Ecodate vol 28 no 1 march 2014

Eco Volume 28 • Number 1 • March 2014

Contents Recent Developments In The Chinese Economy.............................................................. 2-4 Changing Priorities.....................................................................................................2 Measuring China’s Performance. ............................................................................ 2-3

In Recent Years. .........................................................................................................3

The Way Forward - The Third Plenum..................................................................... 3-4

Welfare-system reforms.......................................................................................3

Greater rights for farmers..................................................................................3 Stepping up financial reforms...............................................................................3

Increased dividend payments by State-Owned Enterprises (SOEs)........................4

One-child policy relaxed.......................................................................................4 Conclusion..................................................................................................................4

References..................................................................................................................4

Austerity Or Quantitative Easing?................................................................................ 5-7 The Austerity Approach..............................................................................................5

Quantitative Easing.....................................................................................................5

The Theory..................................................................................................................5 The Results. ...............................................................................................................6

References..................................................................................................................7

Media Watch......................................................................................................................8 The Tapering Of Quantative Easing. ...........................................................................8

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Recent Developments In The Chinese Economy

By Dr Anthony Stokes, Senior Lecturer in Economics Australian Catholic University, Strathfield

Measuring China’s Performance In Recent Years

Since 1953 the People’s Republic of China (PRC) has managed its economy based on the setting of five-year plans. The five-year plans are a series of social and economic development initiatives.

During this time the economy has been shaped by the Communist Party of China (CPC) through the plenary sessions of the Central Committee and National Congresses. The Communist Party plays a leading role in establishing the foundations and principles of Chinese communism, mapping strategies for economic development, setting growth targets, and launching reforms.

China’s economic growth rate has been high in the last decade, compared to the rest of the world, with annual figures ranging from just over 6 per cent to 13 per cent (Figure 1).

Figure 1

Changing Priorities In October 2010, the Communist Party of China’s (CPC) Central Committee approved the guiding principles of China’s 12th Five-Year Plan for National Economic and Social Development (FYP) (2011-2015). The 12th FYP’s guiding principles were to promote the government’s focus on ‘inclusive growth’, which means ensuring the benefits of economic growth are spread to a greater proportion of Chinese citizens. The plan’s key themes are rebalancing the economy, reducing social inequality and protecting the environment. Some important initiatives of the economic rebalancing theme in the 12th FYP include a notional GDP growth rate target of seven per cent, promoting consumption over investments and exports, closing the income gap through increases in the minimum wage and increased social safety nets, and a range of energy efficiency targets. The three areas of the economy that were to receive a major boost from the 12th FYP were health care, energy and technology.

The 12th FYP was a major change in direction for the Chinese economy from the 11th FYP. The 11th FYP involved major infrastructure projects for the Chinese countryside and key developments to update and boost manufacturing capacity.

While the economic growth target was 7.5 per cent, the 11th FYP’s aim was to improve the produce productive capacity of the economy. The 12th FYP has shifted its emphasis to sharing and widening those benefits. As a result it is expected that, while economic growth targets may not be as high a priority in the 12th FYP, social and environmental targets should demonstrate improvements during the period 2011-2015.

According to the IMF (2014), economic growth in China rebounded strongly in the second half of 2013, due largely to an acceleration in investment. This surge is expected to be temporary, in part because of policy measures aimed at slowing credit growth (Figure 2) and raising the cost of capital. Growth is thus expected to moderate slightly to around 7½ per cent in 2014-15, in line with the authorities’ target, and further to 7¼ per cent in 2015-16.

Policymakers have refrained from further stimulating growth, which is consistent with the objectives of safeguarding financial stability and moving the economy to a more balanced and sustainable growth path.

Figure 2

STUDENT ACTIVITIES 1. How does the Communist Party influence China’s economic development strategies?

2. What is the main intent of the Twelfth Five-Year Plan?

3. How have the priorities of the Twelfth Five-Year Plan differed from those of the eleventh plan?

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Measuring China’s Performance In Recent Years (cont’d)

The Way Forward - The Third Plenum In November 2013, the Chinese government unveiled details of the long-term economic reforms agreed to at the Third Plenum, the third meeting of the new leaders of China. Historically, third plenums have served as a springboard for key economic reforms.

