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THE GLOBAL ECONOMY Structural Issues and Future Trends

More on China: Developments and Challenges

1. INTRODUCTION

2. JAPAN AND CHINA – HISTORICAL ACCOUNT

3. MORE ON JAPAN

4. MORE ON CHINA

5. PROGRESS IN AMERICA

6. WILL THE EURO SURVIVE?

7. A SNAPSHOT OF BRICS

8. ECONOMIC OUTLOOK – SOME REFLECTIONS

arne jon isachsen, june 2013

In Economics – as in other walks of life – there are fads and fashions.

Significant changes have taken place over the last couple of years:

• America is back

• The euro is out

• Japan – the new Superman?

• China goes sideways – new leaders have yet to prove themselves

• BRICS – something of the past?

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1. INTRODUCTION


This list a couple of years ago would have looked like this:

• America and Europe are out

• Japan is still in the doldrums, i.e. in her second decades of lost

opportunities

• China knows how to ride a tiger

• BRICS carry the day

Social sciences are not like physics, with irrefutable laws. Social sciences

deal with human beings. Their behavior is not conducive to rules or laws

waiting to be found. Calls for a good deal of humility. (Hayek 1974)

Start with studying Japan’s relation to China, and Japan’s relation to the US.

Gives a good grasp on structural issues and trends for the global economy.

3 arne jon isachsen, june 2013

December 2012: Shinzo Abe of Liberal Democratic Party (LDP) returns as prime

minister. Does not seem like the same man who left office in 2007, after one year.

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2. JAPAN AND CHINA – A HISTORICAL ACCOUNT

1868 Meiji Restoration (not Revolution) in Japan. Have to learn from

the West and does so quite successfully

1894-95 China loses the first Sino-Japanese war.

The days of the emperor are numbered

1904-05 Russia loses war against Japan

1912 The emperor is ousted. Two thousand years tradition is broken.

1937-45 Second Sino-Japanese war. Started in Manchuria where Abe’s

grandfather was instrumental as a military man. Atrocities that

still linger. Both South-Korea and China hold them against Japan

to this day.


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1921 Chinese Communist Party (CCP) established, Mao is there.

1934-35 The Long March – the Communists survive, and Mao takes the reins.

Chiang Kai-Shek has to cooperate with CCP against the Japanese.

1949 Peoples’ Republic of China established. Chiang Kai-Shek to Taiwan.

1950-53 Korean war – no one wins. Americans against Chinese. Korean

peninsula divided between North and South.

1958-61 Great Leap Forward – more than 30 million Chines die.

1966-76 Cultural Revolution – anarchy that is hard to imagine. Mao dies.

1978-92 Deng Xiaoping in charge (born in 1904). Pragmatic: “It does not matter

whether the cat is black or white as long as it catches mice.”

Gradual and careful: “Feeling the stones while crossing the river.”

1989 Tiananmen Square incidence. CCP and Deng draw the line.

Corruption, Inflation, Democracy on the agenda. Deng’s 24 characters:

Keep a low profile, don’t take leadership, and develop your strengths.

1989-92 Which way will China go? Deng’s Southern Tour and he carries the

day. Renewed emphasis on Reform and Open Up.


Restoration of Japan after WW II very successful,

like Germany’s “Wirtschaftswunder”.

Toyota, Sony, Mitsubishi, Toshiba, Hitachi etc. become well-known brands.

Mixed feelings in America – will Japan take over?

Pressure from the US for Japanese Yen (JPY) to appreciate.

1971, one dollar costs 360 JPY.

These days, about 100 JPY for one dollar.

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3. MORE ON JAPAN


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China takes note. Will not give in to American pressure.

Fix the price of one dollar at 8,28 RMB from 1995 to 2005.

A controlled and slow appreciation of RMB follows.

Today’s price about 6,15 RMB for one dollar.

