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Sustaining China's Economic Growth After the Global Financial Crisis (Peterson Institute for International Economics - Publication) Paperback – January 15, 2012
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"There is no question more important for the global economy than China and no closer student of Chinese economic policy than Nick Lardy. It follows that this book should be read by anyone concerned with the future of the global economy." —Lawrence H. Summers, former Director of the White House National Economic Council and Charles W. Eliot University Professor at Harvard University's Kennedy School of Government
"China does not get special dispensation from the rebalancing imperatives that all major economies face in this post-crisis era. Nick Lardy sheds considerable insight into the critical Chinese piece of this agenda—detailing the financial and currency reforms that will be required for the long-awaited transition to a pro-consumption growth dynamic. This book will undoubtedly elevate the debate over China's global economic impact."
—Stephen Roach, Yale University, Non-Executive Chairman Morgan Stanley Asia
"Nicholas Lardy is one of most respected American scholars in China because of his admirable works on the Chinese economy. His new book Sustaining China's Economic Growth after the Financial Crisis is a must-read for those who are concerned with China's growth. So far as I have seen, this book is the most comprehensive, detailed, and well-structured account of the turns and twists of the Chinese government's policy in restructuring the imbalanced economy and responding to the global financial crisis in recent years. Nicholas Lardy's defense of China's stimulus program may raise some eyebrows, but his explanation certainly will inspire more in-depth discussions." —Yu Yongding, President of the China Society of World Economics, and former member of the monetary policy committee of the Peoples' Bank of China
"Nick Lardy is one of the most knowledgeable people on China's economy I know. I always take his opinions on China very seriously, and the contents of this book is no exception. I believe it is a must read for anyone interested in today's economic policies in China." —Bill Rhodes, President & CEO, William R. Rhodes Global Advisors, LLC
"Lardy's book is a masterful account of the policy reforms that China needs to put in place to rebalance its economy and sustain high growth. The book is rich in data and thoughtful analysis, making it essential reading for anyone interested in understanding China's growth prospects." —Eswar Prasad, Brookings Institution
This is the best single book on China, and I use it to prepare for all my trips to that country. (Zbigniew Brzezinski, former US National Security Advisor)
...designed to clarify contemporary China and advise how U.S. 'engagement' with China may best move ahead. There's lots here, but clearly presented, with a great chronology. (Library Journal)
There is no better place to find a compact overview of recent developments in China, through mid-2008, both with respect to economic developments and with respect to China's foreign and national security policy. (Foreign Affairs)
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My only complaint is that it does not sufficiently address why the changes it proposes, which not only make sense but would effectuate the official goals in the most recent 5-year plans, have not been vigorously implemented. The conflicts among the central bureaucracies are noted, but they are not analyzed in the same kind of depth as the economic issues that comprise most of the book.
Perhaps this book needs to serve as the basis for a serious political science / Kremlimology kind of analysis that explains the inner workings of the CPC regime. Or perhaps we outsiders just don't know enough to carry out such analysis.
First, it is universally acknowledged that China requires massive job creation.
Second: the saving rate actually rose sharply after 2001 in response to a decline in real rates of return for household deposits. In other words, Chinese households save a lot under economic necessity, and as the negative returns on deposits rose to over 6%, the rate of income saved rose to 50% of average household income. Saving is high because there is practically no social insurance (2).
This sounds virtuous, but it is unsustainable and immiserating. Requiring persistently high rates of GDP growth in order that the bottom 80% of households can barely stay alive, is a very poor economic model. Moreover, it depends on the renminbi (yuan) remaining at a very low rate of exchange, something which could end very abruptly.
Third, and most obviously, the Chinese economy relies on very high exports. The cheap yuan means imports like electrical machinery and equipment, fuel, power generation equipment, and metal ores are more expensive per unit of Chinese production. This is good for the seven coastal provinces that produce most of the trade surplus, since they, too, enjoy advantageous terms of trade with the rest of China; but for the rest of China, the cheap yuan is yet another transfer of wealth to the rich coastal cities. This thwarts political unity and eventually is going to cripple further economic growth.
Finally, a strategy of trade surplus-driven GDP growth leads to a waste of scarce resources on producing goods for export, without compensating imports. A growing economy needs more, but in this case makes do with less; in 2007, for example, China exported 36% of its GDP and imported only 26%. This imposes a need to ration not only consumer goods, but producer goods as well.
Lardy points out that China's trade surplus is not necessary to provide jobs (p.140); the sort of industrial policy used by China means an excessive investment in capital intensive enterprises. Producing autos for export to Europe ties up a lot more capital investment per worker (or per yuan of payroll) than domestic construction, or domestic services like education (3).
