Opinion: The international financial crisis offers China a valuable opportunity for economic reform
By Wu Jinglian, Caijing 25 December 2008
When problems build up globally, it is impossible for the Chinese economy to remain unaffected. Over the past few years, people have become more and more perplexed by China’s gradually increasing economic imbalances.
Since China’s reform and opening, its investment-propelled growth model has produced a relatively long period of high growth and no serious problems, in part because China benefited from export-oriented policies and strong demand from overseas.
During the early stage of economic reform, there was a large labour surplus in rural areas. That surplus, combined with the inadequate savings in developed countries, gave us an opportunity to adopt export-oriented policies and produce goods for those countries. This had a huge positive influence on Chinese economic development and the living standards of the Chinese people.
Like other countries that adopted export-led policies, China found itself with increasing foreign exchange reserves. That led to the increasing pressure for currency appreciation. Theoretically, we can move one step further along the continuum of foreign exchange reform by letting the currency float. Most of the East Asian countries that implemented export-oriented policies recognized the necessity of this reform. Yet the structure of interests in China made it difficult to implement.
As early as 2003, Chinese scholars called on policymakers to allow the yuan to float and appreciate, but the idea was very difficult to receive approval from government leaders or the public. The yuan did not begin its slow appreciation until July 2005. Whenever there was strong pressure for more yuan appreciation, the central bank intervened in the market and purchased large amounts of foreign currency in order to halt the yuan’s rise. The People’s Bank of China purchased more and more foreign currency, and by October 2006 China’s foreign exchange reserves had reached $880 billion, the highest level in the world.
Now, with foreign exchange reserves close to $2 trillion, it is very difficult to balance China’s large surplus. In 2007 the country had a large asset bubble and stock market capitalization soared to $5 trillion, then fell to $1.3 trillion.
With the U.S.-led financial tsunami now reaching China, multiple issues are rising. U.S. dollar assets depreciated and U.S. companies began pulling money back home to rescue their parent corporations, thus creating a U.S. dollar backflow. All of this made some of the Chinese financial system’s paper assets suddenly disappear, turning the liquidity surplus into a liquidity deficit. In southern China, companies had their cash flow cut off. Because at least 35 percent of China’s economy relies on exports and 20 percent of China’s exports go to the U.S., it is estimated that if the U.S. growth rate falls by 1 percentage point, Chinese exports could fall 4 percentage points.
China needs to overestimate the difficulties it faces and immediately adopt effective measures to cushion the economic shock.
Since so much paper wealth has disappeared, it is possible that asset markets could collapse. In 2008, stock prices have fallen more than 70 percent. But the real estate market is a problem that must be handled cautiously. Loosening monetary policy is not advisable although it might be eased to some extent to prevent a financial meltdown.
Instead, the government should rely on an expansive fiscal policy. During the 1997 Asian financial crisis, the government adopted policies to bolster small and medium-sized enterprises (SMEs). For example, the government required all of China’s major specialized banks to set up organizations to handle loans to SMEs and promised that there would be credit for small enterprises in all regions. These measures did not require the government to spend a lot, but they turned out to be extremely effective.
Some in China are now raising the question of whether the government should take advantage of the global financial crisis to supplant the U.S. dollar with the yuan. Others suggest letting the yuan float and still others are talking about whether China should sell U.S. debt. I think, in this globalized world, every country shares a common interest in a steady global economy. The government’s approach has to be to collaborate with other countries to help each other get through the hard times together.
Long-Term Countermeasures
The fundamental mission for China should be to change the export development model. This is the premise of solving other issues such as excessive resource consumption, environmental degradation and insufficient domestic consumption rate.
Outside China, there are many views on how to reform the international financial system. Some are calling for a “New Bretton Woods System.” Two suggested approaches are diversifying international monetary reserves and forming a regional monetary reserve system. Those approaches should be studied, but at minimum, we should tame dollar production and place it under some kind of international supervision.