Source: The Pacific Exchange Rate Service

100

150

200

250

300

350

400

Jan-65

Jan-66

Jan-67

Jan-68

Jan-69

Jan-70

Jan-71

Jan-72

Jan-73

Jan-74

Jan-75

Jan-76

Jan-77

Jan-78

Jan-79

Jan-80

Jan-81

Jan-82

Jan-83

Jan-84

Jan-85

Jan-86

Jan-87

Jan-88

Jan-89

Jan-90

YENUSD1965-1990


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Source: Federal Reserve Bank

6

6.5

7

7.5

8

8.5

9

3-Jan-95

18-Oct-95

2-Aug-96

21-M

ay-97

11-M

ar-98

23-Dec-98

8-Oct-99

25-Jul-00

10-M

ay-01

1-M

ar-02

16-Dec-02

1-Oct-03

20-Jul-04

4-M

ay-05

22-Feb

-06

6-Dec-06

20-Sep-07

7-Jul-08

23-Apr-09

9-Feb-10

24-Nov-10

12-Sep-11

28-Jun-12

17-Apr-13

RMBUSD1995-2013


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Source: The Pacific Exchange Rate Service

Jan-04

Apr-04

Jul-04

Oct-04

Jan-05

Apr-05

Jul-05

Oct-05

Jan-06

Apr-06

Jul-06

Oct-06

Jan-07

Apr-07

Jul-07

Oct-07

Jan-08

Apr-08

Jul-08

Oct-08

Jan-09

Apr-09

Jul-09

Oct-09

Jan-10

Apr-10

Jul-10

Oct-10

Jan-11

Apr-11

Jul-11

Oct-11

Jan-12

Apr-12

Jul-12

Oct-12

50

60

70

80

90

100

Aug-69

Nov-69

Feb-70

May-70

Aug-70

Nov-70

Feb-71

May-71

Aug-71

Nov-71

Feb-72

May-72

Aug-72

Nov-72

Feb-73

May-73

Aug-73

Nov-73

Feb-74

May-74

Aug-74

Nov-74

Feb-75

May-75

Aug-75

Nov-75

Feb-76

May-76

Aug-76

Nov-76

Feb-77

May-77

Aug-77

Nov-77

Feb-78

May-78

Aug-78

TheJapaneselostcontrol,nottheChineseYen Renminbi


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1988-89 and Japan hits the wall.

Real estate prices down 60-70 %, stocks even more.

1990s – the lost decade, growth of meager one percent.

2000s – more of the same.

Deflation, and government debt accumulates, about 240 % of GDP now.

2006 Shinzo Abe is prime minister for one year.

Back in December 2012, with five PMs in between.


11

The Economist, May 18th 2013


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LDP has run Japan for 54 of the last 58 years. Abe has done his homework.

“After resigning, for six years I have travelled across the nation simply to listen”.

Focus on economics. Draws upon US experience.

• 10 trillion in fiscal stimulus.

• Inflation target of two percent for Bank of Japan in two years.

• Structural reforms, joining Trans-Pacific Partnership (TPP) with America

and ten other countries. Not popular with agricultural and other strong

interests domestically. Also, double sales tax to 10 % next year.

- More positive to incoming FDIs and immigration.

- Reduce overregulation

- More women in the work force


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Structural reforms – somebody will lose. Robust societies can deal with that.

Scary element in Abe’s program: His approach to history.

Enough apologies. “Enrich the country. Strengthen the army”.

Wants the constitution amended:

• Right to have a standing army, navy and air force

• Emperor restored as head of state

• Collective duties emphasized over individual rights

Need 2/3 majority in Diet and simple majority in referendum.

Abe wants the international respect he sees as his nation’s due.

Does that conflict with Mr. Xi’s “Chinese Dream”?


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Source: Worldbank Data


In 2001 China joins World Trade Organization (WTO).

Staying the course as Jiang puts China on the path to more market,

with an outside referee (WTO). (Compare Japan now may join TPP.)

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4. MORE ON CHINA

1992-2002 Jiang Zemin (and Zhu Rongji) in charge and holding three positions:

• General Secretary of CCP

• President of PRC

• Head of Central Military Committee (CMC)

2002-2012 Hu Jintao (and Wen Jiabao) in charge. Hu – likewise – all three postions.

Historic event – peaceful transition of power.

2012 Again, peaceful transition of power, to Xi Jinping (and Li Keqiang).

1978-2002 Annual economic growth of 9,6 %

2003-2012 Annual economic growth of 10,4 %


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China’s share of world GDP from 4 % in 2000 to 15 % in 2012.

Time to be more assertive?

2013, estimated growth of 7,5 %. Reached the end of the high-growth period?

Yes – most likely growth will come down to 6-7 % and over time,

further down. Why? Because of mathematics and demographics.

• 10 % growth for seven years, and GDP doubles.

