General 13/06 Flashcards
What are the main problems for advanced countries in order to restore growth?
Non-economic factors:
- ageing populations;
- falling long-term rates of economic growth;
- inability to engage in substantive and lasting reforms.
Macroeconomic problems:
- the poor state of finances;
- institutions entering a spiral of decline from which it is difficult to escape.
The steady downward trend is due to:
1) the exhaustion of the supply of educational improvements;
2) the exhaustion of the gains from past innovation.
The Rule of 70
To double the income, a country needs 70/g years, in which g is the constant growth rate.
Chinese Growth
The People’s Republic of China was born in 1949, and it started its industrialisation process [investments in heavy industries: steel, concrete, machinery] immediately.
In 1978 Deng Xiaoping started a series of reforms and a general opening up of the Chinese Economy.
❶ Gradual reforms started in rural areas with township and village enterprises (TVEs).
❷ Then first steps followed to open up the economy to foreign trade and investment [which only started to play a significant role in the 1990s].
❸ More generally, China’s economic reforms model became “Crossing the river by feeling the stones”.
❹ Gradualism was a means to:
- circumvent political resistance to reform;
- adopt a pragmatic approach in a heavily distorted environment where the ‘first best’ solutions were unlikely to apply.
❶ Decentralisation and incentives became a powerful tool for progress within the confines of central political guidance.
❷ The distributed benefits of reforms to a large part of the population, to local government and party officials generated strong incentives to pursue growth and promote the market economy.
❸ A dual-track system allowed the survival of the planning system [avoiding a collapse in production] and an unplanned economy to emerge.
The 3 phases of China’s reform
The first phase revolved around the search for the right economical institutions for China.
The second phase started in 1993 with the national congress laying out a comprehensive plan to build the institutions for a market-driven economy. During this phase, there was the entrance of China into the WTO (2001). There was also an explosion in the foreign investment
The third stage happened from 2004 onwards. We have 2 main ingredients. The first is the gradual expansion of the social safety net -> China started to think about national welfare policy. They had a vast working-class and needed to start thinking about pensions, housing and other forms of welfare execution. The other factor was a return to industrial policy -> they started 16 megaprojects and the five-year strategy from 2015 had a great focus on industry policy.
Recent return to industrial policy to the government’s forefront since 2015.
China’s Demographic Transition
Pre-divident: pre-industrial society, high birth rate but also mortality.
Early-divident: with an increase in food supply and sanitation, the death rate falls rapidly as life expectancy increases and the population overall increases. This is a classic case for developing countries, the position of many African countries nowadays.
Late-divident: death rate continues to fall, reaching a floor level and remaining stable from there on as no more significant health and food improvements can be made. The birth rate starts falling and so the total increase in population keeps increasing but at a smaller rate.
Post-divident: birth rate keeps decreasing and the overall population is stable or slowly increasing
No-more-divident: the birth rate is very low and the population starts to decrease slowly or keeps stable. Current situation.
Economic implications of the demographic trends
For a country to grow it needs investment (infrastructure investment, then human capital investment, research, etc).
Impeeding factors to investment:
Too low incomes do not allow suitable levels of savings
Too low incomes do not allow to support high birth rates, which are expected to counterbalance a low life expectancy
In countries late-divident countries, the global dependency rate is very low and frees up resources for saving and, therefore, investment
Dependency ratios: children/adults, elderly/adults, (children+elderly)/adults.
During the 35 years between 1975 and 2010, China enjoyed a period with a very relevant positive gap between the working population vs dependent population, allowing for a window of opportunity during which investment was high.
From now on the old-age dependency ratio comes back to grow (China has entered its fourth phase of DT).
This rise some problems in terms of the welfare state: pension problems firstly, which may slow down future growth.
Middle-income threat: you are stuck in a situation where you are not rich enough to pay for the old population.
History of China’s Economic Growth
❶ Pre-1978 period, growth comes from increases in both physical and human capital. TFP declines by 1.07% a year in this period.
❷ After 1978, capital accumulation and TFP growth reversed their roles [The physical capital/output ratio remained constant and the growth rate of hc was lower]. In contrast, TFP grew rapidly at 3.16% a year, equal to 78% of the growth of GDP per capita.
Ak Mod
The total final output per capita Y depends on:
A: Total Factor Productivity, Knowledge and Technical efficiency
K: Capital (financial c., buildings, technical plants, etc.)
L: Labour (number of employees, worked hours, Skills)
Why do we need sustainable growth?
