U.S. Department of the Treasury

(Archived Content)

HP-566 

Beijing--Thank you very much. I am very happy to be back in Beijing, and I appreciate your warm welcome.

Just over a year ago, Presidents George Bush and Hu Jintao established the Strategic Economic Dialogue, under the leadership of Vice Premier Wu Yi and Secretary Paulson, to address the fundamental strategic challenges and opportunities that lay ahead in our bilateral economic relationship. One thing that has emerged from this dialogue is an even greater recognition of the huge interest each of our countries has in the continued growth and prosperity of the other. When China succeeds, the United States succeeds.

The United States and China have accounted for over 40 percent of total global economic growth in the past five years, and each is a critically important market for the other. For example, U.S. exports of services to China support some 37,000 jobs in high-paying, high-productivity sectors of the U.S. economy. And imports from China provide U.S. consumers and companies with far richer consumer choices and access to more efficient global supply chains than they could hope for in the absence of trade with China. For China, access to the U.S. and international markets – and openness to international investment – has helped to create a world-class export sector and to drive the spectacular rates of economic growth that have turned this country into the global economic leader it is today.

We owe much of the strength and vitality of our economic relationship today to the remarkable success of China's economic development over the last three decades: growth of almost 10 percent per year, a more than eightfold increase in per capita income, and over 250 million people lifted out of poverty. No one here should have any doubt about our admiration for what China has achieved.

But China's economy has changed fundamentally over the past 30, and even 10 years, and you now face a set of new and different challenges in sustaining future economic growth.

The growth model that has transformed China from a largely homogeneous, agricultural economy into a dynamic, increasingly technologically sophisticated economy has been hugely successful to this point. But some of the policies developed for a far different China are now responsible for the buildup of large and rising imbalances.

China's most senior leaders have clearly identified these imbalances. They include imbalances in growth between rural and urban areas, between the coast and the interior, between economic and social advancement, between reliance on internal and external demand, between rich and poor households, and between economic development and environmental protection.

Based on China's current growth model, these challenges are likely to grow. China's growth model for the past several decades has featured high levels of investment in physical inputs to production, such as plants for producing manufacturing exports, but has done comparatively less to foster innovation, entrepreneurship, and the development of the deep and competitive markets. The current growth model has served China well to this point, but it is now exacerbating some of the challenges in achieving balanced growth.

First, growth has been increasingly energy-intensive, causing environmental degradation to accelerate despite Chinese leaders' efforts to strengthen and enforce environmental regulations. Since 2001, the ratio of growth in energy demand to GDP growth in China – a good measure of the energy-intensity of growth – has tripled relative to its level between 1978 and 2000 – putting more pressure on energy supply and increasing the environmental damage from growth.

Second, growth has been highly capital-intensive, reducing the rate at which incremental growth creates new employment opportunities for the Chinese people. Capital and labor are substitutes in economic production, and in an environment of cheap money, Chinese firms have had strong incentives to use more capital and less labor despite China's need to provide jobs for many workers who are now seeking to move from the state and agricultural sectors to the private manufacturing and services sectors.

Third, recent growth has gone hand-in-hand with a decline in both consumption as a share of GDP and household income as a share of GDP. National saving has risen to its highest rate since the beginning of market reforms, and the share of wages in GDP has fallen more than 10 percentage points in less than 10 years. As a result, the Chinese people are capturing a smaller and smaller share of the benefits of growth.

These features of the current growth model are mutually reinforcing. The capital-intensive nature of China's economic growth has been fueled by high national saving, which has both provided the resources for capital investment and encouraged the use of capital-intensive techniques. The pattern of prices – maintained by an inflexible exchange rate – has encouraged production in export industries, many of which are highly resource-intensive. At the same time, as Chinese production has increasingly targeted foreign consumers, domestic consumption has remained low, and the resulting high saving has been channeled back into investment in export sectors, perpetuating the cycle.

High and increasing national saving – and its counterpart, the slow growth of domestic demand – has led to increasing trade surpluses and made Chinese growth increasingly dependent on external demand.

China's leaders understand these issues well and are right to be turning their attention now – rather than later – to reforms aimed at achieving economic growth that stems more from domestic demand, innovation, and high quality investment.

Those reforms include efforts to rebuild the social safety net and address the causes of precautionary household saving, efforts to make education less costly and more widely available, efforts to improve environmental safeguards, and efforts to build a more robust services sector.

