TV interview with me on China CCTV News about Chinese Prime Minister's visit to the UK - particular focus on internationalisation of RMB http://english.cntv.cn/2014/06/20/VIDE1403256725540259.shtml
TV interview with me on China CCTV News about Chinese Prime Minister's visit to the UK - particular focus on internationalisation of RMB http://english.cntv.cn/2014/06/20/VIDE1403256725540259.shtml
RMB internationalization is one of the most important questions for China’s economy. But it is also one where developments will go more slowly than media speculation imagines, due to the real factors affecting it.
An exaggerated picture on RMB internationalization is presented when percentage growth figures are used as these are calculated starting from very low levels. For example, the proportion of RMB payments carried out in the United States in April 2014 rose by 100 percent compared to a year earlier, which sounds spectacular – except that the rise was only to 0.04 percent of all worldwide currency transactions. In April 2014 the RMB accounted for only 1.4 percent of international payments.
Taking China’s strongest area internationally, by the end of 2013, 8.7 percent of world trade was RMB denominated, but around 80 percent of this was with Hong Kong. The dollar’s global share was 81 percent. The European Central Bank states that by the second quarter of 2013 only 0.3 percent of international bonds were in RMB. By the beginning of 2014, 60 percent of foreign exchange reserves were in dollars, 25 percent in Euros and only 0.01 percent in RMB.
These numbers are so low that there is room for huge percentage increases, yielding profitable business for individual financial institutions, without the RMB’s peripheral position in global finance altering.
Beyond these extremely low numbers, there are fundamental structural reasons why the RMB will not play a central role in global finance in any near time frame, and the dollar will remain dominant for a prolonged period.
Only two global currency systems have existed in the last 300 years. In 1717 the pound was linked to gold, establishing the international gold standard. This system lasted for 200 years – its collapse can be taken as either 1914, when it was temporarily suspended, or 1931 when the pound formally broke its previous parity with gold. The second global system, a de facto dollar standard, has lasted for almost seven decades since 1945. The interregnum between the two, 1931-45, accompanied the most catastrophic crisis in world economic history.
There is therefore a prolonged lag between the economic rise and fall of states and changes in international monetary systems. The UK fell behind the United States as the world’s largest market economy in the 1870s, but Britain maintained global monetary dominance for half a century. There was a seventy year lag between the United States, becoming the world’s largest economy and the dollar becoming the dominant international currency.
This extreme “rigidity” in international payments structures flows from the fundamental character of a market system. An efficient market can only operate if there is a single measure of prices – if there were different prices in different parts of the market uncontrollable arbitrage and/or fragmentation would destroy it. Gold provided a single measure for international markets, then the dollar did. The only period in which there was no single price measure, 1931-45, could only exist because the world economy was disastrously fragmented – and the accompanying results, the Great Depression and World War II, were catastrophic.
A necessary consequence of the existence of only a single price standard is that, to allow its functioning, substantial international holdings of whatever is the price unit must exist – large gold holdings under the gold standard, and large dollar holdings under the dollar standard. The scale of these reserves then becomes a powerful factor maintaining the dominance of that monetary unit.
This is why periodic predictions, ignoring economic fundamentals, that the dollar is about to be replaced or challenged by some other unit invariably turn out to be false. For example, the prediction was made that the Euro could replace the dollar. The reality, as the statistics show, is that the dollar continues to dominate international payments.
What are the consequences of these fundamental economic realities for RMB internationalization? The RMB can certainly become a minor international currency, but it cannot challenge the dollar’s dominance. That could only occur if the “dollar system,” as a global price unit, were replaced by an “RMB system” – which would require a revolution in the global economy, and is unrealistic in the coming period.
This, in turn, has major consequences for any liberalization of China’s capital account. As it is impossible, for a prolonged period, to replace the dollar as the dominant international currency, and therefore the dollar remains the dominant unit people wish to hold, the inevitable result of global capital account liberalization since the 1970s was not a multilateral flow between currencies but merely a net inflow into dollars. This strengthened the dollar’s international position, allowing the U.S. to finance its huge balance of payments deficits.
Countries which ignored these economic fundamentals, and mistakenly believed international capital account liberalization was a multilateral system, rather than one to allow funds to flow into dollars, were hit by economic crisis. For example, South East Asian countries, which had mistakenly imagined that they could benefit from capital account liberalization, were taught a devastating lesson in the crisis of 1997 that the only large scale net flows which the global payments system permits are into the dollar.
This current international monetary system is certainly unjust. Gold was produced internationally, therefore could not be controlled by a single country, and was a multilateral unit against which all currencies were measured. In contrast the “dollar standard” means one country’s currency is the unit in which all others are measured, giving the United States a type of “monetary monopoly” – with many consequent advantages in the international monetary system. But there is nothing that can be done about this until another unit can replace the dollar as setting international prices. Until then international crises, even those originating in the United States, as in 2008, do not weaken the dollar’s position. As Eswar Prasad comprehensively documented in The Dollar Trap: “Global financial crisis has strengthened the dollar’s prominence in global finance.”
Because the inevitable factual content of the international monetary system is to allow flows into the dollar, capital account liberalization, which would be required for full internationalization of the RMB, has become an extremely destabilizing economic force. Joseph Stilitz, Nobel Prize winner in economics, concluded, reviewing the history of financial crises:
“Capital account liberalization was the single most important factor leading to the crisis. I have come to this conclusion not just by carefully looking at what happened in the [Asian] region, but by looking at what happened in the almost one hundred other economic crises of the last quarter century… capital account liberalization represents risk without a reward.”
“Risk without reward” is a necessary consequence of the structure of the international monetary system, and capital account liberalization, as simply creating a flow into dollars. Large scale RMB “internationalization,” which would require liberalization of China’s capital account, would therefore lead to a large outflow of China’s capital into the United States and dollar assets to the detriment of investment in China. For this reason, as leading Chinese economist Yu Yongding put it:
“China has to maintain its capital controls in the foreseeable future. If China were to lose control over its cross-border capital flows it could lead to panic and so capital outflows would turn into an avalanche and eventually bring down the whole financial system.”
China therefore can, undoubtedly, develop limited RMB internationalization within a global monetary system continuing to be dominated by the dollar – particularly for trade. But any idea that the RMB can challenge the dollar’s position, or escape the dangers of liberalization of the capital account, is an illusion and at worst could seriously damage China’s economy.
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This article originally appeared at China.org.cn.
This chart shows the dominant long term trend in the US economy - gradual deceleration. A 20 year moving average is used to eliminate all cyclical or short term trends. The deceleration from 4.4% in 1969, to 4.1% in 1978, to 3.5% in 2002, to 2.5% in the first quarter of 2014 is clear. The temporary recovery in the late 1990s and beginning of the 21st century proved unsustainable and was followed by a sharper fall.
This trend shows that the most enduring feature of the US economy, which must be explained by any analysis, is not any analyses of business cycles, particularly those of a 'manic-depressive' type, but this very long term slowdown of the US economy.
Furthermore, as this deceleration has been going on for 40 years, it clearly has extremely deep roots which are very difficult to reverse. Unless dramatic changes in US economic policy take place, therefore slow deceleration should be built into projections for the US economy.
China is by now strong enough to deal with any external threat to its development. Only major internal errors can block its progress. One well known such threat is any attempt to return to an administered, as opposed to a ‘socialist market’, economy. However negative financial events – increases in interbank lending rates, falls in share prices, much higher bond yields than in other major economies, falls in manufacturing and service sector PMIs - highlight another danger, that of ‘market romanticism’ as opposed to ‘market realism’. This consists of verbally adhering to a ‘market economy’ but in fact not understanding what a market economy is. Put formally, market romanticism is simply the economics of neo-liberalism.
Various negative trends which have shown themselves in China’s economy in the immediate last period in reality have a clear and simple market origin. As shown in the chart China’s total savings rate has significantly fallen from 53.2% of GDP in 2009 to 51.4% of GDP in 2012 – it is important to note that total savings are not only those of households but also company savings and the ‘negative savings’ of the government budget deficit. Total savings data is not yet published for 2013 but there is no indirect data, in particular for company profits, showing a major recovery in savings rates.
This decline in China’s savings rate has as consequences rising interest rates, a decline in investment, and therefore economic slowdown – tendencies at present expressing themselves.
Interest rates are the price of capital and express the balance between capital supply (savings) and demand for capital (investment). As savings rates have significantly fallen one of two things must occur – or both. Either interest rates must rise, as the supply of capital has fallen relative to demand, or investment, the demand for capital, must decline.
As frequently occurs, both trends are taking place in China. Demand for capital, that is investment, is slowing – a trend augmented by rising interest rates. Taking a three year moving average, to eliminate effects of purely short term fluctuations, the chart below shows that by 2012 the real inflation adjusted growth rate of China’s fixed investment fell to the lowest since 2001 at 9.9%.
Inflation adjusted data for investment in 2013 is not yet published, but current price data shows the annual increase in fixed asset investment fell from 21.2% in January 2013 to only 19.9% in the latest available data. As there has been no corresponding fall in inflation it is almost certain that the real rate of increase of fixed investment fell further in 2013.
Simultaneously with falling investment China’s interest rates have risen. This was partially disguised in 2012 as inflation was declining – therefore real interest rates could rise without the headline grabbing nominal rate increasing. But as China’s inflation ceased falling in 2013 nominal rates began to rise significantly.
The result is that not only have China’s interest rates risen in absolute terms, as shown in both bond and interbank lending markets, but they have particularly risen relative to the global benchmark US rates – US savings levels, in contrast to China, have been rising for the last four years. At the beginning of 2008 the yield on China’s 10 year government bond yields was only 0.5% higher than the US, whereas by the 2nd week in January 2014 it was 1.9% higher. The sharp spikes in interbank interest rates last summer, and again late last year, were manifestations of the same process of rising interest rates.
With China’s growth rates falling, and interest rates rising, the recent fall in the share market was logical.
A slowing rate of investment and rising interest rates necessarily produces slows economic growth and therefore more slowly rising living standards – as the rate of increase of GDP is overwhelmingly the most important source of rising consumption. China’s GDP growth fell from 9.3% in 2011 to 7.7% in 2012, and its growth rate of consumption fell in parallel from 10.7% to 8.4%. Again inflation adjusted data for 2013 is not yet available, but without adjusting for inflation the rate of increase of retail sales fell from 14.9% in November 2012 to 13.7% in the same month in 2013. As in the same period the rate of increase of the CPI rose from 2.0% to 3.0% almost certainly the growth rate of consumption was falling.
These problems were accurately predicted in advance. A falling savings rate is merely another way of saying that the percentage of consumption in the economy is rising – that is ‘consumption led growth’ is occurring. But predictably such a rise in the percentage of consumption in the economy is making the situation worse not better.
Understanding how a market economy works equally shows the only way to strategically overcome these problems. That as a country becomes more economically advanced capital investment plays a larger role in its growth is both confirmed by modern econometrics and predicted by the great economists from Adam Smith onwards – in an advanced economy investment’s role is six times as important as productivity increases in economic growth, with 57% of growth coming from investment, and only 9% from productivity improvements. But without foreign borrowing investment requires exactly equivalent domestic saving.
The only strategic way to deal with present economic problems is therefore to raise the savings rate again –which will simultaneously allow a faster growth rate of investment and, by increasing the supply of capital, allow interest rates to fall, thereby lessening problems in the interbank and bond markets. As the largest contributor to savings comes from companies, this therefore requires increasing company profitability and limiting the diversion of company profits to consumption (via excessive dividend payment or other means).
The factual arithmetic of a market economy therefore requires understands that maintaining a high level of savings and investment is the single biggest challenging facing China’s development and all policies, including in finance, must therefore be aimed at sustaining it.
‘Market romanticism’, because it does not understand the facts of a market economy, wrongly believes productivity increases, achieved via tinkering with markets, can compensate for a fall in China’s savings and investment rates. It is ‘penny wise and pound foolish’ - concentrating on hoped for efficiency improvements which even if they were successful could not compensate for falls in savings and investment.
‘Market realism’ and ‘market romanticism’ are therefore clashing in the present economic situation in China. ‘Market realism’ concentrates on the key fact of the necessity to maintain the high savings and investment rates – increased market efficiency is useful but cannot compensate for problems in these more fundamental economic factors. ‘Market romanticism’ wrongly believes that increased efficiency in markets can compensate for declines in the savings rate or even advocates policies which would reduce the savings level further.
But as is said in the West ‘facts are stubborn things.’ Carrying out policies of ‘market romanticism’ necessarily produces financial and economic problems.
Developing a ‘socialist market economy’ is the way forward for China, and return to an administered economy would be disastrous. But as recent negative financial trends confirm it is necessary to reject the myths of ‘market romanticism’ to develop such an economy.
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An edited version of this article appeared originally in Chinese in a series of discussion articles on the market economy on Sina Finance.
The announcement of the relaxation of China's one child policy created great discussion in China and internationally. But its significance was widely misunderstood. Contrary to myth, the increase in China's labor supply plays little role in China's rapid economic growth. In reality, 96 percent of China's economic growth comes from factors other than a rising labour supply. Therefore, there is no reason why China's economy should slow significantly because China's working age population stopped growing in 2012. The mistaken view, sometimes expressed, that China will grow old before it becomes rich is therefore the reverse of the reality: China will grow rich before it grows old. To demonstrate clearly why, first the facts will be stated and then their implications analysed.
A worker of a company processes galvanized products in Qingdao, east China's Shandong Province,[Xinhua/Yu Fangping]
Even an elementary back of an envelope calculation shows why increases in China's working age population have made only a relatively small contribution to China's economic growth. Indeed, this is so immediately clear it is somewhat of a puzzle that the myth ever existed in some quarters that China's growth depended essentially on increases in labor and therefore China's economic growth faces a serious "demographic challenge" due to the end of the increase in the working age population.
From the beginning of reform in 1978 up to 2012, the average annual increase in China's population aged 15-64, the international definition of working age, was 1.7 percent. Over the same period the annual average increase in China's GDP was 10.2 percent -- almost six times as fast. The increase in China's working age population was therefore only 17 percent of the rate of increase of China's GDP -- showing clearly that the rate of growth of population could not possibly explain, or be the main reason for, China's rapid economic growth.
Looking at the trends in more detail shows still more clearly that population trends did not determine China's economic trajectory. Taking five year moving averages for changes in working age population and GDP, to remove the effects of short term fluctuations, China's average annual growth rate of working age population was 2.8 percent in 1983, five years after the beginning of reform. By 2000 this had fallen to 1.6 percent, and by 2012 it was only 0.6 percent. The growth rate of China's working age population was therefore consistently falling.
But China's GDP growth showed the exact opposite trend. Annual average GDP growth rate was 8.1 percent in 1983, 8.6 percent by 2000, and 9.3 percent by 2012. Therefore while the growth rate of China's population was falling its economy was accelerating! This shows clearly changes in China's labor supply were not the prime cause of its economic growth.
