This article presents a brief overview of China’s growing prominence in the global economy and explores the global financial crisis’ spillover implications on China’s financial markets and macroeconomy. Alternative methods of estimating these effects are presented and critiqued. China, contrary to common belief, was hit particularly hard by the global recession brought on by the financial crisis. It experienced a significant reduction in exports, which were only partially offset by China’s massive stimulus package. While growth was still substantially above international standards, it fell by the same amount as the United States. The report concludes with a brief assessment of some of China’s major obstacles in rebalancing its economy to maintain high growth.
What impact did 2008 have on China?
In the aftermath of the global financial crisis, China implemented the world’s largest stimulus package in late 2008. China was also the world’s first major economy to recover from the crisis. Following a brief but severe downturn in 2008, the Chinese economy recovered and expanded by 8.7% in 2009 and 10.4% in 2010.
How did China weather the financial crisis of 2008?
In 2007, China’s export to GDP ratio was 35%. Exports decreased by 2.2 percent in November, compared to a 25% increase in September. This drop in exports may have slowed GDP growth by 3%. If the indirect effects are taken into account, China’s 2008 growth rate could have been reduced by more than 5%.
China’s export promotion policy has resulted in a high level of export dependency. However, from a macroeconomic standpoint, China’s high export dependency might be attributed in part to overcapacity produced by excessive investment. Fixed asset investment (FAI) and net exports combined to account for more than 60% of GDP growth in 2007. The engine of Chinese growth is FAI and exports.
Significantly, FAI growth has typically outpaced GDP growth. Since 2001, this has resulted in increased investment rates. In this unsettled context, how is China’s growth drama playing out?
Because FAI is higher than the other components of aggregate demand, the potential growth rate increases. As a result of the excess demand (overheating), overcapacity will emerge. Because the growth rate of FAI is larger than the growth rate of other components of aggregate demand in China, sustainable growth is impossible.
Overcapacity can only be absorbed by a further increase in the growth rate of FAI if the growth rates of other components of aggregate demand do not rise. This feedback loop causes FAI to speed up in order to absorb overcapacity.
The rate of FAI expansion will eventually reach a limit set by social, environmental, natural resource, ecological, or other limits. The growth process will then break down due to deflation.
To avoid the growth process from collapsing, either FAI growth can be reduced or the growth of the other aggregate demand components can be boosted. The equalization of FAI growth rates with other components of aggregate demand is a necessary and sufficient prerequisite for long-term stability and sustainability.
In 2004, when signs of overcapacity began to emerge, the government attempted to stifle fresh investment projects. A good example is the steel business. China produced almost 400 million tons of steel in 2004. Concerned about overcapacity, the government halted new steel mill building. However, robust steel demand, owing to real estate expansion and strong export demand, meant that new steel factories continued to pop up. In 2007, China produced more than 600 million tons of steel.
Temporarily, growth was maintained, but at the expense of economic equilibrium. From mid-2007, China’s inflation rate accelerated due to investment frenzy and high external demand. For many years, the robust foreign demand postponed the emergence of overcapacity.
However, export demand is exceedingly volatile. The global financial crisis caused export demand to plummet in the second half of 2008. Overcapacity that had been dormant for a long time suddenly erupted. In September and October 2008, the abrupt turn from inflation to deflation was quite striking.
Overcapacity and the need for adjustment were unavoidable, whether or not the GFC occurred. The global economic crisis only exposed China’s growth pattern’s weakness in a dramatic way.
Following the Great Recession, the Chinese government responded fast with a stimulus package and monetary expansion to counteract decreasing GDP growth.
The government announced a 4 trillion Yuan stimulus program (14 percent of 2008 GDP) for 2009 and 2010 in November 2008.
China’s stimulus package’s success is unsurprising. China’s budget deficit has been so low during the last decade that its debt should only be around 20% of GDP after the stimulus. The Chinese government has plenty of room to deploy expansionary fiscal policy to compensate for the lack of export demand.
One-quarter of the 4 trillion yuan plan is being funded by the central government through direct grants and interest rate subsidies. Bank credit is the stimulus package’s second most important source of funding.
Local governments offered 18 trillion yuan stimulus packages of their own. The central government would issue government bonds worth 200 billion yuan on behalf of local governments, but commercial bank credit is projected to be the most important source of funding for the proposed local-government projects.
Since 2009, China’s recovery has been aided by monetary expansion. To complement the expansionary fiscal policy, the People’s Bank of China (PBOC) has implemented a very expansionary monetary policy. Bank credit surged by 7.3 trillion RMB in the first half of 2009, already above the annual objective.
As a result, liquidity has been flooded into the interbank money market. This resulted in the phenomenon known as “flour being more expensive than bread,” with interbank interest rates being lower than interest rates on commercial bank deposits.
When the Western banking system was on the verge of collapse, China’s banking system was comparatively safe. As a result, an increase in bank credit and wide money has resulted from increased liquidity in the interbank money market. What are the long-term consequences of these two GFC responses?
Although expansionary fiscal and monetary policies have succeeded in stopping a decline in growth, their medium and long-term consequences are a source of concern.
First and foremost, China’s economic style is characterized by investment overdrive. As a result of the stimulus package, the investment rate has risen from 25% in 2001 to 50% today. As a result, China’s overcapacity is likely to worsen in the future.
