Download Lessons from the Economic Crisis

Macro Problems and Macro Policy
in China and the United States:
Lessons from the Economic Crisis
Bruce L. Reynolds
Department of Economics
University of Virginia
[email protected]
Prepared for presentation at George Washington University’s Elliott School of
International Affairs: “G2 at GW: A conference on Chinese Development and U.S.-China
Economic Relations”, Nov. 20, 2009.
I thank Lisa Luo, Shirley Xue, Geng Chen, Xintong Wang and Mu Chen for their able
research assistance.
Preliminary: Please do not cite or disseminate this paper without the author’s
permission. I welcome comments and criticisms.
Introduction
A year ago, the collapse of the U.S. housing bubble, and the attendant crisis in our
financial markets, sent a shock wave through the world economy. Geologists use seismic
shocks to study deep structures in the earth. We have a similar opportunity here, and we
should make good use of it.
This morning, I’ll sketch three areas where we could add to our knowledge. First,
we can explore technical aspects of China’s macroeconomy, and the evolution of fiscal
and monetary policy levers in China. Second, by juxtaposing the policy response in the
U.S. and in China, we can judge the capacity of each state to respond quickly and
powerfully to an immediate crisis. The third area, which I’ll just touch on at the end, is
the subject of this afternoon’s panel: the urgent need for cooperation between the U.S.
and China.
I. Learning More About China’s Macroeconomy and Macro Policy
a. Let’s use the crisis to study macro linkages. In the wake of the past year’s
turbulence, Chinese policymakers might well ask themselves: What price do we pay for
linking our own economy so fully with the rest of the world? There’s a large literature on
the linkage between trade openness and macroeconomic volatility.1 Trade dampens
1
J. Giovanni and A Levchenko, “Trade Openness and Volatility”, Review of Economics and Statistics
91:3 (August 2009), 558 provides a useful review of this literature. See also J. Imbs, “Growth and
Volatility”, Journal of Monetary Economics 54:7 (2007), 1848 and T. Laursen and S. Mahajan,
macro shocks that originate at home, but trade brings in, and can even magnify, external
shocks. The Ministry of Finance estimates that for each 1% drop in U.S. GDP, Chinese
exports dropped by 6% in 2008/9. So an obvious task for some ambitious researcher
would be to track that shock through the rest of the Chinese economy, using it to learn
more about the costs and benefits of linkage.
b. Let’s learn more about fiscal federalism, Chinese style. Decentralization sets up a
kind of game between Beijing and local governments. Yingyi Qian and others have
traced attempts by China to shape an incentive structure, a set of rules, that produce a
growth-enhancing local response to central fiscal initiatives, rather than the rent-seeking
behavior that Vishny and Schleiffer call the “grabbing hand”.2 China’s 4 trillion RMB
stimulus package came with the following rules: we’ll provide a one-third central
government subsidy for stimulus projects proposed by local governments. The NDRC
will select among proposals based on three criteria: job creation, growth potential, and
“the applicant’s ability to raise a significant portion of the funds”.3 Did that incentive
structure lead local governments to game the system, by putting forward projects with
weak repayment prospects and/or little prospect for local funding? In the paper I present
some evidence that this has happened.4
“Volatility, Income Distribution and Poverty”, in J. Aizenman and B. Pinto (Eds.), Managing Economic
Volatility and Crises: A Practitioner’s Guide (New York: Cambridge University Press, 2005) pp. 101136).
2
Y. Qian et al, “Regional Decentralization and Fiscal Incentives: Federalism, Chinese Style”, Journal of
Public Economics 89:9-10 (2005) 1719; A. Shleifer and R. Vishny, The Grabbing Hand: Government
Pathologies and Their Cures (Cambridge: Harvard University Press, 1998).
3
24 Geoffrey Revelle and Jerry Chiang
4
By September, the volume of projects submitted by local governments had swelled, according to various
sources, to 10TY, 14TY or 18TY. Caijing 24 (12 Sept 2009). During the first 8 months of 2009, 85 BY in
municipal investment bonds were issued – triple the pace of the prior four years. (20: ChinaStakes Monday
Oct. 26 2009, “RMB 4 Trillion Stimulus…”) The May 2009 National Audit Office report on the
c. What can we learn about China’s evolving monetary mechanism? Three months
after the U.S. economy crashed, the Chinese economy was awash in liquidity.
