At the annual meeting of China’s parliament last week, it was announced that the country would maintain its growth target at about 6.5 per cent in 2018 while targeting “high-quality growth” and containing financial risks. It seems that worries about slowing growth have receded. Chinese growth is hovering between 6.5 per cent and 7 per cent, but economists see it decelerating to closer to 6 per cent in the coming years. Will China’s growth slow so much that it never becomes a wealthy nation?
The answer to the question of whether one-fifth of humanity will become prosperous will transform not only the livelihoods of people in China, but also the world economy. But is it possible for a communist country to become rich? Although China has veered far from its Marxist roots, there are communal principles derived from Karl Marx, such as elements of communal property and state ownership, that still permeate the economy. China would be the first mixed economy to become affluent. China is unusual in that strong growth has taken place while it remains a communist state governed by the Communist Party. It is therefore unsurprising that the rule of law and other market-supporting institutions, such as private property protection, are weak, as there is no independent judiciary. This gives rise to the “China paradox”, because the country has grown well despite not having a well-developed set of institutions. China’s economic growth is, therefore, in many respects both impressive and puzzling. Indeed, one of the most complex areas of Chinese growth is the role of legal institutions. The predominant view is that market-supporting institutions, such as those which protect property rights and provide contracting security, are important for growth. China as an outlier requires a closer examination. Specifically, the reliance on relational contracting – transacting with those you trust – can help reduce reliance on the judicial system which is being gradually improved as more Chinese firms clamour for better protection of their inventions, for instance. The role of informal institutions such as social capital, also cannot be overlooked. Entrepreneurs in China have relied on social networks, known as guanxi, to overcome the lack of well-developed legal and financial systems. The cultural proclivity towards interpersonal relationships meant that social capital played a key part in the development of self-employment and the impressive emergence of the private sector. That China would allow entrepreneurs to emerge within a communist system is, perhaps, not something Marx would have anticipated. After reaching “middle-income status” in the early 2000s, China found that it needed to rebalance its economy to grow in a more sustainable manner. Its ability to overcome the “middle-income country trap”, whereby countries start to slow after reaching upper-middle-income levels and never become rich, depends on it. Poor countries tend to grow through exports and cheap manufacturing. Growth in a middle-income country is driven more by consumption by its own middle class, leading to a diversified economy that is not heavily reliant on exports to consumers in other countries. China has also shifted towards services so that the “factory of the world” now has a bigger services sector than manufacturing. The country is still upgrading manufacturing, expanding overseas investment and opening up its financial sector more. It is also promoting the internationalisation or global use of its currency, the renminbi. To achieve these aims will require examining the institutional framework of the economy, including the role of state-owned enterprises and the legal system. The retention of large state-owned firms and the problematic lack of a level playing field for both foreign and domestic private firms vis-à-vis state-controlled companies raises doubts as to the efficiency of China’s markets and thus its ability to grow. There’s also the issue of financial stability. All major economies experience a crisis eventually. We know from past experience that an economic crisis, depending on the causes, could trigger a long-lasting downturn. Marx would view this as inevitable in a capitalist economy. In China, a financial crisis linked to too much debt or some other issue in its banking system would not be surprising. Estimates of total Chinese debt by the Bank for International Settlements and others place it around 260 per cent of gross domestic product, similar to Europe and the US. But a key difference is the large amount of corporate debt in China, which is more worrying than government debt if there is a risk of large-scale bankruptcies that could bring down the banking system. And part of that debt is owed to the shadow banking system, where lending is done outside the formal banks. Shadow banking debt isn’t measured accurately, so the overall level of Chinese debt is a concern. The growth of shadow banking is linked to the Chinese government not introducing sufficient competition into the state-owned banking system. A rapidly growing economy, powered increasingly by private entrepreneurs, requires credit. As private firms sought funds that the formal banking system, which predominantly lent to state-owned firms, was reluctant to provide, unlicensed lending grew. Progress in reforming the state-owned banks that dominate China’s financial system is slow, owing to the powerful vested interests that benefit from running state-owned banks. Here, the communal property system hampers the growth of the marketised economy, and yet reform is difficult in a communist regime. So, can China grow rich? It will require addressing some key challenges related to its communist political system and the partial retention of state ownership. China’s transformation into a largely market-based economy, still ruled politically by a communist party, would not have been foreseen by Marx, for whom communism and capitalism could not coexist. Marx might have been intrigued by the continuation of the communist political system governing an economy that shares challenges such as inequality with the most capitalistic of economies, the US. If China overcomes its challenges and becomes rich under capitalism, then perhaps Marxists might have to reconsider the role that his principles played in guiding communist China – because in Marx’s theory, after capitalism takes hold, there is always scope for a worker rebellion and revolution in the future. President Donald Trump certainly thinks it does. Since his campaign, he has tweeted frequently about his unhappiness with America’s trade deficit. Trump’s latest response is to impose tariffs on imported steel of 25% and 10% on aluminium. He once observed the problem was that there were a lot of Mercedes-Benz in New York and not many Chevrolets in European cities. But is that due to unfair trade barriers which can be addressed through imposing tariffs or to what consumers in America and Europe demand?
