Economy Policy Analysis of China

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1.          Introduction of Chinese economy since 1980s

 

1.1    Economy reform since 1978

 

In the late 1978, China announced a program to reshape its economy under the leadership of the visionary leader, Deng Xiao Ping who started the experiment began in the early 1980s by setting up the Shenzhen Special Zone and offer attractive package for foreign firms such as unique tax, customs, and trade incentives to attract the foreign direct investment and to test the use of a free-market economic model in a single small zone (Menelly 2010, p.15). But only until 1992 during a visit to Shenzhen Special Zone, Deng Xiao Ping officially announced that China will use a socialist market economy model to begin the country’s modernization (Killion 2006, p.137). Ever since then, the economy reform had continued through the major effort of relaxation and exit of direct planning controls, increased reliance on market forces, attracting FDI, state owned enterprise (SOE) reform and open to the outside world (Bléjer 1991, p.2). And in the following two decades the Chinese economy had experienced a rapid growth till today which had been greatly contributed by the government’s pragmatic economy policies and political policy in term of putting the social stability as the priority resulting in low cost advantage and highly stable economy environment.

 

1.2    Government role

 

Following a successful communist revolution and independence in 1949, China had established itself as a Marxist state together with a radical new vision for the planning and operating of the national economy (Veeck 2007, p.182). In 1953 China begun its first five-year plan, through the State Council and State Planning Commission and other relative ministries, the Chinese government had strict control over the economy by performing the function of planned and organized production and the relative resource allocation and even pricing and distribution of the products. Even after the economy reform that began in the early 1980s the government role in the economy activities has lessened to a large degree together with the increased role of the private and the market forces, the government of China still played a very important role in the market. For example, in some big and critical such as telecommunication, aviation, railway, insurance and petroleum the state owned enterprises still control the business as the government had issued strict limitation on the entry of these industries for a political reason. Also, the market is far from perfect which call for the participation of the government under some situations. What’s more a lot of uncertainties need to be ironed by a strong government role to ensure the stability of the economy market.

 

1.3    Long term economy targets

 

China’s long term development plans which are designed to range from 2010 to 2020 are to change the planned economic system into a market-based economy system. This goal requires the government to perform structural reforms such as facilitating the reorganization of the state owned enterprise to build up a more liberalized, open and integrated economy (Pigott 2002, p.365). In term of the short term plans, as quoted by the Chinese premier Wen Jia Bao in the Report on the work of the government at the fourth session of the Eleventh National People’s Congress on March 5th 2011 that from 2011 to 2015 the GDP growth has been set at 7% and focus will be shifted to the improvement in the quality and the performance of the economic growth (Wsj.com 2011). And based on the 2010 prices level, in 2015, the last year of the twelfth five year plan, the GDP of the country will be expected to reach or exceed CNY 55 trillion. Several detailed goals had been set: percentage of GDP spent on R&D will be increased to 2.2% to encourage technological innovation, also the environment protection in the economy development is also being focused by setting a number of target in major indicators such as energy consumption and CO2 emissions per unit of GDP need to be reduced by 16 percent and 17 percent respectively; other goals include targets in improvement of people’s wellbeing such as creating a extra 45 million urban jobs in the next five years and government’s internal reforms.

 

2.          Economy policies

 

2.1    Fiscal policies

 

Fiscal policy comprises majorly the setting of the amount of government expenditure given the level of government revenue, which is decided by the tax structure and the economic conditions (Chow 2007, p.139). And because government expenditure is considered as part of the social total demand, the increase or decrease of the government expenditure will influence the aggregate demand which make possible to stimulate the social demand by using a proactive fiscal policy. In this point, it would not be necessary for a plan economy like what the Chinese economy was before the economic reform because total output and distribution of the social goods would be under strict control and plan by the government by setting the output target for the state enterprises. And with the increasing dominance of the market forces and deregulation effort encouraged by the economy reform, the Chinese government had shifted to a more indirect way to influence the market using a powerful and influential fiscal policy. And the preference of the usage of the fiscal policy to influence the market by the Chinese government could be seen from an example happened during the 1998 Asia financial crisis. In 1998, when the negative effects of the Asian crisis was spreading to China and depressed the external demand for the Chinese good with an intensified deflation, the Chinese government changed the “appropriately tight” fiscal policy that was the first reaction that the government made to the financial crisis in 2007 to an active fiscal policy by issuing an additional foreign debt which valued 8 billion yuan and this active fiscal policy was later endorsed by the Standing Committee of the People’s Congress in August and then a more aggressive fiscal policy was adopted by the government by issuing an additional 100 billion yuan of the treasury bonds which were all used in the infrastructural building (Lau & Geng 1999, p.180). Similar active fiscal policy could also be found in the most recent global financial crisis.

