Download Lecture Notes

Wuhan University
September 2012
Lecture Notes
Dr. Thomas Lairson
September 1
10:00 - 12:00
Many predictions and theories about the Chinese economy
Daily data about the Chinese and global economy
The Global Economy and the Chinese Economy
1) The Global Economy, 1780-2012
Epochal Shift in the Global Economic Power Balance
How did this happen?
1780-1980 – Western dominance
Western economic, political, and knowledge institutions create power
1980 – 2012
Emerging Economies combine
 improved knowledge,
 political and economic institutions to capture and apply Western knowledge
and
 leverage Western economic openness to catch up and surpass advanced
economies.
TWO TRACK GLOBAL ECONOMY
When Will China Catch the US?
The Economist’s interactive chart.
2018 – 2024
Very Large Gaps in Per capital income
US
$45,000
China
$ 4,600 (exchange rate)
$ 9,000 (PPP)
At PPP China can catch-up to the US in 2060 - 2080
New Global Division of Labor
West – Knowledge, innovation, brands, management (consume)
Emerging Economies – manufacturing and production, local innovation (produce
and save)
Implications of Global Shift
Increased competition for scarce resources
Power and influence
Natural resources
Key currency
Knowledge resources
Geopolitical position: TNCs, military bases, alliances
Define terms for global economic interdependence
Economic growth with equity for largest number
Greater ideological conflict over how economic growth can happen
State Capitalism versus Liberal Capitalism
Can China Overcome the Middle-Income Trap
Easy Gains – Peasant famers become factory workers sell to rich nations
Harder Gains – create national firms to compete with foreign firms
Very Hard Gains – average firms are world class
Extremely hard gains – consistent innovation at the technology frontier
Middle-income trap: cannot get beyond easy gains
Diminishing returns to investment in infrastructure
Total factor productivity growth slows down
Shift from savings/investment/labor intensive to knowledge-based
production and domestic consumption
China must have sophisticated management to make the hard decisions about
investment and organization to keep TFP rising
Dynamic Economy restructures forcing difficult changes
Many companies and organizations will resist changing system
Changes in Financial System
Finance and structural power in a capitalist economy
Political organization of finance
I.
Market-based finance; independent banks, limited regulation,
no political allocation of financial resources; market interest
rates and exchange rates
Strengths: dynamic; distributed decisions; rapid adaptation;
diversity; supports innovation
Weaknesses: short-term profit-oriented; allocated on current
prices; poor on long term investment; dependent on limited
vision of markets
II.
State-based finance; state-owned or controlled banks; heavy
regulation; state allocation of financial resources; manipulated
interest rates and exchange rate
Strengths: State actors have alternative and important
information and interests; long-term anticipation of future
prices; good at allocation from behind the global curve
Weaknesses: Tend to rigidity; as good or poor as political
perspective; reallocation is slow; political favoritism; crony
capitalism; poor at dynamic innovation support
Financial systems must achieve a dynamically evolving balance of pricebased short-term allocative efficiency using distributed and political
decision-making systems
Middle-income trap often results from overly centralized and politicized
financial systems;
China must rebalance its financial system to make it based on more
distributed systems of decision-making
Adopt a more flexible exchange rate
Can the RMB become a Key Currency?
Key Currency Criteria – U.S. and China
Foreign confidence in macroeconomic stability
U.S.
shaken
China
moderate
Deep and liquid capital markets
dominant
low
Capital account convertibility
very high
low
Flexible exchange rate
very high
very low
International medium of exchange in
trade and finance
dominant
low
Foreign central banks as hedge against
financial crises
dominant
some
The use of renminbi in trade settlement is
growing
i
Cross border trade settlements in renminbi
350
300
percent
6.0
billion renminbi
5.1 percent
Imports
5.0
Exports
250
4.0
200
3.0
150
pe ce t o
percent
of
total trade
2.0
100
50
1.0
0
0.0
2009 Q3-Q4
2010 Q1
2010 Q2
2010 Q3
2010 Q4
C a s tota
China’s
total e
exports
po ts 2010:
0 0 $
$1.75
5 ttrillion
o
China’s total imports 2010: $1.52 trillion
Sources: People’s Bank of China.
15
Resource-dependent growth
Will Chinese economic growth result in reversal of the long tern decline in
commodity prices?
Managers must plan for a world of higher commodity prices as emerging
market economies develop.
Cost control, sustainable business practices are essential part of manager’s
skill set.
Globalizing Chinese Firms
FDI and M&A from emerging markets to developed economies
Developed FDI to Emerging – greenfield
Emerging FDI to Developed - acquisition
Why do firms in emerging markets buy firms in developed markets?
Access to markets, finance, knowledge, technology, brand
Emerging market firms pay with cash (no debt) and pay too much
The Chinese Economy
Chinese economic growth has been phenomenal for more than 30 years
10% for 34 years = 32 times bigger in 2012 than 1978
Can it continue?
Managers must have a good sense of macroeconomic trends
Issues in the Chinese economy
Growing work force to stagnant work force – population is ageing
High productivity growth from labor shift
Uncertainty about sources of productivity growth in the future
Investment – Consumption
The end of the export boom
US charges China’s surplus is result of manipulated undervalued currency
Poor argument but the RMB will rise
Managers must compensate for rising domestic costs with higher
productivity and cost savings
Overinvestment = poor investment = lower growth
Best example of overinvestment is US housing industry from 2002 – 2008 all
driven by market processes
State-directed investment can lead to bad decisions too
“China as a whole saved an extraordinary 51% of its GDP last year. Until China’s investment rate exceeds
that share, there is no cause for concern, says Qu Hongbin of HSBC. Anything China fails to invest at
home must be invested overseas. “The most wasteful investment China now has is US Treasuries,” he
adds.”
