The economy policy in People’s Republic of China

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Index of figures

Figure 1Cultural dimensions model analysis of China and United States…………. 4

Figure 2 Cultural dimensions model analysis of China and United States………… 6

 

Index of charts

Chart 1 A comparison between the money supply growth rates in the US and China      15

Chart 2 China PPI and CPI……………………………………………………………………… 16

 

Table of contents

Index of figures………………………………………………………………………………………………….. 1

Index of charts…………………………………………………………………………………………………… 1

Table of contents…………………………………………………………………………………………………. 2

The economy policy in People’s Republic of China………………………………………………………. 4

1.      Background information of China……………………………………………………………………… 4

1.1           Political factors……………………………………………………………………………….. 5

1.2           Economic factors……………………………………………………………………………… 5

1.3           Social and cultural factors…………………………………………………………………… 6

1.4           Technologies factors………………………………………………………………………….. 7

2.      Macroeconomic policy mix adopted in the past three decades……………………………………. 8

2.1           Fiscal policy……………………………………………………………………………………. 8

2.1.1      Definition and theories………………………………………………………………… 8

2.1.2      Objectives of fiscal policy in China…………………………………………………. 9

2.1.3      Fiscal policy of China…………………………………………………………………. 9

2.1.3.1  China’s expansionary (or proactive) fiscal policies during the global financial crisis 9

2.1.3.2  China’s Fiscal Policies during the Post-Crisis Era: still proactive…….. 11

2.1.4      Taxation reform……………………………………………………………………….. 11

2.1.5      Critics……………………………………………………………………………………. 12

2.2           Monetary policy……………………………………………………………………………… 13

2.2.1      Definition and theories………………………………………………………………. 13

2.2.2      Objectives of monetary policy in China………………………………………….. 14

2.2.3      Monetary policy during the global financial crisis……………………………… 14

2.2.4      China’s monetary policies during the post-crisis era: gradual tightening…… 15

2.2.5      Exchange rate reform………………………………………………………………… 15

2.2.6      Critics……………………………………………………………………………………. 16

3.      Comparing the economic performance of China and Brazil…………………………………….. 17

4.      Suggested policy mix for the improved performance of China’s economy………………….. 17

4.1           Following market rules rather than government orders……………………………… 17

4.2           Fiscal policy: balance the “productive” and “non-productive” government expenditures   18

4.3           Monetary policy: continue tight monetary policy but watching the market closely 19

List of reference………………………………………………………………………………………………… 20

Appendix A. Priorities of China’s Economic Stimulus Package and Relevant Data……………… 26

The economy policy in People’s Republic of China

 

1.        Background information of China

The People’s Republic of China (PRC) is located in southwest of Asia with a total population of approximately 1.34 billion according to the sixth national population census carried out on November 1, 2010 (Overpopulation.org 2011). China is the third largest country in the world in term of area occupied and it accounts for one-fifteenth of the earth’s land mass. The capital city is Beijing. Other important and large cities include Guangzhou, Shanghai, Tianjin and so on. China is considered as one of the oldest civilization in the world with a recorded history that dates back more than 4,000 years. The country has a rich and diversified culture and is known for its great historical achievements such as the Great Wall of China (Loh 2005, p. 1). Below we will introduce the macro environment of China using a PEST model which is one of the most common models used to analyze the macro environment by focusing on four elements: Political, Economical, Social-demo-graphical, and technological factors (Faarup & Aabroe 2010, p. 89).
figure1

Figure 1Cultural dimensions model analysis of China and United States

Source: geert-hofstede.com 2011

1.1    Political factors

 

