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Sustaining China's Economic Growth after the Global Financial Crisis (Peterson Institute for International Economics - Publication) [Paperback]

Nicholas R. Lardy

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15 Nov 2011 Peterson Institute for International Economics - Publication
This study examines China's response to the global crisis, the prospects for altering the model of economic growth that dominated the first decade of this century, and the implications for the United States and the global economy of successful Chinese rebalancing.

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Product details

  • Paperback: 275 pages
  • Publisher: Peterson Institute for International Economics (15 Nov 2011)
  • Language: English
  • ISBN-10: 0881326267
  • ISBN-13: 978-0881326260
  • Product Dimensions: 23 x 15 x 1 cm
  • Amazon Bestsellers Rank: 340,787 in Books (See Top 100 in Books)

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Most Helpful Customer Reviews on (beta) 4.0 out of 5 stars  7 reviews
10 of 13 people found the following review helpful
4.0 out of 5 stars Lucid and Pithy Exploration of China's Economic Weaknesses 6 April 2012
By Jiang Xueqin - Published on
Economist Nicholas Lardy's new book is a lucid and pithy exploration of China's economic weaknesses, and how Beijing can grapple with them.

In Lardy's analysis, the Chinese economy is "unbalanced"; it relies too much on exports and residential property prices to fuel its economy, two distortions and dependencies that favor certain interests at the expense of the nation.

Consider exports. China has created a global addiction to its cheap goods, but with consequences for its environment and to its economy, as well as the global economy. China subsidizes its exporters with cheap power and water, as well as easy access to bank loans. Then there's how China undervalues its currency, which in turn has led to distortions in the global economy. But despite government subsidies, China's export industries make little money if at all, which forces the government to subsidize them even more; the Chinese have raised "corporate welfare" to a whole new level.

Then there are the urban real estate bubbles, fueled by what Lardy calls "financial repression": low bank interest rates that tax depositors, and a scarcity of investment vehicles. To put in perspective the real estate bubble, consider this statistic: "After 2003, the urban population increased by an average of only 19 million annually, but average residential housing investment of 6.8 percent of GDP was two-thirds larger than in 2000-2003, and annual residential housing starts soared from 490 million square meters in 2004 to 1,290 million square meters in 2010."

These economic trends have led Premier Wen Jiabao himself to call China's growth "unsteady, imbalanced, uncoordinated, and unsustainable."

Lardy frames the problem and solution more technically and diplomatically, while calling for a bold shake-up of China's economy:

"The central thesis of this study is that the evidence from the past seven or eight years shows that modest, marginal, incremental economic reforms will not lead to a fundamental rebalancing of China's economy. Underlying financial distortions - including administrative controls that keep deposit interest rates low, an undervalued exchange rate, subsidized energy, and so forth - are contributing to a significant ongoing misallocation of resources throughout the Chinese economy. These distortions contribute to a low share of wages and a high share of corporate profits in national income; a low share of household disposable income in GDP; a high share of savings and a low share of consumption in household disposable income, and thus a low share of private consumption in GDP; a high share of household savings allocated to housing; an elevated share of investment in GDP; and a still large external surplus. A much more concerted and sustained effort is needed to remove underlying financial distortions if China's economic imbalances are to be reversed."

Lardy lists four fiscal policy measures to "re-balance" the Chinese economy from one that's driven by exports and real estate bubbles to one driven by domestic spending and services. First, the government needs to stimulate private spending by cutting personal taxes, as well as spend more on social goods such as health, education, welfare, and pensions. Second, the government needs to stop controlling interest rates on both deposits and loans, allowing capital to flow more efficiently to entrepreneurs instead of directing it towards state-owned enterprises. Third, it needs to increase the value of the renminbi. Finally, it needs to stop subsidizing state-owned enterprises with cheap commodity prices as well as cheap access to capital.

While these solutions sound both complicated and expensive, Lardy makes a compelling argument they're neither.

Beijing itself has the power and mechanisms to liberalize bank loans and the renminbi's exchange rate, and needs not convince the provinces to go along (which would be politically impossible).