Former leader Deng Xiaoping launched reforms to open the economy to the outside world at a third plenum in 1978. That was followed in 1993 with an endorsement of the ‘socialist’ market economy, paving the way for sweeping reforms spearheaded by then Premier Zhu Rongji, which led to China’s entry into the World Trade Organisation.

Since 2010, China’s benchmark interest rate has risen from 5.25 per cent in 2010 to six per cent at the end of 2013. The impact of this has been to lower credit and money supply growth (Figure 2) and to take pressure off inflation.

Chinese unemployment remains remarkably stable despite swings in economic growth rates. The Chinese unemployment rate decreased to 4.0 per cent in the third quarter of 2013 from 4.1 per cent in the second quarter of 2013. From 2002 until 2013, China’s unemployment rate averaged 4.1 per cent reaching an all time high of 4.3 per cent in June of 2011 and a record low of 3.9 per cent in September of 2002 (Figure 3).

This time, the focus of the 60 point reform plan is economic rebalancing by increasing the urban population and greater efforts to promote consumption to and move away from exports and investment, China’s main growth engines.

Figure 3

The main elements of the reform plan are: i. Welfare-system reforms

In regards to the external sector, China recorded a current account surplus of $49.8 billion US in the fourth quarter of 2013.As shown in Figure 4 this reflects a continued strengthening of the current account surplus since 2011.

China will loosen the controls on the household registration system, which blocks migrant workers and their families from access to education and social welfare beyond their home villages. Changing this system is a key step towards liberalising the labour market, allowing the free movement of labour and encouraging urbanisation. The largest cities such as Beijing, Shanghai, Guangzhou and Shenzhen will still have strict rules applied to them, however, the change will mean a more mobile labour force and an increase of workers into increased employment in factories, where there are have been labour shortages.

ii. Greater rights for farmers

Figure 4

Chinese farmers will be granted rights to ‘possess, use, benefit from and transfer their contracted land, as well as the right to use their land ownership as collateral or a guarantee’. At the moment, all land in China is owned by the government with farmers only permitted the right to work the soil in their area.

Analysts say this change is important to encouraging urbanisation and shifting China’s economy to a consumer-driven one since it could enable farmers to cash in on the value of their land, invest in new ventures and move to the cities.

iii. Stepping up financial reforms

The improvement in the current account surplus in 2013 has occurred despite China’s exporters being disadvantaged by the Chinese currency, the Yuan, appreciating about 2.8 per cent against the U.S. dollar in the last 12 months.

STUDENT ACTIVITIES 4. Using Figure 1, describe China’s recent economic growth performance.

5. Using Figure 2, explain how the Chinese authorities are attempting to safeguard financial stability.

6. How has China’s unemployment rate fluctuated over the past decade?

Refer to Figure 3.

7. Using Figure 4, assess the strength of China’s current account surplus.

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One of the key financial reforms that was proposed allowed for the setting up of a deposit insurance system by early 2014.

This would give qualified private investors the power to set up banks and expand the financial system. The reforms also include loosening controls on the pricing of water, electricity and natural resources and revamping the system for Initial Public Offerings (IPOs) for firms listing on the stock market.

Analysts believe that the insurance scheme would protect depositors as China is worried that some smaller lenders are at risk of instability and possibly even liquidation as banks compete for deposits in a more open regime. China’s central bank removed controls on lending rates earlier in 2013. The Chinese financial system is moving towards a market bias and it is putting more emphasis on market based policies.

The implication is that the private sector will play a greater role in the Chinese financial markets in the future.

The Way Forward - The Third Plenum

Conclusion

(cont’d)

In December 2013, the Chinese leaders and economic planners at the Central Economic Work Conference emphasised that the reforms should be integrated into all sectors of China’s economic and social development in 2014, and China should maintain continuous and stable macroeconomic policies. The top Chinese leaders stated that next year ‘the core is to seek steady progress and promote reforms and innovations’. It is necessary to fully understand the relationship between ‘sustainable and healthy development’ and ‘economic output growth’, and China should improve the ‘quality of growth’ while avoiding ‘side-effects’.

