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The Huge Trade Surplus And China’s Economy

A mainland economic expert analyzes China’s ever-growing trade surplus and its impact on the economy.

Looking back at China’s economy in 2006, the most remarkable phenomenon was the gigantic trade surplus of US$177.5 billion. The total foreign trade in 2006 amounted to US$1.76 trillion, representing an increase of US$338.78 billion, or 23.8 percent over the level in 2005.

From January to November 2006, China’s total imports and exports reached US$1.69 trillion. The exports of US$875.4 billion represent a 27.5 percent growth over the first 11 months of 2005; the imports of US$718.52 billion represent a 20.6 percent increase over the same period of the previous year. The 11-month trade surplus was US$156.52 billion.

Year 2006 was significant not only for strong trade growth but also for the trade surplus that grew ever larger almost every month. Monthly trade in October and November reached a record high of US$23.83 billion and US$22.92 billion, respectively. The monthly trade surplus from January to December was, in billions: US$9.49, $2.453, $11.19, $10.457, $13.004, $14.5, $14.61, $18.8, $15.3, $23.83, $22.92, and $21.0, respectively, totaling almost US$180 billion.

The 2006 number was almost double that of 2005’s US$101.0 billion. For previous years, the surplus was US$50 billion in 2004, US$30 billion in 2003, and US$22.5 billion in 2001. What caused the huge growth in the trade surplus over the past two years?

China Has Exported 70 Percent of Its Economic Growth

The US$1.76 trillion trade volume in 2006 was approximately 65 percent of China’s GDP. This ratio is not only an indicator of China’s dependence on foreign trade but also evidence that China’s products flow to foreign countries. Yu Yongding, a famous scholar, once described it: "Trade surplus means a misplaced resource allocation."

The ratio of trade surplus to GDP is an important figure. China’s trade surplus constituted 2.5 percent of the GDP in 2004, 4.5 percent in 2005, and more than 7.0 percent in 2006. If China’s economy grew by 10.5 percent in 2006, then about 8.0 percent of the growth would have gone to foreign countries. Only 2.5 percent of the high growth benefited the Chinese people.

People may say that 7.0 percent of the net exports from the GDP are from Chinese people’s savings accounts, and that it is equivalent to the Chinese people lending US$180 billion to foreigners. It is questionable, however, whether these loans will ever be paid back.{mospagebreak}

China, a developing country that should have used its valuable resources to improve its people’s living standards, has instead been exporting a huge volume of resources. This is indeed the most critical problem in China’s growth mode. Of course, China is also accepting foreign investment. If we assume 2006’s direct foreign investment is US$50 billion, this amount could partially offset the resource drainage from the trade surplus.

The media has reported that, in November 2006, Japan’s trade surplus surged 54 percent, but the total amount was merely US$7.96 billion. After 59 months of continuous growth, Korea’s trade surplus in November 2006 was only US$2.86 billion. The total trade surplus of Japan and Korea in November was less than half that of China, while their combined GDP was more than double that of China. The Chinese economy’s dependence on foreign countries is second to none. If China’s growth is mainly for selling goods in exchange for foreign currency, what is the real benefit to the Chinese people?

Is China’s Economic Development on a Balanced Path?

The huge trade surplus and the 65 percent trade-to-GDP ratio are indications that China’s economic growth is out of balance. Using human body structure as an analogy, some people have strong muscles on their upper body, while others have very strong legs. China’s economy is like a severely disfigured strong man with a big head and puny legs, with one arm very strong and the other skinny. Overall, China’s economy has the following phenomena: Taxes are heavy, income is light; exports are heavy, imports are light; investments are heavy, and spending is light. Consequently, we have the following observation: Monopoly is heavy, competition is light; exports are heavy, domestic consumption is light; upstream sectors are heavy, and downstream sectors are light.