This current financial tsunami will be a blessing for both the U.S. and the world if it can make the American people realize that its development model cannot continue, that they must work together with all countries in the world and at the same time establish a robust global financial system.
The Fundamental Problem
China’s most important decision, however, will be to change its development model. There are obstacles to change at many levels. Government still retains the right to direct large amounts of land, capital and other resources into building so-called “image projects” and “achievement projects” in order to reach political targets.
We also need to upgrade Chinese industry and limit development in capital-intensive and high-pollution industries and seeks high value-added production. But reaching this goal is slow. Some say that China does not have enough talented technical personnel, that the Chinese people are lagging in the capability to innovate, that we do not have a comparative advantage in value-added industries and other reasons.
I do not endorse these views. Although China’s technical personnel still constitute a small proportion of the total population, the country is so big that the actual number of technical staff is number one in the world. China’s research and development (R&D) expenditure for 2007 was number two in the world, after that of the U.S. Our technical personnel have had more than a few independent inventions, and some of these have already moved to important frontlines. Yet the commercialization of these inventions is slow. This is due to barriers in our system that stem from the lack of separation between government and enterprise. Many of our important industrial arenas are in the grasp of monopolistic powers that suppress innovation and hinder the introduction of new technology.
There are two key routes for upgrading China’s industries: one is bringing service into the manufacturing sector to move away from simple processing and toward R&D, design, brand sales and after-sales service – in other words, extending our reach into the service industries. The other route is to develop those current service industries that have high knowledge content. Why is service industry development so slow? As Yale University Professor Chen Zhiwu has said, the main reason is because service industries require much more from the system than do processing and manufacturing. Most importantly, the rule of law is not well established in China, and this creates exorbitant transaction costs for China’s service industries.
In sum, China needs to change its economic development model, and this cannot be done without a push from further reforms – economic reforms and establishing the democratic rule of law. Such moves forward will determine whether we can bring about fundamental change in our economic development model.
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Global Financial Crisis: Surviving the Tsunami
Opinion: The international financial crisis offers China a valuable opportunity for economic reform
By Wu Jinglian, Caijing
25 December 2008
When problems build up globally, it is impossible for the Chinese economy to remain unaffected. Over the past few years, people have become more and more perplexed by China’s gradually increasing economic imbalances.
Since China’s reform and opening, its investment-propelled growth model has produced a relatively long period of high growth and no serious problems, in part because China benefited from export-oriented policies and strong demand from overseas.
During the early stage of economic reform, there was a large labour surplus in rural areas. That surplus, combined with the inadequate savings in developed countries, gave us an opportunity to adopt export-oriented policies and produce goods for those countries. This had a huge positive influence on Chinese economic development and the living standards of the Chinese people.
Like other countries that adopted export-led policies, China found itself with increasing foreign exchange reserves. That led to the increasing pressure for currency appreciation. Theoretically, we can move one step further along the continuum of foreign exchange reform by letting the currency float. Most of the East Asian countries that implemented export-oriented policies recognized the necessity of this reform. Yet the structure of interests in China made it difficult to implement.
As early as 2003, Chinese scholars called on policymakers to allow the yuan to float and appreciate, but the idea was very difficult to receive approval from government leaders or the public. The yuan did not begin its slow appreciation until July 2005. Whenever there was strong pressure for more yuan appreciation, the central bank intervened in the market and purchased large amounts of foreign currency in order to halt the yuan’s rise. The People’s Bank of China purchased more and more foreign currency, and by October 2006 China’s foreign exchange reserves had reached $880 billion, the highest level in the world.
Now, with foreign exchange reserves close to $2 trillion, it is very difficult to balance China’s large surplus. In 2007 the country had a large asset bubble and stock market capitalization soared to $5 trillion, then fell to $1.3 trillion.
