CHINA The Great Awakening

Historical Background The People’s Republic of China developed from: The Soviet central-planning system…

…with its information, incentive, and inflexibility problems.

Historical Background The People’s Republic of China developed from: The confusion and economic disaster stemming from the policies of Mao Zedong

China Under Communism: The Great Leap Forward, Mao’s version of Soviet Style Central Planning Forced industrialization A steel mill in every back yard Disappearing tools and famine

China Under Communism: The Cultural Revolution Red Guards and permanent revolution Remove all productive people (“capitalist roaders”) to the countryside

Enter Deng Xiaoping, (Three Times Altogether)

The Reforms of Deng Xiaoping Phase 1: Reform the Countryside, Deng restructured incentives, making it profitable for peasants to produce.

The Reforms of Deng Xiaoping Phase 2: Financial and Enterprise Reform 1983, SOEs had to meet negotiated output targets, but could then sell any excess in markets. Managers set wages, made investments, retained profits.

The Reforms of Deng Xiaoping An “open door policy” announced 1979 –Four “Special Economic Zones” were created to open regions to foreign investment and partnerships Markets rather than central direction

SEZs located in: Guangdong Province Fujian Province Hainan Province Hunchun Pudong Development Zone (Shanghai)

The Purposes of SEZs As a laboratory to provide reform experience for the inland regions. Promote Inflows of foreign investment, technology, and managerial techniques

Policies in the SEZs Domestic decentralization, no planning or regulation from center Tax incentives to foreign investors

The Result: an Example Shenzhen, a small border town, changed into a modern city In the early years, the average annual growth rate was over 80 percent

The Result: an Example Per capita GDP was 7 times the nation’s average Foreign investment and exports were the primary engines of economic growth

Shenzhen: The Early 1970s Shenzhen: Today

The Reforms of Deng Xiaoping Phase 2: Financial and Enterprise Reform The economic boom continued, but… There was political rebellion (Tiananmen Square, 1989) and subsequent retrenchment

But Communistic Legacies Remain The State-owned enterprises remain a part of contemporary China, and they need reforms. The Communist Party of China remains and needs reforms. Authoritarian methods and bureaucratic traditions likewise remain.

Where is China at Today? The Asian Crisis after the mid-1990s slowed the economy down But by 2000, 9% annual economic growth again became the standard. In early 2006, first quarter growth was over 10%.

The Old Guard: Passing from the Scene? Jiang Zemin, Deng’s heir to power

The Party Today Hu Jintao, Elected General Secretary of the CPC and President of the People’s Republic of China, March 15, 2003.

The Current Scene The global economy puts tremendous pressures on China’s political system. Change is gradual, since the party wishes to perpetuate its own power, but change does go on. Reforms are tentative, the party is not moving quickly toward price liberalization, currency convertibility, or reduction of subsidies.

Leadership Since Deng It is not probable that the CPC will be a part of a peaceful evolution all the way to democratic government.

Political Environment Since Deng The process of democratization began at the same time as the economic reforms, and modest progress has been made since.

Political Environment Since Deng –Purges no longer occur –The National People’s Congress has been strengthened –The legal system has been reformed to prevent any further cultural revolutions. –Human rights abuses remain a problem

Authoritarian Controls still needed? The Party believes that the process of economic development requires authoritarian leadership. Dissent must be managed while painful reforms are administered. The SOEs should be privatized or closed. Many millions will likely be sent into unemployment.

Chinese SOEs and Industries Industrial organization still reflects the vertical relationships characteristic of central planning. Japanese and Korean development focused on protection and independent high-tech development. Chinese high-tech industries dominated by foreign companies.

Chinese SOEs and Industries “Timid business culture” (Gilboy) keeps Chinese firms from developing key technologies and keeps them dependent on the West. SOEs enjoy favored status granting preferential access to capital, technology, and markets, but Reforms have also favored foreign investment. Foreign firms dominate high-tech production and industrial exports.

Chinese SOEs and Industries Firms focus on developing privileged relations with Party (CCP) officials, but avoid horizontal association and networking. Little development of links to research institutions, financiers, partners, suppliers, and the right (feed-back customers). They also forgo investment in long-term development and diffusion.

