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Four Dimensions of China’s Economic Success: Policies for a Second-best World Albert Keidel Senior Fellow, The Atlantic Council of the United States Adjunct graduate professor, Georgetown University [email protected] for the conference: New Economic Thinking, Teaching and Policy Perspectives supported by The Ford Foundation and MINDS With BNDES, Federal Government of Brazil and CAF Rio de Janeiro, Brazil, November 7~9, 2011 Chinese Growth through the Great Recession Returns it to “normal” 8~10% expansion Percent 15 East Asian Financial Crisis U.S. 1991 Recession 10 2008-09 Great Recession U.S. 2001-02 Recession 5 ? -5 USA China Germany Japan 2012 2011 2010 2008 2007 2006 2005 2004 2003 2002 2001 2000 1999 1997 1996 1995 1994 1992 1991 1990 1989 0 The real culprit was U.S. money creation through credit deregulation and nonregulation – an abuse of $ reserve creation 8 China Current Account Balance (% of U.S. GDP) U.S. Consumer Debt (%-points above 12% of GDP) 6 U.S. Consumer Debt U.S. Current Account balance (% of GDP) 4 2 China Current Account 0 -2 U.S. Current Account -4 3 2008 2006 2004 2002 2000 1998 1996 1994 1992 1990 1988 1986 1984 1982 -6 1980 % The GFC Accelerated China’s Reforms 1. Damage was brief and salutary • Little financial impact – but exports were slammed • Forced shift to domestic demand and indigenous value-added • Huge stimulus success illustrated quasi-fiscal capabilities 2. Many programs and projects moved forward • Public investments: infrastructure , housing, health, education • Private sector output surged – not a “return of the state” 3. Innovations stimulated on many fronts • Accelerated restructuring pilots (especially in South China) 4 • Domestic financial diversification and innovation Quarterly GDP Growth, Year-on-Year 16 GDP % Annualized 14 11.9% 12 10 8 9.1% 6.5% 6 4 2 2008 2009 2010 Quarterly Year-on-Year Qtr-3 Qtr-2 Qtr-1 Qtr-4 Qtr-3 Qtr-2 Qtr-1 Qtr-4 Qtr-3 Qtr-2 Qtr-1 Qtr-4 Qtr-3 Qtr-2 Qtr-1 0 2011 5 Q-on-Q GDP Growth, Seasonally Adjusted 16 GDP % Annualized 15.2% 14 12 9.1% 10 8 7.6% 6.5% 6 4 2 1.2% 2008 2009 Quarter-to-Quarter SA 2010 Qtr-3 Qtr-2 Qtr-1 Qtr-4 Qtr-3 Qtr-2 Qtr-1 Qtr-4 Qtr-3 Qtr-2 Qtr-1 Qtr-4 Qtr-3 Qtr-2 Qtr-1 0 2011 Quarterly Year-on-Year 6 Exaggerated Issues to Remember 1. China doesn’t cause “global imbalances” • China’s first surplus in 2005 was too late to cause the GFC • The US 1998-2007 credit bubble caused large US trade deficits • Hence, the U.S. trade deficits also caused China’s large savings 2. Consumption-investment (C-I) imbalances? • China’s high investment (I) rate is the source of rapid growth • A falling consumption (C) rate is normal; C growth is rapid 3. China’s exchange rate is not misaligned • Long-term real trends indicate it is in a reasonable range • Balassa-Samuelson logic doesn’t apply for such a short period • China’s large trade surplus represents a kind of Dutch disease. 7 Basic Policies – Keynesian Stimulus 1. Limited financial sector contagion •Tightly managed capital account eliminated direct exposure •Quickly substituted yuan and HK$ trade letters of credit •Identified U.S. dollar credit abuses as main crisis culprits 2. Large job-focused quasi-fiscal stimulus •15% of GDP over two years – within months of Lehman Bro. •Financed overwhelmingly by directed bank credit •Projects were infrastructure and housing – not balance sheets 3. Social welfare transfer payments to the poor •Encouraged consumption, especially of consumer durables •General funding expansion for education and safety nets 8 Four-dimension Explanation of Success I. Institutional economic leadership capacity II. Heavy focus on public goods provision III. Conscious attention to demand adjustments IV. Rapid strengthening of profit incentives 9 Five-dimension Explanation of Success 0. Values, Norms and Principles I. Institutional economic leadership capacity II. Heavy