Wednesday, January 05, 2005

A reader read my last entry and wisely pointed out the ambiguity in my analysis of the effect of "three agriculture" policies. How is the effect of domestic policies different from the effect of a RMB revaluation. It took some sketching, but I think I have the answer. Of course, real economists out there please feel free to point out any errors.

Because of the "three agriculture" policies, employers are having trouble filling some manufacturing jobs at current wages. Of course, if they increase wages, they will eventually fill these jobs. This is actually fine since “three agriculture” policies create a negative labor supply shock that increases wages but also decreases the quantity of labor supply. Thus, there is no unemployment problem, just problems with China’s competitiveness.

The revaluation of RMB, however, generates a sudden increase in wages for workers (nominal wages stay the same, but workers acquire more international purchasing power) and increase costs for firms. This creates a situation where labor supply outstrips labor demand, and thus unemployment. Chinese manufactured goods will become even less competitive relative to the status quo, and foreign and even domestic investors would relocate to cheaper countries. Of course, China would still be very competitive, but may lose some jobs on the margin to India and Vietnam. Some of these jobs might be taken away from peasants who would want to work in cities despite recent policies, or higher skill urban workers might lose jobs due to relocation.

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