Tag Archives: china

“Made in China” and Comparative Advantage (Blog 14)

It is not a surprising news that with few contract manufacturers in U.S, many businessman turn to China’s expertise and scale. And in an article of WSJ, James R. Hagerty mainly focuses on the toy manufacture market and claims that it’s no fun making toys and toasters in U.S. Truly, “made in China” products can be found everywhere in one’s life, and it seems that the manufacture industry in U.S has coming to fall. However, Is that really a bad thing?

I still remembered the first concept I learned from Econ102 Class, Comparative Advantage, which means that an agent could produce a particular good at a lower relative opportunity cost or marginal cost prior to trade compared with another agent. Actually, the law of comparative advantage explained why countries engage in international trade, both sides could benefit through trading due to their comparative advantage.

While Ricardo’s comparative advantage model mostly applies to the good trade, developing an industry could be viewed at a similar way. Compared with U.S, China’s manufacture industry has at least two advantages: lower cost of labor and less regulation. While lower cost of labor make higher profit possible, less regulation means that Chinese manufactures could produce as many and as variety things as they want without too much restrictions. For example, they do not need to worry about the pollution from production process too much. Those two advantages make manufacture industry, especially for those knickknack and components, a comparative industry. Thus for China, it is wise and profit to take the advantages.

At the same time, U.S also benefits from turning their manufacture industry to China, as U.S could spare more time and effort on the industry they are good at. Say, R&D industry. It is interesting to see that many comments of this article are talking about how U.S’s governments and policies impede the development of its manufacture industry. But actually it is not a bad thing to get rid of “hindrance industry”. Each year China pay a lot of money to learn and buy the most advantage theory and technology from America.

What is more, though Ricardo’s comparative advantage model usually involves only two agents and two goods, it is not harm to imagine what would happen if we bring more countries and commodities in. Umm, actually it is going to be a  quite complex question since we add more agents into a game and the strategy combination are going to increase exponentially…. But anyway, how about each country only produce the goods that it has comparative advantages compared with all others and get other commodities through trading, which will make the whole world a single market.

China’s Economy Is Far From Decline(revised post)

China’s economy has indeed slowed down and seems to be continuing in that trend. Despite upcoming Lunar New Years, which an increase in household spending is typically observed, China’s service sector falls to its lowest in 6 months, Wall Street Journal reports. Many economists predict that China’s growth will slow down to about 6% in 2015 and contract further in the future. But some people are over exaggerating the scenario. There seem to be a lot of news and magazine articles saying that China’s slowing growth signals that it’s heading towards recession, and will bring about global economic instability. (Such as this article in Fortune)

I am here to tell you that China’s decline is a product of its political landscape and that it has plenty of options to stimulate economic activity before its economy is actually in trouble.

First of all, China’s slowing growth is most due to its own policies. The most notable is found in China’s real estate and property development market, which fueled and grew tremendously with China’s economic expansion into what many call a “housing bubble”. Then the Chinese government stepped in and implemented policies aimed at making housing more affordable to lower income families. Their policies are designed to stem speculative real estate investments, such as requiring larger down payments for buying homes if you already own one. And these policies worked as housing prices did decrease, but this also caused potential home buyers to sit and wait before making a purchase. As a result, the housing prices dropped beyond what the government intended, prompting it to draft new policies save this sector. I am almost certain that property prices will increase again in the near future.

Another notable policy that has hit China’s economy is President Xi Jinping’s anti-corruption campaigns. In China, luxury goods such as expensive liquor and jewelry are seldom consumed by households but are instead bought as business gifts aimed at building business relations or deals. (Yes this is morally questionable, but that’s not the point here.) Goods such as Maotai, China’s most expensive liquor brand, have seen sales drop over the past couple years. This story unfolds in the following articles: in early 2011, “Moutai buyers in high spirits“; early 2012, “Shenzhen Party Chief: Corruption to Blame for Pricey Moutai“; then late 2013, “Baijiu-Maker Kweichow Moutai Sobers Up“. Before Xi Jinping came into office, Maotai was a staple drink in business dinners bought using public funds. Banning the use of public funds in such goods have caused demand to dry up. Xi Jinping’s is determined to continue his war on corruption.