Making exact calculations shows the situation even more graphically. It might be naively imagined that as China's working age population grew at 17 percent of the rate of its GDP increase therefore increases in labour accounted for 17 percent, which is under one fifth, of the increase in China's economic growth. This contribution would already seem surprisingly small for those who believe increases in working age population was a major factor in China's economic development, that China's growth rate must therefore now necessarily fall sharply, and China will "grow old before it grows rich." But in reality even 17 percent is a great exaggeration of how much increase in the labor supply contributed to China's growth.
The reason for this is that the increase in the amount of time actually worked grows more slowly than the increase in the working age population. This is because the period of time spent in education rather than work tends to increase, vacations tend to get longer reducing the number of days worked, and other factors.
To show the effect of this, the chart shows the sources of China's GDP growth in 1990-2010 -- the latter being to the latest date for which international comparisons are available. As can be seen, 64 percent of China's growth was due to investment increases, 30 percent to increases in productivity, and only 6 percent to increases in labor. China's rapid economic growth was therefore overwhelmingly driven by increases in investment and increases in productivity with increases in the labour supply playing only an extremely small role. Given its growth rate, eliminating the entire increase in labor into China's economy would have taken only half a percent from China's GDP growth.
But even that 6 percent number slightly exaggerates the role of increases in labor supply in China's economic growth! Increase in labor contribution to economic growth take place due to two processes. The first is a rise in the number of hours worked as the workforce gets bigger (the increase in labor quantity). The second is the improvement in skills and education -- a skilled worker creates more value than an unskilled one (the increase in labor quality).
The increase in China's labor quality is 2 percent per year, in line with the average for developing countries. This has a modest scope to increase with higher expenditure on education and skills -- the average increase in labor quality in a developed economy is 3 percent a year. Only 4 percent of China's GDP growth comes from increases in the quantity of labor, which are affected by demographics.
In short, increases in China's labor supply, due to expansion of the working age population, accounted for only 4 percent of China's total GDP growth -- less than half a percentage point of annual GDP growth!
Claims by those such as that by Financial Times writer David Pilling that "the song of China's miracle has a three-word refrain: Just add people" are therefore absolute nonsense. Only 4 percent of China's growth came from "adding people" and 96 percent came from factors other than "adding people!"
This does not mean no economic problems are created by China's aging population. But these come from a completely different route than shortage of labor. The real economic difficulty China faces with regard to population is that people in work can save, while those not working, because they are too young or too old, generally do not save. The decline of the percentage of China's population in work therefore tends to lower China's household savings rate. As investment necessarily has to be financed by savings, this puts downward pressure on China's investment rate, and as investment is the main source of economic growth not only in China but in most economies this could lower China's economic growth. While the decline in China's working age population does not pose a risk of significant economic slowdown due to lack of labor, it could cause a problem due to fall in savings.
But fortunately households are only one of three sources of savings. Of the other two, government savings are small in almost all countries, and usually negative. But company profits are the biggest source of saving in China. If savings via company profits were to increase, this can compensate for any decline in household savings due to the fall in the percentage of the population which is working.
Maintaining high growth in China therefore depends more on maintaining company profitability than it does on population. A decline in company profitability is a much more serious threat to China's growth than any demographic factor. A rise in company profitability, through its effect in raising company savings, would be a far more powerful factor in maintaining China's economic growth than relaxing the one child policy.
In summary, the claim that China faces a significant slowing of its economy due to population factors, and therefore China will "grow old before it grows rich," is a typical example of myths created by engaging in woolly rhetoric without using numbers. Increases in labor supply play such a small role in China's economic growth that the end of the rise in the working age population will have only a very small effect in reducing China's growth rate. It is what happens to China's productivity, and above all its investment, that overwhelmingly will determine its economic growth and therefore its prosperity. Provided the correct policies are pursued, China will certainly become rich before it becomes old.
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In 2010 Professor Danny Quah, of the London School of Economics, noted: 'In the last 3 decades, China alone has lifted more people out of extreme poverty than the rest of the world combined. Indeed, China’s ($1/day) poverty reduction of 627 million from 1981 to 2005 exceeds the total global economy’s decline in its extremely poor from 1.9 billion to 1.4 billion over the same period.' The aim of this article is to analyse the situation taking data published three years after Quah's analysis; look at the trends not only of extreme poverty, which the World Bank calculates using expenditure of $1.25 a day or less; examine a slightly wider poverty definition ($2 a day expenditure), and compare the trends in other regions of the world economy.
The conclusion is simple. Quah's conclusion still holds. China is responsible for 100% of the reduction in the number of people living in poverty in the world. This finding is the necessary backdrop to any serious and informed discussion of the role of China in the world economy and its contribution to human rights.
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There are many remarkable economic statistics about China.
Nevertheless, impressive as such statistics are, from the point of view of human welfare it is another number which dwarfs all others: the contribution of China to the reduction of human poverty not only within its own borders but in its impact on the world. The astonishing fact remains that China has been responsible for the entire reduction in the number of people living in absolute poverty in the world!
To show this the table below gives the number of those in China and the world living on expenditure less than the two standard measures used by the World Bank to measure poverty. These are the criteria for extreme poverty, expenditure of less than $1.25 a day ($37.5 a month) and those living in poverty – expenditure of $2 day ($60 a month). Charts showing the trends are at the end of the article.
In 1981, on World Bank data 972 million people in China were living on an expenditure of less than $37.50 a month. By 2008 this had been reduced to 173 million, by 2009 it fell to 157 million. Consequently 662 million people were lifted out of extreme poverty in China in the twenty seven years up to 2008 and 678 million by 2009.
In contrast the number of people living in such extreme poverty outside China increased by 50 million between 1981 and 2008 – the number of people emerging from poverty was less than the population increase. This was due to the rise in the numbe of people living in extreme poverty in sub-Saharan Africa. China was consequently responsible for 100% of the world’s reduction of the number of people living in extreme poverty.
Analysing those living on $2 a day ($60 a month), still a very low figure, the trend was even more striking. The number of people in China living on an expenditure of this figure or less fell from 972 million in 1981, to 395 million in 2008, to 362 million in 2009. The number living on expenditure of $60 a month or less in China fell by 577 million by 2008, and by 610 million by 2009.
In contrast the number of those living at this level of poverty in the world outside China rose from 1,548 million in 1981 to 2,057 million in 2008 – an increase of 509 million. Again, China accounted for the entire reduction in the number of people in the world living at this level of poverty.
It is therefore almost impossible to exaggerate what a contribution not only to its own people but to the welfare of the whole of humanity China’s economic progress has made. Without China there would have been literally no reduction in the number of world’s people living in poverty.
The gigantic impact of this on human well-being is not only in its direct effect on personal income and expenditures. It is also in its indirect consequences for human welfare. To take simple examples
The direct and indirect effect of bringing people out of poverty is also the greatest contribution that can be made to human rights, The reality is that China’s bringing over 600 million out of poverty means no other country in the world remotely matches China’s contribution to human wellbeing and real human rights.
Quah, D. (2010, May). 'The Shifting Distribution of Global Economic Activity'.Retrieved January 2, 2012, from London School of Economics: econ.lse.ac.uk/~dquah/p/2010.05-Shifting_Distribution_GEA-DQ.pdf
China has the world’s fastest growth of consumption while its population lives significantly longer than would be expected from China’s level of economic development. These facts clearly establish China has easily the world’s fastest rise in living standards.
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One of the strangest claims about China that sometimes appears in the media is that it has a slow growth of consumption and living standards. In reality China has the fastest growth of consumption of any country in the world – whether this is measured only by household consumption or includes government consumption on areas vital for quality of life such as education and health. Furthermore, indicators show that compared to other countries, China's quality of life is better than would be expected from its present stage of economic development.
First the facts regarding these issues will be established and then they will be analyzed.
Table 1 shows the growth rates of consumption, both total and household, for the G7 and BRIC economies. These economies are selected for comparison as, given China's size, the appropriate comparison is with major economies – not Caribbean islands or African states. Nevertheless including small economies would make no difference – China would still be seen to have the world's fastest consumption growth rate.
The fundamental period of comparison used is from 1978, the beginning of China's economic reform, to 2011 – the latest date for which figures are available for all countries. However, as data is not available for Russia before 1990, a comparison for 1990-2011 is also given.
The pattern is clear. China's average annual increase in total consumption was 7.9 percent in 1978-2011 and 8.5 percent in 1990-2011. The increase in household consumption in the same periods was 7.7 percent and 8.1 percent. China's are easily the world's highest rates of growth of both household and total consumption.
By comparison, India, ranking second after China, has an annual rate of total consumption increase in the same periods of 5.4 percent and 5.9 percent and its rates of increase of household consumption are 5.2 percent and 5.9 percent.
The U.S., by comparison, had an annual growth rate of total consumption of 2.7 percent in 1978-2011 and 2.5 percent in 1990-2011. U.S. growth rates of household consumption are 2.9 percent and 2.8 percent in the same periods. China's consumption growth rate was therefore almost three times as fast as the U.S.
It is obvious that such a rise in consumption – an increase in quantity and quality of food, housing, holidays, phones, cars, furniture, health care etc. – is a decisive factor in determining any country's living standards. China's rapidly growing numbers of smartphones, cars, internet users, those taking foreign holidays etc. reflect its rising living standards. However some people attempt to claim, entirely falsely, that China's dramatic increases in consumption may be offset by other factors – for example weaknesses in health care, deterioration in the environment etc.
Fortunately, this can be tested objectively. Life expectancy, as is well known, is a very sensitive indicator of overall living conditions. As well as most people having a direct goal of living longer, length of life also summarizes the combined impact of health, environment, consumption and other factors on human well-being.
As people in China live significantly longer than would be expected given its economic development level any claim China’s rapid rise in consumption is more than offset in terms of rising living standards by health, environmental or other considerations is false. The evidence is clear that environmental, health and other factors affecting health quality are superior in China than would be expected for its level of economic development.
None of this is grounds for complacency. What have been analyzed here are growth rates, not absolute levels. China’s life expectancy (73.5 years) is still significantly behind the US (78.6 years) let alone Italy (82.1 years) or Japan (82.6 years). China must still undergo a prolonged period of economic growth before it achieves the highest levels of developed economies.
Nevertheless China is developing from a situation where in 1949 it was one of the world’s least developed countries. It is therefore ridiculous utopianism, which in practice would lead to the wrong policies, to believe China can in one step achieve the highest levels of the most advanced economies. The relevant question is whether China is developing living standards and consumption more rapidly than other economies, in which case it is catching up with them, or whether it is developing more slowly than other countries – in which case it is falling behind.
But given that China has the world’s fastest growth of consumption, why is the totally erroneous statement made that China underdevelops consumption? Such claims commit the elementary mistake of confusing China’s growth rate of consumption, the world’s highest, with the percentage of consumption in GDP – which is low in China. But for change in the population’s living standards what counts is how fast their consumption is growing, not the percentage of consumption in GDP – for example the percentage of consumption in GDP of the Democratic Republic of the Congo is an extremely high 89% but it is the world’s poorest country for which data exists!
The conclusion is therefore absolutely clear. China has by far the fastest growth rate of consumption in the world, together with life expectancy significantly above that which would be expected given its level of economic development. China, in short, has easily the world’s fastest rise of living standards.
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I greatly admire and avidly read Gavyn Davies blog, but his latest comments on China, unusually, lack precise numbers which therefore creates some ambiguities which can give unnecessary credibility to wrong analysis. Putting in precise numbers should bring clarity.
China's government has spelt out officially its precise growth target. That is to increase GDP by 100% in 2010-2020 – about four times the prospective growth rate of the US in the same period.
Given China’s cumulative growth in 2010-2012 (17.8%) this means China has to hit a 6.9% average growth rate for the rest of the decade to achieve its target. As all this is unambiguously spelt out the relevant yardstick is whether China will achieve this.
It is a wholly spurious method, not used by Gavyn but used by others, to invent some target China never set and then claim there is a ‘crisis’ because China has ‘failed’ to achieve a target it never put forward! There is no indication China is falling below its projected growth target - China’s growth this year will clearly be above the target rate.
If Gavyn, or anyone else, wants to say argue there is a serious crisis in China, they have to claim growth will fall below the average 6.9% rate – some people do of course, so we will examine that below.
As for the efficacy of the 2008 stimulus programme it can be seen in two sets of figures. In the five years between the 1st quarter of 2008 and the 1st quarter of 2013 China’s GDP grew by 51.8% and the US by 3.5% - the EU and Japan contracted. This is shown in Figure 1.
To remove any claim of possible distortion caused by the depth of the US recession in 2007-2009, in the year to the 1st quarter of 2013 China’s economy grew by 7.7% and the US economy by 1.6% - that is China’s economy grew 6.1% faster than the US economy, or at 480% of the US growth rate. This is shown in Figure 2.
The argument that China is suffering from economic ‘crisis’ on anything like the scale of the US, Europe or Japan, for example because of its recent liquidity problems, is rather like the spurious argument that really the flu is the same as polio because they are both illnesses!
As for the suggestion that Michael Pettis has been proved right I am afraid that although he edits his blog very fairly his predictions on China are extremely inaccurate. In 2009 he insisted: ‘'I continue to stand by my comment last year... that the US would be the first major economy out of the crisis and China one of the last.' This statement is entirely inaccurate – as the more than 50% growth in China and less than 4% in the US since the beginning of the financial crisis shows. His new thesis is that: ‘'I still maintain that average growth in this decade will barely break 3%.' The projection of 3% growth is itself entirely inaccurate but given China’s existing growth this means that for the rest of the decade it would have to grow at 1.6%!!! The reason for such inaccurate predictions is that Michael Pettis makes, as shown in his book The Great Rebalancing, one of the oldest errors in economics – underconsumptionism, that is the confusion of demand (consumption plus investment) with consumption. He himself lists in the opening pages a whole series of underconsumptionist authors.
Coming back to Gavyn’s blog, China’s growth rate continues to be above the target it has set itself of 100% GDP growth in a 10 year period. That will be about 4 times US GDP growth in the same period. China will overtake the US to become the largest economy in the world in approximately 5 years. The rest of the world would be highly delighted to have such a ‘crisis'.
I actually sort of assume Gavyn doesn’t disagree with those numbers? If I am wrong, and he does then of course it would clarify the debate, if he gave his own. But indicating numbers is the best way to clarify the discussion. My projection is simple – China will hit its 100% GDP growth target over a 10 year period.
In June, China suffered its worst liquidity crisis in over a decade. Some sections of the U.K. and U.S. media exploded with wild comparisons to the US financial crisis in 2008.