“Michael Pettis of Guanghua School of Management at Peking University argues that the Chinese
government suppresses consumption in favour of producers, many of them state-owned. It keeps the
currency undervalued, which makes imports expensive and exports cheap, thereby discouraging the
consumption of foreign goods and encouraging production for foreign customers. It caps interest
rates on bank deposits, depriving households of interest income and transferring it to corporate
borrowers. And because some of China’s markets remain largely sheltered from competition, a few
incumbent firms can extract high prices and reinvest the profits. The government has, in effect,
confiscated quarts of barley from the people who might want to eat them, making them available as
seedcorn instead.
What has China got in return? Investment, unlike consumption, is cumulative; it leaves behind a stock of
machinery, buildings and infrastructure. If China’s capital stock were already too big for its needs, further
thrift would indeed be pointless. In fact, though, the country’s overall capital stock is still small relative to
its population and medium-sized relative to its economy. In 2010, its capital stock per person was only 7%
of America’s (converted at market exchange rates), according to Andrew Batson and Janet Zhang of GK
Dragonomics, a consultancy in Beijing. Even measured at purchasing-power parity, China has only about a
fifth of America’s capital stock per person, depending on how its PPP rate is calculated.”
Do China’s SOEs make poor investment decisions? Do they have too high profits and
receive capital at rates that are too low so they make investments without the
discipline of the market?
Yes, but not always and maybe not so much that it matters. China’s SOEs are linked
to entrepreneurial actors in the state who must conform to markets in the near
term.
Are China’s banks adequate?
State-owned banks dominate and allocate to SOEs and state-directed projects
Informal banking system - back-alley banks – provide lending to private
SMEs
Distributed investment system very poorly developed – Wen Jiabao – banks
make profits too easily.
But too much markets for finance is destabilizing; but without better
financial markets savers buy too much real estate
Loosen restrictions on capital flows: liberalize interest rates; enhance
Chinese purchase of foreign assets
Formalize and make legal the Wenzhou banking system
Evidence for massive mis-investment is not persuasive –
Non-performing loans?
Empty office buildings and condos?
Not all of the country’s “malinvestment” will result in bad loans. Some of its outlandish property
developments, including the empty flats of Ordos, were bought by debt-free investors with money to burn.
By the same token, not all of China’s “bad” loans represent malinvestment. Rural infrastructure projects, to
take one example, are often “unbankable”, failing to generate enough income from fees, charges and tolls
to service their financial obligations. But the infrastructure may still contribute more to the wider economy
than it cost to provide. That is especially likely for stimulus projects, which employed labour and materials
that would otherwise have gone to waste.
Evidence of overinvesting – bubble making?
From The Economist http://www.economist.com/node/21552555
If China is over investing, why is its capital stock per capita still so low?
What matters more than aggregate investment is:
1) Ability to move up the value chain
2) Rise in Total factor Productivity – ratio of GDP per unit of capital and
labor
“The striking thing about the growth in China’s total factor productivity is not its absence but its speed: the
fastest in the world over the past decade. Between 2000 and 2008 it contributed 43% of the country’s
economic growth, according to the APO. That is just as big a contribution as the brute accumulation of
capital, which accounted for 44% (excluding information technology). Thus even if some of China’s recent
investment has in fact been wasted, China’s progress cannot be written off.”
Rebalancing of investment and consumption is a large business opportunity
Next 10-20 years China’s consumption as a % of GDP will rise to 50%
Much of this will be driven by continuing urbalization
Rebalance the product and market strategy of China and foreign firms from
top tier cities to lower tier cities where urbanization will be greatest.
How big is China’s middle Class?
In income terms, using the baseline of 30.000 RMB per year:
Chart describes the changing proportions of Chinese in different cities earning over
30,000 RMB per year
This data ignores grey income:
In 2000, only Shenzhen at 25% and Beijing at 5.3% had any significant part of the
population earning this much. All cities in Chart 4 had negligible proportions at this
level of income.
The issue of grey incomes and accurate data on Chinese earnings:
In 2010, an academic from the China Reform Foundation, Wang Xiaolou,
published an influential report on the extent of the unreported—or “grey”—
income of China’s households. The report was controversial, as it suggested that
the discrepancy between officially reported income and the actual wealth held
by Chinese households was equivalent to nearly 30% of China’s GDP in
2008—a staggering amount. It also claimed that the under-reporting of income
was most flagrant among China’s wealthier households, suggesting that levels of
wealth inequality were much wider than officially recognised. Income tends to be
understated in official household surveys, as individuals are concerned that the
information they disclose might be passed to the authorities (tax evasion is rife in
China).
The Economist Intelligence Unit consulted with specialists to build its own
estimates of the actual wealth held by Chinese households. It has developed a
forecasting framework, combining its own macroeconomic data with relevant
academic studies on grey income and income inequality, to generate provinciallevel estimates of actual household incomes in different income bands. The
megalopolis income forecasts in this paper do not include grey income, as it
focuses on city-level data.
The differences between the income projections based on official data and
those factoring in grey- income estimates are stark. For example, in 2010 only
6% of households in Chongqing earned above a cumulative Rmb80,000 after
adjusting for inflation. When factoring in grey income, however, the EIU found
that this proportion rises nearly fourfold to 27%. At the national level, 12% of
households earned above a cumulative real Rmb 80,000 that year. After
adjusting for grey income, however, this proportion nearly triples to 32%.
The under-reporting of real income levels indicates that our forecasts for the
expansion of China’s urban middle classes are likely to be conservative.
Sichuan estimates
The China market is much bigger that has been estimated by official data.
AS incomes rise, we must adjust our estimates of the income elasticities of demand for
many products skewed toward the middle and upper income level products. Demand for
healthcare, education and environmental protection will also rise more quickly than
previously thought.