On the other hand, China’s central bank still have many tools to stimulate economic activity. In response to the slowing growth, China’s central bank has lowered interest rates in November and have successfully bolstered its economy, according to Wall Street Journal. On Wednesday, it also lowered its required reserve ratio to promote bank lending. By lowering its required reserve from 20% to 19.5%, it will free up over $100 billion dollars to lend, according to another article on WSJ. China’s interest rates and required reserve ratio are also so high that there are plenty of room to adjust them to create economic stimuli, unlike many Western countries.

Bottom line is, China still have plenty of options. And if they are exhausted, it can still resort to quantitative easing and negative interest rates. But China isn’t even considering such measures because it doesn’t need to.

Infrastructure Investments: The Road to China’s Future of Growth

In light of today’s budget announcement from the White House, I have decided to explore one of the main focuses of the $478 trillion spending plan that the President has come up with to revive the economy, infrastructure spending.

According to Mark Magnier’s article for the Wall Street Journal titled “Benefits of Infrastructure Spending Not So Clear-Cut, Economists Say,” “Washington-based Progressive Policy Institute concludes that every dollar spent on U.S. roads, bridges and public transport spurs $1.50 to $2 of growth.” According to research conducted by Oxford Economics for PWC’s study titled “Capital project and infrastructure spending Outlook to 2025,” “the Asia-Pacific market, driven by China’s growth, will represent nearly 60% of global infrastructure spending by 2025”

(www.pwc.com/cpi-outlook2025). The study also predicts that Western Europe infrastructure spending will not return to pre-crisis levels until 2018, as Asia’s has been growing this entire time.

“Developing economies, most notably China and other parts of Asia, account for nearly half of all infrastructure spending, up more than 10% from 2006” (www.pwc.com/cpi-outlook2025)

How will China’s success in the race for infrastructure growth will contribute to its economic growth compared to Europe’s?

While China’s economy had been growing in double digits over the last 20 years, growth has slowed recently. This growth is still at a respectable annual growth rate of 7%. China’s economy is maturing and beginning to lose its cost-competitive advantage to other lower cost countries. As this happens, China will need to make strategic investments to sustain its growth.  Investments in infrastructure can serve this growth need. Infrastructure investments immediately create jobs in construction and related industries. Infrastructure investments also provide opportunities for longer term, more sustainable growth and development.

China should continue to make SMART infrastructure investments, especially in high speed rail, ports and airports and wireless high-speed telecommunications to continue to open markets within China and to provide a better quality of life for its citizens.

Virginia Lau discusses Chinese high speed rail in her article “Record breaker: China’s incredible north-south high-speed train line plan” for CNN as the world’s longest high-speed rail line was just proposed to run from “Inner Mongolia’s Baotou city and running through southern Shaanxi, Hubei, Hunan, Guangxi and Guangdong, its final stop would be in Haikou city on Hainan Island, China’s southernmost province” (http://www.cnn.com/2015/01/08/travel/china-high-speed-north-south-rail/). Additionally, this project will connect rural provinces with urban areas such as Beijing. This will promote growth by providing sustainable job opportunities for those in rural areas, as discussed above.

Where’s the future for China’s Manufacturing

China’s economy development has endured a frozen winter in 2014, especially for manufacturing. China experienced a chronic and rapid increase of GDP in the past decade years. Outstanding trade performance with other countries was the base. Many developed countries, such as US, Germany, Korea made China as a perfect platform of outsourcing and offshoring. China’s low wage was its competitive advantage. However, the rising wage and competitions from other developing countries like India, Vietnam and many other Latin American countries blocked the advantage of China’s manufacturing. The profit and employment rate decreased in an impressive pace. “Employment in the manufacturing sector also fell at a faster rate in January, the PMI showed, which is potentially a major worry for China’s government. Chinese leaders have said they are comfortable with slowing growth as long as job creation continues apace. If that changes, they may move more aggressively to stimulate the economy.” (http://www.wsj.com/articles/china-manufacturing-sector-still-weak-key-gauge-shows-1421980031?KEYWORDS=china+manufacturing )

