Impacts of US led economy crisis on the Chinese economy

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Executive summary

 

This study could be divided into five major parts: the first part focuses on the impacts of the current economy crisis triggered by the US credit market on the Chinese economy, the impacts are classified into two categories: direct and indirect impacts; the second part of this study will be attributed to the response policy initiated by the government to cope with the impact coming together with the economy crisis, these policies are also categorized into four divisions, fiscal policy, monetary policy, supply-side policy and trade policy; the third part is the examination of the effectiveness of the governmental policy according to the major economic indicators such as GDP growth rate and CPI; the fourth part of this assignment will review the economy growth of China during the last ten years and the last part of the study ends with two recommendations to the Chinese government in improving the economy performance and maintain a healthy economy system in the near future.

List of charts, tables & figures

 

Chart 1.0 Shanghai Stock Exchange (SSE) Composite Index historical data…………5

Chart 2.0 Decelerated GDP growth……………………………………………………7

Chart 3.0 Chinese export of services and products……………………………………7

Chart 4.0 Chinese unemployment rate during economy crisis…………………………8

Chart 5.0 Error and omission in balance of payment during 2005-2008………………8

Chart 6.0 Exchange rate of CNY against major currencies……………………………9

Chart 7.0 Exchange rate of USD against major currencies……………………………9

Chart 8.0 Historical interest rate in China from 2007 to 2009……………………….12

Chart 9.0 GDP growth rate rebound in 2010…………………………………………15

Chart 10.0 Import of China by month………………………………………………..16

Chart 11.0 Export of China by month………………………………………………..16

Chart 12.0 Historical unemployment rate trend………………………………………17

Chart 13.0 US unemployment rate……………………………………………………18

Chart 14.0 Inflation rate in China…………………………………………………….19

Chart 15 China GDP growth rate since January 2001……………………………..…20

 

Table 1.0 Configuration of the RMB 4 trillion stimulus package (billion CNY)……10

Table 2.0 Consumer Price Index (CPI) by Category (2010.08)………………………19

 

Figure 1.0 Benefit of supply side policies…………………………………………….14

 

Content page

Executive summary………………………………………………………………………………………….. 1

1.     Country background………………………………………………………………………………….. 4

2.     Causes of the financial crisis……………………………………………………………………….. 4

3.     Impact of the crisis…………………………………………………………………………………….. 5

3.1      Direct lost in the capital markets………………………………………………………… 5

3.1.1     Lost in domestic capital market………………………………………………… 5

3.1.2     Lost in US capital market………………………………………………………… 6

3.2      Indirect impact of the crisis in Chinese economy………………………………….. 7

3.2.1     Economy slow down………………………………………………………………. 7

3.2.2     Balance of payment fluctuations………………………………………………. 9

3.2.3     Forced appreciation of Chinese currency……………………………………. 9

4.     Response and impact……………………………………………………………………………….. 10

4.1      Policy response to cope with the economy downturn………………………….. 10

4.1.1     Fiscal policy…………………………………………………………………………. 10

4.1.2     Loose monetary policy…………………………………………………………… 12

4.1.3     Supply-side policies………………………………………………………………. 13

4.1.4     Trade policies……………………………………………………………………….. 15

4.2      Impact of the government policy……………………………………………………… 15

4.2.1     GDP rebound……………………………………………………………………….. 16

4.2.2     Employment…………………………………………………………………………. 18

4.2.3     Consumer Price Index (CPI) and Inflation……………………………….. 19

5.     Economy performance of China for the last ten years…………………………………… 21

6.     Recommendations……………………………………………………………………………………. 22

6.1      Control over high property price………………………………………………………. 22

6.2      More effort on education and health care system construction…………….. 22

Reference……………………………………………………………………………………………………… 24


1.        Country background

 

With the reform and opening up policy initiated in the 1978 by China’s one of the greatest leader Deng Xiao Ping, the chief designer of China’s market economy, China as a developing country has gradually attracted attention from the world. Though more than 30 years’ effort, by introducing large amount of foreign direct investment (FDI) to start its industrialization and urbanization much later than the developed countries, complied by low cost advantages and full support from the government to focus on the economy development, China has been undergoing the fast economy growth in the world which has been described as economy miracle. When the current US led economy crisis happen and started to spread all over the world especially the developed countries such as the EU and Japan, there is a lot of concern about whether China could still sustain its rapid economic growth using the export oriented mode when its largest export destination all witness economy slow down and try to boost their respective market by encouraging consumption of their own products and there are also a trend of raising protectionism to keep the “Made in China” away. The Chinese government has initiated a large stimulus package to revive the economy and offset the influenced of the slowing outside demand. Below let’s first examine the impact of the crisis.

