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Global Economic Crisis


									China–New Zealand Friendship Society Conference Address
Orewa, 8 May 2009

(1) Distinguished guests, ladies and gentlemen, good evening and nihau. Back in February, several experts, including Dr Stephen Roach, presented submissions to the US-China Economic and Security Review Commission of the US Congress. In speaking about the challenges China faces, and possible strains on China‟s relations with the rest of the world, I‟ll be reflecting some of the points made in those submissions. I acknowledge the contribution to my thinking made by the authors. As a means of highlighting some of the ways in which the global recession could affect China‟s relations with the rest of the world, (2) I‟m going to try and answer these three questions. 1. To what extent has China‟s situation as an economic power changed in the past sixty years? 2. What challenges does the global recession present for the new China? 3. How can China and the rest of the world avoid repeating the mistakes made during the Great Depression? To what extent has China’s situation changed? (3) It‟s eight years since I lived and traveled quite extensively in China. However my memories of things that demonstrated the strides the Chinese were taking to modernize their economy, and to become a leading economic force, are strong. I remember for example how the skyline in the part of Shanghai where I lived was festooned with huge construction cranes. And I remember the claims made by some of my Shanghaiese contacts. They insisted that there were more cranes operating in Shanghai than were operating in the whole of the rest of China, and that there were more cranes operating in China than in the rest of East Asia and Japan combined. I don‟t know whether they could have substantiated their claims, but I do know that development was afoot from the seacoast to the three gorges dam on the Yangtse River and on into the towns beyond.

changes, challenges and possible strains on China‟s relations with the rest of the world presented by the global recession

China sixty years on:

Army Bay, Hibiscus Coast

Graham Lamont

For the full text of the submissions presented to the Economic and Security Review Commission of the US Congress go to


And the statistics of the growth in China‟s economic production since 2001 show that the development that impressed me then continued strongly up until late in 2008. (4) o The value of China‟s industrial output increased on average by 16.5% in each of the five years between 1 January 2003 and 31 December 2007. (5) o The value of China‟s total GDP grew by around 12% in each of the three years between 1 January 2005 and 31 December 2007 (6) The recent IMF projections for growth in 2009 underscore what China has achieved in her quest to become one of the world‟s major economic players. While the growth rates of older economies are projected to fall – in Europe by -2.8%, in the US by -3.8%, in Russia by -6.0% and in Japan by -6.2% – China‟s economy is projected to continue growing by at least 6.5%. This would be outstanding performance. I don‟t have time to give a detailed description of China‟s economic situation after the Communists took over, and in the years when Chairman Mao was in control. All I can say now is that China‟s current situation is a far cry from what prevailed for example in the years during Mao‟s “Great Leap Forward”. Then, China was so short of the foreign exchange needed to import the steel and military hardware that Mao coveted, that the Chairman arranged for massive amounts of grain and meat to be exported to Russia and her satellites. Meanwhile, at home, in less than a twoyear period, an estimated 37,000,000 people died of starvation. Clearly China‟s economic situation has changed dramatically. China has indeed emerged as a major economic player. However that doesn‟t mean that China faces a problem free future. Indeed the opposite is true. If I invited each of you to identify just one of the challenges China faces at this time, we‟d soon build up a long list. I‟m sure that our list would include issues like: (7)  How to reduce greenhouse gas emissions and improve air quality in Beijing, Shanghai, Wuhan and similar cities.

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How to justify China‟s law and order policies that are often portrayed as breaches of human rights. How to develop commercial practices that will give westerners confidence that business will be conducted fairly.

Each of these issues is an important challenge that China needs to overcome but, in the time available, I can‟t talk about any of them. I‟m going to focus instead on the challenges generated by the current global recession. I‟m going to do that because failure to handle these challenges well has the potential to damage very seriously China‟s relations with the rest of the world. And so we come to our second question. (8) What challenges does the global recession present? The most obvious challenge is the challenge of recession. The figures relating to China‟s economic growth show that the Chinese economy hit the wall in late 2008; (9) the annual industrial growth rate fell by almost 50% from around 12%, which had been the average in each of the three previous years, to 6.5%. Clearly China, along with the rest of the world, is going through a serious recession. And the way the Chinese leaders have responded shows that they consider the decline in economic activity in China is serious and worrying. To date they have poured more than 4 trillion yuan into public infrastructure, rural development, social welfare and technology advancement programmes all designed to stimulate the internal economy. But there‟s an associated issue that worries China‟s leaders even more than the decline in business activity. That issue is sharply rising levels of unemployment. (10) The Chinese government announced recently that 20,000,000 of its migrant workers who regularly flock from the countryside to the cities seeking work, are now unemployed. If the official figures are right, about 4% of the Chinese work force is unemployed. However unofficial observers estimate that the actual rate of unemployment is twice the official figure. And everyone agrees


