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Causes of and Remedies for the People’s Republic of China’s External Imbalances: The Role of Factor Market Distortion

The current account surplus of the Peopleâ€™s Republic of China (PRC) has drawn much foreign and domestic attention. This paper focuses on the reasons and remedies for the PRCâ€™s current account surpluses. Rather than deploying the standard explanations, we argue that asymmetric market liberalization and the related factor market distortion is the root reason for the PRCâ€™s external imbalances. These cost distortions have artificially lowered PRC production costs, raised profits, and improved their productsâ€™ international competitiveness which has not only stimulated the economy, but also brought about severe structural risks. We completed a crude estimation for factor cost distortions in the PRC during 2000â€“2009 which matched its current account surpluses quite well. In order to rebalance the economy, we recommend that the PRC should adopt a comprehensive reform package focusing on removing the factor market distortions.