China Research

A discussion forum on emerging markets, mainly China – from a macro, micro, institutional and corporate angle.

The AIIB and How Not To Repeat Historical Mistakes

May 6, 2015

Old hero looks on bad temperedly as would-be new hero launches his idea for a new global financial order. Old hero tries for all he is worth to prevent the new idea from gaining currency among his erstwhile followers. His efforts are to no avail. The new hero manages to amass overwhelming support for his proposed institution.

Ah you might well say. This is all about the Asian Infrastructure Investment Bank, new hero being China and old hero being the USA. Right? Yes indeed. But there is actually another answer which could be considered equally as correct. It is the case of the creation of the IMF. On that occasion the new hero was the US with the UK being the grudging old hero. At that point, not even an alternative idea put forward by none other than John Maynard Keynes was able to prevent the dollar based international structure from being born.

The IMF was created in 1945. And now it is 2015. 70 years is a long time in economics, perhaps. Yet surely not that long for the American memory not to be stirred and to recognise the irony of the turn of events. Well may be not. But it is certainly an indication that people react in pretty much the same fashion when the same kind of shock hits them.

That said it is difficult to envisage the renminbi acquiring the position that the US dollar did in the immediate postwar years. In passing, it should also be noted that the US dollar’s reign itself did not last that very long. The dollar’s convertibility to gold was terminated in 1971 after all, thereby effectively ending the dollar’s position as unchallenged international key currency. Nevertheless the Chinese currency is even more disadvantaged than the dollar of those days in that China’s economic supremacy of today is nowhere near that of the US in the immediate postwar years. At that point, everyone else was struggling with postwar redevelopment. They desperately needed dollars to finance that endeavour. The renminbi is so clearly not in that position.

In Japan we have the saying “acorns comparing heights” indicating competition among contestants who are not that different from each other in terms of ability. There is no outstanding winner with undisputed might. This is very much the case now that we live in a highly globalised world in which people, goods and money flow so effortlessly over borders. No single nation or region can boast of being the oak tree rather than an acorn. China may be an extremely super large acorn but it remains an acorn nonetheless and not the tree.

Moreover, the dollar of pre-1971 years was the only currency that was convertible to gold at a fixed price. The renminbi enjoys no such exceptionality.

All this being said, one can understand China’s motivations behind the AIIB initiative quite well. It needs access to the infrastructure development market of Asia. In needs some big projects on which it can use up its vast excess production capacity. Having run out of investment opportunities inside its own economy, it is now looking for space elsewhere. It is also looking for a way out of dollar-dependency. It wants access to global finance in its own right without having to rely on the dollar as a gateway.

So the new kid on the block is trying to grow up in a workable fashion. The US should look back on its experience of 70 years ago and try to avoid the British mistake of attempting to block the newcomer’s way. Begrudging new people access to club membership is never a very sophisticated thing to do. They will sulk, become defiant and go on to create a club of their own. This will more often than not lead to unproductive squabbles and pitch warfare.

It was refreshing to watch the British manoeuvre on this occasion. To be the first to stand up and be counted as a member of the AIIB club was a stroke of piratical genius. It seems that the country’s buccaneer spirits have not died down completely. A completely different performance to 70 years ago. Much more sensible. It is a typical case in point which shows you that when you are no longer the old hero whose position is being threatened by youthful rivals you can relax and come up with some impish ideas about position taking.

Most pitiful in this context has been Japan’s response to the AIIB idea. It would have done better to try to outdo the British. If a young and upcoming very large Asian acorn is trying to boost infrastructure development in the area, a more mature and more experienced Asian acorn of not at all negligible size should welcome the opportunity to lend a hand. Or even both hands. Having secured the position of wise old advisor, Japan could have gone on to mediate between old hero and new hero. Alas no such luck. Japan just keeps looking on with scared stiff eyes for the new comer and apologetic diffidence for the old timer. Pathetic.

 

 

 

 

 

Noriko Hama
Professor & Dean at Doshisha Business School, Kyoto

 

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Japan’s (Abenomics’) Failure – are there Growing Risks for other Asian Countries and the World Economy?

December 3, 2014

In the third quarter, Japan’s economy tumbled again into a recession. “Abenomics” – i.e. the economic program of prime minister Shinzo Abe (LDP) – proved to be a failure. Expressed very briefly, “Abenomics” means that the Bank of Japan (Nippon Ginko) two years ago was committed to massively print money in completely uncharted waters in order to combat the long-lasting deflationary problem.

Furthermore, Abe wanted to do something about the excessive government debt (more than 240 % of GDP), for example by raising the VAT from 5 to 8 last April – a measure that obviously contributed to the current recession and made Japanese consumers even more reluctant. For this reason, another planned VAT hike has been postponed.

Bad advice

One of the intellectual fathers of “Abenomics” was Nobel Prize winner Paul Krugman who during a long time had complained about Japan’s “irresponsible monetary policy” (and who also had accused the Swedish Riksbank for a similar failure – and who, unfortunately, has quite a number of supporters among Swedish academics and financial analysts). The idea of the whole experiment was to print money in borderless amounts for government expenditure – government expenditure that should give positive multiplier effects on consumers and private corporate investors. Furthermore, some inflation should be created this way.

