CHINA’S EVOLVING MARKET ECONOMY

JOSEPH E. STIGLITZMARCH, 2005

• MANAGING A MARKET ECONOMY

• CHINA AND THE GLOBAL ECONOMY: CHALLENGES, OPPORTUNITIES, RESPONSIBILITIES

MANAGING A MARKET ECONOMY

• OBJECTIVE: SUSTAINABLE, EQUITABLE DEVELOPMENT

• MARKETS DO NOT ENSURE GROWTH WITH SOCIAL JUSTICE– Problems of growing inequality

• Regional inequalities• Urban-rural inequalities

– Legitimacy of the sources of wealth– Trickle down economics does not work

MANAGING A MARKET ECONOMY

• MARKETS DO NOT ENSURE ADEQUATE PROTECTION OF ENVIRONMENT– Especially important as China enters phase of

heavy resource utilization

• MARKETS DO NOT ENSURE THAT CITIES WILL BE LIVEABLE– Need urban planning– Road networks, parks, infrastructure– Especially important with increasing

urbanization of China

MANAGING A MARKET ECONOMY

• But markets do not even ensure economic efficiency– Adam Smith’s invisible hand: markets, pursuit

of self-interest leads as if by an invisible hand to efficiency

– But stringent assumptions underlying theory– Reason invisible hand often appears invisible is

that it’s not there– Greenwald-Stiglitz theorem showed that

whenever information is imperfect or asymmetric or markets incomplete (that is always) markets are not constrained Pareto efficient

MANAGING A MARKET ECONOMY

• Role for government in ensuring efficiency– Externalities and public goods– Providing physical and institutional infrastructure– Regulating the environment– Funding basic research– Providing social insurance– Government loan programs– Macro-economic stabilization– Regulating the market

• Conflicts of interest• Ensuring competition• Disclosures• Monitoring banks and securities markets

CONTROVERSIES

• COMPETITION POLICY• CORPORATE GOVERNANCE• INDUSTRIAL POLICY• MACRO-ECONOMIC STABILIZATION

COMPETITION POLICY

• COMPETITION REQUIRED FOR ECONOMIC EFFICIENCY

• MARKET INCENTIVES TO REDUCE COMPETITION (COLLUSION, MONOPOLIZATION)

• CHICAGO SCHOOL: markets are contestable; all that is needed is potential competition; even a market with a single firm can be contestable; monopolies cannot persist

COMPETITION POLICY

• NEW VIEW– Market power is pervasive– There are a large variety of practices which

firm engage in to reduce the force of competition

– Markets are seldom contestable—even small sunk costs destroys contestability

– Problems are especially severe where there are network externalities

– Problems of monopolization have thus increased in New Economy

• Conclusion: need for strong competition authority

CORPORATE GOVERNANCE

• Problems of corporate governance were blamed for East Asia crisis

• Corporate governance problems manifested in U.S. in corporate scandals of the 90s—– Had a huge cost on the economy

• Long standing puzzle—recognized by Marshall

• Part of New Information Economics

CORPORATE GOVERNANCE

• CHICAGO VIEW– Firms should maximize stock market

value– Paying no attention to other

shareholders– Markets (through takeover mechanism)

ensures market value maximization– Doesn’t matter how one privatizes,

privatization will ensure economic efficiency (Coase theorem)

• NEW VIEW– No theoretical justification for Chicago view– Oversimplistic

• Does not understand limitation of take-over mechanism

• Role of management in affecting ease of take-over – Experience in Russia, elsewhere showed that how

privatization was conducted (and other aspects of legal framework) had immense consequences—asset stripping rather than wealth creation

– Need to pay attention to all stakeholders– Variety of checks and balances

• Banks• Protections for minority shareholders from majority• Protections of all shareholders from management

CORPORATE GOVERNANCE

• Example of corporate governance regulations– Glass-Steagall—separation of commercial and

investment banking– Accounting firms—hired by audit committee,

limitations in non-audit services– Disclosure of stock options– Restrictions on poison pills, anti-takeover

measures– Rules governing boards, voting, etc.

