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Questions from Germany: China Writ Large

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I was in Berlin a few weeks ago and did an interview with Tagesspiegel and wanted to share it in English with readers, as interest in China is so strong these days. I think this Question and Answer session with the journalist Harald Schumann reflects well the questions many Europeans have on their minds...

Der Tagesspiegel Interview by Harald Schumann
November 21, 2011

“Even China has to step on the breaks” // World Bank Chief Economist Justin Yifu Lin about the effect  of the debt crisis on the world economy, China’s reserves and the Communists’ flexibility.

Mr. Lin, as a result of the debt crisis in some euro-states, Europe risks to sink back into a recession. What effect will this have on the world economy?

Lin: Europe is still the largest market in the world. If growth stops here, it inevitably will also slow down all other economies. This is different from the last recession. Back then, developing countries and emerging economies were able to maintain their speed of growth, largely balancing out the drop in demand in  industrialized countries and therewith lead the economic upturn. But currently the markets in the emerging economies are following the same pattern as the markets in the industrialized countries.  Since August, you can also see this by looking at the prices of stocks and government bonds in these countries. Now there is no longer the confidence that the emerging economies can disconnect themselves from what is happening in Europe and the US.

Last time, China on its own was able to create nearly a trillion dollars worth of demand through its economic stimulus plan. Why should that not work a second time?

Lin: Back then, that probably helped and all other large countries did similar things in the end. However, now the capacities, to intervene via the state, are much lower everywhere, including in countries like China, India, or Brazil. In those countries, too, state debt rose while inflation rates increased. These countries now have to step on the breaks, if only to stabilize their own economies.

In the course of their economic stimulus plan, the Chinese provinces built up a mountain of bad debt and, at the same time, a vast shadow banking system -- which got out of control -- developed.  Is it possible for a credit bubble to burst in China, as happened in the US three years ago, and which would push the country into  recession?

Lin: No, this is something that is exaggerated in the media. Of course, there are a number of bad investments, but these are not threatening the stability of the financial system. Even the most spectacular case, the debt wave in the city of Wenghou, which was often reported on, is not really threatening. About 250 companies had to declare insolvency there because they were heavily indebted. But this region has about 100,000 companies. Of course, the Chinese authorities have to stay alert and limit credit distribution. However, until now, there is no systemic problem. 
If China is so stable, wouldn’t it be time to finally let the exchange rate of the yuan float freely? The governments of the US and EU have been complaining for a long time that China is creating unfair trade advantages for itself by keeping the yuan low, therewith pushing down the prices of its exports and producing a large trade surplus.

Lin: Counter question: Do you believe that Germany’s currency is valued unfairly, because it has such a large trade surplus?

No, Germany has the euro and its course is determined by the marketplace. But for many years wages have been increasing more slowly than productivity, while they rose more quickly elsewhere. That is why German goods, relatively speaking, kept getting cheaper.

Lin: And this is how Germany created advantages for itself. What I want to say: A trade surplus is not yet proof of an undervaluation of a currency. In a developing country like China, there exists for a long time a large underemployed work force from the traditional agriculture sector. In the process of conversion to a modern economy, wages inevitably rise slowly.  And this certainly created a price advantage on China’s exportable goods. But the process of integrating the large workforce into the modern sectors is now almost complete. You can also see this by looking at the phenomenal growth of wages in the Chinese export industry. Since 2008, they have increased annually by about 15 to 20%, despite the crisis.

Is that not even more reason to let the exchange rate fluctuate freely?

A country in transition like China needs stability; that is why it is better to control it. It could be a slow appreciation, but it has to stay predictable for companies.

Would it really harm China if the yuan could fluctuate freely in the market according to supply and demand?

If there were fast speculative in- and outflows of capital, it could create big problems. Even wealthy Switzerland and Japan intervene in the currency markets, because they don’t see any other option. These severe currency fluctuations are harming the real economy. 

But the large trade surplus is also harming China itself. It delivers good commodities and in return receives financial assets in weakening currencies in the amount of now already more than two trillion dollars and euros.
Lin: Of course, this has to be balanced out sooner or later. But if the appreciation of the yuan happens too quickly, it will also hurt the consumers in wealthy countries. Either they would have to pay much higher prices for many goods or they will import them from other countries. Neither would be of use to them. But in China, unemployment would rise and the growth rate decline. That would also not be good for the world economy.

But China cannot indefinitely keep accumulating a surplus of two-hundred billion dollars in  foreign currency reserves, annually.

Lin: Of course not, I agree with that. The question is just whether China should stop it now or if this happens step by step over a longer period. Currently, the most important task is to keep up growth, especially in wealthy countries. However, this cannot be achieved via the exchange rate. Quite on the contrary: when commodities from China become more expensive, the available revenues will decrease and this will likely slow the economy.

We could instead buy more commodities produced at home.

Lin: No, most of the imported goods from Asia have not been produced in Europe and the US in decades; that wouldn’t be possible.

China’s foreign currency reserves make it possible for China’s state companies to buy equity worldwide and gain influence in governments through the distribution of loans. Is there a risk of Europe selling out and Chinese interests dominating the world economy?

Lin: These are just exaggerated impressions. I believe that trade and globalization bring prosperity. Commodity and capital flows are simply a part of this. Isn’t it good when Chinese companies invest in Europe, precisely at a time when there is too little investment over here. Besides: Until now, European companies have invested almost ten times more capital in China than the other way around.

Many commentators in the West question whether the Chinese mix of autocracy and half-open markets can function in the long-run. People are becoming wealthier, but they are getting no political freedom. Isn’t this bound to go awry?

Lin: Every system has to adjust when the conditions change. Of course, people are demanding more rights over time and want to take part in decision-making. But the Chinese system has continuously adjusted and changed over the last 30 years, if nothing else, to maintain growth. I think this ability to adjust will also be there in the future.
So you believe in the flexibility of the Communist Party?

If it weren’t flexible, it would not have been successful for the last 32 years.

Many contemporaries, especially managers in the large global companies, consider the Chinese model rather superior to the western democracies, since decisions can be made and pushed through more quickly. Which system will prevail in the end?

Lin: Neither. Important is how each country finds the right path for itself in order to adjust to changes. I don’t think that it is about the competition of two systems; the countries are too different for that.

This is what Europe is also struggling with at the moment. The differences between the countries have led the eurozone into a deep crisis. Do you believe that the euro can be preserved as the common currency of the 17 countries?

Lin: Yes. It is most importantly about re-creating trust in the marketplace. If enough financial capacity is made available to help the debt-ridden countries out of their squeeze. The economic requirements are actually apparent to almost everyone. I think that in the end, reason will prevail.



Justin Yifu Lin

Former World Bank Chief Economist and Senior Vice President

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