China needs Rebalancing. The West has been crying hoarse for more than 6-7 years now. Now renowned China economist Nicholas Lardy, Senior Fellow at Peterson Institute of International Economics and author of Sustaining China's Economic Growth after the Global Financial Crisis (2012), China's Rise: Challenges and Opportunities (2008) and China’s Unfinished Economic Revolution (1998), etc (along with Nicholas Borst) has brought out a Policy Brief on how China needs to implement this very crucial economic task of Rebalancing.
What is Rebalancing?
Wen Jiabao had said as early as 2007, that the Chinese economy was “uncoordinated, unsteady, imbalanced, and unsustainable.” The Chinese leadership realized that the extreme economic policies it had been following for almost 2 decades were going to have severe consequences if they were not rectified. This was the policy of suppressing private consumption and in turn focusing on the pursuit of super high levels of investment-led export-led growth. Over-investment over long periods leads to large amounts of mis-allocated capital and the potential of unsustainable asset bubbles which can crash the economy. Moreover, Western markets are facing near recessionary conditions and China can no longer depend on export-led growth to rescue it. The Chinese leadership has realized that its single-minded pursuit of growth in order to economically empower China as quickly as possible against a undependable and untrustworthy West, has resulted in a highly distorted and unbalanced economy. This can boomerang against China in unpredictable dangerous ways. Rebalancing is the process for restabilising the economy.
So what does Prof Lardy say about managing Rebalancing in China?
He says that for Rebalancing, domestic consumption needs to be spurred and Investment needs to be tempered through a set of policies. Essentially this can be done through 4 ways.
Firstly, implementation of Market determined interest rates.
This will tend to increase deposit rates which means banks will have to increase their lending rates. This in turn will result in reduction of investment activity and divert funds from capital investment towards labor intensive sector resulting in job creation and therefore increased household income. High deposit rates will also alleviate the 'financial repression' conditions existing in China. Higher returns on deposits will increase the confidence of the citizens in their economic situation resulting in higher consumption!
Second, Revalue the Yuan or Appreciate the Currency
The hugely devalued currency (yuan) used to make Chinese exports considerably cheaper (unfairly) as compared to other countries. This along with China's very low hukou-based labor costs had led to the 'Chinese Price' phenomena - very cheap Chinese prices which had made Chinese exports so attractive. This was the engine of China's export-led growth which had resulted in China's massive trade/ current account surplus. China definitely needed to address this huge imbalance. But things have changed in the last few years. China’s current account surplus in the first half of 2012 fell to only 2.1 percent of GDP, down dramatically from the 10.1 percent peak in 2007. So China has done quite a bit. But further work needs to be done to set things completely right.
Third, Market based Energy Prices
Price controls on fuels act as a hidden subsidy to China’s industrial sector, which consumes two-thirds of energy production. This has subsidized the growth of the capital-intensive sector at the cost of the consumption-based service sector. Removing these subsidies for manufacturing would eliminate the incentives for investment which in turn would flow to the service sector (which is consumption based) increasing wages and consumption. Between 1980 and 2002, the services sector share of the GDP, doubled from about 20.5% to 41.5%. But this trend has changed sharply since 2003. As a result of the severe intensification of the financial repression and investment directed policies, this ratio has increased only marginally to 43%!
Fourth, Redistribution mechanisms and Reduction of Inequality
Enormous gains have accrued to capital owners over the past decade and worsened inequality. Wage share of the GDP has declined considerably. The above mentioned policies of Market-based interest rate, exchange rate, and energy prices, will help increase the wage share of GDP and thereby reduce inequality.
But more is required to be done to address the Social problems. The Chinese government needs to continue to develop social safety nets in order to reduce precautionary saving by households. With such nets in place people will not need to save for their old age. With greater income in hand, people will spend more increasing the consumption in the economy.
In addition, China should increase the progressiveness of taxes as there is too much reliance on indirect, and therefore regressive, tax collection. Finally, further reforms to the hukou household registration system would reduce inequality between rural and urban areas and improve the living standards of China’s migrant workers. This too would result in increased spending by citizens.
Finally the authors touch on the Politics of Rebalancing. Many are saying that 'vested interests' are blocking Reform and further (economic) Reform cannot take place without political reform. The authors disagree with this view. There are pockets like SASAC where the vested bureaucratic interests are definitely at play. But the authors say that this phenomena is essentially limited to certain pockets. Rebalancing has increasingly greater support across the the Chinese leadership.
Click here to access the full report.
Relooking at Soros comments about Renimbi in 2009 end
George Soros had said that China will be the New World Revered Currency.