Time for China to move from macro-stability to macro-sustainability: making macro-stimulus work and maintaining its effects

Abstract

We attribute the success of China's monetary–fiscal policies in producing 8.7% growth in 2009 to the following: (1) the capital adequacy ratio requirement was not binding because the banks’ capital had not been reduced by losses on assets like subprime mortgages; (2) the initial fiscal position was sound, and this allowed a substantial expansion of the budget deficit; and (3) the state has direct control over the actions of the state-controlled enterprises and the state-controlled banks, which dominate large segments of the economy, and so could order the state-controlled enterprises to ramp up investments and the state-controlled banks to ramp up lending. However, these quick decisions can be hasty actions that increase the role of the state-controlled firms in the economy and generate non-performing loans in the future. Chinese policy-makers can eliminate the trade-off between maintaining sufficient aggregate demand and ensuring economic efficiency by replacing the present macro-stimulus with new market-friendly growth drivers. Small and medium private banks should be legalized and interest rate liberalized to promote the formation of new private businesses. Farmland should be privatized so that new entrepreneurs would have the collateral to access investment loans. The termination of the household registration system and the adoption of the principle of future home ownership would accelerate high-quality urbanization, whereby the state would build public housing for migrants. China's high economic growth and its integration into the global economy are now threatened by increasing calls in the developed countries, especially in the USA, for protectionism against Chinese exports. As these calls have been prompted by China's chronic trade surplus and by the present deep recession (from the Global Financial Crisis), China should aggressively reduce the trade imbalances (e.g. by removing export rebate, liberalizing imports and modernizing the financial sector) to forestall protectionism.

Keywords:

• Global Financial Crisis
• land privatization
• capital adequacy ratio
• principle of future home ownership
• balance-sheet repair
• demand-replacement therapy

JEL classifications:

• E44
• E51
• E65
• F41
• G21
• O53
• P31

Acknowledgements

This paper benefited tremendously from Wing Thye Woo's participation in the conference Economic Integration in the Greater China Region organized by the Department of Economics and the Social Science Research Centre on Contemporary China at the Universidade de Macau and the Chinese Economists Society in Macao on 29 March 2009. We are very grateful to Kwan Fung, Sun Guang-Zhen and Chen Yu for their kind guidance and patience in the writing and revision of this paper.

Notes

1. Strauss-Kahn (2010).

2. The 2007 Goldman Sachs study is written by Dominic Wilson and Anna Stupnytska (2007).

3. See, for example, Auslin (2009), Cowen (2009) and Forsythe (2009).

4. Chen (2010). See also Barboza (2010).

5. According to the WTO, the changes in world export and import were, respectively, −23% and −24% in value (nominal) term and −12.2% and −12.9% in volume (real) term in 2009; and the changes in China's export and import were, respectively, −16% and −11% in value term and −11.1% and +2.8 in volume term. Trade in current dollar terms dropped more than trade in volume terms because of the fall in the prices of oil and other primary commodities (World Trade Organization 2010).

6. China's holdings of US treasury reached $938.3 billion in September and October 2009. China replaced Japan as the largest US treasury holder at the beginning of 2009. (United States Department of the Treasury 2010).

7. See, for example, Bosworth and Flaaen (2009).

8. According to Top 200 in China's Foreign Trade 2009, an annual report published by China Customs Magazine, among the top 200, 153 firms are foreign-invested firms; their export accounts for 77.8% of total export of the Top 200.

9. There are various estimates on employment involved in export related industries. According to Liu (2005), the commodity and service export provided more than 89 million jobs in 2005.

10. Of the 1.96 million people who lost jobs, 0.4 million were from state-owned enterprises; 0.2 million were from collective-owned enterprises; and 1.4 million were from firms with other ownership structure (e.g. privately owned enterprises, foreign-invested enterprises).

11. Previously, after releasing huge amount of RMB to stabilize the exchange rate of RMB yuan against the dollar, the central bank would sell large amounts of central bank bills to mop up the excess liquidity. Since the fourth quarter of 2008, the central bank almost stopped selling this type of bills during 2009.

12. Ministry of Finance (2009).

13. Ma decomposed the GDP growth rate in 2009 according to the components of demand in the GDP identity and found the contributions of capital formation, consumption (private and government) and foreign trade to be 92.3%, 52.5% and −44.8%, respectively.

14. Other countries which had positive growth rate of the GDP in 2009 are India (6.5%), Indonesia (4.5%), Australia (1%), South Korea (0.2%) and Saudi Arabia (0.2%) (Central Intelligence Agency, The World Factbook).

15. Plafker (2010).

16. Woo and Zhang (forthcoming) show that ‘the value of the money multiplier is zero when CAR is not met; is one when CAR is binding and when the asset purchased by the central bank requires the commercial bank to hold capital against it; and equals the reciprocal of the required reserve ratio when CAR is not binding’.

17. If speculative demand had been the overwhelmingly dominant cause for the property boom, then house rents would not have risen substantially (because the speculative investors would tend to rent out their extra units). Instead, rent in Beijing in March 2010 was 19.6% above that in March 2009 (see China Daily 2010).

18. It should be noted that housing construction is relatively labour-intensive and that home decoration is highly labour-intensive.

19. We do not consider listed banks where the state holds the controlling share (many times through state-controlled intermediaries, e.g. ‘legal persons’) to be private banks in the true sense.

20. The management of state assets and the regulation of the financial sector should also be reformed to eliminate the phenomenon of repeated recapitalization of the SCBs.

21. See, for example, Krugman (2010a, 2010b), Wolf (2010), The New York Times (2010a), and the hard-hitting editorial ‘Will China Listen?’ in The New York Times (2010b). See Woo (2008) for a detailed discussion on the causes of US-China trade tensions

22. For example, Lardy (2007) wrote that the more desired growth path is one marked by ‘a reduction in China's national savings rate’ (p. 10) and by a reduction in ‘China's excessive rate of investment’ (p. 10). The latter ‘is a prerequisite to a successful transition to a more consumption-driven growth path’ (p. 10).

23. Liu and Woo (1994) show formally and empirically that an underdeveloped financial system, ceteris paribus, raises the savings rate and hence increases the current account balance.

24. In order to match the fund granted by the central government, the investment fund pledged by provincial government is as high as 27 trillion yuan.

25. See Woo (2008) for a package of short-run and long-run measures to reduce China's trade imbalances.