Today’s Financial Times and last week’s Economic Observer had articles that display the kinds of confusion that economic crises can create among policymakers. The Financial Times article was actually an opinion piece written by Wang Qishan – a Vice premier in the State Council and presumably one of the top three or four economic policy decision-makers in China.
It starts out, correctly I think, by warning that the global crisis is far from over. “The global financial crisis is still spreading,” Wang warns, “The world economy is going to get worse before it gets better, and the situation remains serious.” Much of the article discusses the same grab-bag of regulatory reform proposals whose purported aim is “to prevent a repetition of this financial crisis,” which include financial regulations to “strengthen, on the basis of sovereign rules, co-operation in regulating international private capital flows, financial institutions and markets, financial products and intermediaries.”
I have already written why I think financial reform aimed at preventing financial crises (as opposed to improving the capital allocation process during “normal” times) is largely a waste of time, and to that end I will remind my readers that Hyman Minsky, whose understanding of financial instability surpasses everyone else’s, argued that: “Stability, in a world with an uncertain future, and complex financial instruments, is destabilizing.” In “A Minsky Meltdown: Lessons for Central Bankers”, a speech delivered on May 1, Janet Yellen, president of the San Francisco Federal Reserve Bank, explains:
As Minsky’s financial instability hypothesis suggests, when optimism is high and ample funds are available for investment, investors tend to migrate from the safe hedge end of the Minsky spectrum to the risky speculative and Ponzi end. Indeed, in the current episode, investors tried to raise returns by increasing leverage and sacrificing liquidity through short-term – sometimes overnight – debt financing.
Avoiding financial crisis, in other words, is a total pipe dream because to the extent that we are successful and enforce conditions of stability we actually increase the probability of future instability.
But that is an aside. Wang goes on in his article to propose action:
It is imperative for countries to co-ordinate macroeconomic policies and for all to adopt stimulus, fiscal and monetary policies. It is vital unequivocally to reject protectionism of all kinds.
Anti-protection sentiments are, of course, all fine and good, but it doesn’t make sense to define protection too narrowly. In contrast to Wang’s sentiments, last week’s Economic Observer had a very different take on protection.
China should give preference to locally-produced goods in government procurement, the Ministry of Finance said at an April 22 meeting focused on the issue. Assistant minister Zhang Tong said at the meeting that most of the public welfare projects benefiting from the government’s four-trillion-yuan stimulus package announced late in 2008 were closely related to government procurement.
Chinese law stipulates that government procurement favor local goods. But the EO has learned that many officials were not satisfied with the amount of local goods that the government had purchased since stimulus funds kicked in last November.
Against this backdrop, China’s State Council ordered on April 10 that government at all levels give preference to domestic goods, and new regulations tightening government procurement have been slated for legislation in 2009.
It is hard for anyone, especially the country that does most to export overcapacity, to preach free trade while putting into place such blatantly obvious restrictions on trade. Of course some might argue that this is no different than the “Buy American” provisions discussed last year by the US congress, but I think in fact it is very different, for at least three reasons.
First, the “Buy America” provisions were never enforced and, what’s more, they are in many cases against US law. Of course they may also be against the law in some cases in China, but there is a robust legal mechanism in the US that can be used to prevent the US government from enforcing rules that violate US laws or US trade agreements. Importers, American as well as foreign, can sue the US government with every expectation of winning in court, in a way that no one, especially no foreigner, would even attempt doing in China.
Second, US government procurement is a tiny fraction of total US purchases, even taking into consideration the US fiscal stimulus. In China, almost the entire stimulus package is going to expand investment in SOEs and/or government projects, so the share of government procurement in total GDP is much, much higher in China. That makes it a far more trade-constraining measure in China than it could ever be elsewhere.
Finally, and probably most importantly, China is the country that most desperately needs foreign demand to absorb its excess capacity. In a world of contracting demand, China is the country that is most likely to suffer from protection, for the same reason that it is the country that benefits most from absorbing other country’s badly-needed demand. In that case it is not enough to say that China is just doing what everyone else is doing (and never mind that it is much harder for foreigners to invest in China or sell to China than it is for China to do either abroad), since any dispute that resolves itself in greater trade protection hurts China worse than it hurts the other disputant.
