Re-balancing China: Essays on the Global Financial Crisis, Industrial Policy and International Relations available in Hardcover
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About the Author
Peter Nolan is the Chong Hua Professor of Chinese Development and Director of the Centre of Development Studies at the University of Cambridge.
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Essays on the Global Financial Crisis, Industrial Policy and International Relations
By Peter Nolan
Wimbledon Publishing CompanyCopyright © 2014 Peter Nolan
All rights reserved.
RE-BALANCING IN THE FACE OF THE GLOBAL FINANCIAL CRISIS (1): NOVEMBER 2008
Pile the sandbags to save the dyke and prevent it bursting:
Zhu lei sha dai, [TEXT NOT REPRODUCIBLE IN ASCII]
Jia gu di ba, [TEXT NOT REPRODUCIBLE IN ASCII]
Fang zhi jue kou [TEXT NOT REPRODUCIBLE IN ASCII],
1. The Global Macro Economy
Act I. The new age of boundless growth
During the era of capitalist globalization since the 1970s, there has been a long, slowly developing global asset bubble, which gathered pace in the new millennium. The mechanism is exactly the one predicted by Keynes, Kindelberger, Minsky and Galbraith. They each warned that deregulated financial markets have an inbuilt tendency to create asset bubbles. A vicious circle develops naturally in which credit expansion based on increasing asset values stimulates further increases in asset values. The intensity of such asset bubbles is increased by the wide sense that a 'new age' has arrived in which the prospects for growth and profits are boundless due to new technologies and markets. The era of capitalist globalization has nurtured such sentiments on an unprecedented scale.
The central mechanism of the financial crisis is the money-creation machine unleashed by financial market deregulation, led by Wall Street. Since the 1970s, under the leadership of the Washington Consensus institutions, driven by the interests of Wall Street banks, the United States promoted bank privatization and deregulation across the world. The period witnessed a growing 'financialization' of the economy, as credit expanded in all its various forms. Between 1980 and 2005, the ratio of financial assets to global GDP globally rose from 109 per cent to 316 per cent. By 2006–2007, the volume of global derivatives had risen to around ten times global GDP.
The IMF was confident that new forms of risk management and risk distribution had eliminated the possibility of a global financial crisis. In 2006, the IMF stated: 'Risk is now so widely distributed throughout the global economy, that the financial system is so "thick" as to be virtually indestructible.' The world had survived a series of financial crises, including the Mexican 'Tequila Crisis', the Russian crisis and the closely associated crisis at Long-Term Capital Management, the Asian financial crisis and the Argentinean crisis, and it had survived the shock of 9/11.
Act II. Financial crisis
Scene I. The first phase of the financial crisis began in August 2007 with the US 'subprime' crisis and the beginnings of the decline in US house prices. By the spring of 2008 it was apparent that the financial crisis was spreading beyond the subprime sector and into international financial markets. A process of debt deleveraging set in globally across the high-income countries. Interbank lending tightened. However, there was still a widespread belief that the crisis would be of relatively short duration, and no worse than other post-war crises. This belief was helped by the fact that 'emerging markets' in general, and China in particular, were thought to have 'decoupled' from the OECD countries. This helped to create a 'Severn Bore' of financial speculation, which entered global commodity markets, as the global 'money tsunami' was pushed into a narrower channel of speculation.
Scene II. Confidence was shattered by the events of September and October 2008. These few weeks witnessed the collapse of a succession of leading financial institutions across the OECD countries, including giant financial firms such as Lehmann Brothers, AIG, Merrill Lynch, Washington Mutual, Wachovia, HBOS, Fortis and Dexia. Large swathes of the financial system were wholly or partially nationalized. Instead of being the 'lender of last resort', the state became the 'lender of first resort' in order to keep the financial systems of the OECD countries functioning. Across all countries, rich and poor, stock markets crashed and property prices began to fall seriously. Deleveraging accelerated. Interbank lending ground to a halt. Bank lending to commercial and individual customers slumped. The commodity price bubble disintegrated.