 

2.        Causes of the financial crisis

 

The fundamental reason of economic crisis or credit crunch rooted in a deregulated market which allow people to strive for their own interest even in a short term. This was how the economic crisis happened in the United States housing market. The widely accepted financial adjustable rate and other underlying assets have encourage the poor people or the middle class to purchase more properties even though they could not afford to pay off all the loan to buy the house, but the financial tools make such a miracle to help them get benefit from the continual raising prices of property. But the prices could not rise in a long term and while the prices go down and people could not pay the loans, property market falls together with the banks. So the stimulation of the ineffective demand for the real estate laid the foundation of this financial crisis and the government should also take a large part of responsibility for not having put a close eye on monitoring the uses of the financial derivatives which are off high risks and could create huge fortune in a short term while at the same time they also could make the economy collapse overnight. Or in the end we could say that it is the greed of human being that caused this financial crisis.

 

3.        Impact of the crisis

 

3.1    Direct lost in the capital markets

 

3.1.1            Lost in domestic capital market

 

According to the historical date from 31 December 2007 to the same day of 2008 the Shanghai Stock Exchange (SSE) Composite Index drop so significantly that the stock market lost nearly two thirds of the market value during 2008 (Fas.org 2009) as shown in the chart below. The lost in the stock market value directly contributed to the difficulties faced by the companies that relied on the stock market to raise fund for capital to keep the business in operation and influence small investors’ life who could not sustain the lost.

 

Chart 1.0 Shanghai Stock Exchange (SSE) Composite Index historical data

Source: Stock.sohu.com 2010

 

3.1.2            Lost in US capital market

 

Two bad oversea investments by China Investment Corporation (CIC) had marked the lost that the Chinese sovereign wealth fund had suffered from the economy crisis: an approximate lost of USD 2.0 by CIC in the investment in the Blackstone Group and the other oversea investment that also attract wide critics belongs to the investment in the United States investment bank Morgan Stanley according the close stock price of USD 24.68 on 1st November 2010 compared to USD 48-57.68 per share forcing a loss of more than USD 1.7 billion out of its 6.8 billion investment (Secretchina 2010). Even though other qualified large state owned or private corporation and approved financial institutions also suffered billions of loss directly from the economy crisis but such scale of loss seems to be very mild to the Chinese economy by taking into consideration another simple fact the GDP of China had reached US$4.4216 trillion in 2008 (China.org.cn 2009), the year the economy crisis spread in a world wide scale. What’s more the lost in the direct investment in the oversea capital market being very limited thanks a lot to its control over activities in oversea capital as theoretically speaking cross-border capital could only flow out of China via FDI (Foreign Direct Investment), officially approved foreign borrowing, foreign institutional investors (Youngding 2010).

 

3.2    Indirect impact of the crisis in Chinese economy

 

3.2.1            Economy slow down

Three major indicator have demonstrated how the growth of the Chinese economy had been slowed down due to the economy crisis: GDP growth rate, trade and FDI and number of work created. A double digit GDP growth is more like a task that need to be achieved by the Chinese government especially forced by the currently undergoing fast urbanization, and China just cannot stop or even slow down in this fast growing mode. And it’s believed that a less than 8% GDP year on year growth could lead to social unrest in China with the large number of new job seekers, around 20 million every year (Xinhuanet.com 2008). As illustrated in the chart below and complied with the data that the fourth quarter GDP growth in 2008 was only 6.8% on a year-on-year basis and the first quarter in 2009 even recorded the lowest growth rate of 6.1% which was reportedly the slowest quarter growth rate in 10 years (National Bureau of Statistics of China 2009).

