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

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 AKeidel@Keidel.us. for the conference:

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

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  1. 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 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 CAF Rio de Janeiro, Brazil, November 7~9, 2011

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

  3. The real culprit was U.S. money creation through credit deregulation and non-regulation – an abuse of $ reserve creation

  4. 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) • Domestic financial diversification and innovation • Hong Kong collaboration and RMB internationalization

  5. Quarterly GDP Growth, Year-on-Year

  6. Q-on-Q GDP Growth, Seasonally Adjusted

  7. 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.

  8. 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

  9. Four-dimension Explanation of Success • Institutional economic leadership capacity • Heavy focus on public goods provision • Conscious attention to demand adjustments • Rapid strengthening of profit incentives

  10. Five-dimension Explanation of Success • 0. Values, Norms and Principles • Institutional economic leadership capacity • Heavy focus on public goods provision • Conscious attention to demand adjustments • Rapid strengthening of profit incentives

  11. 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

  12. 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”

  13. 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

  14. 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/capita

  15. 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 settlement

  16. How can we evaluate the developed West? • 0. Values, Norms and Principles • Institutional economic leadership capacity • Heavy focus on public goods provision • Conscious attention to demand adjustments • Rapid strengthening of profit incentives

  17. What about the teaching of Economics? • 0. Values, Norms and Principles • Institutional economic leadership capacity • Heavy focus on public goods provision • Conscious attention to demand adjustments • 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?

  22. Is the yuan now following a basket?!

  23. 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 • Show potential benefits of One-Country-Three Systems

  24. 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

  25. 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 global financial markets

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

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

  28. What caused China’s surpluses? Sharply slower investment to fight inflation. China’s exchange rate didn’t do this:

  29. 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$

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

  31. Currency Movements versus $ During the Crisis %

  32. Finally, China’s reserves aren’t “massive.”At end-2010, still only 26% of M2.

  33. Income Distribution – Long-term Trends

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

  35. China’s Seven Economic Regions

  36. Regional per-capita income divergence … But with rapid growth in all regions

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

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