It was now no longer tenable to speak of the superiority of 'free, undistorted financial markets' over tightly regulated financial markets. The age of 'wild capitalism' had come to a shuddering halt. No one could now doubt that a new era of extensive regulation of financial markets was the only way forward, though no one could be certain of the way this might happen practically, and what the respective role for national and global regulation might be. It was no longer tenable to speak of the 'decoupling' of developing countries from the OECD countries in a closely integrated capitalist international economic system.
Following the Federal Reserve's rescue of Bear Stearns, Martin Wolf commented: 'Remember Friday 14 March 2008: it was the day the dream of global free market capitalism died.' In the same week Joseph Ackerman, chief executive of Deutsche Bank, said: 'I no longer believe in the market's self-healing power.' In May 2008 the former head of the IMF, Horst Kohler, delivered a devastating verdict on liberalized global financial markets:
The complexity of financial products and the possibility to carry out huge leveraged trades with little capital have allowed the monster to grow ... The only good thing about this crisis is that it has made clear to any thinking, responsible person in the sector that international financial markets have developed into a monster that must be put back in its place ... We need more severe and efficient regulation, higher capital requirements to underpin financial trades, more transparency and a global institution to independently oversee the stability of the international financial system.
Act III. From financial crisis to economic crisis
During the depth of the crisis in early autumn 2008 the global banking system had 'looked into the abyss'. The Economist magazine, the cheerleader of global deregulation, memorably had a cover picture in which a solitary person stared into a dark abyss. Only massive state intervention prevented a complete meltdown of the global banking system. This was a choice of no choice. US treasury secretary Hank Paulson said:
I don't like the fact that we have to do this. I hate the fact that we have to do this. But it is better than the alternative ... Government owning a stake in any private US company is objectionable to most Americans, me included. Yet the alternative of leaving businesses and consumers without access to financing is totally unacceptable.
Although the world pulled back from immediately falling into the abyss, the financial crises now began to enter the 'real economy'. Huge injections of government funds into the financial system and successive reductions in the official rate of interest were unable to stem the decline in asset prices and widespread deleveraging. It proved impossible to 'catch the falling knife'. By early November 2008, the main weapons available to OECD governments to avert a recession had already been used. The continuing decline in asset prices, including both property and the stock market, had a profound effect on the wealth of OECD citizens, causing a widespread effort to rebuild household balances by saving more and spending less on 'inessentials'. This effect was reinforced by greatly increased insecurity, including the prospect of reduced pensions, and by tightening bank lending. The severe economic downturn was likely to lead to a massive second wave of credit losses on consumer and corporate loans, which would cause further deep damage to the already eroded capital bases of banks and other financial institutions, causing further restrictions to bank credit. The market for a wide array of assets dried up as the leverage machine went into reverse and everyone tried to get to zero leverage.
From fears about inflation during the final phase of the asset bubble, global markets suddenly realized that the OECD countries faced the possibility of a long period of 'malign deflation', with a high risk that a negative spiral would be set in motion in which people postponed spending in the hope of further price falls. Moreover, during this process there was the prospect that the real value of debt would increase, thereby further damaging households' wealth position, and reducing their incentive to spend in a further vicious twist to the downward spiral. The spectre of looming deflation drove government bond yields to historically low levels as investors rushed to their relative safety away from equities and other asset classes: 'The mood is "give me Treasuries at the expense of all other asset classes" as spreads blow out and stocks slump ... There is no place to hide but in US Treasuries. You cannot hide in corporate or mortgage bonds.' The shocking realization loomed that the world faced the prospect of enduring on a global scale the ills that had afflicted Japan on a national scale in the 1990s following the bursting of its asset bubble in the 1980s.
In the space of two months in autumn 2008 the Financial Times' reports on the crisis had moved from 'global financial crisis', to 'global economic slowdown', to 'world in recession'. The Financial Times' headline on 21 November read: 'Fear stalks the world economies.' Its headline on 22 November read: 'Dark days see warnings of far worse yet to come':
Any lingering hopes that some parts of the world economy, particularly the fast-growing emerging markets such as China, would remain immune from the crisis were snuffed out. With remarkable speed in the past two months, a worrying but apparently manageable credit crunch has turned into a global financial crisis and a recession across much of the world's economy.
