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China can avoid West's economic mistakes

By Chen Ping: 0 Comment(s)Print E-mail China.org.cn, December 30, 2012

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Bear the air [By Jiao Haiyang/China.org.cn]

The global financial crisis which originated in the U.S. in 2008 is a precious historical experience for China to see the deleterious effects of the macroeconomic policies of John Manyard Keynes and Milton Friedman.

The U.S. government first implemented a large-scale expansionary monetary policy and then a large-scale fiscal policy. Although these policies have avoided a generalized run on banks, they have not broken the financial oligarchy's monopoly. Neither have they reformed the welfare system or military expansion, which led to a fiscal crisis. These policies have produced a high unemployment rate and sluggish economic recovery.

Recently, the U.S. Federal Reserve announced to expand its third-round quantitative easing program which has triggered global inflation and social unrest. We should be aware of the limitations of western macroeconomic policies and avoid falling into the trap of sacrificing our sustainable development for short-term interests, which Is what the West appears to be doing.

The Keynes-Friedman pitfall

Since the 1930s, Keynesian fiscal policy and monetary policy based on the teachings of Milton Friedman have been seen as an effective tool to save capitalism and avoid another Great Depression. Although these two policy tools have their respective focuses, their goals are confined to restoring the short-term economic balance: this in turn maintains the status quo for vested interest groups.

Macroeconomics attributes market fluctuations to a surface imbalance of aggregate demand. It also denies the division of labor caused by the technical revolution from the supply party and the rises and falls of the powers as well as the structural changes caused by the new world order. It fools people with presumptive regulations based on the theories of mass psychology. But it refuses to make any structural adjustment on politics and economy.

Such policymaking centers on the domestic economy and neglects the influence from international competition on domestic policy in an open economy. Instead of facing problems, Western governments use the neo-classical economics to cover this game of interest groups. With this kind of thinking, it becomes nearly impossible for them to walk out of an economic crisis unscathed.

It was not Roosevelt's new deal that pulled the U.S. out of the Great Depression. It had to wage wars to boost its economy. As I warned at the Melbourne Conference in 2009, if the U.S. does not desire to work with China and the EU to restructure world order, it will not be able to fully recover from the financial crisis.

The Libyan War and the tensions in Northeast Asia and the South China Sea have shown that the U.S. and Western Europe have already fallen into the Keynes-Friedman trap.

The question now is how will Chinese economists learn from these lessons and promote the independent development of economics.

China adopted similar fiscal and monetary policies as other large countries during the 2008 financial crisis, but the effect was much better than those applied in the U.S., Western Europe and Japan. Why? Chinese policy makers understood the pitfalls of applying Keynes/Friedman theories to apply an expansionary fiscal policy while easing monetary policy to fuel domestic demand and lessen international pressure.

Short-term stimulus will aggravate the crisis

Western macroeconomic policies put undue emphasis on the role of the demand side, while neglecting the supply side. Adam Smith, Karl Marx and Joseph Schumpeter all stressed the industrial revolution and the development of the division of labor. This has sped up technological progress and structural evolution. But neo-classical economics creates a myth of consumerism and overstates the self-stability of market competition based on allocation of resources.

Keynes discovered that the shortage of aggregate demand would cause voluntary unemployment, thus justifying a fiscal expansion to boost consumption. However, he did not realize that the real cause of short-term aggregate demand is the rise and fall of industries and their plights in the transition. A high unemployment rate produced by such structural factors cannot be cured by short term fiscal or monetary policies.

The US's problem lies in the excessive debt ratios of its residents, companies and governments at various levels. The high cost of social welfare, military expenses and the U.S. legal system has gradually weakened its companies' international competitiveness.

Consumers and companies do not dare to consume or invest after servicing interest on their debts.

In contrast, China's problem lies in its companies' low profit margins. Most Chinese companies lack indigenous core technologies or marketing channels. Therefore their profits are much smaller than that of Western companies. But if China expands its social welfare or increase workers' salaries largely by administrative means, this may cause mass bankruptcies among the small and medium enterprises. This would be exactly the opposite of its motive to boost consumption.

Whether the purpose of the fiscal expansion policy is to stimulate consumption or to improve companies' core competences, it should be analyzed on a case-by-case basis. Governments should not blindly follow other countries' policies. In China's case, the government should improve the international competence of its enterprises and workers as well as create jobs by developing new industries. A short-term consumption stimulus, in contrast, will squeeze out companies' technological innovation capacity and therefore aggravate the current crisis.

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