Rebalancing would require allowing the yuan to rise to a realistic exchange rate (4). Increased government expenditures, including possibly a period of deficits as the PRC rebuilt its desiccated social services, would provide adequate demand while China's industrial system rebalanced. Understandably, Lardy does not insist on the Chinese authorities privatizing the state-owned enterprises (SOEs), since efforts to do this have been a flashpoint in Chinese politics since the 1980s (and--given prior experience--SOE privatization is unlikely to affect the desirability of China as an investment destination), but he does think SOEs ought to be more financially accountable to their owner (p.72).
Lardy's understanding of the dilemmas faced by the Chinese economic managers seems very advanced; he is very nuanced and serious, and this is not a polemical book. Many of the recommendations are already being implemented, but not forcefully enough.
Where the book disappoints is Lardy's expectation that rebalancing--an extremely major shift in China's industrial development policies--will be desirable to the Chinese. For millions of Chinese workers, such a shift would lead to a greater share in the national product; social injustice could be tackled; and China could be freed from the risks of a global downturn. However, the Chinese economy would accomplish all this by pulling away from cutting edge technologies. In other words, today China possess the technical capacity to achieve almost anything the West can, albeit on a very limited scale. It can explore space, but millions of its rural poor are trapped in the Middle Ages. It's very sensible to recommend that a developmentalist state invest in the medieval peasants, instead of moving ahead to create a lunar base. But this is a choice countries never make, and I think the reason is pretty easy to see.
Partly it's that technological achievement is not hydraulic: ideally, a country could develop so that every family lived in about the same level of well-being. Instead, it's impossible to diffuse industrial activity evenly. The Chinese actually have tried to do this harder than anyone else, with disastrous results. And anyway, no one wants to abandon the commanding heights of the global economy, in the hopes of reducing the Gini coefficient.
The other point is that Lardy believes "the market" will find a satisfactory equilibrium, and people who are used to managing a reforming economy know that never happens. Why, is the subject of another book.
UPDATED (12 April 2013): Readers need to be advised that this book is published by the Peter G. Peterson Institute for International Economics (IIE), a "thinktank" founded by a leading PE tycoon (and former Secretary of Commerce under President Nixon). Peterson founded the eponymous institute to promote state austerity in public policy and has recruited some fairly prominent people to lend it respectability. Many readers of this review may approve of the IIE's ideological agenda, but it needs to be known in advance.
It's not clear to me what the IIE hoped to accomplish by publishing this book, although possibly it's attempting to push a new buzzword for austerity. I have not taken away any stars because of the author's association with a propaganda vehicle because I did not detect any propaganda, but that doesn't mean it's not there.
(1) Current account balance: annual rate of increase in financial claims against foreign nationals by the citizens of a country; includes the sum of the trade surplus, net foreign aid, and net foreign factor income, i.e., income from investments abroad minus outflow of earnings from investments held by foreigners. A large current account surplus tends to increase the size of the monetary base.
China's authorities have sterilized the influx of dollars, meaning they have adopted policies that reduce the amount of new deposits the banking system generates from the new reserves. For the consequences of unsterilized foreign reserves--from the point of view of the Chinese CCP--please see Victor C Shih (2008), or my review of same.
(2) The relation between saving and social insurance is complex. China's lack of basic income security has led to a high savings rate, but France has a very high rate compared to other developed countries (17%). The USA has a very poor social insurance system and almost no net saving at all.
(3) According to Huang Yasheng (2008), China's underinvestment in education has led to a huge increase in illiteracy, as well as a disastrous decline in other services.
(4) According to the IMF, this would be RMB 4.28 per US dollar, instead of the current RMB 6.21. See 2012 World Economic Outlook Database, purchasing power parities data. For the record, currencies hardly ever have an exchange rate commensurate with their purchasing power parity. For instance, 22 Indian rupees in India buy as much as $1 US buys in the USA, but the exchange rate is INR 54 to the dollar. The Australian dollar is thought to have PPP of $0.642 US, but costs $1.041 US on international markets--a markup of 62%. Estimates of PPPs come from the World Economic Outlook Database of the IMF. Values for forex rates were as of 30 March 2013.
Despite China's economic success in the past three decades, Nicholas Lardy, renowned expert on the Chinese economy at the Peterson's Institute for International Economics, articulates China's economic challenges ahead and offers suggestions in his book Sustaining China's Economic Growth: After the Global Financial Crisis. Lardy seeks to explain China's economic policy during the global financial crisis and analyze challenges facing the Chinese leadership in sustaining growth rates in the coming decades. He suggests that China's economic imbalances will require fundamental market-oriented reforms; modest, marginal, and incremental reforms only provide lip service that cannot bring China onto a new growth path. Lardy examines the technical and political challenges that these comprehensive reforms entail.
