Sunday, 31 January 2010

Taking the wrong road to recovery - by Michael Burke

Michael Burke, a regular contributor, to Socialist Economic Bulletin, has an article 'Taking the wrong road to recovery' in Tribune.

Memo to Martin Wolf - India and China show that to maintain support for globalisation reliance on 'trickle down' needs abandoning

In his blog from Davos Martin Wolf, chief economics commentator of the Financial Times, notes: 'I am listening to Lawrence Summers as I write. He has emphasised that we cannot maintain global integration if it is seen as a source of domestic disintegration. This tension - that between the global economy and domestic politics - is a central challenge of our time. It affects everything we try to do.'

Martin Wolf is a very strong supporter of global economic integration for reasons he set out in Why Globalisation Works and numerous other writings. The danger he warns against is that popular backlashes in favour of protectionism will undermine the process of global economic integration. In the US and a number of European countries popular sentiment in favour of protectionism has increased - although its effect on those who make economic policy, as regards the most important issues, is as yet far more limited.

For slightly different reasons to Martin Wolf this blog is also strongly in favour of the process of global economic integration and against protectionism. The reason for this is that division of labour, followed by investment, is the most powerful force in economic growth and in the modern era participation in increasing division of labour is necessarily international in scope. Preventing popular, indeed any, backlashes in favour of protectionism is therefore an important question.

In dealing with this issue Martin Wolf could reflect on the difference in sentiment between India and China on the one hand and the US and Europe on the other. In India a government pledged to take the country down the strategic path of integration in the international economy was re-elected with a convincing mandate. In China, as anyone who visits the country knows, popular support for the 'opening up process' (official terminology for the country's orientation towards globalisation) remains high. The contrast in popular mood between India and China on the one hand and the US and Europe on the other is therefore striking.

Part of this difference is, of course, the much more rapid growth of India's and China's economies compared to Europe and the US. However, simply rapid growth is not sufficient to maintain popular support for international economic integration - and while the US and European economies have been expanding less rapidly than India and China they were, prior to the current recession, still growing.

The former BJP government in India achieved rapid economic growth but was tossed out of office by the electorate. Entirely rationally the population will not support globalisation if this merely yields higher GDP figures recorded in statistical works,. They will support globalisation only if it delivers better living standards for them. The majority of India's population considered the BJP's rapid economic growth had not delivered for them and therefore voted against the government.

The strategic concept of the new Congress government under Manmohan Singh was, and remains, 'inclusive growth'. It aimed at rapid growth, using global economic integration as a key means to achieve this, but did not rely on 'trickle down' to make sure the mass of the population shared in its benefits. Conscious programmes of redistribution of resources to rural areas, and less well off sections of the population, were part of the bedrock of 'inclusive growth'.

It is also notable in China that Hu Jintao's 'harmonious society' has included direct measures to redistribute the benefits of growth to those who were not previously perceived as having gained sufficiently. In China's stimulus package to confront the international financial crises, price reductions on consumer durables were targeted on rural areas, the government has reintroduced free education, a major expansion of the health care system is taking place, large scale investment is taking place in the less well off inland provinces etc.

In short, both India and China have abandoned 'trickle down' as the method of ensuring all share in the growth produced by international economic integration.

In the US and Europe, on the contrary, the movement has been towards greater reliance on unfettered free markets. The evidence shows, however, that unfettered operation of the market increases inequality sharply. The most notable result of this is that median wages in the US have relatively stagnated for two decades at the same time as relatively sustained economic growth occurred - it is necessary to look no further than this to understand populist backlashes in the US. In the US the gap in income and wealth between the bottom and top of society has widened greatly, as it has in Britain. The US and Britain by relying on 'trickle down', by the operation of the free market, have therefore sharply increased inequality - and, in the case of the US, deterioration of the economic situation for significant layers of the population has occurred.

India and China, in short, have abandoned 'tickle down' while the US and Europe have embraced it. In India and China support for strategic global economic integration remains high. In the US and Europe a backlash against it has developed.

Martin Wolf, in his entirely justified argument against the US and Europe embarking on protectionism, can therefore consider the contrast in the popular mood in India and China. It may indicate why, to maintain popular support for globalisation, the US and Europe also need to abandon reliance on 'trickle down'.

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This article originally appeared on the blog Key Trends in Globalisation.

