The Next China and the World Economy

Today's Outline

  1. Course Introduction and syllabus
  2. 4 Key Drivers of China's Economy
  3. Review of Macro Terms

What is this Course About?

  • Macroeconomics for emerging economies
  • China’s economic circumstance in a historical context
  • China’s economic circumstance compared to the U.S.

A Bit About Myself

  1. 老家： 密歇根
  2. 活动：踢足球
  3. 研究：经济发展，区域经济，地理经济

Three Key Drivers of the Chinese Economy

  1. Population

  2. High Savings

  3. The Role of the Government

1. Population

China’s Inexpensive Vast Pool of Labor

Arriving daily from the rural areas to the city.

China's Rural-Urban Migration

China's Getting Old

(Source: China NBS.)

Lewis Turning Point

Will Urbanization Help Offset Declining Labour Supply?

2. Savings

(Source: IMF World Economic Outlook)
  • China Highest Savings Rate in World (~ 50 % of GDP)
  • 'Savings' include retained earnings of companies
    • fewer investments, lower dividends, lower disposable income
  • U.S. Peaked in 1960s at 25%; now around 18%

Or the other side of the coin: Consumption

Collision Between Two Key Drivers

Savings/GDP x GDP/Population = Per Capita Savings
China .51 x USD 5,420 = USD 2,764
United States .16 x USD 51,197 = USD 8,192

China is Lower on the Curve but its Savings Curve is Higher

China's Savings Rate Comparatively High

Group Discussion (3-4 students)

Break into groups and introduce yourselves (name, hometown, major, favorite dish you ate during 春节)

Then, discuss the following：

  1. Do you think China has reached the Lewis turning point? Can a two-child policy or dismantling the Hukou system help?

  2. Why is China’s Savings Rate So High?

3. The role of the Government

  1. “What is prudence in the conduct of every private family can scarce be folly in that of a great kingdom.” Adam Smith. The Wealth of Nations (1776).

    • But individuals operating in their own interest leads to the public good.

  2. “It is not possible for one to teach others while he cannot teach his own family. Therefore, the ruler, without going beyond his family, completes the lessons for the state.” Confucius. The Great Learning (500 BC).

    • There is a necessary ordering of authority with the state clearly at the top.

Five-Year Plans Economic Report of the President
GDP to grow by 7% annually on average. Consumption and Saving
More than 45 million jobs to be created in urban areas. Developments in Housing Markets
Rise in domestic consumption. Business Fixed Investment
Service sector value-added output to account for 47% of GDP, up 4 percentage points. Business Inventories
Annual grain production capacity to be no less than 540 million tons. Government Outlays, Consumption, and Investment
Construction and renovation of 36 million apartments for low-income families. State and Local Government
Expenditure on R&D to account for 2.2% of GDP. Real Exports and Imports

Indicator 2010 2015 Avg. annual growth rate
– GDP (trillion yuan) 39.8 55.8 7% Expected
– Urbanization rate (%) 47.5 51.5 4% Expected
People's livelihood
– Per capita disposable urban income 19109 > 26810 > 7% Expected
– Per capita disposable rural income 5919 > 8310 > 7% Expected
– Number of enrollment in basic medical insurance in urban/rural areas (%) 3% Binding
– Number of low-income apartments built in urban areas (units) 36 mill Binding
– Total population 1.341 billion < 1.39 billion < 7.2% Binding
– Average life expectancy (years of age) 73.5 74.5 1 year Expected

The Rise and (Fall?) of the Chinese Economy

Main Risks Facing the Chinese Economy

Main Financial Risks to Chinese Economy

  1. Real Estate Bubble

  2. Stock Market Bubble

  3. Municipal Debt

  4. Excess Capacity

  5. Capital Flight

… We will look at each of these risks during the course.

Group Discussion (3-4 students)

In your groups, discuss the following：

  1. What do you think is the key challenge that China faces?

Brief "Macro" Review

The Historical Trajectory of Macro-Economics

  • Kuznets Waves
  • Say’s Law and Equilibrium
  • Quantity Theory of Money
  • Monetarism
  • Keynes
  • Real Business Cycles
  • DSGE Models

Key Distinctions in this Course

  • Business Cycles vs. Growth Cycles.
  • Real Variables vs. Nominal Variables.
  • Stocks vs. Flows
  • Endogenous vs. Exogenous Variables.

Growth Cycle: China

Business Cycle: U.S.

  • The shaded columns indicate business cycle recessions, periods in which there was an absolute decline in economic activity.
  • For every shaded area, we see outright declines in GDP levels." (Schramm 9)

Growth Cycle: China

  • China tends to experience only growth cycles (slower positive growth) as indicated by the shaded areas.

Only One Outright Recession for China

Real Variables and Nominal Variables

  • Nominal Variable: Prices we can see in the day-to-day

    • e.g. the price we actually pay for an apple or a bowl of rice at a store or restaurant

  • Real variables: Attempt remove the effects of price changes over time, which confound what is happening in a real sense.

    • e.g. The nominal price of a bowl of rice increases by 50% from year t to year t+1. If we eat one bowl in each year, we consume the same but we spend 50% more in year t+1. Real consumption is 1 bowl of rice.

    • Price indexes can remove the price effect from nominal variables by converting them to real variables; can be used to measure inflation.

      • Price indexes are numerical measures of average prices for goods and services, and are used to compare average price changes over time.

      • Important Indices: Consumer Price Index (CPI), Production Price Index (PPI), GDP deflator, etc.

Flows vs. Stocks

  • Flow variables: economic phenomenon that appear during a period of time.

    • e.g. a person’s gain or loss of weight.
  • Stock variables: Levels of economic phenomenon that represent the accumulation of flows
    • e.g. one’s total weight – the sum of the flows of weight gains and losses per year that occurred over a lifetime)

Flows vs. Stocks

  • Types of Economic Variables at the company level:
Income Statement (Flow) Balance Sheet (Stock)
Inflation Price
Savings Wealth
Balance of payments Foreign exchange reserves
Birth Rate Labor force
Open market operations Money supply
Investment Capital stock
Budget deficit Public debt
Current account deficit External debt

Endogenous vs. Exogenous Variables

  • Is the weather exogenous or endogenous in economics?

Endogenous vs. Exogenous Variables

  • Endogenous Variables: Key (output) variables that we use economic models to study
    • e.g. economic growth, unemployment, or inflation
  • Exogenous Variables: Key (input) variables considered to be important drivers of our endogenous (output) variables, which we assume are given and do not try to explain or predict.
    • e.g. the weather in most economic models would be exogenous; economists do not have an interest in explaining the weather, but it is clearly an important important factor.
      • bad weather may cause a crop failure (endogenous variable)
      • weather is exogenous to the model.

A Review of 10 Important "Macro" Facts

  1. Demand is important. A large drop can cause a recession
  2. Supply is important. A large drop can cause a recession.
  3. Money supply is important. Rapid increase relative to output leads to inflation.
  4. Increased government spending can crowd out other economic sectors
  5. Monetary policy works through several channels:
  6. Lack of flexibility in wages and prices can lead to economic recession or an economy operating above full employment
  7. There is no long-run trade-off between inflation and the unemployment rate
  8. Fiscal policy is relatively more effective under fixed exchange rate regimes; monetary policy relatively more effective under floating exchange rate regimes.
  9. The presence of rational expectations (e.g. economic agents form accurate expectations) tends to reduce the effectiveness of activist fiscal and monetary policies.
  10. Recessions triggered by financial crises have greater depth and length than recessions triggered by conventional demand and supply shocks.