that unemployment numbers are likely to rise significantly – perhaps to 50,000,000 – during this year. People in many countries share the view that high levels of unemployment are undesirable because they damage the fabric of a society. The Chinese Government seems to be particularly concerned about it. Why? The answer can be found in Chinese history. Some of you will know that Chinese history is like a repeating circular story; the bulk of China‟s history is a record of how one dynasty replaced another in this sort of way.  Out in the country, a local boy stood out from the crowd as someone willing to stand up for the rights of the ordinary people – the peasants. His reputation spread and he gathered a band of loyal supporters around him. In due course the group considered itself strong enough to go to the existing rulers and request better treatment. Unfortunately the rulers turned a deaf ear to the complaints and many of the protesters were punished for being uppity. Eventually the local leader and his peasant supporters became exasperated and decided that the only option open to them was to revolt. In the end, the people were successful in overthrowing the old guard and they installed their hero and his friends as the new leaders. At first, everything was sweetness and light. However, as time passed, the new leader and his buddies forgot how and why they‟d been given power; they became neglectful and cruel, and wouldn‟t listen to complaints. And so, out in the country, a local boy stood out from the crowd as someone willing to stand up for the rights of the ordinary people – the peasants. And history began to repeat itself.

increased unemployment could lead to unrest and social instability is likely to keep Chinese leaders awake at nights. In his submission, Dr Roach told the Congress Commission, “The Chinese leadership will do everything in its power to avoid worker unrest”. But he went on to say, “In this global recession, that challenge is daunting to say the least.” The recession and the resulting unemployment are certainly huge challenges. But there‟s another challenge that well and truly tops any of the other challenges China faces. And this takes us to my third question. (12) How can China and the rest of the world avoid repeating the mistakes made during the Great Depression of the 1930s? The challenge facing the whole world today is how to avoid repeating the mistakes made, particularly by the United States, in the years following the 1929 stock market crash that triggered the Great Depression. It‟s a challenge for China in particular because, in some important ways in recent years, China has played the kind of role the US played in the lead up to the 1930s Depression. A brief look back into history will help explain what I mean. In the 1920‟s mass migration from the countryside to America‟s cities, plus massive investment in new technology like tractors on farms and the increasing use of assembly lines in factories, contributed to very high levels of production in the US. But the goods produced became significantly more than what the US could absorb. US firms therefore exported a very large proportion of their overproduction to Europe. By 1929 the value of US exports to Europe was 75% higher than the value of what the US imported from Europe. This export trade enabled the US to build up massive cash surpluses. And the US Federal Reserve used these surpluses to purchase a large chunk of the gold held by European countries, as well as the Treasury Bonds that countries issued so that their banks would have foreign currency to lend to their importers


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One of the things that‟s characterized Chinese leaders, at least since 1949, is that they‟ve been keen students of China‟s history. And the decision to send tanks into Tiananmen Square is only one example of how the possibility of worker unrest can spook nervous Chinese authorities. (11) Even the possibility that significantly


However the party ended in 1929 when the very high level of borrowing sparked a major collapse of the stock and bonds markets. The fall in the value of bonds was so great that most foreign borrowers found they could no longer afford to raise the money needed to continue purchasing America‟s over-production. Countries that till then had been happy to help America get rid of her over-production put up the shutters. And the downturn in demand for American products was reflected in rapidly rising unemployment in the US; by 1934, 25% of the American work force was unemployed. Now let‟s jump forward to the late 1990‟s. By that time the amount of goods produced in China had become significantly more than the home market could pay for. However China discovered that people in other countries, notably America, were keen to buy Chinese goods. (13) What started as a trickle became a flood; the value of Chinese goods exported to America grew by more than 10% a year in recent years. This flourishing export trade enabled China to build up massive cash surpluses. And, following the example set by the US in the 1920s, China used those surpluses to purchase a very large quantity of the Treasury Bonds issued by the US Federal Reserve. But now, once again the party‟s come to a screeching halt; and, unfortunately, virtually every country in the world is going to have to endure the hangover. The fundamental question the world‟s leaders, and particularly China‟s leaders, have to answer is “How should we respond to this challenge?” The way that major countries responded to the 1929 stock market crash made the misery of the Great Depression virtually inevitable. Even before the 1929 crash it was becoming clear that the Europeans wouldn‟t be able to absorb the flood of American exports. In the two years following the crash, US exports to Europe dropped by 70%, and American companies reacted to the fall in demand by putting off workers. The Republican Government‟s response was to pass the SmootHawley Tariff Act in June 1930. (14) The thinking behind the Act