The development of the financial services sector – including increased access to consumer finance for Chinese households – will be particularly important to ensuring that strong Chinese growth continues. Access to capital is key to ensuring that Chinese entrepreneurs are able to capitalize on their capacity for innovation. And access to a wider range of higher-yielding savings instruments would provide all Chinese households with the tools they need to build assets more rapidly, allowing for higher consumption and living standards both today and in retirement. Developing a modern financial sector is not an easy thing, but investment by foreign firms – and the advanced risk management skills and market expertise that comes with it – can play an important role in expediting the process.

While rebalancing growth will require a number of the major structural measures that I have mentioned, price measures – including exchange rate adjustment – must also play a role. Flexible prices play a critical function of allocating resources on the basis of accurately-matched costs and benefits, and they fulfill this function with great effectiveness and at very low cost.

The exchange rate has become a highly charged issue in U.S.-China economic relations. This is unfortunate, because as many non-official and non-American observers have argued, exchange rate flexibility is extremely important to China. I therefore want to be very clear about what increased currency flexibility in China will, and will not do, for the United States and China.

For the United States, what it will not do is cause a significant reduction in the U.S. trade deficit, nor will it provide a magic bullet for solving the problems of American industries facing overseas competition. What increase currency flexibility will do is remove a major cause of the perceived unfairness in our bilateral relationship, allowing us to move on to the important long term challenges the United States and China jointly face.

For China, more currency flexibility will not restrain growth, nor will it lead to deflation. We have already seen the resilience of China's exporters to currency appreciation, with many enjoying higher profit margins today than they did two years ago. In East Asia, Korea, Indonesia, and Australia have all had currency appreciations far larger than China's, while maintaining strong growth and price stability. So did Japan in the 1970s, an example more relevant to China than Japan in the 1990s.

What currency flexibility will do for China is support – and in fact be a necessary component of – a growth strategy that brings higher consumption to Chinese households and more balanced, harmonious, and sustainable growth. This transition will occur through a decrease in the price of imports and the introduction of stronger incentives for Chinese companies to produce for Chinese consumers. What currency reform will also do is provide Chinese policymakers with greater freedom to use monetary policy to maintain price stability and avoid asset bubbles. This is of particular significance given China's recent acceleration of inflation. All of this will lead to growth that is more stable, more China-centered, and more effective in raising the living standards of the Chinese people than China's current growth model now is.

I know there are many in China who have expressed concern that more rapid currency appreciation will hurt low income workers in some sectors. To the contrary, by encouraging employment growth in less capital-intensive domestic-oriented industries, exchange rate appreciation will open up new opportunities for low- and un-skilled workers. Even more important for the poor is that industries serving domestic consumption demand will create new jobs at a much faster rate. According to a recent study by Robert Feenstra (an economist from the University of California) growth in domestic demand has proven three times more effective in generating employment in China than growth in exports

I have said a great deal about the current challenges for China. What about for the United States?

We have emphasized that the U.S. trade deficit and China's trade surplus are outcomes that are primarily driven by domestic rather than international economic factors. For the United States, our trade deficit can only be reduced through decisive measures to increase both private and public saving – the opposite problem China faces in its efforts to reduce a large trade surplus. To meet this challenge, we are committed to continuing to improve our fiscal outlook, particularly through measures to address the challenge of entitlement spending reform. We have already taken steps to increase incentives for private saving through tax reforms affecting capital income, and we are striving to broaden these tax reforms to further boost personal saving.

The United States must also continue to strive to avoid the siren song of protectionism. We must not sacrifice the long-term gains of openness by pursuing short-term and misguided responses to the challenges presented by global international markets. President Bush and Secretary Paulson are committed to ensuring America's open trade and investment climate.

Before concluding, I would like to emphasize the importance of re-energizing bilateral investment, a critical aspect of our economic relationship. Talk of protectionism can easily invoke national passions, and it is important for both our countries to keep in mind the tremendous benefits that openness to foreign investment has brought to our economies. It is critical that we promote better mutual understanding. Both sides could benefit from sharing information on and discussing our respective policies to foreign direct investment. On our side, we warmly welcome investment from all of our international economic partners, and China is a very important partner to us.

Ensuring that both the U.S. and Chinese economies continue to grow strongly – in ways that do not worsen global or domestic imbalances – is vital to each of us and to the global economy. In today's dynamic and transforming economy, recipes for past success do not guarantee success in the future. China and the United States need to adjust their policies to ensure vibrant economies as well as harmonious societies, both at home and globally.

Out mutual commitment to overcoming these challenges is critical to the well-being of the people of both our countries and will shape the broader global economic landscape for generations to come.

Thank you very much.