Transcript China and the Global Financial Crisis

China and the Global
Financial Crisis
Joseph E. Stiglitz
March 2009
A Deep and Prolonged Downturn
• The first truly global downturn of the
modern era of globalization
• Downturn in the U.S. will be the most
severe since the Great Depression
– And may be even more difficult to deal with
– With huge losses in the financial sector
The Myth of Decoupling
• All countries are being affected
– America exported its toxic mortgages
– America exported its deregulatory philosophy
– Now America has exported its recession
• Developing countries that have been most successful in
enmeshing themselves in the global economy are likely
to be most adversely affected
– Through unprecedented decreases in exports
– Through massive changes in capital flows
• Irony: capital is flowing back to the US from which the crisis
originated
– Even countries that have pursued good economic policies (e.g.
better bank regulation than the U.S.) are being affected
This crisis will put great strains
on all countries
• Not only decreased exports, but also lower
investment
• Anxieties about future income, decreases
in wealth, reducing ability to borrow, higher
unemployment all contribute to lower
consumption
• Risk of high unemployment
– In China, reverse migration—new strains on
rural sector
Recovery will be more difficult
• In the past (such as the East Asia crisis)
countries could export their way out of a
downturn
• But this is a global crisis
• So this is not an option—the only option is
for the global economy to recover together
A Global Crisis Requires
a Global Response
• Yet responses are still at the national level
• Because of “externalities” (benefits that
accrue to others) the size of the stimulus is
likely to be too small
• And countries are likely to try to maximize
domestic multipliers—undermining
effectiveness of global multipliers
• Implying that the global recovery will be
slower than it otherwise would be
Analysis of the Crisis
• This is a classical recession—with a lack of
aggregate demand
• But there are also supply side effects—lack
of availability of credit, and increasingly, firms
with limited net worth, many being forced into
bankruptcy
– With a consequent loss of informational and
organizational capital
– Bankruptcy and near bankruptcy of financial
institutions especially problematic
Crisis fundamentally different
from most downturns
• Inventory cycles—once inventories
depleted, economy restarts
• Central bank steps on brakes too hard
because worried about inflation
• Realizes mistakes, takes foot off brake,
puts gently on accelerator, and economy
quickly recovers
– Damage to institutions (especially financial
institutions) is long lasting and hard to repair
• Demand and supply are intertwined
• Huge losses in firms with downward shift
in demand
• Huge reductions in demand for
investment, inventory holding, and risk
taking as firms’ balance sheets deteriorate
• US says that restoration of financial
system is necessary for restoration of the
economy
• But restoration of financial system is not
sufficient
• There will still be a problem of lack of
demand
– For example from reduced consumption
– As America’s savings rate returns to more
normal level
Restoration of the financial
system will not be easy
• Bank bail-out very costly, not restarting lending
– Backward looking, rather than forward looking
• $700 billion in a new lending facility, leveraged 10 to 1, would
have created $7 trillion in lending capacity
• Should have put more emphasis on recapitalizing good banks
that actually do lending, rather than zombie investment banks
that have been engaging in gambling
• Should have put more emphasis on reducing risk for new loans
– Worry--Zombie banks being kept alive, needing repeated
funds, perverse incentives, not in national interest
– Government getting bad deal (as little as 25 cents on the
dollar in shares, shares plummeting in value, remaining
share value related to bail-out option)
• Huge government borrowing needs, increased deficits
compromising governments ability to undertake other
objectives
• Again, effects may be long lasting
• Government buying bad assets at too high a price or
assuming downside risks is NOT the solution—simply
shifts losses from private sector to public
• Socializing losses while leaving gains in private sector is
recipe for disaster
• NOW, even if we were to restore capacity and
willingness to lend, there may be lack of demand for
funds—downward vicious circle
Crisis exposed fundamental
flaws in system
• Not just a matter of a few rotten apples
• Not just a matter that they were
unprepared for a once in a century
tsunami—they created tsunami
• Evolutionary processes failed—excessive
risk takers drove out more prudential firms
Massive market failure
• Huge demands—in US, and world
– Investment required to retrofit world for global
warming
– Problems of poverty
– Combined with massive unemployed
resources
– Both labor and capital
– Massive market failures leading up to crisis
– Important lesson for how to run a market
economy
Implication
• Not just a minor “repair job”—slight
tweaking in the system
• Rather, more fundamental reforms in the
economy
• America’s economy has not served its
citizens well even before crisis: most have
incomes lower in 2007 than in 1999; most
face high levels of economic and health
security
• But America’s new economic model—
Corporate Welfarism or Ersatz
Capitalism—socializing losses and
privatizing gains, is likely to be even worse
– Both for most citizens
– And for the aggregate economy—major
misalignment of incentives
Designing a Good Stimulus
• Big global multiplier
• Help redirect economy in ways consistent
with the “vision” of the future—and
address long standing needs—not
recreating failed system of the past
• Good investments create an asset,
offsetting the liability of increased
government deficits (or reduced reserves)
• Flexible—automatic stabilizers that spend
more when and if more is needed
• Plans for sequential stimuli if more is
needed
• Sensitive to micro-economics—where are
jobs being lost, where are they being
created
This is an Opportunity for China
• 11th Five Year Plan set out an agenda for
harmonious, sustainable growth —a long run
vision
– Increasing domestic consumption and investment,
less export dependent
– An innovation economy
– More environmentally sustainable growth
– Helping the rural sector
– More broadly promoting social harmony
• Crisis may provide an opportunity to carry
forward this agenda—but it will not be
easy
• China has always adapted policies to
changing circumstances
• These are dramatic changes in
circumstances
Large and well designed stimulus
• Focuses on the transformations outlined in 11th
five year plan
– China has been engaged in vendor finance
• Vendor finance can be used to support domestic
consumption and investment
• Raising living standards of those in China
• Providing basis of long term growth
– As it stimulates the economy in short run
– Just as measures taken in 1997/1998 crisis provided foundations for
growth in subsequent decade
Large and well designed stimulus
• Helping those in the rural sector—promote
equality and consumption
• Identifying other weaknesses in the
economy—and by addressing these, help
lay foundations for future growth
– Better rental housing market—focusing on low
income housing (up 171%)—could help labor
mobility
– Better financial markets for small and medium
sized enterprises and for the rural sector
• Better social protections (health and
education and retirement), especially in
the rural sector—promote consumption
– (healthcare up 38%, education 24%)
• Promoting service sector and other labor
intensive industries
• NOT promoting sources of imbalances
and environmental problems
• Public transportation, not private
automobiles
Finding the right balance
• Question--does the current stimulus
package strike the right balance?
