Saturday, 13 February 2010

Briefly on China’s Growth and Future

Some economists, usually Keynesian, have suggested that China’s recent growth has come as a result of following the so-called “exports-growth” model. The explanation behind this is that China is doing well because of exporting so much (China overtook Germany in 2009 as the largest exporter). This has been possible, Keynesian economists say, due to China’s central bank low interest rate policy, which still fights to keep the Chinese currency yuan (RMB) artificially undervalued against the dollar (the biggest buyer of Chinese products). This in turn makes Chinese products cheaper vis-à-vis the dollar and other currencies and therefore stimulates export in a large scale.

This, however, is not true. Anyone that understands the capital theory well knows that growth can only come from an increase in capital. Nothing else can make growth possible, and neither can China’s central bank nor its other socialist Gosplan ministries which strive to calculate. Capital increase, in turn, is only possible through savings and investment. Without one’s abstention from consumption, capital increases are not possible. If China has grown, it’s only because its citizens save more than they consume. The Chinese hard-working citizens have an incredible savings rate standing at 57%, in contrast to that of U.S. which is a symbolic 8%. This means that the average Chinese citizen saves more than half of what he/she earns in a year. The saved income is then either invested somewhere or loaned to banks which then fund Americans’ and Europeans’ consumption-intensive behavior. Naturally, the capital accumulation at this scale couldn’t have been possible without China’s liberalization reforms undertaken by the Deng Xiaoping regime. The massive economic liberties and privatizations that emerged allowed for the division of labor to a satisfactory extent. The slashing of government spending, regulations and interventions reduced crowding out effects and produced more positive outcomes for the Chinese people.

The role of central bank in all this is entirely negative. Instead of paving the way for people to rightfully accumulate capital per head and thus increase their standard of living, the central bank is engaging in inflationary policies that have many severe effects. First, low interest rates meant to make the yuan so massively undervalued will distort (and have already distorted) the capital structure. By messing with the market’s time preference, the sudden availability of cheap credit will induce entrepreneurs to embark on investment projects which are not profitable because they are a) unsustainable and b) the demand for them is temporary (also fueled due to easy credit). When the central bank increases the interest rates later in order to avoid high inflation, these investment projects will come under enormous pressure and will have to be liquidated. In short, the policy will create recessions. The second negative effect is the destruction that this policy will have on savings. Although this may not be as risky in China, exactly because the pool of savings is good, it nevertheless will artificially increase consumption and direct it more towards consumable goods, leaving the capital goods to deplete. Although the policy will favor companies that export, it will only do so at the expense of the Chinese citizens who are faced with rising domestic prices. If China’s central bank really wants to help its people, it should abolish and leave the monetary system in private hands.

One should also note, however, that China is not growing at the rate that it is being reported. This is because a) GDP is not an accurate measurement of one country’s growth, and b) China is still a socialist country which means it will falsify its economic indicators to promote the “socialist paradise.” GDP is based on the Keynesian framework that every spending is somebody’s income. GDP therefore measures spending in an attempt to also measure income and therefore “overall wealth.” This is done by multiplying the quantity of goods by their prices. China’s monetary pumping which has caused the prices to rise will therefore show as an increase in wealth in the GDP. In real terms, however, the Chinese are less prosperous. The same inflationary policy is also making it possible for the GDP of U.S. to rise even at a time when the effects of the crisis have yet to unfold entirely. This is without mentioning many other deficiencies of GDP, such as the failure to account for leisure. China’s socialist nature and recently growing nationalism will want to sell China as an emerging super-power and a key player in world affairs. This means that statistic falsifications are being done on daily basis. The limitations that the government places on foreign investigators and journalists alike impede them to give an unbiased account of the state of Chinese economy. It’s no secret, however, that China is growing at a fast pace.

While that is so, it doesn’t mean that China is without challenges in the future. Both domestically and internationally, there are obstacles needed to be overcome. While a free, libertarian China would have no problem in dealing with them, the current regime will sweat hard to keep their act together and survive the bumpy ride. Domestically, China should expect a lot of dysfunctions in some private sectors due severe misallocations of capital fueled by the above-mentioned central bank’s low interest rate policy. Internationally, China will have problems dealing with the dollar crisis, as they have around over $2 trillion reserves in dollars. Although the weak dollar will give China political capital to ask for important commodities such as oil to be denominated in any other currency (e.g. euros), their pile of serves will mean they are more or less depended on dollar’s value. In this sense, China will look to get rid of the dollars as quickly as possible. Whether China continues to grow or not is a matter of the regime. The more restrained that they are and the more they leave to the Chinese individuals to decide for themselves, the more prosperity will China have. On the other hand, the more they interfere in the economy through the central bank, regulation increases or subsidies, the less prosperous will China be. The goal for a better future is simple: continue economic liberalizations and let the people be.

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