Case analysis of the economy policies of China

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List of figures

 

Figure 1 the Export growth of export in China…………………………………………….. 4

Figure 2 The US Gross Domestic Product GDP History………………………………. 14

Figure 3 Long term current account deficit of the United States…………………… 16

Figure 4 The Chinese Gross Domestic Product GDP History……………………….. 16

Figure 5 current account surplus of the China…………………………………………….. 17

 

List of tables

 

Table 1 Performance of the major monetary indicators………………………………….. 9

 

List of charts

 

Chart 1 Announced and delivered fiscal stimulus…………………………………………. 6

Chart 2 The breakdown of the 4 trillion yuan economic stimulus package……….. 7

Chart 3 Monthly export and import growth rate and trade surplus in China…….. 9

Chart 4 New banking lending; World Bank staff estimates………………………….. 10

Chart 5 Movements of the the interest rate and the reserve requirement ratio…. 11


 

1.     Introduction……………………………………………………………………………………………… 3

2.     Background and impact of the global financial crisis……………………………………… 3

3.     Analysis of the policy responses to the global financial crisis………………………….. 4

3.1           Fiscal expansion policy………………………………………………………………….. 5

3.1.1     Fiscal stimulus packages………………………………………………………….. 5

3.1.2     Tax policy………………………………………………………………………………. 7

3.1.2.1 Value-added tax reform and tax rebate policy……………………… 7

3.1.2.2 Reduce the tax burden for the individuals…………………………… 8

3.2           Loose monetary policy…………………………………………………………………… 9

3.2.1     Money supply growth……………………………………………………………… 9

3.2.2     Interest rate reduction……………………………………………………………. 11

3.2.3     Reserve requirement ratio adjustment………………………………………. 11

3.2.4     Currency policy…………………………………………………………………….. 12

3.3           Supply side policy……………………………………………………………………….. 13

3.3.1     Restrictions on export of raw materials……………………………………. 13

3.3.2     Boost production efficiency…………………………………………………… 14

4.     Comparing the economies of China and United States…………………………………. 14

4.1           United States economy development from 1980 to 2010…………………. 14

4.1.1     GDP growth and economy recessions……………………………………… 14

4.1.2     Long term current account deficit…………………………………………… 15

4.2           Chinese economy development from 1980 to 2010…………………………. 16

4.2.1     GDP growth and economy raising…………………………………………… 16

4.2.2     Current account surplus…………………………………………………………. 17

5.     Summary and concluding remarks……………………………………………………………… 18

6.     Recommendations……………………………………………………………………………………. 19

6.1           Clear the “Time Bomb” (local government debt)……………………………… 19

6.2           Economic reorientation in the long term…………………………………………. 20

Reference……………………………………………………………………………………………………… 21

Appendix 1 US Gross Domestic Product GDP History Fiscal Years 1980 to 2010…. 25

 

Case analysis of the economy policies of China

 

1.        Introduction

 

Economy polices despite the different policy mix used by different governments in the world are adopted to achieve the planned economy growth and development goals. And it is repeatedly verified that no economies could be strong enough to sustain a long period of non-growth in the economy without causing a number of social issues and this is true even for the United State, the current super economy power in the world. And continual development in economy helps resolve many social and economic problems. This study will be targeting at China, one of the most popular and fastest growing economies in the world that probably is attracting more attentions than the economy of the United States given the fact that it provides more business opportunities and the study will focus on analyzing the economy policies adopted by the Chinese government particularly during the most recent financial crisis to achieve the goals of keeping fast economy growth to speed up the modernization process in China. And the analysis of the economy policies will be categorized into three major types of policies: fiscal policy, monetary policy and supply side policy followed by a comparison between the Chinese economy and that of the United States during the past three decades. And the study in the end provides critical conclusions and remarks and some recommendations to resolve some problems in the current economy of China.