 

In 2008 happened the credit crunch in the financial market of the United State which soon escalated to a global wide economic crisis resulting in slowdown of the global economic growth with the economy of the United States and manage industrial and developed countries projected to contract sharply, and to the countries like China and India which had experience a fast economic growth are also likely to keep the positive growth but experience a substantial slowing of their economies (Peters 2009, p.27). In response to the coming decreasing foreign demand and with the reference to the experience of 1997 Asian financial crisis, the government soon directly turned to a progressive fiscal policy which will be elaborated below.

 

2.1.1            The region’s largest fiscal stimulus package

 

After the break out of the economic crisis, the government soon introduced the region’s largest fiscal stimulus package ($584 billion) in the late 2008 which equals to around 13 percent of the GDP of 2008 (United Nations 2009, p.99) which was dedicated to stimulate the domestic demand in the following two years and it had been followed by a number of follow up plans and policies. As shown in the chart below, the 4 trillion yuan stimulus package had the large government expenditure majorly spent on the infrastructure investment with 45% of the money spent on railways, roads, airports, and the power grids, 25% on the post-disaster rehabilitation, 9% on the rural livelihood and infrastructure.

 

Chart 1 The fiscal stimulus package of China

Source: National Development and reform commission 2008

 

With the large injection of government expenditure into the market in various industries, the GDP growth of China in 2009 managed to achieve a 9.2 percent growth (Peopledaily.com.cn 2011) tough it was still low for China compared to the double digit growth that it had maintained for long. And through the implementation of the large stimulus package and the following plans and policies, the Chinese economy had been reenergized from the shock of the economic crisis which could be seen from the decrease in the unemployment rate in the first half year of 2010.

 

Chart 2 The unemployment rate before and after the economy crisis

Source: Tradingeconomics.com 2011

 

 

2.1.2            Value-added tax reform

 

Value Added Tax in China is one of the important sources of fiscal revenues for the government, especially the central government. Value Added Tax in China is a production based which could be very confusing for the enterprises. And in 2009 the Chinese government carried out a national wide reform on the value-added tax (VAT) to enable the capital spending to be deducted from the VAT to realize the final goal of reduction in the enterprise tax burden (U.S. Geological Survey, 2010). And this tax reform also worked together with the increased bank lending policy to help the enterprises to go through the financial difficulties (Citigroup Global Market Inc, 2008). Now the government is trying hard to convert the production-based VAT to a consumption-based VAT in a number of industries, and this reform would reduce the tax burdens though it also reduced the tax income of the Chinese government as the VAT accounts more than 30 percent of the tax revenue.

 

2.2    Monetary policies

 

2.2.1            Policies in exchange rate

 

From approximately 1982 to the beginning of 1994, under guidance of the central bank of China the USD to CNY exchange rate had gradually increased which means that the yuan weakened against the USD. And also during this long period in which the Chinese economy begun to experience a beginning stage to grow since the implementation of the economy reform and opening up policy in 1979, the Yuan trading was under close supervision and was allowed to fluctuate by less than 1 percent during the period (Meyer 2010, p.46).