Andrew
Batson calls this “one of the most dramatic monetary expansions in history”, and credits
it with keeping the Chinese economy upright.5
The data in Figure 1, from the PBOC, show a year-on-year increase of loan
balances of over 4.5 T RMB in the first quarter of 2009 alone. The next figure, from the
World Bank’s November 2009 quarterly report, shows the spike in money growth even
more vividly. This begs the question: Did this monetary expansion merely accommodate
the stimulus projects that Beijing had already approved administratively? Or did it
separately stimulate new economic activity? Did it fuel a new asset bubble?
And a final issue: exit strategy. The monetary surge leaves China with at least as
pressing a need for a monetary exit strategy as the U. S. Federal Reserve. In perhaps six
months, the PBOC will have to apply the brakes. Let’s watch to see if China continues
implementation of the stimulus package complained that “local governments take central government
projects as a free lunch…so long as they can win the project and thus win central funding, even if local
matching funds don’t materialize, the project won’t be given up halfway through.” 39:
http://www.022net.com/2009/5-20/475923302668653.html.
5
“China Rises on Power of Stimulus”, Wall Street Journal Online (16 July 2009)
its gradual transition away from administrative, quantitative credit rationing, in favor of
the interest rate mechanism?6
II. Size of Shock, Policy Response and Policy Impact
Now I’ll talk, more discursively, about what we can learn by placing the experience of
the U.S. and of China – the macro shock, the policy response, and the policy impact side by side. I argue that the U. S. experienced a larger macro shock than China; that
while each country’s policy response was constrained by circumstances, the U. S. had
less room to manoeuvre; and that as a result, China’s response was distinctly larger
(despite a smaller shock), and faster, and more effective.
a)How big was each shock? One way to measure a macro shock is to ask: How large a
portion of anticipated spending, as a percentage of GDP, has suddenly disappeared? In
the U.S., the burst housing bubble and the collapse of the stock and financial markets
sharply reduced private spending in 08:IV and 09:I. In the paper I present estimates
ranging from 7 to 12% of GDP.7 9% seems like a reasonable number.
6
Wenlang Zhang, “China’s Monetary Policy: Quantity versus Price Rules”, Journal of Macroeconomics
31:3 (September 2009) 473. See also R. Burdekin and P. Siklos, “What Has Driven Chinese Monetary
Policy Since 1990? Investigating the People’s Bank Policy Rule”. East-West Center Working Paper 85
(2005)
7
Hans Timmer, the World Bank’s chief economic forecaster, estimates a 10% drop in private spending,
which means roughly an 8% shortfall in overall GDP. Cited by Mark Weisbrot, “China’s Economic
Lessons to the U.S.”, Guardian Unlimited, July 23, 2009:
http://www.guardian.co.uk/commentisfree/cifamerica/2009/jul/23/china-us-trade-economic-stimulus One
can line up J.P. Morgan’s authoritative monthly forecast for the U.S. economy in 2008/2009 issued in
For China the shock was a reduction in demand for its exports. Exports constitute
perhaps 30% of Chinese GDP. Absent a shock, exports would have grown, by perhaps
20% in 2009. Instead, in 2008:IV and 2009:I exports dropped at a 25% annual rate.8
The implied shock to the economy as a whole is roughly 6% of GDP.9
b. The policy responses. Economic circumstances constrained both countries’ policy
response. In the U.S., an aging population and a sclerotic political system had produced a
large structural deficit. On Dec. 16, 2008, Obama met a dozen top advisors, including
Biden, Summers, Axelrod, Geithner, Orzag and Romer, to confront the crisis. Romer’s
analysis saw a $2 trillion output gap, implying a stimulus package of at least $1.2 trillion.
But Summers’ agenda-setting memo presented only $580B and an $890B options.
Axelrod argued that a $1.2 trillion starting point would simply lock up the political
process in Congress, risking no package at all. Orzag pointed out that mechanically, it
might be difficult for government to spend money at that rate. And Summers, looking
down the line at the issue of debt service, worried that so large a package could shift the
political conversation to the fiscal deficit, spooking the long term bond market.10 The
legislation that passed on Feb. 17, 2009 was for $787 billion.
February 2008 (pre-shock) and the November 2008 forecast (post-shock, but pre-policy response). That
comparison suggests that in the fourth quarter of 2008 and the first quarter of 2009, U.S. GDP declined by
7% due to the shock. The Carnegie Endowment’s Bert Keidel, writing in November 2008, calls for a
stimulus program in the range of “10 to 20 percent of GDP”. Albert Keidel, “China’s Stimulus Lesson for
America”, Web Commentary Christina Romer, the head of the Council of Economic Advisors, argues
forcefully that the shock was “at least as great, and probably greater than (the shocks) at the start of the
Great Depression”. Christina Romer, “Back from the Brink”, speech to the Chicago Federal Reserve Bank,
Sept. 24, 2009, p. 4
8
Wayne Morrison puts exports at 37.5% of Chinese GDP in 2008. Congressional Research Service
Report, July 2009.