 

2.        Background and impact of the global financial crisis

 

The current global financial crisis was originated in the United States and it was intensified in the September of 2008 with the bankruptcy of Lehman Brothers and financial difficulties faced by many other financial institutions of which many were in large scale (Nabli 2011, p.175). And soon the crisis spreads fast to other major economies resulting in an ongoing global economy recession that concerns the most central governments. And in China, the financial crisis extended its impacts through three key channels: trade channel, private capital flows and financial channel. In the trade channel as seen from the figure below, the export growth had dropped largely from a 20 percent growth in the middle of 2008 to an annualized contraction of more than 25 percent in the beginning of 2009. And the influence through the channel of private capital flows could be seen from the massive contraction of private capital flows worldwide though China is less affected as a net capital exporter. And in the financial channel, the large foreign reserves had suffered lost due to the large investment in the dollar assets.

 

Figure 1 the Export growth of export in China

Source: World Bank; China Monthly Update (April, May, June, July 2009)

 

3.        Analysis of the policy responses to the global financial crisis

 

Significant and even some radical changes had happen to the Chinese government’s macroeconomic policy mix which were proposed initially or adopted unwillingly by the government concerned to offset adverse global economic conditions in term of slowing export growth, dropping commodity prices and increasing unemployment rate by policies such as boosting domestic demand and large liquidity injections in the banking system and to the domestic firms. Below we will discuss the particular policies which included aggressive fiscal policy, loose monetary policy, supply side adjustment and trading policy adopted by the Chinese government to contain the impact of the global financial crisis which was considered as complex and changing situation with the deepening of the global financial crisis and to keep the healthy economy growth in a difficult time.

 

3.1    Fiscal expansion policy

 

3.1.1            Fiscal stimulus packages

 

Fiscal easing in term of direct fiscal stimulus measures had been widely used for helping and supporting the domestic demand in most countries and regions and the situation was also similar in the Asia among the major economies in fear of the fast spreading of the impact of the global financial crisis. As shown in the chart below, the World Bank had estimated that most counties would most probably spending what they had planned through ways such as announcing additional stimulus packages (The World Bank 2010, p.19).

(in percentage of GDP)

 

Chart 1 Announced and delivered fiscal stimulus

Source: national authorities and staff estimates and projections

 

As in the case of China in the November of 2008, a national stimulus package equivalent to four trillion yuan, or US$586 billion that mainly involved the creation of a loosen credit condition, taxes cut and massive infrastructure building plan was announced by the Chinese government as the major move to stop the global financial crisis from hitting the world’s third largest economy at that time (Kiritsis, Emmanouilidis, Koronios & Mathew 2010, p.734). And the stimulus package which was equivalent to four trillion Yuan was meant to be spent over the following two years to finance the programs in ten major areas. The large expenditures as described in the chart below will include programs such as spending 1.5 trillion Yuan in the infrastructure construction which mainly referred to the railway, roads and airports building and spending another 1 trillion Yuan in the rebuilding from several disasters which mainly referred to the Sichuan May 12 earthquake that attracted the concern of the whole country and another 400 billion was allocated to the low priced housing construction followed by approximately 370 billion in both innovation and industrial promotion and the agricultural infrastructure building.

 

 

Chart 2 The breakdown of the 4 trillion yuan economic stimulus package

Source: Mori 2009

 

According to Zhang Liqun, researcher with the Development Research Center of the State Council that the large government expenditure plan had been anticipated to play a big role in maintaining the economy growth because 4 trillion yuan investment equaled to an equivalent of one third of the nation’s total fixed asset investment of the previous year of 2008 (News.xinhuanet.com 2008).

 

3.1.2            Tax policy

 

3.1.2.1      Value-added tax reform and tax rebate policy

 

From the beginning of the 2009, the value-added tax was introduced in 1994 to increase the Government’s tax revenue and curb excess investment will be reformed from a production type into a consumption base which is targeting at eliminating the overlapping and complicated value-added taxes with the hope to reduce the tax burden of the firms not only during the financial crisis period but in a long run (Wang 2009, p.36). And during the implementation of the reform, the current value-added tax rebates for 3770 export items in some key labor intensive export industries such as textile and garment. This strategy was used to increase the incentives of the export industries while many developed countries had been urging their people to purchase good made in their home countries rather than buying the low priced good marked as “Made in China” to stimulate their own economies.