The Conference statement added that, in addition, China should continue implementing proactive fiscal and prudent monetary policies in 2014.It also outlined six major economic tasks for 2014 - ensuring food security, reducing overcapacity, containing debt risks, improving regional development and social welfare, as well as promoting further opening up of the economy.

iv. Increased dividend payments by State-Owned Enterprises (SOEs)

SOEs will be required to pay larger dividends to the government, with 30 per cent of earnings from ‘State capital’ to be paid back to the State and used for social security and social infrastructure by 2020. Currently China’s 113 large SOEs under direct government control typically pay five to 20 per cent of their profits to the government in dividends. Private firms, meanwhile, will be encouraged to play a greater role in the economy. Despite this the Chinese government reinforced its stand that State run enterprise will always be ‘the fabric of the social policies of the republic’ and that private equity will remain ‘capped’.

The overall impact will be that large state-owned enterprises will retain their monopolies, but they will have to pay more of their income to the central government, which it says it will use to build more hospitals and schools thus improving the living standards of the population.

Some of the minor reforms could begin early in 2014. Others will take years to take effect. Despite this new economic vision, the Third Plenum includes no political reforms. The Chinese government clearly believes it can improve social harmony, their biggest concern right now, by expanding the economy through greater liberalisation, not by opening it up to democracy.

v. One-child policy relaxed

The controversial one-child policy introduced in 1979 has contributed to falling birth rates. Now the policy is to be eased to allow couples to have two children if one of the parents is an only child. For China, this is a major departure from the one-child policy that was put in place in the late 1970s to prevent the country’s population from spiralling out of control.

The change in policy comes about against a backdrop of declining birth rates and changing demographics in China, including a reduction in the working population.

References Asia – Pacific News, Economics behind China relaxing its one-child policy, 15/11/2013, viewed at http://www.cnbc.com/id/101201784 CBI, China’s Twelfth Five Year Plan (2011-2015) - the Full English Version, viewed at: http://cbi.typepad.com/china_direct/2011/05/chinas-twelfth-five-new-plan-the-full english-version.html#sthash.Kswuw4T5.dpuf CNBC, China’s economic reforms: What you need to know, 17/11/2013, viewed at http://www.cnbc.com/id/101205322

STUDENT ACTIVITIES

English News CN, Xinhua Insight: China to pursue reforms while steadying growth, 14/12/2013, viewed at http://news.xinhuanet.com/english/indepth/2013-12/14/c_132968027.htm

8. What is the significance of a third plenum.

International Monetary Fund (2013-14), World Economic Outlook, viewed at http://www.imf.org/

9. Discuss the main implications for China’s economic development of the third plenum held in 2013.

KPMG, China’s 12th Five-Year Plan (2011-2015) - KPMG Insight Series, viewed at http://www.kpmg.com/cn/en/issuesandinsights/articlespublications/publicationseries/5 years-plan/pages/default.aspx

10. Describe the main elements of 2013’s Third Plenum.

Reserve Bank of Australia (various years), Reserve Bank of Australia Bulletin, Sydney, RBA, viewed at http://www.rba.gov.au/

11. Briefly discuss the six major economic tasks for 2014.

Third Plenary Session of 18th CPC Central Committee, viewed at http://www.xinhuanet.com/english/special/cpcplenum2013/

12. Essay: Evaluate the changing priorities of China’s Five-Year plans over the past few decades.

Trading Economics, viewed at http://www.tradingeconomics.com/

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Austerity Or Quantitative Easing?