To understand the political system of a country or a society it is supportive to have a look at the recent history of the political system (Nagel 2010, p. 4). Socialism, particularly the Marxist brand of socialism, made a late appearance in China and it could almost be said that this coincided with the formation of the Chinese Communist Party in 1921 (Guillermaz 1972, p. 16). Since then, in particular after the end of the internal war in which the Kuomintang of China (KMT), also known as the Chinese Nationalist Party supported by the western forces loss the battle, and the Communist Party established the so called socialist new China, the People’s Republic of China, the political activities become a major theme of the social focus. Dispute and battle based on the ideology has dominated the political life and even influenced the economic side of the society until the late 1970s after the death of the famous Chairman Mao ZeDone. In year 1978, the government introduced the reform and openness policy announcing that the Communist Party of China (CPC) would shift its political guideline from class struggle to economic construction that reshaped the political thinking regarding the various ideology problems and economic problems (Huan 2010, p. 196). And since them, the political focus has been focusing on the economic growth and it seems that the government tries to avoid many social conflicts and suppresses the demand for democracy to some extent to concentrate on the economic development. As a result, political stability becomes the top priority in the political guidelines with some threats and risks accumulated.

 

1.2    Economic factors

Economic factors not only refer to the economy systems but also include the changes in the interest rate, the levels of employment and how well a country is trading with oversea nations (Canwell & Sutherland 2005, p. 76). In the first 30 years after the founding of the PRC in 1949, the Chinese government carried out a system of planned economy, and targets and quotas for various spheres of economic development were set by the “planning committees” of the state. As mentioned above, the economy development of the country began to speed up with the beginning of China’s economic reforms which started in 1978 when the household contract responsibility system was introduced there in the agricultural sector. And in 1984, the reform was furthered to the cities and the major industries (Jobschina.org 2009). At present, the Chinese economy has been developed along with the direction of building a open and free market economy which has been widely accepted by many economies. Though its two largest traders, EU and the United States have classified China as a “non-market economy”, it is believed that these two major economies has use this classification to give domestic industries an easier life for a while as according to the WTO treaties, China will automatically get market-economy status at the WTO in 2016 (chinadaily.com.cn 2011).  

 

1.3    Social and cultural factors

 

Figure 2 Cultural dimensions model analysis of China and United States

Source: geert-hofstede.com 2011

Social and cultural factors include areas such as demographic changes, cultural attitudes and social trends (Graham & Allan 2008, p. 39). “Culture is the collective programming of the mind distinguishing the members of one group or category of people from others” as proposed by Professor Geert Hofstede who conducted one of the most comprehensive studies of how values in the workplace are influenced by culture (geert-hofstede.com 2011) and proposed the famous Hofstede cultural dimensions model which help analyze the national cultural systems. Here we check out the social and cultural system of China using Hofstede cultural dimensions model which includes Power Distance (PDI), Individualism versus Collectivism (IDV), Masculinity versus Femininity (MAS), Long term orientation (LTO) and Uncertainty Avoidance (UAI). In term of Power Distance (PDI), after analyzing the political history of China that we have briefly introduced above, it is not hard to understand that the in the culture of China, power distance is large with people obeying the rules and regulations made by the government without too many questions; accordingly in term of Individualism versus Collectivism (IDV), individualism is less obvious in China which has a long history of suppressing the individualism and uphold the collectivism in the socialist ideology; another major dimension that yields distinct results between the US and China is the Long term orientation (LTO) which shows that the Chinese people tend to have a long term plan and focus on the interests obtained in the future rather than the current benefits.

 

1.4    Technologies factors

 

As said by Anthony Henry (2008, p. 57) that without doubt that some of the major changes taking place in the general environment that impacting both the policy making and competitive environment in the market are technological. Under the planned economy that had been the controlling system for a long period of time, science and technology had contributed greatly to national construction but separated from the economy. In 1981, the government proposed new policies for developing science and technology in the new historic period which stressed their service to the modernization construction and that progress of science and technology should go hand in hand with the economic and social development. The 15th CPC National Congress again put forward the strategy of developing the country through science and education, and sustainable development, and made scientific progress a priority for economic and social development (china-embassy.org 2004).

