Reducing the U.S. Current Account Deficit by Recycling Capital Inflows from China

Pengfei Wang, Yi Wen and Zhiwei Xu suggest a way to bridge US Current Account Deficit. The long paper is here and a shorter version is here.

The authors say US should simply recycle the capital inflows from China back to China as FDI. Returns on fixed capital in China are  much higher.

First, why China exports its savings to US? It is because it does not have proper capital markets:

First, we need to understand why China is willing to lend to the United States when it is still struggling with low consumption per capita. The answer is that Chinese households need to save for precautionary reasons but do not have good domestic investment opportunities for their savings. Hence, financial capital (demand for liquid financial assets) tends to flow abroad from China to more developed economies (especially the United States) because household savings in China cannot be channeled effectively to its production sector. In other words, private firms in China are not able to gain free access to household savings despite rapid productivity growth. So China’s excessive saving rate is not matched by its domestic investment rate. This mismatch, in turn, implies that the rate of return to fixed capital in China’s private production sector is significantly higher than it is in the United States.

Indeed, the real rate of return to fixed capital in China has exceeded 20 percent in the past two decades, while the real rate of return to financial capital (such as bank deposits and short-term bonds) has been negative. Despite such an enormous gap, households in China save excessively in the form of bank deposits, indicating severely underdeveloped financial markets within China. This lack of a sophisticated financial system has been driving China’s household savings into the United States to seek safer and better returns (see Wang, Wen, and Xu, 2012).
So, US could just recycle these flows back to CHina:
However, the enormous gap between returns to household savings and returns to fixed capital in China also offers a tremendous profit opportunity for U.S. investors, especially U.S. firms. Basically, the United States can simply recycle the financial capital inflows from China and re-export them back to China in the form of foreign direct investment (FDI).1 In so doing, the United States gains a substantially larger rate of return from FDI than China does from owning U.S. government bonds. FDI outflows from the United States to China can offset China’s massive financial capital flows into the United States and help rebalance America’s large trade deficit with China. 
US policymakers should encourage FDI to China:
Therefore, rebalancing its trade deficit with China does not mean American consumers need to tighten their belts or American firms need to lower their domestic investment rate. Instead, the U.S. government can encourage U.S. firms to produce more capital goods and send them to China in the form of FDI, which has been strongly favored by the Chinese markets. This approach will also increase U.S. employment in the manufacturing sector. Ironically, the current U.S. policy in practice discourages American FDI outflows to China rather than encourages them, as the government fears technology transfers and losses of domestic employment. For example, in 2010 the total accumulated FDI outflows from the United States to China and other less developed countries accounted for just 5 percent of U.S. gross domestic product, whereas the total financial capital inflows into the United States from China and other less developed countries accounted for more than 25 percent. This imbalance of two-way capital flows and policy orientation toward American FDI outflows have exacerbated the U.S.-China trade imbalance problem.
I am not really sure. This is just flow of funds from one country to the other.
It might be tried for a shorter term. But over a long term China needs to develop its financial system to channelise savings towards higher return projects. US needs to lower its consumption to lower its CAD. Running large CADs and relying on flows is a bad strategy.

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