Article in China Economic Growth Forecast - Essay Example

? Macro & Micro economics Table of Contents Table of Contents 2 0 Article Summary 3 2.0 Introduction 3 3.0 Analysis 3 3 Export led growth 3 3.2 Restructuring the economy: reducing the wealth gap 5 3.3 Accommodative policy 5 3.4 Fiscal policy 7 4.0 Conclusion 9 References 10 1.0 Article Summary The article titled “China economic growth lower than forecast” was published by BBC on 10 February 2009. The report presents the policy actions taken by the government of China after noting that the country is depicting lesser growth rate than the last quarter of 2012. 2.0 Introduction China has followed the export led path of growth which has brought admiration for the economy from the international sphere (Razmi 2009, 1). Since the net export is a part of the gross domestic product, considerable rise in exports has led to significant rise in GDP of the country. This in turn is reflected in the higher growth rate of the economy. The growth of an economy is measured by calculating the changes occurring in the total volume of output in the economy or the real income of the individual residents of the nation. However, in recent years there has been less than expected level of economic growth. Therefore the government has adopted different fiscal and monetary policies to boost up economic activities in the country. This paper analyses the policy prescriptions followed by the government as presented in the article. 3.0 Analysis 3.1 Export led growth The 1993 United Nations System of National Accounts (1993 SNA) allows the countries to calculate their growth with the help of any of three credible indicators; the volume of the country’s gross domestic product (GDP), real gross domestic income or the real gross national income. The GDP is the easiest and the most uncomplicated way to account for the growth of a country (World Development Indicators: 2012, 217). The gross domestic product is defined as “the market value of all final goods and services produced within a country in a given period of time” (Mankiw 2011, 494). The most commonly used approach to measure the GDP is the expenditure method (Taylor 2006, 138). Economists denote GDP as ‘Y’ and divide the components of GDP in to four parts; consumption (denoted by C), investment (denoted by I), government expenditure (denoted by G) and the net exports made by the country (denoted by NX) (Mankiw 2011, 496). The identity that represents the GDP calculation is as follows: Y = C + I + G + NX The net exports component of the GDP is actually the difference between the amount of export and the amount of imports made by the economy. If this difference is positive, it implies the amount of total exports is greater than the amount of total import and positive net exports increases the total GDP of the country. If the level of exports falls short of the level of imports, there is negative net export and the amount of GDP declines. The Chinese policy of emphasizing on exports has brought dauntless growth in the Chinese economy since the past three decades. However, recently the Chinese have been facing a huge external constraint in this path of growth. China depends on the international market heavily for its exports, particularly the U.S. and the Europe. The large scale exports made to the U.S. is leading to massive trade deficit in the U. S. It is causing financial vulnerability and discouraging the country’s manufacturing sector. This can potentially harm the development process of the country and stall its course of recovery that is still in progress after the severe sub-prime crisis that occurred in the year 2007. Since the USA is a large country in terms of the Chinese exports, recession in the country might affect the entire world economy, including China. Hence the Chine policy makers have considered shifting their attention towards domestic demand. As the article published in a BBC website says, the policymakers have expressed the desire “to increase domestic demand to reduce its dependence on exports and achieve more sustainable growth” (BBC, 2013). Demand-led growth spurs expansion in the economy through development of the demand side as well as the supply side within the economy. 3.2 Restructuring the economy: reducing the wealth gap The Chinese economy at present has been reflecting a deceleration in its growth pattern. Rise in industrial output and the annual rate of increase in the fixed asset investment in the country has been less than expected. However, there has been a rapid emergence of a middle class in China over the last three decades (Fewsmith 2007). On the other hand, the urban rural income gap is increasing depicting a rising wealth gap (Sicular et al. 2007, 93). Domestic demand acts like an engine that helps in an overall growth in the economy from both the demand and supply sides. It supports an “inclusive growth model” (BBC 2013). 