China’s Policy Response to the Global Financial Crisis

China’s Policy Response to the Global Financial Crisis Joseph E. Stiglitz Beijing March 2009

A Deep and Prolonged Downturn • The first truly global downturn of the modern era of globalization • Downturn in the U.S. will be the most severe since the Great Depression • And may be even more difficult to deal with • With huge losses in the financial sector

The Myth of Decoupling • All countries are being affected • America exported its toxic mortgages • America exported its deregulatory philosophy • Now America has exported its recession • Developing countries that have been most successful in enmeshing themselves in the global economy are likely to be most adversely affected • Through unprecedented decreases in exports • Through massive changes in capital flows • Irony: capital is flowing back to the US from which the crisis originated • Even countries that have pursued good economic policies (e.g. better bank regulation than the U.S.) are being affected

This crisis will put great strains on all countries • Not only decreased exports, but also lower investment • Anxieties about future income, decreases in wealth, reduced ability to borrow, higher unemployment all contribute to lower consumption • Risk of high unemployment • Reverse migration—new strains on rural sector

A Global Crisis Requires a Global Response • Yet responses are still at the national level • Because of “externalities” (benefits that accrue to others) the size of the stimulus is likely to be too small • And countries are likely to try to maximize domestic multipliers—undermining effectiveness of global multipliers • Implying that the global recovery will be slower than it otherwise would be

Designing a Good Stimulus • Big global multiplier • Help redirect economy in ways consistent with the “vision” of the future—and address long standing needs—not recreating failed system of the past • Good investments create an asset, offsetting the liability of increased government deficits (or reduced reserves)

Flexible—automatic stabilizers, that spend more when and if more is needed • Plans for sequential stimuli if more is needed • Sensitive to micro-economics—where are jobs being lost, where are they being created

This is an Opportunity for China • 11th Five Year Plan set out an agenda for harmonious, sustainable growth —a long run vision • Increasing domestic consumption and investment, less export dependent • An innovation economy • More environmentally sustainable growth • Helping the rural sector • More broadly promoting social harmony

Crisis may provide an opportunity to carry forward this agenda—but it will not be easy • China has always adapted policies to changing circumstances • These are dramatic changes in circumstances

Large and well designed stimulus Providing basis of long term growth • As it stimulates the economy in short run • Just as measures taken in 1997/1998 crisis provided foundations for growth in subsequent decade 1. Public works—including infrastructure (especially railroads, help address global warming problems, long run productivity benefits)

2. Helping move to an innovation economy • Support science and technology • Good time to attract to China scientists that are having difficulty getting jobs elsewhere • Creating a knowledge economy/knowledge society

3. Improved social protections and services • healthcare up 38%, education 24% • Double benefit—can encourage more consumption • Especially important in rural sector, with returning migrant workers • Better financial markets--Micro-credit may enable gainful employment • Other measures to help poor • focusing on low income housing (up 171%)—could help labor mobility • Will it be enough?

4. Economic restructuring • Helping transform the economy to less export dependence • Promoting consumption of certain goods to take up slack from drop of exports • Industrial restructuring • To improve efficiency

Some Questions • Will industrial consolidation reduce competition? • Is there enough support for small and medium sized enterprises, the real job creators—e.g. through increased available of finance? • Will it be possible to increase consumption significantly, in a time of economic anxiety?