In early November the IMF forecast that in 2009 there would be negative GDP growth across the whole of the OECD, with a decline of –0.2 per cent in Japan, –0.5 per cent in the eurozone, –0.7 per cent in the USA and –1.3 per cent in the UK. By the third quarter of 2008, consumer demand was falling seriously across the whole of the OECD, including demand for automobiles, trucks, electrical appliances, furniture, toys, footwear and clothing. In the United States between July and September consumption fell at an annual rate of 3.1 per cent. US car sales fell from an annual rate of 16.1 million units in October 2007 to 10.7 million units in October 2008. In the eurozone, as early as August 2008, car sales fell by an annual rate of 16 per cent. The CEO of Renault, Carlos Ghosn, said: 'The issue is: how are we going to survive for the next three months? not: how are we going to compete for the next ten years?'
The prospect over the next 6–18 months of a serious recession in the OECD countries and a fall in the growth rate of imports, or even an absolute decline in imports, is hugely important for developing countries. The OECD countries account for 73 per cent of total world imports. These are the crucial motors for economic development in developing countries in the era of capitalist globalization. The impending recession will reduce the profitability of firms headquartered in the OECD countries. In addition, they will face much tighter conditions in credit markets. These factors combined will cause them to reduce their plans for capital investment globally. The collapse of world commodity prices will cause large difficulties for LMIEs (low- and middle-income economies) that rely heavily on primary commodity exports (Table 1.1), which will lead to a slow increase or even an absolute fall in demand for imports by primary commodity producers.
2. Implications for China in the Next 6–18 Months
China's unbalanced growth model
Deep integration with the international economy
Since the policies of 'reform and opening up' began in the late 1970s, China has become ever more deeply integrated into the international economy.
Foreign trade. China's growth strategy has been heavily oriented towards foreign trade. Since the 1980s, no other economy has achieved such rapid export growth as China. Between 1985 and 1995 its export volume grew by 15 per cent per annum, and between 1995 and 2006 the rate of growth accelerated to 20 per cent per annum. The share of foreign trade in China's GDP rose from 10 per cent in 1978, to 33 per cent in 1990, and reached 49 per cent in 2002 (Table 1.2). It continued to rise thereafter, reaching no less than 67 per cent in 2006. China's foreign trade ratio today is far above that of other large, continental-sized economies, such as the USA, Russia, Brazil, India and even Japan, and is comparable with that of small- and medium-sized open economies, such as Denmark, Finland, Korea, Israel, Mexico and Sweden. The foreign trade ratio of the eurozone is 65 per cent, which is a similar level to China's. However, a large fraction of the 'foreign trade' is carried on within the eurozone itself, and the 'foreign' trade ratio of the eurozone as a whole in terms of the region's trade with the countries outside the eurozone is much lower.
China's deep integration with the international economy has profoundly affected the country's development. It has brought large gains from comparative advantage, enabling China to export labour-intensive goods in huge quantities. It has also made China deeply vulnerable to fluctuations in the international economy.
Foreign investment. International firms investing in China have become central to the country's economic growth. Foreign-funded enterprises account for 57 per cent of export earnings and 90 per cent of China's exports of 'new and high-technology products'. Two-thirds of the patents granted in China are awarded to foreign enterprises and persons.
High rates of saving and investment and rapid growth of heavy industry compared with light industry
A central criticism of the so-called 'planned economy' before 1978 was the fact that it was locked into a development path which had a high investment rate and unbalanced growth of heavy and light industry. It was widely argued that the move towards a market economy deeply integrated with the global economy would change this growth pattern. In fact, this growth pattern has intensified as China integrates into the global economy.