 

Chart 3 Chinese Yuan Exchange Rate Chart (USDCNY)

Source: State Administration of foreign Exchange 2011

 

In 2004 the exchange rate reached the lowest at 7.62 yuan in exchange for 1 USD, and in the same year the yuan was pegged to the US dollar. And from 1997 to 2005 the improving current account balance enabled the government to keep a peg of 8.27 yuan per USD. And on 21st July 2005, the Chinese yuan finally stop the pegging to the USD and shifted to a “managed float” allowing 0.3% float against a basket of currencies each day (Das 2006, p.80). Though the yuan was once re-pepped again in 2008 during financial crisis, now the managed float exchange rate which is based on the supply and demand in the market with the reference to a basket of foreign currencies[1] is still used by the Chinese government as a strategy to gradually increase the RMB exchange rate flexibility and also the monetary flexibility for managing the economy (Barth 2009, p.309).

 

Chart 4 The undervaluation of Yuan from 1995 to 2008

Source: Goldstein & Lardy 2009, p.25

 

Even the Chinese government had abandoned the pegging USD policy and shifted to a more flexible managed float exchange rate which is based on the supply and demand in the market and allows gradual appreciation of the China yuan under the domestic and foreign pressure, but still it is generally believed that the Chinese currency is much undervalued for a long time. As the chart shows, the difference between the two lines estimates the undervaluation of the currency and the undervaluation of the Yuan have kept the Chinese good in a more competitive position in the global market. And the Chinese government also hinted that the country is benefiting from the undervaluation of the Chinese currency as in many occasions the Chinese officials had argued that the promotion of the rapid domestic growth rather the appreciating the currency will be the most important policy focus in China though many had claimed that the undervaluation actually promote the Chinese economic growth at the expense of other countries which the Chinese government denied (Morrison 2010, p.11). Nevertheless, in the perspective of the Chinese government, the undervaluation of the Yuan really provides support for the fast investment driven and export driven economy growth that makes the life of the people much better through the creation of millions of jobs.

 

2.2.2            Continual fast growth in money supply

 

Chart 5 Chinese cost raised by 72% since 2007

Source: Barrislotterer.com 2008

 

As the chart above shows, since 2007 the Chinese manufacturing cost raised by 72%, in order to keep a low cost advantage the Chinese continues the monetary supply policy to increase the M1, M2 and M3 money supply in the money circulating of the country’s economy and these increased money has been used by the government to buy up dollars at inflated prices in order to maintain the RMB value artificially low. According to the Chinese premier Wen Jia Bao in the Report on the work of the government at the fourth session of the Eleventh National People’s Congress on March 5th 2011, though the Chinese government will implement a so call “prudent” monetary policy but a target of 16% increase in the broad money supply (M2) was set for 2011 which is still higher than the GDP growth. And the increase of the monetary supply has push up the foreign exchange reserves which will be discussed in the next point. Though so far the increase of the money supply has successfully help keep fast economic growth in China, but there is also risk of a capital loss on dollar assets in the event of eventual appreciation of the Yuan (Goldstein & Lardy 2006) and also high inflation rate that makes people’s life more difficult.

 

2.2.3            Foreign exchange reserves management

 

Chart 6 Foreign exchange reserves from 2001 to 2008 (billions of US dollars)

Source: State Administration of foreign Exchange 2011

 

The foreign exchange reserves refer to the foreign currency deposits and bonds held by central banks and monetary authorities of a country to support and monetary policy and maintain the safety and stability of the financial market against the possible risks. And the management of foreign exchange reserves is mainly an aspect of exchange rate policy. With the rapid economy growth in term of fast GDP, export and FDI growth, the foreign exchange reserves of China also keep a fast increasing trend, and according to the most recent statistics released in March People’s Bank of China the foreign exchange reserves of China hit the record high $3.044 trillion with a 24.4 percent increase compared to that of last year (China.org.cn 2011) which further strengthens China’s No.1 position in foreign exchange reserves which China took by passing Japan in 2006 (Finance.people.com.cn 2006). And in term of the configuration of the large foreign reserves, U.S. dollar assets account for 70 percent of China’s foreign exchange reserves following by the Euro which accounts for around 20 percent. To better manage the large foreign exchange reserves that had been criticized as losing value with the weakening US dollar and Euro against the Chinese Yuan for a long time, the Chinese government in 2007 issued special bonds that worth RMB 1.55 trillion by the Ministry of Finance which would be used to acquire approximately USD 200 billion of China’s foreign exchange reserves as the base of the registered capital (China- inv.cn 2008). The China Investment Corporation (CIC) not only aims at maximizing the shareholder’s value but also focus on investing on the key resource based industries in a global scale to source the needed resource to support the needs of the economic growth of China.