The abnormal development is caused by the unbalanced capital distribution. In other words, the resource distribution among different sectors is severely out of proportion. Some sectors absorb too much nutrition and become very strong. Other sectors are very weak due to long-term shortage of (blood) supply and malnutrition. For instance, Suzhou is famous for its attraction of capital, but in such a high investment area, the personal savings rate is very low. This means that despite large foreign investments, the local people don’t have much money; most of the products sold there are very cheap.{mospagebreak}

Some scholars, however, even praise the high ratio of trade to GDP. For example, Mr. Lin Yifu believes that China’s foreign trade has not exceeded that of Japan and Korea in their peak years. Mr. Wang Jian believes that China’s future trade will be even stronger as developed countries continue transferring manufacturing to China. Mr. Wang Jian even believes that by 2030 China’s foreign currency reserve will be as high as US$10 trillion. But I honestly believe that if China follows this growth pattern, China’s economy will most likely have collapsed long before then. This is because many parts of China’s development are irrational.

Re-examining China’s Mercantilist Development Model

I have been calling China’s current development model a traditional mercantilist model. This model, to make it sound better, is to be frugal. To put it undiplomatically, it is to achieve the country’s growth or, more specifically, that of a handful of people, at the expense of the majority of the Chinese people’s income. This development model includes searching for job opportunities globally, exporting domestic products, and accumulating foreign currency reserve.

Two conditions are necessary for this model to be successful. One is low wages, or cheap labor; the other is a large enough overseas market. The first condition has been achieved. China has a huge labor resource and a legal system that guarantees a ready supply of cheap labor (that is, migrant workers from rural areas, nonexistence of workers’ right to strike or bargain with management, a nonfunctional trade union). Especially in China, the tradition of low wages was already established during the old planned economy. Therefore, after decades of reform, the general level of wages remains very low.

This type of low-income economy not only results in cheap products; it also contributes to a lack of domestic consumption. Economies of this kind share a common goal: to actively develop an international market and sell products to foreign countries. As a result, these countries normally have a high trade surplus and a growing foreign currency reserve, while the bank savings rate tends to be very high.

However, these countries also share another attribute: People’s living standard is kept at a low level because their spending power is low. In these countries, businesses can accumulate huge wealth while governments normally possess powerful financial resources. However, from the perspective of development, this model of a strong government, strong business, and weak labor is different from models that focus on human capital.

In general, there is a limit to China’s mercantilist model, which cannot continue on the same path forever. Its capacity is primarily measured by how people feel satisfied with this mode of growth. If the majority of the people can’t improve their living standard over a long period of time, then they will question the legitimacy of economic reform.{mospagebreak}

Economists, including Mr. Wang Tongsan, have also found that this problem represents unhealthy symptoms in China’s economy. The cycle starts with certain industrial sectors that have an overcapacity while the domestic market demand is relatively weak. Because of this, manufacturers are forced to develop an export market. This causes increased exports and a foreign currency overstock. To balance the foreign currency reserve, the finacial authorities must increase the money supply, which in turn helps accelerated investment. Because of the unbalanced domestic income distribution, investment and consumption disparity occurs. The economy, due to the lack of a strong domestic demand, is led by strong investments and exports. Under such a circumstance, a generous money supply causes implicit inflation pressure. Although in the short run it has not caused the consumer price index to climb, it has obviously led to an increase in the price of capital. This situation provides some upstream industries with the incentive to make irrational investments for short-term profit, making the future overcapacity problem even worse.

Facing such abnormal development and unbalanced cycles of economy, people have given various kinds of policy suggestions, such as changing the interest rate, having a uniform tax for foreign and domestic companies, and placing constraints on land use. In my opinion, the most fundamental problem is still low wages for labor, which leads to low spending and large resources to export at a cheap price. The biggest factor causing low wages for labor is the lack of labor rights. Therefore, economic measures alone are not enough to solve the problem; we need political reform to facilitate a resolution.

