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Lin Justin Yifu: International Economic Crisis: Causes and Lessons Lin Justin Yifu: International Economic Crisis: Causes and Lessons

2012-07-26

Lin Justin Yifu: International Economic Crisis: Causes and Lessons

Speaking at “CCER/CMRC China Economic Observer(CEO)”The Special Report of the 30th Conference

Since the spring of 2005, “CCER/CMRC China Economic Observer (CEO)” Conference has been held each season during the last seven-and-half-year. On July 21, 2012, the 30th“CCER/CMRC China Economic Observer” Conference was held in the National School of Development (NSD) at Peking University. Speakers include Dr. Justin Lin, Honorary Dean of NSD, former Chief Economist and Senior Vice President of World Bank; Dr. Gang Yi, Vice President of the People’s Bank of China and Secretary of the State Admission of Foreign Exchange; Prof. Guoqing Song, professor of NSD and member of the Central Bank’s Monetary Policy Committee; and Dr. Stephen Green, China Research Director of Standard Chartered Bank. They discussed the causes and lessons of the global economic crises, international investment of Chinese enterprises, short-term macroeconomic situation, and macroeconomic data analysis.

The conference was hosted by Professor Lu Feng, the Deputy Dean of NSD. Based on the 29th Langrun Economic Forecast, Professor Lu summarized the views of 22 specially invited organizations about Chinese macroeconomic situation in the third season of this year and provided the following conclusion: China’s Domestic Demand is at its nadir. Foreign demand is expected to remain stable. Macroeconomic situation could get back to normal. Inflation has been going down. Interest rate is declining, and moderately loose monetary policy will continue.

The speakers’ main points have been summarized as follows.

Lin Justin Yifu: International Economic Crisis: Causes and Lessons

As we all know, this international economic crisis is caused by the burst of real estate bubbles in the United States. Many popular theories from abroad believe that the occurrence of these bubbles is caused by unbalanced international trade and excessive foreign reserve in China and East Asian economies. Besides, China and the other nations in the East Asia have purchased large sum of US treasury securities and held down interest rate, causing large amount of capital to flow into real estate market and stock market. This flow of capital has caused bubbles to appear in those markets. According to those theories, the causes of this international crisis are the externally unbalanced East Asian countries and their economies.

If those theories are correct, what is the reason for the East Asian economies to have kept such large amount of foreign reserve? To answer this question, there have been three hypotheses: The first hypothesis supposes that East Asian economies pursue export-oriented development strategy, which is to increase trade surplus through increasing export volume. The second hypothesis states that, since the East Asian financial crisis in 1998, countries in the region including South Korea, Thailand, and Malaysia have started to increase their foreign reserve through increasing export volume in order to protect themselves against speculators. The third hypothesis states that the Chinese government has increased export volume and foreign reserve in order to suppress the exchange rate of RMB.

During the conference, Professor Lin questioned all the above hypotheses. Firstly, Professor Lin pointed out that East Asian economies have been following the export-oriented development strategy since 1960s and maintaining a balanced trade until the year of 2000. Therefore, despite of the increase in trade surplus during the recent years, export-oriented development strategy cannot be the cause of the unbalance of international trade after 2000.

Secondly, as the self-protection hypothesis states, the trade surplus of current account in East Asian economies has increased dramatically since 1990s. However, for countries like Japan and Germanyself-protecting through increasing foreign reserve can be considered unnecessary., but they have also experienced dramatic increase in the trade surplus of their current account. Besides, the trade surplus of Chinese current account and foreign reserve has far exceeded the amount needed for self-protection since 2005.

Thirdly, is the international economic crisis really caused by Chinese policy on the exchange rate of RMB? China has been blamed of undervaluing the exchange rate of RMB since 2003. However, the trade surplus of China has increased only since 2005. In 1997 and 1998, the exchange rate of RMB is considered to have been overestimated, but the trade surplus in 2003 is even lower than the trade surplus in 1997 and 1998. Trade surplus cannot be reduced at the same time when currency exchange rate of RMB is undervalued. Between 2005 and 2008, the exchange rate of RMB to US Dollar has increased by 20%. However, the unbalance of international trade and Sino-American trade has continued to deteriorate. Besides, if the undervaluation of RMB by Chinese government is actually the major cause of international and American trade unbalance, the other developing countries that have been competing with China should have reduced their trade surplus and foreign reserve. However, the entire foreign reserve of all the developing countries has increased from $1,000 billion in 2000 to over $ 5,000 billion in 2008.

