This book, with detailed data and convincing arguments, describes the economy imbalance in China in four approaches before and after the financial crisis and also provides reforming suggestions to rebalance the economy, namely fiscal policy reform, financial reform, exchange rate reform and price reform.
1. Chapter 1:
Chinese QE is different from US’s in the sense that after the occurrence of financial tsunami Chinese government increased expenditures on affordable housing, rural and other infrastructure, public health and education, the environment, and technical innovation, while US cut tax for households. In addition, Chinese policy aims to stimulate the real demand for loans mainly bank lending by lowering the benchmark interest rate for several times.
There are a lot critiques for Chinese stimulus program, but the author holds opposite opinions. First, the author adopts data to prove that banking lending is not excess by showing that Chinese banks are in strong position to provide credits. Second, he argues that the industrial capacity is not excessive, believing that it is necessary to increase capacity in emerging economy and the rapid growth of consumption will soon absorb the capacity after all. Third, the author analyzed the positive effects of stimulus program on households’ disposable income and consumption eventually. Finally, he points that the fiscal situation and financing policy of local governments are not optimal and not that pessimistic meanwhile. The “White Elephants” are quite a few and most of the projects are able to generate positive economic return.
2. Chapter 2:
This chapter analyzes the imbalance of Chinese economy from four perspectives:
Expenditure approach: the analysis shows that investment plays an increasing important role in economy growth in China since 2003, while household consumption growth has lagged the underlying growth of the economy and the percentage contribution to GDP is falling consistently. In addition, the export and goods and services also became a major driver of the economy since 2005.
Production approach: the decreasing agriculture share of GDP is typical for developing countries while the service share keeps quite low and industrial share too high in China. The imbalance indicated in production approach is mainly due to two distortions: undervalued RMB exchange rate since 2002 and domestic low factor price such as capital, land and energy. Both distortions lead to unusual high profits for manufacturing sector, which explained the high share of industry in GDP.
Income approach: from 1990s to 2008-2009, two sources of data show both employee compensation and enterprise profits dropped, while the government income from tax increased as a result. The trend is a perfect explanation for the decline in consumption as percent of GDP since the household disposable income dropped.
The savings-investment approach: the saving and investment by component data shows that for household sector, investment increased far less than saving; for enterprise sector, investment rose as much as saving while for government component, investment increase far more than saving, which is major source of saving investment imbalance under evaluation. The implications are: every sector contributes to the saving-investment approach; government played an equally important role in the imbalance for the periods.
3. Chapter 3:
The chapter focuses on examining how China can adopt a new model to rebalance its economy to sustain growth, from four perspectives of policies:
Fiscal Policy: in the past, the government adopted tax reduction policies to stimulate consumption but the effect is quite modest. It is suggested that SOEs should pay dividend taxes to contribute rebalancing. In addition, since policies focusing on government expenditures have more direct and greater effects, the government set up a rural cooperative medical insurance scheme and new pension program and also eliminated school fees significantly. In all, transfer payments to household should be increased.
Evaluation: though sound beautiful, the fiscal policy reform is lack in practicality primarily because it would be difficult to let the SOEs to pay dividends. Without sufficient tax revenues, the government will find it difficult to maintain large-scale of transfer payments.
Financial Reform: interest rate liberation is the core issue for financial reform in China at this stage. The real rate on household deposit since 2003 kept to be negative, which is essentially an implicit tax and a direct result of central bank’s policies. What is interesting is, the real interest rate and the saving rate have inverse relationship in China. Besides, the author has another interesting point that interest rate liberation would help increase the consumption as a share of GDP in China.
In addition to interest rate liberation, the writer believes the high required reserve ratio and purchasing quotas of government bills/bonds should be lowered to reasonable level. Finally, the author believes the low interest rate stimulate the ever-increasing property prices since people regard houses as an investment asset class more than residential purpose. Then he expressed his concern about the potential crisis could arise when houses gradually lose investment property.
Exchange Rate Policy: Since 2003, the central bank, PBOC, consistently and systematically sells domestic currency and buys foreign exchange, resulting a huge foreign exchange reserve. The author holds that the government should allow the exchange rate of RMB to be determined by the supply and demand in the market and stop accumulating the exchange reserve. The approach is considered to be able to contribute to economic rebalance in two ways: reducing China’s global external surplus and stimulating the process of market-determined interest rate process. With two potentially conflicting objectives, keeping RMB undervalued and maintain domestic price stability, PBOC takes sterilization monetary actions composing of issuing bills to commercial banks and raising the required reserve ratio, in order to offset the increasing domestic money supply. In order to avoid financial losses to the commercial banks, PBOC sets the interest rate at a quite low rate, which allow PBOC to sterilize on cheap. The other reason for PBOC’s sterilization is to reduce the inflow of “hot money” abroad.
In addition to PBOC, the MOF ensures the commercial banks’ profit by setting an interest rate ceiling. Those profits, in return, guarantee the pay-back to CIC, which holds great debt for the banks.
The author again asserts that a market-determined interest rate could help rebalance the economy by reducing bank spread for almost a half and reducing the dependence on investment as an economy growth.
Price reform: the factors under the price control of government such as environmental standards, energy and land are currently severely underpriced, which increased profits for manufacturing sector. The author uses crude oil price and electrical price adjustment regime in China to illustrate the factor pricing mechanism in China. It is concluded that the government should let the market play more important role in determining the factor prices like what they did before 2004.
At the end of this chapter, the author refutes the arguments that raising labor wages and increasing consumer credits can serve to rebalance the economy.
Chapter 4:
Global economy imbalance is generated when some countries are considered to have brighter economy prospects and runs current account deficits due to capital inflow. Global economy imbalance rose sharply after 2004 with China’s share of imbalance increased by 0.5% of the total imbalance. Though different views about global imbalance, it is common view that imbalance is harmful and large capital inflow from China to US lowered the interest rate in US, which eventually result to the financial crisis. In order to better monitor the global economy imbalance, the G20 outlined a process to measure whether a country has “persistently large imbalance”.
The implication for China is that global economy is really global and China’s growth model in the past objectively contributes and generates the global imbalance, which may potentially result to economy crisis, and in return destroy the domestic economy growth in China. Therefore, it is important for China to rebalance its economy and help reduce the global imbalance in order to create a long-term stable global economy environment.