Today, it seems to be obvious that the Krugman-/Abe-experiment has failed. Extreme monetary expansion cannot work in the long run and never replace a structurally well-founded growth/supply side policy. If it was that easy…Something to remember in Sweden and in Frankfurt (ECB) as well.

It would be good idea if the world listened less to Krugman and consortes. With quite some luck, the previous monetarization in the U.S. by the Fed may be managed without major distortions. Janet Yellen understands economics. But Japan and Europe (ECB; Sweden included) function quite differently and have probably very different reactions functions for increased liquidity.

M x V = P x Q

Old fundamentals may help. Let’s for example, look at Irving Fisher’s so-called “equation of exchange” (1911): M x V = P x Q (M = money in circulation, money supply, V = velocity of money circulation, P = price level, Q = expenditures in real terms).

In our context, V, P and Q are the interesting variables. V stands for the average frequency that one unit of the currency/money is spent. An important point in this context is the fact that the “equation of exchange” is an identity equation which means that it is always valid whatever number you put in it. Consequently, the new number for V is not known in advance when M is changed. The same can be said about P (inflation) and Q. These simple facts make the effects of strongly extended money supply uncertain and, consequently, the whole basket of different kinds of quantitative easing (QE) – an instrument which central banks so actively apply these days or intend to use as an instrument for better growth and higher inflation (the Riksbank, unfortunately, included).

Now, in order to make the whole process of monetarization work, it is necessary that the velocity of money circulation increases visibly. Consumers and investors should be willing to spend more money more rapidly. And here we come finally to the point: consumers and investors must believe in the future. This is about behavioral economics.

Behavioral economics needs more attention

In the Japanese case, this necessary condition for a successful expansion of the money supply is not there. The Japanese are not showing enough confidence in the future. This is why any continuation of Abenomics will fail again under current structural conditions. A new policy failure – and the economic outlook for the currently third largest economy in the world will worsen much more.

In this case: at some point – within the forthcoming decade – negative contagion from Japan on other Asian countries and the whole global economy could happen. Consequently, the next Japanese government has to think more about giving real confidence in the economic future. So far, 25 years have gone without positive results. Institutional economics and the lack of behavioral studies explain a lot of this ineffective economic policy.

Economic history tells us that printing money and other liquidity-creating measures never really could cure long-term problems in the real economy.

This is indeed an important experience that academic researchers, decision-makers in central banks/governments and on financial markets should remember more actively.

 

Hubert Fromlet
Senior Professor of International Economics, Linnaeus University
Editorial board

 

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When will an Asian Win the Nobel Prize in Economics?

October 1, 2014

So far, we have not seen many winners of the Nobel Prize in Economics – or more exactly “The Riksbank’s Prize in Economic Sciences in Memory of Alfred Nobel” – who had their roots in emerging countries. Arthur Lewis (1979) from St.Lucia and Amartya Sen from India (1998) were two positive exceptions. But what about the chances that an Asian economist may win the Nobel Prize this year again?

There are altogether 200-300 serious candidates for the Nobel Prize in Economics. Usually, the award goes to American economists – but not necessarily. Among candidates with Asian roots – Israel and Japan excluded in this context – I see clearly Avinash Dixit as the strongest candidate for 2014(born in Mumbai, India) , nowadays working as a professor at Princeton University, dealing with microeconomics, industrial organization, public economics, international trade plus growth and development theories. Dixit is also included in my own list of the “Top 10 Favorites” that will be published on October 3.

Dixit’s main challengers from Asia should be free trade supporter Jagdish Bhagwati (New York University) from India and Partha Dasgupta (University of Cambridge) from Bangladesh. Dasgupta has done important research on the environment which is so badly needed for emerging countries – but also on poverty, nutrition and knowledge. One should not either forget the very important field research of Abhijit Banerjee (MIT) with focus on development economics, many times taking research results from his home country India. The main outsider with roots in Asia could be Hashem Pesaran (with roots in Iran, econometrics and empirical macroeconomics). Sendhil Mullainathan – born in Tami Nadu/India – can develop to a serious Nobel Prize candidate but is currently still by far too young (research areas: behavioral finance, development economics).

Another well-known and important economist from the emerging-country world is, of course, Hernando de Soto from Peru (corruption, informal economy, institutions). (Almost) the whole continent of South America is still waiting that the Nobel Prize Committee will give him the highest award for economic research. However, it may be the case that de Soto is judged as not being sufficiently anchored in the academic economic world of models and mathematics.

But if this year’s Nobel Prize in Economics is not going to one of the names mentioned above it remains possible that other representatives of “growth and development” will be awarded, probably from the U.S. This would be another way to put more emphasis on emerging markets.

On October 13, we will know more about it. Competition with other economists and research areas is tough.

 

Hubert Fromlet
Senior Professor of International Economics, Linnaeus University
Editorial board

 

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