focus on public goods provision III. Conscious attention to demand adjustments IV. Rapid strengthening of profit incentives 10 I. Institutional Economic Leadership 1. Corporate government structure • Executive function is by a management committee – The SC • Communist Party is all-pervasive system of outside directors • Web of checks, balances and consultation institutions 2. Farsighted policy implementation abilities • Most powerful agency is Economic and Reform Commission • Investment planning & project design are ahead of the game • Statistical information is adequately reliable 3. Quick decisions to meet short-term shocks • Information and analysis come together rapidly • Leadership selection insulated from crippling corruption 11 II. Focus on Public Goods 1. Infrastructure, education and health • Considered necessary to enable healthy market forces • Investments extend to rapid expansion of strategic sectors 2. Financed from a repressed banking system • • • • Non-risk-taking depositors enjoy little if any real return Commercial banks lend to development banks and to projects More efficient than a liberalized market-based banking system Capital controls support repression and strengthen stability 3. Moderate crime, corruption & social unrest • Wrenching changes and unmet expectations are major issues • Avoidance of overly rigid “rule of law” 12 III. Macroeconomic Demand Management 1. Quantitative credit controls and interest rates • Lending patterns and scale receive targeted adjustments • Interest rates important for moderating deposit growth • “Macroeconomic” in Chinese includes “sectoral adjustments” 2. Three-decade pattern of macro fluctuations • Growth rates slow and speed up – independent of exports • Complex origins – inflation concerns and a grain cycle • Fluctuations also useful for reform implementation 3. U.S. credit bubble: a demand disturbance • Beijing couldn’t control combo of FDI and export demand • Slowing domestically-based demand caused trade surpluses 13 IV. Profit and Income Incentives 1. Thirty-plus years enabling market forces • Land reform, state enterprise privatization and labor reform • Freeing up rural-to-urban migration seeking jobs & housing • Price reform’s major shift in direction of relative scarcities 2. Retained earnings and direct equity funding • Shadow (opportunity-cost) rates of return are very high • Active investors manage risk carefully • Labor pay levels correlate highly with educational attainment 3. Political influence of wealthy is limited • There is no campaign finance issue • Lower-level corruption is at normal levels for GDP/capita14 0. Values, Norms & Principles 1. Nationalism and poverty reduction • Leadership’s self-evaluation for national effectiveness • Both lip service and resources aimed at poverty reduction • Shared emphasis on economic rights and personal rights 2. Confucius and Daoism, not Stalin • Axial Age (c. 500 BCE) had China ahead of the Greeks • Emphasis on individual responsibility for welfare of others • Harmonious development has deep Confucian roots 3. Rights to petition for grievances have limits • Tiananmen demonstrations were not pro-democracy • Administrative litigation law frequently leads to settlement15 How can we evaluate the developed West? 0. Values, Norms and Principles I. Institutional economic leadership capacity II. Heavy focus on public goods provision III. Conscious attention to demand adjustments IV. Rapid strengthening of profit incentives 16 What about the teaching of Economics? 