The Chinese Macroeconomy and Financial System

A U.S. Perspective

Ronald M Schramm

• Publisher: Routledge
• Year: 2015
• Print ISBN: 9780765643919
• eBook ISBN: 9781317511922
• Topic: Business
• Subtopic: Business General
• Index: Business

This new textbook on the Chinese economy clearly presents all that the world's second largest economy has accomplished, as well as what work remains to be done. As economic development in China for the last 30 years has been mostly "top down," this text focuses on the macroeconomic and monetary sides of the economy. Utilising case studies throughout, the book uses not only the traditional macroeconomics tools in explaining the Chinese economy, but also takes a novel approach by assessing China as a company. Through employment of models from finance, such as cash flows and valuations, the text is able to dig deeper into understanding the fundamental characteristics of the Chinese economy. The book also presents extremely useful analysis of the comparisons and contrasts between Chinese economic activity and that of the U.S. economy.

eResources including chapter questions with solutions and lecture slides will be available on this webpage.

1 Introduction

书山有路勤为径

Diligence is the Royal Path to Learning

China and the United States are married. Whether it is a good marriage or a bad marriage will only be determined in the coming decades. In the chapters that follow, we explore their economic relationship—an important factor in all marriages.¹ It is remarkable that along almost any economic dimension, we find China and the United States as complementary partners who often operate in starkly opposing ways. This makes for a truly fascinating study. In most of this text, the primary focus is on China. Comparisons are made with the United States as a counterpoint; a way to highlight similarities and differences.

China’s economic reforms toward a market-based economy began in 1978 (two years after the death of Chairman Mao Zedong) and have continued since then without halt. Throughout the following chapters, we must keep that date in mind since most of the discussion, data, and analysis we use really applies to the modern Chinese economy—and the process of moving to a market-based economy which started in earnest in 1978. Although China is one of the oldest civilizations on earth (dating back to at least 221 BCE), it is, in another sense, one of the world’s youngest large modern economies. We could say that China is historically and culturally older but economically younger than the United States. Many scholars have written about the significant steps in China’s development process since 1978. Wu Jinglian (2005) and Barry Naughton (2007), for example, provide excellent step-by-step descriptions of China’s remarkable path of economic progress from both before and after that critical year. Naughton describes how the post-1978 period represents both an abrupt departure from and a continuation of historical economic patterns. We will not attempt to cover the same ground in this book.

Instead, this textbook combines macroeconomic analysis and data for China and the United States, and incorporates a novel approach to macroeconomics using tools and frameworks from finance, microeconomics, and management. This approach is particularly useful when thinking about China, a country that is often managed like a company. China is an incredibly dynamic economy, and its significance in the world arena is ever increasing. In tandem with China’s development into an economic powerhouse, there has been an explosion of academic research and news coverage related to the Chinese economy. In writing this textbook, we owe much to other academic scholars in China and around the world, as well as the excellent China research being done by the International Monetary Fund (IMF), the World Bank, the Organisation for Economic Co-operation and Development (OECD), the Bank for International Settlements (BIS), the Chinese Academy for Social Sciences (CASS), China’s National Bureau of Statistics (NBS), the Federal Reserve System (FED), a number of other international organizations and of course, the Economist magazine. This is the first textbook to tap into much of that new knowledge, synthesize it, and present it in a modern macroeconomic framework.

Four Key Drivers for the Chinese Economy

At least four key drivers of the Chinese economy today distinguish it from the United States and other large countries around the world. These key drivers help to explain many of the aspects we find puzzling about China—both in terms of macroeconomics and in daily life.

A Large Population

China has the world’s largest population; at 1.35 billion people, it is larger than its nearest competitor (India) by roughly 100 million citizens. This large population resides on a substantially smaller plot of arable land than is found in the United States, and must be fed, clothed, housed, and kept healthy. Accomplishing this is still a daily struggle for a good portion of China’s population. This vast labor pool, which is available to a cohesive political system, deeply influences which industries thrive in China and which products are traded with the rest of the world. Furthermore, economic growth relies heavily on labor growth, a key factor of production. Chapters 1, 4, 5, and 9 discuss China’s economic growth, savings, and consumption, demographic shifts, and employment—all of which deal with this key factor from different angles.

A Very High Savings Rate

Among the world’s large economies, China has the highest savings rate in the world—at close to 50 percent of GDP. To put this in perspective, the highest national savings rate achieved in the United States since World War II was 25 percent (in the mid-1960s). That rate has steadily declined to today’s rate of around 18 percent. This large savings pool has important implications for investment, future growth, and China’s current account imbalance with (and capital account lending to) the United States. In Chapter 5, we examine why China’s savings rate is so high (or why its consumption is so low) and try to gauge what future Chinese savings will look like. Chapters 3, 4, and 6 look deeply into the implications of China’s high savings rate both domestically and globally.

The Government’s Role

The role of government in economic management is significantly greater in China than in the United States. China establishes and implements Five-Year Plans, which provide direction from the top down for China’s key economic institutions—all the way from China’s central bank to provinces, townships, and academic institutions. While, at a microeconomic level, Chinese individuals and companies can be ferociously competitive and independent, they operate in an arena managed from the top. Paradoxically, the fierce competition at the microeconomic level is partially a result of the absence of a government role. Rule of (commercial) law and regulatory enforcement are still at an inchoate stage in much of China—particularly at the local level.

The directives in China’s Five-Year Plans are not mere blandishments; rather, they are targets which anyone operating in China must understand and respond to. In many of the coming chapters, we ask how a Chief Financial Officer (CFO) or Chief Executive Officer (CEO) might look at a particular macroeconomic problem. This approach is intended to help us understand how top-down management works in an economy such as China’s. Chapters 7–10 discuss both the institutional arrangements and structures for making macroeconomic policy in China, and the actual policies undertaken in recent years.

