When East Beats West?

Cover Editorial - EO print edition no. 434

Translated by Paul Pennay
Original article: [Chinese]

After making it through a year when it appeared that the world economy may have fallen off the edge of a cliff and we faced the threat of the worst economic downturn since the Great Depression, many countries are now beginning to show, to varying degrees, signs of economic recovery.

China is no exception, in the second quarter, GDP grew by 7.9%, meaning that the economy is on track to achieve the Chinese policy goal of "protecting eight," that is maintaining 8% GDP growth in 2009.

Although there are still many places that are reporting news which doesn't particularly encourage optimism, the fact that in the face of great difficulty, the world economy seems to have avoided falling into the abyss of another Great Depression, has economic regulators around the world letting out a huge collective sigh of relief.

As usual, the role played by government in rescuing the economy is being debated by economists, but the majority view is that the economic stimulus policies of various governments around the world were effective.

After markets crashed in the fall of 2008, a lot of Western countries took a number of emergency economic measures to rouse their economies. These included large increases in the money supply, injecting liquidity into the financial system, altering the structure of bank capital through the government acquisition of shares and huge cuts to interest rates that resulted in real interest rates falling to zero.

In mainstream Western society, nearly everyone see these moves as temporary measures that have been adopted in order to deal with the crisis. Even many Keynesian economists think that after the government has weathered the crisis, the banks that have been "nationalised" should once again be re-privatized.

Therefore, the biggest dilemma facing the West at the moment is not whether the current financial and economic systems should be retained or abolished, but, rather, how to manage a transition that on the one hand ensures that the intrusive government policies already enacted continue to be effective, while at the same time attempting to limit the cost and negative side effects of these policies. This will be especially true as the signs of economic recovery become more apparent.

If the adjustment is carried out too early, it may cause the incipient recovery to run out of steam, and if policy makers are too cautious and delay the timing of the switch, they risk the scourge of persistent inflation.

In this sense, the West still faces many difficult policy challenges.

Similarly, although China is now being hailed by some Western economists as the great hope for leading the world out of the crisis, the country shouldn't become to self-satisfied or pat itself on the back after hearing this praise.

Chinese Premier Wen Jiabao summarised the difficulties facing the Chinese economy during a recent inspection tour of Zhejiang, saying "We are currently in a critical period where we have to keep moving ahead or else we'll fall behind."

Although both China and the West have suffered the effects of the global economic crisis, the difficulties that each face are very different.

The slowdown in China's exports and GDP growth rate over the past year is mainly due to the economic contraction that has taken place in most Western countries and the over-reliance on exports and investment.

The structural defects that cause insufficient domestic demand have existed for a long time, even if the current crisis had not occurred, it was likely that these problems would have raised their head sooner or later.

The sudden contraction in external demand brought on by the crisis has only exaggerated the consequences of a chronic systemic problem.

Given that asset prices in the United States continue to fall and unemployment rates continue to rise, even if an economic recovery takes place and growth returns, demand from American consumers is likely to remain low as many of them are still mired in debt.

As the effects of the American stimulus package begin to wane, it's likely that demand for Chinese exports will also trend downward.

This will inevitably put more pressure on China's to push ahead with domestic structural reforms.

A more pressing problem is that in the first half of this year, China injected a large amount of liquidity into the country's financial institutions - though it should be added, in contrast to the United States, China's financial system did not face a serious shortage of funds.

Between January and July, new loans increased by a record 7.73 trillion yuan, up by almost 4.9 trillion on the same period in the previous year.

Minimal structural reforms combined with a significant increase in credit has simply fueled an already-existing asset bubble. Something we could have avoided by learning from the recent Japanese and US experience.

As Western countries have been thinking long and hard about how and when to restore conventional economic policy, China should also be considering the possibility that the enormous economic stimulus plan and the dramatic growth in liquidity may result in negative outcomes.

At present both China and the West find themselves at a difficult juncture, but it's not a zero sum game where the weakness of one party equates to a gain for the other.

Rather, the two sides are tied together as are their respective fortunes.

For China, apart from thinking about the real economic problems, we should also do away with the erroneous belief that: When the West's economy runs into trouble, we can use the plight of the West to prove the success of China's economic model. Similarly, when the West's economic recovery begins to provide external demand for Chinese exports, that we can use the growth created by this demand to once again put off the need for structural reforms.

As the saying goes, a crisis is an opportunity for reform.