 

3.1.2.2      Reduce the tax burden for the individuals

 

One major direction of the tax reform for the individuals is to reduce the tax burden especially for the middle and lower income classes. Faced by the severe conditions that come with the deepening of the financial crisis in the industrial export, the Chinese government had placed greater hope in the domestic market targeting in the large saving in the residential sector. And to support the government’s strategy to stimulate the domestic consumption, the government had adopted the following tax policies to reduce the tax burden for the individuals: the State Council had decided that no individual income tax on individual savings deposit interest shall be imposed on deposit interest from October 9th 2008 for a temporary basis (Chinatax.gov.cn 2008); The Ministry stated that the tax rate would be lowered to only one percent for the purchase of the houses that are 90 square meters or smaller and will end an income-tax exemption on profits from the sale of real estate reinvested within one year. And in the long term the government relies on the raising the tax exemption income threshold of the individual income tax. But the change of the tax exemption income threshold had not been done in a short period so that it had not been helpful during the financial crisis. But the reform of the personal income tax was soon proposed in 2009 after the happening of the global financial crisis. And only until recently, the top legislature on Monday started its second reading of an amendment to the country’s individual income tax law and it is been reported that the proposal once passed will bring up the tax exemption income threshold for individuals to 3,000 Yuan which is equivalent to 461.5 U.S. dollars. And also the minimum tax rate is also proposed to be reduced from 5 percent to 3 percent and these two changes is said to be able to give 70 percent of the monthly salaried taxpayers a lower tax burden (Gov.cn 2011).

 

3.2    Loose monetary policy

 

3.2.1            Money supply growth

 

 

Table 1 Performance of the major monetary indicators

Source: CEIC China Database; World Bank staff estimates

Note: M1 = money supply; M2 = M1 plus quasi-money

 

 

Chart 3 Monthly export and import growth rate and trade surplus in China

Source: Keidel 2009

 

A severe export slump that kicked in during the fourth quarter of 2008 as seen from the figure worried the Chinese Politian’s very much because of the expected serious effects on employment in export industries in coastal area of China (Bottelier & Baru 2009, p.88), and soon the Chinese government radically changed the monetary policy from a tight monetary policy which had been set to curtain the expected inflation directly to a loose monetary policy targeting at boosting credit expansion and providing help and support to the economy activities (Nabli 2011, p.180). From the fact that the M1 supply growth rate had increased dramatically from 9 percent in the fourth quarter of 2008 to 17 percent in first quarter of 2009 and 24.8 percent in the second quarter and similar growth could also be found in the broad money M2 supply, we can conclude that the central bank of the Chinese government since the last quarter of 2008 had begun the injection of substantial liquidity into the banking system. Together with the ambitious and loose monetary policy, there had been an expected extraordinary growth in the bank lending: the bank loans growth rate increased from 14.5 percent in the third quarter of 2008 to 18.8 percent in the last quarter and even reached 29.8 percent and 34.4 percent in the following two quarters.

 

 

Chart 4 New banking lending; World Bank staff estimates

Source: CEIC China Database

Note: mma = monthly moving average; s.a. = seasonally adjusted

 

 

3.2.2            Interest rate reduction

 

The Chinese government not only implemented a loose monetary policy by injecting large amount of substantial liquidity into the banking system, but it also used the interest rate policy to encourage the new bank lending for the business. On 23 December of 2008, the Chinese central bank had already cut interest rates for the fifth time in four months since the first cut in the interest rate on 16 September of the same year which had been the first interest rate cut in more than six years (Jeffries 2011, p.191). After the frequent and big interest cut, in 2009 the new lending accounted for around 30 percent of the GDP of the year. And this continual cut of interest rate will assist to lower the cost of borrowing for companies in difficulties.

 

Chart 5 Movements of the the interest rate and the reserve requirement ratio

Source: Zheng & Tong 2010, p.58

 

3.2.3            Reserve requirement ratio adjustment

 

Another move that was also used to increase the banking lending and credit is to lower the reserve requirement ratio though changing the required reserve ratio has been considered as a very blunt way of affecting the money supply (Kennedy 2000, p.134) but its effect is immediate and influential because increasing reserve requirement ratio causes a contraction in the money supply while reducing the ratio release the money supply in a very short time. During the same period, the reserve requirement ratio was reduced to the level of 14 to 15 percent. As the chart shows, in end of 2008 and the beginning of 2009, the reserve requirement ratio had been as low as 13.5 percent.