• Does it spend enough in promoting
innovation and promoting the
environment?
• Does it spend too much on large
infrastructure projects and promote certain
priority sectors—possibly increasing
supply/demand imbalance?
A Deeper Look: Why is China’s
Savings Rate So High?
• Household savings rate only slightly too high—better
social protections would have both direct and indirect
effects on consumption
• Small businesses have a high savings rate because of
lack of access to capital
• Unusually high level of income in corporate sector,
unusually high profits, and unusually high retained
earnings—partially reflection of low wages
– Need to develop provincial and local banking system—
encourage small and medium sized enterprises (often labor
intensive)
– Competition for labor might lead to higher wages
– Competition for funds might lead to higher payouts
• High profits contribute to high level of
investment
• Mismatch between growth in supply and
growth in demand
• Disparity made up by exports
– But that may be difficult now
– With resulting deflationary pressures
– With accompanying macro-economic risks
• May be key sectors with market distortions
– Underpricing of natural resources—full pricing would
generate public revenues for public investment, e.g.
in research and environment
– Telecom—problem in many countries of the world
• KEY ISSUE IS CONTINUING THE
TRANSFORMATION OF THE CHINESE
ECONOMY TO A MARKET ECONOMY—BUT A
MORE HARMONIOUS AND SUSTAINABLE
MARKET ECONOMY
Concern about America’s Response
• Costly delay—often takes months before
full effects of stimulus are felt
• Stimulus too small, given the magnitude of
the problem
– About half offset by “negative” stimulus from
states and localities
• Stimulus not well designed
– About a third in tax cuts, likely to have limited
effect
Learning the Lessons from
America’s failure
• Better regulation, especially in the financial sector
– But also in corporate governance—perverse incentive structures
• And better regulatory structures—enforcement matters
• Competition policy—we allowed banks to grow too big to
fail
• Monetary policy framework flawed
– Need to pay attention not just to inflation
• Many seemed to think that low inflation was necessary and almost
sufficient for strong growth
• Never was evidence or good theory in support of this view
• Now it is clear how wrong that view was
– Need also to pay attention to financial stability
Learning the Lessons from and for
Globalization
• Globalization can bring benefits
• But also problems—contagion
– Crises can spread quickly around the world
– China needs to be careful about financial and capital market
liberalization
• Spirit and letter of international agreements are being broken
– Worry about protectionism
– But “Buy America” provision is protectionist, and details of wording may
be worse, discriminating against developing countries
– Subsidies (bail-outs, guarantees, some government lending facilities)
are even more distorting of global market place than tariffs
• Developing countries can’t match
• No longer question of a level playing field, especially in financial services
• Long-run implications for the nature of an “open, competitive, fair” global
market place
• Worry that some international agreements hamper flexibility needed
to respond to crisis
– Restrictions on imposing needed regulatory reforms
This is a global crisis requiring a
global response
• New global regulatory system—must be comprehensive
to avoid regulatory arbitrage and go well beyond just
transparency
• Problem shifting to developing countries
– They don’t have funds to respond
– Need for additional financial support
• Without usual counterproductive, procyclical conditionality
– If this doesn’t happen, global imbalances will grow, robust
recovery will be at risk
• Reforms needed in international financial institutions
– Not only didn’t address problems before they occurred
– Also pushed policies that contributed to the crisis
– Those with liquid funds have inadequate voice
Three Key Recommendations of
UN Commission
• A new Global Credit Facility, with better
governance than existing institutions
• A Global Economic Coordinating Council
• A new Global Reserve System
– Problems in global reserve system at heart of global
imbalances
– Contributing to insufficiency of global aggregate
demand
– Problem long recognized (Keynes)
– Current system is fraying
– Now is the time to initiate reforms
China has vital role to play
in global recovery
• Maintaining strength of its own economy through
appropriate macro-economic policies
• Contributing to a balanced global recovery,
through assistance to developing countries
• Working, through G-20 and the UN, to make the
reforms that will be necessary to restore
confidence and make a more stable global
economy