3.3 Accommodative policy This policy is followed by the Federal Reserve in an effort to increase the level of money supply in the economy, which would provide banks with more money that they would be able to lend out (NASDAQ, 2011). Rate of interest signifies the opportunity cost of holding money. Low rate of interest implies that the opportunity cost of holding money is low. The money demand curve is downward sloping; as interest rates fall firms and households switch away from financial assets. Hence the quantity of money demanded increases. (Source: Author’s Creation) Accommodative monetary policy is also known an easy monetary policy and this tool is used to bring back the health of the economy back to normal when the total demand in the economy is so less that it might reduce the level of income and output in the economy as well as the level of employment in the country (Jain and Tomie 1995, 29). China is now following accommodative policy by reducing interest rates so as to increase borrowing, and amplify investment and consumption activities in the economy. It would lead to availability of ‘loanable funds’. An increase in supply of loanable funds increases the equilibrium real interest rate from i1 to i2, and it increases the equilibrium quantity of loanable funds from L1 to L2. This ultimately increases the level of investment spending in the economy. (Source: Author’s creation) 3.4 Fiscal policy Alongside reduction of interest rates by the central bank of China, the government has also taken initiatives to make higher spending. Fiscal policies implemented by the central government affect the macro policy objectives of the government and helps to control the process in which the economy is moving towards attaining growth. Chinese Prime minister, Li Keqiang’s government, has adopted discretionary fiscal policy so as to deliberately change the spending by the government and achieve its objectives of increasing the investment activities in the country. The government has “approved infrastructure projects worth more than $150bn (?94bn)” (BBC 2013). Such expansionary fiscal policy is aimed at improving the investment climate in the economy and increasing the level of investment activities in the economy. The outcome is an increase in the level of real GDP in the economy and reduction of the level of unemployment. This counters the existing slow economic growth by boosting up investment activities by entrepreneurs in the country and consumption by the domestic customers. Increase in government spending can raise aggregate demand by more than the initial amount of hike in government spending. This is termed the multiplier effect of fiscal policy. Increase in government spending will lead to increased consumption via ‘induced spending’ (Schiller 2011, 217). The multiplier effect of fiscal policy can be calculated by dividing the change in real GDP by the change in government spending. (Source: Author’s creation) The multiplier effect leads to further increase in the level of consumption after the first round of injected spending by government. With an initial increase in government spending by an amount of $Y billion moves the aggregate demand curve towards the right from AD1 to AD2. This represents the influence of this initial injection of $X billion. At a given marginal propensity to consume, it is the first round of increase in consumption. This additional income by all market participants is now invested in the economy creating more income for the participants. This is multiplier induced increase in consumption, which shifts the aggregate demand curve further to AD3. This happens in the short run, when prices cannot adjust. Hence all these adjustments in consumption level occur at the same price level. Aggregate demand in the economy rises, boosting up economic activities without increasing the price level. 4.0 Conclusion China has achieved remarkable economic growth in the past few decades, but since the first quarter of this year the actual level of economic growth is lesser than the expected level. Certain external constraints have made Chinese policy makers to look forward to domestic demand to boost up the economic activities. A transition is taking place from an export based growth objective to a domestic demand led growth objective. In order to support the economic objectives, the central government has implemented both expansionary monetary policies and expansionary fiscal policies. The accommodative monetary policy is found to help the government spur investment which is quite effective in increasing employment level in the economy thereby leading to higher output. From the original identity of GDP says, increase in investment necessitates increase in the left hand side of the identity, thereby increasing the economy’s output. References BBC, 2013. China economic growth lower than forecast. Accessed May 22, 2013, http://www.bbc.co.uk/news/business-22148991 Fewsmith, Joseph. 2007. “The Political Implications of China’s Growing Middle Class”. China Leadership Monitor, 21: 1-8. Jain, Chaman L. and Igor M. Tomie. 1995. Essentials of Monetary and Fiscal Economics. New York: Institute of Business Forec. Mankiw, Gregory N. 2011. Principles of Economics. Connecticut: Cengage learning. NASDAQ, 2011. Accommodative monetary policy. Accessed May 22, 2013, http://www.nasdaq.com/investing/glossary/a/accommodative-monetary-policy Razmi, Arslan. 2009. Is the Chinese Investment- and Export-Led Growth Model Sustainable? Some Rising Concerns. Accessed May 22, 2013, http://scholarworks.umass.edu/cgi/viewcontent.cgi?article=1011&context=econ_workingpaper Schiller, Bradely R. 2011. The Macro Economy Today. New York: Tata McGraw-Hill Education. Sicular, Terry, Yue Ximing, Bjorn Gustafsson, Li Shi. 2007. “The urban–rural income gap and inequality in China.” Review of Income and Wealth 53(1): 93-126. Doi: 10.1111/j.1475-4991.2007.00219.x. Taylor, John. 2006. Principles of Macroeconomics. Connecticut: Cengage learning. World Development Indicators: 2012. 2012. Washington, DC: World Bank Publications. Read More