 

By keeping large foreign exchange reserves there are at least three major strategic significances: the first function is making international payment, for example the import of some strategic material and key technologies need to be paid by foreign currencies; the second function is that it increase the safety of the finance market especially when emergent situations happen such as financial crisis and war which will lead to the large retreat of the foreign investment; thirdly, the large foreign exchange reserve enable the government of a country to intervene in the foreign exchange market to influence the float of the home currency; what’s more the sufficient foreign reserves provide firm support and great flexibility to the monetary policy. For example, expansionary monetary policy leads to a loss in foreign exchange reserves as the economy and a large amount of foreign exchange reserves could offset such loss in a long period of time. As in the case of China, the large foreign exchange reserve could have two more functions: on one hand, large foreign exchange reserve support the government with leverage when facing the pressure from the US and EU to appreciate the Yuan as China is hold large quantity of the US treasury bonds and on the other hand the large foreign exchange reserves also ensure confidence of the people and foreign investors in the financial and economy stabilities and safety.

 

2.2.4            Inflation and interest rate changes

 

Chart 7 The inflation rate before and after the economy crisis

Source: Tradingeconomics.com 2011

 

Chart 8 The interest rate before and after the economy crisis

Source: Tradingeconomics.com 2011

 

The interest rate has close relationship with the inflation rate, since the 1990s the Chinese government had used the interest rate policy to battle with the inflation and deflation that shows extremity in China though the effectiveness of the interest rate changes have been doubted for long due to the special banking system and  consumer psychology in China. Between 2007 and the beginning of 2008, as the chart tells that inflation had been very high which was caused by the high housing price due to the excessive investment and flow in of the international hot money in the real estate market, and to curtain the excessive investment in the property market and bring down the record high housing prices which could cause social instability in China, the Chinese government since 2007 had raised the interest rate for six consecutive times and also the reserve requirement ratio had been raised for fifteen time with the decisions made by the Peoples’ Bank of China Monetary Policy Committee to curtail the lending. But the fierce fights against the high house price led inflation had soon seen a turnaround in the latter half of 2008 with the breakout of the financial crisis that change the market condition in a sudden. Since the September of 2008, as demonstrated in the chart above, the interest rate was cut four times reaching a point below 5.5 in January of 2009 and which lasted until late 2010 and in accordance with the interest cut, the bank reserve requirement ratio was also cut in large degree.

 

2.3    Supply side policies

 

2.3.1            Revitalization plan in ten industries

 

Although a 4 trillion stimulus package had been made to stimulate the domestic demand, the industrial data in the late 2008 didn’t make the Chinese policy makers rest assured. In the single month of November of 2008, the export growth jumped from 19.2% in the previous month to 2.2% while import growth also decreased from 15.7% to -17.9%, and as a result the value-added growth also decreased. As the country had set the target of GDP growth of 8% in 2009 which is expected to keep the unemployment from getting worse, in order to achieve the set target of growth, the Chinese government enacted another plan to support the economic growth which is the revitalization plan in ten industries (Cctv.com 2009). The revitalization plan in ten industries covers ten major industries such as the equipment manufacturing, iron and steel, logistics, petrochemical and textiles which accounted for more than 80% of the national total industrial output value and 1/3 of the GDP (U.S. Geological Survey, 2010). The revitalization plan was designed to restructure the industries in which the structure already can not meet the needs of the modern business world after 30 years’ development particularly in term of weakness in independent innovation, productivity and resource consumption. Through the implementation of the revitalization plan in ten key industries the government had used the economy crisis as an opportunity to readjust the direction of these industries and upgrade them with modem technology and competitiveness.

