Huang Yiping and Tao Kunyu*
China Center for Economic Research
Peking University
No. E2010002 February 25, 2010
[Abstract] China’s large current account surpluses not only destabilize its macroeconomic conditions but also are also at the center of global rebalancing. The literature offered five explanations for such surpluses, most of which are important but fail to account for the recent surge and/or offer actionable policy responses. In this study, we propose an alternative hypothesis for China’s large current account surpluses: asymmetric market liberalization and associated cost distortions. This unique reform approach was the fundamental cause of both extraordinary growth performance and growing structural imbalances during the reform period. Indeed, estimates of cost distortions provide good fits of the current account. Estimated cost distortions rose after 2004 but peaked in 2006 at 12.2 percent of GDP. The worst of the external imbalance problem may be already behind us. We argue that, for rebalancing its economy, China needs a comprehensive package focusing on further liberalization of factor markets. Exchange rate policy should be an important part, but exclusive focus on the currency could be counter-productive.
Key words: China, current account surplus, imbalance, exchange rate, asymmetric market liberalization, cost distortion
* This is a draft paper to be presented at the project conference on “Trans-Pacific Rebalancing” on March 3-4, 2010, in Tokyo, jointly organized by the Asian Development Bank Institute and the Brookings Institution. A revised version of the paper is also to be presented at the Asian Economic Panel meeting on March 22-23, 2010, in Seoul, jointly organized by the Columbia University, Keio University and Korea Institute for International Economic Policy.