INDUSTRIAL POLICY

• Chicago view: no role for industrial policy – Makes no difference whether

economy produces computer chips or producer chips

– Government can’t pick winners– Should rely on strong intellectual

property rights

• New view: – Related to market failures (externalities of R &

D, underinvestment in knowledge)– Not a question of picking winner, but of

correcting market failures– Every successful government has used

industrial policy– Governments have a remarkable record of

success– Excessively strong intellectual property rights

may actually impede economic efficiency and slow down pace of innovation

– Know now better how to manage industrial policies

MACRO-ECONOMIC STABILIZATION

• Most important market failure– Massive underutilization of economic

resources,– With huge social consequences

• Markets are not self-adjusting (at least not fast enough)– Since Keynesian interventions,

economic downturns have been shorter, expansions longer

MACRO-ECONOMIC STABILIZATION

• Some lessons from recent experiences– Poorly designed tax cuts may not provide

much stimulus– But well designed tax cuts can provide strong

stimulation– Monetary policy may not lead to increased

investment– But may stimulate economy through

consumption, increased indebtedness• Putting future economy at risk

MACRO-ECONOMIC STABILIZATION

• Some lessons from recent experiences– The government should use the full panoply of

instruments at its disposal• Major mistake in nineties was not raising margin

requirement• Resulted in bigger than necessary bubble—and

bigger ensuing recession

– What matters is not just interest rates, but credit availability

• Implication for China: – should use administrative measures – Need to strengthen banking institutions

II. CHINA AND THE GLOBAL ECONOMY: CHALLENGES,

OPPORTUNITIES, RESPONSIBILITIES

The new landscape Enhancing china’s growth Strengthening the global economy Addressing global environmental

issues

THE NEW LANDSCAPE

The current global economy The new geo-politics

THE CURRENT GLOBAL ECONOMY

China has succeeded in rapid growth even when other parts of the world have had only moderate growth

It has become an engine for much of rest of the world

And especially for Asia China’s growth alone has had global

impact on commodity and shipping prices

BASIC PREMISE

Growing recognition that we live in a “positive-sum” world

China’s growth and success can contribute to a more prosperous and more stable global economy- Challenge is to combat “zero-sum”

thinking prevalent in some quarters- Especially when the thinking primarily

focuses on job losses

THE NEW GLOBAL ECONOMY

New globalization—integration of countries of the world— puts enormous strains on global economy– Standard theory predicts lowering of wages,

especially of unskilled workers– Has not happened in the past largely because

of differences in technology, access to markets– But predictions of standard theory are more

likely to be evidenced in the future– And pace of change may make adjustments

difficult

THE CURRENT GLOBAL ECONOMY

New imbalances in global economy: America’s fiscal and trade deficits —

enormous drain on global savings Exchange rate instability Energy prices

– Uncertainties– Limitations to future growth

THE NEW GEO-POLITICS

China’s entry into the WTO:– Has given China greater access– Provided some protection against

protectionism elsewhere – Put new demands on China

Unipolar world And new unilateralism

- Is it consistent with global stability?

ENHANCING CHINA’S GROWTH

WTO accession entails a need for changes within China:

Agriculture– Essential to do something to maintain growth

with equity– Renewed emphasis on productivity increases

to compete effectively with subsidized agricultural goods from abroad

– Need to explore variety of other mechanisms for providing assistance within WTO framework

WTO ACCESSION ENTAILS A NEED FOR RESPONSES WITHIN CHINA

Financial services:– Need to ensure broad access to finance

• Generalized Community Reinvestment Act (CRA)– Need to enhance domestic productivity

• Countries have a natural competitive advantage in the provision of domestic services (based on localized information)

• Very little that cannot be imitated• Weaknesses often a result of failing to appreciate

importance of service sector in general and financial services in particular

• Changing role of banks and financial institutions in move towards market economy

• Broad based mortgage markets, insurance, consumer loans can be important stimulus for future growth

• But will need to be monitored closely—excesses in many countries

WTO ACCESSION

Seizing new opportunities for growth: New rules of game not only provide

greater access into China, but also provide reciprocal access for China– China’s growth has been based on

access to international markets, capital inflows, and technology

– In the future, new rules may help getting more assured access to resources, markets, and technology