Such comparisons were nonsense, however, based on an elementary economic mistake. The U.S. did not suffer a liquidity crisis in 2008. It faced an insolvency crisis. The former is a shortage of means to meet immediate payments; the latter occurs when banks' liabilities exceed their capital. In 2013, Chinese financial institutions faced liquidity problems, but not a single major institution failed. Numerous U.S. financial institutions collapsed in 2008. Comparing the two events is rather like claiming that the flu and the bubonic plague are equally serious, since both are illnesses!
But not being the bubonic plague doesn't mean that in its own terms flu is not unpleasant, or that it doesn't have side effects that last for some time. Therefore, it is important to analyze the crisis' causes in order to determine whether similar events will recur. While the exact form of crisis was not predictable - it never is - both Chinese economists and the present author predicted why there would be problems for the Chinese economy. Now that June's symptoms have been somewhat ameliorated, whether a similar crisis emerges in the future depends on whether the key mistake that led to the present one is resolved.
The key symptom of June's crisis was a spike in interbank lending rates to a 13 percent peak. Willingness to pay this indicated that financial institutions urgently needed cash. Analyzing the links between the underlying disease and the symptoms shows why.
The core problem that led to the liquidity crisis was advocacy that China abandon the policies which for 35 years have made it the world's most rapidly growing economy, in favor of something termed "consumer led growth," a theory that boosting consumer demand will lead companies to a more rapid increase in production of consumer goods and a more rapid rise in living standards. Unfortunately, this theory factually doesn't take into account that investment is the main source of economic growth, and conceptually it doesn't understand what a market economy actually is.
A market economy necessarily can only be "profit led growth." Output does not increase due to "demand," but only because of profit. Failure to understand this pushed the economy towards the liquidity crisis via its key policy proposal that the percentage of consumption in China's GDP be increased, and to pay for these purchases the percentage of wages in GDP should increase.
Increasing the percentage of wages in the GDP necessarily means reducing the percentage of profits. Therefore the theory of "consumer led growth" in reality advocated that a profits squeeze should be applied to companies via wages growing more rapidly than GDP. Regrettably, in the first part of 2013, this policy was pursued, with China's consumption rising significantly more rapidly than its investment, an indication wages were rising more rapidly than GDP. This produced the only possible consequence in a market economy: a chain reaction leading to crisis, which duly broke out in June in credit markets
Wages rising more rapidly than GDP squeezed company profits. By May 2013, the overall profit increase by companies listed on China's A-share market was zero percent - they were falling in inflation-adjusted terms. Consequently, both private and state-owned companies starting reining in investments. In the first five months of 2013, growth in fixed assets investment was 0.2 percent lower than growth in the first four months, and private investment growth was 0.1 percent less than it had been a year before.
This, in turn, led to economic slowdown. GDP growth fell from 7.9 percent in the last quarter of 2012 to 7.7 percent in the first quarter of 2013, placing greater pressure on profits. Profits were then squeezed further by the rise in the RMB exchange rate, which created difficulties for China's exporters.
This inevitably affected credit markets. With profit growth slowing, and in some cases, becoming negative, companies needed credits to plug holes in cash flows. Simultaneously, as companies were using cash to plug payment holes and not to invest, credit became less effective at stimulating growth. Given that profits were squeezed in most sectors, companies diverted what resources they could into markets which were more profitable - most notably, real estate, fuelling price increases in this sector. The pressure on company profitability therefore expressed itself via ballooning demand for credit, ineffectualness of credit in accelerating growth and excess upward pressure on real estate prices.
To attempt to stop ballooning credit, the Central Bank tightened liquidity. But this tackled symptoms, not the disease - rather like treating chicken pox by pressing on the spots. The disease was therefore not cured. Indeed the situation worsened as companies' cash flows were now squeezed from two directions - from the fundamental processes described above and by the Central Bank's liquidity tightening. If this dual pressure had continued, there would have been a financial collapse. Therefore, the Central Bank had to alter course and inject credits.
By supplying liquidity, the Central Bank took pressure off companies from one side, thereby overcoming the immediate crisis. But the underlying cause of the problem will not be overcome until the company profits squeeze is fully reversed.
Finally, while a crisis would have occurred anyway, it was worsened by the incomplete structure of China's banking system. China, like every country, must possess a core of system making banks that are "too big to fail." Such huge banks will never be adequately responsive to small companies' needs, however. In the U.K., which has a private dominated banking system, there are endless complaints by smaller companies about large banks! China has not yet created an adequate system of "small enough to fail" banks, which are responsive to smaller companies, around its large core lenders. Instead, an insufficiently regulated shadow banking system developed.
But the same fundamental factors that made it possible to accurately predict rapid growth of China's economy for 35 years show it is relatively easy for China to overcome these problems, as they are self-inflicted policy problems, not objective constraints.
In 2012, under the influence of the World Bank report on China, similar policies were pursued in the first half of the year. They also led to a growth slowdown. When this policy was reversed in mid-2012, with an investment stimulus, growth accelerated from 7.4 percent to 7.9 percent. In 2013, unfortunately, the wrong policy was pursued for longer and therefore led to June's crisis.
Lin Yifu, former senior vice president of the World Bank, recently stated: "Those who advocate that China's economy should rely on consumption are, in fact, pushing the country into a crisis." Regrettably, June's events confirmed these words.
Large forces in China are working against the errors that led to the June crisis. Companies do not want profits pressured. Slower economic growth will lead to less rapid increase in living standards, creating dissatisfaction among consumers. As June's events in China's financial market were a liquidity crisis, not one of solvency, and China's banks remain highly profitable with assets far outweighing liabilities, no systemic damage has been done to China's banking system. June's events simply demonstrated that even in a country with China's very strong macroeconomic fundamentals, an incoherent theory can wreak havoc. A non-sequitur like "consumer led growth," which necessarily applies a profit squeeze to companies, inevitably leads to economic crisis.
June's credit market explosions were simply the market economy reminding everyone that, within it, there can never be "consumer led growth." Only "profit led growth" is possible.
Hopefully the appropriate lessons have been drawn.
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An earlier version of this article appeared at China.org.cn.
China’s National People’s Congress (NPC) has set a 7.5% official GDP growth target for this year. Lin Yifu, former Senior Vice-President and Chief Economist of the World Bank, and one of China’s most important economists, predicts that China can maintain 8% annual growth for 20 years. A key question is evidently whether such targets are realistic. Can China maintain this type of growth rate?
The immediate negative factors are evident. The international context for China’s economy this year is bad. The Eurozone economy is shrinking, Japan is stagnant and US growth is anemic. A 16% fall in world commodity prices since their peak has led to slower growth in major developing economies such as Brazil.
China’s policy makers initially underestimated the problems in the advanced economies. Adjusted for inflation, imports by developed economies have not regained pre-financial crisis levels. China therefore did not achieve its 2012 target of a 10% trade increase – the ctual rise was 6.2%. The lower 8% trade growth target set for 2013 is more realistic if still challenging. All major motors for growth will therefore have to come from China’s domestic economy.
In terms of strengthening China’s relative international economic position, and maintaining its ranking as the world’s most rapidly growing market, all this makes no difference. China is the world’s most open major economy, so it cannot cut itself off from international trends. China’s growth rate inevitably goes up or down with global economic fluctuations – the constant is that China strongly outperforms these trends.
To give more precise numbers, a rule of thumb of over 20 years, which successfully passed the test of events, is that China grows on average at whatever the advanced economies expand at plus 6% - the greater outperformance during the financial crisis was untypical. Developed economies this year will probably grow at around 1.5-2.0%, implying China will grow at 7.5-8.0% - in line with official forecasts. This is consistent with the official target of doubling the size of China’s economy between 2010 and 2020.
But for estimating expansion of China’s market, and growth of living standards, the absolute rate at which China’s economy develops is obviously key. It is therefore worth looking beyond short term ups and downs to the fundamental factors determining how fast an economy grows. This makes clear why China will achieve its 7.5-8% growth target. It also eliminates ‘manic-depressive’ analyses of China’s economy – periodic oscillating predictions of ‘hard landing’ and ‘rampant growth’ which appear in some parts of the media.
The current infatuation with examining consumption in China’s GDP is misleading in terms of analysing its economic performance. A country’s consumption growth is overwhelmingly determined by its GDP growth – internationally 87% of consumption increase is determined by the latter. If China’s GDP grows rapidly consumption will grow rapidly. If China’s GDP growth slows its consumption, over anything other than the very short term, will be lower than its potential with high GDP growth.
Every economy’s growth, including China’s, is necessarily determined by two key parameters: how much it invests and how efficiently that investment creates growth. Taking the five year average for 2006-2011, the latest internationally comparable data, China’s fixed investment was 43.1% of GDP, and it invested 4.1% of GDP for its economy to grow by a percentage point. Consequently, as a matter of simple arithmetic, China’s economy grew at an annual average 10.5%.
The lower the percentage of GDP invested for any given economic growth the more efficient that investment is. Furthermore, contrary to some myths, China’s investment is extremely efficient by international standards as the Table shows. For example in 2006-2011 China needed to invest 4.1% of GDP to grow by 1% whereas the US invested 24.3% - China’s investment was six times as efficient in generating GDP growth as the US. Even before the international financial crisis the US invested 7.0% of GDP to grow by 1% compared to China’s 3.4%. These key numbers determine how fast China’s economy grows.
If China’s economy is to slow, as some critics argue, then it is necessary one or both of these key parameters changes. Either China’s percentage of investment in GDP must fall or the efficiency of its investment in generating GDP growth must decline – there are no other choices.
Taking first investment efficiency, the Table shows that almost all economies were negatively affected by the international financial crisis. China was no exception – the percentage of GDP which had to be invested for its economy to grow by a percentage point rising from 3.4% to 4.1%. But this deterioration was less than for most countries – the US figure rose from 7.0% to 24.3%, Germany’s from 8.2% to 18.4%.
China’s investment efficiency would have to fall greatly not to achieve its 7.5% growth target. If China’s recent investment level was maintained then the percentage of GDP it needs to invest to grow by a percentage point would have to rise to over 5.7% before China failed to hit its growth rate target. Maintaining China’s efficiency of investment is therefore a constant challenge for the government, but China has a considerable safety margin in setting its target growth. The government’s entire focus is on maintaining the efficiency of investment, not reducing it.
The other possibility for slowing China’s economy would be a sharp reduction in the percentage of investment in GDP. There are certainly some in China advocating reducing the level of investment in GDP, but not by nearly enough to prevent China hitting its growth targets. At its present level of investment efficiency China’s GDP growth rate falls by 1% for each 4.1% reduction in the percentage of fixed investment in GDP. But in the last 5 years China’s annual GDP growth averaged 10.5%. To reduce China’s GDP growth below 7.5% requires a fall in the percentage of investment of GDP of 10%. No serious figure in China, as opposed to a few Western analysts, advocates this. A fall in investment share of 2-4% of GDP, the type of figure sometimes advocated, would only slow China’s economic growth by 0.5-1.0%.
Therefore international economic headwinds are negative. But in both the efficiency of its investment and the percentage of investment in GDP China has considerable safety margins for achieving its growth targets - unless the administration makes very large errors the growth targets will therefore be met. Indeed, looking at these margins of manoeuvre, Lin Yifu’s 8% is perhaps more realistic that the government’s 7.5% - administrations always like to announce they have exceeded targets.
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This article is slightly edited for an international audience from one which originally appeared in Shanghai Daily.
In the 4th quarter of 2012 China’s economy speeded up, with GDP growth rising to 7.9%. For 2012 as a whole China’s GDP rose by 7.8%. Internationally this contrasted sharply with the EU and Japan, both of which have passed into new downturns, and the US where economic growth in 2012 was 2.2% - anaemic compared to previous recoveries. China’s industrial production in the year to December rose by 10.3% - compared to 2.9% in the US. China’s annual economic expansion now exceeds the US in dollar as well as percentage terms – China’s GDP in 2012 rose by $982 billion compared to $600 billion for the US.
The scale of changes in the world economy involved can be seen even more clearly if the period since the international financial crisis began is taken. Peak US GDP prior to the financial crisis was in the fourth quarter of 2007. Since then China’s GDP has grown by 52.5%. But in the 4th quarter of 2012 US GDP was only 2.4% above its pre-crisis level.
In the last five years China’s economy has therefore grown more than twenty times as fast as the US while the economies of the EU and Japan have shrunk. In current dollar prices China’s GDP has risen by $4.7 trillion and the US by $1.65 trillion.
In industrial production, the most internationally traded sector, and the one with the fastest productivity growth, the change in the last five years is even more dramatic. On the latest available data EU industrial production is 12% below its pre-crisis peak and Japan’s 22% below. In the US, despite unsubstantiated talk of ‘industrial revival’, in December US industrial output was still over 2% below its peak of more than five years previously. In the five years up to December 2012 US industrial production had fallen by 3%, but China’s industrial production had risen by 80%.
These huge economic shifts pose two questions entering 2013. This year can China maintain the pickup in economic momentum that was clear in the fourth quarter of 2012? Can China maintain this over the medium/longer term with the consequences for further changes in the structure of the world economy flowing from this? Examining the economic processes unfolding at the beginning of 2013 gives the answer ‘yes’ to both questions – and for the same reason.
Turning back to short terms trends, undoubtedly at the beginning of 2012 China's economic policy makers had underestimated the difficulties in the developed economies. China's official prediction of a 10% export increase in 2012 could not be achieved without significant growth in developed markets. This did not materialize and exports rose only 7.9%.
As external demand was overestimated there was a delay in launching a program to stimulate domestic demand. Therefore China’s economy slowed. By May 2012 annual fixed asset investment growth had fallen to 20.1%, the lowest for a decade. In August the yearly increase in industrial production declined to 8.9%. In the same month the annual increase in industrial company profit fell to 6.2%.
However, by mid-2012 policy was adjusted appropriately. In late May Premier Wen Jiabao announced an infrastructure centred investment program that grew to $157 billion. Theoretical support to this new stimulus was given by former World Bank Chief Economist and Vice President Lin Yifu - who has now returned to Beijing to be a major influence in China’s economic policy making.
The correctness of these policies was rapidly shown. By December the investment decline reversed, with the annual increase in fixed asset investment rising to 20.6%, and industrial output growth accelerating to 10.3%. Industrial company profits grew – rising to a 22.8% annual increase in November. These trends underlay the GDP growth increase from 7.4% in the third quarter to the fourth quarter’s 7.9%.
In a perfect world doubtless China would have launched its domestic stimulus a few months earlier. But in economics it is impossible, due to the enormous number of variables involved, to make precisely accurate projections, only orders of magnitude can be accurately predicted. In particular policy makers had to take into account that China’s population is extremely inflation adverse. If export demand had been at the level expected, launching a domestic stimulus would have threatened economic overheating with inflationary dangers. In the grand economic scheme of things, with China’s GDP rising at 7.8%, the US at 2.2%, and the EU and Japan not at all, a few months delay is virtually neither here nor there.