Wednesday, 27 January 2010

Investment Not Cuts – by Michael Burke

The British economy may have escaped from recession in the final quarter of 2009 - just. The preliminary estimate for GDP growth in the quarter was the smallest possible statistical rise of just 0.1%. Since the recession began in early 2008 the economy has contracted by 6%. This is the sharpest recession in Britain in the post-WWII period.

Although there are likely to be revisions to the latest data, there can be little dispute about the driving force of the recession. In common with many other economies, the primary cause of the recession has been the slump in investment (gross fixed capital formation). From its peak at the end of 2007, investment has fallen at a rate four times as fast as the decline in GDP, and is down 24%, making it the major contributor to the aggregate decline - as shown in the chart below.

From a peak in Q1 of 2008 real GDP has fallen an annualized £80bn in real terms. Over that time investment has fallen by £53bn, or two-thirds of the entire decline in output. In addition, business inventories have fallen by a cumulative £10bn over the course of the recession. Taken together, the decline in investment and inventories amounts to £63bn, or nearly four-fifths of the entire decline in GDP.

Utilising the findings of modern econometrics SEB has shown how investment is the primary determinant of future prosperity. In Britain currently, it is also the immediate route back to economic growth.

The slump in investment preceded the decline in GDP and, from its peak level and by itself, it accounts for thee-quarter of the total decline in activity. Household spending is also lower under the impact of lower employment. Statistically, net exports have made a positive contribution to the economy of £13bn, at least in accounting terms, as imports have declined at an even faster rate than the decline in exports. At the same time government spending has slightly offset the ferocity of the recession, but the real increase in government expenditure has been minimal, at £5bn, compared to the £80bn fall in aggregate output.

The recession is an investment-led slump in activity. Unless and until this is reversed, there can be no guarantee that a very weak recovery will not fall back into renewed contraction.

The Public Sector Deficit

Despite the depth of the recession and its cause, much of the media debate in Britain has focused on one of the effects of the downturn, the rise in the public sector deficit. Worse, the economically illiterate notion of cutting public spending in response has gained increasing support, from both the main opposition parties as well as many in government.

As we have already seen the rise in real government spending has been paltry in the course of the recession, up 1.8% in real terms since Q1 2008. SEB has previously shown how the driving force behind the rise in the deficit has been the decline in taxation revenues .

The chart below illustrates the effect of the recession on tax receipts. In the Financial Years (FY) 1997/08 to 2007/08 current tax receipts grew at an annual average rate of just over 5.6% to stand at £549bn. [1]

A continuation of this trend would produce tax receipts of £612bn in the current FY. This compares to a projection from the Treasury of total receipts in the current FY of £498n, having previously fallen to £534bn in FY 2008/09 under the impact of the recession.[2] The difference between the trend level and the Treasury projection for this year amounts to £114bn. This is almost the entirety of the Treasury's projection for the entire budget deficit of £128bn, equivalent to 9.1% of GDP.[3] Over the same two year timeframe, public sector current expenditure is projected to rise by £71bn.[4] Even though this is partly as an automatic response to rising unemployment and increased eligibility for welfare payments, the actual rise in public sector current expenditure is precisely in line with the 2002/08 trend.

In all the clamour to reduce pay, public services and jobs in the public sector, this important fact has been overlooked. The rise in the deficit is almost entirely due to the slump in taxation receipts.

Investment Deficit

It is clear that a sharp increase in government investment could tackle the driving force of the recession - the investment decline. At the same time, any significant improvement in economic activity would reverse the deterioration in government finances.

The private sector has created a large investment deficit. The public sector could offset it. In fact, public investment is set to be 3.5% of GDP in the current FY, a cumulative rise equivalent to 1.8% of GDP since the recession began. This modest level is actually the highest level under New Labour. But it is a wholly inadequate response as the overall decline in investment has totalled 4.9% of GDP with another 0.3% deducted from GDP via de-stocking of inventories. The government also plan to cut back on investment to 2.7% of GDP next year and reduce it back below 2% in subsequent years.

A characteristic of the New Labour governments has been an unwillingness to undo the blight of Thatcherism, where government investment averaged just 1%, way below the rate of depreciation. New Labour increased that to an average 1.5%, fractionally above the depreciation rate. However, from 1963 onwards, until Thatcherism the growth in government investment averaged 5.25%. A return to those levels is currently required, amounting to £65bn in real terms.

SEB has previously shown there are large 'multipliers' attached to government investment. There is no magic in this. All businesses invest to achieve a higher return than the capital deployed, usually much higher than the initial capital outlay. Government can do the same. There is often an additional benefit. The benefits of a new private enterprise are available only to those who can pay for them, and will be closed if it becomes unprofitable. A new rail line, new housing or new broadband superhighway raises productivity for all and is a benefit to the whole of society.