 

Chart 2.0 Decelerated GDP growth (Source: Tradingeconomics.com 2010)

 

Chart 3.0 Chinese export of services and products (Tradingeconomics.com 2010)

 

The deceleration in the GDP growth was largely contributed by the decline of export due to weakening demand from the US and European markets as according to world bank data in 2007 the export value reach a USD 1.22 trillion accounting for 37% of Gross Domestic Product (GDP) that year (World bank 2008). And when demand for Chinese product declined in a sudden due to the economy crisis the export oriented economy mode would definitely force the domestic economy to slow down. Then with the unpromising future, there were wide spread phenomenon of the closure of many factories that were surviving depending on the oversea orders, a delayed and high employment rate seems to be expected with reasons as shown in the chart below.

 

Chart 4.0 Chinese unemployment rate during economy crisis

 

3.2.2            Balance of payment fluctuations

 

Chart 5.0 Error and omission in balance of payment during 2005-2008

Source: State administration of foreign exchange

There were a significant of fluctuations of balance of payment in China at the beginning of the economy crisis due to the frequent inflow and outflow of international hot money as indicated by the digit of errors and omissions in the current as the chart above demonstrates. Such flow of international hot money with the purpose of seeking harbor of safety or seeking opportunity back in the developed market had posed significant risks for the Chinese government to stabilize the CNY exchange rate and control the bubbles in the property market (Yu 2008).

3.2.3            Forced appreciation of Chinese currency

 

Chart 6.0 Exchange rate of CNY against major currencies (Finance.google.com 2010)

 

Chart 7.0 Exchange rate of USD against major currencies (Finance.google.com 2010))

 

As the chart above shows, with the continual depreciation of the US dollar, the Chinese Yuan was forced to appreciate against the USD but depreciate against some other currencies such as European currency, such forced appreciation of the currency on one hand brought direct lost to the large foreign reserve and in the end of 2008 China was still keeping a record high 1.946 trillion USD foreign exchange reserve (State Administration of Foreign Exchange 2009) which is still growing today and has exceeded 2.4 trillion this year; on the other hand the more critical problem caused by the forced appreciation of Yuan against USD would be the lost of low cost advantages in the foreign trade especially with the United States.

 

4.        Response and impact

 

4.1    Policy response to cope with the economy downturn

 

4.1.1            Fiscal policy

 

In November 2008 when the damage of the US triggered worldwide economy crisis was felt by strongly by the Chinese business men and common people, Chinese government released its own expansionary fiscal policy, a RMB 4 trillion (USD 580 billion) stimulus package aiming at easing the economy slow down domestically. This package of money will be used over the coming two years in 10 major areas as shown in the figure table below.

 

Building affordable and low-rent housing280
Rural infrastructure and increasing rural incomes370
Transportation infrastructure construction1800
Health and education40
Environment protection350
Enhancing innovation and industrial restructuring160
Disaster rebuilding1000
Total4000

Table 1.0 Configuration of the RMB 4 trillion stimulus package (billion CNY)

Source: National Development and Reform Commission

 

Looking at the configuration of this huge stimulus package, nearly half of the fiscal budget will be invested in the infrastructure construction which is traditionally the area where the government used to invest in. And a quarter of the 4 trillion Yuan will be poured into the rebuilding of the Sichuan where the disastrous earthquake happened. The large scale of infrastructure directly encouraged by this package will help increase the demand of steel to ease the fast drop from the export side as China had emerged as the largest exporter of steel in 2006. Beside the large scale of direct expenditure of the government, the stimulus package also covered tax reductions to benefit the business sector by policies such as purchase tax reduction and raising threshold of individual income taxes to stimulate domestic consumption. And it is believed that the implementation of this stimulus package could increase the GDP growth by 1 percent in next two years.