Nevertheless there exists a small industry of those claiming China is ‘soon’ to suffer deep economic crisis – the ‘soon’ merely progressively moving forward in time when it doesn’t materialize. A few examples will give the flavor of the genre:
The fact that such predictions are regularly refuted by events does not stop them being put forward. A slight delay in China launching a domestic stimulus in 2012 therefore created a frenzy of speculation in such circles regarding a ‘hard landing’ or ‘crash’ in China’s economy – which as always failed to materialize and instead, as already noted, China’s economy accelerated.
A new ‘theory’ therefore had to be put invented of why China’s economy will substantially slow – that China’s government is allegedly sacrificing the long term interest of its economy for a short term ‘fix’. According to one formulation of this, by Jamil Anderlini and Simon Rabinovitch in the Financial Times: ‘China went into reverse in the second half of 2012 in its efforts to rebalance its economy… Though steady, consumption took a back seat to capital spending as a driver of growth.’
Unfortunately this line of argument makes as little sense as, and will be therefore be just as refuted by events as, the numerous others.
First, taking the long run, modern econometrics shows clearly that as an economy develops it becomes more dependent on investment for growth, not less. As China moves from a developing to a developed economy investment would be expected to play a greater role in its growth.
Second Lin Yifu has rightly stressed that the industrial upgrading of an economy consists of it moving from labor intensive to increasingly investment intensive industries. This is precisely the path China is following with its exports increasingly switching from labour intensive products such as textiles and toys into more capital intensive ones such as ships, construction equipment, smartphones and cars.
Finally, in the purely short term, the present global economy conforms to economic theory showing that investment fluctuates more than consumption, and it is investment downturns which therefore create economic recessions. The latest data shows in developed economies fixed investment is nearly 10% below its peak and has been declining since the first quarter of 2012. China’s ability to counter such threats by an investment stimulus program is therefore a sign of the strength of its economy, not a weakness. It is this ability to control and raise investment which determined that China’s economy continued to grow rapidly, while the sharp decline of investment in the developed economies led to their stagnation or renewed recession.
Consequently, rather than China’s government’s policies sacrificing the long term strength of the economy to short term expedients, the stimulus launched from summer 2012 integrates both short and long term considerations in economic development. This is why the majority of predictions for growth in China’s economy in 2013, from both Chinese and the majority of international experts, are for a further speed up in GDP growth to more than 8% - the World Bank’s 8.4% being fairly typical.
The main dangers to China’s growth in 2013 are therefore not domestic but those from external weakness in developed economies. The latest prediction by the World Bank for growth in 2013 is 1.9% in the US, 0.8% in Japan and -0.1% in the Euro Area. For this reason the World Bank’s overall projection for global growth is a low 2.4% in 2013.
Naturally China, as the world’s second largest economy, and the world’s largest goods exporter, cannot isolate itself from world economic trends. If the world economy slows in 2013 China is likely to slow, and if the world economy accelerates China’s economy is likely to speed up. But whatever the short term ups and downs China will continue to enjoy its 6-7% growth lead over the developed economies.
In regard to the medium term a major turning point in world history is being approached. The IMF projects that, in comparable price levels, that is parity purchasing powers, China will overtake the US to become the world’s largest economy in 2017. At market prices China will overtake the US to become the world’s largest economy a few years later. Exactly when the latter transition will take place depends on the assumption on exchange rates, with 2019-20 being the most central date. To be safe it may be said China will become the world’s largest economy ‘within 10 years’. Given the short time scale, unless China’s economy slows very drastically and very quickly this transition is inevitable.
No one alive has ever lived in a world in which the US was not the largest economy – it gained that position in approximately 1870. It is, among other reasons, because it is mentally difficult for humans to adjust to the new and never experienced that constant theories are put forward that China’s economy must be about the slow substantially. But, for the reasons already outlined, China will maintain its rapid economic growth. That is 2013’s realistic economic perspective.
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An earlier shorter version of this article appeared in China Daily.
China's economy in 2012 was "a tale of two halves": In the first six months slowdown, even a feeling of developing crisis; in the second half recovery and accelerating growth. The story therefore had a happy ending. But it is worth noting what went wrong in the first half, and how it was corrected in the second, as this contains lessons for the future.
The initial problem in early 2012 was simple. China's economic policy makers underestimated the problems in the developed economies. China's official prediction of 10 percent export increase in 2012 could not be achieved without significant growth in developed markets. This did not materialize – the US economy grew slowly while Japan and the EU's fell into a new decline. Consequently, as is now officially stated, 2012's export target will not be achieved.
This itself was not an extremely serious error. It is impossible in economics, due to the enormous number of variables involved, to make precisely accurate predictions, only orders of magnitude can be accurately predicted. The undershoot in export growth in 2012 will not be enormous. To compensate for international demand being weaker than predicted China required a domestic economic stimulus. It was here that a much more serious problem initially arose.
Early in 2012 the World Bank produced a report arguing that China's state should "get out" of the economy – something clearly going against a new state stimulus program. Supporters of such neo-liberal policies in China, for example Lang Xianping, launched a campaign arguing that a stimulus program was futile and that China faced terrible economic depression. Western authors such as Nouriel Roubini advanced less extreme versions of the same analysis.
Such "the state must get out of the economy" neo-liberal policies have produced economic disaster where they have been pursued in countries as diverse as Europe, Latin America and Russia. I warned in this column in March that such policies would damage China's economy.
By summer 2012 the damaging consequences of state failure to intervene were clear. In May annual fixed asset investment growth fell to 20.1 percent, the lowest level for a decade. In August the yearly increase in industrial production declined to 8.9 percent, from 11.4 percent in January. In the same month industrial company profit fell 6.2 percent year on year. A sense of malaise, even elements of crisis, was evident during the first half of the year under the impact of policies which reflected neo-liberal opposition to state intervention.
Fortunately from mid-year policy changed, creating the happy economic ending to the year. In late May Premier Wen Jiabao announced growth must receive more support. An infrastructure investment program that grew to US$157 billion was launched. Theoretical support to the new stimulus was given by former World Bank Chief Economist and Vice President Lin Yifu – who specifically stressed an investment based stimulus package was preferable to a consumer based one.
These policies meant the state "getting back" into the economy – not in the sense of trying to administer it, but in that of setting the overall investment level. Such policies are familiar in either Chinese economic analysis stemming from Deng Xiaoping or Western ones coming from accurate reading of Keynes. Premier Wen Jiabao also turned the economic tables, explicitly justifying not only the 2012 stimulus but the earlier one in response to the 2008 financial crisis.
The stimulus package launched in mid-2012 was rightly of a much smaller scale than 2008's. In 2008 the world economy plunged downwards in the greatest economic decline since 1929. A huge stimulus was necessary to guard against downturn on such a scale – particularly under conditions where not only was there severe existing global recession but also further downside risks. The 2008 scale of stimulus, US$586 billion, was to guarantee China's economy was not dragged into global downturn.
But in 2012 there was stagnation, not sharp decline, in the advanced economies. China's required stimulus was therefore much smaller – a program on 2008's scale would have been highly undesirable in overheating the economy in these different circumstances. The announced infrastructure stimulus in 2012 was approximately one third of 2008's. But the state was "stepping into" the economy on an appropriate scale.
The correctness of these policies was shown rapidly. By November the investment decline had reversed – the annual increase in fixed asset investment rising to 20.7 percent. The same month year on year industrial production accelerated to 10.1 percent. Industrial company profits began to grow – rising to a 20.5 percent yearly increase in October and 22.8 percent in November. Profits growth in October and November was so strong that it turned the 1.8 percent yearly decline in January-September into a 3.0 percent increase in January-November. While GDP growth for the 4th quarter 2012 will not be available until later it would be highly astonishing, given these trends, if it were not higher than the 3rd quarter of 2012's 7.4 percent.
What are the conclusions, and what are 2013's perspectives? It showed, as always, the disastrous consequences of neo-liberal opposition to appropriate state intervention in the economy. A moderate problem facing China, lower than anticipated growth in developed economies, and consequently somewhat slower than anticipated export growth, became a significant crisis due to opposition to appropriate state intervention. However once policies were corrected, and appropriate investment stimulus policy measures adopted, all the advantages of China's economic structure came into play. Within a few months China's economy was recovering with an impetus that is strong enough that it will clearly continue into 2013.
China's difference to Western economies is that once the appropriate economic policy response is decided it has structures to deliver it. The Chinese state has sufficient levers that it can set an overall investment level in the way that Deng Xiaoping or Keynes considered necessary. This created rapid economic recovery in the second half of 2012. In contrast the Western economies have no structures to set the overall investment level. The latter remains purely in private hands – something Keynes explicitly warned would create crisis.
In the Western economies, to attempt to reverse the decline in fixed investment which is the core of the Great Recession, governments are reduced to running huge, ultimately unsustainable, budget deficits or flooding the economy with money – symbolized by the various quantitative easing programs in the US and hyperexpansionary monetary policies now followed by the European Central Bank and Japan's central bank. These have failed both to reverse the investment decline in developed economies while threatening other states in the global economy with inflation and currency fluctuations due to this excessive monetary expansion. China's policies ensure its own investment does not decline, thereby generating economic growth, while not pumping excessive monetary stimulus into the global economy.
Provided the policies which brought China's economy success in the second half of 2012 are continued, its economy's prospects for 2013 are clear. China's economy in the 2nd half of 2012 was on an upward trajectory shown clearly by upward shifts in profitability. As this was still growing it will clearly continue into the first half of 2013. Projections of accelerated growth for the first half of 2013, compared to 2012, therefore appear well founded.
During the course of 2013 external conditions will have to be reviewed to see if the existing domestic stimulus is sufficient – theoretically the domestic stimulus could be reduced if export conditions significantly improve, or it could be accelerated further if external conditions deteriorate. But 2013's basic dynamic is that China will grow much more rapidly than other major economies, due to its structural strength and its much superior mechanisms for dealing with economic downturns which 2012 again demonstrated.
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This article originally appeared on China.org.cn.
The following article originally appeared in China Daily Europe.
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In the next 15 years one of the greatest turning points in world history can occur. In five to seven years China will become the world's largest economy. In about 15 years China will achieve the annual $12,000 GDP per capita qualifying it as a developed economy by World Bank criteria. China is so large that these events will change the world. For example, China's 1.3 billion population is larger than the combined 1.1 billion of all existing developed economies.
But these successes are not inevitable. China has enjoyed tremendous economic achievements since 1978, experiencing in the last decade the fastest per capita GDP growth in any major economy in history, and the fastest growth of consumption in a large country. It achieved this because it followed economic policies laid out by Deng Xiaoping from 1978. But now an attempt is being made by some to divert China onto an economic path, neo-liberalism, which has failed wherever it has been carried out. Examining the factual record of neo-liberal policy shows the scale of what is at stake both for China and internationally.
Neo-Liberal policies were applied in Latin America in the 1980s. The result was that Latin America's per capita GDP fell by an average 0.5 percent a year for 10 years.
In the former Soviet Union neo-liberal shock therapy, based on full privatization, was carried out after 1991. Russia's GDP fell 36 percent, the greatest decline of a major economy in peacetime in modern world history. Russia's male life expectancy fell by four years, to only 58, by 1998 and Russia's population today is 7 million less than it was in 1991.
Neo-liberal policies in the US instigated under Ronald Reagan led to the colossal accumulation of debt that culminated in the international financial crisis of 2008. During the earlier Keynesian period of US economic policy, lasting from the end of the Korean War (1950-53) until 1980, US state debt fell from 70 percent to 37 percent of GDP. During the succeeding neo-liberal period US state debt rose to 88 percent of GDP by last year. Over the same period the 10-year moving average of annual US GDP growth fell from 3.3 percent to 1.6 percent. Under neo-liberal policies US state debt more than doubled, and US economic growth halved.
Given neo-liberalism's disastrous record, which is even starker when compared with China's growth, how can anyone advocate that China adopt such a failed policy? The answer is that intellectually this can be done only by making no reference to economic facts or by falsifying them. An example of the latter is the assertion that China's investment is less efficient than that of economies such as the US when the facts show the opposite. Even before the international financial crisis China had to invest only 4.1 percent of GDP to produce each percentage point of economic growth, compared with the 8.8 percent in the US. Since the financial crisis the US position has worsened.
Neo-liberalism fails as economic policy because it refuses to follow science's first rule of starting with the facts, or, in the famous Chinese phrase, it refuses to "seek truth from facts". Rather in the style of pre-Copernican astronomers who insisted that the sun orbited the Earth, because they failed to make measurements showing the Earth circles the sun, neo-liberals construct models of an economy that does not exist. They imagine an economy made up of millions of competitive firms (technically "perfect competition"), in which prices are flexible downward as well as upward, and in which investment is a low percentage of the economy. The real economy is nothing like this.
The scale of investment has been rising for 300 years to levels of 20 percent, or even more than 40 percent, of GDP. Huge financial structures were necessarily created to centralize the resources for this. Banks now agreed to be "too big to fail", and which therefore cannot be allowed to operate in a free market without incentivizing uncontrollable risk taking. Due to this high investment the world's most important industries - automobiles, aviation, computers, finance, pharmaceuticals - do not operate according to "perfect competition" but are monopolies or oligopolies. As neo-liberalism does not correspond to economic reality its policies are necessarily damaging.
For this reason, even when not fully adopted, neo-liberalism's influence damages China's economy. For example, early this year severe negative pressure on China's economy occurred due to a downturn in the global economy driven by a fall in private investment. However, due to the influence of neo-liberal views, that the State should "get out" of the economy, the necessary stimulus to counter this was not launched early enough. Fortunately, in the second half of the year, China's government launched a required medium-scale State-led investment stimulus that stabilized the economy during the third quarter and should now lead to accelerated growth.
The consequences for the popularity of those implementing neo-liberal policies, and for social stability, are also clear. For example in Britain David Cameron launched the Big Society, the concept that the state should be small and be replaced in social protection by the market and voluntary organizations. But factual evidence shows that pure operation of the market increases, not decreases, social inequality and fails to provide social protection. The result under Cameron was sharply rising social inequality, ridiculing of his policies even by those not associated with the political opposition, and a collapse in the government's popularity.
In China, where there is a widespread consensus that in the recent period social inequality has gone too far, and which due to size is more difficult to govern than any European state, to embark on neo-liberal policies, which would inevitably increase inequality, would not only be economically damaging but socially and politically destabilizing.
However, neo-liberalism is not just an intellectual theory. Many people profit from it. In the US most of those in the finance sector who led its economy to disaster in 2008 retain the private wealth gained from neo-liberal policies.
Two groups of people would gain from neo-liberalism in China, and therefore support it. The first are some financial layers in the country. The second are US neo-con circles that aim to maintain the US as the world's largest economy despite remorseless arithmetic showing this is impossible.