Although trade deficit of the US has increased through Sino-American trade, the percentage of American trade deficit with all the East Asian countries has dropped from 61.8% in 1990s to 44.9% between 2000 and 2009. Therefore, all three of the above hypotheses are inaccurate in pointing out the actual causations of this international economic crisis. In fact, as the integration of regional industrial chain has shifted light manufacturing industry from other East Asian economies to China, the US’s trade deficit with East Asian countries (the trade deficit between US and East Asian countries) has also been transferred to Sino-American trade.

Professor Lin believes that the international trade unbalance has occurred because US Dollar has been the international reserve currency, and the US government has modified two of its policies: Firstly, the US government has deregulated its market and allowed financial organizations to perform high lever bar operations. Secondly, the burst of Internet bubbles in 2001 has caused Federal Reserve to adopt low interest policy in order to stimulate the US economy. This policy has caused dramatic increase in monetary and credit capital as well as excessive speculation, triggering bubbles in the US’s real estate market and stock market. Since 1980s, the US, along with European countries, has deregulated their market activities. Some of the most direct results of this deregulation are the occurrence of high lever bar operation, increase of creditable capital and liquidity. At the same time, the burst of the US’s Internet economy bubbles is supposed to bring America into depression. However, Alan Greenspan has adopted a loose monetary policy in order to avoid this depression. This policy has prompted Federal Reserve to slash interest rate via twenty-three consecutive cuts in eighteen months. The interest rate in the US has dropped from 6.5% in 2001 to 1% in the eighteen months after the execution of Greenspan’s monetary policy. The consequence of such low interest rate is excess liquidity and excessive speculation, which has eventually caused the bubbles in real estate market and stock market.

The wealth effect of the bubbles has prompted American consumers to overextend. Compounded by the development of financial derivative and innovation that allows families to sell appreciated value of their real estate, the rapid increase in demand has dramatically increased the debt of American people. The Afghanistan and Iraq Wars have further enlarged the US’s financial deficit, causing domestic demand and trade deficit to soar. Because US Dollar has been international reserve currency, this deficit of the US has been maintained through increasing supply of money. In 2000, China has become the major supplier of America’s labor-intensive manufacturing products. This transition has caused increased trade deficit with America. The trade deficit of China with its East Asian suppliers has also increased year by year.

A large amount of capital has flown out from the US into developing countries due to the excessive liquidity caused by the change of US policy. This outflow of the US capital has increased from $2,000 billion in 2000 to $12,000 billion in 2007 and helped Chinese economy to grow rapidly. Between 2000 and 2007, the growth rate of developing countries has reached the highest point in history. Their economic growth has caused increased trade surplus in capital exporters including Germany and Japan. This accelerated development of developing countries has also increased the demand of fuel, raw material, and other natural resources, causing the price and trade profit of resource exporters to increase..

Since US Dollar has been international reserve currency, central banks of other countries can only use their foreign income to purchase US treasury securities or other financial capitals. This phenomenon has caused a large sum of money to outflow from developing countries to the US and created a false indication of low exchange rate.

Why has the trade surplus of China increased so much? Large amount of trade surplus shows high domestic savings rate. Some researchers believe that such high domestic savings rate is caused by the lack of social security system and aging population in China. However, the sum of family saving in China makes up only 20% of China’s GDP. This percentage is on the same level with that of India. One of the characteristics of China’s high savings rate is that Chinese enterprises have especially high savings rate, which is caused by several problems inherited from the double-track system reform: financial capitals are overly concentrated in large banks and capital market, causing an implicit subsidy to large enterprises; natural resources are lightly taxed; monopoly occurs in some industries. In order to fundamentally adjust income distribution, increase family income and consumption, and reduce trade surplus, Chinese government has to solve the above problems.

