China’s Remarkable Recovery From the Great Recession, and Implications For Its Future

Although China was hit hard by the Great Recession, its economy rebounded very quickly. Why?

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The Great Recession was a period marked by a sharp decline in economic activity, beginning in December 2007 and lasting officially until June 2009. It started in the United States when the housing market crashed, but contagion effects spread to the United States’ trading partners, one of the biggest of which was China. China’s economy relies hugely on exporting their goods overseas, and when American households lost about $16 trillion of net worth in the recession, they couldn’t afford to buy as many imported goods from China. Despite China’s permanent level of exports falling by 45%–a staggering amount–its economy rebounded incredibly fast, faring much better than that of any developed country. The crisis even affected countries without close financial links to the United States, such as Russia and South Africa, with these nations also decreasing their demand for Chinese products. Why did China recover so fast, given its export-driven growth model, while the rest of the world didn’t? The answer lies in the response of the Chinese government and a party system with the control necessary to push through stringent domestic policies, even if they caused short-term pain for its already struggling firms.

To start with, China introduced a RMB¥ 4 trillion (equal to $584 billion) stimulus package in 2008, to be put into infrastructure and social welfare programs by 2010. This stimulus was comparable in size to the United States’ own stimulus packages, but it came from an economy about one-third the size at the time, so the effect was more drastic and the initiative much bolder than any other country dared to enact. With its packages, China hoped to spur economic activity and increase its citizens’ total demand for goods and services, or aggregate demand, through the creation of jobs and welfare initiatives. If consumers use the money from these support policies to purchase more goods and services, their spent money circulates and get re-spent on new goods and services, bolstering the economy otherwise weakened from the recession. All of this went superbly for China: “total industrial production in China nearly doubled between 2007 and 2013 despite the crisis and an extremely weak international demand for Chinese goods, whereas the United States has experienced zero growth in industrial production and that in the European Union and Japan has declined by 9.3% and 17.1%, respectively.”

The United States enacted programs with similar goals, so why did China’s work while the United States’ didn’t? The difference was largely influenced by the Chinese government’s control of the economy. China has a market authoritarian system, where the government can keep a much closer handle on any economic activity in their country. In the United States, there is a much less restrictive free market system, and firms are under less pressure to do anything for the good of the country, instead focusing on minimizing profit loss. Once the Great Recession hit, American firms were hesitant to borrow and invest in expanding operations when aggregate demand was still low, and consumers weren’t willing to spend when firms weren’t hiring. In China, this wasn’t the case; they had things like state-owned enterprises (SOEs) run by the government, and the government took rapid steps to help the country even though they incurred debt and loss in the short run.  

China’s state-owned enterprises also acted as a sort of automatic stabilizer for their economy. Automatic stabilizers are policies and programs designed to balance fluctuations in a nation’s economic activity without needing intervention by policymakers. This stands in contrast to the pro-cyclicality of typical, privately-operated firms, which tend to restrict their operations in times of recession. While this minimizes the risks they take during a downturn, it also means firms are less eager to do business, dragging out the length of economic recovery. Normally SOEs are supposed to maximize profit just like privately owned enterprises, but beginning in 2008, they consented to increased production and investment spending, which provided major benefits to the economy and helped the economy start to grow again. Favorably for China, almost 20% of industrial employment following the 2008 crisis came from SOEs; with so many jobs remaining active during and after the recession, their economy was able to recover much more quickly and effectively in a manner not possible in countries without SOEs or similar programs.

While China’s policy actions involving SOEs worked out in the short run, risks posed by its Keynesian approach should be addressed. The timeline for the recovery of demand can vary greatly, so Chinese firms that stepped up production post-recession would be in an even worse position if their increased output went unpurchased. Past efforts by the Chinese government to influence demand have been notoriously unsuccessful, especially thanks to its people’s strong propensity to save. Data also show that from 2008 to 2015, China’s M2 measure of money (total cash and checking deposits plus savings deposits, money market securities, mutual funds, etc) increased by 16 percent annually, but during the same period, China’s economy expanded at a rate less than half that. Domestic inflation, as well as expectations of inflation, has been high since 2008. Taken as a whole, China’s success should be taken with a grain of salt and under different circumstances may have even damaged the economy more.

