The article discusses China’s growth in these recent years. It forecasts that China’s growth is not sustainable; thus growth rate will cease next year because the country is operating at full potential, facing the risk of overcapacity. In addition, China now has to face the severest national debt In Its history, which puts Its economy In extremely vulnerable state. The author also argues that China should stop relying on strong fiscal policy, but to Initiate an economic reform If It wants to keep Its dazzling growth record. Let us analyze whether China’s situation is as problematic as the author perceives.
Economic growth indicates an increase in national output as well as national income. There are two types of economic growth, long-run and short-run. In the short term, economic growth is influenced by aggregate demand (AD). If there is spare capacity in the economy, an increase in any components of AD – includes consumption (C), investment (l), government expenditure (G) and net export (X-M) – will give rise too higher level of real GAP. Long-run growth, on the other hand, depends on the economy aggregate supply, which is also known as productive capacity.
The article predicts China’s growth Is a short-run growth because the mall drive for It Is the pro-active expansionary fiscal policy that China has been adopted since 2008, the year of global financial crawls. Two mall tools that the Chinese government put In place to combat this great recession are a stimulus package and comprehensive tax reform. As mentioned above, government expenditure is a component of AD, so when the government expenditure changes, AD changes and thus real GAP changes subsequently. This induces a change in consumption expenditure, which bring in the process of government expenditure multiplier.
In the case of China, the stimulus package includes 4 trillion Yuan to spend on boosting China’s domestic demands . AD changes from ADO to DAD (Figure 1), causes real GAP to rise from YOU to Yell . This increase in government expenditure initially increases the income of rural citizens, since low-income housing projects will get 400 billion Yuan, and 370 billion Yuan will be used to improve rural people’s well-being. Better-off rural citizens now have higher purchasing power, thus would be able and willing to purchase more, which boosts consumption expenditures. With rising revenue,
China’s businesses in all parts of the nation boom and expand their payroll. A second round of increased consumption expenditure increases income further. DAD rises to DAD, and Yell increases to YE. As such, the expansionary fiscal policy is effective in driving up economic growth as they gear the economy on track of recovery for its target of eight percent during global financial crisis up to dated. Price level LIARS LORA’S Real GAP Another tool that was used to boost China’s AD is tax reform. Chinese government cut the value-added tax (VAT) by excluding investment from the tax base, starting from
January 2009. The measure aims at reducing business tax burden and increasing investment. No VAT means higher profit margin for foreign investors as the cost of production is reduced significantly. China becomes more attractive to foreign direct investment (FAD). Meanwhile, the government increases tax rebates for some export goods. For example, on November 1 1, 2008, the government increases tax rebates for textile, clothing, toys, and other goods. The rebate rates for textile and clothing increases from 14% to 15% on February 1, 2009, and to 16% on April 1, 20093.
Since investment and net export is another component of AD, an increase in investment promises an increase in AD and an increase in national income subsequently. Higher purchasing power results in increased consumption expenditure. Tax multiplier effect steps in Just like government expenditure multiplier effect, bringing DAD to DAD and YE to YE. Two factors that limit the effectiveness of discretionary fiscal policy are economic forecasting and estimating potential GAP. Fiscal policy changes take a long time to become effective.
Fiscal policy must target forecasts of where the economy will be in the future. Economic forecasts have improved significantly in the last few decades, but we must take into account the fact that China is a large country with a huge population of diverse skill levels and income gap, thus the forecasting might not be so accurate. In addition, discretionary fiscal action might move real GAP away from potential GAP and create other macroeconomic problems. Another problem is that it is difficult to tell whether real GAP is below, above or at potential GAP.
Therefore, discretionary fiscal action might move real GAP away from potential GAP instead of toward it. If real GAP is Y 1, expansionary fiscal policy might bring the economy to full employment at the potential GAP YOU. However, if the Chinese government overestimates its potential GAP, the growth of AD does not stop at DAD but continue to increase to DAD. Inflation without economic growth occurs as real GAP remains at Yell while price level increases from Pl to UP, which is one of the reasons why the article believes China’s growth rate will cease in the near future.
However, the article’s stance might not be completely true because China’s stimulus cages is put in place not Just for short-run growth, but also give rise to long-run economic growth. Long-run economic growth comes from increasing quantity and quality of factors of production in the economy. This growth is determined by the change in both capital and labor, demonstrated by an outward shift of LORA’S to LIARS . The biggest share in China’s stimulus package is roughly 1. 5 trillion Yuan, which goes to infrastructure construction including railways, roads, airports, urban power grids and irrigation projects.