 

3.2.4            Currency policy

 

From 1994 until the middle of 2005, China had used a policy of pegging the RMB to the US dollar at an exchange rate of about 8.28 yuan to the dollar and this pegging currency policy was aiming at promoting a relatively stable national business environment for the foreign trade and investment activities in the mainland of China (Morrison 2010, p.2). And the stability of the Yuan exchange rate was achieved by the government’s large purchasing the US dollar denominated assets in exchange for new printed yuan to avoid excess demand or supply for the yuan. And in July of the same year, the China’s central bank changed the currency policy by saying that the exchange rate would be more adjustable and flexible according to the demand and supply condition of the currency with reference to exchange rate movements of currencies in a basket rather than just US dollar. Since then the gradual appreciation of China yuan had been allowed. During the period of July 2005 to July 2008, the exchange rate of dollar-yuan had lowered from around 8.11 to as low as 6.83 with an appreciation of 18.7 percent. In the late 2008 when the impacts of the economic crisis became evident, the China’s central bank re-pegged the value of yuan back to the U.S. dollar to stabilize the value of yuan and avoid fluctuation of yuan and maintained the product competitiveness in the largest export market. But this decision was made despite the high pressures from the Western governments and the International Monetary Fund that had been urging for a stronger RMB (Birdsall & Fukuyama 2011, p.115). What’s more, the strategy to re-peg the yuan to the U.S. dollar on the other hand also increased the fluctuation of the yuan to the other currencies such as the Euro.

 

3.3    Supply side policy

 

The supply side economics which resembles the laissez-faire economics due to it prefers fewer government programs and regulations and less taxation argues that economy developed could be achieved without resulting in a high inflation rate because inflation can be lowered more effectively be increasing the supply of goods (Janda, Berry & Goldman 2009, p.563). Supply side polices usually take the forms of tax cuts, market deregulation, fewer government programs, encouraging higher production efficiency and increased investments to increase the supply in the market as a final target.

 

3.3.1            Restrictions on export of raw materials

 

The restrictions on export of raw materials as a strategy to tackle the difficult economy condition during the financial crisis had not been mentioned as a policy but it did exist. As claimed strongly by the United State government that China after the happening of the financial crisis had actually tightened the control over the supply of rare earth elements, valuable minerals which are critical to the high-technology goods. For example, in the name of some of the rare earths are extracted under dire environmental conditions, the Chinese government restrict the export of the rear earths while the domestic producers’ access to such resources will not be restricted actually put the domestic high technology good producers in a more advantageous position because the increase supply in the domestic market of the above mentioned raw materials will drive down the price of the materials for the domestic manufacturing industries though such export restriction policy had been widely criticized.

 

3.3.2            Boost production efficiency

 

With the fast growing of the economy size of China and the raising production cost which is enhanced by the increasing labor cost especially in the relatively more developed coastal areas of China and the forced appreciation of the Yuan, China has now more focusing on promoting a higher production efficiency with lower energy input than ever to reposition the source of industrial competitiveness from low cost labor to high output efficiency. A strategic move in the economy aiming at promoting the production efficiency is the government’s introduction of the concept of Total Factor Productivity (TFP). TFP is the part of industrial output that has not explained by the amount of input used in manufacturing. Its level is designed by how efficiently and intensely the inputs are utilized in production. And TFP will become a critical and important variable for judging the success of the nation’s 12th Five-Year Plan.

