a real e+chan-e rate is thro!-h hi-her inflation than
abroad" #o an American b!er) a *' increase in the !an price of Chinese e+ports is
the same as a *' appreciation of the !an a-ainst the dollar" ;r 3roeber ar-!es
that rebalancin- the econom b r!nnin- an inflation rate of %/0' wo!ld be
preferable to either a sharp increase in the !an) which co!ld ca!se bi- 5ob losses in
e+port firms) or a -rad!al appreciation which attracted lar-e spec!lati.e capital
inflows) as happened in 200*/0@" Inflation is alread plain- the bi--er role" #he
!an has risen b onl %' a-ainst the dollar since earl 200&) et) accordin- to
calc!lations b The Economist) the !ans real e+chan-e rate a-ainst the dollar
7meas!red !sin- !nit labo!r costs in ind!str8 has stren-thened b 17' 7see ri-ht/
hand chart8) beca!se costs in China are risin- m!ch faster than in America"
The runaway risk
1hat abo!t the ris$ that inflation co!ld -et o!t of control) as in Aatin America in the
1&@0s and 1&&0s or in China itself in 1&@&) when an inflation rate of o.er 2*'
tri--ered !nrestB C!nawa inflation is !s!all the res!lt of fiscal e+cess) financed b
printin- mone) or ri-id labo!r mar$ets) which prod!ce a wa-e/price spiral that the
central ban$ fails to stop" >nli$e Aatin America in the past) China has a record of
fiscal pr!dence and trade !nions are docile" Its labo!r mar$et is m!ch more fle+ible
than in the late 1&@0s) when most wor$ers were in the state sector"
China is more li$e (apan and So!th 3orea d!rin- their eras of rapid -rowth than an
Aatin American co!ntr" D.er 1*/ear periods endin- in (apan in 1&72 and So!th
3orea in 1&&0) E4F -rowth a.era-ed aro!nd &' a ear and inflation a.era-ed */0'
witho!t it acceleratin- o!t of control" Chinas -o.ernment cannot be complacent
abo!t risin- prices" It sho!ld anchor e+pectations b settin- an e+plicit inflation
tar-et" Interest rates on ban$ deposits need to be raised in line with inflation to
enco!ra-e ho!seholds to $eep their mone in the ban$ rather than spec!late in
propert or shares" Dtherwise ne-ati.e real interest rates will inflate asset b!bbles"
#hat implies China still needs a more fle+ible e+chan-e rate so it can lift interest
rates while those in America remain low" 2!t a bit more inflation wo!ld be welcome
as well"