The table below shows the estimates of the UK Treasury Model from a variety of fiscal stimulus. To illustrate their effect; if the recent VAT cut cost government revenues £1bn, the economy would be boosted by £300mn in the first year, and by £600mn in Year 2 and by £800mn in Year 3, and so on.

The calculations above also only takes account of the impact in the first three years, while the effectiveness of the stimulus usually persists far longer. In addition, these are only averages derived from long-term experience. Most research in this area is agreed that the effectiveness increases when any of the following conditions apply: when there is large unused capacity in the economy, when interest rates are low and when access to credit is hampered. All of these conditions currently apply so the effectiveness of any stimulus measures currently would be significantly increased.

Of course, all this increased activity provides increased taxation revenues. Again, the Treasury has estimates of how much.[5] Over two years, every 1% increase in GDP will lead to an improvement in both the level of public sector borrowing and the budget deficit of just under 0.75% of GDP. According to the Treasury estimates, this arises from a combination of increased taxes (0.5%) and lower spending, mainly welfare payments (over 0.2%).

So, to take just the Year2 impact, an increase government spending equivalent to 1% of GDP raises GDP by 1.4%. This in turn produces an improvement in the government deficit of (1.4 multiplied by 0.75) = 1.05%. Therefore, the increase in government investment is more than self-financing. It proactively reduces the deficit, as well as reviving the economy. It should again be stressed that these results, based on Treasury analysis, are only the averages that apply over the long run, not the current crisis conditions, where the effects would be much stronger.

This is the logic being applied across most industrialised nations currently. Yet, having engaged in a modest level of stimulus in 2009, Britain is the only country in the G20 which intends to do nothing to stimulate the economy in 2010.[6]

Worse, the debate here is dominated by political leaders bidding to outdo each other in their tough stance on public spending. The only serious point of dispute centres on the timing of those cuts, with the Tories promising spending cuts from day one of their new government and Nick Clegg abandoning a host of spending commitments in pursuit of savage cuts. In a recent speech Peter Mandelson argued that the lesson of the 1930s is that removing the support of government spending reduces the tax take and makes the deficit worse. He then went on to say that is exactly what New Labour would do, only later and more slowly than the Tories have threatened.

Mandelson was right in his observation, and completely wrong in his illogical conclusion. The multipliers outlined above work both positively and in reverse. Or, as the Business Minister puts it, spending cuts reduce the tax take and push the deficit higher.

The determination to avoid the appropriate policy of increasing investment leaves the authorities overly reliant on monetary policy to revive activity. It is true that a weaker currency and low interest rates have prevented an even greater collapse in activity from occurring. But bank lending is not increasing nor have exports revived. Over the medium-term a persistent ultra-loose monetary policy risks creating renewed asset price inflation, in stock markets, commodities and in house prices. A real threat to government funding could arise from rising inflation and another sharp decline in the currency.

The Bogeyman of the Bond Market

The objection raised to increased government spending is that the government depends on international bond markets for funding, and these investors will not accept the required increase in government borrowing to fund investment.

But SEB has previously shown that bond markets have a demonstrable preference for reflationary policies, as reviving economic activity is the surest way for investors to get their money back. In Europe, yields have fallen where reflationary measures are adopted - in Germany, France, Belgium, the Netherlands etc. They have also risen when 'austerity budgets' have been adopted, as in the case of Ireland's unique experiment in fiscal contraction.

For most of 2008 Ireland and Belgium had exactly the same yields. Belgium provided stimulus measures; Ireland cuts. At the beginning of this year, along with pay and welfare cuts, Irish taxpayers are paying over 1% more than Belgium in 10-year bond yields.

The chart below shows the trend in British and German government bond yields over the last four months. In 2009 the new German government surprised many, including the financial markets, by announcing a large package of measures that included both tax cuts and investment. In Britain, Alistair Darling's Pre-Brudget Report announced that there would £415mn of fiscal contraction. British bond yields have risen faster than German yields since that time.