Professor Lin believes that there are lots of lessons we can learn from this international economic crisis. The constant unbalance of international trade is unsustainable to either a country with trade surplus or a country that has trade deficit. If developed countries could have faced the problems and figured out effective solutions instead of shifting their responsibilities during the early stage of international trade unbalance in 2002 and 2003, the worst global economic crisis since the Great Depression could have been avoided or relieved.

Governments of developed countries have their reasons to shirk their responsibilities and shift the blame onto others. However, their behavior is also directly connected to the aggregation of academic world. When researchers study a phenomenon, they should keep open minds and should not be satisfied merely when their hypotheses are accordant with the phenomenon they are observing. Before arriving at a conclusion, researchers should observe and infer using various hypotheses and make sure that all the results are in accordance with known facts. As China’s economic position has been raising, economic policies of China will have an increasing global influence. Along with this increasing global presence, various conflicts will also occur. China will always be in a passive position if Chinese economic policies must be composed based on foreign economic theories. It is the responsibility of Chinese researchers to find economic theories that are suitable to deal with domestic and international situations. Only then, we can take hold of our own destiny and play an active role in global negotiations.

Lastly, Professor Lin shared with us about his optimistic view of the economic future of China. He believes that China has the potential to maintain an average annual growth of 8%. This belief has been doubted by some researchers for two reasons: firstly, there has never been a country that can maintain an annual growth of 8% for more than fifty years; secondly, when the average per capita income (calculated by purchasing power) of a rapidly developing country reaches $10,000, the growth tends to slow down. From the perspective of New Structure Economics, the growth rate of a country is determined by the rate of its technological innovation and industrial upgrade. However, the growth potential of a developing country should be determined by its later comer advantage instead of its level of income. Based on the purchasing power in 1990, when the per capita income of Japan and Germany reaches $10,000, equals to 65% of that of the US; however, when the per capita income of China reaches $10,000, our per capita income is only less than 25% of that of the US. Therefore, with the same level of $10,000, there is a huge difference in the potential of backward advantage.

Of course, China needs to maximize its advantage of backwardness for technological innovation and industrial upgrade in order to turn its potential into reality. Besides, China also needs to overcome all the economic, social, and institutional challenges of a developing country and create a stable, healthy, and sustainable environment for rapid economic development and growth.

Written by Xiaoguang Liu,Translated by Ricky Binhai Hu, July 24, 2012

Lin Justin Yifu: International Economic Crisis: Causes and Lessons

Speaking at “CCER/CMRC China Economic Observer(CEO)”The Special Report of the 30th Conference

Since the spring of 2005, “CCER/CMRC China Economic Observer (CEO)” Conference has been held each season during the last seven-and-half-year. On July 21, 2012, the 30th“CCER/CMRC China Economic Observer” Conference was held in the National School of Development (NSD) at Peking University. Speakers include Dr. Justin Lin, Honorary Dean of NSD, former Chief Economist and Senior Vice President of World Bank; Dr. Gang Yi, Vice President of the People’s Bank of China and Secretary of the State Admission of Foreign Exchange; Prof. Guoqing Song, professor of NSD and member of the Central Bank’s Monetary Policy Committee; and Dr. Stephen Green, China Research Director of Standard Chartered Bank. They discussed the causes and lessons of the global economic crises, international investment of Chinese enterprises, short-term macroeconomic situation, and macroeconomic data analysis.

The conference was hosted by Professor Lu Feng, the Deputy Dean of NSD. Based on the 29th Langrun Economic Forecast, Professor Lu summarized the views of 22 specially invited organizations about Chinese macroeconomic situation in the third season of this year and provided the following conclusion: China’s Domestic Demand is at its nadir. Foreign demand is expected to remain stable. Macroeconomic situation could get back to normal. Inflation has been going down. Interest rate is declining, and moderately loose monetary policy will continue.

The speakers’ main points have been summarized as follows.

Lin Justin Yifu: International Economic Crisis: Causes and Lessons

As we all know, this international economic crisis is caused by the burst of real estate bubbles in the United States. Many popular theories from abroad believe that the occurrence of these bubbles is caused by unbalanced international trade and excessive foreign reserve in China and East Asian economies. Besides, China and the other nations in the East Asia have purchased large sum of US treasury securities and held down interest rate, causing large amount of capital to flow into real estate market and stock market. This flow of capital has caused bubbles to appear in those markets. According to those theories, the causes of this international crisis are the externally unbalanced East Asian countries and their economies.

