Sunday, June 17, 2007

Carnegie Report on Economic Growth and Rural Society in China

Today, I would like to review a recent report on Chinese economy and its rural society, released from the Carnegie Endowment for International Peace. This report, entitled “China’s Economic Fluctuations and Their Implications for Its Rural Economy”, is written by Senior Associate Albert Keidel, in collaboration with Dr. Liu Jianxing of the International Cooperation Center in National Development and Reform Commission, China. This is a considerable advantage of this report, because China is so gigantic, old, and complicated that it is difficult to understand this country solely from American, Japanese, or European point of view.

According to this report, China’s economic growth is driven by domestic demand, even though its trade surplus has expanded rapidly. Also, Keidel says that Chinese economic policy has systematically disadvantaged rural society. Let me review this report more in detail.

This Report discusses the history of Chinese economic policy since the post-Mao era. After Mao Zedong had passed away in 1976, President Hua Guofeng made the post-Mao strong investment program. In 1978, the Chinese government launched market reforms, international openings, and agricultural price reforms. Keidel’s report focuses on analysis of the causal relations behind China’s economic cycles since the 1978 reform and its implications to rural economy, rather than policy recommendations.

Albert Keidel points out that Chinese economy has been experiencing the cycle of fast growth and slow growth phases since then. Unlike other rapidly developing East Asian economies, China’s economic growth has been driven by domestic expansion. During the period of “dot com” boom of US economy in late 1990s, China suffered from slow growth. On the other hand, China enjoyed rapid growth in 2002 when the United States and export-oriented Asian economies slowed down. Trade and Foreign investments are important to transfer foreign technologies and management skills into China, but they are not engine for its economic growth.

The report has four chapters. Chapter 1 introduces basic economic cycles. With graphical set panels, readers can compare basic trends and fluctuations of fast growth and slow growth phases. Chapter 2 talks of methodology to explain origins of economic cycles. With this methodology, Keidel investigates macroeconomic cycles thoroughly in Chapter 3.

Based on statistical and historical evidence, the author tells that China’s 30 year economic expansion cannot be explained by foreign investment, trade, or other external factors. Albert Keidel classifies the phase as the following.

1978 ~ 1982: Post-Mao Spending, Price Reform, and Restructuring
The combination of overly ambitious investment programs, a border war with Vietnam, and rural reforms raising agricultural prices played the dominant roles in first-fueling overheating. Then, official reaction to overheating brought on the slow period, using reductions in government spending and administrative investment cutbacks. Drought and crop failure in northern China had no overall significant national impact.

1983 ~ 1987: Land Reform and New Factory Management
The period exhibits overheated growth, monetary expansion, inflation, and subsequent sharp credit tightening along with other administrative measures to cool off the economy. As becomes increasingly the case in later cycles, the independent power of market forces and sources of macroeconomic instability grow in significance compared with the direct influence of government and Communist Party policy.

1987 ~ 1990: Inflation, Bank Panic, Credit Cutoff, and Severe Slump
Unexpected economic market forces made the cyclical extremes much more serious. Inflation this time, however, in 1988, was more severe than earlier bouts in the reform era, and it provoked an energetic late-1988 program to cut credit for investment and bring inflation down in a two-year period, targeting 1989–1990. The tightening was particularly unpopular in urban areas, requiring strenuous implementation in 1989. By late 1989, output had slumped; and by 1990, both output growth and inflation were low. In late 1990, with the two-year target period over, the top leadership made the decision to reinvigorate the economy. Despite the cycle’s short duration, its various fluctuations had been severe.

1991 ~ 2000: Urban Price Reform, Layoffs, and Growth Slump
This phase is perhaps the most interesting for exploring cycles themselves and the role played by domestic demand, including household consumer demand. It witnessed the explosion in FDI starting in the early 1990s, conclusion of the earlier incomplete price reforms, a severe bout of overheated inflation (1993–1994), a delayed boom in rural China, and then dramatic enterprise reforms and layoffs in the later 1990s. Rural participation in the cycle was also fundamental, but it will be the subject of additional analysis in the remainder of the report.

2001 ~ 2005: SARS Investment Boom and Export Surge
The 2001-2005 surge is still continuing today. As shown in figure 3.13 on page 50, the combination of domestic and foreign demand contribution to GDP articulates that China’s economic expansion is not export-oriented. Keidel suggests that domestic capital formation can be responsible for rapid economic expansion today. In his analysis, neither domestic consumption nor domestically sourced investment accounts for rapid growth in 2001. He estimates that increase in inventories caused high growth. Though SARS epidemic hit the economy in 2003, the Chinese government overcame the crisis by stimulating investments.

In Chapter 4, the author argues that the role of rural economy is beyond providing food, raw materials, and inexpensive labor. He discusses this from the following points.

1. Does the rural economy have an independent dynamism of its own?
2. Has the impact of China’s fast and slow periods since 1978 been more difficult for the rural economy than for the rest of the country?
3. How much did national and urban policies and fluctuations directly cause fluctuations in the rural economy?
4. Did the rural economy have its own independent influence on the national economy?

Having reviewed these questions, Keidel concludes that rural economy was a passive responder to national economic policy until 1990s when it began to exert some independent stimulus on national trends. A failure to appreciate the role of rural economy can result in, or has resulted in excessive macroeconomic volatility as it happened in 1990s. Keidel insists that Chinese leaders learn from this lesson.

Albert Keidel is a professional economist who has worked for US Treasury and World Bank Office in Beijing. This report is recommended for those who have advanced knowledge in economic policy. Cool headed analysis and well arranged charts are helpful to understand Chinese economy in depth.