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Elliott Parker, Ph.D.Professor of Economics

University of Nevada, Reno

The People’s Republic of China is currently the largest economy in the world, with the world’s fastest growth rate and its largest population.

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China's Real GDP Per-Capita (RMB)

-5,000

0

5,000

10,000

15,000

20,000

25,000

19781979

19801981

19821983

19841985

19861987

19881989

19901991

19921993

19941995

19961997

19981999

20002001

20022003

20042005

20062007

20082009

2010

GDP Net Exports

China’s annual Gross Domestic Product was 34 trillion Yuan (Renminbi) in 2009

– about $5 trillion at official 2009 exchange rates.

– almost $4000 per capita.

USA GDP is about $15 trillion.

– almost $50,000 per capita.

China’s currency is currently considered undervalued

– Purchasing power parity comparison is almost double.

China’s annual real per-capita growth rate is 9% over the last decade.

This is currently the fastest in the world, but is not as fast as Japan (1950-1975) or Korea (1960-1990).

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100

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300

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500

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700

800

900

1000

1100

1200

1300

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1 5 9 13 17 21 25 29 33 37 41 45 49

Years

Init

ial Y

ear

= 10

0

Japan since 1950

South Korea since 1960

China since 1978

U.S.A. since 1950

Source: Maddison (2003)

China’s future?

If China and the USA maintain current growth rates (assuming they are accurate), China will be the world biggest economy in a dozen years, and will catch up to the USA in per-capita terms in 30 years.

But these growth rates cannot be maintained. Smaller economies grow faster due to the catch-up effect. After this decade, the USA cannot possibly continue to import as much as China will have to export.

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China is also an economy still in transition from a poor, rural command economy to a dynamic and prosperous market economy, with a stark contrast between a large and mostly poor rural population, and relatively advanced, westernized, and wealthy cities.

Geography and Population

� China’s population is 1.3 billion people (currently growing at only 0.5% per year).

� Roughly 60% of Chinese live in rural areas, and most of the people in the east.

� China used to be 90% rural. This is one of the largest human migrations ever.

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China’s land area is roughly 3.7 million square miles, compared to 3.5 for the USA (including 0.6 in Alaska). The U.S. is bigger if you include water (the Great Lakes).

China’s average population density is more than four times that of the USA.

China is very mountainous

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So where do Chinese live?

Major Cities and Provinces� The capital Beijing is China’s

most modern city, with 18m people and a per-capita income of 70,000 RMB ($10,000) in 2009.

� Jiangsu province is China’s largest industrial producer.

� Shanghai is the largest city (19m) and the richest (80,000 RMB or $12,000 per capita).

� Guangdong (96m) is now China’s largest province, followed by Henan and Shandong (95m each) and Sichuan (82m).

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Population Density

� China has significantly less farmable land than the USA, so the density per unit of arable land is almost nine times that of the USA.

� Rapid Chinese growth requires that it transition from agriculture to labor-intensive industry.

� China is also spending enormous amounts for public and private investment: 40% vs. 15% average for USA.

Share of GDP

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1978 1982 1986 1990 1994 1998 2002 2006 2010

Consumption Investment

Exports Imports

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According to UNR History Professor Hugh Shapiro, there are several reasons China had so many people:

� Medicine

� Technology

� Hygiene

� Highly efficient land use

� Efficient premodern agriculture

As a result, China’s population reached 450 million by 1949.

Medicine

Hugh’s specialty is the history of Chinese medicine, and he argues that it was much more advanced than medicine in the West until the last Century, though also very different. Acupuncture, herbal medicine.

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Technology

� Ancient Chinese invented many things before the West, including the compass, papermaking, printing, gunpowder, the shadow clock, the abacus, the seismometer, and the crossbow.

� In the 1200s, China produced much more pig iron than England did in the 1700s. They used natural gas for fuel, and could deep mine. They also invented the iron plow, the propeller, the suspension bridge, the parachute, the seed drill, and the double-action piston pump.