 

2.        Macroeconomic policy mix adopted in the past three decades

 

2.1    Fiscal policy

 

2.1.1            Definition and theories

Fiscal policy is defined to mean all government policy dealing with government spending and government collection of revenue, mostly taxation. It is believed that the economic role of government that most directly influences the level of output, income, and employment is its taxing and spending of money. Fiscal policy consists of decisions to spend and to tax (Sherman, Hunt, Nesiba & Ohara 2008, p. 565). Fiscal policy can affect the economic growth through the size of the government’s budget balance (and resulting in government debt) and the scale and composition of taxation and public expenditure. Though increased government spending also create demand in the market which tend to stimulate the economy, it is believed that permanent fiscal deficits will come with high interest rate which crowds out the private sector investment and reduced the long term growth potential of the economy (Mueller 2002, p. 1986). Also the effect of expenditure in the market could be differentiated based on what type of expenditure it is. Based on Kneller, Bleany and Gemmel (1999), “productive” expenditure (defined as public service, health and education, transport and communication) tend to increase growth while “nonproductive” spending (refers to majorly socially security and welfare spending) would have limited contribution to the economy growth.

 

2.1.2            Objectives of fiscal policy in China

In China, the three major targets and priorities of the fiscal policies, prudent or loose, are to achieve the objectives of price stability, full employment, and economic growth.

2.1.3            Fiscal policy of China

 

2.1.3.1      China’s expansionary (or proactive) fiscal policies during the global financial crisis

 

Two years ago, the unexpected global financial crisis is considered by many economists to be the worst financial crisis since the Great Depression of the 1930s played havoc on the world economy and posed severe challenges on the macro-economic control for every country. In dealing with this disaster, fiscal policies are regarded as an important measure. In November 2008, like many other countries China announced to shift its macro-economic policies into moderately relaxed monetary policies and proactive (or expansionary) fiscal policies, which turned out to be very effective (cdrf.org.cn 2010). In November 2008, a 4 trillion Yuan (US $ 586 billion) stimulus package was announced by Beijing which is first among the world’s major economies to put together a substantial package to tackle the crisis. The stimulus package consists of bank credit, fiscal spending, and unspecified sources of funding and was targeting the domestic investments and consumption as the sources of economic growth. As a share of economic output, the Chinese stimulus package amounted to roughly 7 per cent a year for the two years which was at that time the largest (Birdsall & Fukuyama 2011, p. 116).

 Figure 3

Figure 3 China’s stimulus plan in pie chart form

A stimulus package estimated at 4 trillion yuan (about 570 billion U.S. dollars) will be spent over the next two years to finance programs in 10 major areas, such as low-income housing, rural infrastructure, water, electricity, transportation, the environment, technological innovation and rebuilding from several disasters, most notably the May 12 earthquake. The policies also include a comprehensive reform in value-added taxes, which would cut industry costs by 120 billion Yuan (xinhuanet.com 2008). As demonstrated in the figure above, the majority of the huge stimulus package would be spent in the infrastructure construction and post disaster reconstruction and technology advances which as mentioned above are all classified as “productive” expenditures (defined as public service, health and education, transport and communication) and they tend to increase economy growth and thus the composition of the stimulus package also hints the effectiveness of the package in stimulating the economy growth. But the relative negligence of the “nonproductive” spending (refers to majorly socially security and welfare spending) has been widely criticized which will be discussed later. Coupled with the expansive monetary policy, the fiscal policy was effective during the course of the global financial crisis which last from 2008 to 2009 as the gross domestic product (GDP) reached 33.54 trillion yuan (4.91 trillion U.S. dollars) in 2009 and the economy expanded 8.7 percent in 2009 from a year earlier, indicating that China had achieved its full-year growth target of 8 percent for 2009, according to the official data (Gov.cn 2010).