It is notable too that in countries where speculative and rentier capital does not play such an important role as in the British economy, reflationary policies have been adopted without much controversy. The right wing governments of Germany, France, Belgium and the Netherlands and others have each engaged in a variety of reflationary measures, with success dependent on the scale and composition of the stimulus packages. Not only have they each emerged from recession earlier than Britain, they have also seen their government bond yields fall relative to British government yields and their government deficits are now expected to decline faster than Britain’s.[7]

To take just one example, Germany's fiscal stimulus measures now amount to 4% of GDP, whereas Britain's stimulus was just 1.6%of GDP and has now ended. But the IMF expects Germany's government deficit to be zero by 2014, and Britain's to be 6.8% of GDP. The most spectacular confirmation of this approach has been the Chinese fiscal stimulus, amounting to 12.7% of GDP, which caused the budget deficit to rise this year to just over 3% of GDP.

Because investment is the appropriate response to the economic crisis it is also the remedy for the fiscal crisis. For that reason, there is no borrowing impediment to increased government spending for investment.


1.Treasury Public Finances Databank, C4,

2. Treasury, Pre-Budget Report December 2009, Table B10

3. Treasury Public Finances Databank, KEY,

4. Treasury Public Finances Databank, B1,

5. Treasury, Public Finances and the Cycle, Treasury Economic Working Paper No.5, November 2008

6. IMF, The State of Public Finances Cross-Country Fiscal Monitor: November 2009, SPN/09/25, Annex, Table 2,

7. European Commission, Euro Area Report, Autumn 2009, Statistical Annex,

Sunday, 24 January 2010

Goldman Sachs rightly stress capacity constraints and not overcapacity are dominant in China

Relatively widespread coverage in economic media has been given to an important new analysis published by Goldman Sachs pointing to the inflationary consequences of major capacity constraints emerging in the Chinese economy. As Geoff Dyer noted in the Financial Times on 22 January: 'According to Yu Song and Helen Qiao... the most extreme example is in the auto sector, where extra shifts mean factories are running at above capacity. They also see emerging bottlenecks in electricity, coal and even in aluminium and steel which only a few months back seemed to be suffering from chronic overcapacity.

'"The capacity overhang has been quickly whittled down in major industrial sectors," they wrote... The apparent rebound in Chinese exports, which grew 17 per cent in December compared to the year before, has reinforced the impression that the output gap is shrinking.

'Inflationary pressures could also come from the labour market. Before the crisis, which led to millions of migrant workers losing jobs, wages were rising quickly as the labour supply started to slow. Surveys of job centres suggest employment is returning to pre-crisis levels.'

This analysis, which is confirmed not simply by the individual sectoral studies carried out by Yu Song and Helen Qiao but by macro-economic analysis, is intrinsically important for analysing China's current economic situation. But it also refutes the bad, and inaccurate, piece of economics produced last year by the European Chamber of Commerce in China which suggested overcapacity was the key issue in this regard in China - unfortunately this report was picked up in an editorial the Financial Times. To show the report's errors were evident not only after the event I cite my letter in the Financial Times in reply:

'The basis of the report is an alleged clash between a "rising savings rate in the United States", supposed to account for a decline in the US trade deficit, and China's economic policy. Factually no "rising savings rate" in the US savings rate has occurred. Since the second quarter of 2008 US savings have declined from 12.7 per cent of GDP to 10.4 per cent of GDP.

'In any country, including China, it is evidently possible to point to individual industries suffering from overcapacity, as well as those with insufficient capacity – a statistical measure necessarily means cases below and above average.

'Simply citing particular cases, as the report does, therefore establishes no general case of "overcapacity" as regards China's economy. This same mistake applies within individual industries. For example, in the Chinese chemical sector the report notes 50 per cent of the industry is in a balanced state of supply and demand, 30 per cent of products are in short supply, and 20 per cent have overcapacity problems – a normal market situation.'

Hopefully this new analysis by Goldman Sachs will put an end to erroneous claims overcapacity is the key issue in China. On the contrary it confirms clearly that capacity constraints, that is undercapacity and not overcapacity, is the dominant issue facing the Chinese economy in this field.

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This article originally appeared on the blog Key Trends in Globalisation.

Saturday, 9 January 2010

China's dramatic surge in domestic demand

China has achieved a dramatic expansion of its domestic demand in 2009. It is likely that GDP figures will show that China's domestic demand rose by around 11% last year while China's trade surplus fell by over thirty percent. These estimates are made using conservative assumptions and it is probable the eventual out turns will be even higher - although they will not alter the essential picture, This article looks at this remaking of the pattern of China's demand.