Beyond these unrealized risks, China also created several other hazards for itself set to materialize in the coming years, including increases in its already dangerous levels pollution and higher inequality among Chinese citizens. It has overproduced steel thanks to government subsidies and tax breaks, drawing the ire of competing steel-producing nations. Its debt has risen to approximately 50% of its GDP in part because of its post-recession policy actions, and it’s uncertain how easily they can repay it. Furthermore, with demand for Chinese exports unlikely to return to pre-recession levels, and because investment already accounts for almost half of its economic activity, China should look to do things like boost household incomes through higher wages and lower social security contributions, put in place fairer resource prices, interest rates, and distribute dividends from state-owned enterprises, or increase spending on pensions and healthcare if it wants to continue its economic growth and achieve its promise for the future.

Much Ado About Rice: Thailand’s Rice Market Exploitation Wildly Backfires

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On August 25, former Thai Prime Minister Yingluck Shinawatra was due to appear in court to hear the verdict on her trial over involvement in a rice subsidy scandal. If she is found guilty of negligence, she could face up to ten years in prison. Yet Ms. Shinawatra never showed up in court, and many officials believe she may have fled the country.

The rice subsidy program, which led to Ms. Shinawatra’s impeachment in January of 2015 as well as her subsequent trial, started off as a well-intentioned plan to help Thailand’s agricultural sector. It was one of the main selling points for her populist party, Pheu Thai, during the 2011 campaign cycle, and helped to win the party a landslide victory. Approximately 23 percent of the Thai population are farmers, and the subsidy program was intended to help Thailand’s rice farmers earn more for their crop.

The program worked like this: the government would buy rice from farmers at up to double the market price. Then, the rice would be stockpiled and withheld from the global market in order to drive global rice prices up. Once global rice prices rose, the Thai government would sell the rice and make a profit in the process.

At the time the program was implemented, Thailand was the world’s largest exporter of rice. In addition to having a warm, damp climate, Thailand has an abundance of fresh water sources, making it an ideal location for rice production. Furthermore, the Thai people have plenty of experience producing rice–it has been their staple crop for over 5,000 years. (“In the water there are fish, in the field there is rice” is a proverbial Thai saying). All of these factors combine to give Thailand an overall advantage in rice production vis-a-vis many other countries, which have neither the climate nor the experience in such a line of production.

When a country has this comparative advantage in the production of a good, it means that that country can produce that good more efficiently than other countries can. For example, Thailand can produce rice more efficiently than Norway can because its climate and topography are better suited for rice production. Therefore, Thailand will gain the most economically if it can focus its resources on rice production, thereby producing more rice at a lower cost.  Thailand can then purchase the goods and services it does not produce as efficiently from countries that do have comparative advantages in those lines of production. If we consider the Thailand and Norway example, we notice that Thailand can sell its rice to Norway and in turn buy oil, a good that Norway has a comparative advantage in. If two countries can play to their comparative advantages and focus on what they can produce most efficiently, they can produce more, sell more, and purchase other goods at lower prices. Thus, two trading partners can actually gain from trade.

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Former Thai PM Yingluck Shinawatra has come under fire for the rice debacle

It is important to remember, however, that a comparative advantage in a certain line of production does not guarantee that a country will dominate a given market. In designing the rice subsidy program, this was the Thai government’s — and Ms. Shinawatra’s — critical mistake. There is no such thing as a patent on rice production; anyone who lives in an area with ideal conditions for growing rice can do so. Thailand is not the only country with ideal conditions for growing rice. When Thailand withdrew rice from the global market, countries such as India and Vietnam jumped in to fill the gap. The presence of these competitors meant that the global price of rice did not rise as the Thai government had hoped. Instead, rice prices plummeted, going from a peak of $1,000 per ton in 2008 to around $390 per ton in 2014. Thai farmers were edged out of the global rice market, rice exports fell by a third, and the Thai government was forced to stockpile 18 million tons of rice in the first year of the program alone. In the end, the rice subsidy fiasco cost Thailand around $15 billion. Given that GDP per capita in Thailand hovers around $6,000, this is a gargantuan sum.

