Macroeconomic Convergence, Financial Development and Economic Growth: China - Literature review Example

?Macroeconomic convergence, financial development and economic growth: CHINA Literature Review Introduction China began its economic reform from the year 1978. Since then the nation has experienced steady and rapid growth of per capita economic growth which is among the highest rates in the global economic history. This dramatic post-1978 economic growth has been attributed to numerous global and internal factors. Among the many domestic factors there are new economic policies made by the government, high rates of savings among the common people and government induced opportunities for investments from international firms. This paper reviews several articles which focuses on the economic growth of China and the impact of all the internal and external factors. The Economic Rise of China: Threat or Opportunity? In this article the author has focused on the international aspects of economic development in China. China has changed its foreign trade policies since 1978 when it encouraged free trade and abolished trade restrictions. The government encouraged private companies to engage in foreign trade. The gross domestic product (GDP) of China has increased substantially and in 2002 China’s GDP was more than eight times than that of 1978. Globally, China had the fastest long-term rate of growth from 1978-2002. China’s growth was steady and fast even during the global growth recession in 2001. The author has pointed out that foreign direct investment has also been largely responsible for the growth of China’s economy. Since the economic reform in 1978, China’s perspective has changed on foreign investment. China now considers foreign investments as causes for its own economic development. China created many opportunities for foreign investments in 1980 and although in the beginning the flow of capital was modest, in the early 1990s the inflows increased to more than $25 billion. This expansion continued even in 2001 and 2002 when foreign direct investments in other countries dropped substantially. In 2002, China became the first preference of foreign investors. In spite of this positive scenario of China’s economic development the author speculates that such remarkable economic growth does not guarantee future success. The challenge is on the leadership of China to maintain the fast growth of economy and also provide high living standards to the people. China needs to reduce tariff levels to meet its commitments to the World Trade Organization. This will increase foreign competition and for this changes in the economic structure will be needed. This will further lead to unemployment causing social unrest. China also needs to face the challenge of reforming the financial system especially its weak banking system. Since most of the state-owned banks suffer from capital deficit their levels of profits remain extremely low compared to the international structure. The author has also commented on the implications of the economic growth of China on the United States. Since China has rapidly increased its international trade volume, it has become a huge market for the U.S. firms. As far as trade relation between U.S. and China is concerned, it has been seen that exports from China have been proved to beneficial to many Americans as they can now afford high quality consumer goods at low prices, but this has also caused resentment among many manufacturers and workers of America. Americans industries that produced similar products that are imported from China have suffered. This has caused temporary unemployment in the labour market but in the long run as new industries develop many displaced workers are hired. (Lardy, 2003) Why has China Survived the Asian Crisis so well? What Risks Remain? In this article the authors have explored the features of the economic system of China that helped the country survive the Asian crisis in 1997 and 1998. The crisis however strongly affected the international trade relations of China and foreign investments. Nevertheless China did not face severe economic depression because of its ability to maintain a strong GDP growth performance in 1997 and 1998. In the entire 1998, “GDP was 7.8 percent higher than a year earlier, with output in the fourth quarter about 9 percent higher than a year earlier” (Fernald & Babson, 1999, p.3) production in the industrial sector also managed to reverse its declining performance in the second half. China’s economy continued to show steady progress during the 1997-1998 Asian crisis. China’s stable economic condition during the crisis can also be indicated by its currency strength. During the period of crisis when there was plummeting currency devaluation in Asia, China showed a remarkable performance of maintaining the stability of its currency. Another factor that helped the country survive the crisis was its large reservoir of foreign exchange. This helped China cope with the sizeable external debt which amounted to $130 billion in mid-1998. China had one advantage over the other regions of Asia in the sense that it had external debt relatively small in proportion to its GDP. It was noted that “China’s short-term external bank debt relative to reserves is among the lowest in Asia” (Fernald & Babson, 1999, p.8). The internal picture of China was however similar to other regions facing the crisis with “poorly regulated banks making policy loans to inefficient, over-leveraged state enterprises” (Fernald & Babson, 1999, p.8). These