More important, the costs of not doing anything are just too great for China's political system to bear. Currently, China's economy is structured to benefit state-owned enterprise and real estate companies, creating a situation where China is helping the rich get richer at the cost of a vibrant society, a clean environment, and a healthy economy. Financial liberalization would break this stranglehold of the vested interests, and help build a more rational and robust economy: depositors' money would go to companies that actually make money, creating more jobs, increasing real wages, and slowly weaning China off its unsustainable dependency on exports to fuel growth.

So, if the solution is this straightforward and simple - and the consequences of the problem so dire and dangerous - then why hasn't China acted already?

Is it because financial liberalization isn't a priority for the team of President Hu Jintao and Wen? Is it because they're not powerful enough to enforce their views on the rest of the Politburo? Is it because they're heading out the door, and would rather have the new team of Xi Jinping and Li Keqiang deal with the problem?

I have my own theory: Considering how poor and populated, chaotic and unmanageable China is, it's in the long-term best interests of China's elite to behave like parasites and predators.

China's elite are enriching themselves by bankrupting the state, and, already having shifted assets and family abroad, will continue to do so until the state itself collapses.

We've seen this behavior consistently throughout Chinese history, most recently with Chiang Kai-shek's misrule that permitted the Communists to rise to power.

And now, as the Chinese would say, history is about to complete yet another circle.
2 of 2 people found the following review helpful
4.0 out of 5 stars Rebalancing for the Successful Oligarch 1 April 2013
By James R. Maclean - Published on
This is a solid piece of scholarship, in which Lardy seriously examines the challenges facing the authorities in China. After the catastrophic collapse of asset prices in OECD nations, and its negative income effect, China was still reliant on its large but potentially endangered current account balance as the primary engine of economic growth (1). Despite excellent and well-executed fiscal strategies for responding to the GFC-2008, Lardy observes that the PRC's growth strategy is imbalanced and unsustainable.

First, it is universally acknowledged that China requires massive job creation.

Second: the saving rate actually rose sharply after 2001 in response to a decline in real rates of return for household deposits. In other words, Chinese households save a lot under economic necessity, and as the negative returns on deposits rose to over 6%, the rate of income saved rose to 50% of average household income. Saving is high because there is practically no social insurance (2).

This sounds virtuous, but it is unsustainable and immiserating. Requiring persistently high rates of GDP growth in order that the bottom 80% of households can barely stay alive, is a very poor economic model. Moreover, it depends on the renminbi (yuan) remaining at a very low rate of exchange, something which could end very abruptly.

Third, and most obviously, the Chinese economy relies on very high exports. The cheap yuan means imports like electrical machinery and equipment, fuel, power generation equipment, and metal ores are more expensive per unit of Chinese production. This is good for the seven coastal provinces that produce most of the trade surplus, since they, too, enjoy advantageous terms of trade with the rest of China; but for the rest of China, the cheap yuan is yet another transfer of wealth to the rich coastal cities. This thwarts political unity and eventually is going to cripple further economic growth.

Finally, a strategy of trade surplus-driven GDP growth leads to a waste of scarce resources on producing goods for export, without compensating imports. A growing economy needs more, but in this case makes do with less; in 2007, for example, China exported 36% of its GDP and imported only 26%. This imposes a need to ration not only consumer goods, but producer goods as well.

Lardy points out that China's trade surplus is not necessary to provide jobs (p.140); the sort of industrial policy used by China means an excessive investment in capital intensive enterprises. Producing autos for export to Europe ties up a lot more capital investment per worker (or per yuan of payroll) than domestic construction, or domestic services like education (3).

Rebalancing would require allowing the yuan to rise to a realistic exchange rate (4). Increased government expenditures, including possibly a period of deficits as the PRC rebuilt its desiccated social services, would provide adequate demand while China's industrial system rebalanced. Understandably, Lardy does not insist on the Chinese authorities privatizing the state-owned enterprises (SOEs), since efforts to do this have been a flashpoint in Chinese politics since the 1980s (and--given prior experience--SOE privatization is unlikely to affect the desirability of China as an investment destination), but he does think SOEs ought to be more financially accountable to their owner (p.72).