Despite the heavy losses that the Thai government sustained, then Prime Minister Shinawatra refused to end or reform the program. As the program lost more and more money, government scandals and social unrest ensued. In February of 2014, a group of rice farmers threatened to park 100 tractors at Bangkok’s airport as they had not been paid for their rice. In May of 2014, Ms. Shinawatra was removed from office by the Thai Constitutional Court after six months of anti-government protests, riots, and occupations of government buildings. In July of this year, the military junta now in control in Thailand froze some of Ms. Shinawatra’s bank accounts and ordered her to pay $1 billion in civil damages. And on August 25, the same day Ms. Shinawatra failed to appear in court, her former commerce minister, Boonsong Teriyapirom, was sentenced to 42 years in prison for falsifying government-to-government rice deals with China in an attempt to cover up losses on the rice subsidy scheme.

Ms. Shinawatra’s rice subsidy program, which started off as a well-intentioned plan to help Thai farmers, ended in losses and Ms. Shinawatra’s removal from office. Interestingly, much of the instability that stemmed from the program and the government’s response to its failure is rooted in economics, or rather, faulty economic assumptions. It is true that Thailand has a comparative advantage in rice production. Yet the benefits of a comparative advantage can only be reaped if a country sells the goods it produces well and maintains its market share. Pulling out of the market is very dangerous, for a competitor may be ready and willing to take your place.

 

Conservative fiscal policy in Japan prevents rise in inflation

The Japanese economy is facing an unusual series of problems which have proved difficult for officials to address. Low birth rates and strict nationalization policies have resulted in an aging, shrinking population. Although Japan has the third largest Gross Domestic Product (GDP) in the world, it has had virtually no growth in the past two decades. Structural problems and, as we will examine in this article, overly cautious monetary policy have caused deflation in recent years.

Negative interest rates, the promise of 0% interest on a 10-year bond, and attempts at actively discrediting the Bank of Japan (BOJ) have all failed to raise inflation rates in Japan. Even in a world where developed countries are stuck in a state of secular stagnation due to sky-high corporate savings rates, Japan stands out. If one adheres to Ben Bernanke’s prescription that the mission of a central bank is to “strive for low and stable inflation,” and “promote stable growth in output and employment,” then it is the responsibility of the BOJ to fix the problem of zero growth and deflation.

According to Martin Wolf at Financial Times, corporations in Japan are saving over 20% of their capital. This makes up nearly 8% of Japanese GDP. When money is being held in banks instead of invested, money changes hands less frequently, effectively decreasing the money supply. Like with most things, the less money there is in circulation, the more it is worth. Wolf refers to this as a “savings glut.” Conservative corporate policy is currently causing deflation in Japan and hindering growth.

This negative externality created by the private sector should clearly be disincentivized. By creating seigniorage — profit created by issuing currency — the BOJ could effectively tax this stockpiling of yen. Printing more bank notes would increase the money supply and therefore decrease its value. This currency devaluation would create more incentives to invest rather than save, and, as an added benefit, would create much-needed growth in the manufacturing sector.

Issuing currency with nothing to back it may seem bold, but it has been tried before. In 2011, the European debt crisis caused the euro to crash. Believing that it was a strong, safe currency, many investors began trading their euros for Swiss francs. Switzerland’s currency began to gain value very rapidly. In order to prevent the massive appreciation of the franc, the Swiss central bank committed to printing as many francs, and purchasing as many euros, as needed to keep the franc to euro ratio above 1.20. As shown below, the franc first depreciated due to the announcement itself, but the policy was first put to the test in January 2012.

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Data from: Global Financial Data

 

Capping the franc turned out to be a success. The creation of seigniorage stopped the growth in deflation and even managed to create some small inflation. The policy would not be put to the test again until the franc began to appreciate again in late 2014. This time, however, the Swiss central bank did not remain as astute. Instead of allowing the policy to take effect, they lifted the cap, and as a result, deflation skyrocketed.

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Data From: http://www.inflation.eu

 

If the BOJ adopted a similar policy, it could jump start its countries slow economy and move towards its goal of consistent growth. Savings rates would decrease, spurring more investment. The yen would depreciate, spurring growth in the manufacturing sector. Finally, this printed money could be used to pay for additional social programs for the aging population, or to pay back some of the massive debt the country has acquired.