China’s economic imbalance is not particularly difficult to identify. The country produces far more than it consumes, household spending remains weak and years of investment-led growth have left it dependent on manufacturing and exports.
The harder question is what China should do about it.
Economists broadly want China to import more, export less and encourage households to consume more rather than save. But a debate involving Gita Gopinath, former first deputy managing director of the International Monetary Fund, Michael Pettis, senior fellow at the Carnegie Endowment, and other economists shows how quickly that consensus breaks down once the discussion turns to solutions.
At the centre of the disagreement is the yuan. One argument holds that China needs structural reforms that put more income in the hands of households and encourage consumption. The other gives currency appreciation a much larger role in shifting income away from producers and towards consumers.
The debate matters because both approaches seek the same outcome but carry different economic and political costs. And even if economists settle the argument, another question remains: whether China wants to pursue either prescription.
The GGR Case
Gita Gopinath, Pierre-Olivier Gourinchas, former IMF chief economist, and Hélène Rey, professor of economics at London Business School, argue that China’s policies have themselves contributed to a weaker yuan.
Weak household spending, the property slowdown, high savings and a persistent current account surplus are at the heart of the problem under what can be described as the Gopinath-Gourinchas-Rey, or GGR, framework.
Their argument does not dismiss the possibility that the yuan is undervalued. Instead, it treats the weak currency as a symptom of China’s underlying economic imbalance rather than its cause. Simply revaluing the yuan, therefore, would not address the fundamental problem.
The GGR framework identifies two problems with relying on currency appreciation: one economic and the other political.
A stronger yuan would make Chinese exports more expensive and imports cheaper. That should increase imports, reduce exports and narrow the trade surplus. But the effect could be limited and could create another problem.
China is already dealing with deflation, with prices weak or falling. Cheaper imports could put further downward pressure on prices. Falling prices can encourage consumers to delay purchases, squeeze company profits, discourage investment and weaken demand.
That would work against the objective of getting Chinese households to spend more.
There is also a timing problem. Exporters often price goods in US dollars and existing contracts do not change immediately. Exports may therefore take time to respond to a stronger yuan, limiting the initial effect of currency appreciation.
Then comes the political problem.
Persuading China to revalue the yuan could lead to confrontation. The GGR argument instead holds that Beijing may be more willing to accept policies aimed directly at the household sector because such measures could align with China’s longer-term economic interests.
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The Pettis Case
Pettis disagrees with that sequence.
His argument starts with the distribution of income. China runs a large trade surplus because households receive too little income, according to this framework. Any policy that shifts income towards households could therefore help correct the imbalance.
That could include higher wages, stronger pensions, tax cuts, welfare spending, lower industrial subsidies or stronger unions.
But redistribution comes with a cost. Higher household income has to come from somewhere, meaning businesses, exporters or governments would bear part of the burden.
Pettis argues that yuan appreciation offers a way to make that transfer with lower trade-offs.
The mechanism works through purchasing power. A stronger yuan makes imports cheaper while making Chinese exports more expensive. Exporters lose some of their advantage, while households gain purchasing power.
Chinese consumers can buy more imported goods, spend more while travelling abroad and get more for their money when purchasing goods and services priced in foreign currencies.
In effect, income shifts from producers towards households.
If households then consume more, that spending need not be limited to imported products. They could also spend more on domestically produced goods and services, reducing China’s dependence on exports.
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Where Both Struggle
Neither framework is without problems.
Critics of the GGR approach argue that it understates the role of the exchange rate. Previous periods of yuan appreciation have coincided with a decline in China’s trade surplus, suggesting that the currency can form part of the adjustment.
The framework may also place too much faith in domestic reforms. China’s leadership has shown limited willingness over a long period to implement the kind of changes that would shift more income towards households.
Pettis’ approach faces a different problem: more household income does not necessarily translate into more consumption.
Chinese households do not save only because their incomes are low. Uncertainty also matters. A struggling property market, an ageing population and weaknesses in public healthcare and pensions can all encourage households to save rather than spend.
If a stronger yuan cuts corporate profits while households continue saving, China could end up with weaker businesses without receiving the expected boost to consumption.
Exporters could also lose competitiveness. Without support, companies could respond by freezing recruitment, cutting wages or reducing jobs. That would create another economic problem and potentially a political one for the Chinese Communist Party.
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Beijing’s Priorities
Neither argument offers a cost-free answer.
The GGR framework depends heavily on China accepting structural reforms. Pettis gives the exchange rate a more direct role, but yuan appreciation could impose economic and political costs before higher household consumption materialises.
The GGR approach appears more persuasive to me because it addresses the structural causes of China’s imbalance rather than relying primarily on the exchange rate.
But the larger question is whether Beijing is looking for either solution.
China has long resisted external pressure to appreciate the yuan. It has also shown limited appetite for the consumption-led policies recommended by the IMF over the years.
Instead, China has continued to emphasise manufacturing, technological upgrading and exports even as domestic consumption has struggled.
Its five-year plans and official speeches have maintained that focus, particularly on production and exports involving new technologies.
That leaves economists debating two different routes towards a more consumption-driven Chinese economy while Beijing continues to pursue a different set of priorities.
The argument over which prescription works better may therefore be less important than whether China wants the medicine at all.
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