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February 1, 2016

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China adopts ‘new normal’ as reforms continue

China’s shift from export-driven growth to a model based on domestic services and household consumption has been bumpier than some anticipated.

Yet by historical standards, China’s economy is still performing well — at near 7 percent annual GDP growth, some might say very well — but success on the scale that China has seen over the past three decades breeds high expectations.

There is a basic lesson: Markets “with Chinese characteristics” are as volatile and hard to control as markets with American characteristics. Markets invariably take on a life of their own. To the extent that markets can be controlled, it is through setting the rules of the game in a transparent way.

All markets need rules and regulations. Good rules can help stabilize markets. Badly designed rules, no matter how well intentioned, can have the opposite effect.

For example, since the 1987 stock-market crash in the United States, the importance of having circuit breakers has been recognized; but if improperly designed, such reforms can increase volatility.

Moreover, what happens in markets may be only loosely coupled with the real economy. The recent Great Recession illustrates this. While the US stock market has had a robust recovery, the real economy has remained in the doldrums.

Still, stock-market and exchange-rate volatility can have real effects. Uncertainty may lead to lower consumption and investment (which is why governments should aim for rules that buttress stability).

What matters more, though, are the rules governing the real economy.

Today, deficient global aggregate demand requires governments to undertake measures that boost spending.

Such spending can be put to many good uses.

Critical needs

China’s critical needs today include reducing inequality, stemming environmental degradation, creating livable cities and investments in public health, education, infrastructure, and technology.

The authorities also need to strengthen regulatory capacity to ensure the safety of food, buildings, medicines and much else. Social returns from such investments far exceed the costs of capital.

China’s mistake in the past has been to rely too heavily on debt financing. But China also has ample room to increase its tax base in ways that would increase overall efficiency and/or equity.

Environmental taxes could lead to better air and water quality, even as they raise substantial revenues; congestion taxes would improve quality of life in cities; property and capital-gains taxes would encourage higher investment in productive activities, promoting growth.

In short, if designed correctly, balanced-budget measures — increasing taxes in tandem with expenditures — could provide a large stimulus to the economy.

The challenge facing China as it confronts the problem of excess capacity is that those who would otherwise lose their jobs will require some form of support; firms will argue for a robust bailout to minimize their losses. But if the government accompanied effective demand-side measures with active labor-market policies, at least the employment problem could be effectively addressed, and optimal — or at least reasonable — policies for economic restructuring could be designed.

There is also a macro-deflationary problem.

Excess capacity fuels downward pressure on prices, with negative externalities on indebted firms, which experience an increase in their real (inflation-adjusted) leverage.

If the authorities embrace better-designed demand-side reforms, they will have greater scope for more comprehensive supply-side reforms.

Joseph E. Stiglitz, a Nobel laureate in economics, is University Professor at Columbia University and Chief Economist at the Roosevelt Institute. Copyright: Project Syndicate, 2016. Shanghai Daily condensed the article.


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