 

4.        Comparing the economies of China and United States

 

4.1    United States economy development from 1980 to 2010

 

4.1.1            GDP growth and economy recessions

 

Figure 2 The US Gross Domestic Product GDP History

Source: Usgovernmentspending.com 2011

The United States became the world’s largest economy by 1880 supplanting Great Britain with its dominance completed in 1913 (Conot 1986, p.735) and since then the United States had been raising in a fast speed and it is widely believed that the dominance of the United States in both economy, political and military became actually established after the World War II with economy slow down of other leading economies due to the participation of the war while the United States had not been one of the major battlefields of the war and even managed to make a profit out of the war by selling weapons. In the first quarter century after World War II— from 1946 to 1973— the economy grew rapidly with an average growth rate of 3.8 percent while the real median household income surged 55 percent (United States Bureau of Labor Statistics 2000). And since the year 1973, the Unites States economy was featured by both slower growth rate with an average year on year growth of 2.7 percent and also a nearly stagnant living standard. Beside the general slow economy growth the world’s largest economy has also been troubled by the economy recession that happened time by time during the past three decades. For example, significant recessions include the GDP drop of 2.9 percent during the 1981 – 82 recession, economy output fell by 1.3 percent during the 1990 to 1991 economy downturn, a mild GDP decrease of 0.3 percent in the 2001 recession and the most recent one and also the worst recession in the past 30 years is the most recent financial crisis caused directly by the derivatives market and subprime mortgage crisis in which the GDP fell by 4.1 percent from the beginning of 2008 to the same period of 2009.

 

4.1.2            Long term current account deficit

 

And in the trading area, the United State is probably the most significant nation in the world when it comes to international trade. While maintaining one of the top three exporters in the world, it has long been dominating the import side. As told by the figure of the history of the current account, and the exact data shows that the trade deficits had been sustained since 1976 and such current account deficit became to grow in 1982 and even reached top high with US 140 billion during the financial crisis.

 

(billion USD)

 

Figure 3 Long term current account deficit of the United States

Source: U.S. Bureau of Economic Analysis 2011

 

4.2    Chinese economy development from 1980 to 2010

 

4.2.1            GDP growth and economy raising

 

 

Figure 4 The Chinese Gross Domestic Product GDP History

Source: The World Bank Group 2011

 

After the death of Chairman Mao Zedong in 1976, the Chinese economy slowly started a new era under the guidance of Deng Xiaoping who proposed the market economy to reform the planned economy as the new direction of modernization. And the reformed officially began in 1979 and soon when the Chinese Politian concentrated on the social and economy stability and open door policy to attract the foreign investors to do business in China, the Chinese economy entered a period of high speed growth in term of GDP that continues to date. Since 1983, the double-digit GDP growth became norm contributing to the fastest economy growth in term of GDP in the major economies in the world for the past three decades (Hsu 2008, p.17) though the validity of the data of the GDP has long been put under doubt. But the trend of fast economy growth is widely accepted which is still expected to continue in the near future. Even in 2009 while the financial crisis had deepened and the major effects on the finance and economy of the most economies became significant, the Chinese economy still managed to achieve a GDP growth by 8.7% (Cnn.com 2010) with a series of timely policy changes that have been discussed. In comparison with the United States, in term of overall economy growth, China though with a much smaller GDP total volume than that of the United States, but the current high growth rate has given a promising future to the Chinese economy provided that the Chinese government could managed to remove the uncertainties and risks in the economy and only then the predictions of surpassing the United States to become the largest economy in the world in the middle of this century would be possible.

 

4.2.2            Current account surplus

 

Figure 5 current account surplus of the China

Source: State Administration of Foreign Exchange 2011

By adopting an export driven growth strategy, China has successfully become the factory of the world since the 1990s through large inflow of foreign investment, and along with the large export growth, the current account surplus become significant in the new century characterized by enlarging trade surplus. Such large trade surplus was enhanced by the inadequate public service in the social security, medical care, education and other social welfare compared to the fast economy growth (Katz & Holmes 2008, p.166). What is more, referring to the fast growth of the current account deficit in the United States, there is correlation to some degree between the United States and China in the current account changes. As claimed by Åslund and Dąbrowski (2008) that since 1986, China’s bilateral surplus with the United States actually has exceeded the overall trade surplus menacing to say that China is running trade deficit with other partners while maintains a large trade surplus with the United States. And this also reviews the fact that there has been a fast transfer of manufacturing and assembly operations from Japan, Taiwan and other countries to the mainland of China which has resulted in the high growth in the China-US bilateral trade surplus. And this is also one of the reasons the foreign exchange reserve, majorly U.S. dollar keeps refreshing the records.