The population of the US is only 23 percent of China's. The only way the US could remain the world's largest economy is if China's per capita GDP, and by implication its living standards, never reaches 23 percent of US levels. Quite rightly China's population will never accept they can only have less than one quarter of the US living standard; nor in the future will India. As China's GDP per capita moves toward that of the US China's economy will become first the largest and later the strongest in the world. The only way to stop this is to sharply slow China's economic growth, neo-liberalism's disastrous consequences being the way to achieve that.
China's economic rise immensely benefits not only itself but humanity. When, in about 15 years, China achieves advanced economy status, 35 percent of the world's population, for the first time in modern history, will enjoy the benefits of this. When China has come so close not only to full national revival but to decent living standards for its people it would be one of the greatest tragedies in world history for neo-liberalism to block this.
The underlying weakness in the US, European and Japanese economies was underestimated in China’s forecasts for 2012. The US is currently consuming more capital than it creates, while its percentage of investment in GDP is near post-World War II lows. Japan’s investment levels have declined for two decades while its savings rate has fallen. EU investment is the lowest percentage of GDP since World War II and declining. These economies cannot achieve rapid recovery under such conditions.
These structural features dictated the poor short term performance of Western economies during 2012. The EU entered a new recession with GDP still 2.1% below 2008’s peak levels. Japan’s latest GDP data shows tortoise like 0.8% annualized growth with output still 1.9% below its peak. US GDP growth decelerated from 4.1% at the end of 2011 to 1.7% in the last quarter. The US PMI fell for three months to 49.6 in August. US industrial production in the same month only rose 2.8% compared to a year previously – less than a third of China’s growth.
The problems in developed economies directly affected China. China’s 10% projected export increase in 2012 will not be achieved, helping explain why China's economy significantly decelerated in the first part of the year. GDP growth fell to 7.8 percent in the first half of the year, while August’s industrial growth declined to 8.9 percent and the official manufacturing Purchasing Managers Index fell to 49.2.
Weakness in Western economies can to a certain degree be compensated for by China’s export growth to developing countries as the latter now constitute 53% of China’s exports. But as Western economies still account for almost half China’s current global market the growth prospects for China’s exports are structurally limited. Consequently, as the great majority of analysts conclude, China’s economic expansion in the next few years must be based primarily on domestic demand. It is therefore good news for China’s economy later this year that lessons drawn by China’s economic policy makers have begun to overcome some confusions which existed earlier regarding the dynamics of China’s domestic demand. This process has been aided by policy recommendations by Lin Yifu - China’s former World Bank Senior Vice President and Chief Economist.
Problems had earlier been created in discussion of China’s economic policy by confusing ‘domestic demand’ with ‘domestic consumption’. The two are not the same. Domestic demand consists not only of domestic consumption but also domestic investment. Formulas such as the following, which were regularly used, were therefore erroneous: ‘China will not be able to rely on exports for its economic growth. Therefore, China will have to adopt a consumption-driven growth strategy.’
From the viewpoint of increasing domestic demand, China’s exports can just as much be replaced by raising China’s domestic investment as by increasing consumption. Indeed whether, and in what proportion, to expand China’s domestic demand by expanding investment or consumption is a crucial economic policy choice.
The clarity necessary on this has been highlighted by Lin Yifu and confirmed by trends in China’s economy in the first part of 2012. Lin argued that, compared with boosting consumption, encouraging investment is a more sustainable and successful path. This analysis, which is justified by factors set out in Lin’s writings on long term economic growth, was also clearly confirmed by trends in China’s economy during 2012.
Some deceleration in China’s economy was inevitable in 2012 due to negative international trends. Nevertheless this was magnified earlier in the year by errors in China’s normally surefooted economic policy which are now being overcome.
China’s economic policy during the last period took as a key aim raising consumption – i.e. living standards. This indeed should be economic policy’s aim – the target should be maximizing the sustainable rate of increase of consumption. But unfortunately this became confused with a different idea of sharply increasing the percentage of consumption in China's GDP. These two goals are actually contradictory as GDP growth, which is largely fueled by investment, underpins sustainable consumption. Sharply increasing consumption’s percentage in GDP cuts investment levels, thereby inadvertently leading to lower GDP and consequently lower consumption growth.
The practical consequences of this confusion were clear in 2012. To attempt to raise the share of consumption in China's GDP, wage increases far above the economy's growth rate were pushed through. In the most striking examples, Sichuan raised the 2012 minimum wage by 23 percent, and Shenzhen announced a 16 percent increase to the 2012 minimum wage following a 20 percent increase in 2011.
Such measures increased inflationary pressures in China’s economy and squeezed private and state company profits, helping create in the first half of 2012 a trend accurately termed ‘profitless growth’. Falling profits in turn led to investment reductions, with fixed asset growth declining from 25.0% in August 2011 to 20.2% in August 2012. Falling economic growth also reduced government tax receipts, pressuring the state budget.
This process illustrates why the phrase ‘consumer-led growth’, sometimes used in China, is fatally confused. In a market economy production does not take place because there is a demand for consumption. It only occurs if production is profitable. As profits declined in 2012 investment fell, the economy slowed, and consumption's growth rate therefore declined. The growth rate of retail sales, before adjusting for inflation, fell by 4.9 percent between December 2011 and August 2012 while the CPI fell by 2.2 percent. Real retail sales growth, the main factor in consumption, therefore fell. Predictably, attempting to sharply increase consumption's percentage in GDP led to the population’s consumption rising more slowly!
But while consumption was boosted the government initially did not use available policy tools to halt the decline in fixed investment – as shown by the fall in fixed asset formation. These policies are now being corrected. Instead of the confused formula of ‘consumer-led growth,’ Premier Wen Jiabao has rightly emphasized ‘a pattern in which economic growth is jointly driven by consumption, investment and exports.‘ A $154 billion state-stimulated investment program has been announced. These practical steps by the government are clearly broadly in line with the economic policy arguments advanced by Lin Yifu.
If China's government continues these corrections, China’s growth will stabilize and then accelerate towards the end of 2012.
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This article originally appeared in China Daily.
An important article by Gavyn Davies on his Financial Times blog analyses the effects of US quantitative easing (QE) on bond, share and commodity markets and the relation of these to trends in the productive economy.
Gavyn Davies charts the graph in Figure 1.
His commentary is self-explanatory:
‘A quick glance at the graph suggests that equities, bonds and commodities have all been in bull market trends ever since the successive rounds of quantitative easing started. However, a closer inspection reveals that this is not in fact the case. Only bonds have been in a continuous uptrend. The behaviour of global equities and commodities can more meaningfully be split into two separate phases.
‘From the start of the recovery to the end of April 2011, both equities and commodities recorded extremely strong bull markets, with both asset classes rising by some 90 per cent.
‘Since then, however, the bull market in risk assets has fizzled out. In the second phase (shaded blue), equities have been volatile around a broadly flat trend, and commodities have actually fallen by 16 per cent from the peak, despite their recent rally. Quantitative easing has not been powerful enough, at least up to now, to restore the 2009-11 bull market.’
As regards bond markets the essentially continuous upward trend of prices noted by Gavyn Davies naturally indicates that the intended goal of QE of depressing interest rates has been achieved. As regards commodity prices he is accurate that these have not yet regained their post-financial crisis peaks reached in April 2011 – as is clear from Figure 2.
World share prices have also not significantly risen above their April 2011 post-international financial crisis highs – see Figure 3. However this graph also illustrates the sharp difference between US and non-US share price performance.
US shares have continued to advance since April 2011, more than overcoming their decline in the second half of 2011. Non-US shares have, however, fallen back from April 2011 levels.
Whereas up to April 2011 US and non-US share markets moved in the same direction, both showing recovery, since April 2011 US and non-US share markets have moved in opposite directions with the former having risen and the latter fallen.
In order to illustrate this more clearly Figure 4 shows the changes in world, US and non-US share prices since 31 March 2011. By 21 September US share prices were 9.9% above their 31 March 2011 levels whereas non-US share prices were 9.2% below them.
These contrary trends in US and non-US share prices naturally don't contradict Gavyn Davies’s fundamental argument. But they highlight an important trend within its overall framework.
US QE policies have been accompanied by, almost certainly caused, a significant and continuing rise in US share prices which continued after April 2011. But US QE policies have been accompanied since April 2011 by a fall in non-US share prices. Any analysis of trends in world markets must take into account and explain these divergent trends.
It is also unlikely that the explanation can simply be more rapid economic growth in the US compared to other economies . Despite some recent slowdowns emerging economies have grown significantly more rapidly than the US, but emerging economy share prices have performed significantly worse than the US – Figure 5. Whereas emerging economy share prices have fallen by 14.2% since 31 March 2011 US shares have risen by 9.9%.
The Federal Reserve could, therefore, argue that it has created a ‘wealth effect’ within the US through QE – US house prices have also stabilised and then risen slightly this year. However the data from commodity markets and non-US share markets indicates no such effect has been created by QE outside the US.
Whether US QE has contributed to the negative trends in non-US economies, as countries such as Brazil have argued, would of course requires a separate article. The distinction between US and non-US markets is however relatively clear.
The following article originally appeared in Beijing Times.
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This week Greece’s Prime Minister Samaras met, and publicly argued, with German Chancellor Merkel over the EU’s latest attempt to solve the Greek economic crisis. Given that earlier misunderstandings in China of the dynamics of Europe’s crisis have damaged its own economy it is therefore important that a correct assessment is made of this new stage in Europe.
The reason China was previously damaged by a wrong analysis was that the seriousness of Europe’s economic crisis was considerably underestimated. By July 2012 China’s exports to the EU had declined by 16% in a year – easily the most serious blow to China’s exporters. Yet a year previously few analysts in China were predicting such negative European trends.
The reason for this widespread underestimation of the seriousness of the situation was that many analysts in China supported austerity policies being pursued in Europe and rejected the alternative proposal for European governments to launch economic stimulus programs. As most European governments were following austerity, and austerity was considered the correct policy, such Chinese analysts concluded Europe’s crisis would be overcome.
However the results clearly show that Europe’s austerity policies have worsened the situation and analysts who supported Europe’s austerity policies were dangerously mistaken.
To assess accurately Europe’s real economic dynamics, and their consequences for China, first the overall results of the different policies pursued internationally to deal with the financial crisis can be summarized and then the situation in individual European countries analyzed.
Internationally three types of policies were adopted in response to the financial crisis:
· The EU combined loose monetary policy with no stimulus to the productive economy – the ‘austerity’ approach. The outcome is that EU GDP is 2.1% below its peak of four years ago and Europe is in ‘double dip’ recession.
· The US combined loose monetary policy with a stimulus to consumer spending via a large budget deficit. The outcome is that average annual US GDP growth in the last four and a half years is only 0.4%
· China combined loose monetary policy with an investment focused stimulus to the productive economy. China’s GDP grew by more than 40% in four years.
The EU’s ‘austerity’ policy was therefore easily the least successful approach to dealing with the financial crisis. This is further confirmed by analyzing the individual EU countries committed to austerity. In the UK, where Cameron’s government voluntarily implemented the policy, GDP is 4.5% below its peak output and the UK is in a new recession. Considering countries which adopted austerity as a condition for bailouts, Ireland’s economy is 8.8% below its peak, Portugal’s GDP is 5.2% below its peak and has been declining for two years; Spain’s economy is 4.7% below its peak and is in a new recession, while in Greece the economy has contracted by 13.0%.
Given these dreadful economic results analysts in China should realize support for Europe’s austerity policies was mistaken. Instead they should hope European leaders will initiate an EU wide economic stimulus. As Greece is clearly too small to launch this, a stimulus must be started by the main European economies. International experience confirms such a stimulus will be more effective if concentrated on investment, as in China, rather than on consumption as in the US. If neither stimulus is launched then China must prepare for a long drawn out European crisis with negative consequences for China’s economy.
One of the most stupid economic claims, sometimes recycled even in economic and financial media which should know better, is that China has a slow rate of growth of consumption. On the contrary China has the fastest rate of growth of consumption of any major economy in the world.
The data for the latest 10 year period for which data exists is set out in the table below. Only Russia comes close to matching China’s increase in consumption in that period. China’s rate of growth of consumption is sixty per cent higher than India's, three times as fast as South Korea's and approximately ten times as fast as the main G7 economies.
I have a new article at the Guardian's Comment is Free analysing China's economic success both during the international financial crisis and in general since since 1978. It analyses the theoretical bases of China's economic policies in terms of both Chinese and Keynesian economic theory. The article starts:
'Few things better illustrate the difference between the state of China's economy and that of the rest of the world than the fact that its newly announced GDP growth figures of 7.6% were analysed as a "slowdown". In any other major economy this would have been considered blistering growth threatening overheating. Instead, it is clear China has room for further stimulus measures in the second half of the year.
'Indeed, as the international financial crisis has unfolded, there have been few starker contrasts than those between China, the US and the EU. Europe has combined loose monetary policy with little or no stimulus to the productive economy – the "austerity" approach. The result has been that the EU's economy shrank by 2% over four years – the UK's shrank by 4.4%. The US has combined loose monetary policy with a consumer stimulus delivered via the budget deficit. The result? The US economy has grown by 1.2% in four years. India, which followed the US model of a budget deficit delivering a consumer stimulus, saw its growth decline from 9.4% in the first quarter of 2010 to 5.3% in the first quarter of 2012.
'Meanwhile China, which combined expansionary monetary policy with an investment-led stimulus, has experienced more than 9% annual average growth throughout the four years of the financial crisis.'
The rest of the article can be found here.
Four years into the international financial crisis, it is clear that the economic policies followed in Europe to deal with it have failed to do so. For a long time, there was a refusal to examine the real facts of Europe's economic situation and take the appropriate policy measures. Once Europe does start to analyse its economic problems correctly, however, it will see that it has a lot to learn from China. Naturally this does not mean that Europe can mechanically copy China's approach, but there are important trends which Europe can study.
The fundamental trends in Europe's economy are illustrated in Figure 1. This shows the changes in different components of the European Union (EU)'s GDP since the first quarter of 2008 – the peak of the last business cycle and immediately before the onset of the financial crisis. It may be seen that the negative trend in the EU economy is entirely dominated by its fall in investment. The EU's trade balance has improved during the financial crisis, government consumption has risen, and the fall in personal consumption is relatively small. But the fall in fixed investment is huge, amounting to 150 percent of the total decline in GDP. This fall far more than offsets the performance in other economic sectors. The economic situation in Europe is therefore entirely dominated by this investment fall.
After four years of failing to look at the real situation, an identification of this actual core problem in Europe's economy is beginning to emerge. European Parliament President Martin Shulz recently wrote on Europe's crisis: "…what is to be done? First, targeted investment should be given priority." José Manuel Barroso, the European Commission president, and Olli Rehn, the European commissioner charged with dealing with the euro crisis, have now said it is likely that EU leaders will agree next month to increase the capital of the European Investment Bank by €10bn ($13 billion), which could be used as collateral to start large infrastructure "pilot projects" on a pan-European scale.