– Including by making investments elsewhere in the world

THE GLOBAL RESERVE AND FINANCIAL SYSTEM

Essential for global stability But it has not been working well Growing dissatisfaction in developing

countries in general, and in Asia in particular- Allows U.S. to have access to cheap

credit- Net transfer from developing countries

NEW REALITIES Many in Asia are waking up to the new realities:

– They are the world’s net savers– Why should they be lending money to the richest

country of the world at low interest rates?– Basic principles of portfolio diversification would call

for diversification of reserve assets– And increased perceived risk associated with U.S.

dollar would lead to further diversification out of the dollar

– Members of the Class of ’97 (countries hurt by East Asia crisis) feel that their interests were not given sufficient weight during the crisis

– There needs to be more Asian cooperation– Greater understanding of Asian economic systems

and realities

CAN THE CURRENT SYSTEM CONTINUE? Reserve currencies need to be good store of value Which is why inflation has always been viewed so negatively by

central bankers But the credibility of a currency as a reserve currency depends

also on exchange rates For foreign holders of dollars, weakening of the exchange rate is

as bad as an increase in inflation Even true for domestic wealth holders, because of opportunity

costs Negative dynamics—as confidence erodes, people move out of

currency, weakens currency Now there are alternatives to dollar Problem is partly inherent—reserve currency country gets

increasingly in debt as others hold its currency; ease of selling debt entices borrowing; but eventually, debt gets so large that credibility is questioned

Countries are beginning to look for alternatives or complements to current global reserve system. China will have to be play a central role in developing these new systems

CHINA AND THE DEVELOPING WORLD

China as an economic role model– Proof that a country can do better without ‘Washington Consensus’ policies Both in growth And poverty And in other indicators of human well being

CHINA AS ROLE MODEL Promoting development:

– Help other developing countries get fairer trade agreements in development round

– Assuage the fear of other developing countries – the fear that China will take over all their export markets, especially in the post MFA world

– Engage in fair bilateral trade agreements

And ensure that such agreements are not to exploit its development partners for special interest:– Standard theory emphasizes greater gain from north-

south agreements– But practice often looks different– Because those agreements are often unfair

Efforts in that direction are likely to be ‘win-win’ situation; even if China as a whole sacrifices a little, global benefits will exceed costs

CHINA, SUSTAINABLE DEVELOPMENT, AND THE GLOBAL ENVIRONMENT

China’s growth in coming years will require huge resource (including energy) usage, with global effects

If growth is to be sustainable, measures for conservation must be undertaken

Some of the measures can simultaneously help other developing countries

GLOBAL WARMING

Increased evidence of effects:– Melting of polar ice cap– Antarctica

China could unilaterally announce commitments to reduce greenhouse gases per unit GDP and/or undertake tax/regulatory measures to reduce carbon emissions

Providing role model for other developing countries and beginning process of global engagement

Engage in enhanced emissions trading scheme with other developing countries

Including carbon sequestration– Recognize avoided deforestation– Especially important for rainforests like

the ones in Papua New Guinea– Support schemes for certified lumber– Ensure that developing countries get full

and fair value for their resources– Which will consequently reduce their need

for deforestation

GLOBAL WARMING

CONCLUDING REMARKS

China is no longer a small player in the global economy

China’s growth will impose strains on the global economic system

Even though in the long run, if well managed, all will benefit from this

China will need to put more emphasis on domestic demand growth and continued emphasis on improvements in productivity and technology

China will need to be aware that globalization in many countries—both developed and less developed—has been accompanied by increasing inequality and economic insecurity, and will need to undertake explicit measures to combat these

CONCLUDING REMARKS

Corresponding to its increased role in the global economy, it will need to take increased responsibilities

For changing the rules of the game, strive to enact – Reforms in the global financial system (reserve

system) that enhance stability and fairness– Reforms in the global trading system that are

fairer and ones that truly promote the developing countries

CONCLUDING REMARKS

For improving the global environment– Conserve on resource utilization– Help create a global agreement

reducing emissions by developing countries

– e.g. through the new rainforest initiative

CONCLUDING REMARKS

For promoting the well being of other developing countries– Both by example– Development oriented trade– Development oriented investment– Assistance

Everyone in the world will benefit And China will be doing well for itself

by doing good

CONCLUDING REMARKS