Why is rebalancing the Chinese Economy important for sustaining
economic growth?
Action
Raise the renminbi
Raise interest rates
Winners
Losers
 Households as consumers,
 Exporters
especially middle and lower
 PBoC
middle classes
 Service industries
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Raise wages

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Transfer state assets

Households as savers,
especially the middle and
upper-middle classes
Service industries
Labor-intensive industries
Small and medium
enterprises

Households as workers,
especially lower middle
classes and urban workers
Consumer and retail
businesses
Capital intensive industries
with domestic customers

Employers,
especially lowincome labor
intensive companies
Households, with the
distribution depending on
the form of privatization

Government,
especially local
officials




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Capital intensive
industries
Real estate
developers
Banks
Local governments
Speculators
PBoC
What is the Global Economic Environment for Rebalancing?
TWO TRACK GLOBAL ECONOMY
When Will China Catch the US?
The Economist’s interactive chart.
2018 – 2024
New Global Division of Labor
West – Knowledge, innovation, brands, management (consume)
Emerging Economies – manufacturing and production, local innovation (produce
and save)
Implications of Global Shift
Increased competition for scarce resources
Power and influence
Natural resources
Key currency
Knowledge resources
Geopolitical position: TNCs, military bases, alliances
Define terms for global economic interdependence
Economic growth with equity for largest number
Greater ideological conflict over how economic growth can happen
State Capitalism versus Liberal Capitalism?
Authoritarian State Capitalism vs Liberal State Capitalism
Can China Overcome the Middle-Income Trap?
Easy Gains – Peasant famers become factory workers sell to rich nations
Harder Gains – create national firms to compete with foreign firms
Very Hard Gains – average firms are world class
Extremely hard gains – consistent innovation at the technology frontier
Middle-income trap: cannot get beyond easy gains
Diminishing returns to investment in infrastructure
Total factor productivity growth slows down
Shift from savings/investment/labor intensive to knowledge-based
production and domestic consumption
Labor must migrate from rural farmers to factory workers to service workers
China must have sophisticated management to make the hard decisions about
investment and organization to keep TFP rising
Dynamic Economy restructures forcing difficult changes
Many companies and organizations will resist changing system
Investment – Consumption
The end of the export boom
US charges China’s surplus is result of manipulated undervalued currency
Poor argument but the RMB will rise
Managers must compensate for rising domestic costs with higher
productivity and cost savings
Overinvestment = poor investment = lower growth
Best example of overinvestment is US housing industry from 2002 – 2008 all
driven by market processes
State-directed investment can lead to bad decisions too
“China as a whole saved an extraordinary 51% of its GDP last year. Until China’s investment rate exceeds
that share, there is no cause for concern, says Qu Hongbin of HSBC. Anything China fails to invest at
home must be invested overseas. “The most wasteful investment China now has is US Treasuries,” he
adds.”
“Michael Pettis of Guanghua School of Management at Peking University argues that the Chinese
government suppresses consumption in favour of producers, many of them state-owned. It keeps the
currency undervalued, which makes imports expensive and exports cheap, thereby discouraging the
consumption of foreign goods and encouraging production for foreign customers. It caps interest
rates on bank deposits, depriving households of interest income and transferring it to corporate
borrowers. And because some of China’s markets remain largely sheltered from competition, a few
incumbent firms can extract high prices and reinvest the profits. The government has, in effect,
confiscated quarts of barley from the people who might want to eat them, making them available as
seedcorn instead.
What has China got in return? Investment, unlike consumption, is cumulative; it leaves behind a stock of
machinery, buildings and infrastructure. If China’s capital stock were already too big for its needs, further
thrift would indeed be pointless. In fact, though, the country’s overall capital stock is still small relative to
its population and medium-sized relative to its economy. In 2010, its capital stock per person was only 7%
of America’s (converted at market exchange rates), according to Andrew Batson and Janet Zhang of GK
Dragonomics, a consultancy in Beijing. Even measured at purchasing-power parity, China has only about a
fifth of America’s capital stock per person, depending on how its PPP rate is calculated.”
Do China’s SOEs make poor investment decisions? Do they have too high profits and
receive capital at rates that are too low so they make investments without the
discipline of the market?
Yes, but not always and maybe not so much that it matters. China’s SOEs are linked
to entrepreneurial actors in the state who must conform to markets in the near
term.
Changes in Financial System
Finance and structural power in a capitalist economy
Political organization of finance
I.
Market-based finance; independent banks, limited regulation,
no political allocation of financial resources; market interest
rates and exchange rates
Strengths: dynamic; distributed decisions; rapid adaptation;
diversity; supports innovation
Weaknesses: short-term profit-oriented; allocated on current
prices; poor on long term investment; dependent on limited
vision of markets
II.
State-based finance; state-owned or controlled banks; heavy
regulation; state allocation of financial resources; manipulated
interest rates and exchange rate
Strengths: State actors have alternative and important
information and interests; long-term anticipation of future
prices; good at allocation from behind the global curve
Weaknesses: Tend to rigidity; as good or poor as political
perspective; reallocation is slow; political favoritism; crony
