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August 11, 2015

Latest Posts from Economist's View

Latest Posts from Economist's View


'Is China’s Growth Miracle Over?'

Posted: 11 Aug 2015 12:33 AM PDT

This is by Zheng Liu, "a senior research advisor in the Economic Research Department of the Federal Reserve Bank of San Francisco": 

Is China's Growth Miracle Over?, by Zheng Liu, BRBSF Economic Letter: China's economy grew 10% per year for over 30 years beginning in the early 1980s. No other country in modern history has achieved such exceptional growth for so long. Before the global financial crisis, China's growth was primarily driven by productivity gains. Since 2008, however, growth has slowed and become increasingly dependent on investment.
Because China has been a large and expanding market for other countries, its growth prospects have important implications not just for the Chinese people but also for the global economy. This Letter examines the sources of China's growth and some factors contributing to the recent slowdown, and offers a cautiously optimistic view of China's future growth.
China's growth miracle
Since the early 1980s, China's open-door policy and economic reforms have led to a remarkable growth performance. As Figure 1 shows, China's real GDP grew about 10% per year on average for 30 years before the recent slowdown. At that rate, national income doubles every seven years. No other country in modern history has achieved such high growth for so long.

Figure 1
China's real GDP growth, annual percent change

China's real GDP growth, annual percent change

Source: IMF World Economic Outlook, CEIC.

Rapid economic growth has significantly raised the living standards of the Chinese people. According to data from the Penn World Tables, China's real GDP per person rose steadily from around 5% of the U.S. level in 1980 to about 20% in 2011. The World Bank estimates that, during the same period, over 600 million people in China have been lifted out of extreme poverty, defined as living for under $1.25 per day.
Engines of China's growth
Theory suggests that three factors contribute to economic growth: capital accumulation, labor force expansion, and productivity improvement. Empirical evidence in China's case suggests that growth in the third factor, known as total factor productivity, has been an important contributor to the three-decade growth miracle (see Zhu 2012). A series of domestic economic reforms beginning in the 1980s led to more efficient allocations of capital and labor and also better aligned private incentives. The open-door policy attracted foreign direct investment, which in turn brought new management practices, technological know-how, and access to the world market for Chinese businesses. These policy changes boosted productivity. As productivity improved over time, investment and production expanded. Although capital investment also contributed to growth, its contribution is limited by diminishing returns and thus, investment cannot be the main driving force of sustainable growth.

Figure 2
Accounting for China's growth

Accounting for China's growth

Source: Penn World Tables and author's calculations.

Figure 2 shows the contribution of each of the three factors to China's growth since 1980. The calculation follows the growth accounting approach described by Zhu (2012), with China's labor income share fixed at 0.5. The data for real GDP, employment adjusted for human capital levels measured by years of schooling, and capital stocks are taken from the latest version of the Penn World Tables (version 8.1; see Feenstra, Inklaar, and Timmer 2015 for a summary of the data).
As shown in Figure 2, China's rapid growth was driven mostly by productivity gains and investment rather than employment growth. For example, out of the roughly 10 percentage points of average growth in the 1990s, capital accumulation accounts for about half of it, productivity improvement accounts for another 4 percentage points, and employment gains account for the remaining 1 percentage point. Labor's limited role in part reflects China's one-child policy that limits population growth and restrictive policies on internal migration, such as the "Hukou" system that restricts citizens' abilities to work in cities other than where they were born. The figure also reveals a significant decline in the contribution of total factor productivity since 2008. Accordingly, China's growth has become more dependent on capital investment in this more recent period.
The recent slowdown and new policy measures
During the global financial crisis, demand for Chinese exports fell substantially. Meanwhile, waning productivity gains presented further challenges for sustaining high growth. The Chinese government responded to the crisis by adopting a large-scale fiscal stimulus package, which was announced in November 2008 and implemented quickly in 2009 and early 2010 (Wong 2011; Faust, Lin, and Luo 2012). This policy accommodation significantly boosted investment growth, especially in targeted areas such as infrastructure and construction, and led to short-run booms in output in 2009 and 2010. Nonetheless, growth has slowed substantially since 2011. The average growth rate between 2011 and 2014 was about 8% (see Figure 1). Growth slowed further to 7% in the first two quarters of 2015, and the Chinese government officially lowered its growth target to 7% for the year. Although this rate is still quite remarkable by international standards, it is significantly lower than the 10% average recorded in the previous three decades.
The recent slowdown has raised the concern that China might be falling into a pattern commonly referred to as the "middle-income trap" (see, for example, Eichengreen, Park, and Shin 2011). Historically, fast-growing countries have often fallen into such a trap, in which growth slows sharply as income reaches a threshold level and wages rise sufficiently to erode a country's comparative advantage.
However, some countries have successfully avoided the middle-income trap and moved to high-income status, which the Organization for Economic Co-operation and Development defines as GDP per capita of $12,500 based on 2011 constant international prices. These include China's neighboring countries Japan and South Korea. In the 1960s, Japan had per capita real GDP of about $6,000 and an average growth rate of over 10% (see Figure 3). In subsequent decades, however, Japan's GDP per capita rose and its growth slowed. By 2011, Japan's GDP reached over $30,000 per capita and growth slowed to about 1.25%. South Korea has followed a similar path since the 1980s.