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The full data for China's trade in 2009 will be published next week. Data for GDP will be published later. These will give a more fine grained picture of China's economic development in 2009. However data for the first 11 months of China's trade this year have already been issued and there is no doubt that the official 8.0% target for GDP growth will be met and exceeded. These already published figures therefore allow a clear picture to be formed.

To take first the ballpark numbers, and using conservative assumptions, China's trade surplus, that is its net exports, will have declined in 2009 by around or slightly over $100 billion - over thirty percent. China's GDP will have increased by over $350 billion if growth in 2009 was 8.0% and by approaching $400 billion on the assumption that growth was 8.5%. Detailed figures are given in Table 1. Assumptions used to calculate these are given in Note 1.

Taking first trade, in 2008 China's exports were $1.431 trillion and imports $1.333 trillion. China's trade surplus was $298 billion. In the first 11 months of 2009 China's exports were $1.071 trillion - a fall of $248 billion, or 18.8% compared to the same period in 2008. China's imports in the same period were $0.891 trillion - a fall of $167 billion, or 15.8%. China's trade surplus dropped from $261 billion in the first 11 months of 2008 to $180 billion in the same period of 2009 - a decline of 31%.

To give a projection for 2009 as a whole, if the 31% fall in the trade surplus was maintained for the entire year then China's trade surplus in 2009 would be $206 billion - a decline of $92 billion. In reality the drop is likely to be greater as China's trade surplus in December 2008 was an exceptionally high $39 billion. The actual decline in China's trade surplus for 2009 is therefore likely to be at least $100 billion - another way of stating that China in 2009 added a net $100 billion to international demand. The excellent export figures in the rest of Asia at the end of 2009 in significant part reflect this boost in demand from China.

In order to estimate the effect of the decline in the trade surplus on the structure of China's demand it is useful to translate trade figures into GDP percentages. This involves taking into account service sector trade, and various relatively small statistical adjustments, which lead to China's total surplus of exports over imports in 2008 being $353 billion in national accounting terms. As China's net export situation is dominated by trade in goods it is assume for simplicity below that the national account trade position also falls by 31%.

China's GDP in 2008 was recently revised upwards to 31.405 trillion yuan or $4.6 trillion at the official exchange rate. No change in the figure for net exports has however been published. As the trade position is easier to measure than GDP, where the upward shift was accounted for primarily by a previous underestimate of output in the small service sector, the figure for China's net exports is unlikely to change greatly. This upward GDP revision changes downwards slightly China's export surplus in 2008 as a percentage of GDP - from the previously publishes 7.9% of GDP to 7.7%. This figure is used in Table 1.

Turning to 2009, the official GDP growth projection for the year was 8.0%. However it is clear from the first three quarters results that the eventual figure for growth will not only be achieved but almost certainly exceeded. As the aim in this article is to use conservative assumptions, and therefore take figures which are least favourable for the position presented, it will be assumed for calculation that GDP growth in 2009 was 8.0%. A higher GDP growth rate, given that trade figures are unlikely to change greatly, would imply a higher growth of domestic demand than that indicated in Table 1 below.

Assuming an 8.0% growth rate, the increase in China's GDP in 2009 would imply an increase in GDP of approximately $368 billion - the exact figure depending primarily on the assumption made on the inflation rate to translate an 8.0% increase in constant price terms into current prices.

Taking the assumption of a $109 billion decline in the export surplus, that is 31%, and a $368 billion increase in GDP implies that China's domestic demand in 2009 rose by $477 billion, or 11.2%. This would be one of the highest increases in domestic demand in a single year ever achieved by any country in history.

On this data China's export surplus will have fallen from 7.7% of GDP in 2008 to 4.9% of GDP in 2009, or by 2.8% of GDP. China's domestic demand, conversely, will have risen from 92.3% of GDP to 95.1%. Detailed revision of these figures will be given as final trade and GDP data for 2009 is published. They will, however, not alter the fundamental picture.

Table 1

10 01 08 China GDP 2008-2009

The implications of such data are clear. China did not require a surge in its trade surplus for its economy to undergo rapid growth in 2009 - as some argued. China successfully shifted demand into its domestic economy. An approximately $100 billion decline in net external demand was more than cancelled by a more than $450 billion increase in domestic demand. This must be counted, in light of the extremely negative external economic situation, as one of history's most successful and skilful pieces of macro-economic management. Simultaneously with rapid domestic economic China's trade surplus declined - easing global imbalances and particularly boosting exports from other Asian economies.