Given the Chinese economy's heavy reliance on exports to foreign market, Lardy describes China's policy response to the global financial crisis as "early, large, and well designed" (5). Lardy points out that quite contrary to common belief, the stimulus package in 2009-10 did not privilege state-owned enterprises at the expense of the private sector; in fact, private firms and family businesses experienced significant improvement in access to bank loans, as did the state-owned enterprises. In 2009-10, private firms became the most crucial source of China's growth of exports for the first time ever.
Although the stimulus packages were able to sustain the Chinese economy during the global financial crisis, Lardy argues that they do not address the structural problems that are looming large on the horizon. In a 2007 speech at the National People's Congress, Chinese Premier Wen Jiabao described China's economic growth as "unsteady, imbalanced, uncoordinated, and unsustainable" (44). According to Lardy, China's most outstanding economic imbalances include: 1) low private consumption expenditure, 2) highly elevated share of investment in GDP, 3) an outsized manufacturing sector and a tiny service sector, 4) gigantic official holdings of foreign exchange, and 5) increasingly outsized and potentially unsustainable rate of investment in residential property.
In order to make China's economic growth more sustainable, the Chinese government has implemented a series of policies to correct the imbalances; however, their effects to date have not been very promising. Since 2003, the government policy has kept the renminbi undervalued by having the central bank intervening massively in the foreign exchange market. To prevent the expansion of the ensuing expansion of the domestic money supply, the central bank has engaged in two types of large-scale and continued monetary actions, referred to as sterilization: 1) issuing bills to commercial banks, and 2) raising the required reserve ratio, the share of deposits that commercial banks place at the central bank (97). Several signs indicate that China's financial system has become more repressed since 2004, when the government abandoned its policy of interest rate liberalization. These signs include, but are not limited to, negative real interest rate on household savings, an augmenting required reserve ratio, an emerging and significant informal credit market, and a sharp drop in public holding of government bonds share.
To more effectively amend these imbalances, Lardy presents measures to ameliorate the situation and analyzes both technical and political challenges posed by the much-needed reforms. According to Lardy, China needs to pursue liberalization policies so that the market will play a greater role in setting the value of the Chinese currency and interest rates. In the meantime, the government should facilitate building a stronger social safety net to encourage household spending; the social goods include, but are not limited to, health care, education, welfare, and pensions.
In addition to liberalizing the country's fiscal policies and improving social benefits, Lardy analyzes the weak possibility of an endogenous rebalancing despite continuous increments in real wages. Even though real wages have been growing in recent years, Lardy writes that China's unit labor costs vis-à-vis those of its trading partners have not been increasing as a result of a comparable increase in labor productivity in the trading goods sector.
Internationally speaking, Lardy argues that it is unclear whether China will initiate sustained rebalancing efforts even when China's stated national and international economic policy objectives align. The current impediments include financial repression, undervaluation of the exchange rate for renminbi, and provision of subsidies in production. A renewed interest in rebalancing efforts surfaced at the National People's Congress in the spring of 2011, but whether the government has the political will and capital to implement the rebalancing policies have yet to be seen.
Despite Lardy's quite holistic dissection of China's economic and fiscal challenges, the book could have included a more in-depth analysis of the impact of China's political organization on economic policies that may be at odds with rebalancing efforts. Lardy hints that powerful interest groups may have kept policies at its status quo for their personal benefits. He could have gone further to analyze two things that constrain the initiation and implementation of more liberal economic policies: 1) the shrinking power of China's top leader and 2) protracted and often difficult consensus building among several powerful political factions. From Deng Xiaoping, to Jiang Zemin, to Hu Jintao, and to Xi Jinping, the top leader is endowed with less and less power to direct and implement reforms. As a result and at the same time, the top leader is increasingly facing powerful political factions vying for influence. For Xi Jinping, any reform plan will come out of the negotiation and comprise among different factions. The Chinese leadership recognizes these political challenges. During the Anhui delegation's meeting at the 12th National People's Congress meeting on March 5, Wang Yang, who is likely to become China's new vice premier with the responsibility for reforms, described reform as cutting off one's own flesh; that is, China must be determined to break through vested interests.
By and large, Sustaining China's Economic Growth is a timely work that provides a comprehensive and persuasive analysis of China's economic challenges in the wake of the global financial crisis. Author Nicholas Lardy has a decades-long background in studying about and writing on China's economy; this book is a new addition to his series of best writings on the Chinese economy. The economics part is beyond reproach, though Lardy could have factored more political analysis into his argument. The subject matter is technical, but Lardy explains it well enough to make it understandable to an educated audience who may not have a deep background in global finance and economy.