China Research

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

Re-visited – Is China Facing the Middle-Income Trap ?

March 5, 2014

Aiyar et al (2013) define the “middle income trap” as “a phenomenon with hitherto rapidly growing economies stagnating at middle-income levels and failing to graduate into the ranks of high-income countries”. Eichengreen et al (2013) use in a relatively recent analysis the critical “modes” for possibly commencing middle-income trap problems at the GDP per capita range of USD 10 000-12 000 and at the USD 15 000-16 000 level .

Thus, Eichengreen and al rather regard the middle-income trap as a process which can contain several steps. Following Eichengreen et al, China could currently indeed be relatively close to the lower mode – but this still uncertain. Interestingly, Eichengreen et al also conclude that the verification of a middle-income trap situation has shown a sustained reduction in the GDP-growth rate for as much as seven years; so far China has – the strong stimulus year of 2010 subtracted  – noted  five out of these seven years with the declining growth phenomenon (if we define two years with equal official growth rates as shrinking on trend; the average Chinese GDP growth declined during 2009-2013 to roughly 9 percent compared to 11 ½ percent during 2004-2008, with no major changes in average credit growth during these two periods ).

But Eichengreen et al have also found that some other characteristics which until now fit quite well to China and the description of a potential trapped middle-income country. They mention mainly quite high GDP-growth rates before the visible weakening of growth rates, a worsening demographic outlook, very high investment ratios and an undervalued currency. These criteria are very much in line with China’s development in recent years – but still too short-lived for making sufficiently sure about China’s real position in a “middle-income trap” application.

Since we do not know enough about the answer to the question whether China is about to enter the stage of a “middle income trap” or not, it would be very prudent if China could adapt the reasonable economic strategy plans of CPC’s  Third Forum congregation in November 2013 as much as possible. The degree of urgency may be somewhat uncertain – but certainly not the need of putting China fundamentally and structurally forward by new strategies and reforms in a lot of political, social and economic areas.

One should acknowledge that a lot of strategies that are needed for avoiding the trap of a middle-income country according to modern literature (also Agénor et al 2012), actually can be found in the Communist Party’s  60 different reform chapters of the Third Plenum from November 2013.

Interestingly, Agénor and his co-writers add in their article in general terms: “The middle-income trap is avoidable if governments act early – rather than late, when the benefits of cheap labor and the gains from imitating foreign technology are all exhausted  –  and decisively to promote innovation.”

To sum up: China faces the concrete risk to be caught in the middle-income trap – but it is probably not (quite?) there yet.  Many of the most needed urgent policy changes, however, are part of the Third Plenum’s envisaged strategy changes and improvements. Following Agénor’s advice, there is no time to lose for China’s political leaders to meet their own – reasonable – strategies and plans from the Third Plenum with courage and decisiveness.

References

Agénor, P-R et al (2012), “Avoiding Middle-Income Growth Traps”, Voxeu, December 21.

Aiyar, S et al (2013), “Growth Slowdowns and the Middle-Income Trap”, IMF Working Paper 13/71.

Eichengreen, B et al (2013), “Growth Slowdowns Redux: New Evidence on the Middle Income Trap”, NBER Working Paper No 18673.

Langhammer, Rolf (2012), “China Ahead of a Middle-Income Trap?” LNU blog:  www.chinareserach.se, from February 6.

Third Plenum (2013), “The Decision On Major Issues Concerning Comprehensively Deepening  in Brief”, Communiqué: http:/www.china.org.cn./china/third_plenary_session/2014-01/16/content_31212602_15htm

 

 

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

 

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Is Abenomics a Success?

February 6, 2014

Japan, the third largest economy in the world, has set up strategies for economic growth plans, namely Abenomics in an attempt to resolve its specific economic problems. Ongoing discussions on desirability of their strategic economic growth plans and concerns on their influence on the neighboring economies in the Asian region and on the globe are hanging albeit some of their macroeconomic indicators show arguable signs of heading to the right direction. This article takes a brief look at the cores of the strategic growth plans of the giant economy and evaluates Abe’s economic growth plans in 2013, addressing challenges of Abenomics that are lying ahead.