These policy changes, while a step in the right direction, are too small to turn the situation around. The EU is a US$16 trillion economy. The idea that a $13 billion program, only 0.06 per cent of the EU GDP, can offset the US$343 billion decline in EU investment since the first quarter of 2008 is clearly unrealistic.
The European Commission admits that there is €82 billion (US$106 billion) in unused structural funds in the EU's medium-term budget. This could theoretically be used to tackle the investment decline. But firstly, even the use of this entire sum is less than one third of the decline in investment which has taken place in Europe. Secondly, national governments have not yet agreed that these funds can be used for a European investment program.
Therefore four years after the beginning of the crisis, EU governments are beginning to discuss the right issues, but the practical measures they are proposing are still much too small to deal with the scale of problems that Europe faces.
The difference with China can be seen clearly in Figure 2, which shows the results of the stimulus program launched by China in 2008 to counter the international financial crisis. This stimulus program directly targeted raising investment – in particular infrastructure and now housing. The results are evident. Far from falling sharply, as in Europe and the US, China's investment rose. Consequently, compared to the situation on the eve of the financial crisis, China's economy expanded by over 40 per cent in four years compared to growth of 1 per cent in the US and a contraction of 2 per cent in Europe. China's stimulus program was $586 billion, or about 13 per cent of China's 2008 GDP – the majority part directly targeted investment.
China's stimulus, in terms of proportion of GDP, is equivalent to a program of US$2 trillion in the EU today. An investment program on that scale would be substantially too large in the EU at present – the situation is not as critical as in 2008. Nevertheless it is only necessary to compare this number to the $13 billion discussed by EU commissioners today, to see how inadequate is the scale of the proposed EU response to the present situation.
Jens Weidman, president of Germany's Bundesbank, has complained about the lack of policy tools available in Europe: "Now that fiscal stimulus has reached the bounds of feasibility in many countries, monetary policy is often seen as the 'last man standing'…However…contrary to widespread belief, monetary policy is not a panacea and central banks' firepower is not unlimited." But Weidman's conclusion exists only because Europe, somewhat arrogantly, refuses to study the country which passed most successfully through the international financial crisis – China.
Two years ago I wrote: "The dispute… between the US and Europe over'economic stimulus' versus 'deficit reduction' convincingly demonstrates the superiority of China's system of macro-economic regulation. China has faced no similar dilemma. It has simultaneously carried out the world's biggest economic stimulus package while running a budget deficit which is entirely sustainable – under 3 percent of GDP. China has therefore not had to face the choice between continuing fiscal economic stimulus measures and placing the priority on budget consolidation."
This remains the key problem. Unless Europe is prepared to grasp the nettle of a large "China style" program, one based on state-led investment, Europe is likely to face, at best, years of economic stagnation.
China's authorities have always rightly clarified that it is not arguing for its economy to be a model for others. It rightly insists every country is specific and therefore no country can or should mechanically copy another. But nevertheless China learned many things from other countries. For its own sake, Europe should start to learn from China
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This is an edited version of an article which originally appeared at China.org.cn.
This blog has frequently drawn attention to the extremely close correlation between China’s consumer inflation (CPI) trends and world commodity prices – Figure 1. It is world commodity prices, rather than monetary data, which provides the best indicator of China’s inflation trends. In that light how is China’s 3.6% CPI figure for March to be analysed? As China’s inflation trend is a major determinant of China’s ability, or otherwise, to pursue expansionary economic policies this is a major issue not only for that country but for the world economy.
It is evident China’s CPI is not powerful enough to drive world commodity prices. The correlation between the two indicators therefore necessarily shows either, or both, that world commodity prices determine China’s CPI shifts, or more probably that some third factor, for example overall global economic trends, determines both. In either case China’s CPI would be expected to follow trends in global commodity prices.
In that light China’s 3.6% CPI for March is not particularly surprising. Despite the monthly increase from 3.2% in February the overall downward trend in China’s inflation continues – Figure 2. The 3.6% CPI figure in March is a decline of almost half since the 6.5% peak in July 2011 and is within the government’s 4.0% target.
The fact that March saw an upward tick within a descending trend of China’s inflation is in line with the fact that, as this blog has analysed, world commodity prices stopped falling between December and the end of March – Figure 3. This, as was noted here, was likely to slow the decline of China’s inflation rate and therefore the March figure was not highly surprising. What is significant, however, is that late in March and so far in April a new downturn in international commodity prices started, probably under the impact of softening in the global economy – Figure 3. If that downturn continues then, as analysed here, it would be expected that China’s CPI would start to decline again.
Therefore, to have a perspective on China’s economy, world commodity prices and China’s CPI in April must be watched closely. If global commodity price changes continue their downwards trend it would also be anticipated, on the basis of existing trends, that China’s CPI will also fall – creating further room for expansionary policies. If world commodity prices were to fall, but China’s CPI did not, it would indicate that existing correlations between global commodity prices and China’s CPI no longer held.
April will therefore be a significant month not only for China’s economy but for the theoretical analysis of it.
After stability from December to March world commodity prices have started falling again - Figure 1. This indicates global economic softening but good news for China’s inflation and therefore increased possibilities for China’s economic policy to adopt an expansionary approach.
Looking at the trends in greater detail, world commodity prices fell sharply during the second half of 2011. The Dow Jones-UBS spot commodity index fell from a year on year increase of 46.4% in June 2011 to a fall of minus 7.8% in December 2011. However then until mid-March 2012 no further decline occurred. As China’s consumer price index (CPI) is highly correlated with global commodity prices this raised the danger that inflationary pressures in China had ceased lessening - with negative consequences for the ability of China to undertake expansionary economic policies.
However during the latter part of March and the beginning of April 2012 commodity prices resumed their year on year fall. By 5 April the Dow Jones-UBS spot commodity index had fallen 12.9% below its level a year previously.
As commodity prices are an extremely sensitive and up to date indicator of global economic conditions two conclusions may be drawn from this.
Because of the significance of such trends further development of world commodity prices must be be watched closely.
Protectionist measures by the US government have received considerable publicity. These include tariffs against China's solar panel exports, the dispute over rare earths, a bill against "subsidized" exports passed by both houses of the US Congress and other steps.
These measures are real. But it is also important not to exaggerate them. Protectionism is not the main trend in the global economy. This is shown both by factual economic trends and considering the underlying forces at work. Protectionist measures affect trade at the margins but do not alter the core of world trade which continues to expand.
To show this first consider the facts. The volume of world trade fell severely during the international financial crisis, declining by 19.7 percent between April 2008 and May 2009. But it then more than recovered. According to the latest available data, by January 2012 the volume of world trade was 4.8 percent above pre-crisis levels - Figure 1.
After the financial crisis US imports fell sharply, from 15.7 percent of GDP in the third quarter of 2008 to 10.6 percent of GDP in the second quarter of 2009, but then recovered to 14.8 percent of GDP by the fourth quarter of 2011.
Regarding relations between China and the US, frequently seen as the main area of protectionism, in dollar terms China's exports to the US rose 22 percent between their pre-crisis peak in September 2008 and the same month in 2011, well above the 15.4 percent increase to the EU, and not far behind the 27 per cent increase to Japan. In short, US post-financial crisis trends showed trade recovery, not deepening protectionism. Nor was protectionist actions even the main trend in trade between the US and China.
Claims that protectionism is the dominant trend in the world economy are therefore factually exaggerated, and take individual developments out of context without examining their overall weight.
Analysis of fundamental economic forces confirms why protectionism is not the main trend. Modern production is on such a large scale that it cannot find an adequate market for its volume of production, at efficient levels, purely within a national economy. That is why, for example, China's reform and opening-up was necessary, but exactly the same pressures affect the US.
Even in 1929 serious retreat into protectionism led to disastrous economic decline and crisis, culminating in economic and political destabilization of all countries and finally world war. Today, when production is on a far larger scale than 1929, the economic results would be more catastrophic. This is why all major economies have so far rejected large-scale protectionism.
Fundamental economic analysis therefore confirms what the facts reveal, that certainly there will be some protectionist actions, but these will be at the margins, and globalization, not protectionism, will remain the main trend in the world economy.
Nor is protectionism likely to be the main instrument of US 'neo-cons' or a Republican president. US neo-cons have much experience in how to slow Asian economies. This was successfully achieved against Japan and then the South East Asian "Tiger" economies during the 1997 debt crisis. In neither case was protectionism the main weapon.
The first 'neo-con' strategy was to transfer disputes from the economic realm, where the US is gradually weakening, to the military and political fields, where the US remains much stronger.This tactic is followed in the US 'pivot' toward the Asia-Pacific region.
Within the economic realm the main methods US 'neo-cons' used were forcing other countries to overvalue their currency, forcing cuts in investment levels, which slow economies, and lower foreign inward investment to reduce technology transfer. All these methods are being attempted against China. Protectionism is not dominant in any of these methods.
Attention must certainly be paid to real protectionist measures but exaggerating the degree of protectionism is factually incorrect, not based on analysis of the world economy's main forces, and fails to identify the main economic tactics used by US 'neo-con' circles.
Competition within globalization, not protectionism, is still the world economy's main trend.
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Economic development’s purpose is to improve the conditions of human beings. Robert Lucas put it eloquently, in frequently quoted words, examining the consequences of different rates of economic growth: ‘I do not see how one can look at these figures without seeing them as possibilities. Is there some action a government of India could take that would lead the Indian economy to grow… If so, what, exactly?… The consequences for human welfare involved in questions like these are simply staggering: Once one starts to think about them, it is hard to think about anything else.’
In this framework it should be stated, soberly and with due consideration, that China’s economy since 1978 is the greatest economic achievement in world history. This article shows this in the prosaic language of statistics. But of course that is not the real issue. What really counts is the consequences of this for human beings – escape from poverty, improvement in life expectancy, improved health, expanded potential for education, improvement in the position of women, and many other dimensions. Economic statistics, such as GDP per capita, simply underpin this improvement in human conditions.
The scale of China’s economic achievement
A problem in assessing the true scale of China’s economic achievement is that partial statistics are frequently used to state it. Some of these, for example that China has become the world’s second largest economy, or that it has raised 620 million people out of internationally defined poverty, are extremely striking (Quah, 2010). But nevertheless, because they are partial, they do not capture the full scope of what has occurred. Only when systematic data is used does the full magnitude of China’s achievement become clear.
Again, even when systematic comparisons are attempted, the scale of China’s economic achievement is frequently underestimated because inappropriate measures are used. For example when comparing rates of economic growth, in calculating contributions to economic welfare, it is misleading to take individual countries as the unit of comparison, rather than the proportion of world population affected – rapid economic growth in a small country evidently contributes less to human well being than rapid growth in a large country.
In order to give an initial systematic comparison, therefore, Table 1 shows the percentage of world population affected at the point when sustained rapid growth commenced in major economies. For example the first country to experience sustained rapid economic growth was the UK in the industrial revolution - which was in a country with 2.0 per cent of the world’s population. The sustained rapid US economic growth after the Civil War was in a country with 3.3 per cent of the world’s population.
There are, of course, arguments about some additional individual countries that might be included in the comparison – for example Italy from 1950 (1.9 per cent of the world’s population) or Spain from 1960 (1.0 per cent of the world’s population). But it is evident from the data that introducing such extra countries makes no difference to the essential situation.
No other economy starting sustained rapid economic growth even approaches the 22.3 per cent of the world’s population in China in 1978 at the beginning of its new economic policies. For comparison Japan’s rapid post-World War II growth was in a country with 3.3 per cent of the world’s population, and the growth of the four Asian ‘Tigers’ (Hong Kong, Singapore, South Korea, and Taiwan) was in economies with only 1.4 per cent of the world’s population.
Only India’s sustained economic growth after the late 1980s, in a country with 16 per cent of the world’s population, even begins to approach China’s achievement in scale, but the percentage of the world population affected is still lower than China’s, as is India’s growth rate.
Introducing the necessary correction of population size also makes clear that the method sometimes utilised of ranking by country size is misleading. To see why it need only be noted that, if current exchange rates are used, on the World Bank tables for 2010, the latest year for which comprehensive statistics are available, 87 of the countries for which data was available have a higher GDP per capita than China and 83 had a lower. This appears to place China about half way up the list of world rankings. As when the People’s Republic of China was created in 1949, or economic reform was launched in 1978, China was one of the world’s most economically underdeveloped countries this might appear a quite good performance, but it wholly understates China’s achievement.
The reason is that ranking by country takes no account of relative population. For example among the countries above China are the Seychelles, Palau, St Kitts and Nevis, Dominica, and Antigua and Barbuda – all with a population of less than 100,000. If the real international position of China is to be assessed then, again, size of population must be taken into account. Figure 1 below, therefore, shows the percentages of world population living in countries with GDP per capita above and below China and shows the real proportions of China’s economic achievement.
In 1978 countries containing only 0.5 per cent of the world’s population had a GDP per capita below China’s, while 73.5 per cent had a higher one – China itself accounted for 25.9 per cent of the world’s population for which data was available. By 2010, using the same measure, the percentage of the world’s population living in countries with a higher GDP per capita than China was 31.3 per cent - given the speed of increase, it is clear that when 2011’s data is published it will show that less than 30 per cent of the world’s population lives in countries with a higher GDP per capita than China.
Therefore in only slightly over thirty years China, containing more than twenty per cent of the world’s population, has moved from being one of the world’s least economically developed countries, to a position where less than one third of the world’s population lives in countries with a higher GDP per capita, and where China’s position is rising rapidly.
Checking these current price statistics against international parity purchasing powers (PPPs), which takes into account different price levels in different countries, confirms the same result. Measured by PPPs in 1980, the first year for which World Bank data is available, only 1.3 per cent of the world’s population lived in countries with lower GDP per capita than China and 73.0 per cent in countries with a higher one. By 2010 only 31.5 per cent of the world’s population lived in countries with a higher GDP per capita than China.
Another way of measuring is to compare China to the rest of the world’s population. To do this, the best measure is not the average as, for well known statistical reasons, averages covering wide ranges are excessively affected by small numbers of extreme values. This is confirmed very clearly by world data. Only 25 per cent of the world’s population has a GDP per capita above the global average and 75 per cent have one below it. A better, and the standard, measure of incomes is to make a comparison to the median – the exact mid-point.
In 1978 China’s GDP per capita was only 42 per cent of the median for the rest of the world’s population. By 2010 China’s GDP per capita was 289 per cent of the median.
That since 1978 China, with more than one fifth of the world’s population, has moved from being one of the poorest countries in the world to a situation where less than one third of the world’s population has a higher GDP per capita is without historical precedent. Never before in human history has such a large proportion of the world’s population advanced so rapidly.
A number of conclusions clearly follow from the above data – in addition to the obvious one of simply recognising this as a fact of economic history. But for now it need simply be noted, soberly and with due measure, that China’s is quite literally the greatest economic achievement in world history.
