Tag: trilemma

China has a key role in the global economy. Recording double digit growth for a number of years and posting impressive export figures, China’s has been an economy on an upward trajectory. But its growth has been slowing and this might spell trouble for the global economy, as was discussed in the following blog. For many, China is the pendulum and the direction it moves in will have a big influence on many other countries.

There are some suggestions that China’s rapid growth has been somewhat artificial, in particular following the financial crisis, where we saw massive investment by state-owner enterprises, banks and local government. This has led to a severe imbalance within the Chinese economy, with high levels of debt. One of the key factors that has enabled China to grow so quickly has been strong exports. China has typically had a large current account surplus, often balanced by large current account deficits in many Western countries.

The exchange rate is a key component in keeping strong export growth and the devaluation of the Chinese currency in August (see What a devalued yuan means to the rest of the world) is perhaps a suggestion that export growth in China is lower than desired. Devaluing the currency will boost the competitiveness of Chinese exports and this in turn may lead to a growth in the current account surplus, which had fallen quite significantly from around 10% to 2%.

The problem is that China is currently imbalanced and this is likely to create problems around the world. With globalisation, the free movement of capital and people, deflation in the West and falling world asset prices, the situation in China is crucial. Although you will find many articles about China and blogs on this site about its devaluation, its growth and policy, the BBC News article below considers the conflicts that exist between three key economic objectives:

1. currency stability
2. the free movement of capital
3. independent monetary policy

and the need for some international co-operation and co-ordination to enable China’s economy to return to internal and external balance.

China’s impossible trinity BBC News, Duncan Weldon (8/9/15)

Questions

  1. What is meant by internal balance?
  2. What is external balance?
  3. Would you suggest that China is suffering from an imbalanced economy? If so, which type of imbalance and why is this a problem for China and for the world economy?
  4. The article refers to the trilemma. Why can an country not achieve all 3 parts of the trilemma? You should explain why each combination of 2 aspects is possible, but why the third is problematic.
  5. Use a diagram to explain why a fall in the exchange rate will boost the competitiveness of exports and why this can create economic growth.
  6. Why is a devalued Chinese currency bad news for the rest of the world?
  7. How could international co-operation and co-ordination help China?