5 % growth in year 8, and in absolute terms, same growth as in year 1.

• 2012, number of people in working age starts to come down. Dependency-

ratio on the increase. Payback time for the demographic dividend.

Real investments 50 % of GDP, and private consumption only 35 %. Should be

the other way around. What does that take? More equal distribution of income.


19

The Economist, October 27th 2012


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Corruption endemic to China. May undo the system. Sort of Catch 22:

• If you don’t get rid of corruption, China will fall apart.

• If you are to get rid of corruption, the one-party-system shall have to go.

Corruption, Distribution, Environment; something has to give.

If not, a drama à la 1989 may be in for a replay.

In the fall CCP’s Central Committee will meet.

Until the mid-1990s, reforms without losers. Not possible now.

The biggest vested interest is the interest represented by CCP itself.

Xi/Li need to consolidate power in the months ahead.

Are those who benefit so abundantly from the current system

able and willing to act to change it?


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What does CCP has up its sleeve on economic reforms?

• Take on State owned enterprises (SOEs) and State owned banks (SOBs).

– Pay dividend to the owner, the Ministry of Finance

– Competition from private companies, i.e. break up monopolies

– SOBs channel more money to private small and medium sized firms

• Do away with hukou-system, i.e. unfair registration systems.

• Increase government commitments to fund education, health and

pensions (increased dividend from SOEs will come handily in here).

Zhu Rongji in late 1990s: Restructured SOEs and 40 million people lost

their jobs. He sweetened the pill by opening up the housing market.

People could buy the state owned flat they lived for a penny or two. You

lost your job, but got a flat.


22

The Economist, July 14th 2012


• Monetary policy very expansionary and creative.

– Quantitive Easing (QE), Fed buys of securities from the banks, so

they can increase loans.

– The rate of interest drops to almost zero.

• Fiscal policy likewise quite expansionary.

– Budget deficit of 10 % of GDP in 2009.

– Estimated budget for 2013, reduced from 5,3 % to 4 % of GDP.

– Government debt close to 100 % of GDP.

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5. PROGRESS IN AMERICA

September

2008

Lehman Brothers bankrupt. Financial crisis.

American financial institutions had behaved very badly.

October 2008 TARP, with 700 billion dollars, to save the financial system.

Quick and reasonably successful action.


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Structural policy, mixed bag.

• Consolidated banking systems, took losses, and lending resumed

• But stalemate in Congress on tax increases and cut in budgets

Four years of hardship, beginning to pay off.

Markets more positive on the US economy.

“Reshoring” – meaning that manufacturing comes back to America.

Fracking revolution, and America reduces her imports of oil.

Unemployment still high, more than 7 %.

Expansionary monetary policy until unemployment down to 6,5 %.


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Deficit on current account down to 2 % of GDP.

American system quite ROBUST. Can take a beating, not easy in China.

One country and can restructure the banking system, not so easy in EU.

The “sequester” – how will that affect the economy?

Congress cuts across the board on public outlays. Full effect in the fall.

America is working on the Trans-Pacific Partnership (TPP) with Asia.

Transatlantic Trade and Investment Partnership (TTIP) with EU .

Geopolitical purpose. Not to contain China, the Americans claim.

David Cameron will renegotiate the deal with EU and put it to a referendum

In 2017. Not to the liking of the Americans.


28

The Economist, April 28th 2012


The EU went one step too far when introducing the euro in 1999.

Now, for six consecutive quarters the euro area has experienced

negative economic growth.

And the rate of unemployment is 12,1 %.

When you no longer can change the exchange rate, nor have an

independent interest rate, transfers between countries are necessary.

Monetary union should be preceded by fiscal union. Instead, assumed

away fiscal problems through the Stability and Growth Pact (SGP).

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6. WILL THE EURO SURVIVE?


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Source: Perspektivmeldingen 2013

10 year yield on selected European government bonds


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For B to be successful, A is a requirement.

Nevertheless one goes ahead and creates B. And A shall have to follow suit.

B is monetary union. A is fiscal union. Will the gamble – because that is

what it is – be brought to a successful end?

Democracy is not working well here. Politicians and bureaucrats in Brussels

do not take big issues to the people.

First step towards fiscal union is the establishment of banking union.

• Common rules for equity etc. for banks

• ECB as the supervisor

• Common insurance scheme for deposits up to 100.000 euro

• Common resolution mechanism for banks


32

But Germany and other northern countries with the euro are skeptical to

bailing out Club-Med banks and depositors. Dragging their feet.