conditions are not matter of concern for China because in China “banks can and will continue to lend even if loans go bad”. This means that in order to sustain their profit figure the banks in China will not need to control their loans. There is also the factor that the Chinese government continues to guarantee bank deposits because most of the banks are state owned. This helps sustain faith among the depositors which in turn helps maintaining a sound deposit base in banks. Since China has strong position in the payment department and has large reservoirs of foreign investments, its economy is not vulnerable to external pressures. But the risk remains that economic growth in China can slow sharply (Fernald & Babson, 1999). Accounting for Growth: Comparing China and India In this article the authors have examined the sources of economic growth in China and India in the past 25 years. They have mentioned here that in most of the twentieth century only that portion of the world population has enjoyed the benefits of economic growth who live in those industralised countries where per capita income is high. But in the past 25 years both China and India have shown significant growth in their economies and reduction in poverty. The authors have analysed the economic growth patterns of both the countries. China has mainly seen its development in the industrial sector since it has opened more avenues for foreign investments thus encouraging inflow of capital. This has been achieved by international reforms made by the government by reducing trade barriers aggressively. In the period between 1978-2004 “China’s annual output growth averaged a whooping 9.3 percent” (Bosworth & Collins, 2008, p.49). During this period China faced a 2 percent growth in employment. Since the growth of employment is determined by growth in labour force population, it has been seen that during the period of 1993-2004 the employment growth has been slow which indicates that during this period there was a steep decline in the birth rate. The authors have also stated that the growth of output per worker in China also faced a sharp increase after 1993 (Bosworth & Collins, 2008, pp.49-50). China’s growth during the period between 1978-2004 has also been in the fields of agriculture and services. Although China is facing a slow growth in the labour force population but in the future it can sustain its economic growth by shifting the workers from agriculture to more productive sectors like the industrial sector. Another factor for China’s growth in economy is higher productivity due to educational skills of younger workers in which China has made a greater progress. Although China has made a remarkable progress in the international dimension, it needs to focus more on domestic markets by increasing efficiencies in the financial sector. (Bosworth & Collins, 2008) China’s Macroeconomic Performance and Management During Transition In this article the author has described the macroeconomic performance in China in the period of economic reform since 1978, has also analysed the factors for its growth and interim phases of instability, and has also explained how China has managed to cope with this complex and volatile process. Before the economic reform in 1978 monetary institutions were mainly controlled by the state and so autonomous macroeconomic tendencies in China are relatively recent. Since 1978, the macroeconomic performance of China has been at par with countries like Japan, Korea and Taiwan. The reform process was first performed on agricultural sector and then extended in the industrial sector. This was possible because of 9 percent GDP growth since 1979. From 1979 to 1984, there has been a steady increase in the agricultural sector. However from 1983 there was a decline in this sector. From this time the reform process in China began to embrace the manufacturing and industrial sectors and since then the industrial sector became a primary target for reform. During this period the national product of China increased by 66 percent (Yusuf, 1994, p.72). The author talked about three aspects of China’s microeconomic performance in this period. Firstly, although there was a rapid expansion in this period, the pressure of inflation was mostly absent until the late 1980s. Even after considering the market prices of consumer goods, it was seen that inflation was in the lower range till 1985. Secondly, China has rapidly entered the modernisation era because of its strong performance in the export sector and major reforms in international trade policies. Thirdly, there has been a continuous process of economic and political reforms which has provided the scope for acceleration in investments accommodated by credit policy. There is a common term “stop-go” that is used to describe the reform process of China (Yusuf, 1994, p.74). It indicates the wider macroeconomic policy of adjusting domestic investment and consumption demand with price changes. The author has concluded that if China’s high rate of saving is sustained, then it can cope with growing demands. The government should focus on safeguarding the savings of household and public sectors. (Yusuf, 1994) Completing China’s Move to the Market In this article the author has explained about the economic reforms introduced by China. This article also focuses on the successes and failures of these reforms in particular sectors and the incomplete nature of many such reforms. Agriculture, foreign trade and small-scale firms I China has gone a long way towards a market system. The