With the U.S.-led financial tsunami now reaching China, multiple issues are rising. U.S. dollar assets depreciated and U.S. companies began pulling money back home to rescue their parent corporations, thus creating a U.S. dollar backflow. All of this made some of the Chinese financial system’s paper assets suddenly disappear, turning the liquidity surplus into a liquidity deficit. In southern China, companies had their cash flow cut off. Because at least 35 percent of China’s economy relies on exports and 20 percent of China’s exports go to the U.S., it is estimated that if the U.S. growth rate falls by 1 percentage point, Chinese exports could fall 4 percentage points.
China needs to overestimate the difficulties it faces and immediately adopt effective measures to cushion the economic shock.
Since so much paper wealth has disappeared, it is possible that asset markets could collapse. In 2008, stock prices have fallen more than 70 percent. But the real estate market is a problem that must be handled cautiously. Loosening monetary policy is not advisable although it might be eased to some extent to prevent a financial meltdown.
Instead, the government should rely on an expansive fiscal policy. During the 1997 Asian financial crisis, the government adopted policies to bolster small and medium-sized enterprises (SMEs). For example, the government required all of China’s major specialized banks to set up organizations to handle loans to SMEs and promised that there would be credit for small enterprises in all regions. These measures did not require the government to spend a lot, but they turned out to be extremely effective.
Some in China are now raising the question of whether the government should take advantage of the global financial crisis to supplant the U.S. dollar with the yuan. Others suggest letting the yuan float and still others are talking about whether China should sell U.S. debt. I think, in this globalized world, every country shares a common interest in a steady global economy. The government’s approach has to be to collaborate with other countries to help each other get through the hard times together.
Long-Term Countermeasures
The fundamental mission for China should be to change the export development model. This is the premise of solving other issues such as excessive resource consumption, environmental degradation and insufficient domestic consumption rate.
Outside China, there are many views on how to reform the international financial system. Some are calling for a “New Bretton Woods System.” Two suggested approaches are diversifying international monetary reserves and forming a regional monetary reserve system. Those approaches should be studied, but at minimum, we should tame dollar production and place it under some kind of international supervision.
This current financial tsunami will be a blessing for both the U.S. and the world if it can make the American people realize that its development model cannot continue, that they must work together with all countries in the world and at the same time establish a robust global financial system.
The Fundamental Problem
China’s most important decision, however, will be to change its development model. There are obstacles to change at many levels. Government still retains the right to direct large amounts of land, capital and other resources into building so-called “image projects” and “achievement projects” in order to reach political targets.
We also need to upgrade Chinese industry and limit development in capital-intensive and high-pollution industries and seeks high value-added production. But reaching this goal is slow. Some say that China does not have enough talented technical personnel, that the Chinese people are lagging in the capability to innovate, that we do not have a comparative advantage in value-added industries and other reasons.
I do not endorse these views. Although China’s technical personnel still constitute a small proportion of the total population, the country is so big that the actual number of technical staff is number one in the world. China’s research and development (R&D) expenditure for 2007 was number two in the world, after that of the U.S. Our technical personnel have had more than a few independent inventions, and some of these have already moved to important frontlines. Yet the commercialization of these inventions is slow. This is due to barriers in our system that stem from the lack of separation between government and enterprise. Many of our important industrial arenas are in the grasp of monopolistic powers that suppress innovation and hinder the introduction of new technology.
There are two key routes for upgrading China’s industries: one is bringing service into the manufacturing sector to move away from simple processing and toward R&D, design, brand sales and after-sales service – in other words, extending our reach into the service industries. The other route is to develop those current service industries that have high knowledge content. Why is service industry development so slow? As Yale University Professor Chen Zhiwu has said, the main reason is because service industries require much more from the system than do processing and manufacturing. Most importantly, the rule of law is not well established in China, and this creates exorbitant transaction costs for China’s service industries.
In sum, China needs to change its economic development model, and this cannot be done without a push from further reforms – economic reforms and establishing the democratic rule of law. Such moves forward will determine whether we can bring about fundamental change in our economic development model.
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