The evolution of the Sino-American Co-dependency: modelling a regime switch in a growth setting

This work presents a two-country two-stage growth model capturing the special relationship that has emerged in recent years between the US and China (the so-called BWII regime described by Dooley et al., 2003). The Chinese authorities maintain a competitive (i.e., undervalued) exchange rate in order to sustain the high-productive exporting sectors, foster growth and absorb the large amount of rural workers into the industrial sector. Thus, China runs current account surpluses against the US and accumulates US assets in the form of foreign reserves. The US policy-makers are supposedly more concerned with keeping high the consumption possibilities of the population and exploit the Chinese willingness to finance the US external deficits. We consider three scenarios for the future state of the Sino-American co-dependency. All the scenarios share phase 1, resembling what has actually occurred in recent years, but differ in accordance with what fiscal policy the Chinese authorities adopt, and whether and when China fully liberalizes its capital account and floats the currency (thus starting phase 2). Scenario A is quite optimistic because the Chinese fiscal policy is effective in partially substituting the mercantilist policy undertaken in phase 1 as a fundamental source of demand for tradables and as an engine of growth. Scenario B emphasizes the risks for China of abandoning too early the peg of the exchange rate. Finally, Scenario C shows that a Chinese continuation of the current export-led growth strategy can be economically feasible and lead to the mobilization of the Chinese manpower into the advanced sectors of the economy.