Paulson's expectations problem

International Economy, The, Wntr, 2007 by C. Zoakos

Ever wonder why China's economic and political leadership only gives lip service to serious appreciation of the RMB? The numbers explain all. In China today, foreign-funded companies employ a mere 3 percent of the labor force (24 million workers) but produce 55 percent of China's exports, 80 percent of export growth, 22 percent of China's GDP, and 41 percent of GDP growth. By comparison, the domestic companies employ 97 percent of the labor force (776 million workers) and produce 45 percent of exports and 78 percent of GDP (assuming official statistics are correct). Labor productivity for the foreign-funded sector is nine times as high as that in the domestic sector.

Here's the problem. Markets expect U.S. Treasury Secretary Hank Paulson to be successful at negotiating with China an appreciation of its currency. Yet Paulson would be the first to point out that because China's domestic sector suffers from such low productivity, any significant appreciation of the RMB would completely wipe out its export competitiveness. The only way for the 97 percent of China's labor force to become as productive as the 3 percent working in the foreign-funded sector is to modernize China's financial system for allocating resources. But that, Paulson knows full well, is likely to take decades to accomplish.