清华 - 布鲁金斯公共政策研究中心 brookings-tsinghua center for public policy 清华 -...

清华 - 布鲁金斯公共政策研究中心BROOKINGS-TSINGHUA CENTER FOR PUBLIC

POLICY

清华清华 --布鲁金斯公共政策研究中心布鲁金斯公共政策研究中心BROOKINGS-TSINGHUA CENTER FOR PUBLIC POLICY

Reform for Sustainable GrowthReform for Sustainable GrowthPolicy Options for China’s Macro Stabilization

and Capital Market Development

肖耿Geng XIAOGeng XIAO

[email protected]@tsinghua.edu.cn

清华 - 布鲁金斯公共政策研究中心BROOKINGS-TSINGHUA CENTER FOR PUBLIC POLICY

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Challenges to Public Policy Research

1. Ideas:– How to apply economic theory to the policy issues in the real world?– What are the policies that could bring the highest benefits to the people

and society as a whole?

2. Markets for ideas:– How to disseminate your ideas to the policy-makers and the public in

the market for ideas and to have an impact?

3. Barriers to policy change (costs of institutional change):– What are the barriers to the adoption of good policies

4. Entrepreneurship in policy research and policy making– How to remove the barriers to the implementation of good policies?


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Summary

• The main economic challenge to China:– is to develop smoothly-functioning planning, financial, regulatory

systems that can employ China’s surplus labor and surplus capital, which show up now respectively as hidden unemployment and sustained current account surplus, in an efficient, harmonious, and environmentally-friendly way.

• Reforms on Prices and Institutions Necessary – Eliminate price-control, make real interest rate positive, and stabilize

exchange rate.

– Reduce hidden transaction costs between labor and capital by developing more efficient and stable financial sector


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Misunderstandings

• RMB appreciation/depreciation– is more about China’s inflation/deflation rather than about China’s

competitiveness; Inflation and RMB appreciation are substitutes in the longer run and they are equivalent channels for the adjustment of China’s domestic price level relative to that of US (real appreciation of RMB)

• Current account surplus – is more about exporting of surplus capital which cannot hire surplus labor

productively, than about competitiveness.

• China’s competitiveness – is more about declining transaction costs due to reform, rapid technological

progress due to opening and globalization, and low labor costs due to large surplus rural labor than exchange rate adjustment and current account imbalance

• Bubbles in property and stock markets – is more about low or negative real interest rates and inefficient investment

than about exchange rate, current account surplus, inflation or competitiveness


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Key Challenges in 2008 After 30 Years of Reform and High Growth

• China’s macroeconomic conditions and capital market development challenges in 2008

1. 1. Surplus labor (or hidden unemployment)Surplus labor (or hidden unemployment)

2.2. Surplus capital (excessive liquidity)Surplus capital (excessive liquidity)– is more about China’s inflation/deflation rather than about China’s


3. 3. Price distortion: inflation, price control and dominance Price distortion: inflation, price control and dominance of large SOEsof large SOEs– Rising prices in food, oil, raw materials– Rising wages due to inflation and labor contract law– Inefficient use of energy, natural resources and environment.

4. 4. High volatility and bubbles in the property and stock High volatility and bubbles in the property and stock marketsmarkets


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China’s Surplus Labor

• In 2006 the total employment in China is 764 million – 119 million of migrant workers (average monthly wage of $120)

– 362 million rural workers.

– 481 million unskilled workers (119+362)

• 481 million rural and migrant workers in China face 2 choices

– stay in the villages

– find a job in the cities

• If they stop working, their unemployment will not be counted in the official unemployment statistics

– This hidden unemployment increased sharply this year according to observations by local officials in coastal provinces


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China’s Surplus Capital9% of GDP in 2006;11.5% of GDP in 2007

FOREX Reserves(Right Scale)

Trade Balance (Left Scale)

Unit: 100 million dollar


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One-way steady appreciation of RMBlittle effect on reducing current account surplus but creating

speculative capital inflows

7.40

7.50

7.60

7.70

7.80

7.90

8.00

8.10

8.20

8.30

8.40


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Hot Money = Reserves Change - Trade Balance – FDI

(chasing extra return on RMB appreciation, US-China interest rate gap, and capital gain on property and stock market bubbles)

Foreign exchange reserve

Balance of trade

FDI


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Inflation is coming but not due to fiscal deficit, current account deficit, excessive

consumption, or efficient investment

PPI

CPI

CPI-PPI


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China subsidizes the whole world, too much inefficient investment

• Price control on energy and raw materials – which distort prices for major factor inputs

– leading to over-use of energy and raw materials and environmental damages

• Unclear ownership or state ownership of natural resources

– which distorts prices for many natural resources– leads to over-use of natural resources and environmental

damages

• Large SOEs in the monopoly sectors – distort prices of their products and services

– Leading to over-use (i.e. electricity) or under-use (i.e. telecom services) of their products and services

• China is effectively subsidizing the consumers of Made-in-China products around the world, which is not sustainable!


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Ownership No. of Firms Profits Assets Employees Taxes Return on Assets

State 69.8 87.94 93.63 89.32 92.69 1.40

Collective 5.80 2.22 4.15 2.35 1.67 0.80

Private 17.8 7.08 1.73 7.00 3.94 6.08

Foreign 6.6 2.76 0.48 1.33 1.70 8.48

Structure and Performance of Top 500 Chinese Enterprises in 2007 （ %）

SOEs Performed Worse than Non-SOEsbut Still Dominated in Strategic Sectors

and among Large Enterprises

Source: China’s Top 500 Enterprises, 2007.