China’s manufacturers held no response but expected government’s help. “CHINESE MANUFACTURING: Surveys by HSBC Corp. and a Chinese industry group found manufacturing activity in the world’s second-largest economy weakened in January. The China Federation of Logistics and Purchasing said its purchasing managers’ index fell to a 28-month low. A separate index by HSBC edged up but still showed activity contracting. Both blamed weak demand in China and abroad. Analysts said they expect this to prompt Beijing to inject more credit into the economy or launch other stimulus measures.” (http://www.cnbc.com/id/102387664 ) But only relying on government’s money injection cannot solve the problem for long run. China’s manufacturing must make a profound modification.

How to make the change is a complex question. Japan is a perfect exemplary country that China can learn from. Japanese manufacturing did not feel pale to live when many developing countries entered the market. What they did was to make everything exquisite. For example, they made the pot more readily for cooking rice; they made knifes more easily for cutting; they even made the toilet seat ring more comfortable. Many Chinese tourists wait for 2 or 3 hours to buy those manufactures in Japan. This seems a little ridiculous. Nevertheless, this definitely indicates Japanese manufactures have better quality than China. Moreover, Japanese labor’s wage are dozen times of Chinese labor’s wage because of their extraordinary skill. Japanese manufacturing relied on their delicate way owed their own standing in the market.

For China, saying goodbye to the low wage labor and cheap manufactures are the right choice for next move. This demands more technical assists without doubt so using more fund to elevate the level of technique is the most essential issue.

Chinese Central Bank Injected 400 Billion Yuan

Chinese central bank drilled about 400 billion yuan (nearly $65 billion) to the banking system at the beginning of the January 2015. PBOC(The People’s Bank of China), which is led by the State Council, is responsible for introducing policies, setting marketing strategy, monitoring other banking and stock system, controlling exchange rate, issuing currency, and managing the treasury. There are other five state-owned banks: Industrial and Commercial Bank of China, Agricultural Bank of China, Bank of China Limited, China Construction Bank, Bank of Communication, are taking charge of implementing the assigned policies for the society. These banks will utilized the 400 billion yuan to compensate their deposits and put more money flood to the market.

The five state-owned banks has suffered the declining profits since the PBOC has introduced a policy of cutting the interest rate down in 2014. They do not have enough deposits to satisfy the demands of the big developing market so this billions of fund will reboot the liquidity. “About 500 billion yuan in loans made in September by China’s central bank to the country’s top five state-owned banks are coming due this month. Uncertainty over whether the central bank would renew those loans has led the banks to grow wary of lending out their funds. Meanwhile, banks in China have been squeezed in recent weeks because many investors shifted their funds out of banks and into the stock market.”(http://www.wsj.com/articles/chinas-central-bank-injects-about-400-billion-yuan-into-interbank-market-1418284627?KEYWORDS=Chinese+central+bank) This time’s injection expressed central bank’s determination of solving the problem.

Moreover, China has experienced the lowest increase of its GDP during the last decade in 2014. The feeble performance of the real-estate market in China, especially in big cities, including Beijing, Shanghai, and Guangzhou, are one of the essential role. The chairman Xi Jingping’s tough attitude towards combating corruption also punched many business. People’s desire of investing and consuming are both debated. This is another pivot contribution of sluggish China’s economy.

With this 400 billion yuan, China’s state council announced to introduce the deposit-insurance system. “In disclosing plans for a deposit-insurance system, policy makers appeared to nod to rising concerns about financial risks. Deposit insurance will help maintain ‘public confidence’ in China’s banking system, said the People’s Bank of China in a statement accompanying the draft plan. The central bank, which is spearheading the effort, also said the insurance program will ensure that “risks will be discovered early and risks will arise less frequently.”(http://www.wsj.com/articles/china-releases-draft-plan-for-bank-deposit-insurance-1417340960) If the deposit-insurance system is successfully implemented, people’s credibility of saving will be dramatically increased while the competition of banking system as well as. Then, banks will attain more deposit for investments. With the 400 billion yuan, China wish its development will keep mighty in 2015.