Lardy's understanding of the dilemmas faced by the Chinese economic managers seems very advanced; he is very nuanced and serious, and this is not a polemical book. Many of the recommendations are already being implemented, but not forcefully enough.

Where the book disappoints is Lardy's expectation that rebalancing--an extremely major shift in China's industrial development policies--will be desirable to the Chinese. For millions of Chinese workers, such a shift would lead to a greater share in the national product; social injustice could be tackled; and China could be freed from the risks of a global downturn. However, the Chinese economy would accomplish all this by pulling away from cutting edge technologies. In other words, today China possess the technical capacity to achieve almost anything the West can, albeit on a very limited scale. It can explore space, but millions of its rural poor are trapped in the Middle Ages. It's very sensible to recommend that a developmentalist state invest in the medieval peasants, instead of moving ahead to create a lunar base. But this is a choice countries never make, and I think the reason is pretty easy to see.

Partly it's that technological achievement is not hydraulic: ideally, a country could develop so that every family lived in about the same level of well-being. Instead, it's impossible to diffuse industrial activity evenly. The Chinese actually have tried to do this harder than anyone else, with disastrous results. And anyway, no one wants to abandon the commanding heights of the global economy, in the hopes of reducing the Gini coefficient.

The other point is that Lardy believes "the market" will find a satisfactory equilibrium, and people who are used to managing a reforming economy know that never happens. Why, is the subject of another book.

UPDATED (12 April 2013): Readers need to be advised that this book is published by the Peter G. Peterson Institute for International Economics (IIE), a "thinktank" founded by a leading PE tycoon (and former Secretary of Commerce under President Nixon). Peterson founded the eponymous institute to promote state austerity in public policy and has recruited some fairly prominent people to lend it respectability. Many readers of this review may approve of the IIE's ideological agenda, but it needs to be known in advance.

It's not clear to me what the IIE hoped to accomplish by publishing this book, although possibly it's attempting to push a new buzzword for austerity. I have not taken away any stars because of the author's association with a propaganda vehicle because I did not detect any propaganda, but that doesn't mean it's not there.


(1) Current account balance: annual rate of increase in financial claims against foreign nationals by the citizens of a country; includes the sum of the trade surplus, net foreign aid, and net foreign factor income, i.e., income from investments abroad minus outflow of earnings from investments held by foreigners. A large current account surplus tends to increase the size of the monetary base.

China's authorities have sterilized the influx of dollars, meaning they have adopted policies that reduce the amount of new deposits the banking system generates from the new reserves. For the consequences of unsterilized foreign reserves--from the point of view of the Chinese CCP--please see Victor C Shih (2008), or my review of same.

(2) The relation between saving and social insurance is complex. China's lack of basic income security has led to a high savings rate, but France has a very high rate compared to other developed countries (17%). The USA has a very poor social insurance system and almost no net saving at all.

(3) According to Huang Yasheng (2008), China's underinvestment in education has led to a huge increase in illiteracy, as well as a disastrous decline in other services.

(4) According to the IMF, this would be RMB 4.28 per US dollar, instead of the current RMB 6.21. See 2012 World Economic Outlook Database, purchasing power parities data. For the record, currencies hardly ever have an exchange rate commensurate with their purchasing power parity. For instance, 22 Indian rupees in India buy as much as $1 US buys in the USA, but the exchange rate is INR 54 to the dollar. The Australian dollar is thought to have PPP of $0.642 US, but costs $1.041 US on international markets--a markup of 62%. Estimates of PPPs come from the World Economic Outlook Database of the IMF. Values for forex rates were as of 30 March 2013.
4 of 6 people found the following review helpful
2.0 out of 5 stars Interesting, But Maybe We Just Don't 'Get It' 12 Mar 2013
By Loyd E. Eskildson - Published on
Author Lardy got my attention on the first page - 'China's policy response to the global financial and economic crisis was early, large, and well designed.' After initially welcoming the slowing of domestic economic growth, especially in housing, its central bank initiated a monetary easing policy in September 2008, and the State Council followed up a few weeks later by rolling out a $586 billion stimulus program for expenditures on affordable housing, infrastructure, public health and education, the environment, and technical innovation. The American Recovery and Reinvestment Act was not signed into law until mid-February 2009, and relative to the size of the respective economies, the U.S. package was much smaller. Further, while the Chinese program overwhelmingly consisted of increased expenditures, about one-third of the U.S. package consisted of tax cuts, much of which was used to pay down debt instead of financing additional consumption. China's growth rate dropped only slightly in 2009 (9.2%), while most other nations suffered the sharpest decline in 60 years.