major factors of China’s reform in the rural sector were free trade of agricultural products in the market and decollectivization of the rural society. However, till 1985 the government had control over trade of major crops like grain. After December 1978 secondary crops and household products had free markets like rural trade fairs. The market-oriented reforms proved to be very successful in the agricultural sector in China. The service sector in China was divided into productive and non-productive sectors with most services belonging in the non-productive sector. In China private restaurants and personal services were not encouraged while commerce and finance were controlled by the state. The reform focus was more on sectors producing material goods. The new opportunities were grabbed mainly by the traders and the transport workers. There was also a tide of individually or collectively owned restaurants and small shops. In many interior provinces construction workers got the job for building apartments for urban residents. There was a section population termed as “floating population” who migrated to the cities for work purposes but were classified as urban residents (Perkins, 1994, p.30). These people who previously could not get food ration coupons could now get their required food from the market. Prior to 1976, the foreign trade system was controlled by the state and there was government monopoly over purchase and sales. There was no direct interaction between the foreign investors and the companies in which they are investing. Since 1976, policies were changed and domestic enterprises were encourages to engage in import activities. These new policies paved way for international market for manufacturers and increase of foreign investments. (Perkins, 1994) Reforming China’s Economic System In the first part of this article the author talked about rural and urban reforms in China between 1977 and 1987 and in the second half the author talked about the impacts of such reforms on the economic performance of China. The most important factor that contributed towards making China a wealthy nation was rise of national production. State control over production sectors were released to provide the production units in industry and agriculture the freedom to make decisions based on their “superior understanding of local circumstances” (Perkins, 1988, p.603). Incentives in the form of wages and bonuses were introduced to increase productivity of labour. The author suggested four chief measures for China to achieve a well-functioning market system. His first suggestion was that “inputs and outputs must be available for purchase and sale in the market” without interference from government bureaucracy (Perkins, 1988, p.604). His second suggestion was “enterprise or farm decision makers must behave in accordance with the rules of well-functioning markets” (Perkins, 1988, p.604). This means that increasing profits must be the most important goal of the enterprise managers. His third suggestion was that “markets faced by enterprise managers must be competitive” (Perkins, 1988, p.604). Monopolistic situations must be averted as such situations are created more by government interventions than economic conditions. Fourthly, the author suggested that “prices on a well-functioning market must reflect long-run relative scarcities in the economy” (Perkins, 1988, p.605). If prices do not follow this principle then there can be market inefficiency as the producers and consumers will get wrong information. China has taken huge steps towards in expanding the function of market in both rural and urban areas, but there still remain major reforms to be made in the central planning towards the functioning of markets. However, the reforms made by the government had a huge impact on the economic performance of the country. The positive impact could mostly be felt in rural areas although there were urban successes too. In the 1980s foreign trade was rapidly growing and there was increased availability of consumer goods and services. (Perkins, 1988, p.642) Law, Finance and Economic Growth in China Although the economic system of China is one of the largest and the fastest growing economic systems in the world, yet the standard is not well developed by existing standards. In this article the authors have compared the economic growth in the formal sector which includes all state-owned firms and the informal sector that includes all other firms. The legal and financial procedures are stronger in the formal sector than the informal sector and for this there is an economic imbalance in these two sectors. The authors conclude that “there exist very effective, non-standard financing channels and corporate government mechanisms to support the growth of the informal sector” (Allen et.al, 2002, p.2). The fund raising mechanisms differ between the firms of the two sectors. The firms belonging to the informal sector are mostly jointly owned companies or privately owned companies. These firms depend on “self-fundraising” which comprises of “private equity, debts, loans and many other informal contracts from communities, other firms and institutions, investors from Taiwan, Hong Kong and other countries” (Allen et.al, 2002, p.5). The economic growth in the informal sector has been much faster than that in the informal sector. This has created a challenge for the research and policy makers. Their decision on whether to standardize the legal and financial procedures in the informal sector needs more research since economic