China: Limited Economic Policy Options
One interesting aspect of the current global economic funk is the speed at which China has gone from desperately trying to cool its economy from overheating to desperately trying to boost it. We have already seen aggressive rate cuts, a mammoth fiscal stimulus package, and a halt – indeed, mild reversal – in the rise of the yuan currency to protect exports. The key difference between a Chinese slowdown and a slowdown in other countries is that in China, this could test the entire political-economic system that has been in place for the past 60 years.
So, what can China do?
Devalue the yuan: China could choose to effect a small, one-off devaluation of the yuan to boost exports. Or, less controversially, it could steer the currency lower, which is what already seems to be happening and is being reflected in the non-deliverable forwards market. The precedent for a Chinese devaluation was set at the start of 1994, when the yuan was devalued by 33% from CNY5.82/US$ to CNY8.72/US$ – although a repeat of such a move would be unthinkable today.
The problem is that a weaker yuan would delay the resolution of global imbalances, which needs China to spend (and therefore import) more, and the US to save (and therefore import) less. I should mention that Chinese private consumption as a percentage of GDP has actually fallen from 51% in 1990 to 37% in 2007, according to Asian Development Bank figures (although it has obviously risen in absolute terms). In addition, a yuan devaluation would anger China’s trade partners, potentially leading to protectionism, or even competitive devaluations of Asian currencies.
Cut interest rates further: China has already cut interest rates by 189 basis points from 7.47% to 5.58% this year. The one-year lending rate is now only 27bps above 5.31%, the rate at which it was held steady for three years between 2001 and the start of the most recent tightening cycle in October 2004. Given the scale of China’s concerns, I see scope for more rate cuts.
However, as with many other countries, the efficacy of lower interest rates will be severely tested. Japan cut rates to zero in the 1990s and again in 2001, and this did not help matters. The US is also heading for zero interest rates, but low rates will not be useful if no-one wants to borrow.
Increase infrastructure spending: China was already building more infrastructure even before slowing growth became a concern. It is natural for an emerging economy, especially one as geographically large as China, to spend more on roads, railways, airports, and power plants. However, at some point it could follow Japan’s example of building ‘bridges to nowhere’. A key difference with Japan is that China can make those ‘nowheres’ ‘somewheres’, since the government is actively seeking to open up the landlocked inner and western provinces to development. Thus, if we see massive job losses along the eastern seaboard, I would expect to see a corresponding shift in labour to the inner provinces.
Build a world-class social safety net: A better option would be to spend more on building adequate health and social safety systems. One reason often cited for China’s high savings rate is that people need to save up for medical treatment or possible retrenchment, given that loss of jobs has often meant loss of social benefits that come with the job. Thus, in the long term, China could increase consumption by providing a safety net that would obviate the need for such high savings.
Increase military spending: This may sound extreme, but we are living in extreme times. Historically, authoritarian (and even some democratic) governments have increased defence spending to boost the economy. Even Ronald Reagan did this in the US in the early 1980s, although he did so for political rather than economic reasons. China is already raising defence spending, but could accelerate programmes such as its long-cherished goal of creating a blue-water (i.e. ocean-going) navy. Moreover, defence spending, if diverted to qualitative rather than quantitative improvements, could also yield new technologies for the civilian sector. The risk, of course, is that China’s neighbours interpret its defence spending as an aggressive move, sparking a new arms race. China could also eventually seek to become a major arms exporter – at present, it is the world’s 10th biggest arms exporter (US$3.4bn worth in 2000-07, versus US$52.8bn by the US).
Overall, I see very few new policy options for China to prevent its economy from slowing down as a result of the global recession. Thus, I think that a deceleration to 6.0-7.0% in 2009 is quite realistic – in fact, growth could be even slower.