Professor Kuo-Ping Chang

1. China’s Macro-economy and Financial System Professor Kuo-Ping Chang

2. Macroeconomic Policy in China ● After 1949, the Chinese economy experienced relative price stability for more than 30 years. ● Following the economic reform in 1979, price increases remained a substantial and common phenomena almost throughout the 1980s and mid-1990s. Professor Kuo-Ping Chang

3. Macroeconomic Policy in China ● From 1978 to 1992, China’s liberalization was gradual with a fairly stable price level and extraordinary rapid output growth. ● Since 1989 in Eastern Europe and the former Soviet Union, rapid liberalizations attempted in the face of falling real output generated much higher inflation. ● Yet, both regions’ fiscal policies were surprisingly the same. Like its socialist counterparts in Europe, the Chinese government’s revenue, as a share of Gross National Product (GNP), has fallen sharply. Professor Kuo-Ping Chang

4. Macroeconomic Policy in China ● How did China manage to avoid inflation while its government was such a heavy borrower from the state bank system? (1) It first liberalized the areas like agriculture where subsequent productivity growth was rapid. In 1978, agriculture communes began to break up into small farm leases (household responsibility system with duration of 10-15 years). Between 1979-1983, with over three quarters of the population still in agriculture, farm output surged by 8-10 percent per year. Professor Kuo-Ping Chang

5. Macroeconomic Policy in China By 1984, the focus of rapid economic growth had shifted to rural light industry, which began to absorb much of the labor force released by productivity improvements in agriculture. Small-scale private traders flourished. Unlike the state firms, those market-driven town- and village-owned enterprises (TVEs) were outside of the official price and output control. Professor Kuo-Ping Chang

6. Macroeconomic Policy in China (2) China imposed very hard budget constraints on, and gave little bank credit to, the newly liberalized non-state sectors in industry and agriculture. Along with the household responsibility system (HRS), state procurement prices paid farmers for compulsory quotas of grains and foodstuffs were sharply raised toward world-market levels. The remaining surpluses could then be freely sold to private markets. Together with the increase in output, the big improvement in the newly-independent farmers’ terms of trade greatly increased their cash flows. Professor Kuo-Ping Chang

7. Macroeconomic Policy in China In the early 1980’s, the improved cash position enabled farmers to self-finance their on-farm investments. While building up their cash and saving deposits relative to their rising incomes, farmers (who were over three-quarters of the population) became big net lenders to the government through the state banking system. Professor Kuo-Ping Chang

8. Professor Kuo-Ping Chang

9. Macroeconomic Policy in China (3) China set positive real interest rates on saving deposits. The resulting enormous growth in saving and stocks of financial assets allowed the liberalized sector to finance itself, the Chinese government, and the deficits of the slowly reforming state enterprises. From the mid-1980s to near present, this dramatic and voluntary buildup of savings by rural households was replicated throughout the rest of the economy as industry succeeded agriculture as China’s leading growth sector. Professor Kuo-Ping Chang

10. Macroeconomic Policy in China The enormous increase in broad money holdings (M2) from about 28% of GNP in 1978 to about 97% in 1991. Because of central government’s continued ownership of the state banking system, it could offset its deteriorating fiscal position by borrowing back these rapidly rising financial surpluses of urban and rural households or of the non-state sector generally. Professor Kuo-Ping Chang

11. Macroeconomic Policy in China Why were these so high savings kept in the banks? (1) No places to go: not in capital markets or precious metals or real estate or foreign investment; (2) Price control though not perfect but stable; (3) More importantly, when inflation soared (e.g., in 1988-1989, it was about 18%), the government responded by fully indexing some interest rates. Professor Kuo-Ping Chang

12. Macroeconomic Policy in China Professor Kuo-Ping Chang

13. The Exchange Rate Regime ● China may have the potential problem of so-called “conflicted virtue”: (1) As the stock of dollar claims cumulates, domestic holders of dollar assets worry more about a self-sustaining run into the domestic currency forcing an appreciation. (2) Foreigners start complaining that the country’s ongoing flow of trade surpluses is unfair and the result of having an undervalued currency. Professor Kuo-Ping Chang

14. The Exchange Rate Regime ● Several ways to solve this problem: (1) Reduce its current-account surplus: Let imports expand more rapidly by reducing trade barriers faster than its WTO timetable requires, and eliminate special incentives given to exporters. (2) Reduce the financial magnitude of the FDI inflows by letting joint ventures finance more of their operations within China—by borrowing from Chinese banks, or by issuing more stocks and bonds domestically. Professor Kuo-Ping Chang