If those theories are correct, what is the reason for the East Asian economies to have kept such large amount of foreign reserve? To answer this question, there have been three hypotheses: The first hypothesis supposes that East Asian economies pursue export-oriented development strategy, which is to increase trade surplus through increasing export volume. The second hypothesis states that, since the East Asian financial crisis in 1998, countries in the region including South Korea, Thailand, and Malaysia have started to increase their foreign reserve through increasing export volume in order to protect themselves against speculators. The third hypothesis states that the Chinese government has increased export volume and foreign reserve in order to suppress the exchange rate of RMB.

During the conference, Professor Lin questioned all the above hypotheses. Firstly, Professor Lin pointed out that East Asian economies have been following the export-oriented development strategy since 1960s and maintaining a balanced trade until the year of 2000. Therefore, despite of the increase in trade surplus during the recent years, export-oriented development strategy cannot be the cause of the unbalance of international trade after 2000.

Secondly, as the self-protection hypothesis states, the trade surplus of current account in East Asian economies has increased dramatically since 1990s. However, for countries like Japan and Germanyself-protecting through increasing foreign reserve can be considered unnecessary., but they have also experienced dramatic increase in the trade surplus of their current account. Besides, the trade surplus of Chinese current account and foreign reserve has far exceeded the amount needed for self-protection since 2005.

Thirdly, is the international economic crisis really caused by Chinese policy on the exchange rate of RMB? China has been blamed of undervaluing the exchange rate of RMB since 2003. However, the trade surplus of China has increased only since 2005. In 1997 and 1998, the exchange rate of RMB is considered to have been overestimated, but the trade surplus in 2003 is even lower than the trade surplus in 1997 and 1998. Trade surplus cannot be reduced at the same time when currency exchange rate of RMB is undervalued. Between 2005 and 2008, the exchange rate of RMB to US Dollar has increased by 20%. However, the unbalance of international trade and Sino-American trade has continued to deteriorate. Besides, if the undervaluation of RMB by Chinese government is actually the major cause of international and American trade unbalance, the other developing countries that have been competing with China should have reduced their trade surplus and foreign reserve. However, the entire foreign reserve of all the developing countries has increased from $1,000 billion in 2000 to over $ 5,000 billion in 2008.

Although trade deficit of the US has increased through Sino-American trade, the percentage of American trade deficit with all the East Asian countries has dropped from 61.8% in 1990s to 44.9% between 2000 and 2009. Therefore, all three of the above hypotheses are inaccurate in pointing out the actual causations of this international economic crisis. In fact, as the integration of regional industrial chain has shifted light manufacturing industry from other East Asian economies to China, the US’s trade deficit with East Asian countries (the trade deficit between US and East Asian countries) has also been transferred to Sino-American trade.

Professor Lin believes that the international trade unbalance has occurred because US Dollar has been the international reserve currency, and the US government has modified two of its policies: Firstly, the US government has deregulated its market and allowed financial organizations to perform high lever bar operations. Secondly, the burst of Internet bubbles in 2001 has caused Federal Reserve to adopt low interest policy in order to stimulate the US economy. This policy has caused dramatic increase in monetary and credit capital as well as excessive speculation, triggering bubbles in the US’s real estate market and stock market. Since 1980s, the US, along with European countries, has deregulated their market activities. Some of the most direct results of this deregulation are the occurrence of high lever bar operation, increase of creditable capital and liquidity. At the same time, the burst of the US’s Internet economy bubbles is supposed to bring America into depression. However, Alan Greenspan has adopted a loose monetary policy in order to avoid this depression. This policy has prompted Federal Reserve to slash interest rate via twenty-three consecutive cuts in eighteen months. The interest rate in the US has dropped from 6.5% in 2001 to 1% in the eighteen months after the execution of Greenspan’s monetary policy. The consequence of such low interest rate is excess liquidity and excessive speculation, which has eventually caused the bubbles in real estate market and stock market.