9
Taking 08:III as 100, exports fall to 87.5, 20% below the anticipated 110 level. 20% x 30% = 6%. Yu
Yidong, a CASS economist, suggests 5%. [36] Pieter Bottelier suggests 5.4%. [5]
10
Ryan Lizza, “Inside the Crisis”, The New Yorker (12 October 2009)
China could afford a more expansionary fiscal policy. Its budget deficit was low. In
March, China projected a modest 2009 fiscal deficit of 3% of GDP, and official debt will
probably be only 20% of GDP even after the stimulus.11 And the banking system could
accommodate fiscal expansion. Three years of tight monetary restriction, designed to
reduce overheating, had left the system with large excess reserves.12 But China’s
response was also constrained, in at least two ways. First, the share of investment in
China’s final demand is unsustainably high and rising. A stimulus that involved more
investment would only exacerbate the need to rebalance the economy towards consumer
demand. Second, compared with a mature industrial economy like the U.S., China is in
the midst of great change – the transition from a rural, agricultural economy to an urban
industrial society. That transition creates enormous social strains, such as tens of
millions of migrants seeking urban jobs. A stimulus package would have to
accommodate those stresses as well.
Given these constraints, how did each government respond after the Sept. 29 stock
market crash? Let’s start with China. Within a month, the Chinese government had
shaped a stimulus plan. It was approved by the State Council on Nov. 5. The main
outlines were announced Nov. 9. Specific breakdowns were spelled out by the NDRC
on Nov. 27: 1.18 trillion RMB in central government spending (half to occur by the end
of 2009, the other half thereafter), and 550 M RMB in tax relief for 2009. The combined
11
Yu Yidong, “China’s Stimulus Shows the Problems of Success”, Martin Wolfe blogsite, Financial
Times (Aug. 26, 2009)
12
Keith Bradsher, “Recovery Picks Up in China as U.S. Still Ails”, New York Times (18 Sept 2009)
central spending and tax relief planned for 2009, slightly over 1 T RMB, was about 3.3%
of 2008 GDP.
Insert Table 1 here
Table 1 shows planned and actual central government spending from the Y1.18T NDRCmediated stimulus program. Actual spending was high in 08Q4 and 09Q2, fell
somewhat, and then surged again in 09Q4.
The much-heralded figure of 4 trillion RMB includes intended cost-sharing with local
governments. Local funding has lagged far behind the intended one-third/two-thirds
central/local cost sharing formula. If local funding is falling short by 50%, the Chinese
stimulus in 2009, including local funding and tax relief, will prove to have been roughly
4.1% of 2008 GDP13.
13
Author’s calculation: [.450 + .225 + .550]/30.
This figure shows the impact of the Chinese stimulus rather clearly. The blue
and black lines show the two main components of private sector investment. We see the
sharp drop in 08/09. The red line shows government-influenced investment, which
substitutes for private investment in an adroit fashion; and then private investment turns
around.
In the United States, the lame duck Bush Administration balked, in the fall, at
even a $100 billion infrastructural spending stimulus. By the time the new administration
was in office and legislation had passed through Congress, it was mid-February, three
months later than the Chinese action. And China had already spent 180 BY (2.4% of
quarterly GDP) in fourth quarter 2008. [Insert Table 2 here] Table 2 shows that US
spending began only in first quarter 2009, with a trickle: $11.8 billion (0.3% of quarterly
GDP). And this early spending was exclusively tax or state fiscal relief, which has a
smaller multiplier than infrastructural spending.
This rather arch figure, taken from Greg Mankiw’s blog, tells one side of the
stimulus impact story. It’s taken from an Administration report of February 2009, as the
stimulus package was being approved. The pale blue line shows some notional path that
unemployment might have followed in the absence of stimulus. To this the
Administration adds a dark blue line showing the predicted impact of the stimulus.
Mankiw then does them the unkindness of tracing in the actual path unemployment has
followed, in the months since the report was issued.
But that’s just unemployment. What about GDP growth? Which stimulus has
been most effective at renewing economic activity, the U.S. package or the Chinese
package?
