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Wednesday, November 30, 2005



I'm not a economics buff, so I was wondering if somebody would answer this question for me. Everybody talks of over investment in China, and the fact that growth is export driven and not consumption driven which will make the coming years difficult for China.

To me the solution to this problem seems simple. Cut government expenditure on infrastructure, increase taxes in overheated sectors, and then divert these savings by giving tax breaks for china's poor. This will take care of further over investment, and also increase domestic consumption. The increased consumption will take care of the current excess capacity.

While GDP, which has been growing largely through investment might not register 9% growth, the purpose of growth has always been to increase the quality of life for the average person and therefore also assure political stability for the communist party. The increased domestic consumption may also serve to straighten out trade imbalances.

I haven't heard any economist mention something like this so I'm assuming there is something wrong with my logic, can someone explain to me what it is?

Edward Hugh

"The risk of deflation has long gone in the US, and it is even waning in Japan."

I'd be a little careful here New Economist. I think the important point would be that there is such a thing as a business cycle. So the expansionary phase in global growth won't last forever. The issue is what happens when we hit the downside. I think the deflationary danger is evident in China, and the issue will then be the extent to which China sets global prices: in which sectors and to what extent.

I think Japan is far from done with deflation. And I also think that it isn't off the mid-term agenda in the US. Part of the issue is the future of the dollar. If Japan fails to make a substantial recovery and the yen continues weak, and ditto for the eurozone, then the strengthening dollar can produce a real and present deflation danger in the US at some point.

Which is why the appointment of Ben Bernanke is so appropriate. If the Bundesbank has been haunted by German hyperinflation of 1923, then Bernanke is surely deeply influenced by three years of dramitic deflation in the US in the 1930s.

One interesting marker of what may be to come is the US yield curve situation and the threat of inversion. Now normally, as everyone says, normally this marks the onset of a recession. But this isn't necessarily the case this time. There may be other factors at work this time round: working out what those might be should help us see more clearly what could happen next.

Stephen Roach's global team had a very interesting discussion on all this on Monday:





Cut government expenditure on infrastructure --– so, no clean water, decent sewage, irrigation, power, telecoms, roads, rail, hospitals, schools ... those folks don’t need infrastructure, right?

Increase taxes on overheated sectors --– how do you decide which sectors are overheated? Is it the luxury residential villas, but not affordable housing? Widget exports but not gizmo makers?
Better question: WHO decides what is overheated? Bureaucrats who’ve never worked in the corporate sector (let alone the private sector)?

Divert these savings by giving tax breaks for China’s poor --– Savings? You just killed off the engines of growth and you expect there to be “savings”?
Ah, and China’s poor don’t pay taxes, so “tax breaks” would have to be direct subsidies.

This will take care of further over investment --– and all other investment!

And also increase domestic consumption --– retail sales are rising 13% this year; how much more stimulus do you want?

The increased consumption will take care of the current excess capacity --– Are China’s poor going to buy those surplus Christmas ornaments, DVD players, laptop hard drives and The Gap fashions?

Opinion: In China, the purpose of growth is to create ~15 million new jobs a year, thereby staving off unrest, insurrection, chaos, revolution and civil war. Nothing more.

OK, the last was a bit over the top. Apologies. But, job creation is still the key.

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