� Until 1750 or so, China was more advanced country than any in the West.

� This is a terra cotta soldier from the tomb of the first Qin Emperor, from 2200 years ago.

� He carried a crossbow.

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Deep drilling for salt and natural gas, circa 100 AD

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The double action piston bellows

Hygiene: habitual boiling of water for tea drinking

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China has long used its land intensively

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Long Tradition of Living in, and also Abusing Nature

China Before Mao� China was able to feed and maintain a large population for many centuries, through many imperial dynasties.

� China was dominated by Mongols in 1300s, by Manchus in 18th-19th Centuries, by European nations fom 1840s – 1940s, and by Japan from 1937-1945.

� Overpopulation and economic decline began just as European nations began to take off.

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China under Chairman MAO Zedong

� Civil War between Communists and Nationalists after WWII. Nationalists fled to Taiwan.

� October 1, 1949: People’s Republic of China founded by Chairman Mao.

� PRC not recognized by USA until 1970s, was very isolated from the rest of the world.

� China fought the USA to a standstill in the Korean War.

Communist China

� Mao led the communist party, and they tried to create a socialist economy like the Soviet Union.

� Soviet-style nationalization of industry in 1950s, where the government owns and controls all firms.

� Gradual collectivization of agriculture, so people farmed in large groups. Equal sharing, but very little incentive.

� Great Leap Forward (1958-60) led to world’s worst famine: 30-50 million died.

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The Cultural Revolution

� 1966-69, -76.

� Started with criticism

of a playwright.

� Red Guards and attack on Four Olds: old customs, old culture, old habits, old ideas.

� Universities, schools, factories, much of China shut down, torn apart.

Much damage was done.

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DENG Xiaoping

� Mao died in 1976.

� DENG Xiaoping emerged as “paramount leader” in 1978 after his followers were elected to the highest positions.

� He ended “Politics in Command,” and replaced it with pragmatic “black cat, white cat” approach.

� He changed the rules to make sure no other leader could have Mao’s power again.

� Chinese Communist Party repudiated Mao’s policies without repudiating Mao.

Deng’s Economic Reforms

� Open Door Policy : China was opened up to foreign visitors, foreign investors, and foreign trade.

� Rural Reform: Land was allocated to families instead of to big groups called communes. Rural towns and villages could invest in and produce manufactured goods.

� Industrial Reform: State-owned firms were reformed in an effort to make them more efficient. They became more productive, but also were able to get more investment than they could productively use, while more competition and poor management led to falling profits for the state.

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The Socialist Market Economy, 1992 –

� Under President JIANG Zemin, the CCP renounced the idea that economic reform was just a temporary stage.

� Instead, the new policy was to create a developed market economy with the CCP in charge. State firms would be the “cornerstone” but not necessarily the dominant type of firm.

� To promote trade, the currency was unified and devalued to the black market rate. The current account became “convertible”.

� Most state firms were transformed into LLCs, and the best could raise money by going public – though the state retained a controlling share.

� State banks were split into commercial and policy banks.

Governance

� Chief of State is President HU Jintao, who is also General Secretary of the Chinese Communist Party. The President is appointed by the National People’s Congress to up to two five-year terms.

� Head of government is Premier WEN Jiabao, also appointed by the NPC, together with the entire State Council.

� China’s appointed leaders are all members of the

CCP, as are most representatives to the NPC.

� China is run by the Chinese Communist Party. Provincial/municipal governments are appointed by the central administration.

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China’s Changing Industrial Structure

� New Chinese private firms, wholly-owned foreign firms allowed, but these have little access to bank loans or the stock market.

� Policy of “release the small, retain the large” for state firms, leading to huge layoffs in 1990s and creating large Korean-style firms.

� Export sector dominated by rural firms, foreign-owned firms, and private firms; relied upon to deal with urban unemployment problem.

