Employees of a factory at Pengsheng Industrial Park, located 70 kilometers from Tashkent, Uzbekistan, produce ceramic tiles via an assembly line.

 

The “reform and opening-up” policy ushered in an era of unprecedented economic progress. From 1980 to 2010, China’s average annual growth rate exceeded 10 percent while that of developed countries hovered around 2 percent to 3 percent. In the wake of the 2008 financial crisis, the global economy has undergone structural transformation.

Though China has outperformed all other countries, it has encountered a series of challenges as well. The sources of growth have weakened while structural, institutional and recurrent problems loom large. The goal of sustainable development now hangs in the balance. In essence, reasonably high growth rates are crucial to structural overhaul, yet a thoughtful outbound economic strategy may prove to be more pertinent to addressing challenges ahead.

 

Past strategy
An outbound economic strategy consists of four elements: trade, currency, investment and a coordinating mechanism that weaves them all together.

Under the auspices of the “reform and opening-up” policy, China has transitioned from a closed economy to an open economy. It embraced an export-oriented trade strategy, with an eye on surplus. It adopted a weak currency to safeguard the domestic economy and financial system. The hallmarks of this policy are an enclosed capital market, an undervalued currency, a fixed exchange rate and the delayed internationalization of the yuan. It also encouraged foreign direct investment.
 

Such strategies were compatible with the predominant feature of Chinese economy of the past three decades, i.e. a seemingly inexhaustible supply of low-cost labor. It also meant that the Chinese economy was demand oriented. China’s economic growth was driven by external demand consisting of direct investment and an export surplus. To stabilize external demand, China has maintained an undervalued and weak currency for three decades. Though, it is also true that the country’s limited strength cannot buttress a strong currency. Its economic structure requires such a static system.

 

‘New normal’
After three decades of reform, the Chinese economy has entered what its leaders have dubbed the “new normal,” meaning that, regardless of interim fluctuations, supply instead of demand is the decisive factor of growth.

An economy is supply centered when its output is decided by productivity instead of investment, consumption or export. The key components of productivity are labor force, capital equipment and technology. In a supply-centered economy, the supply of labor force and other production factors is often consistent with employment, placing a cap on aggregate economic output.
 

In China, many industries are saddled with excess capacity, which is a sign of structural distortion caused by a malformed mechanism of economic growth. When there is a labor shortage, the excess capacity created by a distorted economic structure has little to do with demand-driven economic growth. A surge in demand results in a surge in wages, meaning that a limited workforce will be drawn to popular trades. Afterward, some industries will experience increased productivity, while some will become less productive. Aggregate national economic output may or may not increase, while inflation is very likely to occur due to rising wages. To sum up, if an economy is suffering a labor shortage, its productivity is contingent on labor supply.

 

Sharp turn
Under the “new normal,” domestic economic growth is no longer contingent upon demand. Logically, export volume and trade surplus should no longer be prioritized. High export volume and trade surpluses indicate that a plethora of domestic resources, such as labor force, are used to feed the demand of other countries. If there is an excess of domestic resources, exports and the surplus generated will mobilize superfluous resources, boost economic growth, amass international currency and ward off hazards brought by oscillating international financial and energy markets. However, if domestic resources are insufficient, export and trade surplus will not accelerate economic growth but undermine public welfare. On the contrary, import and trade deficits will mitigate resource shortages and thus stimulate growth.
 

A trade deficit is usually unsustainable, unless imports are settled in domestic currency. Among major economies, only the United States and the United Kingdom have registered a perpetual trade deficit. In global trade, only the dollar and the pound have registered higher payment ratios than the respective shares of the United States and the United Kingdom in the global economy. In 2013, nearly 39.5 percent of global trade was settled in dollars, while US imports and exports only accounted for less than 10.4 percent of the global sum. For the United Kingdom, the two figures were 9.13 percent and 3.17 percent correspondingly. Since the two countries mostly settled trade using their own currencies, they are able to maintain a long-term deficit. This indicates that the ability to sustain a trade deficit requires currency internationalization.

 

New frontier
Although China is unable to settle massive amounts of imports from developed countries in its own currency, countries alongside the “Belt and Road” may welcome the yuan. Therefore, when trading with developed countries, China should attempt to strike a balance. When trading with underdeveloped countries on its periphery, China should prioritize import and trade deficit. Such a strategy will propel its currency into neighboring countries, paving the way for the internationalization of the yuan.
 

In addition, China should stop absorbing foreign direct investment indiscriminately. Rather, it should seek to attract “blue-chip investment” and invest in other countries. The so-called blue-chip investment would contribute to industrial upgrading. Outbound investment would allow China to transfer labor-intensive enterprises to neighboring countries, for those enterprises no longer contribute to China’s comparative advantage. Hopefully, China can use the yuan to settle import volume from neighboring countries, fuel domestic economic growth with their resources, such as low-cost labor and set the stage for the internationalization of the yuan. Border provinces, such as Yunnan, will play a pivotal role in the country’s outbound economic strategies.
 

Facing South Asia and Southeast Asia, Yunnan Province is one of many hubs along the “Belt and Road.”South Asia and Southeast Asia are among the most densely populated areas in the world. Four billion people inhabit the latter, and the former is even more populous, given that India alone has a population of 1.3 billion. China and neighboring countries in the two regions are complementary in terms of economic structure. In this light, Yunnan province will serve as an outpost and a pilot zone in China’s new economic blueprint.

 

Gong Gang is Director of the Financial Research Institute at Yunnan University of Finance and Economics.