Can China become consumer-driven?

As most of you have already heard by now, China’s economic growth in 2014 have slowed to levels not seen in over 20 years: a mere 7.4%, Wall Street Journal reports.  Raising concerns of diminishing global demand for commodities which could weaken the global economy as a whole.

China’s growth in the past few decades, since Deng Xiaoping opened China to the world, has been one of the greatest success story of economic reform and policy in recent history. Fueled by rapid industrialization and infrastructural development, China’s GDP is over 10 times larger than what it was just 20 years ago. Many economists have questioned how long China can sustain it’s growth. And alas, China has slowed down. Despite falling oil prices, the IMF predicts that China’s growth in 2015 will be as low as 6.8%

China’s government is on top of this issue, with President Xi Jinping saying that the nation needs to adapt to a “new normal” in the pace of economic growth and remain “cool-minded” amid a slowdown that analysts forecast will lead to the weakest expansion since 1990. (Bloomberg)

Furthermore, President Xi aims to steer China’s economy away from industry-driven growth to a more sustainable consumer-driven growth, like the United States and many fully developed western countries. But this will be no easy task. According to the CIA World Factbook‘s 2013 data, China’s GDP composition consists of 10% in agriculture, 43.9% in industry, and 46.1% in services. Compared to the U.S.’s which consists of 1.1% agriculture, 19.5% industry, and 79.4% services; United Kingdom’s consists of 0.7% agriculture, 20.5% industry, and 78.9% services; and many other developed countries share a similar spread. We can see a huge disparity in the proportions where China’s agriculture and industry is far ahead but services lag behind.

Yes, China’s growth has put more money into the consumer’s hands; yes, the Chinese are now spending more than ever on luxury goods and services; and yes, China is heading towards that goal. But there are also huge social issues that need to be addressed. In my trip to China last year, I have seen that much of China’s growth has been in urban environments, resulting in huge migrations of people into industrialized urban zones. This leaves rural area even more underdeveloped, creating huge income gaps. Cost of living in urban environments have also gone up; in places like Beijing and Shanghai, consumer goods cost even more than the U.S. In rural towns, however, there have not been much change. The Chinese government is aware of these issues and have increasingly made efforts to develop rural zones, but it doesn’t seem enough. Another issue is that the Chinese generally have a saver’s mentality; a lot of us emphasize saving now so that we can have more later. To top it off, the Chinese government is reluctant to adopt stimulus policies; though I am assuming this is because of the saver’s mentality, stimulus packages will not have much of an effect on consumer spending.

China’s endgame seems to be a consumer-driven economy. But as of now its rural zones still require large amounts of infrastructural development. To juggle industrialization in rural zones and de-industrialization in urban zone will surely be a challenge.

 

Anti-Corruption Movement and the Law of Diminishing Returns(Blog8)

Anti-graft is one of the most hot topic in China this years. With the President Xi Jinping’s “Tigers and Flies” push, many officials, from senior officials to cadres have come croppers. However, with the accomplishment the movement reached, more and more queries and complains also rise up.

In fact, anti-graft actions have never leave public’s eyes. Even before the new China, the government spared no effort to push anti-corruptions. But the problems never be solved. Recently a news reveals that China is trying to enforce old rules on office sizes of cadres, which actually should have been followed by officials for at least ten years. And as described in a WSJ’s article, China’s anti-corruption is in quagmire after the initial ‘shock and awe’.

The question here is why. Why it is becomes harder and harder to push the anti-graft? And why a country can never totally clean the corruptions away?

The law of diminishing returns is a basic concept in economics. If we consider the achievement of the anti-graft movement as output from ‘anti-graft factory’ , then the law applies: the marginal output of a production process is decreasing as the amount of a single factor of production incrementally increased, while the amounts of all other factors of production stay constant. Put another way, the anti-corruption movement becomes harder and harder because executors only focused on one or several factors that could lead to graft, but neglected the others.

