Woo - The Structural Nature

Woo - The Structural Nature - The Structural Nature of...

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The Structural Nature of Internal and External Imbalances in China Wing Thye Woo Economics Department University of California One Shields Avenue Davis, CA 95616 wtwoo@ucdavis.edu 29 December 2005 Abstract China has a built-in inflationary tendency because of the partially-reformed nature of its economic system. Specifically, the post-1978 marketisation of the economy has interacted with the continued state ownership to create an inflationary "liquidity tango" between the state-owned enterprises (SOEs) and the state-owned banks. Whenever the hard budget constraint is imposed on the SOEs, China's dysfunctional financial system would impart a deflationary bias to the economy and render China a capital exporting country by constraining the growth of aggregate demand to be less than the growth of aggregate supply. The use of price mechanisms as the only instruments for all economic problems is not appropriate for China's transitional economy, e.g. trade surpluses are better handled by the establishment of an efficient financial intermediation mechanism than by appreciation of the Yuan. I am deeply indebted to Fan Gang, He Liping, Huang Yiping, Tong Jinzhi, Yu Yongding, Zhang Liqing, and Zhang Xiaojing for sharing their insights on China's economy with me, and to the Citigroup office in Hong Kong for assistance in data compilation.
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1 29 December 2005 The Structural Nature of Internal and External Imbalances in China Wing Thye Woo University of California, Davis wtwoo@ucdavis.edu Introduction China’s economy started 2004 with public expectations exactly opposite to those that it started with in 2003. 2003 had been preceded by five consecutive years of deflation and below average growth rates – see Figure 1. To add to this gloomy background, 2003 came in accompanied by the onset of the Severe Acute Respiratory Syndrome (SARS), the economic impact of which was widely expected in May 2003 to cost the economy 1 to 2 percentage points off the GDP growth rate. 1 GDP growth in 2003, however, confounded most expectations by registering a rate of 9.5 percent because of very high growth in the last two quarters. 2004 thus began with considerable concern about possible overheating of the economy. The background is that the two times since 1978 that the GDP growth had gone up to 9 percent (1981 and 1991), the following few years had double-digit growth, accompanied (with a lag) by high inflation. The natural question in 2004 was, therefore, whether the government’s expansionary policies to counter SARS had gone too far, and whether the subsequent correction would again err too sharply on the other side? China, which had been under U.S. and Japanese pressure to appreciate the Yuan as part of its international responsibility to eliminate imbalances in the global balance of payments, was then also told that Yuan appreciation was also for its good. 2
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Woo - The Structural Nature - The Structural Nature of...

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