Lardy's main interest, however, is casting a shadow over how little progress China has made towards redirecting the economy toward consumption and away from exports and investment. This would both ameliorate the impact of slowed economic growth on citizens in the coming years and reduce the likely opposition from its trading partners. He wants China to raise domestic interest rates, appreciate its currency, raise energy prices (still partially controlled), and finance its expansion of the social safety net by directing its profitable SOEs to pay higher dividends.

Its amazing to me however, how the naysayers have never stopped hectoring and criticizing China's economy, as well as predicting its imminent demise - primarily because it tramples all over their ideology of minimizing government involvement. They also forget some of the reasons China takes the stances it has - eg. low currency value to boost export employment and prevent excessive foreign loans that may become problematic such as was the case in the late 1990s Asian crisis in many other Asian nations.

China's government is trying to get people to save less and spend more - increasing those covered by medical insurance in rural areas to 833 million in 2009, 10X the number in 2004. (A large portion of urban citizens are already covered.) And it is working to expand its government-backed retirement system. It has also mandated higher minimum wages, and keeps deposit rates artificially low. (The Chinese people compensated by saving a higher share of disposable income.)

I've become tired of naysayers vs. China - quick to point a finger when they violate our ideologies, but never able to consider learning from them.
5.0 out of 5 stars What's next in China's development 19 May 2013
By Koo Tat Kee - Published on
Format:Kindle Edition
Lardy has a deep understanding in the current state of the Chinese economy. His views are well supported by statistical data. He shows the way where the Chinese economy should be heading in order to complete the structural changes needed for sustainable development and becoming a high-income country. Let the market forces 'get the price right' is what he would like to recommend. Resource misallocation and government subsides should be corrected by working markets via the price signals.

Lardy is particularly interested in urging the Chinese authorities to end financial repression and to liberalize the interest rate in financial market. In this way, scarce capitial can be allocated more efficiently to the most productive enterprises, private or state-owned. Put together, as in other advanced economies, market forces should reign. Lardy's book should be taken seriously by the Chinese development planners.
4.0 out of 5 stars Compelling and comprehensive economic analysis, but needs more in-depth political analysis 11 Mar 2013
By Shiran Shen - Published on
Since market reforms championed by Deng Xiaoping began underway in the late 1970s, China has made impressive strides in economic development, sustaining double-digit growth for an extended period of time. While the world economy suffered the most severe decline in 60 years during the 2007-09 global financial crisis, China's economic growth only ticked down slightly to 9.2 percent in 2009. China was the fastest growing emerging market both during and immediately after the crisis, and has thus emerged as a critical engine for the entire global economy.

Despite China's economic success in the past three decades, Nicholas Lardy, renowned expert on the Chinese economy at the Peterson's Institute for International Economics, articulates China's economic challenges ahead and offers suggestions in his book Sustaining China's Economic Growth: After the Global Financial Crisis. Lardy seeks to explain China's economic policy during the global financial crisis and analyze challenges facing the Chinese leadership in sustaining growth rates in the coming decades. He suggests that China's economic imbalances will require fundamental market-oriented reforms; modest, marginal, and incremental reforms only provide lip service that cannot bring China onto a new growth path. Lardy examines the technical and political challenges that these comprehensive reforms entail.

Given the Chinese economy's heavy reliance on exports to foreign market, Lardy describes China's policy response to the global financial crisis as "early, large, and well designed" (5). Lardy points out that quite contrary to common belief, the stimulus package in 2009-10 did not privilege state-owned enterprises at the expense of the private sector; in fact, private firms and family businesses experienced significant improvement in access to bank loans, as did the state-owned enterprises. In 2009-10, private firms became the most crucial source of China's growth of exports for the first time ever.

