Chinese Economic Policy in the 21st Century: Growth, Imbalance, and Considerations for Australia
Prospects for Future Growth
The rise of China as a leading exporter has further been linked to the rapid growth of supply chain networks in Asia that are centred on China contributing significantly to China’s increasing productivity in manufacturing (International Monetary Fund, 2012). East Asian economies and some European countries have managed to avoid significant competition with China by moving further up the value-added chain, where it is noted that greater vertical specialization has so far mitigated the impact of horizontal competition (European Commission: Enterprise and Industry, 2004, Jin and Li, 2007). Giovanni, et al, 2012, support this view by demonstrating that using a prospective simulation of ‘unbalanced’ productivity growth in disadvantaged Chinese economic sectors, a majority of countries in the world would experience large welfare gains.
With Chinese trade surpluses exceeding 3 trillion USD, China has accumulated significant foreign-exchange denominated in USD. This large accumulation resulted in the net purchase of large quantities of American debt that has been cited by some to have contributed to the cheap credit that fuelled the 2008 US housing bubble. Following the bailout that ensued and in response to the GFC, the US government created large quantities of credit at the expense of its value. China has particular cause of concern regarding the value of its dollar denominated assets and has responded by both pushing for an alternatives to the US dollar and diversifying its holdings from US-reserves. As is, approximately 54% of Chinese foreign reserves are held in the form of US assets (down from 65% in 2010).This diversification from the dollar has however led to a replacement by euro and yen denominated bonds, in turn contributing to upward pressure against the dollar. Onset of the Euro-ciris however has further adversely affected the value of Chinese Euro holdings, forcing China to re-examine the sustainability of its large trade surpluses. An alternative to the diversification from the dollar would be the internationalisation of the RMB, for which, since 2008, the People’s Bank of China has signed bilateral RMB currency swaps with eight other central banks totalling more than 720 billion RMB. Offshore RMB deposits and trade settlements have increased since 2010 adding weigh to a HSBC prediction that by 2012 nearly $2 trillion of annual trade (over 40% of China’s total) could be settled in yuan, making it one of the top three currencies in global trade (The Economist, 2009). This internationalisation process is however complicated by the perceived undervaluation of the RMB which could subject it to sharp appreciation, limiting other countries’ willingness to hold liabilities denominated in RMBs.
China should thus reform its financial system with the additional aim of reducing its current and capital account surpluses. If it cannot reduce its surpluses, it has to translate the surpluses into assets other than US Treasuries, which include increasing outbound FDI, engaging in mergers and acquisitions, selling panda bonds, engaging in currency swaps, and providing aid to developing countries.(The Economist, 2009, Yu, 2009)
On a domestic level, issues regarding China’s economy exist and attempts at addressing imbalances in the Chinese system have been unsuccessful as previously demonstrated in the 2008 stimulus package which instead of increasing consumer demand, lead to an influx of capital into investments (The Economist, 2012e, Yu, 2009). While GDP growth was maintained, it was also partially achieved via increasing liquidity fuelling real estate prices and accelerating inflation bias as was shown by a strong divergence in broad money growth and GDP growth in 2009 (Guo and Li, 2011). Overinvestment in key sectors of China’s economy in tandem with relatively sluggish growth in domestic consumption has resulted in excess industrial capacity which if not addressed timely, could initiate an overproduction crisis characterised by at least the widespread bankruptcy of enterprises and massive unemployment (Liaowang, 2005).
With regards to the long term prospects of Chinese economic development, China will have to address demographic trends, characterised by an ageing and declining population, that have been accelerated by its One-child Policy (figure 10). In this regards, China will have to anticipate falling economic growth due to a decline in labor input to the extent of anticipating deflation as a result (Iwata, 2004). The ageing process further entails the decline of household saving rates due to a greater dissaving by the retired elderly in turn affecting China’s ability to maintain its current monetary and fiscal policies (Iwata, 2004, Krugman, 1998). This trend will also likely be greatly dissimilar to other countries of similar ageing characteristics, as China will likely grow old before it grows rich, giving rise to profound financial and social consequences (The Economist, 2012a).
