Abstract
This paper offers a theoretical basis for the concept of rebalancing and applies it to China, where it is currently a topical issue. Rebalancing here means the correction of economic and social imbalances built up during industrialization. This correction is accompanied by a structural transformation towards a more inward- and consumption-driven growth path, associated with growth slowdown. Attempts to mitigate this growth slowdown by either retarding this structural reform process or by using expansionary stimulus programmes as done over the past decade in China create new imbalances that have to be corrected (rebalanced) again. Managing these multiple rebalancing tasks together is a tremendous undertaking, as this paper shows.
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Notes
Although it first seemed as if East Asia would not be significantly affected by the crisis, from September 2008 to the first half of 2009, all emerging economies in East Asia faced a sharp decrease in rates of export growth leading to even negative values accompanied by a falling output (see Kawai and Lee 2015, 32).
This view is not uncontroversial among Asian economists as it can be argued that fewer exports is not an (not the only) option for small and thus export-dependent economies. Even for China, export-dependency is not the major problem, rather the too high investment ratio (see below).
Previous discussions about rebalancing (in China) have been rather a-theoretical.
Also in a one-party system like in China there are terms of offices; in China five-year-periods, which are associated with five-year-plans, where specific goals are set.
As recently started in China; this will be explained below in chapters 3 and 4.
As mentioned, this red line can endogenously shift upwards by allowing a longer lasting overshooting of the goal, thereby triggering rising expectations or claims behaviour.
Such effects have not only been experienced by developing/emerging economies but also by developed economies, of course. For example, Great Britain knows this very well when thinking back to the years of Thatcherism. But also many other countries had to suffer huge costs over a long period of cleansing and consolidation in the 1980s following previous temporary economic successes triggered by expansionary stimulus programmes.
This is the result of a strategy chosen deliberately by Deng Xiaoping in the mid-eighties (in order) to develop a large, poor country quickly.
Therefore, Deng Xiaoping’s strategy choice, which is also known as the ‘get rich first’ strategy, allowed some people (in particular those living in coastal regions) to get rich first, serving as examples for the rest of the country, so that later, the whole Chinese population would benefit from this increasing wealth (e.g. via spillover effects).
See the World Development Indicators (World Bank 2016).
Examples can be found among the experiences of East European post-Communist countries when they underwent necessary structural transformation processes towards a market-type economy in the early 1990s.
There is much evidence in the literature for such sluggish adjustment behaviour of expectations and claims behaviour (see, for example the literature on adaptive expectations building in economics).
In the period between 2011 and 2015 the Chinese government aimed to increase the service sector contribution to GDP up to 43.3 % (in contrast to this, the 11th five-year plan target was 40.3 %) and over the next five years (until 2020), the Chinese government wants to reach the 56 % mark. China was able to meet the goals of the last two five-year plans. In order to reach the 13th five-year plan target as well, the service sector has to grow by an average of 3.5 % p.a. (until 2020).
In this context, a current discussion in Western industrial countries on the interrelationship between credit growth and productivity slump (against the background of the ‘old’ theories of Wicksell, von Mises and von Hayek) could well be transferred to China as well. The main argument is that credit cycles lead to imbalances in the real economy. Credit expansion allows firms to get easier financing for risky (lower quality) projects so that misinvestment or misallocation becomes more frequent (see, e.g. Gorton and Ordonez 2015). Hence, the share of less productive activities widens at the expense of more productive sector activities during credit booms (see, e.g. Borio et al. 2016). When booms eventually burst, this is likely associated with painful adjustments. Cecchetti and Kharroubi (2015) developed a model that allows them to predict that expanding the financial sector favors investment projects that are characterized by high collateral for credit but low productivity (e.g. real estate). Furthermore, they show that skilled labour is attracted away from more productive sectors when the financial sector expands.
I refer here to the critical values constructed by the EU Commission for EU countries (see European Commission 2012). However, using these thresholds requires caution, in particular because the EMU countries and China are characterized by significant differences in their respective economic and political structures. Nonetheless, these thresholds may be useful in gaining a first indication and to establish a starting point for further research. Indeed, China is on its way to becoming a developed country and the China’s imbalances may expand even further in the near future.
That is, the manufacturing sector has run into labour shortages and hence has to start paying higher real wages. In other words, China has reached the ‘Lewis turning point’ (Lewis 1954).
The Quarterly Forecast and Analysis Report of the Center for Macroeconomic Research, Xiamen University (2015), indicates that the ‘total amount of social security, medical, and educational expenditure in public fiscal expenditure gradually rose from 29.5 % in 2010 to 31.7 % in 2014’. Nonetheless, as argued there, the welfare system in China is still underdeveloped relative to Western economies where ‘(i)n 2011, the EU-27’s spending on health, education, and social protection together accounted for 47.8 % of the central (federal) government spending’ and ‘(i)n 2013, the US social security, Medicare, and Medicaid spending accounted for 48 % of federal fiscal expenditure’ (Center for Macroeconomic Research of Xiamen University 2015, 57).
As Anzoatesui et al. (2015, 2–3, 24–25) emphasize, over the past years, China’s government has created large distortions by intervening in the market process and driving the economy into disequilibrium. For example, low administratively controlled interest rates and other distortions artificially boosted savings rates and reduced the cost of capital in China. This, together with implicit state guarantees, supported the building up of imbalances.
For these necessary steps, see Wagner (2015).