Confidence in government’s determination and ability to maintain economic strength in spite of adverse external conditions Even if growth is less than targeted, will be real achievement Greater challenge is ensure that actions today are consistent with long run goals

A Deeper Look: Why is China’s Savings Rate So High? • Household savings rate only slightly too high—better social protections would have both direct and indirect effects on consumption • Small businesses have a high savings rate because of lack of access to capital • Unusually high level of income in corporate sector, unusually high profits, and unusually high retained earnings—partially reflection of low wages • Need to develop provincial and local banking system—encourage small and medium sized enterprises (often labor intensive) • Competition for labor might lead to higher wages • Competition for funds might lead to higher payouts

High profits contribute to high level of investment • Resulting in mismatch between growth in supply and growth in demand • Disparity made up by exports • But that may be difficult now • With resulting deflationary pressures • With accompanying macro-economic risks

May be key sectors with market distortions • Underpricing of natural resources—full pricing would generate public revenues for public investment, e.g. in research and environment • Telecom—problem in many countries of the world KEY ISSUE IS CONTINUING THE TRANSFORMATION OF THE CHINESE ECONOMY TO A MARKET ECONOMY—BUT A MORE HARMONIOUS AND SUSTAINABLE MARKET ECONOMY

Concern about America’s Response • Costly delay—often takes months before full effects are stimulus are felt • Stimulus too small, given the magnitude of the problem • About half offset by “negative” stimulus from states and localities • Stimulus not well designed • About a third in tax cuts, likely to have limited effect

Disappointment in financial restructuring • Bank bail-out very costly, not restarting lending • Backward looking, rather than forward looking • $700 billion in a new lending facility, leveraged 10 to 1, would have created $7 trillion in lending capacity • Worry--Zombie banks being kept alive, needing repeated funds, perverse incentives, not in national interests • Government getting bad deal (as little as 25 cents on the dollar in shares, shares plummeting in value, remaining share value related to bail-out option)

Huge government borrowing needs, increased deficits compromising governments ability to undertake other objectives • Government buying bad assets at too high a price or assuming downside risks is NOT the solution—simply shifts losses from private sector to public • Socializing losses while leaving gains in private sector is recipe for disaster

Learning the Lessons from America’s failure • Better regulation, especially in the financial sector • But also in corporate governance—perverse incentive structures • And better regulatory structures—enforcement matters • Competition policy—we allowed banks to grow too big to fail • Monetary policy framework flawed • Need to pay attention not just to inflation • Many seemed to think that low inflation was necessary and almost sufficient for strong growth • Never was evidence or good theory in support of this view • Now it is clear how wrong that view was Need also to pay attention to financial stability

Learning the Lessons from and for Globalization • Globalization can bring benefits • But also problems—contagion • Crises can spread quickly around the world • China needs to be careful about financial and capital market liberalization • Spirit and letter of international agreements are being broken • Worry about protectionism • But “Buy America” provision is protectionist, and details of wording may be worse, discriminating against developing countries • Subsidies (bail-outs, guarantees, some government lending facilities) are even more distorting of global market place than tariffs • Developing countries can’t match • No longer question of a level playing field, especially in financial services • Long run implications for the nature of an “open, competitive, fair” global market place • Worry that some international agreements hamper flexibility needed to respond to crisis • Restrictions on imposing needed regulatory reforms

This is a global crisis requiring global response • New global regulatory system—must be comprehensive to avoid regulatory arbitrage, go well beyond just transparency • Problem shifting to developing countries • They don’t have funds to respond • Need for additional financial support • Without usual counterproductive procyclical conditionality • If this doesn’t happen, global imbalances will growth, robust recovery will be at risk • Reforms needed in international financial institutions • Not only didn’t address problems before they occurred • Pushed policies that contributed to the crisis • Those with liquid funds have inadequate voice

Three Key Recommendations of UN Commission • A new Global Credit Facility, with better governance than existing institutions • A Global Economic Coordinating Council • A new Global Reserve System • Problems in global reserve system at heart of global imbalances • Contributing to insufficiency of global aggregate demand • Problem long recognized (Keynes) • Current system is fraying • Now is the time to initiate reforms

China has vital role to play in global recovery • Maintaining strength of its own economy through appropriate macro-economic policies • Contributing to a balanced global recovery, through assistance to developing countries • Working, through G-20 and the UN, to make the reforms that will be necessary to restore confidence and make a more stable global economy

China’s Policy Response to the Global Financial Crisis