was, “If they won‟t buy our exports, we‟ll make it harder for them to sell their exports in America; we‟ll achieve this by increasing the size of the tariffs importers have to pay when they bring in foreign made goods. That should encourage Americans to buy locally produced goods instead.” The clearly foreseeable outcome of this protectionist policy was a tit for tat battle as one country after the other introduced or increased tariffs. The US in particular paid dearly for following this policy. By 1938, 13% of workers were still unemployed and the situation didn‟t change significantly until America committed itself to supplying the massive amounts of equipment that Britain and her allies needed to fight World War II. In the circumstances it‟s not surprising the Smoot-Hawley type of response is considered one of the greatest mistakes made after the 1929 collapse. But have the world‟s leaders, including the Chinese leaders, taken the lesson of what happened in the thirties on board? If the actions of a significant number of members of the US Congress are any indication, the answer to that question is, “Probably not.” In the three years 2005-2007, 45 pieces of anti-China trade legislation were introduced into Congress; the bills weren‟t passed but they gained a surprising amount of support. And many American business leaders and opinion makers have been quick to accuse China of being ultimately responsible for causing the recession. The critics normally focus on two issues: (15) 1. The fact that the Peoples‟ Bank of China controls the value of the Chinese Yuan. 2. The fact that China has used its huge export trading surpluses to lend massive amounts of money to the US Treasury. It‟s undeniable that China, unlike most developed countries, doesn‟t have a floating currency; it doesn‟t allow the value of the Yuan to be set by what traders will pay for it in international money markets. Instead the PBoC fixes the rate at which it will sell Yuans. The critics argue that the effect of rate fixing has been that, when compared with the $US and other major currencies, the Yuan‟s been undervalued. This has meant that Chinese goods could be sold in


the US, and elsewhere, at cheaper prices than might otherwise have been the case. This, say the critics, has allowed China to undercut the prices foreign businesses needed to charge, and many of those businesses have had to shut their doors. According to the critics, by maintaining an artificially low exchange rate China‟s been a „trading predator‟; it‟s kept a low rate in order to protect it‟s own industries and so gain a competitive advantage in international markets. Even worse is the fact that the Chinese have used their ill-gotten foreign currency gains to invest heavily in US Treasury loans and buy up American assets. It would be helpful to explore in detail whether these criticisms are valid but I don‟t have time to do that this evening. All I can do is make these three basic points: 1. In the first half of 2008, China‟s average monthly trade surplus was $16.7 billion; the monthly average for the second half of the year was $32.9 billion, almost double the first half-year figure. These rapidly growing trade surplus figures suggest there‟s an element of truth in the argument that China‟s fixed exchange rate has helped her earn a large amount of foreign exchange. (16) 2. However, what the critics don‟t acknowledge is that, since July 2005, China has allowed its exchange rate to rise by about 21% relative to the $US. Nor do they seem to take notice of the experts who say that the Yuan is undervalued by 10% at most. 3. And US leaders chose, not only to maintain the rate of consumer spending and overseas borrowing, but also to increase it in order to finance among other things the war in Iraq. If China hadn‟t cooperated by buying US securities, the US would have had to borrow from other lenders. For these sorts of reasons I think it‟s unreasonable, even ridiculous, to suggest that China‟s actions were a major cause of the current global recession. But, while more could be said about the sorts of criticisms I‟ve mentioned, we need to focus on the real challenge China faces.

