On Thursday, the Chinese government responded to intense U.S. government pressure and revalued the renminbi. The revaluation was very modest – only 2% - and the government indicated it would permit a tightly managed float going forward, allowing the renminbi to fluctuate in a band of 0.3% on any given day.
The business press naturally is giving this a lot of coverage - for example, see The Economist, the Financial Times and the Wall Street Journal. While highlighting many dimensions of this move by the Chinese government, this coverage generally does not address the potential for blowback in global competition.
Let’s put aside whether this is just a symbolic move by the Chinese government or will lead to more significant changes in the exchange rate over time. Let’s also not get mired in a debate about what the “real” value of the renminbi is or ought to be.
Let’s assume instead that Washington gets what it wants – a meaningful revaluation of the renminbi as a way to dampen competitive pressures on U.S. manufacturers, slow the growth of offshoring activity and enhance our balance of trade. While there is still time, we may want to explore the unintended consequences that a meaningful revaluation of the renminbi might have on business competition. Then perhaps we should reconsider whether this is a course we really want the Chinese government to pursue. (We’ll also leave aside the unintended consequences in public policy domains like the continued funding of U.S. government deficits or the potential for increased political instability in China if economic growth significantly slows or the prospect of growing nationalism in China if the US is perceived as pursuing a protectionist agenda.)
Why are policy makers so focused on the value of the renminbi? In part, because they believe that Chinese companies rely on wage arbitrage as the basis for competition in global markets. Chinese companies pay their workers anywhere from one quarter to one tenth of the wages that American companies can afford to pay here in the U.S. This is a significant competitive advantage, especially in labor intensive industries like assembly based manufacturing. It may even be at least in part an "unnatural" competitive advantage if the Chinese government is artificially holding down the value of its currency.
Even if this assumption is correct, what does the revaluation of the renminbi accomplish? Few believe that a market-based revaluation of the renminbi would wipe out the wage advantage of Chinese companies. At best, any market driven revaluation of the renminbi would marginally reduce this wage advantage. It would still leave significant competitive pressure on U.S. companies and strong incentives for U.S. companies to set up offshore operations to participate in wage arbitrage.
But we need to dig deeper and challenge the basic assumption that wage arbitrage is the sole, or even primary, basis of competition for Chinese companies. In fact, in a growing number of areas like mobile phone technology, Chinese companies have already developed world-class capabilities. More importantly, they are building capability at a very rapid rate across an even broader range of industries, ranging from consumer electronics to motorcycles and fuel cells.
What is driving this pace of capability building? It’s simple. They have an enormous sense of urgency. Chinese executives are driven by an overwhelming sense that they were blocked from participating in the world economy for fifty years and that they have to work very hard to make up for lost time. They are also aware that any wage advantages are likely to be temporary at best. They face growing competition from emerging economies that offer even lower wages. They even face growing competition in major urban areas from other Chinese companies willing to offer higher salaries for experienced managers and employees with distinctive skills.
Chinese executives are channeling this sense of urgency into aggressive and creative bootstrapping – working with other specialized companies in distributed networks to get better even faster than they could on their own. In the process of doing this, Chinese companies are developing a whole new set of management techniques to foster rapid incremental innovation – both at the product and process level. Few Western companies yet understand the significance of this innovation at the level of management techniques. Global process networks and productive friction are just two of the techniques that these companies are perfecting to accelerate capability building.
So what does this have to do with the revaluation of the renminbi? Any revaluation of the renminbi will only intensify this sense of urgency on the part of Chinese executives. Even the 2% revaluation on Thursday, as modest as it is, will serve as an early red flag (no pun intended) of the risk of further revaluation ahead. Chinese executives will have no choice but to redouble their efforts to build capability even faster and pursue additional innovation in management techniques to bootstrap even more aggressively. At best, the revaluation of the renminbi may offer only a brief respite for U.S. companies, while intensifying the longer-term competitive challenge from Chinese companies. Paradoxically, this same revaluation is likely to lead to greater complacency by American executives, many of whom believe that, if they can only reduce the impact of wage arbitrage, their competitive positions will be secure.
Let’s also not forget an even more subtle impact from the revaluation of the renminbi. U.S. companies to date have benefited disproportionately from the opportunities created by offshoring to participate in wage arbitrage. European companies, through a combination of different mindsets and restrictive labor laws, have been much less aggressive in exploiting offshoring opportunities. To the extent that a renminbi revaluation reduces the potential for wage arbitrage, it also reduces a competitive advantage for U.S. companies in global competition with European companies.
So, let’s see - more rapid capability building by Chinese companies, greater complacency of U.S. companies and reduced competitive advantages for U.S. companies in global competition with European companies – why again are we pushing so strongly for renminbi revaluation? What’s the alternative? Maybe U.S. companies should use the growing competitive pressure from Chinese companies to get better faster themselves.
There may well be other reasons to seek a revaluation of the renminbi. But let’s not pursue this course in order to “protect” U.S. companies or U.S. workers from growing competitive pressures. If that is our goal, we may in fact find that we have accomplished just the opposite – intensifying economic competition from China and increasing the vulnerability of U.S. companies in the global economy. The blowback may take us by surprise.
Of course, I may be jumping the gun with my concerns. Thursday’s move was symbolic. Maybe both governments intended the move to be symbolic and nothing more. This way, the U.S. government can claim a victory and the Chinese government can show its “accommodation” to U.S. concerns in advance of the visit to Washington by President Hu Jintao in September. For the sake of U.S. companies, let’s hope this is the case. There may yet be time to re-evaluate our policies.