� China’s urban landscape has been suddenly transformed

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Not always for the best…

Rural China� Most Chinese still live in rural

areas, on less than $2 per day.� Rural areas continue to have

large surplus labor problem, and many worry about effect of U.S. agricultural imports on farm prices.

� Reports of many protests by farmers over extractive rural leaders.

� Recent experiments in local elections.

� Widening poverty gap between rural and urban areas.

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China’s Labor Force In 2004, China’s official labor force was roughly 770 million people.

� 490 million were employed in rural areas (140m in township and village enterprises, 20m in private firms, 21m self-employed, and more than 300m million in agriculture).

� 265 million were employed in urban areas (67m in regular state units, 14m in LLCs, 6m in listed firms, 30m in private firms, 10m in foreign-owned firms, and 25m self-employed).

� Estimates for the “floating population” of informal rural-urban migrants are as high as 100 million people.

� The average wage was approximately 16,000 RMB/year (6400 in farming, 11,000 in manufacturing, about 20,000 in finance, research, and foreign-owned firms).

China’s Foreign Trade and Investment

� China has gone from a closed economy to the world’s largest exporter, and its second largest importer.

� China buys 7% of USA exports, after the EU, Canada, and Mexico, and followed by Japan.

� China supplied 19% of USA imports, followed by the EU, Canada, Mexico, and Japan. Majority of these imports are from USA-invested firms.

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Leading Trading Nations, 2009

C Country

Exports

Billion $ Share

%

Chg Country

Imports

Billion $ Share

%

Chg

1 China 1,202 9.6% -16 1 USA 1,605 12.7% -26

2 Germany 1,126 9.0% -22 2 China 1,006 7.9% -11

3 USA 1,056 8.5% -18 3 Germany 938 7.4% -21

4 Japan 581 4.6% -26 4 France 560 4.4% -22

� China’s trade surplus is mostly with the USA. It runs a deficit with the rest of the world.

� China’s trade surplus has been narrowing recently.

Foreign Investment

� By 2006, China was receiving over $70 billion in Foreign Direct Investment per year. China is the largest recipient of FDI in the less developed world.

� It was also technically the largest recipient in the world, but this amount included amounts from Hong Kong.

� After HK, the USA is the largest investor in China.

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China’s entry into the

� China was an original member of the GATT, but this seat was kept by Taiwan after the civil war until the 1970s.

� China was given MFN status under the Jackson-Vanik amendment, but this required an annual review of its human rights record.

� China was finally admitted into the WTO (along with Taiwan), and agreed to open its import, telecommunications, and banking sectors to foreign competition and investment. Chinese tariff rates came down dramatically.

� China is seen by many as dragging its feet, especially in banking, but this year the sector is starting to open more.

Education� Literacy rate is roughly 90%.

� China has more than 30 million new high school graduates per year, plus 2.4 million traditional college graduates, 1.9 million returning adult graduates, and 150,000 advanced graduates.

� The most popular majors for advanced graduate study are engineering, management, science, medicine, and law.

� China’s exports have typically been concentrated in labor-intensive products that used to be produced by other Asian countries, but China is starting to move into more higher-tech areas.

� China’s government is making a major investment in its universities, attracting back professors from top-ranked schools in USA and elsewhere. Qinghua, et cetera.

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State Banking

� China has four big state-owned banks, two of which now are partially owned by private owners, plus a number of other smaller national and city banks.

� Local governments have had influence over bank lending, and loans have been biased towards state firms.

� Banking is poorly regulated, and there have been a number of major cases of bank officials absconding with or diverting very large sums.

� Banking has had a high non-performing loan ratio for the past decade or more, and under Premier ZHU Rongji the gov’t tried to address the problem, with mixed results.

� China has a very high savings rate, and deposits remain in state banks due to implicit state guarantees.

China’s Bubbles?

� For almost two decades, China has been trying to privatize its housing stock. Prices have soared, and analysts expect they have a housing bubble.