success in the informal sector is much higher and faster than that in the informal sector. The authors believe that “informal mechanisms and institutions play an important role in supporting the growth in the informal sector” (Allen et.al, 2002, p.36). The Sources and Sustainability of China’s Economic Growth The economic structure in China is growing at a rapid rate across different regions and sectors. However, the coastal industry which is the most advanced regional sector in China is still not technologically up to the standard of global technological structure. In this article the authors explore the implications of these internal and international productivity disparities on the economic growth of China. In 1978, before the beginning of economic reforms in China, the nation held the tenth position in the world’s economy with a GDP of about $ 150 billion (p.1). The first part of this article examines China’s development based on labour productivity gap between the coastal provinces and the international technology frontier which is represented by the United States or Japan depending on the industry. The authors conclude that the gap is still very large but this can be ignored because the economic growth of China is growing faster than another country of this world. The remainder of the article discusses about the issues that contribute towards sustainability of the economic growth in China. Since there is huge gaps of productivity between the Chinese firms and international companies, therefore it is possible for China to sustain its economical growth by catching up on the global technology and China does not currently needs to focus on technological innovations. (Jefferson et.al, 2006) Ethnic diversity and economic growth in China China is a country of diverse ethnicity. China has experienced the fastest economic growth in the world for the last thirty years. However, it has been observed that economic growth in the coastal provinces has been much higher than that of the internal provinces. This has given rise to economic disparities within the population of China. Today, an estimated 40 million people live in poverty in Western China (Dincer & Wang, 2011, p.2). This article focuses on the impacts of ethnic diversity on the economic growth of China. The growing economic disparity in different regions of China poses a challenge for the economic policy makers. Although it is not possible for ethnic diversity to have a full impact on the economic differences between the coastal and internal provinces, still it can be considered as an important factor. This article concludes that “going from complete homogeneity to complete fractionalization decreases the growth rate real per capita GDP by almost 2.5 percentage points, while going from complete homogeneity to complete polarization decreases the growth rate by almost 2 percentage points” (Dincer & Wang, 2011, p.7) Domestic Saving and Economic Growth in China In this article the authors explore the relationship between the growth of domestic savings and the economic growth in China. The rapid growth of the economic structure in China has been made possible largely by the willingness of the common people in China to save a high percentage of their income. High saving can provide sufficient capital resource which ensures the “mobility of capital and the stability of the banking industry” (Lean & Song, 2008, p.3) Moreover high savings can contribute towards larger investments which in turn accelerates the GDP growth of China. In China it can be observed that a “long-run co-integration relationship exists between both growths of domestic savings and economic growth” (Lean & Song, 2008, p.11) Conclusion The economic growth in China provides opportunity and challenges in the global economy. China’s rise has become a major contributor of economic development in the Asian region. China has so far used foreign competition for its rapid economic growth. This has however limited the reform of China’s banking system and if this is not remedied then economic sustainability will be at stake. References 1. Allen, F. et.al. (December 23, 2002) Law, Finance and Economic Growth in China, Journal of Financial Economics, Vol. 77, No.1, pp.1-58 2. Bosworth, B. & Collins, S.M. (2008) Accounting for Growth: Comparing China and India, Journal of Economic Perspectives, Vol. 22, No.1, pp.45-66 3. Dincer, O. & F. Wang (2011) Ethnic diversity and economic growth in China, Journal of Policy Reform, Vol. 14, No.1, pp.1-7 4. Fernald, J.G. & O.D. Babson (February, 1999) Why has China Survived the Asian Crisis so well? What Risks Remain? Federal Reserve System, pp.1-34 5. Jefferson, G.H. et.al (2006) The Sources and Sustainability of China’s Economic Growth, Brookings Paper on Economic Activity, Vol. 37, No.2 pp.1-47 6. Lardy, N.R. (August 1, 2003) The Economic Rise of China: Threat or Opportunity? Economic Commentary, Vol. 22, No. 1, available at: http://ideas.repec.org/a/fip/fedcec/y2003iaug1.html (accessed on August 15, 2012) 7. Lean, H.H. & Song, Y. (2008) Domestic Saving and Economic Growth in China, Journal of Chinese, Economic and foreign trade studies, Vol. 2, No. 1, pp. 5-17 8. Perkins, D. (1994) Completing China’s Move to the Market, Journal of Economic Perspectives, Vol. 8, No.2, pp.23-46 9. Perkins, D. (1988) Reforming China’s Economic System, Journal of Economic Literature, Vol. 26, pp.601-645 10. Yusuf, S. (1994) China’s Macroeconomic Performance and Management During Transition, Journal of Economic Perspectives, Vol. 8, No.2, pp.71-92 Read More