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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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Hard landing [By Jiao Haiyang/China.org.cn]

The peril of increasing interest rates

Monetary policy looks easy to operate, but its effect is a double-edged sword. Friedman mistakenly assumed that market prices can be determined by the quantity of money alone. Therefore he thought that monetary expansion can avoid interest conflicts and prevent a financial crisis. But this is only a theoretical fantasy which works in a closed economy without any financial innovation or international competition.

In the shadow of the international financial crisis, the U.S. implemented zero interest rates and a monetary expansion which has triggered a large sum of capital outflow. The money flowed to the East Asian market, which has a high growth rate, or to the European dollar market which has a high interest rate. The Fed monetary policy has become feeble and impotent since the money drain.

The decisive factor of investment is not the borrowing cost, but the future economic growth point or the returns available in various regions or industries.

Therefore, China must be very prudent in its application of monetary policies like increasing interest rates or bank reserve requirements. These policies will not only increase pressure on the RMB revaluation and attract international hot money, but also raise risks on mortgages and SME financing and further worsen the employment outlook for college students and migrant workers.

Systemic reform is more important than price intervention

Neo-classical economics assumes that when market scale or resources are limitless, consumers or investors make decisions independently, and there is no market manipulation or speculation, prices will allocate resources appropriately.

But according to the famous Adam Smith theorem, the division of labor is limited by the extent of the market. If small groups of buyers or investors can own a large percentage of the market share, they can distort the price and create bubbles. So the systemic reform is more important than the price intervention in terms of overall economic stability.

The US's pillar industry – the automotive industry ―suffered a heavy blow during the 2008 financial crisis. The reason lies in the high welfare costs in America. The medical cost per capita in the U.S. is three times of that in Japan and twice that in Europe. One General Motors' worker, on average, has to support four retirees. The welfare costs for running a factory in Southern U.S. is two times than that in Japan, Germany and South Korea. Even though the company has access to the latest technology, it's still in an unfavorable position in terms of international competitiveness.

The Obama administration has tried to intervene in the health insurance market to break the private insurance oligarchy. In doing so, he was accused of implementing socialism and even Nazism. Extending medical coverage to all Americans without raising taxes or affecting vested interest groups is impossible; one of these will have to give if health care reform can be successfully implemented.

Compared with the incompetence of the gridlocked U.S. political system, China has applied bold reforms on the marketing of state-owned enterprises and banks during this crisis. As a result, millions of workers from state-owned enterprises have been laid off.

But China also has to address its problems in real estate, especially the high cost of housing in coastal cities caused by the hoard of speculators and local interest groups. The pilot property tax program only targets new buyers. China must quickly take action to prevent the housing bubble from spiraling out of control.

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