capitalism; poor at dynamic innovation support
Financial systems must achieve a dynamically evolving balance of pricebased short-term allocative efficiency using distributed and political
decision-making systems
Middle-income trap often results from overly centralized and politicized
financial systems
China must rebalance its financial system to make it based on more
distributed systems of decision-making
Adopt a more flexible exchange rate
 RMB as reserve currency – requirements
Foreign confidence in macroeconomic stability (moderate)
Deep and liquid capital markets (low but growing)
Capital account convertibility – no restrictions on capital flows (low but
with loosening of controls)
Flexible exchange rate (very low)
Use as international medium of exchange in trade and finance (low but
growing)
Held by foreign central banks as hedge against financial crises (some
Are China’s banks adequate?
State-owned banks dominate and allocate to SOEs and state-directed projects
Informal banking system - back-alley banks – provide lending to private
SMEs
Distributed investment system very poorly developed – Wen Jiabao – banks
make profits too easily.
But too much markets for finance is destabilizing; but without better
financial markets savers buy too much real estate
Loosen restrictions on capital flows: liberalize interest rates; enhance
Chinese purchase of foreign assets
Formalize and make legal the Wenzhou banking system
Evidence for massive mis-investment is not persuasive –
Non-performing loans?
Empty office buildings and condos?
Not all of the country’s “malinvestment” will result in bad loans. Some of its outlandish property
developments, including the empty flats of Ordos, were bought by debt-free investors with money to burn.
By the same token, not all of China’s “bad” loans represent malinvestment. Rural infrastructure projects, to
take one example, are often “unbankable”, failing to generate enough income from fees, charges and tolls
to service their financial obligations. But the infrastructure may still contribute more to the wider economy
than it cost to provide. That is especially likely for stimulus projects, which employed labour and materials
that would otherwise have gone to waste.
Evidence of overinvesting – bubble making?
From The Economist http://www.economist.com/node/21552555
If China is over investing, why is its capital stock per capita still so low?
What matters more than aggregate investment is:
1) Ability to move up the value chain
2) Rise in Total factor Productivity – ratio of GDP per unit of capital and
labor
“The striking thing about the growth in China’s total factor productivity is not its absence but its speed: the
fastest in the world over the past decade. Between 2000 and 2008 it contributed 43% of the country’s
economic growth, according to the APO. That is just as big a contribution as the brute accumulation of
capital, which accounted for 44% (excluding information technology). Thus even if some of China’s recent
investment has in fact been wasted, China’s progress cannot be written off.”
China's eagerness to improve its infrastructure is not misplaced or exaggerated, argues Nicholas Lardy,
senior fellow at the Peterson Institute for International Economics in Washington, D.C. Lardy notes that
China ranks only 27th internationally in the World Bank's 2010 analysis of global trade logistics, which
measures infrastructure development and customs efficiency. "Clearly, there is scope for many more
economically productive infrastructure projects in China," says Lardy.
Loren Brandt and Zhu Xiaodong of the University of Toronto argue that China's worst imbalance is not
between investment and consumption but between SOE investment and private investment. According to
their calculations, if state capitalists had not enjoyed privileged access to capital, China could have
achieved the same growth between 1978 and 2007 with an investment rate of only 21% of GDP, about half
its actual rate. A similar conclusion was reached by David Dollar, now at America's Treasury, and ShangJin Wei of Columbia Business School. They reckon that two-thirds of the capital employed by the SOEs
should have been invested by private firms instead.
Rebalancing of investment and consumption is a large business opportunity
Next 10-20 years China’s consumption as a % of GDP will rise to 50%
Much of this will be driven by continuing urbalization
Rebalance the product and market strategy of China and foreign firms from
top tier cities to lower tier cities where urbanization will be greatest.
Source: The Economist, October 20, 2012 http://www.economist.com/blogs/freeexchange/2012/10/rebalancingchina?spc=scode&spv=xm&ah=9d7f7ab945510a56fa6d37c30b6f1709
Health system and health care – does government in China have a
for health care?
responsibility
Health Care – Goals of the 12th Five Year Plan
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
greatly expanding access to basic medical coverage for citizens,
modernizing the country’s health care infrastructure and improving
grassroots health care delivery,
broader basic health care coverage,

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expanded infrastructure for grassroots medical networks,
public awareness in disease prevention,
improved health care administration,
creation of national health care benchmarks and standards
heavy investments in health care IT
Can the RMB become a Key Currency?
Key Currency Criteria – U.S. and China
Foreign confidence in macroeconomic stability
U.S.
shaken
China
moderate
Deep and liquid capital markets
dominant
low
Capital account convertibility
very high
low
Flexible exchange rate
very high
very low
International medium of exchange in
trade and finance
dominant
low
Foreign central banks as hedge against
financial crises
dominant
some
The use of renminbi in trade settlement is
growing
i
Cross border trade settlements in renminbi
350
300
percent
6.0
billion renminbi
5.1 percent
Imports
5.0
Exports
250
4.0
200
3.0
150
pe ce t o
percent
of
total trade
2.0
100
50
1.0
0
0.0
2009 Q3-Q4
2010 Q1
2010 Q2
2010 Q3
2010 Q4
C a s tota
China’s
total e
exports
po ts 2010:
0 0 $
$1.75
5 ttrillion
o
China’s total imports 2010: $1.52 trillion
Sources: People’s Bank of China.
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