 

 

4.1.2            Loose monetary policy

 

In September 2008, announcement had been made by the People’s Bank of China, the central bank of China, regarding the shift of monetary policy from a five year long tightening one to a loose one to “solve prominent problems in the current economic operation…and ensure a steady, rapid and sustained economy development” (Nytimes.com 2008). Three major tactics were used to achieve the goal of a loose monetary policy. The first tool tactics was to increase the money supply to provide with enough of credit in a downturn economy environment. In January of 2009, the central bank reconfirm its moderately easy monetary policy in 2009 by setting the goal of offering a 17 percent growth in the broad money supply targeting in provide sufficient resources in the capital market though there was not severe credit crunch like what happened in the United States but the increase of the liquidity was to help the stock market and property market out of the difficulties faced at that time.

 

Chart 8.0 Historical interest rate in China from 2007 to 2009 (Tradingeconomics.com 2010)

 

The second tactic that the central bank used to enforce a loose monetary policy was through lowering interest rate. As illustrated in the chart above, the interest rate had been reduced from 7.47%, the benchmark interest rate in 2008, to as low as 5.31% in January in 2009 and had been maintained throughout the year. The previous tactic to increase the broad money supply only provide sufficient resources in the capital market and the low interest rate could reduce the cost of companies’ financing and thus increase the profit margins. The third tactics which was easing bank lending restriction also focused on the easing the financing difficulties in the capital market. In addition to increasing money supply quantity and lowering interest rate, by further removing the lending restriction the loose monetary policy was accessible and applicable to a wide range of business making the monetary policy more effective.

 

4.1.3            Supply-side policies

 

Supply-side policies refer to majorly macroeconomic policies designed to increase the supply-side potential of an economy in term of quantity and quality of goods and services by lowering barriers for to business activities to contribute to faster rate of economic growth.

 

Structural policy of tax cuts

 

Structural policy of tax cuts according to Premier Wen Jiabao refers selective tax reduction on the special taxes and particular industries. For example, reform on the value added tax was started in 2009 which included tax reduction policy that allowed purchasing value added tax in some industries to be offset to encourage the update of old manufacturing equipments but a company could not enjoy such tax reduction if it had no plan on purchasing new equipment. Other tax reduction also cover raising threshold of individual tax and export tax rebates. And according to the Xie Xuren, the minister of finance, the structural policy of tax cuts would reached RMB 550 billion in 2009 to effectively reduce the tax burden of the business and increase the capital investment and encourage technology innovation (Fdi.gov.cn 2009). This structural policy of tax cuts was focusing on reducing the tax burden and encouraging capital spending by companies that could add to the aggregate demand in the market.

Increased education and training

 

There was no doubt that education would be an important area that would benefit from the economy stimulus package as it had always been, particularity in the rural education. The increasing investment in education theoretically will improve the labor productivity and increase the AS as shown in the figure below. But another contradictive fact that millions of fresh graduates with high education are still looking for a simple decent job seems to just postpone the unemployment rate to the near future and thus post a discount on the effectiveness of the strategy of increasing education and training.

 

Figure 1.0 Benefit of supply side policies

 

Improving Transport and infrastructure

 

Looking back on the 4 trillion Yuan stimulus package, more than a half of the package fund will be invested in the construction of infrastructure and transportation especially in the rural areas. According to the data issued by Ministry of Railways the investment on the railway construction in 2008 had reached RMB 600 billion with a 77.9% year on year growth compared to that of 2008 (Mor.gov.cn 2010). Investment in the transportation is likely to reduce the cost and contributing to a higher efficiency of transportation thus lower the cost of the firms.

4.1.4            Trade policies

 

Two major directions marked the trading policies that the government used to tackle the slowing demand from the major developed that suffered from the economic crisis and increasing protectionism from these countries. The first direction was the export tax rebate to offset the forced appreciation of Chinese currency and keep the export product maintaining in a low cost. In June 2009, the Ministry of Finance and the State Administration of Taxation had approved the raise on export tax rebates on the selected products majoring in labor intensive, high-tech and high value-added products covering 3,486 types in detail (Peopledaily.com.cn 2008). Two kind of products attract a lot of notice belonged to the textile product and some iron and steel products. The export tax rebate rate of the garment and textile product had been raised three time in a years to 15% and a nice percent tax rebate will be applied to the steel products to stimulate the export. The second direction belonged to the defense policy against the protectionist policies adopted by some trade partner. In the beginning of 2009, there had been frequent trade investigations against Chinese products from EU, the United States, and some developing countries also. In return besides active participation in resolving the trade investigations under the established bilateral trade remedy cooperation mechanisms under the WTO framework, China also fight back using trade weapons. Later in June 2009, China initiated the anti-dumping (AD) and countervailing (CVD) investigations against the sedans and sport utility vehicles of cylinder capacity more than 2000cc imported from the United States.