Demography, growing demand for better life quality and well-being. With growth, it is easier to manage many of the problems we face. In order to have growth, we need to ensure a good quality of fundamentals: human capital, institutions’ quality, tax burden, public and private debt, rules and trust.
Understanding Total Factor Productivity Differences
- Human Capital: worker’s skills -> this comes from education and training (more education and training usually means better wages)
- Technology: more efficient technologies increase the productivity parameters.
- Institutions: foster human capital and technology growth by securing basic rights such as A) Property Rights B) The Rule of Law C) Government Systems D) Contract Enforcement
The Middle Income Trap
Several developing countries experienced rapid economic development. At some point in their development they began to experience economic stagnation [or slower growth compared to previous levels] over a sustained period of time: a phenomenon labelled as the ‘middle income’ trap.
Middle-income countries find themselves in a trap because they can no longer compete in standardised, labour-intensive commodities, as wages are relatively too high (can’t be simply a place of cheap labour anymore), but they have not achieved the ability to compete in higher value-added activities on a broad scale, as productivity is relatively too low.
The migration of people from the unproductive sides of the country to the productive parts slows down or the population just gets older.
It is very difficult to keep moving up the value chain (you can only go so far with production of let’s say tomatoes like Mexico and to move to a technological hub is impossible).
How to get out of the middle income trap?
Education, Specialization, Democratization, Strong middle class Large scale institutions at a world-class level
Factors that indicate that China might be stuck in the middle income trap
- China is losing its advantage in low-cost labour. A decline in China’s workforce could drive up wages faster than productivity gains.
- China has already experienced a slowdown in TFP growth in recent years
- Potential slowdown in the near future: The IFM (2017) warned that for China: “A sharp slowdown in the future remains a risk”.
Evolution of Employment in China
- Underemployment in rural areas allowed the industrial sector to expand and increase its labour force with no pressure to raise wages.
- However, since 2005, the “labour shortage” phenomenon has begun to turn up in coastal cities
- This finding has important policy implications both for the general global economy as well as for China’s future development.
Policy Themes for Getting ou of the Middle Income Trap
Policymakers in middle-income countries must focus on the transition from productivity growth stemming from inter-sectoral resource reallocations to intra-sectoral catch-up technological growth (moving up the value chain). Also develop more mature institutions. Focus on:
- Innovation: Competition and new capital investments and R&D can create an environment for innovation
- Cities: ‘Smart cities’ have become a dominant theme in recent economic development literature
- Demography: The danger for all middle-income countries is that of growing old before they get rich
China: Growth Sources, Trends and future Challenges
Capital Accumulation
Low dependency ratio conducive to high savings; unlimited supply of labour preventing diminishing return on capital
Challenge: Unsustainable. It is difficult always to find new productive investments, especially when there are shortages in the labour market for high-skilled positions
Quantity of Labour
Population structure guarantees labour supply, which turns into a comparative advantage in labour-intensive manufacturing.
Challenge: Unsustainable. Demographic dividend disappears as economy passes Lewis turning point (situation in economic development where surplus rural labour is fully absorbed into the manufacturing sector)
Human Capital
Education expansion and mass labour entry improves the quality of stock of workers
Challenge: Education expansion eventually slows, calling for enhancing its quality and equality
Total Productivity Factor (TPF)
An increase from the improvement of incentives and resource allocation system
Challenge: Increasingly challenging and important to sustain growth; requires new sources of increase
TPF (Resource Allocation)
Reallocating efficiency of resources through labour mobility from agriculture to industrial sectors
Challenge: Dominant in the early stage of development; diminishes after Lewis turning point
TPF (Technology)
The utilisation of advantages of backwardness through absorbing foreign technology and management
Challenges: A gap narrows; technological progress increasingly rely on independent innovation
Population Factor
A widely defined demographic dividend is manifested in all factors driving rapid growth
Challenge: Diminishes as China ages; the second dividend available from removing remaining barriers to movement
Romer Model: Increase in the share of research
If we increase the share of the working population doing research, initially the output will go down (as fewer people are working on producing output) but in the long run, the output per person will be higher because we’ve increased our growth rate.
Change in China’s Economic Model
- Old model based on statal intervention and strong exports is no longer sustainable:
The Chinese economy was characterised by high levels of investment, infrastructure building. China has been investing half of its GDP.
But now a lot is lost, most things needed were already built -> they need to shift toward more complex mechanisms.
