- A Breath of Fresh Air, but Questions About the Meaning of China’s Economic Imbalances Remain
This is an important and amazingly detailed review of China’s economic policies since around 2004 and of major policy challenges facing the government; the fact- and comment-laden footnotes are essential reading. The book is vintage Lardy: long on analysis and numbers and (very) short on opinion unsupported by the facts. Chapter One on China’s response to the recent global financial crisis is a breath of fresh air. It provides an excellent overview of Beijing’s huge stimulus program initiated in late 2008. While recognizing flaws in the program, Lardy effectively debunks the popular theory that most additional credit was channeled to state-owned companies at the expense of private firms and that a large part of infrastructure investment was wasted. The need for different policies to finance infrastructure in the future is correctly emphasized. The next three chapters explain how China’s economy became so imbalanced, how macroeconomic imbalance can be measured, what can be done about it and why rebalancing its sources of growth—consumption, investment and net exports—is not only in China’s interest, but also in that of the United States and other trading partners. The final chapter provides a realistic overview of obstacles to rebalancing, including interest groups that benefit from subsidized factors of production (including credit) and an undervalued exchange rate.
The book’s main conclusion is that financial repression has become more severe after 2004 and that, as a result of this and other distortions, China’s economy remains seriously imbalanced in spite of the government’s stated objective—prominently and repeatedly announced since 2004—to rebalance the economy’s growth pattern for long-term sustainability. Lardy’s main recommendation is that more aggressive, better-coordinated policies are needed to achieve rebalancing, especially with regard to interest rates, the exchange rate, fiscal policy, and energy pricing. His highest priority in this regard is to [End Page 189] allow deposit rates to become market-determined for which a more flexible exchange rate policy is a pre-condition. I agree with this and other policy recommendations in the book, but I have some questions about the analysis and interpretation of the facts.
I agree that financial repression in the form of negative real deposit rates has become a serious problem in China and that a decisive move toward market-determined rates is overdue. However, we should not forget that for much of the time since the start of China’s unique approach to market-oriented reforms, financial repression—often in forms other than negative real interest rates, for example, allocation by the state of private bank deposits to government-sponsored development projects—effectively compensated for fiscal weakness and enabled the country to achieve much higher growth rates (including household consumption growth!) than otherwise would have been possible. Financial repression is not necessarily always a bad policy, as the U.S. Federal Reserve would probably agree, given its ongoing efforts to keep U.S. interest rates artificially low.
Other areas where my perspective is somewhat different from Lardy’s are: (1) the importance of China’s low consumption/GDP ratio, (2) the relationship between that ratio and China’s relatively large current account surplus, (3) prospects for reducing that surplus (external rebalancing), and (4) the relative importance of China’s undervalued exchange rate in explaining the explosion of the country’s external surplus from around 2003 (until it peaked in 2007) and its decline from 2008.
Household Consumption and Trade Imbalances
According to official statistics, China’s household-consumption/GDP ratio has indeed been declining for over a decade and is now extraordinarily low by any standard at approximately 34 percent (compared to about 70 percent in the United States). But why should we be so concerned about that ratio when China’s consumption growth rate is the highest among large economies, by far? Isn’t consumption growth the real objective of economic development? Faster overall growth, which China was...