 

4.2    Impact of the government policy

 

 

 

 

 

4.2.1            GDP rebound

 

Chart 9.0 GDP growth rate rebound in 2010 (Tradingeconomics.com 2010)

Source: Tradingeconomics.com

 

As stated in the chart above after touching the bottom in the quarter of 2009, the Gross Domestic Product (GDP) growth rate has rebounded strongly back to a double digit growth trend. According to the most recent data, the third quarter GDP growth maintains 9.6% declining from 10.6.% in the first half year. With the strong rebound back to the high growth track, the world bank has raised the GDP growth forecast of China for year 2010 to 10% (Worldbank.org 2010). But analysis from the some economists also pointed out that the slowing GDP growth in the third quarter had shown that the positive impact of the large scale stimulus package and monetary stance is being normalized with the sign of deceleration in the growth of investment, import (Chart 10.0) and domestic consumption. And the most important driving forces to the growth of GDP still lies in the dramatic export growth (Chart 11.0) which means that the economy growth mode has no change, it is still an export oriented growth mode.

 

Chart 10.0 Import of China by month (billion USD) (Tradingeconomics.com 2010)

 

Chart 11.0 Export of China by month (billion USD) (Tradingeconomics.com 2010)

 

So it is still a worrying dilemma that Chinese economy depends too much on the export and inward investment. As Louis Kuijs was quoted in a new conference recently, “Coming from this very strong growth that we have seen recently, China should be able to ease gently into a more sustainable rate of growth in 2011 and the medium term” (France24.com 2010) while at the same time the world bank actually updated its prediction of Chinese GDP growth to 9.6% in 2011, conclusion could be made based on the analysis above that in the next few years the Chinese GDP growth trend and growth mode will be sustainable despite the widely believed increasing trade imbalance rising.

 

4.2.2            Employment

Chart 12.0 Historical unemployment rate trend (Tradingeconomics.com 2010)

 

In term of employment as show in the chart above and complied by the fact that the unemployment rate stood at 4.2 percent in the second quarter and then drop by 0.1% further to 4.1% with 9.05 million urbanites registered as unemployed quoted by an official from the Ministry of Human Resources and Social Security (Chinadaily.com 2010). Based on the data above and the original target of keeping the unemployment rate below 4.6% set by the Chinese government in the end of 2009 and compared 9.6%  (Chart 13.0) US unemployment in September, speaking in paper the Chinese government had did such a good job in containing employment rate by creating new jobs.

 

Chart 13.0 US unemployment rate (Tradingeconomics.com 2010)

But consider this calculated by 9.05 million (4.1%) unemployed urban workers, the urban labor force will total 220.73 million but the population of China has more than 1.325 billion in 2008 according to the data released by World Bank, the government is not only in the position to solve this 9.05 million employment rate in the urban areas, but the more critical problem comes from the current trend of urbanization with hundreds of millions of migrant workers and fresh graduates who are eager to find their jobs in the major big cities in China such as Beijing, Shanghai, Guangzhou and Shenzhen forcing the fast growth in total labor volume. So this also one of the fundamental reasons why the Chinese economy could not afford a slowdown in its growth (Businessinsider.com 2010).