 

2.1.3.2      China’s Fiscal Policies during the Post-Crisis Era: still proactive

 

China’s fiscal deficit hit 950 billion yuan in 2009, a six-year high, but was still less than 3 percent of GDP, considered by many economists as a security line. In the end of 2010, China was still planning to outline a fiscal deficit of 900 billion yuan ($135 billion) for 2010, 150 billion yuan less than 2009’s target. While the central government’s fiscal deficit will decrease to 700 billion, the debt issued by central authorities for local governments will be maintained at 200 billion Yuan. Though the government claimed in 2011 there will be a prudent fiscal policy, many had pointed out that as long as the government keeps a deficit, it is still a proactive policy stance (China.org.cn 2010).

 

2.1.4            Taxation reform

 

Taxation reform has been going through the tax system since its ineption.  In 1983, China set out to change the so-called big pot economic system, switching from profit collection to taxes to finance government expenditures, after a profit was made by an enterprise, 50 percent of it would be surrendered to the government in the form of a product tax, value-added tax and business tax. And enterprises also pay other taxes in the categories of real estate, transportation, land, city construction and additional education (King & Zhang 1992, p. 84). The main problem after the reform of the tax payment for profit delivery was that the items of taxation were still oversimplified and the role of taxation regulating the economy does not work adequately, hence the State Council decided to reform the industrial and commercial tax roundly in 1984 by allowing the profit after tax to be arranged by the enterprises autonomously (Zhang 2009). In order to further open up the market and attract the foreign direct investment and facilitate the foreign investment in term of foreign owned enterprises, the “Income tax law of the People’s Republic of China on foreign investment enterprises and foreign enterprises” was adopted at the 4th session of the 7th National People’s Congress on 8 April 1991 (Waart, Denters & Schrijver 1998, p. 69). In the new century, the taxation reform continues and more changes had been introduced. Some big changes happen during and after the global financial crisis. For example, the Chinese government has utilized the global financial crisis as an opportunity to carry out the fuel tax reform. Beginning on January 1 2009, the Chinese government has finally decided to start a fuel tax plan. According to the plan, the gasoline tax will increase from 0.2 yuan to 1 yuan per liter, and go from 0.1 yuan to 0.8 yuan per liter for diesel. And six categories of tolls for road maintenance and management will be scrapped. Such reform enable the Chinese government with further fuel price cuts in 2009, as the goal of its fuel price reform is to let the market have its say (chinadaily.com.cn 2009). Reforms also could be found in other types of tax categories.

2.1.5            Critics

 

China’s expansionary (or proactive) fiscal policies during the global financial crisis on one hand has shown the government’s efficacy to stop the crisis from badly hurting the fast growing economy on its own financial resource, but also on the other hand there are critics about the government’s behaviors: firstly, China’s stimulus package lacks transparency, In November, the programme designed to stimulate the economy was announced but concrete details were still lacking as congress delegates demanded ‘more transparency’, and also the real size of stimulus package still lies pretty much in the dark. Less than half comes from state coffers as the government has decided that the bulk is to be secured through bank loans. In this context, it remains unclear what proportion of these loans would be regular ones and how much could be best described as ‘secured through finance politics’ (monstersandcritics.com 2009); secondly, the major bank’s quick unleashing a surge of new credits attracted questions. In the first quarter of 2009, the banks pumped out over 4.5 trillion yuan in financing, nearly as much as the 4.9 trillion in lending for all of last year, according to the People’s Bank of China (PBOC). Nearly all the new lending took place even before the National People’s Congress voted to approve the stimulus plan in mid-March. The massive response of China’s banks has raised questions about their independence and commercial decisions, as well as the nature of the investments and the recovery (Lelyveld 2009).

Another issue is with the composition of the stimulus package. As mentioned, the majority of the huge stimulus package would be spent in the infrastructure construction and post disaster reconstruction and technology advances which as mentioned above are all classified as “productive” expenditures while the “nonproductive” spending (refers to majorly socially security and welfare spending) that would have limited contribution to the economy growth has been very limited in the package with only 4 per cent (150 billion yuan) spent directly in the social welfare. This has attracted widely critics that the government has been too much focusing on the long term economic development while leaving the current generation’s interest and welfare unintended.