Another problem is that with such a steep growth the government has more margin for error and people get sloppy, too optimistic, less competent.
A turning point to the Chinese economy came in 2009. Predictions were that a big recession would come, but government policies acted as to not permit that. Boosted investment and spending. This accomplished the goal but was well over what was sustainable. It is sustainable for a big growth rate, but if it falls it isn’t anymore. - More emphasis on private consumption and innovation.
- Challenging implementation of a new sustainable growth model unless China can effectively implement economic reforms.
Signs of an Expected Regression in China’s Economy
- Real state bubble: Chinese property is too expensive and there was an overbuild -> many infrastructures for not enough people
- Stock market bubble
- Municipal debt: Chinese municipal governments shouldn’t be borrowing money, but they were doing it and incentivised by the central government to keep up with the desired investment levels.
- Excess capacity: too much stimulation of investment and confidence, many enterprises and not sustainable that are being kept afloat by cheap credit or political privileges.
- Capital flight: capital leaving the country with fear of the economic collapse, which only further speeds up the process.
However, there are reasons to be optimistic. China has a lot of human capital (they have been investing in this area).
Major long-term challenges facing China’s Economy
- Incomplete transaction to a market economy (still a huge number of state-owned enterprises).
SOEs in the banking sector: creation of the Big Four to support companies through funding in specific sectors - State-dominated banking sector, with excess credit (“cheap money”) and high debt
- Large internal imbalances (of savings, fixed investment and consumption)
Xi Jinping’s new 5-year plan: Dual Circulation (Domestic + External)
Domestic:
- increase domestic demand
- upgrade supply chains
- seek more independence in key technology (more investment in Research and Development)
External:
- welcome Foreign Direct Investment (FDI) in China
- strengthen the BRI strategies
- take advantage of regional trade integration
Key factor for China’s sustainable development: Human and Social Capital
- China is at the forefront of a global transformation and aims to establish itself as a major hub for both the generation of knowledge and the production of innovation.
- The initiative intends to “transform China from a manufacturing giant into a world manufacturing power” by 2049.
- The enhancement of innovation requires building a learning economy, the basis of which is social capital.
Social capital: the networks of relationships among people who live and work in a particular society, enabling that society to function effectively”. It involves the effective functioning of social groups through interpersonal relationships, a shared sense of identity, a shared understanding, shared norms, shared values, trust, cooperation, and reciprocity.
“Made in China 2025” Initiative
- The initiative intends to “transform China from a manufacturing giant into a world manufacturing power” by 2049.
- China is quickly gaining ground on advanced economies in high tech value chains.
- China’s share in manufacturing global value chains has risen sharply from 6% to 19% in the past 15 years at the expense of the EU.
Digital Silk Road (DSR)
China aims to use the Digital Silk Road (DSR) to advance global
technological integration.
1. The DSR draws on three core state-driven strategies: (a) Made in China 2025, (b) the BRI, and (c) China Standard 2035.
2. The defining feature of DSR has been its core focus on connectivity infrastructure, both in telecommunitation/5G, hardware, and smart cities.
3. Chinese companies have signed more than 116 smart-city of safe-city partnerships exporting China’s ‘sharp eyes’ approach to high-tech urban policy.
China needs to Rebalance sources of Growth
Previous drivers of growth are losing traction and others are growing:
- Strong decrease in the contribution of TFP
- Sharp decline in Labour Contribution
- Oversize/Overreliance on infrastructures
- Improvements in the added value of exports
- Expansion in high technology exports
New Reforms: the 3 Ds
- Removing Distortions: resources should be allocated to the most productive sectors of the economy
- Accelerating Diffusion: extend current production frontier to global frontier
- Fostering Discovery: focus on R&D
New Growth Model for Chinese Cities
- Talent Attraction and Retention
- Innovation Capacity
- World-Beating Private Firms
- High Market Transparency
- High Quality of Life
- New Regional Clusters of Cities
- Environmental Quality
The Case of Shenzen
The early 1990s saw the start of the second season of major reforms based on six policy lines.
❶ Structural reform of government and administration systems
❷ Promotion of high-tech companies
❸ Great efforts to keep local bellwether companies
❹ Opening of the ChiNext subsidiary of the Shenzhen Stock Ex.
❺ Allowing international acquisition
❻ Attraction of talents with a study-abroad background.
Shenzhen successfully transformed the foundation of its
economic growth from a cheap labour-intensive industry to a
more innovative and more innovative and technology technology-oriented oriented one.