Political Impact on Industry The unreformed political system suppresses independent social organization and horizontal networking. It reinforces vertical relationships. Chinese firms carry out R&D projects in relative isolation. In 2000, firms spent 93% of their $2.7 bil total R&D outlay in-house, with only 2% on collaborative activities with universities and less than 1% with other firms.

Political Impact on Industry Few Chinese firms develop alliances with or invest in companies in other provinces. Strong local political ties tend to isolate a region from the rest of the economy, so Chinese firms are often smaller and industries fragmented.

The SOEs and Unemployment By 1998, nearly 1/3 of the labor force was unemployed or underemployed. Millions of SOE employees were laid off in the late 1990s.

Economic Reforms Reforms have also attempted to: Allow management greater decision- making prerogatives Impose greater accountability for the bottom line on enterprise management Promote greater labor discipline on the shop floor.

Can market and plan be combined? Overall economic direction includes protection of inefficient industries, fixing the value of the yuan, and statist planning* at the regional level. *Picking industries, subsidizing, and protecting them has been common. There has been a tendency to pick identical industries and generate excess capacity.

Another Chinese advantage: An Open Economy Deng’s early desire to link to the global economy was much more far-sighted than the autarky that crippled the Soviets over their entire existence. As early as 1980, China renewed its membership with the IMF and the World Bank.

China and the WTO After more than a decade attempting to gain admission to the WTO, China officially joined on December 11, 2001 China became the 143 rd member.

Chinese Policy Objectives: Maintaining an Undervalued Currency and Purchasing US Bonds

What are China’s trade policy objectives? Keep the value of the Yuan low to promote exports. Keep the U.S. export market open. 50 million jobs dedicated to U.S. trade. Rural Chinese pour into manufacturing areas seeking work.

How has China kept the Yuan price low? Sell Yuan in foreign currency markets. Buy dollars.

Dollars become foreign currency reserves. How can you make money on reserve holdings? Purchase U.S. treasury bonds.

Why do we sell so many bonds? To finance the war in Iraq, to fund Katrina- related projects, to fund medicare prescription benefits, Etc., Etc.

Purchasing our bonds, China helps maintain the U.S. trade-finance system. We need the foreign funds to sustain our import deficits. Why does China want to sustain our system by purchasing treasury bonds?

They have about two hundred billion dollars invested in it. They want to retain our export markets. U.S. bond yields, although currently fairly low, still higher than those of other major countries.

What happens if China were to sell off their bond holdings? The increase in supply would drive the price down. $96 $92 S1S1 S2S2 So the interest rate rises from 4% to 8%.

When China unpegged the Yuan from the dollar, it was pegged to a market basket of currencies including the Euro. China then purchased Euros to support their new market-basket pegging.

When China Unpegged the Yuan Interest rates rose a little (bond prices fell a little). We panicked. Was China restructuring it’s reserve portfolio?

A cutback can do the same job as a selloff in the Treasury bond market! Cutback Selloff

Japan has been doing the same thing, only they’ve got a lot more bonds! Why do they buy bonds? When they sell Yen, buy dollars in foreign exchange markets...

Japan has been doing the same thing, only they’ve got a lot more bonds! They acquire huge dollar reserves. Buying U.S. bonds yields 3-4% interest. That’s better than just sitting on the dollars. They have c. $740 billion in our bonds and have lost c. $110 billion in value with decline of the dollar.

Japan’s Interest in the Dollar Maintaining the bond market defends the dollar. If bonds sell well, the value of the dollar will not fall. If China stops buying our bonds, Japan's central bank probably would buy more to protect its huge export trade with the US.

Is a selloff likely? Nobody thinks so at the moment, but would it take a selloff to drop bond prices and raise interest rates? No, the cutback would do the job fine.

Could we raise the funds by selling additional bonds to other parties? Of course. How can we get other investors to buy more than they currently want? Raise the interest earnings (drop the costs of the bonds).

Could we raise the funds by selling additional bonds to other parties? But if interest rates go up, then what? Other interest rates rise as well. Crowding-out occurs in private sector investments. Interest rates on housing go up, so the housing boom ends.

What happens if the housing boom ends and all i rates skyrocket?

Fini (The End)

“Let China sleep, for when it wakes, it will shake the world.” -Napoleon