economic strategy since 1990s characterized by two features
high saving and high capital accumulation
saving rate of 43% gdp in 2003 is unusually high
“recent” revision lowered to 40%, still high
savings invested abroad is relatively small
export-led growth
openness, share of trade (X+IM) in gdp is 60% as of 2003
about as open as france and italy, which are integrated into the european single market
by comparison, average trade openness is <40% in latam
in <10 years, china nearly doubled degree of openness by raising both exports and imports by ‘an order of magnitude more than the increase in world trade’
much of the trade is related to processing of imported intermediate goods, around half of all trade
per-capita income
in just 15 years, chinese gdp per capita (ppp corrected) increased from being equal to india to being twice as large; going from 18% korean gdp to 29%
labor productivity growth
between 1990 and 2002, growth in industry averaged 12.5% per year
related to the high investment rate
“learning-by-doing” also contributed to increase
imbalances
uneven growth across provinces
uneven growth across skill levels
safety nets substantially weakened
misallocation of investment
“saving combined with bank-centered financial system and privileged access to funds resulted with misallocation of investment”
macro imbalances
high saving, export-led growth do not imply trade surpluses
however it is widening, from US30Bin2004toUS100B in 2005
reform
“large policy swings would be unwise”
three hands
improve the ability of individuals to insure against risk
“currently” individuals are exposed to high levels of retirement risk, health expenditure risk, education risk (probability child requires expensive education)
reduce or reallocate investment
“currently” investment is too high in manufacturing, too low in services (especially public services)
need for higher public investment in health and education, especially in rural provinces
allow rmb to appreciate to reduce trade surplus
allowing decline in saving relative to investments
each of the three directions is “desirable on its own”
combination of decrease in saving and appreciation in rmb can allow decrease in trade surplus while maintaining balance
however, also conflict in some ways
provision of insurance → too large of a decrease in public saving → required appreciation of the rmb to prevent “overheating” → reduces export sector → curtail process of “learning-by-doing”
“overheating” is aggregate demand growing faster than the economy’s capacity to expand
too large of an appreciation of the rmb might also increase inequality between rural and other provinces
analysis
private saving
43% is very high, especially where saving is net of saving of young and dissaving of old
“golden rule” → saving rate that maximizes “steady state consumption” is equal to share of capital in gdp
by that standard, 43% is “probably too high”
however, china has not reached steady state and can justify higher saving rate in transition
enterprise saving accounts for almost half of china’s saving rate, but household saving is also higher than other countries
household saving is largely consistent with life cycle model (emphasizing saving for retirement)
one-child policy caused assets to be a substitute for children, giving increased saving
distortions also force chinese individuals to self-insure through assets
with decline of state-owned enterprises, public retirement system has largely broken down
provision of health-care services and education has increasingly been based on system of fees, additionally risks are particularly severe in more rural areas
safety nets are also weak for migrant workers from rural to urban areas, some 17.7% of urban population by 2000 census
other factors
saving for housing
saving to start firms
measures will cause macro implication of decreasing saving rate, equivalently increasing consumption
providing retirement and health-care insurance
insurance can be in part be provided by the market
health services
unusually small share of services, among them health services
health services have not increased in proportion to income per capita
shortfall has been “particularly pronounced in rural provinces”
likely three factors behind inadequate health services
lack of health insurance → people self insure through saving → buy less healthcare
income distribution → switch to fee-based system means healthcare has become too expensive for many to afford, different than lack of insurance
34% of urban, 44% of rural respondents did not seek healthcare when ill because of not being able to afford it
privatization of township and village enterprises → increased focus on profit rather than social insurance
healthcare infrastructure has not been maintained
reforms aimed at expanding health service “must focus both on demand and supply”
three main relevant considerations
standard principles of finance
makes sense to finance through debt rather than taxes if spending will benefit people
“golden rule” of public finance → financing consumption expenditures through taxes, investment expenditures through debt
even if investment expenditures have low financial return, as long as social return is high enough
need to achieve internal balance
uncertainty on taxes versus debt means no hard decision should be made
government should finance expenditures mostly through taxes or debt depending on circumstances
debt dynamics
however, growth rate is much higher than interest rate the government has to pay on debt, so worries associated with debt dynamics “disappear”
if growth rate was permanently higher than interest, government could decrease taxes
if growth rate eventually becomes smaller, larger deficits today will lead to only a small increase in debt over time
means larger deficits today might require only a modest eventual increase in taxes in the future
i.e. if deficits are justified on macroeconomic grounds, “should not hesitate to use them”
rmb appreciation
on 2005, stopped pegging rmb to usd
in new regime, “managed float”, rmb can fluctuate in small band centered around dollar parity
inside band, exchange rate fluctuates responding to supply and demand in the market and intervention by pboc
crucial element of new regime is determination of the central parity
central bank will announce closing price of usd in interbank foreign exchange market after closing the market each working day, and will make it central parity for trading against the rmb the following working day
parity depends on intervention
in principle, currency could hit top of the band with excess demand for rmb and limited intervention
causes crawling peg with 6% monthly reevaluation
accumulation of reserves to avoid excess of 0.3% a day might be larger than the amount required in a fixed exchange rate regime
eventually might be easier to let rmb float
appreciation could keep rising under fixed regime, but with floating one-way speculative flows would disappear with uncertainty
two things pboc could do to relieve pressure on the rmb
could remove capital controls asymmetrically
specifically, remove them on capital outflows but not on inflows
bank could let chinese investors acquire foreign assets, or announce path for gradual removal of capital outflows
“extreme rmb exposure of chinese investors suggests that portfolio diversification might significantly add to supply of rmb, limiting appreciation”
“concern is that diversification would reduce deposits at rate faster than speed at which banks can liquidate loan portfolio”
continuing to accumulate reserves
by limiting appreciation, reserve accumulation allows for higher exports, potentially higher “learning-by-doing” and productivity growth
capital loss on accumulated reserves when appreciation takes place in theory could be smaller than output gain from higher productivity
effects of appreciation are “likely twofold”
exports will decrease, and the export sector
for balance, reevaluation must be accompanied by increase in internal demand
appreciation will likely worsen inequalities between regions, between skilled and unskilled workers
given price in dollars, appreciation will lower domestic currency price of agricultural products, therefore also real income in rural areas
overall suggestion
eliminate imperfections behind high saving rate
e.g. measures: design more robust retirement system, provision of health insurance, development of private insurances
let rmb appreciate to reallocate activity away from export sector
gradual removal of controls on capital outflows, tax brakes on fdi would limit upward pressure on rmb
eventually, consider replacing exchange rate rule with simple clean float
other tools, e.g. pollution tax would reduce incentive to invest in export sector without affecting rural incomes
the larger the pollution tax, the smaller the required appreciation for reallocation, so smaller effects on rural/urban inequality
increase provision of health and other public services
target rural areas, since appreciation will redistribute income from rural to urban areas
additionally preventing funds transferred to rural provinces from disappearing through corruption
maintaining balance
too much reduction in individual risk → large drop in saving → risk of “overheating” (demand eclipsing supply) would require large appreciation
too large appreciation would cause inequalities → regional (price of agricultural goods) and skill (implied wage in export sector)
would also slow down process of “learning-by-doing” in export sector