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Negative Real Interest Rate = nominal interest (4%)- inflation rate (7%)

• Negative real interest rate – which distorts the bench-marking price of capital

– leading to the over-use of cheap credit by inefficient projects

– instability of the property and stock markets

– stock index fell about 60% from the peak in Oct 2007

• The distortion in factor prices– makes it difficult to find and finance more efficient projects– effectively raising the transaction costs of surplus capital hiring

surplus worker

• Root of real negative interest rate – The direct root is inflation

– But indirectly, it is currency appreciation and the expectation of appreciation that stopped the central bank from raising the nominal interest rate to fight inflation


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Policy Recommendation 1:Stabilize RMB Exchange RateStabilize RMB Exchange Rate

• Completely stop the RMB appreciation expectation by going back to a more or less fixed rate with the US Dollar or a basket of currencies.

• If necessary, it may be useful to allow the RMB to depreciate a significant amount so as to completely shake off the expectation of one-direction stable appreciation of RMB.

• This new policy option is needed for eliminating the unnecessary uncertainty and complications associated with speculative capital inflows and outflows.


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Policy Recommendation 2:Make Real Interest Rate PositiveMake Real Interest Rate Positive

• When the market no longer has the expectation of one-way steady RMB When the market no longer has the expectation of one-way steady RMB appreciation, PBC can then raise interest rates aggressively to deal appreciation, PBC can then raise interest rates aggressively to deal with inflation and push the real interest rate to a positive level. with inflation and push the real interest rate to a positive level.

• The high interest rate is not intended to depress productive investment The high interest rate is not intended to depress productive investment or consumption. The increase of the nominal interest rate is to off-set or consumption. The increase of the nominal interest rate is to off-set the inflation so as to improve the investment and consumption the inflation so as to improve the investment and consumption efficiency and to avoid future asset bubbles. efficiency and to avoid future asset bubbles.

• Now is the best time to raise interest rates since the stock market and Now is the best time to raise interest rates since the stock market and property market in China have been falling to low levels and are not property market in China have been falling to low levels and are not likely to fall much further. likely to fall much further.

• China can use banking regulation to deter interest rate arbitrage, for China can use banking regulation to deter interest rate arbitrage, for example, impose taxes on interest earnings of those deposits used for example, impose taxes on interest earnings of those deposits used for interest rate arbitrage and install certain inflation-proof deposit rates if interest rate arbitrage and install certain inflation-proof deposit rates if inflation is high, say above 8%.inflation is high, say above 8%.

• With no bubbles in property and stock markets and no expectation on With no bubbles in property and stock markets and no expectation on RMB appreciation, the speculation on US-China interest rate gap will RMB appreciation, the speculation on US-China interest rate gap will not be very profitable after deducting the transaction costs and taxes.not be very profitable after deducting the transaction costs and taxes.


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Policy Recommendation 3:Eliminate Price Control Eliminate Price Control

• Free the prices for key factor inputs such as labor, and, energy, water, and raw materials.

• Elimination of price control means that inflation at a high single digit level will continue for a few years.

• So price reforms should be carried out together with social safety net reforms that help and subsidize the poor directly.

• Price reforms can also be carried out by phase with a clear plan to guide the market expectation on the pace of price liberalization.

• Price reform is likely to stimulate supply and discourage wasteful use.


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How to distinguish between efficient from inefficient investment?

• The entire planning, financial, and regulatory system in the modern economy is developed to answer this question

– to screen out good projects and finance them at low costs while rejecting bad projects.

– These services are desperately needed in China

– They are what make London, Hong Kong and New York the global financial and business capitals

• The essential function of a good modern planning, financial, and regulatory system is

– to reduce the transaction costs between capital and labor so that they can productively work together


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Recommendations on Financial Sector Reform

• K1. Ensure that regulatory rules add social value and improve the enforcement capacity of all regulators

• K2. Privatizing Financial Market Participants

• K3. Simplify tax regimes and reduce tax rates

• K4. Create competition and linkage among capital markets of different tiers and in different regions

• K5. Find innovative low-risk mechanisms to make the RMB convertible


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The idea of a “Shanghai Global Exchange” (for Trading Foreign Currency Securities in China)

• It would effectively bring the off-shore Hong Kong markets back to the Mainland.

• It will reduce the volume of unnecessary cross-border capital flows as compared to the arrangements of QDII or “through-train to Hong Kong stocks.”

• It will create Chinese residents’ demand for foreign currency denominated assets, which will help reduce China’s official holding of foreign exchange reserves.

• It will make Shanghai a truly global market when MNCs such as HSBC and Siemens can be traded together with China’s own best companies.

• It will help a stable development of the Hong Kong capital markets by securing the demand by Mainland investors of the Hong Kong dollar denominated securities, especially before the full convertibility of RMB.


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Summary

• The main economic challenge to China now:– is to develop smoothly-functioning planning, financial, regulatory

systems that can employ China’s surplus labor and surplus capital, which show up now respectively as hidden unemployment and sustained current account surplus, in an efficient, harmonious, and environmentally-friendly way.

• Reforms on Prices and Institutions Necessary – Eliminate price-control, make real interest rate positive, and stabilize

exchange rate.

– Reduce hidden transaction costs between labor and capital by developing more efficient and stable financial sector


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Misunderstandings

• RMB appreciation/depreciation– is more about China’s inflation/deflation rather than about China’s


• Current account surplus – is more about exporting of surplus capital which cannot hire surplus labor

productively, than about competitiveness.

• China’s competitiveness – is more about declining transaction costs due to reform, rapid technological

progress due to opening and globalization, and low labor costs due to large surplus rural labor than exchange rate adjustment and current account imbalance

• Bubbles in property and stock markets – is more about low or negative real interest rates and inefficient investment

than about exchange rate, current account surplus, inflation or competitiveness


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Thank you

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