Although the stimulus packages were able to sustain the Chinese economy during the global financial crisis, Lardy argues that they do not address the structural problems that are looming large on the horizon. In a 2007 speech at the National People's Congress, Chinese Premier Wen Jiabao described China's economic growth as "unsteady, imbalanced, uncoordinated, and unsustainable" (44). According to Lardy, China's most outstanding economic imbalances include: 1) low private consumption expenditure, 2) highly elevated share of investment in GDP, 3) an outsized manufacturing sector and a tiny service sector, 4) gigantic official holdings of foreign exchange, and 5) increasingly outsized and potentially unsustainable rate of investment in residential property.

In order to make China's economic growth more sustainable, the Chinese government has implemented a series of policies to correct the imbalances; however, their effects to date have not been very promising. Since 2003, the government policy has kept the renminbi undervalued by having the central bank intervening massively in the foreign exchange market. To prevent the expansion of the ensuing expansion of the domestic money supply, the central bank has engaged in two types of large-scale and continued monetary actions, referred to as sterilization: 1) issuing bills to commercial banks, and 2) raising the required reserve ratio, the share of deposits that commercial banks place at the central bank (97). Several signs indicate that China's financial system has become more repressed since 2004, when the government abandoned its policy of interest rate liberalization. These signs include, but are not limited to, negative real interest rate on household savings, an augmenting required reserve ratio, an emerging and significant informal credit market, and a sharp drop in public holding of government bonds share.

To more effectively amend these imbalances, Lardy presents measures to ameliorate the situation and analyzes both technical and political challenges posed by the much-needed reforms. According to Lardy, China needs to pursue liberalization policies so that the market will play a greater role in setting the value of the Chinese currency and interest rates. In the meantime, the government should facilitate building a stronger social safety net to encourage household spending; the social goods include, but are not limited to, health care, education, welfare, and pensions.

In addition to liberalizing the country's fiscal policies and improving social benefits, Lardy analyzes the weak possibility of an endogenous rebalancing despite continuous increments in real wages. Even though real wages have been growing in recent years, Lardy writes that China's unit labor costs vis-à-vis those of its trading partners have not been increasing as a result of a comparable increase in labor productivity in the trading goods sector.

Internationally speaking, Lardy argues that it is unclear whether China will initiate sustained rebalancing efforts even when China's stated national and international economic policy objectives align. The current impediments include financial repression, undervaluation of the exchange rate for renminbi, and provision of subsidies in production. A renewed interest in rebalancing efforts surfaced at the National People's Congress in the spring of 2011, but whether the government has the political will and capital to implement the rebalancing policies have yet to be seen.

Despite Lardy's quite holistic dissection of China's economic and fiscal challenges, the book could have included a more in-depth analysis of the impact of China's political organization on economic policies that may be at odds with rebalancing efforts. Lardy hints that powerful interest groups may have kept policies at its status quo for their personal benefits. He could have gone further to analyze two things that constrain the initiation and implementation of more liberal economic policies: 1) the shrinking power of China's top leader and 2) protracted and often difficult consensus building among several powerful political factions. From Deng Xiaoping, to Jiang Zemin, to Hu Jintao, and to Xi Jinping, the top leader is endowed with less and less power to direct and implement reforms. As a result and at the same time, the top leader is increasingly facing powerful political factions vying for influence. For Xi Jinping, any reform plan will come out of the negotiation and comprise among different factions. The Chinese leadership recognizes these political challenges. During the Anhui delegation's meeting at the 12th National People's Congress meeting on March 5, Wang Yang, who is likely to become China's new vice premier with the responsibility for reforms, described reform as cutting off one's own flesh; that is, China must be determined to break through vested interests.

By and large, Sustaining China's Economic Growth is a timely work that provides a comprehensive and persuasive analysis of China's economic challenges in the wake of the global financial crisis. Author Nicholas Lardy has a decades-long background in studying about and writing on China's economy; this book is a new addition to his series of best writings on the Chinese economy. The economics part is beyond reproach, though Lardy could have factored more political analysis into his argument. The subject matter is technical, but Lardy explains it well enough to make it understandable to an educated audience who may not have a deep background in global finance and economy.
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