China has enjoyed near double digit growth for the past decade. However, this has largely been caused by exports. Last year, domestic consumption in China accounted for only 35% of GDP (this compares to 72% in the US). This accounts for the huge current account surplus that China has. This focus on export led growth is fine when the global economy is doing well, but now that the US economy is in a deep recession China is seeing a precipitous drop in exports. Economic growth in China is falling from 10% to 7%; this may still sound very impressive. But, the nature of the Chinese economy is that people argue, growth of less than 6% would lead to a sharp rise in unemployment.

Japan is also in recession, so exports to Japan will remain low.

In the short term, China will face difficulties. On the other hand, this does give some benefits to China

Help to reduce inflationary pressure. With growth at 10% there were worrying signs of overheating and inflation.

It may force China to boost its domestic consumption and rely less on export led growth. This would help to reduce the current account surplus and the global imbalance in savings and debt.

• China economy at crossroads

China and other Asian economies have seen a particular marked rise in food inflation. This creates various problems. Firstly, it particularly affects the rural poor who experience a decline in living standards. Secondly, the rise in food prices indirectly increase the cost of production for the manufacturing sector; many firms feed workers directly.

Imposing price controls enables the government to keep a lid on prices making life more affordable. This is done in countries such as India. However, the basic economic problem is that imposing price controls reduces the incentive for firms to supply more. Therefore, it can actually make the situation worse in the long term because if lower prices discourage investment, the fall in supply will raise future prices. It would be better to allow market forces to raise prices and (hopefully) increase supply.

Can Price controls ever be justified?

One case where price controls may be justified is if rising prices are caused by monopoly power. If prices are kept high by monopolies then a reduction in price will not cause lower supply.

Readers Question: How about the case of cost push inflation like that of China? there’s high inflation and yet the economy is not operating at its full level of employment and due to the fact that its exchange rate is fixed, monetary policies would not be effective but fiscal policies would further increase unemployment. What policies can be implemented to reduce this cost push inflation in a fixed exchange rate system?

Comment on post: Economic Policies to reduce inflation 

It’s a good question. Inflation in China has recently reached an 11 year high of 7.1% (inflation China)

The Chinese blame rising food prices and rising oil prices. However, I would also blame the Chinese government for allowing demand to rise too quickly.

Loose Monetary Policy. The benchmark interest rate in China is currently 7.4%. Although it has been increased several times in the past 12 months, it still represents a very low real interest rate 0.3% (7.4-7.1%) Compare that to the UK, where real interest rates are closer to 3.0%. The low cost of borrowing is encouraging a boom in borrowing, but often the borrowing is badly directed and it could contribute towards a boom and bust in the Chinese property markets.

Undervalued Exchange Rate. Although the Yuan has appreciated in the past couple of years (although the exchange rate is supposed to be fixed it has been allowed to be gradually revalued) However, it is arguably still undervalued. The Chinese government is keen to keep it artificially low to stimulat export led growth. The weakness of the Yuan is indicated by the size of the Chinese Current account surplus.

The problem for the Chinese economy is that growth is very unbalanced. Although some sectors are growing very strongly (manufacturing exports) some areas are not benefitting from growth at all. As you suggest, there is still a high level of unemployment resulting from the poor incomes to be found in farming. Many farmers in the north effectively have very little income so they migrate to the south in the hope of finding better incomes and jobs. The Chinese government is worried that if it doesn’t keep growth at 10% a year, there will be a rise in unemployment and social unrest. (Unemployment also occurs due to the process of privatisation)

However, the problem is that China is taking a very short term view and are risking the future economic stability of the economy. China needs to moderate its inflationary growth through tighter Monetary policy and an appreciation in the exchange Rate. Admittedly you say what policies should they use in a fixed exchange rate, but I would argue why stay in a fixed exchange rate? The government also needs to take steps to reduce the regional and sectoral imbalances in the economy. If they could reduce food inflation, through improving agricultural techniques that would help. There is also a case for trying to combine very small farms so they can benefit from economies of scale and boost productivity. However, these kinds of supply side policies will take a long time to have an effect.

Just goes to show, even with growth rates of 10% a year and you can still have many economic problems (to say nothing of all the pollution created by the growth)

Should China revalue their currency? 

Chinese Growth and interest rates 

China’s next big export - Inflation at Time Magazine

China certainly exports alot to the US. Exports to US totalled $295bn in 2007 (they were 32% of exports

US trade with China TOTAL

•  US exports to China $58,340.1m
• Chinese exports to US $295,817.6 m
• Trade Deficit -$237,477.5m

Source US Trade

However, US is not the only trading partner of China. China has many other markets.

Also with the Chinese economy growing at around 10% a year. A fall in exports to the US, may just slow down growth by 1 or 2 %. This may be beneficial because it will avoid inflationary pressure in China.

The US recession, will lead to further weakening of the dollar. It will create further upward pressure on the Chinese Yuan, even though the Chinese are reluctant to do this.

Overall: The Chinese economy is growing sufficiently fast to avoid being adversely affected by a US recession. However, if the US recession spread to the rest of the world, it would be much more serious.