Then it comes to another interesting question: what factors cause corruption? Moral level? Punishment for corruption? Official’s rank? And how those factors impact the corruption?

Vito Tanzi wrote a paper for the international monetary in 1998, which list tens of individual factors such as regulations, taxation, provision, level of public sector, penalty systems and so on and classified them into direct factors and indirect factors. He pointed out that corruption is a complicated issue and single action is far from enough to deal with it.

What is more, Daniel Treisman from UCLA even run a regression model to quantify different factors’ impact on the graft based on a data collected from nation wild. The result suggested that democracy, a countries’ long-term cultural traditions, and the development of a country’s economics has a huge interrelationship with the corruption. (And there are many other factors)

On the other hand, If we review what China has done so far, mostly it is enforcing the rules and propaganda, such as break the chain of graft, enforce the cubicles for cadres, curtail subsidy and prevent the ‘under-table gift’. It is premising to see those experiments taking paces, however, only the enforcement is not enough. The anti-corruption has already got quagmire. Thus while governors devoted themselves into the anti-corruptions movement, please also spare some energy to develop the economics and people’s moral level(education)

China Latest Country to Devalue Currency

The People’s Bank of China is doing all it can to help quell concerns about the rate of growth in China finally slowing. After achieving miraculous growth for years and as Jake Spring and Xiaoyi Shao write in their article, China’s growth slowest since global crisis, annual target at risk, “China grew at its slowest pace since the global financial crisis in the September quarter and risks missing its official target for the first time in 15 years, adding to concerns the world’s second-largest economy is becoming a drag on global growth.” This article was writing back in October of 2014, but the implications from this slow growth are being addressed today. China has been used to such incredible growth year over year that they have prepared for this type of growth in their industrial capacity. With China finally slowing down, they are going to have vast amounts of factories either not working at all, or working at significantly reduced capabilities. This will also draw down on the potential for companies to expand their businesses in China (an already extremely tough task to do!) As Anjani Trivedi wrote in his Wall Street Journal Article, China Nudges Yuan to 7-Month Low, The People’s Bank of China set the morning reference rate-which typically sets the daily direction- weaker, with traders in Asia then pushing the yuan down to 6.2537 to the dollar, the closest it has ever been to the weak side of its 2% daily trading band.” This devaluing of the currency is an attempt to increase the exports that have been decreasing and increase inflation that has been getting perilously close to deflation. This may seem like a good move on the People’s Bank of China’s part, but they must be concerned into getting into a devaluing race in which all countries lose. This is explained very well in Anjani’s article, “Many central bankers have resorted to letting their currencies fall against those of their trading partners. In the short term, weakening a currency helps exporters by making their goods more competitive in foreign markets. But currency depreciation also raises the risk of a tit-for-tat “race for the bottom” as trading partners seek to outdo one another, only to find gains are limited.” This should be a major concern for countries whose sole reason for devaluing their currency is to try and gain a market advantage and increase net exports. These countries better watch out, as it seems a new countries Central Bank is devaluing a new currency every week!

Decreasing Iron Ore Prices in China

The traditional notions of supply and demand are still relevant in modern economy. Demand, supply and their interactions often determine price and the most efficient means of production in a market. A low supply and high demand typically indicate that there will be a high price in equilibrium. Conversely, a high supply and low demand should lead to a low price. In an ideal world, suppliers and demanders will work in equilibrium to avoid any significant dead weight losses.

Applying these fundamentals to a real-world situation, we can look at the iron-ore industry. Iron-ore, typically utilized in the production of steel, is a large industry and the big 3 are the 3 companies currently leading it. According to the Wall Street Journal article by Rhiannon Hoyle, “Rio Tinto Digs UP Record Volumes of Iron Ore in Australia,” one of these big 3 companies (Rio Tinto) has been increasing output as of late. Hoyle suggests that this expansion has been because they see China needing more steel in the future to build its industries.

