Four Dimensions of China’s Economic Success: Policies for a Second-best

WorldAlbert Keidel

Senior Fellow, The Atlantic Council of the United StatesAdjunct graduate professor, Georgetown University

AKeidel@Keidel.us

for the conference:New Economic Thinking, Teaching and Policy Perspectives

supported by The Ford Foundation and MINDS

With BNDES, Federal Government of Brazil and CAFRio de Janeiro, Brazil, November 7~9, 2011

Chinese Growth through the Great RecessionReturns it to “normal” 8~10% expansion

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USA China Germany Japan

Percent

U.S.1991Recession

East AsianFinancialCrisis

U.S.2001-02Recession

2008-09GreatRecession

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The real culprit was U.S. money creation through credit deregulation and non-

regulation – an abuse of $ reserve creation

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China Current Account Balance (% of U.S. GDP)

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U.S. Current Account

U.S. Consumer Debt

%

China Current Account

4

The GFC Accelerated China’s Reforms1. 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)• Domestic financial diversification and innovation• Hong Kong collaboration and RMB internationalization

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Quarterly GDP Growth, Year-on-Year

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Quarterly Year-on-Year2008 2009 2010

GDP % Annualized

9.1%6.5%

11.9%

2011

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Q-on-Q GDP Growth, Seasonally Adjusted

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Quarter-to-Quarter SA Quarterly Year-on-Year2008 2009 2010

GDP % Annualized

9.1%

15.2%

1.2%

6.5% 7.6%

2011

7

Exaggerated Issues to Remember1. 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.

8

Basic Policies – Keynesian Stimulus1. 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

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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

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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

11

I. Institutional Economic Leadership1. 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

12

II. Focus on Public Goods1. 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”

13

III. Macroeconomic Demand Management1. 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

14

IV. Profit and Income Incentives1. 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/capita

15

0. Values, Norms & Principles1. 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 settlement

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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

17

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

18

Thank you

AKeidel@keidel.us

19

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

20

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

21

China’s Trade Balance: Is this current account component sensitive to exchange rate

movements?

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U.S. Rest of World China

Trade Balance in Goods and Services as % of U.S. GDP

Rest of World

China

United States

1.6%

1.8%

3.4%

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Is the yuan now following a basket?!

1.431.441.451.461.471.481.491.501.511.521.53

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ne July

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Chinese yuan (right side)

euro (left side)

US$ per euro US$ per 10 yuan

2010

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Hong Kong’s RMB role: Highly Strategic1. 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• Show potential benefits of One-Country-Three Systems

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Hong Kong’s Advantages1. 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

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Regional Trade and Business Implications1. 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

global financial markets

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China’s current account surplus wasn’t significant until late in the U.S. bubble

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United StatesChinaRest of the World

Current Account Balance as Percent of U.S. GDP

United States

China

Rest of the World%

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Bubble-matching surpluses were elsewhere; US housing price collapse matched China’s surpluses

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Current Account Balances as Percent of U.S. GDPand U.S. Housing Price % Changes*

UnitedStates

China

%

Northern Europe, Non-mainland-China East

Asia and Oil exporters

% Change inU.S. Housing

Prices*

* Inflation-corrected (CPI-corrected) housing prices (source: www.clevelandfed.org)

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What caused China’s surpluses? Sharply slower investment to fight inflation.

China’s exchange rate didn’t do this:

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Exports Imports hi

Bil. US$ (log scale)

Exports

ImportsChina'sGoods& ServicesExports and Imports

140

210

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460

690

1030

130

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Is the RMB low? … or high?! It’s all politics!After the euro fell in July, 2008 China decidednot to let the RMB depreciate against the US$

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Not during the November-December Lame Duck U.S. Congressional Session!

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US$ per 100 yen US$ per 10 yuan

Chinese yuan (right side)

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US$ per 100 yen US$ per 10 yuan

2010

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Currency Movements versus $ During the Crisis %

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2008 2010

Japan

Thailand

Switzerland

Singapore

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Mexico

UnitedKingdom

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Thailand

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Euro Zone

IndiaBrazil

MexicoUnited Kingdom

Canada

Russia

Finally, China’s reserves aren’t “massive.”

At end-2010, still only 26% of M2.

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S. Korea

Foreign Reserves as a Share of Money Supply

96%

73%

Income Distribution – Long-term TrendsF i g u r e 1 . R u r a l - U r b a n M i g r a t i o n a n d I n e q u a l i t y

. 0

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C h i n aT o t a l

P o v e r t y L i n e sA - C h i n e s e P o v e r t y L i n eB - O l d $ - p e r - d a y L i n eC - N e w $ - p e r - d a y L i n e

A B C2 0 0 5H o u s e h o l d

D e n s i t y *

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C h i n aT o t a l

H o u s e h o l d a n n u a l p e r - c a p i t a i n c o m e i n 2 0 0 5 c o n s t a n t U S $ ( a t 1 9 8 5 a v e r a g e e x c h a n g e r a t e )

A B C2 0 2 5H o u s e h o l d

D e n s i t y * G i n iC o e f f i c i e n t

0 . 4 5 2 6

2 0 2 5

L o c a t i o n : [ I D C o m p o s i t e 1 9 8 5 - 2 0 0 5 H H S u r v e y C a l c u l a t i o n s 1 a 2 . x l s ] C o m p o s i t e 1 9 8 5 - 2 0 0 5 ! $ U $ 6 7 0 5 / 0 1 / 2 0 0 8 1 7 : 4 1

Rural-urban Income Gaps and Farm Labor Shares, China & Japan

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2007

1953

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Ru

ral-

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nco

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Rat

io*

Share of Labor Force in Agriculture (percent)

1974

China

Japan

Rural-UrbanParity

China’s Seven Economic Regions

1985 2005

E. Coast

S. Coast

N. Coast

Central Core

N. Hinterland

S. Hinterland

Far West

Log

Sca

le

6,404

4,901

4,196

3,556

3,218

3,0622,662

2,410

Rural Household 1985-2005Real Per-capita Net Income

(Constant 2000 Yuan)

8.5

7.7

7.4

6.76.6

6.6

6.0

1,258

1,113

1,004

879846748743

Per-capitaRural

Income

Per-capitaRural

Income

Ave. Annual Real Growth Rate

1985-2000 (%)

1985 1990 1995 2000 2005

E. Coast

S. Coast

N. Coast

Central Core

N. Hinterland

S. Hinterland

Far West

Log

Sca

le

6,404

4,901

4,196

3,2183,062

2,662

2,410

Rural Household 1985-2005Real Per-capita Net Income

(Constant 2000 Yuan)

Ave. Annual Real Growth Rate

1985-2000 (%)

8.5

7.7

7.4

6.7

6.6

6.6

6.0

1,258

1,113

1,004

879846748743

Per-capitaRural

Income

Per-capitaRural

Income

Regional per-capita income divergence …

But with rapid growth in all regions

Beijing’s SO2 levels are below Japan’s & Korea’s earlier levels

Ambient SO2 Concentration

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Tokyo, 1968

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1983 19972000

1965

Average annual Parts per Million