By Steven Keen The Age

The Theory

The economic crisis that began in late 2007 took most economists totally by surprise (Bezemer 2009), and their initial reaction was to stimulate the economy as much as possible. As the then US Treasurer Hank Paulson put it in his autobiography, when the crisis began, most economists felt that without a massive government stimulus, the economy could well collapse completely:

The foundation of the theoretical case for austerity is Robert Barro’s argument in ‘The Ricardian Approach to Budget Deficits’ (Barro 1989) that people respond to a budget deficit today by saving more: A decrease in the government’s saving (that is, a current budget

‘We need to buy hundreds of billions of assets’, I said. I knew better than to utter the word trillion. That would have caused cardiac arrest. ‘We need an announcement tonight to calm the market, and legislation next week,’ I said.

What would happen if we didn’t get the authorities we sought, I was asked.

May God help us all,’ I replied. (Paulson 2010, p. 261)

deficit) leads to an offsetting increase in desired private saving.

(Barro 1989, p. 39)

Barro reached this conclusion by positing a highly implausible mechanism, that people respond to a deficit by saving to make bequests to their future descendants, so that they will be able to pay the higher future taxes that today’s deficit would necessitate: ‘The main idea is that a network of intergenerational transfers makes the typical person a part of an extended family that goes on indefinitely’ (Barro 1989, p. 40). Despite its unreality, ‘Ricardian equivalence’ became an accepted reason for mainstream economists to oppose government deficits, and it led to the argument that a government surplus could stimulate private spending—the opposite of the case put by Keynes during the Great Depression.

But as economists recovered from their shock that the crisis had occurred in the first place, two competing approaches to dealing with it emerged: the belief that a reduction in government spending would actually stimulate the economy, versus the view that monetary policy should be used to stimulate private sector spending. The former was initially called ‘expansionary fiscal consolidation’; the latter is known as ‘Quantitative Easing’ (QE).

The Austerity Approach

Alberto Alesina (Alesina, Favero et al. 2012) did empirical work that appeared to find that budget surpluses stimulated the economy when deficit reductions occurred through cuts to government spending. A related argument was put forward by Reinhart and Rogoff, who asserted that economic growth dropped substantially when government debt exceeded 90 per cent of GDP (Reinhart and Rogoff 2010). These empirical arguments were relied upon heavily by European politicians and bureaucrats as they imposed austerity policies upon countries that had breached the Maastricht Treaty’s limits.

The chief objective of Austerity policy was to directly reduce the government deficit by reducing government spending, in the belief that this would lead to a more than offsetting increase in private spending. The European Union applied austerity policies strongly, in part because the 1992 Maastricht Treaty that led to the creation of the Euro set a maximum government debt to GDP ratio of 60 per cent, and a maximum annual budget deficit of three per cent of GDP. Maastricht effectively required austerity to be imposed, since the crisis caused increased government deficits as tax receipts fell and welfare payments rose (Godley 1992).

The theoretical case for Quantitative Easing was the proposition that the global economy was trapped at the ‘Zero Lower Bound’: though Central Banks had cut the short-term rate of interest to zero, this was not enough to encourage savers to spend enough to offset the sharp fall in spending by borrowers. QE was an attempt to reduce longer-term interest rates by buying long-term bonds (since interest rates move in the opposite direction to bond prices) and therefore to stimulate more investment and growth in asset prices. Critics of QE however argued that this policy would lead to rampant inflation via ‘money printing’.

Quantitative Easing The chief objective of Quantitative Easing is to reduce the interest rate on long term public and private debt, via Central Bank purchases of a larger quantity and maturity range of both government and private bonds than in standard Open Market Operations. The USA has been the chief proponent of QE. There have been three phases, the most recent of which commenced in September 2012 when the Federal Reserve pledged to buy $85 billion worth of long term government bonds and private sector mortgage-backed securities every month until unemployment fell below seven per cent.

STUDENT ACTIVITIES

STUDENT ACTIVITIES

5. Explain how, in theoretical terms, fiscal consolidation has been considered to be expansionary.

1. How did economists react initially to the economic crisis that started in 2007?

6. How might austerity be justified in empirical terms?

2. Why did countries in the European Union elect to apply austerity policies?

7. Explain the statement that the global economy was trapped at the ‘Zero Lower Bound’.

3. Why did the United States apply Quantitative Easing?

8. In theoretical terms, discuss the way that quantitative easing might stimulate economic activity.

4. How did the United States implement Quantitative Easing?

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The Results

Figure 2: Rates have not fallen under the largest of the QE

programs (since September 2012)

History, and more careful economic research, has not been kind to austerity, while Quantitative Easing has had a mixed effect—neither being as effective as its proponents hoped, nor as inflationary as its critics anticipated.