❶ S. keeps investing in R&D building high-quality tertiary
education Institutions [13 Universitites].
❷ S. encouraged big firms to stay local so contributing to high fiscal revenue.
❸ S. created a positive circulation among talents, entrepreneurs, governments and economic growth.
❹ In 2000 S’s population reached 7 million, almost doubling the 4.2 million line of the master plan [S. is facing a critical shortage of land resources].
Challenges for Chinese Mega Cities
- Sufficient Resources
- Energy Supply
- Security
- Traffic and Mobility
- Waste Management
Social and Institutional gaps China
Rapid growth has been accompanied by social inequality and severe environmental degradation and pollution. Major development challenges are foreseen in pursuing high-quality green development, specifically:
❶ Social Challenges
Closing the inequality gap.
Strengthening health security.
Ageing before affluence.
❷ Institutional Gaps
Strengthening institutions and capacity to support reforms.
Removing constraints on the private sector.
Investing in innovation and human capital.
Belt and Road Initiative: Motivations and Goals
Connecting the vibrant economic East-Asian circle to the rest of the world.
❶ Looking for new export markets: Infrastructure development in countries along the Belt and Road routes will increase growth in their economies and thus contribute to a growing demand for China’s goods and services goods and services.
❷ Vent for surplus to export overcapacity: In order to alleviate the problems created by excess capacity in the construction and associated sectors, Chinese construction companies are encouraged to look elsewhere for opportunities.
❸ Improving digital connectivity: Part of the BRI is improving connectivity among the countries involved by means of soft infrastructure to create the so-called “digital Silk Road digital Silk Road”.
❹ International stature of the renminbi: China has set the goal of making the renminbi a global reserve
currency.
❺ Securing energy supply: A strategic rationale of the BRI is to secure China’s energy supply through new pipelines in Central Asia and Russia.
❻ Support China’s economic rebalancing: Giving greater impetus to the longstanding go west policies
aimed at rebalancing economic development aimed at rebalancing economic development.
❼ Reducing trade costs: As the world’s biggest trading nation, China’s main interest is to reduce the transport costs.
Implications of the BRI to the Global Economy
- Revising the existing international economic order: Technical knowledge intensive are mainly dominated by highly developed countries. The BRI runs mostly through developing countries, consisting a relevant opportunity.
- Rebalancing the global economy: BRI agregate of nations covers 1/3 of the total world GDP.
- Actively promoting globalization: alleviate the imbalance in economic development between developing and developed countries.
Foreign Criticisms to the BRI
- Executing projects in foreign countries that those countries will have severe difficulties in paying back.
- Using the infrastructures for military purposes
- The overarching objective of the initiative is helping China to achieve geopolitical goals by economically binding China’s neighbouring countries more closely to Beijing.
- Beijing is showing ability to finance projects and to leverage over recipients of these loans selling them high-end industrial goods.
- More questionable is whether China’s neighbours will be willing to absorb its excess industrial capacity.
- The lack of political trust between China and some BRI countries is a considerable obstacle. And what about Europe?
The Investment Equation
It’s made up of two parts. The first is the a_i parameter, reflecting the long-run fraction of potential output that goes to investment. If this was the only term, the investment equation would look like the others. The last part is what’s new, and it indicates how the interest rate enters the model. In particular, the amount of investment depends on the gap between the real interest rate Rt and the marginal product of capital r.
The real interest rate Rt is the rate at which firms can save or borrow. For example, Rt might equal 10 per cent, implying that firms can borrow $100 today if they are willing to pay back $110 next year (assuming there is no inflation).
The marginal product of capital (MPK) r is familiar from the long-run model: it reflects the amount of additional output the firm can produce by investing in one more unit of capital. Our short-run model takes r to be an exogenous parameter determined by the long-run model. Since the marginal product of capital is constant along a balanced growth path, we don’t include a time subscript on r.
The Investment Equation in the Long-Run
In the long run, we have that the output gap is 0 and therefore R_t = r and investments become a fixed percentage of the potential output a_i.
Consider the case where the economy has settled down at its long-run values, so the output is at potential and Yt tilde = 0. In the long run, as we’ve seen, the real interest rate prevailing in financial markets is equal to the marginal product of capital, so that Rt = r. In this case, the IS equation reduces to a simple statement that 0 = a bar. The reason is straightforward: when output is equal to potential, the sum C + I + G + EX - IM is equal to Y bar, and therefore the share a bar parameters ac ai ag aex aim must add up to 1. In the long run, then, a bar = 0. In fact, our baseline IS curve will respect this long-run value. We will think of a bar = 0 as the default case. However, shocks to the economy can push a bar away from 0 in the short run.