Figure 3
Will China follow Japan and South Korea?

Will China follow Japan and South Korea?

Source: Penn World Tables, IMF. Curved line shows fitted trend.

China had a real GDP per capita of about $2,000 in the 1980s, which rose steadily to about $5,000 in the 2000s and to over $10,000 in 2014. If China continues to grow at a rate of 6 or 7%, it could move into high-income status in the not-so-distant future. However, if China's experience mirrors that of its neighbors, it could slow to about 3% average growth by the 2020s, when its per capita income is expected to rise to about $25,000.
This may appear to be quite a pessimistic scenario for China, but China's long-term growth prospects are challenged by a number of structural imbalances. These include financial repression, the lack of a social safety net, an export-oriented growth strategy, and capital account restrictions, all of which contributed to excessively high domestic savings and trade imbalances. According to the National Bureau of Statistics of China, the household saving rate increased from 15% in 1990 to over 30% in 2014. High savings have boosted domestic investment, but allocations of credit and capital remain highly inefficient. The banking sector is largely state-controlled, and bank loans disproportionately favor state-owned enterprises (SOEs) at the expense of more productive private firms. According to one estimate, the misallocation of capital has significantly depressed productivity in China. If efficiency of capital allocations could be improved to a level similar to that in the United States, then China's total factor productivity could be increased 30–50% (Hsieh and Klenow 2009).
To address structural imbalances and thus achieve sustainable long-term growth, the Chinese government announced a blueprint of economic reforms at the Third Plenum in November 2013. The proposed reforms include (1) financial sector reforms—liberalizing interest rates, establishing deposit insurance, and strengthening financial supervision and regulation; (2) fiscal reforms—strengthening social safety nets, introducing more efficient and redistributive taxes, and improving health insurance and pension coverage; (3) structural reforms—reforming the SOEs and the Hukou system and further opening up markets; and (4) external sector reforms—liberalizing the exchange rate and capital account controls.
If these reform blueprints can be successfully implemented, then China should be able to avoid the middle-income trap and sustain long-term growth at a reasonable pace. In the transition process, however, structural reforms may contribute to a slowdown in economic growth.
Growth prospects
China's growth is expected to slow further in the coming years. The International Monetary Fund (IMF) forecasts that growth will be about 6.8% for 2015. With an aging population, slowing productivity growth, and the policy adjustments required to implement structural reforms, growth is projected to slow further to 6.3% in 2016 and 6% by 2017.
Despite the slowdown, there are several reasons for optimism. First, China's existing allocations of capital and labor leave a lot of room to improve efficiency. If the proposals for financial liberalization and fiscal and labor market reforms can be successfully put in place, improved resource allocations could provide a much-needed boost to productivity. Second, China's technology is still far behind advanced countries'. According to the Penn World Tables, China's total factor productivity remains about 40% of the U.S. level. If trade policies such as exchange rate pegs and capital controls are liberalized—as intended in the reform blueprints—then China could boost its productivity through catching up with the world technology frontier. Third, China is a large country, with highly uneven regional development. While the coastal area has been growing rapidly in the past 35 years, its interior region has lagged. As policy focus shifts to interior region development, growth in the less-developed regions should accelerate. With the high-speed rails, airports, and highways already built in the past few years, China has paved the way for this development. As the interior area catches up with the coastal region, convergence within the country should also help boost China's overall growth (Malkin and Spiegel 2012).
Continued robust growth in China would be beneficial for the global economy as well. China's market for U.S. exports has grown steadily from 4% in 2004 to over 7% in 2014. According to an IMF estimate, China contributed about one-third of the world's growth in 2013.
Conclusion
China's growth miracle since the early 1980s has significantly raised the standards of living in China. It has also made China an increasingly important contributor to world economic growth and a large and growing market for U.S. exports. The rapid growth was driven primarily by productivity gains and capital investment. The recent growth slowdown has raised the concern that China's growth miracle could be ending.
However, if the structural reform plans from China's Third Plenum can be successfully implemented, then the recent slowdown could be a smooth transition rather than a hard landing. This gives a reason for optimism that China will avoid the middle-income trap and follow the paths of Japan and South Korea to achieve high-income status.