0. Values, Norms and Principles I. Institutional economic leadership capacity II. Heavy focus on public goods provision III. Conscious attention to demand adjustments IV. Rapid strengthening of profit incentives 17 Thank you [email protected] 18 China Pre-GFC (Global Financial Crisis) 1. Poised for new growth after 1990s’ reforms • Enterprise, labor, banking, fiscal, foreign exchange reforms • Sale of small & medium-sized SOEs; dramatic worker layoffs 2. Both benefits and distortions from WTO • Huge surge in low-skill foreign “assembly” platforms • U.S. credit bubble drove excessive U.S. imports from China • Results: structural distortions & pressure for RMB appreciation 3. Rapid growth & eventual overheating • Not export-led growth; rather, export-led overheating • Accelerated urbanization and real estate construction • Problems: pollution, land disputes, inequalities, inflation 19 Implications for Global Reform – Wish List 1. Internationally binding bank regulation • • • • Global enforcement of commercial/investment bank separation Uniform transparency & regulation of derivatives markets Mandatory coordinated of global liquidity creation Global standards for limiting special-interest political influence 2. International standards for capital flows • Support for developing country short-term (s-t) capital controls • Require s-t lending to be denominated in borrower’s currency 3. Pro-development trade standards • Legitimacy for pro-development strategic protection regimes • Agreement on protection sequences to optimize labor skills 20 China’s Trade Balance: Is this current account component sensitive to exchange rate movements? 6 Trade Balance in Goods and Services as % of U.S. GDP 4 Rest of World 1.8% 2 China 1.6% 0 -2 3.4% United States -4 U.S. Rest of World 2010 2009 2008 2007 2006 2005 2004 2003 2002 2001 -6 China 21 Is the yuan now following a basket?! US$ per 10 yuan US$ per euro 1.55 Chinese yuan (right side) 1.50 1.45 1.40 1.35 1.30 euro (left side) 1.25 US$ per euro January December November October September 2010 August July June 1.20 1.53 1.52 1.51 1.50 1.49 1.48 1.47 1.46 1.45 1.44 1.43 US$ per 10 yuan 22 Hong Kong’s RMB role: Highly Strategic 1. Assist Hong Kong’s economy • Extension of CEPA (Closer Economic Partnership Agreement) • Provide HK a range of privileged financial opportunities 2. Provide a safe & controlled Shanghai lab • HK sophistication and openness promise good RMB lessons • The mainland can control the scale of RMB offshore liquidity 3. Foster long-term RMB internationalization 4. Emphasize China’s “Triffin” critique of U.S. 5. Draw Taiwan closer to the mainland 23 Hong Kong’s Advantages 1. High Quality of Hong Kong institutions • Human capital is high-quality and globally smart • Legal and regulatory systems have excellent reputations • Language – English and Chinese fluency 2. Geographical location • Increasingly integrated coordination with mainland policies • Well situated for providing ASEAN financial services 3. Mainland political commitment • Beijing’s need to maintain HK’s yuan preeminence • General support of HK as a successful SAR 24 Regional Trade and Business Implications 1. As Beijing pushes yuan settlement … • Hong Kong’s advantages will draw international companies • China’s importance for ASEAN trade will grow rapidly 2. If future yuan offshore liquidity is large … • Other world financial centers will need to decide how to move • Financial sector lobbying in other countries could give China a strong bargaining chip in related (or unrelated) negotiations 3. Offshore lessons speed up Shanghai reforms • Mainland financial business opportunities will expand • Chinese financial firms will likely expand penetration of other 25 global financial markets China’s current account surplus wasn’t significant until late in the U.S. bubble % 4 Current Account Balance as Percent of U.S. GDP United States China Rest of the World Rest of the World 2 China 0 -2 United States -4 26 2008 2006 2004 2002 2000 1998 1996 1994 1992 1990 1988 1986 1984 1982 1980 1978 1976 1974 1972 1970 1968 1966 1964 1962 1960 -6 Bubble-matching surpluses were elsewhere; US housing price collapse matched China’s surpluses 12 10 Current Account Balances as Percent of U.S. GDP and U.S. Housing Price % Changes* % % Change in U.S. Housing Prices* 8 6 Northern