The next slide, taken from the Council of Economic Advisors September 2009
report, provides a useful way to frame this question. For 19 countries, it juxtaposes each
country’s stimulus package, measured along the horizontal axis as a percentage of GDP,
against the country’s 2009 Q2 growth rate – but only after subtracting, from that growth
rate, a November 2008 forecast of that same growth rate. The November forecast is postshock but pre-stimulus. So it may capture what would have happened in the absence of
stimulus. Netting it out from the actual growth rate would then show the impact of the
stimulus (combined, of course, with many other unanticipated events).
The regression line shows the best “fit” to this data set. The fact that it has a positive
slope tells us that stimulus increases GDP growth – as one would hope! The fact that it
has a negative vertical intercept tells us that the recession turned out to be even worse
than was forecast in November.
Now let’s consider our two countries. The regression line shows what a given level of
stimulus should be able to do for your economy. The fact that the U.S. lies below the line
says that our stimulus was less effective than the average. China’s data point, above the
line, tells the opposite story.
That’s a nice, tidy conclusion, and I’m tempted to settle for it. But I’m an economist.
Our stories are never simple. A couple of considerations move both the US and China
back towards the line. First, 2% surely overstates the U.S. stimulus. It includes the AMT
patch – a tax cut that surely would have been enacted anyway, and was added in solely to
bulk up the tax cut portion of the package. It ignores the sharp drop in government
spending as local revenues collapsed, estimated at perhaps $100 B.14 And the U.S.
14
See for example D. Baker and R. Deutsch, “The State and Local Drag on the Stimulus”, Center for
Economic and Policy Research, May 2009.
spending was slow to start – even if the 2009 number was 2%, the stimulus was just
beginning when the economy was generating the Q2 GDP numbers used here.
The Chinese government spending, by contrast, was front-loaded. 230BY
(excluding tax relief) was spent in 08Q4 and 09Q1, a stunning 15% of GDP in those two
quarters. Stimulus spending in 2009, including tax relief, was not the 2.6% figure used in
this CEA analysis, but 4.1%
Then the U.S. data point should slide to the left, and the Chinese data point should
slide to the right – moving both countries back towards the line that showing the impact
of a normal, properly-effective stimulus package. This changes our conclusion: The U.S.
package was as effective as one could hope for, from a package that so small, and so long
delayed. To the extent that China’s package worked better than ours, it was because the
decision was swift, the implementation was swift, and the package was large and frontloaded.15
III. U.S. – Chinese Cooperation in the aftermath of the crisis.
The economic crisis provides us with a third fertile are of inquiry: We can explore
the extent to which it generated cooperation between America and China, these
supposedly emergent “G2” countries.
15
One last point that time precludes exploring at the panel: Being on that regression line is not the sole test
of an appropriate stimulus. The higher goal for macro stabilization is to minimize the shortfall between
actual GDP and potential GDP. China’s economy, in November 2009, has already returned to close to its
potential growth path. The U.S., with 10% unemployment, is far below potential GDP, because compared
with China, we stimulated too little and too late.
The participants in this afternoon’s panel will able cover this terrain, and indeed
our two plenary speakers, Harry Harding and Fred Bergsten, are likely to do so as well.
And I’m nearly out of time!
But there are some obvious questions to ask here. First: In the first week after the
markets collapsed, did the top leadership of the two countries communicate? There are
reports of phone conversations between the White House and Zhongnanhai. In the first
month, what communication occurred between the U.S. Treasury and Federal Reserve on
the one hand, and Chinese monetary authorities on the other? In this first year of crisis,
have we had payoff from five years of strategic economic dialogue? Are those working
groups exchanging information in ways that help both countries work together? Second,
what about substantive results of cooperation? Can we find in the short-run remedies
anything that we’d call intelligent policy coordination? And in the longer run, do we see
any signs of the “rebalancing” that we know needs to happen?
On this last point, I admit to feeling discouraged. It’s completely clear – at least,
clear to those willing to look – that the national saving rate in the United States must rise,
and must fall in China, to avert an eventual, sharp, damaging readjustment in the value of
the U.S. dollar. To achieve this, the two governments could agree on coordinated action.
In the United States, we could tax away consumer spending power and invest in our
decaying infrastructure. China could commit more fully to social safety nets that might
leave Chinese households more willing to consume, and some diminution in the very
high rate of profits and retained earnings by large Chinese corporations would also help.
But what we see thus far in the stimulus packages is two countries moving down
exactly the wrong pathways. In the U.S., stimulus has mostly been in social spending,
rather than infrastructural investment. China’s stimulus package is all about
infrastructure. This bodes ill.
I’ll stop here, and I look forward to learning more in the afternoon sessions.