[Viewpoint] The developing world looks to China

China’s trade balance is on course for another bumper surplus this year. Meanwhile, concern about the health of the U.S. recovery continues to mount. Both developments suggest that China will be under renewed pressure to nudge its currency sharply upward. The conflict with the U.S. may well come to a head during Congressional hearings on the renminbi to be held this month, in which many voices will urge the Obama administration to threaten punitive measures if China does not act.

Discussion of China’s currency focuses on the need to shrink the country’s trade surplus and correct global macroeconomic imbalances. With a less competitive currency, many analysts hope China will export less and import more, making a positive contribution to the recovery of the U.S. and other economies.

In all this discussion, the renminbi is viewed largely as a U.S.-China issue, and the interests of poor countries get scarcely a hearing, even in multilateral forums. Yet a noticeable rise in the renminbi’s value may have significant implications for developing countries. Whether they stand to gain or lose from a renminbi revaluation, however, is hotly contested.

On one side stands Arvind Subramanian, from the Peterson Institute and the Center for Global Development. He argues that developing countries have suffered greatly from China’s policy of undervaluing its currency, which has made it more difficult for them to compete with Chinese goods in world markets, retarded their industrialization and set back their growth.

If the renminbi were to gain in value, poor countries’ exports would become more competitive, and their economies would become better positioned to reap the benefits of globalization. Hence, Subramanian argues, poor countries must make common cause with the U.S. and other advanced economies in pressuring China to alter its currency policies.

On the other side stand Helmut Reisen and his colleagues at the OECD’s Development Center, who conclude that developing countries, and especially the poorest among them, would be hurt if the renminbi were to rise sharply. Their reasoning is that currency appreciation would almost certainly slow China’s growth, and would be bad news for other poor countries as well.

They estimate a slowdown of 1 percentage point in China’s annual growth rate would reduce low-income countries’ growth rates by 0.3 percentage points.

To make sense of these two contrasting perspectives, we need to step back and consider the fundamental drivers of growth. Strip away the technicalities, and the debate boils down to one fundamental question: what is the best, most sustainable growth model for low-income countries?

Historically, poor regions of the world have often relied on what is called a “vent-for-surplus” model. This model entails exporting to other parts of the world primary products and natural resources such as agricultural produce or minerals.

This is how Argentina grew rich in the 19th century, and how oil states have become wealthy in the last 40 years. The rapid growth that many developing countries experienced prior to the crisis was largely the result of the same model. Countries in sub-Saharan Africa, in particular, were propelled forward by the growing demand for their natural resources - China chief among those with demand.

But this model suffers from two fatal weaknesses. First, it depends heavily on rapid growth in foreign demand. When such demand falters, developing countries find themselves with collapsing export prices, and, too often, a protracted domestic crisis. Second, it does not stimulate economic diversification. Economies hooked on this model find themselves excessively specialized in primary products that offer little productivity growth.

Indeed, the central challenge of economic development is not foreign demand, but domestic structural change. The problem for poor countries is that they are not producing the right kinds of goods. They need to move away from primary products to high-productivity activities - manufactures and modern services.

The real exchange rate is of paramount importance here, as it determines the competitiveness and profitability of modern tradable activities. When developing nations are forced into overvalued currencies, entrepreneurship and investment in those activities are depressed.

From this view, China’s currency policies not only undercut the competitiveness of poor regions’ industries; they also undermine those regions’ fundamental growth engines. What poor nations get out of Chinese mercantilism is, at best, temporary growth of the wrong kind.

Lest we blame China too much, though, we should remember that there is little that prevents developing countries from replicating the essentials of the Chinese model. They, too, could have used their exchange rates more actively in order to stimulate industrialization and growth. True, all countries in the world cannot simultaneously undervalue their currencies. But poor nations could have shifted the “burden” onto rich countries, where, economic logic suggests, it ought to be placed. Instead, too many developing countries have allowed their currencies to become overvalued, relying on booming commodity demand or financial inflows. And they have made little use of explicit industrial policies that could act as a substitute for undervaluation.

Given this, perhaps we should not hold China responsible for taking care of its own economic interests, even if it has aggravated the costs of other countries’ misguided currency policies.

*The writer is a professor of political economy at Harvard University’s John F. Kennedy School of Government. Copyright: Project Syndicate, 2010.

By Dani Rodrik