Meanwhile the Economic Observer had also last week a very interesting (and a little troubling) editorial on just this subject. The title says a lot: “A shift is needed, but not overnight”. The article starts:
Chen Deming, head of China’s Ministry of Commerce, recently wrote in the Communist party magazine Qiushi that earnings from Chinese exports could trickle down to compensation, and ultimately end up stimulating domestic consumption. He came down against certain popular opinions in China, including that the country relied too heavily on exports, and stressed that although a withering global market has sapped demand for Chinese goods, it has also presented great opportunities. Chinese enterprises needed to push abroad under such circumstances and promote Chinese exports, he concluded.
Chen’s arguments come at a sensitive time for China’s exports. As the Canton export fair opened this past week, the export industry was not optimistic – official data just released showed another slide in China’s export value in March.
The article goes on to discuss China’s transition from export orientation to domestic market orientation. Although many foreign and Chinese commentators, including me, would argue that almost nothing was done to accommodate this transition – indeed that China in the past decade actually deepened its over-reliance on the export sector – the editorial gives the government good marks in managing the process:
In the past few years, the government has long sought to transform the economy from a export-oriented model to a consumption-oriented one, while the Ministry of Commerce strove to reduce the trade surplus. But the economy’s restructuring could not be completed within one day, and a consumption-oriented economy never meant wholly abandoning foreign trade. Eagerness for an overnight success could only lead to adverse consequences. In this sense Chen’s article reflected a realistic attitude.
We believe this was a positive sign that the Chinese government has a deep understanding of the necessity of economic transformation, and that the consumption-oriented model would remain the core of future policy. At the same time, it also meant China understood it needed to be patient throughout the process.
The editorial concludes basically by saying that although China must continue (!) improving the relative importance of domestic markets, it must “stabilize” exports since “foreign demand must still serve as the engine of the Chinese economy for a period of time.”
I think in one sense Minister Chen is right – foreign demand is still the engine of Chinese growth – which is one of the reasons I am so pessimistic about medium-term growth, but of course I am a tad more skeptical than he is that in the past few years there were active policies (as opposed to formal announcements) aimed at reducing China’s over-reliance on exports. For example two of the most obvious steps – increasing the value of the currency and allowing interest rates to rise to a ‘natural” level – were never really seriously tried, remembering that any increase in the RMB against the dollar, and other currencies, must be set against an even faster relative increase in productivity. This was almost certainly because polices aimed at assisting the transition would necessarily have slowed export growth, and with it economic growth in the short term.
The fact that the editorial and the original article from which it was draw were both published, and seem to be arguing a case, gives some indication, I think, of the ferocity of the debate taking palce about the nature of the stimulus package. One side says: Before we can fix the economy we need relief, and that is most likely to happen by reinforcing the existing economic structure. The other side says: The longer we take to postpone the adjustment, the worse.
For the other side of the debate, Hu Shuli in last week’s Caijing insists that “Beneath the surface of China’s ‘warming’ economy are structural impediments to long-term growth that demand attention – now.” He dismisses the recent optimism about China’s “bounce” back with “The ‘warming’ is more show than substance,” and he goes on to say:
Since we know that credit expansion is not the best economic healer, we should spend the coming days thinking about long-term approaches that will help China survive the crisis and pursue lasting development.
China is being forced to rebalance. It’s clear that, regardless of the angle from which we examine the situation, our economy is being squeezed by internal and external crises. Excessive consumption in the United States is a root cause of the global financial crisis. Instead of complaining about this fact, or even quietly congratulating ourselves, China must consider what to do if the United States learns its lesson and, for example, gradually raises its household savings rate. If external demand for Chinese goods is declining, how can internal demand rise?
At this juncture, structural adjustment should not be empty talk. It must involve a series of basic policies that deepen the nation’s economic reform. Structural adjustments can only follow the market’s lead and, for the most part, involve breaking up monopolies, opening the market wider, relaxing controls, and getting the pricing mechanisms right.
Instead of betting even more heavily on foreign demand to bail China out, in other words, China must urgently move towards policies that force the transition, even if those policies are painful in the short term.
And it is not just Caijing that is voicing criticism about the current stimulus policies. A number of very prominent Chinese economists have been scathing (at least in private, so I cannot reveal their names) about the failure to have taken the appropriate steps when conditions were optimal, and are now insisting that to continue increasing reliance on foreign demand is going to create huge problems for China. Increasingly I am hearing people here say that, although few expect a “collapse”, whatever that means, China is facing its own “lost decade” of sub-par economic growth and a very difficult transition. As regular readers know, I am very inclined to agree.
Next week (Wednesday, I think) I will have a piece in the Wall Street Journal arguing that the surge in lending actually makes China’s transition more difficult in the medium term because it will act to constrain future consumption in China. I think Hu Shuli might agree.