Labor: The Great Economic Shock Absorber

China’s workforce is extraordinarily flexible and adaptable. The willingness of the 老百姓 (pronounced lao bai xing, the common man) to relocate and be relocated, work assiduously for low wages under difficult circumstances, hold savings with negative real returns for prolonged periods (all in the hope of a better future) is arguably unmatched anywhere else in the world. At the core of China’s great economic development is its great economic shock absorber. No other economy in the world boasts this extra degree of freedom. This unique characteristic allows Chinese policymakers greater freedom as they experiment with new reforms and major shifts in economic policies. Labor force malleability is, in part, a necessary response in an economy with a large population, scarce resources, and a Confucian tradition of obedience to authority (see Case Study 1.1 below). Table 1.1 presents recent monthly wages for workers in Shanghai, with differing skill sets. Government officials in China are constantly trying to strike the right balance between economic progress and the pressures placed on the average Chinese citizen. In Chapter 5, 7, and 9 we gain greater insight into how this flexibility plays out in China.

Table 1.1 Wages in China remain low, but in recent years have begun to rise substantially.

	Monthly RMB Compensation	Monthly USD Compensation**
Position
Business student (just graduated college)	￥4,000	$656
Business student with Masters (just graduated)	￥7,000	$1,157
Computer science Masters (just graduated)	￥11,000	$1,818
Taxi driver	￥4,000	$661
Restaurant worker (did not finish high school)*	￥1,500	$248
Street hawker (did not finish high school)*	￥1,500	$248
Construction worker (estimated)*	￥2,500–5,500	$413–909
Factory worker (estimated)*	￥2,500–5,500	$413–909

Source: Author created.

* May also receive housing and meals.

** Shanghai, 2014. Assumes an exchange rate of 6.05 Yuan per U.S. Dollar.

Macroeconomics Review and Overview

Macroeconomics is the study of a nation’s economy in the aggregate. Analyzing how the national economy performs, how to enhance its performance, and how its performance impacts global linkages are all key macroeconomic questions. As such, macroeconomics deals with questions of recession and recovery, unemployment, inflation, interest rates, savings, current accounts, investment, and long-run economic growth. Meanwhile, microeconomics deals with individual and firm (company) behavior, and how distinct markets operate. In theory, we should be able to aggregate individual agent behavior in the microeconomy up to the macroeconomy and achieve meaningful results— after all, the macroeconomy should equal the sum of its parts. But this has, so far, proven difficult, especially since the individual agents are not identical (heterogeneous) and can interact in ways that seem irrational. Another approach attempts to take some of the results from microeconomics and finance, and assume that the macroeconomy behaves like one large firm. We often use that approach in this textbook (see the “Macro Finance Insights”), and find that this indeed does provide useful insights into both the Chinese and United States economies.

The Macroeconomic Tradition

Here, we briefly review some important paradigms for macroeconomic analysis that have developed to the present. Before the expression “recessions and recoveries” came into use in the twentieth century, Europe and America experienced “panics.” For example, the Panic of 1819 was America’s first true economic crisis involving high unemployment, bankruptcy, and declines in agriculture and manufacturing production fueled by unchecked bank expansion, credit, and a building boom, all following on the heels of the war of 1812 (this has a certain modern familiarity) (Rothbard, 1962). The fact that economies could fluctuate from boom to bust formed the basis for business cycle analysis, an early attempt at classifying these crises. Early business cycle theorists tried to find regular patterns to economic declines and recoveries (e.g., Kuznet Waves, Juglar Cycles, Schumpeterian Waves), but statistical work has failed to find a regular predictable pattern. Later business cycle scholars made significant contributions in dating historical peaks and troughs in economic activity (Wesley Mitchell and Geoffrey Moore) and in specifying leading, lagging, and coinciding economic series (e.g., stock prices, unemployment, or retail sales). This work still finds great use today, continuing, for example, with the dating committee of the National Bureau of Economic Research (NBER).

While business cycle theory had an empirical bent, economic theory developed simultaneously during the latter half of the nineteenth and early twentieth century. Say’s Law posited that all goods produced and supplied would one way or another be demanded (i.e., that markets would clear based on prices that would always serve to equilibrate demand and supply). Incomes generated in the production process would always be sufficient to demand the goods and services that had been produced. Monetary theory centered around the work of political economists such as David Hume, David Ricardo, John Stuart Mill, and, later, Irving Fisher.

The quantity theory of money linked the amount of money in the economy, M, the average circulation of money or velocity, V, with the price level, P, and real output or real Gross Domestic Product, Q. In this framework, ...

Table of contents

• Cover
• Half Title
• Title
• Copyright
• Dedication
• Contents
• Preface and Acknowledgments
• 1. Introduction
• 2. Measuring and Accounting for the Output of a Nation: GDP
• 3. China and the United States and the Balance of Payments
• 4. Long-Run Economic Growth
• 5. Consumption and Savings in China and the United States
• 6. China’s Path of Investment
• 7. Monetary Policy and Institutions in China and the United States
• 8. Monetary Policy in Action
• 9. The Keynesian Model: Extensions to China and Beyond
• 10. Public Finances and Fiscal Policy in Action
• Appendix A Gross Domestic Product for China in Nominal RMB
• Appendix B Gross Domestic Product at Constant Prices for China
• Appendix C Gross Domestic Product by Expenditure Approach for China
• Appendix D Fixed-Base Price Indices for China
• Appendix E Useful Web sites Related to China’s Economy and Financial Sector
• Index
• About the Author