 

5.        Summary and concluding remarks

 

It is true that exceptional period requires exceptional handling such as the aggressive fiscal policy that inject great cash flow into the monetary circulation that keeps the pulse of the economy activities in the post economy crisis period, but consequences needs to be followed up and digested such as the large local government debt that had been warned for a long time but is only found and identified in a recent time. What’s more the Chinese’s government’s continual reinforcement of the investment oriented economy growth mode through increased investment by government expenditure and encouraging export by measures such as export tax rebates had been widely criticized for leading to imbalance in the economy development. Below some recommendations are given to try to help make clear the problems and provide suggestions on how these problems could be resolved.

 

6.        Recommendations

 

6.1    Clear the “Time Bomb” (local government debt)

 

In April, the Standard & Poor’s estimated that around 30 percent of the bank loads will become sour which would likely to become the largest source of non-performing assets for the industry (Chinadaily.com.cn 2011). Amid the concern about the bad debt that the local governments could have caused by the set up of 6,576 financing vehicles by the end of 2010 to raise money, Premier Wen Jiabao authorized the first audit of the local-government borrowing in March. And according to the result of the audit report released recently, an approximately liabilities of 10.7 trillion yuan which was equivalent to about 27 per cent of China’s economy at the end of last year was found. Then there has already been worrying about the fiscal health of Chinese local governments during the global financial crisis especially in the local government level where the allocation of the fiscal resources is unknown to the public with a lack of transparency in many local governments (Financialexpress.com 2011). And to recover the investors’ confidence in the government’s ability to manage the economy and stop the more and more debts from turning sour, there are two strategies that the central government should do. First, the central government should request the local government to publicize the usage of the fiscal fund collected by debt and penalize those who had used the public fund to their personal interest and also encourage the report of such illegal behaviors. Second, the central should help the local governments that are not able to repay the debt to manage the debt in a more legal way of handling and provide funding if necessary and what is more the central government should request those difficult local governments to discontinue the aggressive fiscal policy and instead the use of a mild positive one will be enough.

6.2    Economic reorientation in the long term

 

As seen from the above discussion, about three quarters of the government’s rescue package are for investment projects, majorly fundamental construction, and because of the Chinese’s government’s continual reinforcement of the investment oriented economy growth way there is criticism and fear saying that such moves will likely to perpetuate the economy’s over dependence on the investment at the cost of consumption which would not be in accordance with China’s long term goal of achieving balanced development (Zheng & Tong 2010, p.63). So in the long run, the government needs to stimulate the domestic demand to achieve the economic reorientation form investment driven to consumption driven. The fundamental basis for the government to depend on the domestic consumption is the world’s no.1 residential reserve ratio of 49 percent indicating a powerful purchasing ability if it could be released. In order to release the purchasing potential, the government needs to focus on three key tasks. The first task that the government needs to do is to expand the public expenditure to build up the social protection network and then the residents could be enabled to purchase the good they need without worrying the expected and accidental future expenditure caused by factors such as illness and children education expenditure. The second task is to increase the salary of the lower end jobs. It is believe that the stability and purchasing power of the society does not come from the class with higher income but the middle class so that many developed countries have been working to expand the proportion of the middle class. And by increasing the salary of the lower end jobs, it helps the middle class to reach a wider range of coverage. The third task will be to combat the inflation and monitor the real estate market closely. The hot real estate market could contribute to the growth of the digits but also it could easily create bubbles that are risks to the health of the economy and increase the cost of living for people.

 

 

 

Reference

 

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Birdsall, N. & Fukuyama, F. 2011, New Ideas on Development After the Financial Crisis. Baltimore: The Johns Hopkins University Press. p.115

 

Bottelier, P. & Baru, S. 2009, Strategic Asia 2009-10: economic meltdown and geopolitical stability. Washington, D.C.: The National Bureau of Asian Research, p.88

 

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Appendix 1 US Gross Domestic Product GDP History Fiscal Years 1980 to 2010

Source: Usgovernmentspending.com 2011

 

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