Rather than causing GDP to grow, austerity caused severe contractions in Europe, and Great Depression levels of unemployment in Spain and Greece. Even strong proponents of austerity like the IMF Chief Economist Olivier Blanchard have concluded that it has failed in practice, largely because the ‘fiscal multipliers’—the relationship between a change in the government deficit and a change in GDP—were much larger than one: a one per cent fall in the government deficit as a percentage of GDP caused a more than one per cent fall in GDP (Blanchard and Leigh 2013).

The intellectual case for austerity was also shown to be hollow, when a university student revealed that there were serious errors in Reinhart and Rogoff’s argument that government debt levels of more than 90 per cent of GDP caused a serious decline in economic growth (Herndon, Ash et al. 2013). In attempting to replicate their empirical results, Herndon found that Reinhart and Rogoff had made simple spreadsheet errors, and aggregated data in a meaningless way—so that one year’s data from New Zealand was given the same significance as two decades of data from the United Kingdom. When these mistakes were corrected, there was only a minor relationship between government debt and economic growth.

Quantitative Easing has had a better track record empirically than austerity—as Figure 1 emphasises, the QE-focused USA has performed far better than austerity-focused Europe—but its track record is still a mixed bag.

Austerity and QE have failed to deliver the results their proponents expected because they both ignore the real causes of the crisis, which was a drastic reduction in private sector debt-financed spending (Keen 2014) that caused a sharp fall in aggregate demand (see Figure 3). Rising public debt was a symptom of this fall in private debt, not the cause of the crisis as Austerity policies imply.

On the other hand, QE has succeeded in part because it has encouraged the private sector to start borrowing again.

Figure 3: The plunge in private sector debt-financed spending

preceded the rise in government debt Change in US Private and Public Debt 20

2008

Private Debt Public Debt

Percent of GDP p.a.

15

Figure 1: The European Union’s comparison of

unemployment rates

10

5

0

0

−5 2000

2002

2004

2006

2008

2010

2012

2014

2016

www.debtdeflation.com/blogs

Since neither Austerity nor QE addressed the true cause of the crisis, it is likely to recur in the future—especially since private debt levels remain at levels that are unprecedented in economic history (see Figure 4).

Figure 4: US private debt is still at unprecedented levels

Its critics are wrong to call it ‘money printing’ because this literally means printing dollar notes or cheques and giving them to the public—something which was done by Australia’s Rudd Government as part of its stimulus program, but is not being done by the Federal Reserve. Instead, the Fed buys bonds either from banks, or from firms that trade in bonds that are known as ‘Primary Dealers’. Buying bonds off banks simply swaps bonds with cash on bank’s assets: it doesn’t put any money into public hands. Buying bonds off Primary Dealers does inject money into the economy, but primarily ends up financing share market purchases rather than consumer spending.

However the bond-buying program has not succeeded in reducing long term interest rates, which actually rose during QE3 (see Figure 2). Its impact therefore seems to have been limited to driving up asset prices, and indirectly stimulating the economy as a result.

US Private and Public Debt since 1820 200 180

Private Debt Public Debt

Percent of GDP

160 140 120 100 80 60 40 20 0 1820

1840

1860

1880

1900

1920

1940

1960

1980

www.debtdeflation.com/blogs

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2000

2020

STUDENT ACTIVITIES

References

9. Examine the results of austerity from the perspective of the European countries.

Alesina, A., C. Favero and F. Giavazzi (2012). The Output Effect of Fiscal Consolidations, National Bureau of Economic Research, Inc, NBER Working Papers: 18336.

Barro, R. J. (1989). ‘The Ricardian Approach to Budget Deficits.’ Journal of Economic Perspectives 3(2): 37-54.