2.2    Monetary policy

 

2.2.1            Definition and theories

Monetary policy refers to government decisions about the money supply and interest rates. Whereas the fiscal policy is largely the responsibility of the central government, the monetary policy is largely the responsibility of the central bank, which is People’s Bank of China (Jillson 2009, p. 401). Also many economists consider that the manipulation of exchange rate is a form of monetary policy, given that exchange rates are affected by changes in interest rate (Higson 2011, p. 119).

2.2.2            Objectives of monetary policy in China

As a big developing country undergoing reform and transition, China has to deal with complicated and rapidly changing economic situation, and its macroeconomic policies are therefore designed to meet multiple objectives, such as reform and development. More specifically, monetary policy also has various objectives, including managing inflation, supporting growth, promoting a balanced BOP account, boosting employment and facilitating financial reform. This fact highlights the importance of making flexible and effective monetary policies to achieve these targets (pbc.gov.cn 2010). According to the theories regarding the fiscal policy some important objectives of the fiscal policy include: desirable price level, desirable level of consumption, desired level of employment, desirable level of income distribution, economic growth and development and equilibrium in the balance of payments (Mba-lectures.com 2009).

 

2.2.3            Monetary policy during the global financial crisis

 

Under the loose monetary policy, China’s M1 supply in 2009 had a year-on-year growth rate of 27.7 percent and the M2 year-on-year growth rate was 32.4 percent. That momentum did not slow substantially in the first 10 months of the year 2010. The country’s monetary policy remained basically the same from 1998 to 2007, the longest period for a monetary policy since 1984 when the People’s Bank of China began to exercise the central bank functions. During this period, the annual newly increased bank lending was about 2 trillion yuan on average, less than a quarter that of 2009 to 2010 (chinadaily.com.cn 2010).

 

2.2.4           
China’s monetary policies during the post-crisis era: gradual tightening

chart2

Chart 1 A comparison between the money supply growth rates in the US and China
In march 2010, the government announced to switch to a prudent monetary policy from a moderately loose stance as the Communist Party’s top leaders decided, a change which was followed by more interest rate increases and lending controls. And it was believed that the Chinese and global markets were little affected by the policy announcement, with investors seeing the new wording as an affirmation of the gradual tightening that Beijing has already started to implement (Huffingtonpost.com 2010).

 

2.2.5            Exchange rate reform

Reform of the RMB exchange rate regime has been making steady progress since 2005 when it moved into a managed floating exchange rate regime based on market supply and demand with reference of a basket of currencies since July 1, 2005 producing the anticipated results and playing a positive role. In the middle of 2010, the People’s Bank of China, China’s central bank, has decided to proceed further with the reform of the RMB exchange rate regime to enhance the RMB exchange rate flexibility under the principle of independent decision-making, controllable and gradual progress (chinadaily.com.cn 2010).

2.2.6            Critics

 

Though the expansionary monetary policy is considered as working fine to supplement the ambitious fiscal policy to fight against the negative impacts of the global financial crisis, there has been some bad consequences due to the loose monetary policy. Without seasonal adjustment, CPI rises in 2009 November by 2.86%; with seasonal adjustment, it is 5.14%; Without seasonal adjustment, PPI declines 8.14%; and with seasonal adjustment, PPI rises by 14.80%. The following two graphs are time series plots of CPI and PPI in China from 2001; CPI_sa (PPI_sa) is CPI (PPI) after seasonal adjustment (Jhqian.org 2009). The high CPI growth has substantially increased the burden of people’s life and lay the boom of social instability in the long run.

chart2

Chart 2 China PPI and CPI

Source: Jhqian.org 2009

3.        Comparing the economic performance of China and Brazil

 

