Made in China – Economic Turmoil or Sensible Change?
In our recent interviews on China with Prof. Rolf J. Langhammer, we talked about currencies, the steel industry and how China must grow in a smarter way. The country has come a long way in the past years, making both good and bad decisions for its and the global economy. Yet, in many respects, China has arrived at a tipping point, where decisions could lead to the next big economic shock.
Rolf J. Langhammer is a Professor of Economics, former Vice President of the Kiel Institute for World Economy and expert on China’s economy. An opinion piece by the author on the same topic was first published on the Mercator Institute for China Studies’ blog “European Voices on China”.
GESblog: China did some thoughtful moves in the past to stabilize the world economy. What did they do right?
Prof. Langhammer: They acted quite reasonable after 9/11, helping to prop up financial markets by abstaining from a panic sale of dollar-denominated assets. In 2008, during the US sub-prime crisis, the Chinese government launched the world’s largest fiscal expansion program to prevent a long worldwide recession. Today, however, China pays the price for this overinvestment as excess capacities in many industries now plague the country in times of lower domestic and international demand.
GESblog: And the Chinese did not always make the right decisions in unexpected situations like during the exchange rate turbulences in August 2015.
Prof. Langhammer: That was a sobering experience of how strongly international financial markets reacted to China’s ineffective operations during those turbulences and thereafter. Instead of giving markets clear signals, China’s authorities erratically switched between exchange rate targeting and exchange rate flexibility. Of course, they are still learning how financial markets react under unexpected events and stress. But the way they mishandled volatile movements in financial markets also point to deeper dilemmas in the management of the real sector: while the goal is to move away from its traditional export orientation, allowing the currency to depreciate would contribute to cementing the old model.
GESblog: The challenges are huge. What are the sensitive issues China has to deal with in order to overcome those challenges without creating a disturbance in the world economy?
Prof. Langhammer: To ensure better economic policy implementation, China mainly has to address four issues: It needs better data quality, fewer conflicting targets, better communication, and, finally, less bureaucratic intervention and greater responsiveness to price signals and market reactions.
GESblog: Let’s break this down. First, what about the data quality?
Prof. Langhammer: This issue should be easy to solve. Chinese economic data are always published on time, but the frequency of publication of key data sets (i.e. quarterly data on GDP by expenditure) and their quality, i.e. in the “new service economy” and the shadow banking activities, show need of improvement. Often Chinese statistics draw an inconsistent picture of the economy with some data (i.e. energy imports) suggesting a more favorable development of domestic demand than other data such as transport volumes, credit growth or electricity consumption. A number of domestic high-quality economic research institutes could play an important role. It would be necessary to strengthen the autonomy of these think tanks and to allow them to scrutinize official data and publish their own research free of interventions and in a competitive environment.
GESblog: No. 2 on your list was “fewer conflicting targets”. What does that mean in China’s case?
Prof. Langhammer: Economists often refer to the “impossible trinity” dilemma, according to which it is only possible to achieve two out of the following three targets at the same time: autonomous monetary policy, exchange rate stability and free capital movement. Striving for exchange rate stability (China pursued this course after August 2015 when it sold foreign exchange to mitigate depreciation) and allowing for freer capital movement has come at a price for the autonomy of China’s monetary policy. Under the current conditions, China should allow more flexibility of the exchange rate while controlling the speed of exchange rate movements by maintaining certain controls on the free flow of capital.
GESblog: What could be improved in terms of transparency and communication?
Prof. Langhammer: These are serious shortcomings of China’s monetary policy. There has to be a clear separation between the tasks of China’s Central Bank and government and party authorities. In order to prevent market uncertainty, the Central Bank should hold regular meetings and communicate decisions to investors and the public via user-friendly channels.
GESblog: Your final point on the list is probably a crucial on because it finds its roots deep in communism and can’t be undone easily: Bureaucracy and deficiency.
Prof. Langhammer: China’s authorities deciding on the allocation of financial resources are still more likely to opt for bureaucratic interventions rather than respond to market signals. This goes back to a misdirected system of incentives. For example, civil servants are often remunerated for initiating prestigious infrastructure projects regardless of their economic cost or environmental impact. China needs to set up independent impact assessment agencies to evaluate public spending and to hold agencies and civil servants accountable for grave and obvious misallocations.
GESblog: What if these issues are not solved in the near future? Is China a threat to the world economy?
Prof. Langhammer: Chinese policymakers are no longer responsible for their own country alone. For its own good, China will need clear and consistent economic policies to increase the resilience of its real economy and financial system against unexpected shocks. No doubt about that. But the Chinese should be aware that the rest of the world is anxiously looking to China as a potential new source for global economic turmoil.