Figure 10: China demographic factors (Reserve Bank of Australia, 2011).
Implications for Australia
With the volume of trade between Australia and China increasing to $105.3bln in 2010, two-way trade has grown at 20.2% per annum since 2005. With Australia’s economy becoming increasingly intertwined with China’s economic performance (Figure 11), strong growth in China’s economy has lead to high demand for Australian resources in spite of high commodity prices. In particular, growth of iron exports from $8.35bln to $40.0bln from 2006 to 2011 represents the single most important factor in Australia’s trade surplus with China (Figure 12; Australian Government Department of Foreign Affairs and Trade, 2010). As a result, despite running a current account deficit (Figure 13), Australia’s economy has remained resilient through the global financial crisis with Australia’s terms of trade rising rapidly from the 1990’s (Lowe, 2010; figure 14).
Figure 11: Australian GDP Growth: Correlation of real quarterly growth (Lowe, 2010).
Figure 12: Balance of merchandise trade with China and value of Iron ore &Concentrates exports(Australian Government Department of Foreign Affairs and Trade, 2010).
Figure 13: Current account balance (Cheung et al., 2010).
Figure 14: Terms of Trade, 2007/08= 100, quarterly (Annual dates prior to 1959; Lowe, 2010).
With regards to investments, Chinese outward direct investment (ODI) to Australia has generally outperformed ODI to other destinations averaging 31 to 40 percent of potential from 2000 to 2008 (Armstrong, 2011). Resistance to Chinese ODI also remains low as demonstrated by the high level of actual to potential FDI. As a result, Australia was the largest recipient of Chinese non-bond FDI in 2011, lending credibility to the notion that Australia’s current account deficit is largely as a result of high private-sector investments rather than low savings (Cheung et al., 2010). Australia should further be commended for being successful in maintaining a strong fiscal position and sound monetary policy framework to prevent foreign funds from building up excesses and distorting the financial system (Cheung et al., 2010, Huang and Wang, 2011).
Sustained growth in exports has however partially fueled upward pressure on the Australian Dollar at the cost of the Australian manufacturing and service sectors. Australia should thus actively pursue measures to allow trade settlements to occur in RMB to limit the risk associated with a potentially over-valued AUD. The bilateral currency swaps valued at 30bln AUD or 200bln RMB signed in March 2012 was thus a step in the right direction (Reserve Bank of Australia, 2012).
From a political perspective, assuming the continued expansion of the Chinese economy and increase in strategic importance, future Australian policy requires an examination based on Australian values within context of Chinese economic growth. On one hand, given China’s considerable appetite for primary resources, it is clear that Australia should aim to maintain its democratic values and rules-based order in the region whilst remaining free from coercion. On the other, policy that encompasses hybrid-engagement and enmeshment both diplomatically and economically is required with the aim of China developing long-term stakes in Australia's future (Medcalf, 2012).
Such policy would have to consider the basis for Chinese expansion overseas, recognising especially the increasing competition within SOE’s and against private and foreign firms as the rationale for overseas investment. Populist reactions that have challenged the open investment regime (such as the ban on foreigners owning agricultural land) in Australia should thus be disregarded to avoid risk of tarnishing its reputation as a highly competitive mining and agricultural industry (Drysdale, 2011, Caixin Weekly, 2010, Huang and Wang, 2011).
China maintained sustained economic growth largely via a mixture of favourable demographic factors and an export-orientated economy, by actively pursuing productivity growth while funneling wealth into investments at the expense of household consumption. Multiple factors pose challenges for China: principally its growing assymetry between household consumption and investments and its changing demographic composition. Should these factors be addressed, China's future economic growth would likely continue, with profound implications for Australia. Australia has benefited from the ‘Asian century’ with the rise of China contributing largely to Australia’s exports of mining products to China. Future Australian policy will need to continue engaging China to ensure a stable and beneficial relationship for both countries.
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