China & the World Economy Week 5: Lecture 3 - Macroeconomics of China's Trade Surplus

Question 1

What are the key macroeconomic features of China’s trade surplus?

Answer 1

China maintains a large trade surplus, especially with developed countries.
This has led to protectionist responses (e.g. US tariffs).
The surplus is driven by high national savings, particularly private savings, even though investment is also high.
The fiscal balance (T-G) is typically neutral (neither large deficit nor surplus).
(Your note): Volatility in the trade balance increased after the 2008 financial crisis.

Question 2

How does macroeconomic accounting explain China’s trade surplus?

Answer 2

National income identity:
Expenditure: Y = C + I + G + NX
Income: Y = C + S + T
Equating both:
(S - I) + (T - G) = NX = CF (Net Capital Outflows)
A positive trade balance (NX > 0) implies:
National savings exceed investment.
Net capital outflows are positive.
(Your note): The second chart shows China’s current account is heavily dependent on the US.

Question 3

How is the real exchange rate linked to China’s trade balance?

Answer 3

Real exchange rate:
ε = E × P / P*
E = nominal exchange rate
P = domestic price level
P* = foreign price level
The real exchange rate adjusts to ensure:
NX = S + (T - G) - I

Question 4

How can policy influence the real exchange rate and trade balance in China?

Answer 4

With a closed capital account, China can control net capital outflows (CF).
Policy tools:
Control household savings
Adjust fiscal surplus
Attract FDI (reduces need for domestic savings to fund investment)
The real exchange rate adjusts to ensure:
NX = CF = S + (T - G) - I
(Your note):
China chose not to open its capital account (option 3 of the “trilemma”).
This allows policy to target a positive NX.
The financial system is underdeveloped, limiting household investment options → higher savings.
Firms are encouraged to invest externally via FDI.
Large net capital outflows (NCO) → large NX.
US should push China to open its financial system, not impose tariffs (which just appreciate the exchange rate and offset tariff effects).

Question 5

Summary of China’s trade surplus

Answer 5

China’s trade surplus is driven by:
High national savings
Moderate investment
Closed capital account (policy-determined CF)
The surplus is not necessarily due to currency manipulation, but real macroeconomic factors.
The real exchange rate adjusts to maintain macroeconomic balance:
NX = S + (T - G) - I
The closed financial system plays a key role in sustaining this surplus.