15. The Exchange Rate Regime (3) Expanding aggregate demand domestically. (4) QDII, Sovereignty Wealth Funds, Allow to sell US mutual funds, etc. Professor Kuo-Ping Chang

16. 2009 Stock Market Indexes Aug 17 July 17 SCI (Shanghai) 2,870.63 3,189.47 CSI 300 (Shanghai and SZ) 3,140.27 3519.81 Hang Seng (HK) 20,137.65 18,805.66

17. Human Capital ● As set out in the 10th (2001-2005) and 11th (2006-2010) five-year plans, the focus on tertiary education differentiates the Chinese case from other countries who earlier at similar stages of development instead stressed primary and secondary education. Professor Kuo-Ping Chang

18. Human Capital ● The number of undergraduate and graduate students in China has been grown at approximately 30% per year since 1999, and the number of graduates at all levels of higher education in China has approximately quadrupled in the last 6 years. Professor Kuo-Ping Chang

19. Since tax reform in 1994, fiscal revenue (tax) increase is about 2-3 times of GDP growth rate. During 1995-2007, gov. income increased 570%; urban citizens 160%; rural farmers 1.2%. Gov. intervenes free markets and Chinese privately-owned corps. wanna get out (e.g., the case of a fruit juice co.). In Zhejing Province, 70% capital went to real estate and stock markets (in 1990, it’s the opposite).

20. Small and medium sized enterprises in China Contribute 60% export; 50% GDP; and 40 tax revenues. Why so little influence? “Guanxi”, deference to authority, hierarchy, don’t want confrontation. Because: No law; No choice implies docile. Results: Private owners migrant to overseas.

21. SOEs Expand and Privately-Owned Withdraw ●In 2009, Increases In The Value of Industrial Outputs: Private 18.7%; SOEs 6.9% Total Assets: Private20.1%;SOEs 14% Employment: Private5.3%; SOEs 0.8% Revenues: Private 18.7%; SOEs -0.2% Profits: Private17.4%; SOEs -4.5%.

22. ●CEOs of SOEs still get high pay: 18 times of their avgerage worker (vs. 360 times in US). ● Not only petrochemical also mining etc. go to SOEs. ● 4 trillion stimulus package mostly went to SOEs. The results: SOEs buy more urban lands. ● In 1998, 2 trillion to reform SOEs used to retire employees; low interest rate loan; transfer debt to equity. And In 2009, 10 monopolistic SOEs (Petro; Telecom for domestic usage only) made money. The rest lost.

23. Forecasts of 2020 China’s Economy by Xinhua Agency (10/1/2009) ● RMB : US dollar = 4.2 :1, appreciate slowly at first and then fast. ● GDP annual growth rate: 8%; close to USA and double than Japan; 20% of world GDP. ● Annual Growth rate of exports plus imports: 8%; 13% of world trade (1st place); more than the USA. From surplus to deficit. ● New car sales more than USA in 2015; energy-saving cars. ● Deregulate banking industry: insurance, securities and mutual funds, etc. ● Textile industry: 40% of world production. ● Stock markets: combine A and B shares; list more than 1,000 overseas companies. ● Population in cities and towns: 0.8 billion; about 60% of total population.

24. Shanghai as an International Financial Center in 2020 Shanghai as an International Freight Center in 2020: Modern logistics; various services; a freight and passengers port. Shanghai as the head of the “dragon” (Dragon means the Yangtze River; Shanghai is at the Yangtze River Delta; Jiangsu and Zhejiang provinces as its two wings; and Hunan, Anhui and Sichuan provinces as its bases).

26. Shanghai as an International Financial Center in 2020 Leading International Banking Center in Asia: Hong Kong: from 1900−1925, and after the war until 1960. Shanghai: surpassed HK in 1925 and 1947. Tokyo: from 1960.

27. The Most Important Feature of An International Financial Center: • Providing services to other countries. • Free Flow of Information (broader than Transparency): news media; communication. • 1.1 Floating Exchange Rate • 1.2 Open both Capital and Current Accounts.

28. Four Regions with Most Chinese Hong Kong: Can do any things unless the law forbids. Singapore: Cannot do any things unless the law permits. Taiwan: May do even if the law forbids (not any more). Mainland China: May not do even if the law permits.