Economists since the days of Adam Smith and David Ricardo have pointed to the latter. Of course there are trade barriers and aspects of the international trading system that are not a level playing field. But, on balance, a country’s trade position is a reflection of its economic strengths and weaknesses. Trump’s planned 10% tariffs on all aluminium imports has led the very industry that it is supposed to help to ask the President to think again. The Aluminium Association that represents 114 aluminium producers has warned the tariff will likely do more harm than good. A tax will raise the cost of traded aluminium that will hurt their industry and their supply chain partners in Europe and elsewhere. Their suggestion is to focus on China as the source of over-capacity. More broadly, that can be said for a lot of trade barriers. If there are trade barriers that distort markets, then adding new tariffs or other barriers is likely to increase the distortions that can harm the industry that it intends to protect. Instead, something more targeted could potentially work better if the grievance can be established as falling within the rules of the World Trade Organisation, e.g., national security or anti-dumping. But, the more important factors that determine a country’s trade position are not tariffs; what a country produces leads to its trade position. This was understood in David Ricardo’s day when Britain repealed the Corn Laws in the mid-19th century which raised the cost of imported grain and was favoured as a protectionist measure by landowners. Ricardo is known as the father of international trade and his model pointed out that a country’s comparative advantage determined what it produced and thus traded. If a country was producing goods that were highly demanded by consumers everywhere, then it would sell that good abroad. So, to improve the trade balance, a country should focus on how to increase productivity and production of highly demanded goods and services. Because of specialisation, a country would produce less of other products and import those while focusing on what it was good at. Looking at America today, its long-standing trade deficit is due to a number of factors. Given that the U.S. economy is largely based on services, the lack of liberalisation of the global market for services in contrast to manufacturing has hindered its exports. America is still the largest exporter of services in the world and tends to run a surplus in this sector. For instance, the U.S. trade deficit rose to 2.9% of GDP due to an increase in its goods deficit and a decrease in its surplus in services exports. To remedy this would entail promoting the opening up of the services sector in markets around the world, which was a part of the abandoned US-EU free trade agreement (TTIP). Once investment flows are taken into account in the broadest measure of the external deficit, America still runs a current account deficit, but it is because foreign companies and investors invest in the U.S. Since the dollar is the global reserve currency, there is a lot of demand for US investments, debt and assets. So, there are “imports” of investment funds, due to the attractiveness of the U.S. economy. America’s deficit with the rest of the world thus reflects a range of economic considerations that explains why it has a long-standing current account deficit, of which tariffs are but a small part. Therefore, trade deficits only matter if they reflect an underlying weakness of an economy. For the U.S., that’s not likely to be the case. Borrowing to invest and counting it separately from day-to-day government spending was an idea proposed by John Maynard Keynes after the last systemic banking crash. He proposed that governments should separate out investment or capital spending from the current spending on welfare, etc. by the government. This way investment that can generate future economic returns to growth can be separated out and the greater transparency offered by counting it separately can help assuage fears of investors. The concerns over the budget deficit since the banking crash have centred on this concern about investor perceptions about the UK as an attractive country to lend to, which determines borrowing costs.
In the Spring Statement, the Chancellor of the Exchequer has done just this. Philip Hammond said that the UK will run a current budget surplus in 2018-19, so it will be borrowing only to invest. The Office for Budget Responsibility (OBR) estimates the budget deficit in that year will be 1.8% of GDP, then falling to 1.6%, 1.3%, 1.1%, and to 0.9% in 2022-23. Public debt is now expected to peak in 85.6% in this tax year and fall thereafter, even figuring in borrowing to invest in capital spending. Keynes was supportive of governments borrowing to invest since he believed the economy usually operated below its potential and public investment should therefore supplement private investment. He believed that since state investment would boost economic growth, it would not mean that government debt would increase as share of GDP. Fast forward to now, that is also the conclusion of the OECD who estimated that raising investment by 0.5% of GDP would increase the size of the economy by at least that amount. Keynes was the first to point out that there is no ‘crowding out’ of private investment when the economy is operating below its potential. ‘Crowding out’ refers to how governments borrowing to invest would make it harder for private firms to do so because their demand for loans would push up the interest rate and make it more expensive for others to borrow. However, since the British economy lost over 6 per cent of its output during the 2008 recession, and interest rates for loans are low, ‘crowding out’ would be unlikely, because the economy has lost so much output that there is a lot of scope for the public and private sectors to invest before their demand for funds pushed up borrowing costs. Moreover, increasing public investment can help economic growth, as it can have a ‘crowding in’ effect. In other words, government investment can make private investment more efficient, for example a good telecoms infrastructure increases the returns to a pound invested by a private company by giving them the fibre network to deliver faster services. The Spring Statement shows that the UK is not aiming to eliminate the overall budget deficit and is instead focused on borrowing to increase spending in roads and housing as well as digital infrastructure. As bond investors’ concerns have shifted from deficits more towards slow economic growth, Britain’s growing emphasis on improving growth through investment, even if it means borrowing, is unlikely to shake markets. And indeed today’s announcement hasn’t. |