Europe, Nonmainland-China East Asia and Oil exporters 4 2 China 0 -2 United States -4 * Inflation-corrected (CPI-corrected) housing prices (source: www.clevelandfed.org) 2008 2006 2004 2002 2000 1998 1996 1994 1992 1990 -6 27 What caused China’s surpluses? Sharply slower investment to fight inflation. China’s exchange rate didn’t do this: 130 Bil. US$ (log scale) Exports 1030 China's 690 Goods & Services Exports and Imports Imports 460 310 210 140 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Exports Imports hi 28 Is the RMB low? … or high?! It’s all politics! After the euro fell in July, 2008 China decided not to let the RMB depreciate against the US$ US$ per Euro RMB per US$ 1.8 6.5 1.7 7.0 RMB 1.6 7.5 1.5 8.0 1.4 Euro 8.5 1.3 9.0 1.2 9.5 1.1 10.0 2005 Euro (US$/€) 2006 2007 2008 2009 2010 RMB (yuan/US$) RMB hypothetical 'basket' value (yuan/US$)29 Not during the November-December Lame Duck U.S. Congressional Session! US$ per 10 yuan US$ per 100 yen 1.29 Chinese yuan (right side) 1.27 1.25 1.23 1.21 1.19 1.17 US$ per 100 yen January December November September 2010 August July June 1.15 October Japanese yen (left side) 1.53 1.52 1.51 1.5 1.49 1.48 1.47 1.46 1.45 1.44 1.43 US$ per 10 yuan 30 Currency Movements versus $ During the Crisis Japan % Japan 25 Thailand 20 Switzerland Singapore 15 Malaysia 10 Thailand China Canada 5 China 0 Canada Brazil India -5 Brazil India Czech Rep. Denmark -10 Euro Zone -15 Mexico United Kingdom Russia -20 -25 2008 2010 Euro Norway Vietnam Mexico United Kingdom 31 Finally, China’s reserves aren’t “massive.” At end-2010, still only 26% of M2. 100 Percent 96% Singapore 90 80 70 60 Foreign Reserves as a Share of Money Supply 73% Malaysia 50 40 India 30 S. Korea 20 20% 10 China China India S. Korea Malaysia 2007 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 0 Singapore Income Distribution – Long-term Trends Figure 1. Rural-Urban Migration and Inequality 1985 Household Density* .8 .6 .4 China Total A B C 1985 Urban Gini Coefficient China Total Rural .2 Rural Poverty Lines Urban 0.3097 .0 .8 .6 2005 A Household Density* B Poverty Lines A - Chines e Poverty Line B - Old $-per-day Line C - New $-per-day Line C China Total .4 Rural .0 .8 .6 Gini Coefficient 0.4557 Urban .2 2005 2025 A Hous ehold Dens ity* B 2025 C China Total Urban .4 .2 Rural Gini Coefficient 0.4526 .0 00 100 100 300 700 1,600 3,600 7,900 17,500 39,000 Household annual per-capita income in 2005 constant US$ (at 1985 average exchange rate) Rural-urban Income Gaps and Farm Labor Shares, China & Japan 1.2 China Rural-Urban Parity Japan 1.1 1974 0.9 1953 0.8 0.7 Japan 1985 0.6 1960 China 0.5 1996 0.4 0.3 2007 0.2 60 50 40 30 20 Share of Labor Force in Agriculture (percent) 10 Rural-Urban Income Ratio* 1.0 China’s Seven Economic Regions Regional per-capita income divergence … But with rapid growth in all regions 6,404 E. Coast S. Coast N. Coast Central Core N. Hinterland S. Hinterland Far West 7.7 7.4 6.7 6.6 6.6 6.0 4,901 4,196 3,556 3,218 3,062 2,662 2,410 Ave. Annual Real Growth Rate 1985-2000 (%) Per-capita Rural Income Per-capita Rural Income Log Scale 1,258 8.5 E. Coast 7.7 S. Coast 7.4 N. Coast 6.7 Central Core 6.6 N. Hinterland 6.6 S. Hinterland 6,404 4,901 4,196 3,218 3,062 6.0 Far West Ave. Annual Real Growth Rate 1985-2000 (%) 2,662 2,410 Per-capita Rural Income Per-capita Rural Income 1,258 1,113 1,004 879 846 748 743 Rural Household 1985-2005 Real Per-capita Net Income (Constant 2000 Yuan) 1985 2005 1,113 1,004 879 846 748 743 Log Scale 8.5 Rural Household 1985-2005 Real Per-capita Net Income (Constant 2000 Yuan) 1985 1990 1995 2000 2005 Beijing’s SO2 levels are below Japan’s & Korea’s earlier levels Average annual Parts per Million Ambient SO2 Concentration 1988 Tokyo, 1968 .06 .05 1965 1997 Beijing .04 .03 Seoul All Japan 1999 .02 1974 1993 2004 1983 .01 2000 1997 .00 0 Japan 5,000 Beijing 10,000 Seoul 15,000 Tokyo 20,000 25,000 GDP/capita 2000 US$