The wealth effect of the bubbles has prompted American consumers to overextend. Compounded by the development of financial derivative and innovation that allows families to sell appreciated value of their real estate, the rapid increase in demand has dramatically increased the debt of American people. The Afghanistan and Iraq Wars have further enlarged the US’s financial deficit, causing domestic demand and trade deficit to soar. Because US Dollar has been international reserve currency, this deficit of the US has been maintained through increasing supply of money. In 2000, China has become the major supplier of America’s labor-intensive manufacturing products. This transition has caused increased trade deficit with America. The trade deficit of China with its East Asian suppliers has also increased year by year.

A large amount of capital has flown out from the US into developing countries due to the excessive liquidity caused by the change of US policy. This outflow of the US capital has increased from $2,000 billion in 2000 to $12,000 billion in 2007 and helped Chinese economy to grow rapidly. Between 2000 and 2007, the growth rate of developing countries has reached the highest point in history. Their economic growth has caused increased trade surplus in capital exporters including Germany and Japan. This accelerated development of developing countries has also increased the demand of fuel, raw material, and other natural resources, causing the price and trade profit of resource exporters to increase..

Since US Dollar has been international reserve currency, central banks of other countries can only use their foreign income to purchase US treasury securities or other financial capitals. This phenomenon has caused a large sum of money to outflow from developing countries to the US and created a false indication of low exchange rate.

Why has the trade surplus of China increased so much? Large amount of trade surplus shows high domestic savings rate. Some researchers believe that such high domestic savings rate is caused by the lack of social security system and aging population in China. However, the sum of family saving in China makes up only 20% of China’s GDP. This percentage is on the same level with that of India. One of the characteristics of China’s high savings rate is that Chinese enterprises have especially high savings rate, which is caused by several problems inherited from the double-track system reform: financial capitals are overly concentrated in large banks and capital market, causing an implicit subsidy to large enterprises; natural resources are lightly taxed; monopoly occurs in some industries. In order to fundamentally adjust income distribution, increase family income and consumption, and reduce trade surplus, Chinese government has to solve the above problems.

Professor Lin believes that there are lots of lessons we can learn from this international economic crisis. The constant unbalance of international trade is unsustainable to either a country with trade surplus or a country that has trade deficit. If developed countries could have faced the problems and figured out effective solutions instead of shifting their responsibilities during the early stage of international trade unbalance in 2002 and 2003, the worst global economic crisis since the Great Depression could have been avoided or relieved.

Governments of developed countries have their reasons to shirk their responsibilities and shift the blame onto others. However, their behavior is also directly connected to the aggregation of academic world. When researchers study a phenomenon, they should keep open minds and should not be satisfied merely when their hypotheses are accordant with the phenomenon they are observing. Before arriving at a conclusion, researchers should observe and infer using various hypotheses and make sure that all the results are in accordance with known facts. As China’s economic position has been raising, economic policies of China will have an increasing global influence. Along with this increasing global presence, various conflicts will also occur. China will always be in a passive position if Chinese economic policies must be composed based on foreign economic theories. It is the responsibility of Chinese researchers to find economic theories that are suitable to deal with domestic and international situations. Only then, we can take hold of our own destiny and play an active role in global negotiations.

Lastly, Professor Lin shared with us about his optimistic view of the economic future of China. He believes that China has the potential to maintain an average annual growth of 8%. This belief has been doubted by some researchers for two reasons: firstly, there has never been a country that can maintain an annual growth of 8% for more than fifty years; secondly, when the average per capita income (calculated by purchasing power) of a rapidly developing country reaches $10,000, the growth tends to slow down. From the perspective of New Structure Economics, the growth rate of a country is determined by the rate of its technological innovation and industrial upgrade. However, the growth potential of a developing country should be determined by its later comer advantage instead of its level of income. Based on the purchasing power in 1990, when the per capita income of Japan and Germany reaches $10,000, equals to 65% of that of the US; however, when the per capita income of China reaches $10,000, our per capita income is only less than 25% of that of the US. Therefore, with the same level of $10,000, there is a huge difference in the potential of backward advantage.

Of course, China needs to maximize its advantage of backwardness for technological innovation and industrial upgrade in order to turn its potential into reality. Besides, China also needs to overcome all the economic, social, and institutional challenges of a developing country and create a stable, healthy, and sustainable environment for rapid economic development and growth.

Written by Xiaoguang Liu,Translated by Ricky Binhai Hu, July 24, 2012