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An earlier and shorter version of this article appeared, in English and Chinese, in Global Times.
The international importance of China’s economy is twofold. The first is practical - the scale of China’s economic growth, its global impact, and the consequences for the improvement of the social conditions of China and the world’s population. The second is theoretical, including the potential international applicability of conclusions drawn from China’s economic policies.
Regarding the latter it is necessary to clearly state that no country can mechanically copy another. As China’s political leaders and economic theorists stress its economy has unique ‘Chinese characteristics’. This was formulated as a cardinal principle by the initiator of China's economic reform, Deng Xiaoping: ‘To accomplish modernization of a Chinese type, we must proceed from China’s special characteristics.’ (Deng, 30 March 1979) Therefore China must: ‘blaze a path of our own.’ (Deng, 21 August 1985). As recently reiterated by Justin Yifu Lin, Chinese Chief Economist and Senior Vice President of the World Bank: ‘we can never be too careful when it comes to the application of a foreign theory, because with different preconditions, no matter how trivial they seem, the result can be very different.’ (Lin, 2012, pp. 66 - emphasis in the original) In that sense, therefore, there is no ‘Chinese model’. However as Lin simultaneously states: ‘Some may think that the performance of a country as unique as China, with more than 1.3 billion people, cannot be replicated. I disagree. Every developing country can have similar opportunities to sustain rapid growth for several decades and reduce poverty dramatically if it exploits the benefits of backwardness, imports technology from advanced countries, and upgrades its industries.’ (Lin, 2011)
There is, however, no contradiction between these different statements. The fundamental structural elements of which an economy is composed (consumption, investment, savings, primary industry, secondary industry, tertiary industry, trade, money etc.) are universal. However the particular way in which these elements combine and are interrelated in any economy is unique and entirely specific both in place and time – which is why no country can copy another’s economic policy, while it can learn from other economies. As analysed below, China has solved in practice problems stated in general macro-economic theory. For that reason such elements, in very different forms and combinations, are of major importance for economic policy elsewhere. However the specific forms and combinations in which such policies are applied are entirely unique both in each country and at different points in time.
The practical impact of China’s economic rise have been considered extensively elsewhere.1 The focus of this article is on the theoretical economic issues. In particular it aims to relate China’s economic performance to Western economic theory which will be more familiar to most readers.
China’s ‘reform and opening up’ process under Deng Xiaoping was, of course, formulated in a Marxist economic framework. It can indeed be clearly outlined in those terms – see the appendix below, for a more detailed account of Chinese discussions on these issues see (Hsu, 1991), but an alternative statement in Western economic terms, those of Keynes, is considered here.
Stated briefly in Marxist terms, China’s reform policy included a critique of Soviet economic policy that this had made the error of confusing the ‘advanced’ stage of socialism/communism, in which the regulation of the economy is ‘for need’, and therefore not market regulated, with the socialist, or more precisely ‘primary’ developing stage of socialism, during which the transition from capitalism to an advanced socialist economy takes place and in which market regulation takes place. This transition should be conceived as extending over a prolonged period. The final formulation arrived at was that China’s was a ‘socialist market economy with Chinese characteristics’. Contrary to suggestions by some writers, for example (Hsu, 1991), such an analysis is in line with Marx’s own writings although, as shown below, it is not necessary to be a Marxist understand it - a more detailed analysis is given in the appendix.
This debate was framed in Chinese terms, without primary reference to previous economic theory in other countries other than Marx himself. The approach, in a Chinese phrase emphasised by Deng, was to ‘seek truth from facts’ (Deng, 2 June 1978). In practical terms in China, such analysis meant abandonment of an administratively planned economy and substitution of a market economy in which the state would control certain key macroeconomic parameters. In terms of ownership it led to ‘Zhuada Fangxiao’ – maintaining large state firms and releasing small ones to the non-state/private sector.
Restatement of Chinese economic policy in terms of Keynesian economics
Most people in the US and Europe are unaware of, or disagree with, Marxist economic categories. To make the essential economic policies clear, therefore, this article will put them in more familiar terms of Western economics – those of Keynes. The proviso is that this is the actual Keynes of The General Theory of Employment Interest and Money - not the vulgarised version in economics textbooks. Geoff Tily’s Keynes Betrayed (Tily, 2007) is one of the best in a series of works outlining the difference between the two. However, there is no substitute for reading Keynes General Theory itself, which differs sharply from the presentation of what is frequently presented as ‘Keynesian’ economics. For example, budget deficits play only a secondary role in both Keynes General Theory and in China’s stimulus packages – even during 2009’s maximum anti-crisis measures China’ s budget deficit was only 3% of GDP. The core of Keynes’ General Theory itself, unlike vulgarisations, centres on factors determining investment. It is therefore through this optic that both Keynes and Chinese economic strategy can be best approached.
In the founding work of classical economics, The Wealth of Nations, Adam Smith identified division of labour as the fundamental force raising productivity, stating as the opening sentence of the first chapter: ‘The greatest improvement in the productive powers of labour, and the greater part of the skill, dexterity, and judgement with which it is any where directed, or applied, seems to have been the effects of the division of labour.’ (Smith, 1776, p. 13) Smith concluded that a necessary consequence of the increasing division of labour was that the proportion of the economy devoted to investment rose with economic development: ‘accumulation of stock must, in the nature of things, be previous to the division of labour, so labour can be more and more subdivided in proportion only as stock is previously more and more accumulated… As the division of labour advances, therefore, in order to give constant employment to an equal number of workmen, an equal stock of provisions, and a greater stock of materials and tools than what would have been necessary in a ruder state of things must be accumulated beforehand.’ (Smith, 1776, p. 277) A more comprehensive treatment of Smith’s views may be found in (Ross, 2011). Marx reached the same conclusion as Smith, concluding that the contribution of investment rose as an economy developed, which he termed the rising ‘organic composition of capital’ (Marx, 1867, p. 762).
Keynes similarly analysed that the proportion of the economy devoted to investment rose with economic development. His explanation was, however, somewhat different to Smith’s as Keynes rooted this in rising savings levels accompanying development. As the percentage of income consumed fell with increasing wealth, the proportion devoted to saving necessarily rose proportionately: ‘men are disposed… to increase their consumption as their income increases, but not by as much as the increase in their income… a higher absolute level of income will tend… to widen the gap between income and consumption.’ (Keynes, 1936, p. 36) As total savings necessarily equals total investment, a rising proportion of saving therefore necessarily means a rising proportion of investment.
A necessary consequence of an increase in the proportion of the economy devoted to investment is that any investment decline will have increasingly serious consequences: ‘the richer the community, the wider will tend to be the gap between its actual and its potential production… For a poor community will be prone to consume by far the greater part of its output, so that a very modest measure of investment will be sufficient to provide full employment; whereas a wealthy community will have to discover much ampler opportunities for investment if the saving propensities of its wealthier members are to be compatible with the employment of its poorer members. If in a potentially wealthy community the inducement to invest is weak… the working of the principle of effective demand will compel it to reduce its actual output, until, in spite of its potential wealth, it has become so poor that its surplus over its consumption is sufficiently diminished to correspond to the weakness of the inducement to invest.’ (Keynes, 1936, p. 31)
Failure of attempts to refute Keynes on the rising proportion of investment
In the mid-20th century attempts were made to dispute this conclusion of classical economics, originally deriving from Smith, of a rising proportion of investment in the economy - Milton Friedman devoted a book, A Theory of the Consumption Function, to attempting to refute Keynes on this (Friedman, 1957). However modern econometrics findings are conclusive in support of Smith and Keynes and against Friedman – the definitive demonstration, as frequently on matters of long term economic growth, being given by Angus Maddison. (Maddison, 1992) Factually, as classical economics and Keynes analysed, the trend is for the proportion of the economy devoted to investment to rise. To illustrate this, Figure 1 shows the percentage of fixed investment in GDP of the leading economies of successive periods of growth over the 300-year period for which meaningful statistics exist.
A reason Friedman attempted, unsuccessfully, to refute Keynes over the rising proportion of investment in the economy is that such a trend, as will be seen, is potentially destabilising - Friedman noted: ‘the central analytical proposition of the [theoretical] structure is the denial that the long-run equilibrium position of a free enterprise economy is necessarily at full employment.’ (Friedman, 1957, p. 237)
There is a parallelism between Keynes’s analysis and Marx’s regarding the role of profit and investment. The latter noted that without offsetting factors, a rise in the proportion of investment in the economy would led to a falling rate of profit as a necessary consequence of a rise in capital relative to the profits stream – i.e. Increasing division of labour, through its effect in raising investment as proportion of the economy, as analysed by Smith, created a tendency to a declining rate of profit (Marx, 1894, pp. 317-375).
Keynes also approached economic fluctuations via profit: ‘The trade cycle is best regarded… as being occasioned by a cyclical change in the marginal efficiency of capital.’ (Keynes, 1936, p. 313) However, Keynes specific development was to approach the potentially destabilising consequences of the rising proportion of investment in the economy via effective demand.
Effective demand is composed of both consumption and investment, with the latter, as noted, tending to rise relative to the former over time. Keynes therefore noted: ‘when aggregate real income is increased aggregate consumption is increased but not by as much as income… Thus to justify any given amount of employment there must be an amount of current investment sufficient to absorb the excess of total output over what the community chooses to consume when employment is at the given level… It follows… that given what we shall call the community’s propensity to consume, the equilibrium level of employment, i.e. the level at which there is no inducement to employers as a whole either to expand or to contract employment, will depend on the amount of current investment.’ (Keynes, 1936, p. 27)
Keynes noted no automatic mechanism ensures a necessary volume of investment to maintain effective demand: ‘the effective demand associated with full employment is a special case… It can only exist when, by accident or design, current investment provides an amount of demand just equal to the excess of the aggregate supply price of the output resulting from full employment over what the community will choose to spend on consumption when it is fully employed.’ (Keynes, 1936, p. 28) Put aphoristically: ‘An act of individual saving means – so to speak – a decision not to have dinner today. But it does not necessitate a decision to have dinner or buy a pair of boots a week hence or a year hence.’ (Keynes, 1936, p. 210). In more technical terminology: ‘The error lies in proceeding to the … inference that, when an individual saves, he will increase aggregate investment by an equal amount.’ (Keynes, 1936, p. 83)
Any investment shortfall would be amplified by the well known economic ‘multiplier’ into much stronger cyclical fluctuations: ‘It is… to the general principle of the multiplier to which we have to look for an explanation of how fluctuations in the amount of investment, which are a comparatively small proportion of the national income, are capable of generating fluctuations in aggregate employment and income so much greater in amplitude than themselves.’ (Keynes, 1936, p. 122) Such fluctuations in investment, combined with consumption, in turn determined employment: ‘The propensity to consume and the rate of new investment determine between them the volume of employment.’ (Keynes, 1936, p. 30)
From this analysis Keynes derived key policy conclusions.
One, well known, is countering recession with budget deficits, which Keynes dealt with as ‘loan expenditure’ – vulgarisation of Keynes lies in reducing his theories to support for budget deficits, not in the fact that he supported deficit spending. Keynes noted: ‘”loan expenditure” is a convenient expression for the net borrowing of public authorities on all accounts, whether on capital account or to meet a budgetary deficit. The one form of loan expenditure operates by increasing investment and the other by increasing the propensity to consume.’ (Keynes, 1936, p. 128)
Therefore, in a famous passage: ‘If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coalmines… and leave it to private enterprise… to dig the notes up again... with the help of repercussions, the real income of the community, and its capital wealth also, would probably become a good deal greater… It would, indeed, be more sensible to build houses and the like; but if there are political and practical difficulties in the way of this, the above would be better than nothing.’ (Keynes, 1936, p. 130)
Such a view of deficit spending naturally did not mean Keynes was indifferent to what deficits should be spent on - today environmentally sustainable investment would be added to his existing list. He had scathing contempt for double standards regarding when deficits were justifiable: ‘Pyramid-building, earthquakes, even wars… may serve to increase wealth, if… our statesmen… stands in the way of anything better… common sense… has been apt to reach a preference for wholly “wasteful” forms of loan expenditure rather than for partly wasteful forms, which because they are not wholly wasteful, tend to be judged on strict “business” principles. For example, unemployment relief financed by loans is more readily accepted than the financing of improvements at a charge below the current rate of interest…wars have been the only form of large-scale loan expenditure which statesmen have thought justifiable.’ (Keynes, 1936, p. 129)
While Keynes supported deficit spending, the causes of recession lay in more fundamental factors affecting investment, which in turn were affected by interest rates: ‘the succession of boom and slump can be described and analysed in terms of the fluctuations of the marginal efficiency of capital relatively to the rate of interest.’ (Keynes, 1936, p. 144) This was because marginal efficiency of capital was ‘equal to the rate of discount which would make the present value of the series of annuities given by returns expected from the capital-asset during its lift just equal to its supply price.’ (Keynes, 1936, p. 135) Consequently, ‘inducement to invest depends partly on the investment-demand schedule and partly on the rate of interest.’ (Keynes, 1936, p. 137)
As investment was affected by interest rates, therefore, a crucial issue to maintain investment at a sufficient level to sustain effective demand was a low interest rate. This problem, in turn, tended to become more acute because of the rising proportion of the economy devoted to investment: ‘Not only is the marginal propensity to consume weaker in a wealthy community, but owing to its accumulation of capital being already larger, the opportunities for further investment are less attractive unless the rate of interest falls at a sufficiently rapid rate; which brings us to the theory of the rate of interest and… reasons why it does not automatically fall to the appropriate levels.’ (Keynes, 1936, p. 31)
The aim of low interest rates was to relaunch investment by ensuring that the return on investment was above the rate of interest plus whatever was the required premium to overcome liquidity preference. But, as Keynes openly acknowledged, such low term interest rates destroy the ability to live from income from interest – which is why, in his famous phrase, Keynes foresaw ‘euthanasia of the rentier.’ (Keynes, 1936, p. 376) He concluded: ‘I see… the rentier aspect of capitalism as a transitional phase which will disappear.’ (Keynes, 1936, p. 376)
Nevertheless, despite support for low interest rates Keynes, did not judge these would be likely by themselves to overcome the effects of an investment decline. It would therefore be necessary for the state to play a greater role: ‘Only experience… can show how far management of the rate of interest is capable of continuously stimulating the appropriate volume of investment… I am now somewhat sceptical of the success of a merely monetary policy directed towards influencing the rate of interest… I expect to see the State… taking an ever greater responsibility for directly organising investment.’ (Keynes, 1936, p. 164) Consequently Keynes believed that regulating the level of investment would have to be undertaken by the state and not by the private sector: ‘I conclude that the duty of ordering the current volume of investment cannot safely be left in private hands.’ (Keynes, 1936, p. 320) It was necessary, therefore, to aim at ‘a socially controlled rate of investment.’ (Keynes, 1936, p. 325)
If, however, the state were to determine ‘the current volume of investment’ then this led Keynes to the conclusion: ‘It seems unlikely that the influence of banking policy on the rate of interest will be sufficient by itself to determine an optimum rate of investment. I conceive, therefore, that a somewhat comprehensive socialisation of investment will prove the only means of securing an approximation to full employment.’ (Keynes, 1936, p. 378)
Keynes noted that this ‘somewhat comprehensive socialisation of investment’ did not mean the elimination of the private sector, but socialised investment operating together with a private sector: ‘This need not exclude all manner of compromises and devices by which public authority will co-operate with private initiative… the necessary measures of socialisation can be introduced gradually and without a break in the general traditions of society… apart from the necessity of central controls to bring about an adjustment between the propensity to consume and the inducement to invest there is no more need to socialise economic life than there was before…. The central controls necessary to ensure full employment will, of course, involve a large extension of the traditional functions of government.’ (Keynes, 1936, p. 378)
It is now possible to clearly see the structure of Keynes’s argument. The rising proportion of the economy devoted to investment meant any downturn in the latter would have increasingly destabilising consequences. Budget deficits could deal with this to some degree, but as the key element was investment, which was determined by interaction between profits and interest rates, low interest rates was necessary. This would lead to the ‘euthanasia of the rentier’. However it was unlikely interest rates would be sufficient themselves and therefore the state would need to step in with ‘a somewhat comprehensive socialisation of investment’ which would however work alongside a private sector.