References

Eichengreen, Barry, Donghyun Park, and Kwanho Shin. 2012. "When Fast Growing Economies Slow Down: International Evidence and Implications for China." Asian Economic Papers 11(1, February), pp. 42–87.

Feenstra, Robert C., Robert Inklaar, and Marcel P. Timmer. 2015. "The Next Generation of the Penn World Table." American Economic Review (forthcoming).

Hsieh, Chang-Tai, and Peter J. Klenow. 2009. "Misallocation and Manufacturing TFP in China and India." Quarterly Journal of Economics 124(4), pp. 1,403–1,448.

Malkin, Israel, and Mark M. Spiegel. 2012. "Is China Due for a Slowdown?" FRBSF Economic Letter 2012-31 (October 15). http://www.frbsf.org/economic-research/publications/economic-letter/2012/october/is-china-due-for-a-slowdown/

Wong, Christine. 2011. "The Fiscal Stimulus Programme and Public Governance Issues in China." OECD Journal on Budgeting 2011(3). http://www.oecd.org/gov/budgeting/Public%20Governance%20Issues%20in%20China.pdf

Zhu, Xiaodong. 2012. "Understanding China's Growth: Past, Present and Future." Journal of Economic Perspectives 26(4), pp. 103–124.

The Macroeconomic Divide

Posted: 11 Aug 2015 12:24 AM PDT

Paul Krugman:

Trash Talk and the Macroeconomic Divide: ... In Lucas and Sargent, much is made of stagflation; the coexistence of inflation and high unemployment is their main, indeed pretty much only, piece of evidence that all of Keynesian economics is useless. That was wrong, but never mind; how did they respond in the face of strong evidence that their own approach didn't work?
Such evidence wasn't long in coming. In the early 1980s the Federal Reserve sharply tightened monetary policy; it did so openly, with much public discussion, and anyone who opened a newspaper should have been aware of what was happening. The clear implication of Lucas-type models was that such an announced, well-understood monetary change should have had no real effect, being reflected only in the price level.
In fact, however, there was a very severe recession — and a dramatic recovery once the Fed, again quite openly, shifted toward monetary expansion.
These events definitely showed that Lucas-type models were wrong, and also that anticipated monetary shocks have real effects. But there was no reconsideration on the part of the freshwater economists; my guess is that they were in part trapped by their earlier trash-talking. Instead, they plunged into real business cycle theory (which had no explanation for the obvious real effects of Fed policy) and shut themselves off from outside ideas. ...

'The History of Discount Window Stigma'

Posted: 11 Aug 2015 12:15 AM PDT

Liberty Street Economics with the history of the Fed's discount window:

History of Discount Window Stigma, by Olivier Armantier, Helene Lee, and Asani Sarkar, FRBNY: In August 2007, at the onset of the recent financial crisis, the Federal Reserve encouraged banks to borrow from the discount window (DW) but few did so. This lack of DW borrowing has been widely attributed to stigma—concerns that, if discount borrowing were detected, depositors, creditors, and analysts could interpret it as a sign of financial weakness. In this post, we review the history of the DW up until 2003, when the current DW regime was established, and argue that some past policies may have inadvertently contributed to a reluctance to borrow from the DW that persists to this day.
The Discount Window's Tradition against Borrowing
The Fed was established in 1913 to create an elastic money supply that would expand to meet high demand for liquidity during times of stress and contract once conditions improved. At that time, there were no open market operations (the buying and selling of government securities in the open market) to conduct monetary policy. Instead, the Fed adjusted the money supply by lending directly to banks through the DW. During these initial years, the DW was used extensively, and there appears to have been no mention of stigma attached to DW borrowing.
From the late 1920s, the DW gradually fell into disuse as the Fed began to take a dim view of DW borrowing and adopted a stance against the practice. The Fed observed that banks were becoming habitual borrowers from the DW, and it was concerned that an overreliance on DW borrowings would weaken banks and make them more prone to failure. Moreover, the Fed had switched to open market operations as its primary tool for conducting monetary policy. Accordingly, it viewed the DW as playing a more subordinate role by providing limited amounts of short-term credit to banks, to meet emergency needs, for example.
Although it discouraged DW borrowing, the Fed generally kept the DW rate below the market rate, in part because the Fed lacked independence from the Treasury and was obliged to keep the DW rate below the market rate to help the federal government finance its deficits at low rates. The Treasury–Federal Reserve Accord of 1951 freed the Fed from pressure from the Treasury, but the Fed continued to maintain the DW rate below the market rate despite recommendations to the contrary. It did so because it believed that banks that legitimately needed DW funds should not face a punitive rate. Thus, between 1914 and 2003, the DW rate was generally below the market rate on banks' primary sources for short-term funding (in other words, the commercial paper rate before 1954 and the federal funds rate since 1954; see chart below).