Given this dramatic increase in China's domestic demand why did a number of commentators fail to foresee this and therefore greatly underestimate the potential for China's economic performance in 2009? In a number of cases it was because they committed an elementary economic error. They reduced the potential for China's growth in domestic demand to its increase in domestic consumption. However domestic demand is composed not simply of domestic consumption but also of domestic investment. China's domestic investment rose rapidly in 2009 as well as its domestic consumption - the combination of the two producing the rapid increase in domestic demand.(2)

In conclusion the fundamental trend is clear. China succeeded in 2009 in achieving an extremely high rate of increase of both domestic investment and domestic consumption - enabling it to overcome, in terms of GDP growth, the negative shock of the fall in exports and the decline in the trade surplus. Sceptics on the ability of China to raise domestic demand were shown to be wrong. China's stimulus package, which produced the results, was shown to be an extremely impressive piece of macro-economic management.

Addition 10 January

The publication of China's trade data for 2009 confirms the points made above. The new data shows China's trade surplus in 2009, on a foreign trade and not a national accounts basis, was $196 billion compared to $298 billion in 2008 - a fall of $102 billion or 34%. An equivalent percentage decline in China's net exports on a national accounts basis would mean a decline in its surplus of $120 billion compared to the $109 billion projected in this article for calculating the increase in China's domestic demand. This reaffirms that the trade assumptions made for calculations in the article above were conservative.

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This article originally appeared on the blog Key Trends in Globalisation.


1. All data, unless otherwise stated, is taken from China Statistical Yearbook 2009. The assumption made for China's export surplus in 2009 is set out in the body of the article. To calculate the changes in GDP in current prices it is necessary to make an assumption on inflation/deflation rates. In 2009 these will be relatively minor, therefore for simplicity they have been assumed to be zero. There is likely to be net deflation in 2009, which would revise the figure for the current price increase in GDP given in Table 1 downwards, however it is also likely that GDP growth will exceed 8.0% which would revise the figure upwards.Therefore Table 1 is given as a qualitative initial projection. Revisions will be given as detailed figures are published.

2. Kieran Latty has a clear numerical explanation of this in a comment on Key Trends in the World Economy.

Wednesday, 6 January 2010

Decline of the Rupee's exchange rate - India moves further towards the 'Asian growth model'

India was one of a number of countries that experienced major currency devaluation against the dollar during and after the international currency crisis. As the comparison to China, which pursued a policy of stabilising the RMB's exchange rate against the dollar after the outbreak of the financial crisis, is particularly interesting the movements of the RMB and the Indian Rupee against the dollar since 2000 are shown in Figure 1.

Figure 1

10 01 06 Rupee, Yuan 2000

As may be seen the Rupee from 2000 up to September 2007 had a tendency to a weaker exchange rate than the RMB. But the difference was not extreme and in September 2007 the two currencies were essentially at parity in terms of exchange rate shifts with a roughly ten percent upward movement in exchange rate against the dollar compared to 2000.

After September 2007, however, a marked divergence between the exchange rate of the RMB and the Rupee began. The RMB first continued to rise and then stabilised, without falling, when the financial crisis began. The exchange rate of the Rupee, in contrast, start falling from September 2007 onwards and this accelerated as the financial crisis developed. The specific trends since the start of the financial crisis are shown in Figure 2.

Figure 2

10 01 06 Rupee RMB July 2008

Taking these movements together, between September 2007 and January 2010 the RMB rose by over 10% against the dollar while the Rupee fell by over 20% between September 2007 and its low point in March 2009. Even after recovery of the Rupee, at the beginning of January 2010 it was still more than 12% below its September 2007 level. As the RMB went up against the dollar in the same period this means that the Rupee has carried out an effective twenty per cent devaluation against the RMB since September 2007.

Given that India runs, relative to the size of its economy, a containable balance of payments deficit, which in 2008 was 2.7% of GDP, no substantive internationally destabilising consequences flow from the devaluation of the Rupee against either the dollar or the RMB. What will be significant however will be to see whether this clear devaluation of the Rupee against the RMB alters the relative dynamics of India's and China's economies.

As this blog has noted on a number of occasions the long term effect of India's economic reforms has been to shift it decisively towards the 'Asian growth model' - that is to a very strong increase in savings and investment rates. Indian Prime Minister Manmohan Singh has consciously supported this policy.

The decline of the exchange rate of the Rupee moves India further towards adoption of the 'Asian growth model'. This is because for countries such as South Korea and China a second component of their economic strategy, alongside high rates of savings and investment, was to maintain a low exchange rate in order to boost exports.