The reality is that, just as at the end of the 1920‟s boom when the high volume of US exports was considered a problem, now many see China‟s exports as the problem. Some leaders also seem to suggest that China should absorb the brunt of the costs associated with remedying the trade imbalances that have arisen in the last ten years. It appears possible that, now that the bubble of consumerism in the US and elsewhere has burst, the policies China has followed could rebound seriously on China‟s own economy. And there‟s a significant risk that the global drop in demand, and the rises in unemployment, could prompt a rash of actions including raising tariffs, and the sort of currency devaluations that were common in the 1930s, all directed at lessening the flow of exports from China. Someone might ask, “What would be wrong with that?” The short answer is that such policies would be a recipe for a repetition of the prolonged misery of the Great Depression. But on this occasion it would be China rather than the US that would have to deal with a dangerous unemployment explosion. And that‟s a prospect that not only terrifies the Chinese leadership – it should concern the world at large. (17) The challenge China faces is huge. It requires China to develop a much stronger, internal consumer base capable of absorbing much of the over-production that China‟s been exporting. This will require making changes like these. 1. The upgrading of rural education so that country children will be equipped to do the kinds of jobs that can lead to higher wages and greater purchasing power. 2. The development of community enriching infrastructure in underdeveloped parts of the country like the west. 3. The provision of better social welfare safety nets like more comprehensive unemployment benefits, retirement allowances and good quality, nation wide public health care. (18) And, as if that weren‟t a big enough challenge, China‟s leaders must handle the rise in unemployment very carefully. They must treat the jobless with sensitivity and without recourse to repression. And they must do all this while still trying to maintain China‟s


current production base. To do otherwise will be to risk even bigger and faster growth in unemployment. I‟m sure you‟ll agree this is no small assignment. Fortunately some Chinese leaders understand the need to make the sorts of changes I‟ve outlined. Two years ago Premier Wen Jiabao acknowledged that the Chinese economy is “unbalanced” and “unsustainable”; he acknowledged also that China needed to embark on changes that will result in economic growth becoming consumer-led rather than exporting centred. And the acceptance of Wen‟s diagnosis by others shows there are those who recognize that continued development of manufacturing plants, and public infrastructure in the east, won‟t be sufficient. These leaders understand the challenge is to create an economy that will improve the lot of the ordinary Chinese and allow a bigger proportion of China‟s population to share the fruits of China‟s phenomenal economic growth. However these sorts of changes can‟t be effected overnight. Long-term commitment and patience will be needed. The question is will other nations cooperate sufficiently to allow China time to make the necessary changes. In his submission to the US Congress Commission, Stephen Roach spelt out the consequences of a failure of the nations to cooperate. (19) He warned, “There‟s hope (of realistic economic recovery within a reasonable timeframe) but it comes with a big “if” – if China and the United States pull together in forging common solutions. If, however, these two nations end up at odds with one another, they will both suffer – with dire consequences for the rest of a crisis-torn global economy. The stakes are enormous. There is no margin for error.” Conclusion It‟s understandable that, at a time when economic activity around the globe seems to be crumbling fast, countries could be tempted to protect themselves from the aftershocks of the crisis. But while it may be easy to understand why protectionist policies may be

proposed, we need to recognize that the rattling of economic sabres will almost certainly be highly counter-productive. It‟s not simply the case that such an approach is unlikely to solve basic economic problems like the imbalance in China‟s economy. It‟s highly likely that one immediate result would be the creation of a situation in which the gut-wrenching levels of unemployment experienced in the 1930s would be seen again, particularly in export dependent countries like China. It‟s also highly likely that such levels of unemployment would produce virtually uncontrollable social unrest that could so easily result in the emergence of dictatorial regimes like Hitler‟s Germany, Franco‟s Spain and Mao‟s China. The consequences of a failure of the nations to cooperate in correcting trade imbalances could be horrendous for the whole world, but especially for China. (20) A confrontational approach, almost inevitably, will poison China‟s relations with other countries to the extent that the world may suffer damaging consequences, on many fronts, possibly for generations. Those who wish to see the world avoid repeating the mistakes of the 1930‟s, and a repetition of the prolonged misery experienced by so many during the Great Depression, may need to be outspoken in arguing publicly for policy that respects Chinese concerns and priorities, and that will encourage China to remain a committed member of the global network. I think this Society could make an important contribution in this area in our own country, and I wish it well as it seeks to do so. Thank you. (21)


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