History of Discount Window Stigma

Given that DW borrowing was cheaper than borrowing on the market, the Fed aimed to limit DW borrowings in other ways, including "direct pressure" on banks not to borrow from the DW. Between the late 1920s and the 1980s, the Fed adopted and amended numerous restrictions on DW borrowing. Whenever DW borrowings increased, the Fed tightened the restrictions to suppress borrowing. For example, in the 1950s, when DW borrowings rose, the Fed issued detailed restrictions distinguishing between "appropriate" and "inappropriate" borrowings; borrowing to fund regular business activities was considered inappropriate. In 1973, the Fed added the requirement that, prior to accessing the DW, banks must demonstrate that they have exhausted private sources of funding. In the early 1980s, following another period of elevated DW borrowings, the Fed levied a surcharge on frequent borrowings by large banks to augment the administrative restrictions.
These policies appeared to have been effective, as DW borrowings (adjusted for the size of the banking sector) remained low after the 1920s, except for occasional minor spikes (see chart below). Thus, the policy of below-market lending along with specific constraints to limit borrowing characterized the Fed's DW for most of the twentieth century.

History of Discount Window Stigma

What Policies May Have Contributed to Discount Window Stigma?
Throughout the Fed's history, several policies may have contributed to the stigma associated with DW borrowing. The Fed's pressure on borrowers to limit DW borrowing likely created the perception among banks that DW use should be avoided. In particular, the requirements that a borrower had to satisfy the Fed that it had a legitimate reason to borrow from the DW and that it had exhausted private sources of funding likely contributed to DW stigma. Indeed, these requirements may have led market participants to presume that if a bank was borrowing from the DW, it must be in trouble, even if, in fact, the bank was borrowing to address a temporary funding shortfall or to meet reserve requirements.
Another important factor that may have contributed to DW stigma was that, initially, the Fed lacked an official stance on DW lending to failing or insolvent institutions. Indeed, until the FDIC Improvement Act of 1991, which restricted Fed lending to undercapitalized banks, the Fed occasionally lent to banks that turned out to be insolvent. A watershed event was the experience of Continental Illinois National Bank and Trust, one of the largest banks to become insolvent and illiquid, which borrowed $3.6 billion under adjustment credit on May 11, 1984. When the DW loan became public, it further increased stigma in a way that administrative restrictions alone were not able to achieve. The incident helped reinforce a perceived link between recourse to the DW and financial problems, which made solvent banks reluctant to access the DW for fear that they might be considered insolvent.
The 2003 Discount Window Reform
To address concerns about DW stigma, the Fed fundamentally changed its DW policy in 2003, when it established the Primary Credit Facility (PCF). Only financially strong and well-capitalized banks are allowed to borrow at the PCF. The rate charged is a penalty rate above the target (range) for the fed funds rate (rather than a subsidized rate, as in the past), as seen in the DW rate chart. The PCF is a "no questions asked" facility—in other words, the Fed no longer asks banks whether they have exhausted all other sources of funding and it has no restrictions on the purpose of the loan. The Secondary Credit Facility was also created at this time, as a facility for weaker institutions that do not satisfy the criteria for Primary Credit—reinforcing the idea that borrowing from the PCF does not necessarily reflect a solvency problem.
The post-reform DW is more consistent with Walter Bagehot's classical principles that central banks should lend freely to illiquid but solvent institutions against good collateral but at a penalty over the "normal" market rate. By lending freely, central banks create an expectation that they will be available to provide as much liquidity as is needed during a crisis and alleviate the high demand for liquidity that triggers most crises. By charging a penalty rate, they ensure that banks borrow as a last resort.
The 2003 reforms, however, do not appear to have removed the perception of DW stigma, as shown in "Discount Window Stigma during the 2007-2008 Financial Crisis," and DW borrowing generally remained sparse (see the second chart, above). A plausible explanation for the persistence of DW stigma is that the old policies left lasting perceptions of the DW, which, among other factors, may have dissuaded banks from readily using it to this day.