Contrary to accusations to the contrary this did not necessarily mean running a large trade surplus, as this depended on developments such as the rate of growth of the economy which helped determine whether imports rose equally - for example China's large trade surplus appeared only in 2005 and is now declining, while South Korea at various times has run large trade deficits. The low exchange rate policy, however, did ensure a rapid development of the share of exports in the economy, allowing economies of scale from production for the international market and other benefits to be achieved. The fact that India was more cut off from the international division of labour compared to is east Asian competitors, that is its share of exports and imports in the economy was relatively low, was an achilles heel.

Having achieved a level of savings and investment which is currently higher than South Korea and the other former East Asian tigers, and is not far behind China, the logical next step for India is to adopt a low exchange rate policy to stimulate exports still further. The changes in the Rupees exchange rate in the last period give the opportunity to achieve this. It remains to be seen whether they will be consolidated.

In addition to the importance for India itself there is an international significance of India's further shift towards a policy of a high savings and high investment coupled with a low exchange rate to stimulate exports. For this, as noted, is precisely the 'Asian growth model'. The fact that the world's second most populous country, soon to become its first, is moving with success further towards such a model has clear implications. Far from the 'Asian growth model' moving to its end after the financial crisis, as some commentators have claimed, it is spreading further.

Watching the exchange rate of the Rupee, and its effect on India's economic performance, is becoming a highly important international issue.

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This article originally appeared on the blog Key Trends in Globalisation.

Tuesday, 5 January 2010

India and China refute the myth of ‘overinvestment’

It is by now well known that the two countries which have come most strongly through the financial crisis are China and India. China’s year on year growth to the third quarter of 2009 was 8.9%. India’s was 7.9%.

Such a result of course has many economic lessons. But one is to decisively refute the myth that high levels of investment are a cause of economic crisis and underperformance. On the contrary China and India have the highest levels of investment of any major economies - as shown in Figure 1 (a comparison to the US is given). The percentage of China’s GDP devoted to gross domestic capital formation (fixed investment) in 2008 was 41.4%.(1) India's was 34.8%.(2) In 2008 China generated 9.6% annual growth and India 6.7%.

Figure 1

US, India, China 1950 Blog

It is, of course, possible to have inefficient investment – i.e. high levels of investment that fail to generate high levels of economic growth. Classic examples of this are countries pursuing inward facing import substitution strategies whether of a market (Argentina) or non-market (the former USSR) type. However medium and long term trends econometric studies clearly demonstrate investment is the single most important source of economic growth after increasing participation in the national and international division of labour.

For the G7 economies as a whole, and the US economy, econometric studies show that more than 50% of economic growth, that is the majority of growth, is accounted for by investment. In consequence these economies cannot grow at more than twice their rate of investment - i.e. the rate of increase in investment determines the rate of increase of GDP. But, far from being inefficient, recent studies show China has among the highest rates of growth of total factor productivity in the world, showing the efficiency of its investment, while Dale Jorgenson and Khuong Vu also found India has a high rate of growth of total factor productivity.

China and India, however, also demonstrate something about the short term and the business cycle. Their very high investment levels were not only the main determinants of their rapid economic growth but also clearly allow them to most adequately confront the cyclical economic downturn.

The Indian Prime Minister Manmohan Singh has repeatedly stressed that the key to growth for both India and China is their very high levels of savings and investment. He has been shown to be entirely right. The two major countries with the highest level of investment in GDP have both the fastest growth rates and have most successfully dealt with the financial crisis.

Those who claim there is a problem of 'overinvestment' should simply look at China and India. They confirm on the practical field what is shown by econometric studies to follow from economic theory. They bury the theory of 'overinvestment'.

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This article originally appeared on the blog Key Trends in Globalisation.


1. Calculated from China Statistical Yearbook 2009.

2. Calculated from IMF International Financial Statistics.

Sunday, 3 January 2010

Who was right and who was wrong on China's economic performance?

Economic analysis should be judged by its accordance with facts. The data is now in which allows a judgement on China's economic growth in 2009. The statistical issue on this is how much above the official growth forecast of 8.0% GDP expansion, made at the beginning of 2009, China will achieve.