10. Assess the relative results of austerity and quantitative easing using the unemployment rates in Figure 1.

Bezemer, D. J. (2009). ‘No One Saw This Coming’: Understanding Financial Crisis Through Accounting Models. Groningen, The Netherlands, Faculty of Economics University of Groningen.

11. How does the implementation of quantitative easing differ from the ‘money printing’ policies that were applied in Australia?

Blanchard, O. and D. Leigh (2013) ‘Growth Forecast Errors and Fiscal Multipliers.’ IMF Working Paper.

12. Explain the true cause of the economic crisis and why austerity and quantitative easing have failed to address it.

Godley, W. (1992). ‘Maastricht and All That.’ London Review of Books 14(19): 3-4.

Herndon, T., M. Ash and R. Pollin (2013). Does High Public Debt Consistently Stifle Economic Growth? A Critique of Reinhart and Rogoff, Political Economy Research Institute, University of Massachusetts at Amherst, Working Papers.

13. Using Figure 4 assess the likelihood of a repeat of the economic crisis in the future.

Keen, S. (2014). ‘Secular stagnation and endogenous money.’ Real World Economics Review 66: 2-11.

14. Using your own research, evaluate the effects that the common currency in the Eurozone has had on the determination of appropriate policies to stimulate economic activity in countries such as Greece and Spain.

Paulson, H. M. (2010). On the Brink: Inside the race to stop the collapse of the global financial system. New York, Business Plus.

Reinhart, C. M. and K. S. Rogoff (2010). ‘Growth in a Time of Debt.’ American Economic Review 100(2): 573-578.

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Media Watch

By Ted Kramer

The Tapering Of Quantative Easing Taking into account the extent of federal fiscal retrenchment (fiscal consolidation) since the inception of its current asset purchase program (quantitative easing), the Committee continues to see the improvement in economic activity and labour market conditions over that period as consistent with growing underlying strength in the broader economy. In light of the cumulative progress toward maximum employment and the improvement in the outlook for labour market conditions, the Committee decided to make a further measured reduction in the pace of its asset purchases. Beginning in February, the Committee will add to its holdings of agency mortgagebacked securities at a pace of $30 billion per month rather than $35 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $35 billion per month rather than $40 billion per month. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. The Committee’s sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee’s dual mandate.

The Committee will closely monitor incoming information on economic and financial developments in coming months and will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labour market has improved substantially in a context of price stability.

If incoming information broadly supports the Committee’s expectation of ongoing improvement in labour market conditions and inflation moving back toward its longerrun objective, the Committee will likely reduce the pace of asset purchases in further measured steps at future meetings.

However, asset purchases are not on a preset course, and the Committee’s decisions about their pace will remain contingent on the Committee’s outlook for the labour market and inflation as well as its assessment of the likely efficacy and costs of such purchases.

To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. The Committee also reaffirmed its expectation that the current exceptionally low target range for the federal funds rate of 0 to 1/4 per cent will be appropriate at least as long as the unemployment rate remains above 6-1/2 per cent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s two per cent longer-run goal, and longer-term inflation expectations continue to be well anchored. In determining how long to maintain a highly accommodative stance of monetary policy, the Committee will also consider other information, including additional measures of labour market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6-1/2 per cent, especially if projected inflation continues to run below the Committee’s two per cent longer-run goal. When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of two per cent.

Source: US Federal Reserve, Press Release, 29 January, 2014

STUDENT ACTIVITIES 1. What has been the main economic indicator guiding the Federal Reserve’s decision to reduce the pace of its quantitative easing program?

2. To what extent has the Federal Reserve decided to taper its asset purchase program in the period covered by the press release?

3. Why does the Federal Reserve consider the continuation of quantitative easing necessary?

4. How important is current inflation in the Reserve’s judgements?

5. Examine the economic outlook and the changing stance of monetary policy, including quantitative easing, as proposed by the Reserve.

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General Editor: Ted Kramer, Head Teacher Social Sciences, Turramurra High School Student Activities Writer: Ted Kramer Managing Editor: Denise Michie