Links for 08-11-15

Posted: 11 Aug 2015 12:06 AM PDT

Job Training and Government Multipliers

Posted: 10 Aug 2015 10:19 AM PDT

Two new papers from the NBER:

What Works? A Meta Analysis of Recent Active Labor Market Program Evaluations, by David Card, Jochen Kluve, and Andrea Weber, NBER Working Paper No. 21431 Issued in July 2015: We present a meta-analysis of impact estimates from over 200 recent econometric evaluations of active labor market programs from around the world. We classify estimates by program type and participant group, and distinguish between three different post-program time horizons. Using meta-analytic models for the effect size of a given estimate (for studies that model the probability of employment) and for the sign and significance of the estimate (for all the studies in our sample) we conclude that: (1) average impacts are close to zero in the short run, but become more positive 2-3 years after completion of the program; (2) the time profile of impacts varies by type of program, with larger gains for programs that emphasize human capital accumulation; (3) there is systematic heterogeneity across participant groups, with larger impacts for females and participants who enter from long term unemployment; (4) active labor market programs are more likely to show positive impacts in a recession. [open link]

And:

Clearing Up the Fiscal Multiplier Morass: Prior and Posterior Analysis, by Eric M. Leeper, Nora Traum, and Todd B. Walker, NBER Working Paper No. 21433 Issued in July 2015: We use Bayesian prior and posterior analysis of a monetary DSGE model, extended to include fiscal details and two distinct monetary-fiscal policy regimes, to quantify government spending multipliers in U.S. data. The combination of model specification, observable data, and relatively diffuse priors for some parameters lands posterior estimates in regions of the parameter space that yield fresh perspectives on the transmission mechanisms that underlie government spending multipliers. Posterior mean estimates of short-run output multipliers are comparable across regimes—about 1.4 on impact—but much larger after 10 years under passive money/active fiscal than under active money/passive fiscal—means of 1.9 versus 0.7 in present value. [open link]

Paul Krugman: G.O.P. Candidates and Obama’s Failure to Fail

Posted: 10 Aug 2015 09:14 AM PDT

The GOP has failed again and again at predicting failure:

G.O.P. Candidates and Obama's Failure to Fail, by Paul Krugman, Commentary, NY Times: What did the men who would be president talk about during last week's prime-time Republican debate? Well, there were 19 references to God, while the economy rated only 10 mentions. Republicans in Congress have voted dozens of times to repeal all or part of Obamacare, but the candidates only named President Obama's signature policy nine times over the course of two hours. And energy, another erstwhile G.O.P. favorite, came up only four times.
Strange, isn't it? The shared premise of everyone on the Republican side is that the Obama years have been a time of policy disaster on every front. Yet the candidates on that stage had almost nothing to say about any of the supposed disaster areas.
And there was a good reason they seemed so tongue-tied: Out there in the real world, none of the disasters their party predicted have actually come to pass. President Obama just keeps failing to fail. And that's a big problem for the G.O.P. — even bigger than Donald Trump. ...
What's the common theme linking all the disasters that Republicans predicted, but which failed to materialize? If I had to summarize the G.O.P.'s attitude on domestic policy, it would be that no good deed goes unpunished. Try to help the unfortunate, support the economy in hard times, or limit pollution, and you will face the wrath of the invisible hand. The only way to thrive, the right insists, is to be nice to the rich and cruel to the poor, while letting corporations do as they please.
According to this worldview, a leader like President Obama who raises taxes on the 1 percent while subsidizing health care for lower-income families, who provides stimulus in a recession, who regulates banks and expands environmental protection, will surely preside over disaster in every direction.
But he hasn't. I'm not saying that America is in great shape, because it isn't. Economic recovery has come too slowly, and is still incomplete; Obamacare isn't the system anyone would have designed from scratch; and we're nowhere close to doing enough on climate change. But we're doing far better than any of those guys in Cleveland will ever admit.

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