� Since 1990s, China has had stock markets (Shenzhen and Shanghai) for shares of partial ownership in state firms and some new private firms.

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Stock Markets� Shanghai Exchange created in 1990, Shenzhen in 1991.� Foreign investors segmented into B shares market (USD in

Shanghai, HKD in Shenzhen) – Forex capital transactions are still not convertible.

� Only state’s best performers initially allowed to list, but state still controlled a majority of shares – stocks a way to raise capital from public without privatizing.

� Market capitalization 26% of GDP in 1997, 30% in 2005.� Market stagnant from 2001-2006, then bubble began.

Shanghai Composite Index has risen 167% in the last year, as Chinese consumers look for higher returns.

� P/E ratios twice as high in Shanghai than HK, for the same firms.

� Cheng: 70% of listed firms really bankrupt, should be delisted.

In 2008, the SSE lost 70% of its value!

Shanghai Composite Index

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Nominal Index

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China’s Exchange Rate Controversy

� China pegged RMB to the Dollar in 1994 at the black market rate, which made China’s exports even cheaper. Currency had been considered overvalued.

� China’s inflation rate has been lower than ours since 1997, and the currency has become more desirable.

� China now accounts for more than 10% of U.S. imports, and is blamed in USA for loss of manufacturing jobs. The USA has lost 2 million manufacturing jobs since 1995, while China has lost 16 million.

� China runs a large current account surplus with the U.S. but a deficit with the rest of the world. Net trade surplus plus financial account surplus � BOP surplus.

Currency Issues� After 1997 Asian Financial Crisis, China did not devalue the Yuan as expected, as maintained limited convertibility.

� Instead, they began to build up large foreign exchange reserves – mostly invested in US Treasuries.

� This savings outflows counteracts the Balance of Payments surplus from trade and foreign investment, and keeps the currency from appreciating and making exports more expensive.

� The problem is that these purchases of foreign reserves increase the money supply, and can be inflationary.

� Chinese began changing peg after 2006.

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1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004

Adjusted for CPI Inflation

1990

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U.S. Dollar

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Japanese Yen

Real Exchange Rate for the Chinese Renminbi

In real terms, Yuan has appreciated since 2006

Real Direct Exchange Rates

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1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

Monthly Data

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RMB Euro Pound

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Will the Currency Keep Appreciating?

� Exchange rate kept low through massive purchases of U.S. Bonds by People’s Bank of China, which now holds more than $1 trillion of US government debt.

� Foreign exchange reserves have financed money growth, but this has been met (so far) by rising money demand.

� Expectation of future appreciation provides implicit insurance for those holding Chinese assets.

� China now pressured to allow currency to revalue or even float, but this is dangerous to banking sector. Alternative may be price inflation from BOP surpluses.

What will the Chinese Do?

� Before 1994 Devaluation: inefficient state enterprises, massive NPL problem in state banks, overvalued RMB.

� RMB kept low after 2000 through massive purchases of U.S. Bonds by PBC. Rising forex reserves financed money growth, but accommodated by rising money demand.

� Inflation rose after 2004, and PBC included other currencies in peg. In real terms, RMB rose 25% against the Dollar, easing inflationary pressure but eroding value of Dollar assets.

� Chinese consumption is still relatively low share of GDP.

EP2

Slide 54

EP2 If you owe the bank Elliott Parker, 7/6/2009

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What if the Chinese stop lending?“If you owe the bank $100 that's your problem. If you owe the

bank $100 million, that's the bank's problem.” - J. Paul Getty

If we owe foreign central banks $1 trillion, then what happens if they think we can’t pay them?

� This debt is denominated in Dollars, so depreciation hurts them, not us.

� A depreciation of U.S. Dollar will increase exports and value of U.S. FDI in China, but reduce exports.

� You can’t, however, keep borrowing easily after that. Interest rates will rise, along with the U.S. risk premium.

� We will also lose the seignorage from the Dollar’s use.