Providing more steel to a place that will likely utilize is it is a competitive advantage in this supply-demand model where there are multiple suppliers. Ideally, you want to be the only supplier in order to make the most profits. By being there and producing record amounts, they are able to over-supply China with this resource so they do not seek it from elsewhere. This increased supply while the demand in China has not changed too much drives the price down. This lower price could mean that other suppliers, particularly small mingling companies, may not be able to continue in this market without losing money. By moving beyond equilibrium, Rio Tinto is creating a market surplus.

An article by the Daily Times is entitled, “Big iron ore miners supply strategy working partially.” This questions the effectiveness of Rio Tinto’s tactics in the Chinese market. While they do note that the market share of the big 3 remains strong, other suppliers in this market will not be driven out easily. The article states “Iron ore prices may have to further fall if the big 3 really are determined to drive competitors out of the market.” This suggests that there will be further price decreases if Rio Tinto and the other 2 of the big 3 continue this attempt to fully control supply. Moving even more out of equilibrium could have detrimental effects to the market but only time will tell what the result will be.

 

 

Sources:

 

http://www.wsj.com/articles/rio-tinto-digs-up-record-volumes-of-iron-ore-in-australia-1421705710

 

http://www.dailytimes.com.pk/business/19-Jan-2015/big-iron-ore-miners-supply-strategy-working-partially

 

On currency manipulation: some questions need to be answered

In the recent Op-ed column of the New York Times, Jared Bernstein argues the Trans-Pacific Partnership (TPP) should include a chapter on currency manipulation. He names some Asian countries including China and Japan as “currency managers”, insisting attempts made by these countries are subsidizing their exports and taxing their imports, which results in persistent trade deficits in the United States. In response to this situation, he suggests first to define what currency management looks like, then to agree on specific retaliation measures for currency managers including tax on the imports of offending countries, fines, and the temporary canceling of certain trade privileges.

Needless to say, there are plenty of examples of “currency management” he refers to, ranging from some developed economies like Japan and Euro area (although they haven’t embarked on quantitative easing policy yet, their intension of depreciating the Euro is clear), and many developing economies including China, Singapore and Malaysia. Still, I think there are at least three questions Bernstein and the US policymakers have to answer before they include a chapter on currency manipulation.

  1. How do they differentiate currency management from accumulating foreign reserves for other purposes?

As Bernstein himself noted, countries buy foreign currencies for various reasons. And other than currency management, one of those motivations is to have foreign reserves as an “insurance” for sudden capital outflows from country. One can immediately think of the recent currency collapse in Russia as an example of this kind of event and one can also imagine that having ample foreign reserve is really important when it happens. Since it is very difficult to predict how big an impact of capital outflow would be, countries (especially emerging economies with relatively volatile domestic currency fluctuations) have an incentive to purchase enough foreign currencies for a rainy day. Can any policymakers define reasonable level of foreign reserve which prevent future currency crisis? I’m rather skeptical about it.

  1. Is purchase of foreign currencies made by central bank a good definition of currency management?

Bernstein argues that weather the central bank is buying foreign currencies or not is a clear test of currency management. But there are other ways to lower domestic currency, again as Bernstein himself points out. Specifically, central bank can attempt to depreciate domestic currency by monetary easing (either by lowering short-term interest rate or implementing unconventional policies like quantitative easing). Since majority of people agree that either purchase of foreign currencies or monetary easing can achieve lowering domestic currency, I don’t really see why only the first one should be the “clear test” of currency management.

  1. Is the Chinese currency still undervalued?

When it comes to the Chinese currency, too many people just assume it is still way undervalued than it should be. Before criticizing China as a currency manipulator, it is important to show evidences for this. In fact, some researchers say that Chinese currency is not undervalued anymore by using the new purchasing power parity (PPP) calculation. While some other institutions like IMF reported that the yuan is “moderately” undervalued, it is almost clear that Chinese currency is heading to the right direction given that China’s current account surplus is now just 2 percent of its GDP (10.1 percent in 2007).

My conclusion is: unless at least those three questions are answered, other countries would think that Bernstein’s argument is rather one-sided even if both parties in the US congress agree with it.