Figure 1. Percentage Investment in GDP in China, Japan and Korea in their Perspective High Growth Time


Figure 2. Investment-to-GDP Ratio for Businesses, Households and Government between 1992 and 2005
Source: International Monetary Foundation Project Paper "What’s Driving Investment in China," December 12, 2006. Website:

Disproportion in Income Distribution, Saving, and Investment

Different development strategies and policies usually generate different economic structures. The condition of the current Chinese economy, marked by high investment, high saving, and low spending, has never occurred even in other developing countries.{mospagebreak}

Figure 1 displays the investment pattern in China, Japan, and Korea over the course of high economic growth. Japan’s high-growth period was between 1962 and 1976, with its investment-to-GDP ratio being between 30 percent and 35 percent for most of those years and 37 percent as the highest. Korea’s high-growth period was from 1984 to 1998, with the same ratio rising from 30 percent to 39 percent, and then dropping to below 30 percent. In China between 1990 and 2006, the ratio started at 25 percent and increased to as high as 48 percent. Both Japan and Korea experienced about 14 years of high investment before the figure dropped down. China’s high investment period has lasted 15 years, and we have seen no sign of it slowing down. To make heavy investments, one needs to have lots of cash. Let us see who is investing in China and who has the money. Figure 2 clearly shows who the real investors are. The top, thicker curve is businesses’ investment; the bottom two dashed lines represent household and government investment. It is clear from Figure 2 that investments from businesses are consistently between 28 percent and 35 percent, while both household and government investment run about 5.0 percent of GDP.

Song Guoqing, a Chinese professor, once mentioned that, over the past eight years, China has been implementing policies to stimulate spending. However, during the same eight years, the share of personal spending of GDP has declined by 8 percent, and that trend continues. Let’s look at the following table to see the changes between household savings and business savings. In 1996, household savings amounted to 20 percent of GDP, but in 2005, the ratio dropped to 16 percent; at the same time, the ratio of business savings to GDP increased from 13 percent to 20 percent over the same period.

Table 1. Change of Percentage Saving in GDP from 1996 to 2005

  1996 2000 2004 2005
Family 20 15 16 16
Business 13 15 19 20
Government 5 6 6 6
Source: Beijing Dajun Economic Observation and Research Center Data Bank

From Table 1, it is clear that over the past decade, the percentage of GDP of the government’s fiscal revenue and of state-owned businesses has steadily risen, while the percentage of personal income has continuously declined. At present, household savings make up 33 percent of total savings, while business savings are 49 percent and government savings are 16 percent. These changes are the reason why domestic spending remains weak. On the one hand, people have little money to spend; on the other hand, the government and businesses have plenty of money to spend and invest.{mospagebreak}

Since the fiscal reform started in 1994, the steady fiscal revenue decline of more than 10 years has turned around. Year after year, revenue has risen. The government’s tax revenue has grown considerably. This to a large extent has deterred personal spending and forced more products to be exported. The cheap exports have not only affected people’s living standards and wasted valuable domestic resources but also have fueled global risk factors, such as the U.S. dollar devaluation. If the U.S. dollar keeps going down, China’s foreign currency devaluation will continue. The hard-earned foreign currency reserve will be at a higher risk.

Let us make another international comparison. Table 2 shows several countries’ saving structure as part of their GDP. Among those, the saving rate in the United States is only 14.3 percent; Korea has the second highest saving rate at 31 percent; China’s saving rate in 2006 was likely to reach 50 percent of GDP. This high saving rate can only cause high investment and high trade surplus. This is why China had a huge trade surplus in 2006.

Who Designed This Model?

From the above analysis, we can see that, due to income distribution disparity, China’s household savings ratio is declining, and the share of disposable income in GDP is rapidly declining. From 1978, when China began the reform and open door policy, until today, private citizens’ income has undergone an "n" shaped change (went up and down). Is this change normal or abnormal? There are many different viewpoints.

I have to point out the following serious situation: That capital income is greater than labor income is the root cause of all economic problems in China. This type of income distribution structure is never seen in Western developed countries.

Table 2. Percentage of Saving in GDP of Several Countries

   China  U.S.  France Japan  Korea  Mexico  India
 Total Percentage of Saving  41.7  14.3  20.7  25.5  31 20.8  28.3
 Household  16  4.8  10.8  8.2  4.5  8  22
 Business  20  10.3  9.5  19.4  14.8  10.6  4.8
 government  5.7  -0.9  0.3  -2.2  10.7  2.2  1.5
Note: Chinese data is for 2005, Mexico is for 2001, India is for 2004, and all others are for 2002. Data source: Beijing Dajun Economic Observation and Research Center Data Bank

Zhong Dajun is the director of Dajun Economic Observation and Research Center in Beijing.

Translated by SCHINASCOPE from