 

2.3.2            Domestic industrial transfer and upgrade

 

The domestic industrial transfer in China refers to the relocation of the labor intensive industries to the less developed regions and provinces. The domestic industrial transfer is made possible due to the inequality development in China which is caused by the long existing policy started from the beginning of the economy reform to focus on the development of the coastal area, but with the increasing labor force that push up the cost of the labor intensive industries the domestic industrial transfer is one of the major strategic plans that the government had already made before the global economy crisis. For example, in 2008 one the most developed provinces, had released the policy named “Decisions about accelerating industrial transfer and labor transfer” to encourage the industrial transfer and leave enough room for further introduction of the quality foreign investment and the upgrade of the remaining industries.

 

 

3.          Comparison between India and China in economy

 

Chart 9 China Gross Domestic Product

Source: The world bank group 2011

 

 

Chart 11 India Gross Domestic Product

Source: The world bank group 2011

 

 

Chart 10 China exports

Source: General Administration of Customs 2011

 

 

Chart 12 India exports

Source: Directorate General of Commerce 2011

 

From the charts we can see that in term of GDP quantity, China has an advantage over India but both of them keep a fast growth rate. And one factor that seems to make India’s economy more healthy is that the export account for less percentage of the GDP suggesting that the Chinese economy is more export oriented while the Indian economy focus more on the domestic consumption driven. Another factor that makes India a more promising future its coming young labor, as shown in the table below China has a labor force 813.5 million while India only has 467 million and with the one child policy that China adopted 20 years ago the aging population will coming and cause a large burden in the economy while India will begin to enjoy the low cost brought by the young and large labor force together with low dependency ratio.

 

Table 1 Basic facts of China and India

Source: Mapsofindia.com 2011

 

4.          Policies recommended for the Chinese government

 

4.1    Focus on social welfare to expand domestic demand

 

From the fact that the 2009 economic growth had been severely influenced despite the implementation of the 4 trillion yuan stimulus package, the largest in the region, we can see that China is now too much accounting on the export to developed its economy and domestic demand didn’t seems to provide enough of support to the economy of such large scale especially with a large bank deposit. When one comes to the conclusion that it is due to the long term plan and conservative consumption concept in people’s mind, but as a Chinese I would come to another conclusion that may more appropriately explain this phenomena: it is due to a more pragmatic understanding the Chinese people’s life that they are not feeling safe to spend the money on their hand while they have to account on these money to arrange everything especially the several key tasks in their life. According to various reports, three major planned functions of the deposit for many years remain the same: children’s education expenditure, pension and housing. And when the public welfare has not been built up comprehensively and people have to save money for education and pension, it is too much to ask people to spend their money as it is already allocated before it is earned. Now with the raising housing price, it is very difficult for common people to purchase a house without paying the loan for another 20 to 30 years. And on the other hand, as early as in 2004, according to the 2005 Social Blue Book issued by the Chinese Academy of Social Sciences the Gini coefficient of China is now above 0.4 and reached 0.47 (Chen & Zhou 2005, p.266), meaning to say that inequality is in improper range and the inequality is too high. So many people still don’t have the money to spend rather not willing the make the purchasing as fortune is not distributed appropriately. So to increase the domestic demand, the government should continue to social welfare in term of providing education, medical, pension and low price houses to people and then people could feel safe to spend their money on other consuming goods.

 

4.2    Relieve the birth control

 

Another policy that the government should carry out is to relieve the birth control which has been enforced strictly for the past two decades, and as mentioned above China has a labor force 813.5 million accounting a large proportion of population that reached 1.341 billion in the end of 2010, and if the current strict birth control policy or one child policy continue, after reaching a labor force high in numbers in 2019 according to some predictions, the country will lose the advantage of low labor cost and the government will also have a number of problems to deal with as the aging population account for a majority of the population. So a timely relieve of the birth control will support the economy in the future which is important for China as a large economy.

 

5.           

Reference list

 

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[1] The basket of foreign currencies are dominated by the United States dollar, Euro, Japanese yen and South Korean won

The end.

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