Energy saving and ecological projects will get 210 billion Yuan. 70 billion Yuan will fund innovation and industrial restructuring as we. This increased labor and capital productivity bring about higher potential output for China. Long-run growth ensures China’s a sustainable increase in real GAP, as well as keeping rate of inflation low, since China’s inflation rate has been going down since 2008. China also adapts moderate expansionary monetary policy to enhance growth during global financial crisis. Interest rate influences investment and consumption expenditure.
When People’s Bank of China’s (BBC) lowered the from 7. 47% to 5. 31%7, investment and expenditure on consumer durables increase. This is because interest rate is the opportunity cost the funds used to finance investment and the purchase of consumer items. When opportunity cost of investment and purchasing of goods is reduced from OR to RI (Figure 2), customers are more willing and able to purchase, leading to an increase in foreign direct investment and expenditures from 10 to II . Figure 2 In addition, a fall in interest rate means that China’s interest decreases relatively to the interest rate in other countries.
Consumers would want to move funds from China to other countries to take advantage of higher interest rate. When money is Ovid away from China, people sell Yuan and buy other currencies, such as US dollar or Japanese yen. With more Yuan being supplied, the price of Yuan falls on foreign exchange market. The lower price of Yuan means that foreigners must now pay more for Chinese goods and services. Thus, the quantity demanded and expenditure on Chinese items increases. China’s export increases. Similarly, the lower price of Yuan means that Chinese now pay more for foreign-made goods and services.
As such, the quantity demanded decreases, the expenditure on foreign-made items decreases, and Chinese imports decreases. Net exports are now improved, however, to a very little extent as compared to the increase brought about by fiscal policy. This is because much of China’s trade involves importing inputs and parts and components with very little import duties (imports for processing) and adding value through processing and assembly of these parts and components into goods that are then re- exported (processed exports).
The processed exports have much higher import content than non-processed exports. Higher cost of import would make China’s processed exports less competitive in the global market. Putting these effects gather, investment, consumption expenditure and net exports are all components of AD, which are sensitive to interest rate. A rise in interest rate, thus, brings an increase in AD. Multiplier effect steps in Just like fiscal multiplier effect. The size of this multiplier effect depends on the sensitivity of expenditure plans to the interest rate.
The larger the effect of a change in interest rate on AD, the greater is the multiplier effect and the smaller is the change in interest rate that achieve BBC objective. While expansionary fiscal and monetary policies bring about economic Roth, they put China in severe debt this year. China now suffers from a budget deficit. The budget deficit is defined as the difference between what the government spends and what the government collects. Government spending takes the form of salaries, defense spending, aid programs, etc.
Government collection predominantly takes the form of taxes. When the government spends more than it collects, a budget deficit. This reduces the price of bonds, raising the interest rate. The increase in the interest rate reduces the quantity of private investment demanded, also increases he demand for and reduces the supply of dollars in the foreign exchange market, raising the exchange rate. When the real exchange rate is high, the relative price of goods at home is higher than the relative price of goods abroad.
In this case, import is likely because foreign goods are cheaper, in real terms, than domestic goods. Thus, when the real exchange rate is high, net exports decrease as imports rise. All of these effects work to offset the increase in aggregate demand that would normally accompany an increase in the budget deficit. That is the reason the article states that China’s economy is vulnerable. However, the situation is not so pessimistic because China has been experiencing a trade surplus from March 2014. Chinese trade surplus nearly doubled to USED 35. Billion in May of 2014 from USED 18. 5 billion in the previous month. While exports posed strong growth, imports declined 1. 6 percent year-on-year. There are many reasons that account for this surplus, but most prominently, the Chinese government’s intervention in exchange markets to maintain the Yuan-dollar peg has been repeatedly used, since an undervalued Yuan would be a type of subsidy on Chinese exports. As when a country pegs its exchange rate, the overspent buys or sells foreign reserves to counter market changes in the demand and supply of the domestic currency.
Given the demand for the Yuan for trade and investment purposes, the Chinese government has been buying foreign exchange, mainly in the form of dollars, and selling Yuan to counteract the rising demand for the Yuan that would, in a free market system, drive up the value of the Yuan. This method promises China a trade surplus, which can be used to pay off national debt. Tremendous growth rate also forces China to face other macroeconomic problems, such as pollution and wasted spending. However, these are less menacing than the budget deficit in the short term but compromise the Chicane’s standard of living.
Thus, I believe that although China does not need an economic reform soon, it is of utmost importance that the Chinese government pays more attention to combat adverse effects brought about by its impressive growth rate in the last decade. Chinese Government’s Official Web Portal. (2009) China’s pro-active fiscal policy and moderately loose monetary policy.