By John Mills (auth.)

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The only practical way of making any economy competitive is to position the exchange rate correctly. This is why the parity of the currency is critically important. There is no other feasible way for a country to change 20 The Exchange Rate 21 the price it charges for the whole of its output sufficiently to make the necessary difference. The higher the proportion of a country’s GDP involved in world trade, the more obvious it is that its exchange rate needs to be correctly aligned vis-à-vis its competitors.

Third, the government should have a clear strategy as regards foreign trade balances. In the short term, fluctuations are unavoidable, but in the longer term these can to a large extent be ironed out. If balance of The Exchange Rate 25 payments surpluses are allowed to accumulate, as happened in Japan in the 1980s and as has been happening in China of late, there will be strong upward pressure on the exchange rate. The converse being clearly the case reinforces arguments for taking a liberal view on protection and in general avoiding impediments to imports.

This conclusion is, however, certainly not necessarily correct. Even if output per head is much higher in the West than in China, the average Chinese product may still be more competitive – indeed, it generally is nowadays, by a wide margin – especially if it involves reasonably straightforward and widely available production techniques. This has nothing to do with productivity, because Chinese output per head is far below that of the West in almost every branch of economic activity. Nor is it because Chinese wages are lower than those in the West, although this will of course have a major impact on the sort of production in which China has the most competitive advantage; notably, labour-intensive assembly work.

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