Tracing this argument one has now arrived at a ‘Chinese’ economic structure - although approaching it via a Keynesian and not a Marxist framework. ‘Zhuada Fangxiao’, grasping large state firms and releasing small ones to the non-state/private sector, coupled with abandonment of quantitative planning, means that China’s economy is not being regulated via administrative means but by general macro-economic control, including centrally of the level of investment – as Keynes advocated.
What is the overall significance of this? Deng Xiaoping’s most famous economic statement is ‘cats theory’ – ‘it doesn’t matter whether a cat is black or white provided it catches mice’. But ‘cats theory’ can be applied to economics itself – it doesn’t matter whether something is described in Marxist or Western economic terms provided the same economic policies exist. ‘Zhuada Fangxiao’ may be arrived at from either a Keynesian or a Marxist framework.
But while one may be indifferent to the colour of theoretical cats it is not possible to be indifferent as regards the policy measures to be taken – steps in budget deficits, interests rates, investment etc are material and precise. Here there is a radical difference in between the US and Europe on one side and China on the other.
In the US and Europe budget deficits have been utilised – although they are under increasing attack. Low central bank interest rates have been pursued and some forms of quantitative easing, driving down long term interest rates through central bank purchases of debt, have been used. But no serious programmes of state investment have been launched – let alone Keynes’s ‘somewhat comprehensive socialisation of investment’.
In China, in contrast, relatively limited budget deficits have been combined with low interest rates, a state owned banking system (‘euthanasia of the rentier’) and a huge state investment programme. While the West’s economic recovery programme has been timid, China has pursued full blooded policies of the type recognisable from Keynes General Theory as well as its own ‘socialism with Chinese characteristics.’ Why this contrast and why has China’s stimulus package been so much more successful than the West’s?
Because in the US and Europe, of course, it is held that the colour of the cat matters very much. Only the private sector coloured cat is good, the state sector coloured cat is bad. Therefore even if the private sector cat is catching insufficient mice, that is the economy is in severe recession, the state sector cat must not be used to catch them. In China both cats have been let lose – and therefore far more mice are caught.
The recession in the Western economies, as foreseen by Keynes, is driven by decline in investment – in most countries decline in fixed investment accounted for two thirds to more than ninety per cent of the GDP fall (Ross, Li, & Xu, 2010). Keynes’s calls for not only budget deficits and low interest rates but also for the state to set about ‘organising investment’ are evidently required. But this is blocked because the state coloured cat is not allowed to catch mice.
To put it another way, the US and Europe insist on participating in a race while hopping on only one leg – the private sector. China is using two legs, so little wonder it is running faster.
To turn from metaphors to economic measures, a large scale state financed house building programme, or large scale expansion of transport, of the type China is following as part of anti-crisis measures not only delivers goods that are valuable in themselves but boosts the economy through macro-economic effects in raising investment. But in the West such state investment is blocked as it creates competition for the private sector. As the top aim in the US and Europe is not to revive the economy, but to protect the private sector, therefore such large-scale investment must not be undertaken.
It is an irony. Keynes explicitly put forward his theories to save capitalism. But the structure of the US and European economies has made it impossible to implement Keynes’s policies even when confronted with the most severe recession since the Great Depression. The anti-crisis measures of China’s ‘socialist market economy’ are far closer to those Keynes foresaw that any capitalist economy. Whereas in the US, for example, fixed investment fell by over twenty five per cent during the financial crisis in China urban fixed investment rose by over thirty per cent. Consequently, there is no mystery why China’s economy has grown by 41.4 per cent in the four years since the peak of the last US business cycle, in the 4th quarter of 2007, while the US economy has grown by 0.7 per cent.
Deng Xiaoping famously said his death was ‘going to meet Marx’. But Deng may also be having an intense talk with John Maynard Keynes. And Keynes would be interested to discuss with Deng’s two cats – who appear to have read the General Theory more closely and accurately than any administration in the West.
Put in more prosaic terms, China’s economic structure, because it allowed ‘a socially controlled rate of investment’ and a ‘somewhat comprehensive socialisation of investment’, could utilise policy tools developed by Keynes but the US and European economies could not. Although Keynes explicitly wished to save capitalism it turned out that Western capitalism could not use his tools, but China’s ‘socialism with Chinese characteristics’ could. Deng Xiaoping could not fit in the framework of Keynes, but Keynes could fit rather neatly within the framework of Deng Xiaoping.
In the article above an account has been given of China’s macro-economic policy in terms of a theoretical framework derived from Keynes. Deng Xiaoping, however, as a Communist naturally explicitly formulated China’s economic policy in Marxist terms - China’s economic reform policies were seen as the integration of Marxism with the specific conditions in China. More precisely Deng stated: ‘We were victorious in the Chinese revolution precisely because we applied the universal principles of Marxism-Leninism to our own realities.’ (Deng, 28 August 1985) Consequently: ‘Our principle is that we should integrate Marxism with Chinese practice and blaze a path of our own. That is what we call building socialism with Chinese characteristics.’ (Deng, 21 August 1985)
Authors, including (Hsu, 1991), have contended that Deng’s economic policies were not in accord with those of Marx. However while China’s economic policies clearly differed from those of the USSR after the introduction of the First Five Year Plan in 1929, which introduced comprehensive planning and essentially total state ownership, it is clear that China’s economic policies were in line with those indicated by Marx. Whether people wish to formulate Chinese economic policy in Keynesian or Marxist terms may be left to them. What is most crucial is not the colour of the cat but whether it catches mice – that is, the practical policy conclusions drawn. This appendix therefore briefly shows that Deng’s essential concepts in launching China’s economic reform in in 1978 corresponded to Marx’s.
The primary stage of socialism
Regarding China’s economic reform policies Deng noted, as stated in Marxist terms, that China was in the socialist and not the (higher) communist stage of development. Large scale development of the productive forces/output was the prerequisite before China could make the transition to a communist society: ‘A Communist society is one in which there is no exploitation of man by man, there is great material abundance, and the principle of from each according to their ability, to each according to his needs is applied. It is impossible to apply that principle without overwhelming material wealth. In order to realise communism, we have to accomplish the tasks set in the socialist stage. They are legion, but the fundamental one is to develop the productive forces.’ (Deng, 28 August 1985) More precisely, in a characterisation maintained to the present, China was in the ‘primary stage’ of socialism, which was fundamental in defining policy: ‘‘The Thirteenth National Party Congress will explain what stage China is in: the primary stage of socialism. Socialism itself is the first stage of communism, and here in China we are still in the primary stage of socialism – that is, the underdeveloped stage. In everything we do we must proceed from this reality, and all planning must be consistent with it.’ (Deng, 29 August 1987)
The fundamental characterisations by Deng have been maintained to the present – thus for example in July 2011 President Hu Jintao stressed that ‘China is still in the primary stage of socialism and will remain so for a long time to come’ (Xinhua, 2011), while speaking to the UN premier Wen Jiabao noted ‘Taken as a whole, China is still in the primary stage of socialism’ (Xinhua, 2010). The conclusion flowing from this as noted by Hsu, was that: ‘From this perspective, a serious error in the past was the leftist belief that China could skip the primary stage and practice full socialism immediately.’ (Hsu, 1991, p. 11)
The conclusion of such a contrast between a primary socialist stage of development and and the principle of a communist society (which, as noted by Deng above, was regulated by ‘from each according to their ability to each according to each according to his needs’) was that in the present 'socialist' period the principle was ‘ to each according to their work’: ‘We must adhere to this socialist principle which calls for distribution according to the quantity and quality of an individual’s work.’ (Deng, 28 March 1978) In Marxist theory, outlined by Marx in the opening chapter of Capital (Marx, 1867), economic distribution according to work/labour is the fundamental principle of commodity production – and a commodity necessarily implies a market. In this socialist period a market would therefore exist – hence the eventual Chinese terminology of a ‘socialist market economy.’ As presented by Deng Xiaoping and his successors above such Chinese analysis is highly compressed but clearly in line with Marx himself.
It is clear Marx envisaged that the transition from capitalism to communism would be a prolonged one, noting in The Communist Manifesto: ‘The proletariat will use its political supremacy to wrest, by degree, all capital from the bourgeoisie, to centralise all instruments of production in the hands of the State, i.e., of the proletariat organised as the ruling class; and to increase the total productive forces as rapidly as possible.’ (Marx & Engels, 1848, p. 504) The ‘by degree’ may noted – Marx therefore clearly envisaged a period during which state owned property and private property would exist. China’s system, after Deng, of simultaneous existence of sectors of state and private ownership is therefore clearly more in line with Marx’s conceptualisation than Stalin’s introduction ‘all at once’ of essentially 100 per cent state ownership in 1929.
Regarding Deng’s formulations on communist society being regulated by ‘to each according to their need’ versus the primary stage of socialism regulated by ‘each according to their work’ Marx noted in the Critique of the Gotha Programme of the post-capitalist transition to a communist society: ‘What we are dealing with here is a communist society, not as it has developed on its own foundations, but on the contrary, just as it emerges from capitalist society, which is thus in every respect, economically, morally, and intellectually, still stamped with the birth-marks of the old society from whose womb it emerges.’ (Marx, 1875, p. 85)
In such a transition Marx outlined payment in society, and distribution of products and services, necessarily had to be 'according to work' even within the state owned sector of the economy:‘Accordingly, the individual producer receives back from society - after the deductions have been made - exactly what he gives to it. What he has given to it is his individual quantum of labour. For example, the social working day consists of the sum of the individual hours of work; the individual labour time of the individual producer is the part of the social working day contributed by him, his share in it. He receives a certificate from society that he has furnished such-and-such an amount of labour (after deducting his labour for the common funds); and with this certificate, he draws from the social stock of means of consumption as much as the same amount of labour cost. The same amount of labour which he has given to society in one form, he receives back in another.
‘Here obviously the same principle prevails as that which regulates the exchange of commodities, as far as this is exchange of equal values…. as far as the distribution of the latter among the individual producers is concerned, the same principle prevails as in the exchange of commodity equivalents: a given amount of labour in one form is exchanged for an equal amount of labour in another form.
‘Hence, equal right here is still in principle - bourgeois right… The right of the producers is proportional to the labour they supply; the equality consists in the fact that measurement is made with an equal standard, labour.’ (Marx, 1875, p. 86)
In such a society inequality would necessarily still exist: ‘one… is superior to another physically or mentally and so supplies more labour in the same time, or can labour for a longer time; and labour, to serve as a measure, must be defined by its duration or intensity, otherwise it ceases to be a standard of measurement. This equal right is an unequal right for unequal labour... it tacitly recognises the unequal individual endowment and thus the productive capacities of the workers as natural privileges. It is, therefore, a right of inequality in its content like every right. Right by its very nature can consist only as the application of an equal standard; but unequal individuals (and they would not be different individuals if they were not unequal) are measurable by an equal standard only insofar as they are made subject to an equal criterion, are taken from a certain side only, for instance, in the present case, are regarded only as workers and nothing more is seen in them, everything else being ignored. Besides, one worker is married, another not; one has more children than another, etc. etc.. Thus, given an equal amount of work done, and hence an equal share in the social consumption fund, one will in fact receive more than another, one will be richer than another, and so on. To avoid all these defects, right would have to be unequal rather than equal.’ (Marx, 1875, pp. 86-87)
Marx considered only after a prolonged transition would payment according to work be replaced with the ultimately desired goal, distribution of products according to members of society’s needs.
‘Right can never be higher than the economic structure of society and its cultural development which this determines.
‘In a higher phase of communist society… after the productive forces have also increased with the all-around development of the individual, and all the springs of common wealth flow more abundantly - only then can the narrow horizon of bourgeois right be crossed in its entirety and society inscribe on its banners: From each according to his abilities, to each according to his needs!’ (Marx, 1875, p. 87)
It is therefore clear that post-Deng policies in China were more in line with Marx’s prescriptions than post-1929 Stalin policies in the USSR. Given the essentially 100 per cent state ownership of industry in China in 1978 'Zhuada Fangxiao' – maintaining the large enterprises within the state sector and releasing the small ones to the non-state sector – together with the creation of a new private sector created an economic structure clearly more in line with that envisaged by Marx than the essentially 100 per cent state ownership in the USSR after 1929. Deng’s insistence on the formula that in the transitional period reward would be ‘according to work’ and not ‘according to need’ was clearly in line with Marx’s analyses. It is notable that in the USSR itself a number of economists opposed Stalin’s post-1929 policies on the same or related grounds – including Buhkarin (Bukharin, 1925) , Kondratiev (Kondratiev), Trotsky (Trotsky, 1931) and Preobrazhensky (Preobrazhensky, 1921-27) (Preobrazhensky, 1921-27). Their works were, however, almost unknown as these issues were ‘resolved’ by Stalin killing those economists who disagreed with him and banning their works - although several accounts have been published outside the USSR – see for example (Jasny, 1972) (Lewin, 1975). China’s economic debates therefore appear to have preceded with reference to China’s conditions and Marx and not any preceding debates in the USSR.
It is therefore clear that China’s post-reform economic policy is in line with Marx’s analysis and that, as stated in Chinese analysis, post-1929 Soviet policy departed from Marx’s analysis – the argument that the converse is true, by Hsu and others, is invalid.
As China’s economic policy and structure can be understood in either Keynesian or Marxist terms it is a more general issue which is to be preferred. ‘It doesn’t matter whether a cat is black or white provided it catches mice’ might appear an appropriate response.
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An earlier and shorter version of this article appeared in Soundings.
Notes and Bibliography