• Affect of US recession on China and Japan 

 Please can you tell me the sites where i can find graphs about the chinese economy. for example, graph about the level of employment, export sector, import sector GDP and so on.

• There is a pdf here on the Chinese Economy, it contains many diagrams and graphs, especially on regional inequality. Pdf link to Chinese economy
• More graphs on Chinese economy 
• Recent history pdf
  
• Brief overview of Chinese economic history here (note no graphs)
• China online story – if you want to buy details, statistics and graphs. click here – China economic review
• China Economy at BBC

Recent Blog Posts on China 

• Should We worry about a strong China?
  
• Chinese Economy 2008
• Chinese Yuan Dollar Forecast 2008

In the next few decades the role of China, and to a lesser extent India are going to play a crucial role in determining economic thought and the state of the world economy. The main feature of the Chinese economy is its overwhelming size. Primarily this is due to its population of 1.3 billion. I think if you take the combined population of China and India you have nearly 50% of the world’s population (figures not accurate)

The rise of the Chinese economy poses some interesting questions. – Who will benefit? and what should we be concerned about.

I wrote a short essay here about the future impact of the Chinese economy.

Readers Question: What is the most important reason why there is an improvement in the economic growth in the chinese out of the following policies. is it Government policy, education, investment from overseas, cheap labour or natural resources.

1. Cheap Labour

China has a large unskilled workforce willing to work for low wages. In the north many farmers struggle to make an income, therefore, they are willing to move south and work in manufacturing for low wages. Therefore, despite high growth, wages have remained low. This has meant Chinese exports have continued to be very competitive. Exports to the rest of the world are one of the main factors behind increased AD and China’s. Cheap labour has also helped avoid wage inflation, which could destablise economic growth.

2. Government Policy

The Chinese government have been keen to promote economic growth (they have been concerned about unemployment from privatised industries and agriculture). Therefore, they have kept the Yuan undervalued. This makes Chinese exports more competitive and has helped the exporting sector. The government have also kept interest rates relatively low. Although, it is sometimes difficult for small business to get loans. Low interest rates have also encouraged some irresponsible lending. Arguably the government have contributed to a boom and there is a danger that the government have allowed growth to be too high. This could lead to inflation and a downturn in the future.

3. Raw Materials.

China has good reserves of raw materials such as coal. However, for many raw materials they are net importers. This is true, particularly, for metals, oil and precious commodities. In fact demand from China is one of the main reasons behind the boom in commodity prices. Therefore, we could say China has experienced growth, despite having to import so many raw materials. The increasing price of oil and metals may be a constraint on future growth.

4. Investment from Overseas.

This increases productive capacity and helps improve technological development. However, as a % of GDP investment from overseas is relatively low.

5. Education

At the moment, China’s comparative advantage lies in unskilled labour intensive industries. However, there is a growing, educated, middle class, which has enable the economy to diversify out of manufacturing. Education will be of increasing importance as China tries to provide greater value added to its industries.

Other factors influencing growth may include:

• Domestic Demand
• Privatisation. Selling state owned assets to the private sector has enabled big efficiency savings.
• Consumer Demand in US

See also:

• Problems of Chinese Economic Growth 
• Prospects for Chinese Economy 2008 
• Chinese Growth and costs of Growth

See also: Chinese Economy 2008 

For many years the Chinese Yuan was tied to the dollar, however in July 2005 the yuan was finally allowed to break away from the dollar. However, unlike most other currencies, the Chinese government still try to influence the level of the Yuan. They have tried to keep the value of the Yuan low, to enable Chinese exports to remain competitive. Chinese record growth is due mainly to its exporting sector. The Chinese government fear that if the Yuan is allowed to become too strong, growth will slow causing unemployment to increase.

As a consequence of the undervalued Yuan, China has one of the world’s biggest current account surpluses (10% of GDP) (surplus = value of exports > value of imports)

As of November 9th, the Yuan appreciated to 7.4108 versus the dollar

The Chinese Yuan has appreciated by a small amount since 2005

Graph to show last 5 years Dollar vs Chinese Yuan (remenbi)

Source: yahoo finance

Prospects for 2008

China is being put under  renewed pressure to allow the Yuan to appreciate. US trade officials are particularly keen to see the Yuan appreciate so that the US can help to reduce its current account deficit

• Inflation in China is increasing. Chinese inflation is getting close to 5%. This is evidence that the Chinese economy is overheating. An appreciation in the exchange rate would help to prevent growth being too fast. An appreciation helps to reduce inflationary pressures.
• Chinese growth to outstrip rest of world, especially US. With Chinese growth significantly faster than other countries, especially the US. This puts further pressure on the Yuan to appreciate.
• Real Politics. Economics is not the only factor in future exchange rate movements. The Chinese government don’t like to be seen as caving into US pressures.
• My prediction is that the Chinese government will become increasingly aware of the real problem in the Chinese economy, which is inflation and too fast growth. An appreciation would be a very good solution for the long term benefit of the Chinese economy. so I predict the Yuan will go under 7 by the end of 2008

• Chinese Economy 2008 
• Problems facing Chinese  economy