Amendment to EU’s treaty is called for, says Angela.

Alternative für Deutschland (AfD), new party in the making.

Main focus – return of the German Mark.

Orderly dissolution of the euro is feasible, they claim.

Angela’s “If the euro fails, Europe fails” does it not hold water?

Sometimes the unthinkable becomes the inevitable.

November 1989 the Berlin wall crumbles.

Two years later Russia exits Soviet Union.

Will Germany exit the European Monetary Union?


33

The Economist, August 11th 2012


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Göran Persson, who was PM in Sweden for ten years:

“The euro is too important not to succeed.” What kind of analysis is that?

With separate currencies each country again is better equipped

to take responsibility for its own economy.

The verdict is still out on the euro.


In 2001 Jim O’Neill of Goldman Sachs coined the concept of BRIC, for

Brazil, Russia, India and China. Well. Perhaps we should get together?

And so they did. In 2011, South-Africa is added to the list.

A mixed bag. Not so much in common. Less successful of late.

Brazil grew at 7,5 % in 2010, compared to 1 % in 2012

India grew at 9 % in 2010, compared to 5 % in 2012

China grew at 10,4 % in 2010, compared to 7,8 % in 2012

Russia grew at 4,3% in 2010, compared to 3,4% in 2012

South-Africa at 2,9% in 2010, compared to 2,5% in 2012

India was a success story 2004-2010, but growth has since then tapered off.

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7. A SNAPSHOT OF BRICS


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China and India have unsettled borders. Skirmishes a few weeks ago.

Li Keqiang in New Dehli recently, calm things down and increase trade.

Problem – India’s export to China a fraction of trade in the other direction.

Last week, Mr. Singh, PM of India, to visit Japan.

2011, Bilateral economic partnership, and trade increased by 35 %.

2012, Common naval exercise.

But the nationalistic rhetoric of Mr. Abe does scare Mr. Singh.

Brazil does not like China’s huge growth in exports, making life difficult

for domestic firms. Also, big FDIs from China to Brazil exploiting

natural resources. Similar to colonial times.

In general, BRICS trade more with the developed nations and with

neighbors than with each other.


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8. ECONOMIC OUTLOOK – SOME REFLECTIONS

Economic forecasting is a risky business.

Ben Bernanke in 2004:

The Great Moderation, the substantial decline in macroeconomic

volatility over the past twenty years, is a striking economic

development….I have argued today that improved monetary policy

has likely made an important contribution not only to the reduced

volatility of inflation but to the reduced volatility of output as

well…. This conclusion on my part makes me optimistic for the

future, because I am confident that monetary policymakers will not

forget the lessons of the 1970s.

However, forecasts we need. Here I am providing one for

the long run by OECD and one for the short run by IMF.


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OECDs estimated annual GDP growth. Percent.

1995-2011 2011-2030 2030-2060

World 3,5 3,7 2,3

OECD 2,2 2,2 1,8

USA 2,5 2,3 2,0

JAPAN 0,9 1,2 1,4

Great Britain 2,3 1,9 2,2

Germany 1,4 1,3 1,0

France 1,7 2,0 1,4

Italy 1,0 1,3 1,5

Non-members 6,7 5,9 2,8

China 10,0 6,6 2,3

India 7,5 6,7 4,0

Indonesia 4,4 5,3 3,4


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Economic growth is one thing. How the fruits of labor is distributed

is another.

While income distribution GLOBALLY has become

less skewed (Why? China’s growth, of course), income distribution

WITHIN most countries is becoming increasingly uneven.

Since 2009 the one per cent with highest income in America has

appropriated 81 % of income increase. Obama in his second inaugural

address:

“Our country cannot succeed when a shrinking few do very well and a

growing many barely make it.”


In the long run fairness and inclusiveness enter the picture.

In China in 1978, income distribution more evenly distributed than

in Norway. China today, more uneven than in America.

Deng said that somebody will get rich first. Yes – he was right.

For growth to be sustainable – to get beyond “Middle Income Trap” –

you need to have INCLUSIVE political and economic institutions.

Need an unbiased system of law that secures private property.

EXTRACTIVE political and economic institutions do not make for

sustained economic growth.

42 arne jon isachsen, june 2013

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