Brazil and China are two members of the BRICs representing the emerging economy power. Below we will compare the economic performance of these two countries. With a larger population, China enjoys a larger GDP (purchasing power parity) with 10.09 trillion USD in 2010 compared Brazil’s 2.172 trillion USD at the same period, but in term of GDP – per capita (PPP), Brazil’s 10,800 USD is more than China’s 7,600 USD representing Brazil’s development of economy is more advanced than China. Both of them grow rapidly in term of GDP growth rate. And the two of them also share similar unemployment rate (6.7% for Brazil and 6.1% for China). In term of fiscal policy, Brazilian government seems to be more powerful than China as it has 39.4 percent share of GDP in the taxes and other revenues when this digit is 20.9% in China. Also the inflation rate in Brazil is 5% which is bigger than 3.2% in China. Therefore, we can apprehend why Brazil has a much bigger public debt which equals to 54.7% of the year’s GDP (cia.gov 2011). Only from these data, we can conclude that China is performing better than Brazil. But the data provided by the China’s government is another question to be answered.

 

4.        Suggested policy mix for the improved performance of China’s economy

 

4.1    Following market rules rather than government orders

 

What the government has been doing in the past three decades since the reform of its economy in the 1980s is to establish a market economy, but it seems that a strong government has still been controlling and directing a number of economy activities and making some critical decisions for the markets, for example as said above, the massive response of China’s banks to increase credit even before the stimulus package was approved has raised questions about their independence and commercial decisions, as well as the nature of the investments and the recovery (Lelyveld 2009), though it seems to be effective under such a strong government that is able to direct everything, but it would affect the normal functioning of the market rules and predictions based on the market behaviors. As a result, in order to build up a desired market economy that could be accepted by more trade partners, the Chinese government has to reduce its roles in influencing the economy activities and play the role of monitoring rather the decision maker.

 

4.2    Fiscal policy: balance the “productive” and “non-productive” government expenditures

While the “nonproductive” spending (refers to majorly socially security and welfare spending) that would have limited contribution to the economy growth has been very limited in the 4 trillion Yuan stimulus package with only 4 per cent (150 billion yuan) of the budget planned to be spent directly in the social welfare, which has attracted widely critics that the government has been too much focusing on the long term economic development while leaving the current generation’s interest and welfare unintended, there is already some social disorder in the current society because of such imbalance. For instance, the Beijing Suicide Research and Prevention Center reported in 2009 that the suicide rate for females was three times higher than for males. Suicide is the no. 1 cause of death among Chinese rural women aged 15-34. About 56 percent of the world’s female suicides occur in China, but only 20% of the world’s population lives in China.500 women commit suicide in China each day (allgirlsallowed.org 2010). Based on such facts, it would be recommended the Chinese government should better balance the “productive” and “non-productive” government expenditures and focus more on the welfare building in the society though it is considered as less effective in boosting the economy, but such balance would create a sense of fair among the society which is better for the sustaining of stability in the society in the long run.

4.3    Monetary policy: continue tight monetary policy but watching the market closely

 

As China continued to adopt the tightening monetary policy in the second half of the year, there has been some ease in the high CPI. According to data from the Ministry of Commerce, the wholesale prices of 18 staple vegetables fell 2.2 percent during the last week of October, while prices of pork and eggs dropped by 1 percent and 0.6 percent, respectively. In addition to lower food prices, declines in world commodity prices and weakening tail-raising factors will also contribute to the CPI’s decline (Xinhuanet.com 2011). But the tightening monetary policy has been contributing to a debt crisis. Cheng Xiaonong, an economist based in the U.S., pointed out that a 30 percent drop in home prices in a short period of time is a sign that a financial crisis is about to hit China. And he said that when the housing bubble bursts and developers go bankrupt, banks will grapple with high default rates and bad debt, resulting in a financial crisis in the banking system” (silverbearcafe.com 2011). Also many business failure cases have been identified in many provinces. In this point, it is important for the government watch the market closely and not to hold the tight monetary policy without giving any flexibility to the market for a breath.

 

 

 

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Appendix A. Priorities of China’s Economic Stimulus Package and Relevant Data

 appendix

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