China’s dilem­mas are the world’s as well

The Pak Banker - - OPINION - Joseph E. Stiglitz

CHINA'S shift from ex­port-driven growth to a model based on do­mes­tic ser­vices and house­hold con­sump­tion has been much bumpier than some an­tic­i­pated, with stock-mar­ket gy­ra­tions and ex­change-rate volatil­ity in­cit­ing fears about the coun­try's eco­nomic sta­bil­ity. Yet by his­tor­i­cal stan­dards, China's econ­omy is still per­form­ing well - at near 7 per cent an­nual GDP growth, some might say very well - but suc­cess on the scale that China has seen over the past three decades breeds high ex­pec­ta­tions. There is a ba­sic les­son: "Mar­kets with Chi­nese char­ac­ter­is­tics" are as volatile and hard to con­trol as mar­kets with Amer­i­can char­ac­ter­is­tics. Mar­kets in­vari­ably take on a life of their own; they can­not be eas­ily or­dered around. To the ex­tent that mar­kets can be con­trolled, it is through set­ting the rules of the game in a trans­par­ent way. All mar­kets need rules and reg­u­la­tions. Good rules can help sta­bilise mar­kets. Badly de­signed rules, no mat­ter how well in­ten­tioned, can have the op­po­site ef­fect.

For ex­am­ple, since the 1987 stock-mar­ket crash in the US, the im­por­tance of hav­ing cir­cuit break­ers has been recog­nised; but if im­prop­erly de­signed, such re­forms can in­crease volatil­ity. If there are two lev­els of cir­cuit breaker - a short-term and a long-term sus­pen­sion of trad­ing - and they are set too close to each other, once the first is trig­gered, mar­ket par­tic­i­pants, re­al­is­ing the se­cond is likely to kick in as well, could stam­pede out of the mar­ket. More­over, what hap­pens in mar­kets may be only loosely cou­pled with the real econ­omy. The re­cent Great Re­ces­sion il­lus­trates this. While the US stock mar­ket has had a ro­bust re­cov­ery, the real econ­omy has re­mained in the dol­drums. Still, stock-mar­ket and ex­change-rate volatil­ity can have real ef­fects. Un­cer­tainty may lead to lower con­sump­tion and in­vest­ment (which is why gov­ern­ments should aim for rules that but­tress sta­bil­ity).

What mat­ters more, though, are the rules gov­ern­ing the real econ­omy. In China to­day, as in the US 35 years ago, there is a de­bate about whether sup­ply-side or de­mand-side mea­sures are most likely to re­store growth. The US ex­pe­ri­ence and many other cases pro­vide some an­swers. For starters, sup­ply-side mea­sures can best be un­der­taken when there is full em­ploy­ment. In the ab­sence of suf­fi­cient de­mand, im­prov­ing sup­ply-side ef­fi­ciency sim­ply leads to more un­der­util­i­sa­tion of re­sources. Mov­ing labour from low-pro­duc­tiv­ity uses to zero-pro­duc­tiv­ity un­em­ploy­ment does not in­crease out­put. To­day, de­fi­cient global ag­gre­gate de­mand re­quires gov­ern­ments to un­der­take mea­sures that boost spend­ing. Such spend­ing can be put to many good uses. China's crit­i­cal needs to­day in­clude re­duc­ing in­equal­ity, stem­ming en­vi­ron­men­tal degra­da­tion, cre­at­ing live­able cities, and in­vest­ments in pub­lic health, education, in­fra­struc­ture, and tech­nol­ogy.

The au­thor­i­ties also need to strengthen reg­u­la­tory ca­pac­ity to en­sure the safety of food, build­ings, medicines and much else. So­cial re­turns from such in­vest­ments far ex­ceed the costs of cap­i­tal. China's mis­take in the past has been to rely too heav­ily on debt fi­nanc­ing. But China also has am­ple room to in­crease its tax base in ways that would in­crease over­all ef­fi­ciency and/or equity. En­vi­ron­men­tal taxes could lead to bet­ter air and wa­ter qual­ity, even as they raise sub­stan­tial rev­enues; con­ges­tion taxes would im­prove qual­ity of life in cities; prop­erty and cap­i­tal-gains taxes would en­cour­age higher in­vest­ment in pro­duc­tive ac­tiv­i­ties, pro­mot­ing growth. In short, if de­signed cor­rectly, bal­anced-bud­get mea­sures - in­creas­ing taxes in tan­dem with ex­pen­di­tures - could pro­vide a large stim­u­lus to the econ­omy. Nor should China fall into the trap of em­pha­sis­ing back­ward-look­ing sup­ply-side mea­sures. In the US, re­sources were wasted when shoddy homes were built in the middle of the Ne­vada desert. But the first pri­or­ity is not to knock down those homes (in an ef­fort to con­sol­i­date the hous­ing mar­ket); it is to en­sure that re­sources are al­lo­cated ef­fi­ciently in the fu­ture.

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