What makes the short-run output fluctuate is the difference between the R_t and r, if they are equal then we have Y tilde = 0.
Shocks to aggregate demand (shift in the IS curve)
- Changes in consumption relative to potential output
- Technological improvements that stimulate investment demand given the current interest rate
- Changes in government purchases relative to potential output
- Interactions between the domestic and foreign economies that affect exports and imports
Positives of Public Expenditure
It contributes to current effective demand
It expresses a coordinated impulse on the economy
It increases the public endowment of goods for everybody
It gives rise to positive externalities to economy and society
The Government Budget Constraint
Government Purchases + Transfer Payments (Social Security, Welfare payments, etc) + Interest Payment on Debts = Taxes + New Borrowings + Change in Money Stock (Printing more money)
Uses = Sources
We’ll assume that Tr and delta_M are zero.
The Government Budget Constraint
Government Purchases + Transfer Payments (Social Security, Welfare payments, etc) + Interest Payment on Debts = Taxes + New Borrowings + Change in Money Stock (Printing more money)
Uses = Sources
We’ll assume that Tr and delta_M are zero.
Government Borrowings
A government can increase its debt if the GDP is growing even faster -> same or less Debt/GDP ratio.
If a country’s debt-GDP ratio gets to be too high, lenders may become worried about the government’s ability to repay its debt, and may stop lending. This will itself prevent government borrowing from growing too large, but it may also force the government to turn to the printing press in order to satisfy its budget constraint. At high and growing debt-GDP ratios, the possibility of high or even hyper inflation becomes a concern. As soon as investors doubt the ability of the government to finance its spending, they may demand higher interest rates on new borrowing. These higher interest rates will compensate them for the possibility that the debt will be repaid with dollars that are worth less because of future inflation. The higher interest payments in turn make it more difficult for the government to satisfy its budget constraint and may precipitate a crisis.
Evolution of Debt
deltaB/Y = (r-g)(B/Y) + (G - T)/Y -> evolution of debt. (G-T) is called the primary balance. Debt is sustainable when at least change in debt per GDP is constant, cioè doesn’t increase.
In terms of the derivative: d_1 + (r - b)*b_0
To account for the inflation factor:
i = r + pi
n = g + pi
Main Functions of a Central Bank
Oversight on the creation of money via specific monetary policy’s instruments (see later)
Acting as the banks’ bank, granting loans to the banks and acting as lender of last resort.
Supervising and monitoring the banking system to ensure compliance of financial conditions and safeguard its good and healthy status.
Monetary Policy - Central Banks
In case of an increase in the money stock via an open market operation, the central bank buys bonds and pays them on the market with newly printed money, so the price of bonds increases and the interest rate decreases with the increase in Ms.
In case of a contractionary monetary policy, the central bank sells bonds and withdraws money from the market: the price of bonds decreases, and the interest rate they pay increases, together with the decrease of money supply.
Pb = 100/(1+i), Pb = price of a bond, i = interest rate. Their relation is negative
Lending Rates
Interbank rates (EURIBOR, LIBOR, etc) are flexible and determined by the supply and demand relantions.
CB process of adapting MS to fit the inflation goals
The central bank can peg the nominal interest rate at a particular level by being willing to supply whatever amount of money is demanded at that level. That is, it makes the money supply schedule horizontal.
Stickiness of Prices
Prices need time to adjust to changes in interest rates, meaning that CB can cause a rapid boom or recession, as output changes are going to occur faster than changes in the prices that will counterbalance this factor.
Short-Run Model
IS curve + MS curve + Phillips curve
Classical Gold Standard
international monetrary system was in practice during the first wave of globalization (1870-1914). It then ceased to exist due to the outbreak of the WWI in 1914 that lead central banks to suspend gold payments.
The system worked well independently to the fact that it was not born in an international conference; countries simply started adhering to this standard over time. At a certain time - after 1907 - the global gold supply stopped to increase, causing major issues to the growth of the global economy that started to be sustained by sterling pound holdings that could be converted to gold at any time in any amount - they were considered as safe as gold. Another big plus is that contrary to gold holdings, central banks could invest sterling holdings to earn interest.