Second, as a result of the stimulus package, investment efficiency has decreased. Overcapacity has been a problem for the economy for some time, and the government is aware of it. As a result, rather than new manufacturing, the stimulus package focused on infrastructure. However, there are still issues with a stimulus package focused on infrastructure. Investment efficiency declines will have a significant detrimental impact on China’s long-term growth.
Third, infrastructure investment is a long-term commitment with no immediate payoff. Investment in manufacturing capacity is also required. If there is no traffic on an eight-lane motorway, where will tolls come from? In addition, waste in infrastructure construction is rampant as a result of rapid implementation.
Fourth, local governments’ over enthusiasm for local investment may cause major problems. Commercial loans guaranteed by local governments will fund the majority of local stimulus initiatives. Local governments in China have an insatiable hunger for extravagant investment projects and sub-optimal resource allocation as a result of institutional frameworks.
Finally, as previously said, China’s monetary policy has been excessively loose. Such low interest rates are unnecessary. In underdeveloped countries, interest rates are an important screening tool. Small and middle-sized private and creative businesses face prejudice in comparison to state-owned monopolistic businesses since borrowing rates are so low. It’s possible that the progress made in enterprise reform will be undone.
To summarize, if the government fails to address fundamental issues head on, the crisis-management tactics may have major negative consequences. However, it is worth noting that the Chinese government is aware of the issues and has begun to take steps to reintroduce structural adjustment to the table.
Hopefully, the Chinese government will be successful in both restoring the economy and correcting the deteriorating structural problem. Only then can China’s future growth have a solid base.
Yu Yongding is a professor at the Chinese Academy of Social Sciences and the former director of the Institute of World Economics and Politics (CASS). This article is an excerpt from his Richard Snape Lecture, which he gave to the Australian Productivity Commission last November in Melbourne.
Which countries were the hardest hit by the financial crisis of 2008?
The crisis had an impact on all countries in some form, but some countries were hit more than others. A picture of financial devastation emerges as currency depreciation, stock market declines, and government bond spreads rise. These three indicators, considered combined, convey the impact of the crisis since they show financial weakness. Ukraine, Argentina, and Jamaica are the countries most hit by the crisis, according to the Carnegie Endowment for International Peace’s International Economics Bulletin. Ireland, Russia, Mexico, Hungary, and the Baltic nations are among the other countries that have been severely affected. China, Japan, Brazil, India, Iran, Peru, and Australia, on the other hand, are “among the least affected.”
What impact does China have on the global economy?
It is now the world’s second-largest economy, accounting for 9.3% of global GDP (Figure 1). From 1979 to 2009, China’s exports increased by 16 percent every year. China’s exports accounted for only 0.8 percent of world products and nonfactor services at the start of that period.
How did China do during the global financial crisis of 2008?
China’s real GDP growth rate dropped from 13% in 2007 to 9% in 2008. Economic growth has been severely hampered by the global financial crisis.
How did the global financial crisis of 2008 influence Asia?
Due to the severe recession in advanced nations and the resulting collapse of global trade, Asia’s exports and growth collapsed in the fourth quarter of 2008 and the first quarter of 2009. Massive fiscal and monetary stimulus, on the other hand, allowed the region to recover quickly.
What did China do in the aftermath of the Great Depression?
China’s monetary system was undermined and its economy was destabilized by fluctuations in world silver prices. In reaction to severe deflation, the government changed from laissez-faire to dedicated interventionism in the market.
What effect does China’s financial crisis have on commerce with the US?
Though the impact of the coronavirus on supply chains may shift the game, newly revealed trade data illustrate the trade war’s early impact on the world’s two largest economies and the future of global trade. Surprisingly, the outcomes are largely the polar opposite of what the White House had hoped for. Tariffs have had no effect on the underlying trade balance of the United States, while China’s trade surplus has grown and its export markets have gotten more diverse.
Significant Costs Without Real Improvement in U.S. Trade Balance
Trump’s lowering of the bilateral trade deficit with China came at a high price, with the economy contracting significantly and China’s total trade surplus increasing inadvertently. And, if it hadn’t been for a fall in oil imports, the US trade deficit would have worsened, casting doubt on the logic of a protectionist strategy aimed at improving the country’s trade balance.
Imports of goods into the United States fell by $44.3 billion in 2019 compared to the previous year (see figure 1). With tariffs in effect on nearly $370 billion in Chinese goods heading for the United States, the reduction was fueled by a dramatic drop in imports from China. Imports from China declined by $87.3 billion year over year in the United States. Except for the year of the financial crisis in 2009, this is the greatest annual drop in U.S. imports from any trade partner.
What makes China so vital to the global economy?
China is becoming increasingly important in the global economy. It is the world’s tenth largest exporter and one of the world’s fastest growing countries. China also receives a lot of foreign aid and borrows a lot of money on the international capital markets. What’s more, it’s attracting massive amounts of foreign direct investmentover $11 billion in 1992 alone.
The ramifications of China’s rise as a key actor in the global economy are examined in this paper. The rest of the world faces significant challenges as a result of its integration into the international economic order. Bringing China’s hybrid market/centrally planned economy into the GATT, adapting to competition from labor-intensive Chinese exports, encouraging more market-oriented reform, and accommodating its desire for international capital are just a few of these issues. However, China’s entry into the global economy opens up significant prospects for commerce, investment, and international cooperation, all of which contribute to global wealth and stability.
Dr. Lardy predicts that China’s rapid expansion will continue, posing new policy issues and opportunities for its trading partners. He proposes a variety of measures to let China fully participate in the global economy.