Abenomics to bounce back

Abenomics which is named after the Japanese prime minister Shinzo Abe got off to a start after the won the re-election in December 2012 with proposing economic growth plans including 1) carrying out aggressive expansion of the governmental expenditure; 2) supporting continual monetary easing via QE (quantitative easing); and 3) running structural reforms to enhance competitiveness of the whole country. The Keynesian-inspired economic growth plan of Abe is aimed at sparkling life into the economy from the 15-year-long deflation through monetary, fiscal and structural policies. This stimulus package along with structural reform worth above $200 billion is focused on government spending with infrastructure projects for building bridges, tunnels, and earthquake-resistant roads, which was already approved by the cabinet in January 2013. The Bank of Japan (BoJ) is embracing the stimulus plan and has set an inflation target of 2 percent (from an earlier target of 1 percent) in January 2013, which it commits to achieve via quantitative easing of buying up mostly short-term government debt that is due to start in 2014.

How will the plan reflate Japan’s economy – and what has been done?

It was hoped that the aggressive monetary expansion will weaken the Japanese Yen, which would give exports a major boost, leading to a rise in corporate earnings, boosting the stock market, resulting in higher wages, thus increasing private consumption and finally escaping from the trap of deflation. As was hoped, the weakening yen against the dollar has taken it to reach to the five-year-low of 105 against the dollar, making yen depreciation against the dollar by 19,9 percent in 2013. [1] As the benefits of a weak yen started to take effect, Japanese exports rose in 2013 along with an increase in sales of cars and electronics to the United States, Europe and Asia, where some signs of recovery in overseas demand are being shown. The stock market rally also followed. Nikkei 225 reached a six-year high and took around 50 percent gain in 2013. News on ‘end of deflation’ followed.

According to the statistics announced by the government in October 2013, Japan’s core consumer price index (excluding food), rose by 0.7 percent in September compared with the same month a year ago, making the fourth monthly gain in a row. Including food prices, the index increased by 1.1 percent. Furthermore, in an survey of 1,000 Japanese retail investors done by Goldman Sachs Asser Management in 2013, 56% percent of respondents replied that they expected deflation to end soon. Based on these indicators as above, Shinzo Abe’s economic policies have achieved success so far. However, there are challenges lying ahead.

Challenges lying ahead

The success of Abenomics so far in large part is indebted to the weakening of yen, which involves two risks. First, weakening yen itself has a downside for the Japanese economy. According to the data of Ministry of Finance released in July 2013, for example, imports to Japan rose 19.6 percent in July 2013, a three-year high, due to a jump in the cost of imports for crude oil and liquefied natural gas. As a result, Japan has an increasing trade deficit, exceeding 1 trillion yen. These rising costs of imports for energy and raw material may press down Japanese corporate profits, which would be negative for Japanese economy.

Second, there is a growing concern over the ripple effect of decline in yen over the globe. In the Asian region including South Korea and Europe are wary of competitive devaluation of countries to boost demand for domestic industry by maintaining domestic currencies weak. In other words, the success of Abenomics depends on other countries not jumping on the wagon of depreciating their currencies, thereby maintaining competitiveness in the international arena.

However, there are economies that start to react to the yen decline. The central bank of Korea already cut its benchmark interest rate by surprise in May 2013, Australia cut its key interest rate to a record low in August 2013, and the same trend in interest rate cut was also followed in Thailand. The world export-led economies in the world like Germany and China are clearly worried. Especially regarding China, the yen decline gets intertwined with even more convoluted China-Japan conflicts.

As was mentioned above, the third core of Abenomics include structural reforms and joining the Trans-Pacific Partnership (TPP) [2] for liberalization measures with its major trading partners. The sovereign disputes over the Diaoyu/Senkaku between Beijing and Japan in the East China Sea have spilled over into Sino-Japan relationships including the economic relationship, which got even exacerbate worse due to Abe’s visit to a shrine that honours Japan’s war crimes including some convicted war criminals. China takes 20 percent of Japan’s trade and thus how successful Abenomics will be in the coming years cannot be free from its economic relationship with China. Abe’s hawkish and nationalistic approach not only distracts the agenda for economic reforms but jeopardizes also economic and political relationships with neighboring countries.