However, as the current president of the European Commission, Jean-Claude Juncker, once said about the difficulties of getting the Euro crisis solved: ‘We all know what to do, we just don’t know how to get re-elected after we’ve done it.’ The Economist (2007), ‘The Quest for Prosperity’, 15 March 2007 (online available at: http://www.economist.com/node/8808044). This can generally be applied to China as well. However more transparency and better political communication of the inevitability of the negative side effects of the rebalancing process would help to overcome this dilemma in China.
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Acknowledgments
I thank my colleagues at these institutions as well as Prof. Xu from Hong Kong University and Dr. Dollar from Brookings Institution for useful discussions, comments and hints. I am also grateful for comments by the editors. My special thanks go to Linda Glawe for her excellent research assistance.
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Appendices
Appendix A: Functions and workings of expansionary stimulus programmes
As described above, China was hit by external demand/exports shocks in the aftermath of the global financial crisis. Figure 9 shows the reaction functions of the two considered policy options of how to react to a growth slowdown originated by such shocks. Path I (in black) shows what happens if the government jumps in with expansionary Keynesian-type macroeconomic (monetary and fiscal) stimulus programmes. Path II (in grey) delineates the effects of the alternative of a ‘market solution’ (when the government provides the right market incentives and institutions and waits for the workings of the market solution via the price mechanism).
Shock reaction with and without policy stimulus programmes (I)
Here, Y* is the equilibrium GDP per capita level, meaning here the GDP per capita level that is consistent with full (or desired) employment. t 0 describes the point in time when an external demand/export shock occurs. Transition path I describes the reaction function if the government jumps in with expansionary Keynesian-type macroeconomic (monetary and fiscal) stimulus programmes in order to mitigate the negative downturn effect triggered by the shock. In contrast, path II shows the transition path if the government chooses the market solution and waits for the effectiveness of stabilisation via the price mechanism. This would presumably take longer and end up in a deeper, more extended recession or depression.
The fundamental relationships can be explained with the traditional income identity:
\( {C}_0+{I}_0+{G}_0+N{X}_0={Y}_0\equiv {Y}^{\ast } \) (full-employment income or output), with C 0 = consumption, I 0 = investment, G 0 = government expenditure, NX 0 = external demand, and Y 0 = aggregate income/output.
Due to the external export shock, NX will decline to NX 1 < NX 0. Hence Y will decline to Y 1 < Y 0. Rebalancing, as understood by the IMF and in the recent Chinese five-year plans, means that external demand (NX) should partly be compensated by domestic private demand (C, I) by restructuring the economy. However, this takes time and in the meantime the growth slowdown originated by the external demand shock could add up to a dangerous level so that the above-described threshold TH may be undershot. To avoid this, the government tries to help out by using expansionary Keynesian-type macroeconomic stimulus programmes (as long as the rebalancing reforms do not become effective). Thus, it compensates the loss of or decline in external demand (NX 1 − NX 0) by additional government demand (G 1 − G 0, where this symbolises the aggregate effect of the governmental support programme (initial investment) and the thereby triggered consecutive private activities acting as multiplicator and accelerator effects).
The alternative policy reaction delineated in Fig. 9 as transition path II is the market solution, i.e. providing a free market framework and waiting for the solution/stabilisation via the price mechanism. Even if the government were to trust this solution mechanism and therefore chose it (which is unlikely in the case of China), the stabilisation would most probably take longer than the Keynesian-type solution. (At least, this was probably the belief of the Chinese government.) However, by choosing the faster Keynesian reaction way, the government accepts that it thus creates economic and social imbalances knowing that they will likely have to be corrected sometime in the future. Path III (dashed black line) in Fig. 9 delineates this correction path. The imbalances making this correction path necessary show up if/as governmental investments and subsidies happen in an unbalanced way, i.e. some enterprises/branches/sectors profit more than others so that overcapacities may arise in some of these and may end up in a boom and bust cycle. In the Chinese case, SOEs have profited more than the other enterprises. Additionally, infrastructure and real estate branches have benefited more than others. In general, the manufactural sector has mostly profited from the stimulus programmes.
If the governmental stimulus programmes and the affected private follow-up investments (in the multiplier–accelerator process) are mostly financed by credit expansion, then a financial crisis (bust) may arise.
The above presentation in Fig. 9 can alternatively be presented in a growth presentation (see Fig. 10):
Here, g* is the equilibrium growth rate, meaning the growth rate that is consistent with full (or desired) employment. Transition path I again describes the reaction function if the government jumps in with expansionary Keynesian-type macroeconomic (monetary and fiscal) stimulus programmes. In contrast, path II shows the transition path if the government chooses the market solution and waits for the effectiveness of stabilisation via the price mechanism. As described, this would take longer and culminate in a deeper, more extended recession or depression. Perhaps (or probably) the growth slowdown during this process would (at least temporarily) undershoot the above threshold TH with the above-described consequences. Therefore, a (risk-averse) government usually chooses the reaction policy described by path I, thus producing imbalances that have to be corrected sometime in the future (delineated by the transition path III in Fig. 10). However, this ironically may then create the undershooting of the threshold, TH, which it was intended to avoid in the first place (by using the transition path I).
Shock reaction with and without policy stimulus programmes (II)
Appendix B: Extent of imbalances in China
In Table 4, the coloured fields delineate that China has exceeded the critical thresholds in this quartile for the yearly change in the respective asset price. Note that we use countrywide house price data here. However, if we focus on the large eastern provinces of China (e.g. Shanghai, Peking or Shenzhen) the yearly change in house prices is much higher.
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Wagner, H. The building up of new imbalances in China: the dilemma with ‘rebalancing’. Int Econ Econ Policy 14, 701–722 (2017). https://doi.org/10.1007/s10368-016-0360-4
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DOI: https://doi.org/10.1007/s10368-016-0360-4