This blog has repeatedly analysed that China's economic stimulus package would be successful and that, therefore, China would experience high growth in 2009. This follows from a long term analysis of the success of China's economy. However this blog evidently made no claim to be unique in this forecast and pointed to others who came to the same conclusion including Jim O'Neill, chief economist of Goldman Sachs, Professor Danny Quah of the London School of Economics, Mark Weisbrot of the Centre for Economic and Policy Research, and Yan Wang of BCA Research. If these are among those who made essentially correct forecasts of the success of China's economic performance in 2009 it is also legitimate, and necessary from the point of view of evaluating future analysis, to register those who clearly got it wrong on China's economy. And to ask whether they have changed their analysis which led to these wrong predictions?

First was the International Monetary Fund. In January 2009 the IMF predicted 6.7% GDP growth in China in 2009. In April 2009, by which time China's economy was already accelerating, the IMF revised downwards its forecast for China's economic growth to 6.5%.

In March the World Bank similarly revised down its prediction for China's 2009 GDP growth to 6.5%.

In March 2009 the OECD Secretary-General Angel Gurria stated that the organisation might revise its forecast for China's GDP growth down to as low as 6.0%.

Turning to private financial institutions, and other economic forecasters, it is practically impossible to follow all of these but it is worth making a non-exhaustive list of some of the more striking or widely quoted. One school was, of course, the 'catastrophists' on China. Leading among these were Gordon Chang, who continued to express the thesis expressed in his book with the self-explanatory title The Coming Collapse of China, which in 2002 declared: 'A half-decade ago the leaders of the People's Republic had real choices. Today they do not. They have no exit. They have run out of time.' (pxxiii). This prediction was made as China was about to experience seven years of the most rapid economic growth in the world. In a similar category comes Societe Generale analyst Dylan Grice,who declares that China is the biggest economic bubble in world history.

Turning to less catastrophist forecasters, prior to 23 April 2009 Morgan Stanley's prediction for China's 2009 GDP growth was only 5.5%. On 23 April it raised this to 7.0% - still an underestimate. Goldman Sach's at the beginning of 2009, despite Jim O'Neill's overall positive assessment, projected 6.0% growth in China in 2009 before raising it in April to 8.3%. UBS at the beginning of 2009 projected China's GDP growth to be 6.5% - raising it in April to 7.0-7.5%. This was despite the fact that in November 2008 Tao Wang, head of China economic research for UBS, predicted 7.5% China economic growth in 2009.

Standard Chartered in the first half of 2009 made a 6.8% prediction for China's GDP growth. Ben Simpfendorfer of the Royal Bank of Scotland in December 2008 was projecting China's GDP growth in 2009 to be 5%. Michael Pettis of Beijing University did not give a quantitative growth prediction but made the qualitative judgement that: ''I continue to stand by my comment… that the US would be the first major economy out of the crisis and China one of the last.' In July Stephen Roach, Chairman of Morgan Stanley Asia, declared his view that he was ceasing to be an optimist on China's economy.

China's actual economic out turn in 2009, with GDP growth that will come in even above the official prediction of 8.0%, shows clearly who was right and who wrong regarding China's economic performance in 2009. Those who believed in the strength of China's economy were right. Those who believed either in 'catastrophe' or significant economic slowdown were wrong.

This is not merely an historical question looking backwards. In most cases there is no evidence that those who made wrong projections, which greatly underestimated the strength of China's economy, have corrected analyses which led to these errors. Such analyses, which have been, refuted by facts, therefore cannot be considered reliable for future projections regarding China's economic performance.

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This article originally appeared on the blog Key Trends in Globalisation.

Projections for China's GDP growth in 2010

China's State Council Development Research Centre predicted on 1 January that China's GDP will expand by 9.5 percent in 2010. iStockAnalyst also carries a readily available and useful summary of some predictions regarding China’s GDP growth in 2010. These include forecasts from the China’s State Information Centre - about 8.5% GDP growth, the World Bank - 8.7%, Asian Development Bank - 8.9%, the Chinese Academy of Social Sciences - 9.0%, International Monetary Fund - 9.0%, Morgan Stanley - 10.0%, CITIC Securities 10.1%, Organization for Economic Cooperation and Development - 10.2%, Goldman Sachs - 11.4%.

What is notable about these figures is not the exact forecasts, as no-one can in fact scientifically predict GDP growth accurately to a tenth of a percent, but that all these numbers are high. Those who believed that China’s GDP growth will be low have apparently given up the battle – or more accurately retreated from the battlefield to lick their wounds. This makes an extremely interesting contrast to the predictions for and actual results of China’s economy in 2009 - which are dealt with in another post.

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This article originally appeared on the blog Key Trends in Globalisation.