 

4.2.3            Consumer Price Index (CPI) and Inflation

 

 

Table 2.0 Consumer Price Index (CPI) by Category (2010.08)

Source: National Bureau of Statistics of China

 

Chart 14.0 Inflation rate in China (Tradingeconomics.com 2010)

 

As illustrated in the table above, the Consumer Price Index (CPI) in total in August increase by 3.5%. And this digit even later raised to a 23 month high 3.6% attracting a 4% growth predictions for the whole year by the market and it is also supported by a lot of research institutions, but the official view did not agree. According to Yao Jing Yuan, the Chief Economist of the Bureau of Statistics, predicted that the annual CPI growth would not exceed 3.5% for three major factors. The first factor is the M2 supply growth which for 2010 is about 19%, much lower than that in 1993 which was 37%; the second factor is the grain out would reach a record high 500 billion kilogram much more than that of 1994 which was 445 billion kilogram, the year the inflation was severe; the third factor is the fix asset investment growth rate is expected to be 24% which is still lower than that in 1993 which was 61% (Chinanews.com.cn 2010). What’s more the lower level of growth is also witnessed in the inflation rate which support the Mr Yao’s analysis. Though in total according what has been demonstrated above together with Mr Yao’s optimistic prediction it seems that the CPI growth is still under control and possible severe inflation has been contained well, but life for ordinary people is not easy since the raise of food price is the highest among the eight categories and situation become worse due to the fast growing global price in edible oil and grain and so the high CPI directly force a significant raise in the cost of life in China.

5.        Economy performance of China for the last ten years

 

Chart 15 China GDP growth rate since January 2001 (Tradingeconomics.com 2010)

 

For the last ten years term from 2000 to present, China has kept an average 9.55% growth rate in GDP in its economy making it surpass Japan to be the second largest economy in term of GDP in the middle of this year (Nytimes.com 2010). And theoretically speaking if an approximate 10 percent GDP growth could be maintain then China could catch with the United States as early as 2030 by nominal GDP. And according to Abby Cohen, the president of the Goldman Sachs Global Markets Institute and Senior Investment Strategist, during last ten years (2000 to 2009) China contributed more than 20 percent to the global GDP growth which is slightly more than that of the United Stated (Usstock.tk 2010). Though there are still many problem that exist in the economy of China due to a fast export oriented growth, and also there are many dubious voices regarding whether such growth mode is sustainable or not, but looking back on the last 10 years based on the major economic indicators China had done a good job to contribute to the global economic development.

 

 

 

 

 

6.        Recommendations

 

6.1    Control over high property price

 

For one who spend more than 20 years in China witnessing the dramatic economy growth and the raise of China as a powerful rivalry in the global economic and political arena, I have always been proud to see the double digit GDP growth but I dare to say people’s life does not become easier while the economy develops. One of the most fundamental reasons why little improvement has been made to people is due to the sky high property price that grows much faster than the GDP growth and such growth has not been properly showed in any publicized documents. So the first recommendation that I will suggest is to contain the high property price. It’s well known that in a perfect competitive market price is set by the demand and supply curves but the problem in the property market of China is that the market has been controlled by the major real estate developers who store up the land and houses and sell them in high prices. Some governments are even willing to see high property price since it will contribute to the GDP growth which is a mission to any governments. In the perspective of ordinary people or in an economy angel the Chinese government should contain the high property prices which could lead to the economic crisis like what has happen in the United States. Actually the government could build more affordable houses to bring more competitions to the market and thus lower the high prices.

 

6.2    More effort on education and health care system construction

 

The second suggestion has close relationship with the first recommendation about containing the sky high prices in the property market, people outside China especially in the western developed countries could not understand why Chinese people tend to work so hard but save the majority in the deposit account even though interest rate has been reduced so many time they just would not cash out the money and spend in cloths and toys which bring a lot of happiness in many ones’ eye but please remember the Maslow’s layer need chart if the basic needs have not been satisfied the higher incentives just would not function. In China, people save money just for the very basic need. People would not limit the spending in three major areas: housing, education and health care. As just mentioned buying a house could simply cause a middle class family’s whole deposit of more than 20 years and education is people’s hope for the future especially in the traditional culture which they would not give up and the health care could also cost any penny of a family if any member of the family get ill and could not afford the medical charges, and the imperfect health care system just could not make people rest assured. So it is reasonable that people would save most their money for the safety’s sake. Any policy to stimulate the domestic need could not take effect if people’ concern about the house, education and health care have not been addressed.

 

 

Reference

 

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Youngding, Y. 2010, The impact of the global financial crisis on the Chinese Economy and China’s Policy Responses, Third World Network, Penang

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