Critics on Abenomics also put Japan’s enormous public debt at the forefront of many criticisms. Japan’s national debt, which exceeds 10 trillion US dollar is more than twice its GDP, is even too large to afford a moderate rise in interest rates. Concerns of some investors who are anticipating inflation is that rising interest rates would have a negative impact on the trade deficit and fiscal position of the government. Such a concern was expressed by Martin Feldstein who wrote in project syndicate that “…the combination of exploding debt and rising interest rates is a recipe for economic disaster.”

Summing up, Abe’s economic plans have shown signs of success in 2013. However, there are growing concerns as to feasibility of its continuing success in the coming years due to the risks that Abe’s policy takes including what is-so-called ‘currency war’, tremendous public debt and disputes with influential economic partners in the region. Whether Abenomics is a success and whether Japan really has bounced back will be tested again with challenges lying ahead in 2014.

[1] Average of weekly MIDPOINT rates. Source: Oanda.com

[2] A proposed regional free trade agreement being negotiated between the United States and eleven other countries in Asia and the Americas.

 

 

 

 

 

 

 

Hyunjoo Kim Karlsson
Senior Lecturer, Linnaeus University

Editorial board

 

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Emerging Markets – the Same Old Story

1. Financial markets have become nervous again about emerging markets. We have seen this flock mentality some months ago. Now it’s back again. Surprised?

2. The answer is “yes” and “no”. Yes, because many analysts never seem to understand how emerging markets really work. They are far from perfect. Shortcomings can be found in many respects: politics, social issues, the financial system, other institutional conditions, macroeconomic balance, etc. No, because financial markets frequently tend to show flock mentality, overconfidence and overreactions also when it comes to emerging markets. This is not new. Now, it’s time again.

3. Many financial analysts complain about lame structural efforts in many emerging economies. What do they expect? Sure, there are so many institutional and political impediments for improvements in this group of countries. Corruption, nepotism and rent seeking are just three of them. How on earth can rapid reduction or elimination be expected in all these complicated areas? By the way, emerging countries do not have homogeneous political, social and economic conditions

4. Consequently, emerging markets have been analyzed too negligent for a long time – and they still are. They are, of course, different from mature countries which by the way can be very reluctant on economic reforms as well. Thus, we should analyze the group of emerging economies and their individual “member countries” at least somewhat differently.

5. One of the major analytical problems is the fact that Western emerging market analysts too much and for too long time have been concentrating on GDP growth and too little on other important indicators, those from microeconomics and financial markets included. Too much focus on GDP growth may be misguiding, particularly in the medium and longer run.

6. Furthermore, it’s not good enough to watch developments in China, India or other emerging economies only from the screen. All these emerging countries function differently compared to our part of the world. “Screen analysis” gives, of course, country analysis even more herd behavior.

7. However, it’s not easy to get out of this analytical dilemma. Most employers would not allow their economists, strategists or sales planners to travel to all these interesting emerging countries in order to get more necessary impressions from “field research”. But it should be done wherever the financial resources are in place.

8. Speaking on my own behalf, I have to conclude that my recent trip to China a few weeks ago gave me more input for the interpretation of the Third Plenum’s communiqué than all the hundreds of pages I read about China’s new economic strategy. Or I should put the following way: just reading about these 16 major points of reforms and their 60 subtitles would not have been enough.

9. What makes future economic developments in China particularly exciting is the great number of goal conflicts that may emerge from these 60, more detailed reform areas. Such an analytical exercise demonstrates that structural reforms in emerging countries are not easy at all.

10. Deepened studies of this kind could make many Western analysts a little bit more humble. The current arrogance against many emerging countries – despite all their really existing shortcomings – cannot always be considered as fair.

 

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

 

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