Savings and investment. China's savings rate has risen from 43 per cent in 1990, already a very high rate in international comparative terms, to 54 per cent in 2006 (Table 1.3), almost twice the average for LMIEs. By contrast, the share of consumption in GDP has fallen from 42 per cent in 1990, already a low share in international comparison, to just 33 per cent in 2006, far below the average for all LMIEs. The economy has relied on a very high rate of investment to generate growth. In 2006, the share of gross capital formation in GDP stood at 45 per cent, compared with 27 per cent for all LMIEs. This suggests an inefficient pattern of resource use, with low technical progress over a large part of the economy and a high incremental capital-output ratio, with a large amount of additional investment needed to generate an additional unit of output.
Heavy industry. In 1990, the share of heavy industry in China's overall industrial output was already high, standing at over 50 per cent of the total gross value of industrial output. By 2006, the share of heavy industry had risen to 70 per cent (Table 1.4). This reflects the highly resource-intensive pattern of development over much of the economy, including low-technology manufacturing for the mass of the Chinese population, and a large role for infrastructure investment.
The process of China's integration into the world economy has produced an 'enclave' economy, which is deeply integrated into the global capitalist economy, alongside a vast hinterland, in which most Chinese people live, and which is only slightly integrated with the global economy.
Foreign trade. A tiny number of provinces with a quarter of the country's population dominate China's foreign trade. Guangdong, Jiangsu and Shanghai alone account for almost three-fifths of China's total exports (Table 1.5). If the provinces of Zhejiang, Shandong and Fujian are included, the total share rises to 80 per cent.
The ratio of foreign trade to provincial GDP varies enormously between the key coastal areas and the hinterland. In a small group of 'super-integrated' coastal areas, including Jiangsu, Shanghai, Beijing and Tianjin, the ratio of foreign trade to GDP stands at over 100 per cent, on a par with small open economies, such as Malaysia, the Netherlands and Estonia (Table 1.6). A group of 'moderately integrated' areas, such as Zhejiang, Fujian and Shandong provinces, have foreign trade ratios of between 40 and 80 per cent. However, for a wide array of provinces, the direct connection with global capitalist markets is weak. Their foreign trade ratios are less than 20 per cent, much below the average for LMIEs. For these provinces, domestic inter-provincial trade is much more important than international trade.
Excerpted from Re-balancing China by Peter Nolan. Copyright © 2014 Peter Nolan. Excerpted by permission of Wimbledon Publishing Company.
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Table of Contents
Introduction; Chapter 1: Rebalancing in the Face of the Global Financial Crisis (I): November 2008; Chapter 2: Rebalancing in the Face of the Global Financial Crisis (II): November 2011; Chapter 3: China’s Industrial Policy at the Crossroads; Chapter 4: Globalization and Competition in Financial Services; Chapter 5: China, Western Colonialism and the UN Convention on the Law of the Sea (UNCLOS); Chapter 6: A New Peloponnesian War? China, the West and the South China Sea
What People are Saying About This
‘Very few Western academics know China through its economy, history and culture as well as Peter Nolan. This is a remarkable book, breathtaking and original in its analysis of the transformations in China’s economy as it seeks to re-balance internally and with the rest of the world. No one has done this better in context and explained the tensions and conflicts within China and with its major trading partners and competitors. I could not put this book down.’ —Andrew Sheng, President of the Fung Global Institute, Hong Kong
‘Peter Nolan offers a range of valuable insights into what the post-2013 scenarios for China and the world might look like. The discussions range from the changing global balance of economic power to the dilemmas of Chinese industrial policies, and conclude with a striking study of China’s changing strategic position and the maritime disputes in the East Asian region. Anyone concerned with the Chinese dimension of our global political evolution should read this book.’ —Christopher Howe, SOAS, University of London
‘“Re-balancing China” is less a book about China than an original and penetrating analysis of the development of global capitalism and China’s place within it. Better than anyone else, Peter Nolan explains the choices facing China’s leadership before and after the global crisis, and the implications of these choices for China and the world. This book is an important response to the alarmism found in so much of the popular and academic writing on China’s rise.’ —Jonathan Pincus, Rajawali Institute for Asia, Harvard Kennedy School