China's Flirtation with Keynesian Economics; C. Lingle

However, while no one expects the transition from communism toward market-based economies to be painless, the full truth is much more brutal in that China's economic future may be rather bleak. After nearly 50 years of experimenting with a failed economic system, China is now flirt ing with another widely repudiated theory, Keynesian economics. The recent National Peoples' Congress announced plans for a sub stantially larger budget deficit aimed at stim ulating domestic spending to avert an eco nomic slowdown. This attempt to re-inflate China's domestic economy combines numer ous interest rate cuts (at least seven since May 1996) and massive public spending on infra structure that began during 1998. Attempts to boost overall domestic spend ing through credit expansion and pump prim ing are hallmarks of Keynesian policies. It is worth noting that where applied elsewhere in the post..World War II era, these policies even tually contributed to rising misery indexes (unemployment rates plus inflation rates) and rising public-sector debt, and brought Christopher Lingle is an independent corporate consultant, a visiting professor at Universidad Fran cisco Marroquin in Guatemala, and author of The Rise and Decline of the Asian Century (Hong Kong: Asia 2000, 1998). His e-mail address is CRL@po.cwru.edu.

"stagflation" into the economic lexicon. In short, although there were some illusory or, at best, temporary benefits, deficit spending and loose monetary policy tended to make matters worse. Apart from the dubious record of deficit spending, we might inquire whether China's economic illness has been properly diag nosed. While there are warning signs of a dangerous deflationary spiral, the proposed remedies are off base. China's problem with deflation cannot be resolved through Keynes ian "reflationary" policies, as they only act as countercyclical measures at best. China's current price instability is a symp tom of other fundamental problems in its domestic economy. To some degree, trying to play in the global economy on its own terms has exposed these faults. But the basic prob lem is that China faces a glut of manufactur ing inventories and insufficient domestic spending. There has been a decline in retail prices since the first quarter of 1999. This is not surprising since China's industrial capaci ty is estimated to be almost double current demand.

Domestic demand is suffering since work ers in state-owned enterprises who have kept their jobs are saving more in light of planned downsizing that must eventually lead to cut ting 50 million jobs or more. Although always high, China's marginal saving rate has climbed substantially over the past year to a remarkable 68 percent. 35 36 THE FREEMAN/IDEAS ON LIBERTY • DECEMBER 1999 Declining Exports Meanwhile, export growth is dwindling. In particular, China has lost ground in some cru cial product groups like steel and shipbuild ing. Devaluation of the Korean won and Japanese yen has eroded China's comparative advantage in pricing. There are also various signs that foreigners are viewing their pres ence in China much more critically. In a Japan's Export-Import Bank survey,manufac turing firms with three or more overseas affil iates identified China as the worst on the basis of foreign direct investment performance.

Unsurprisingly, statistics offered by China show that investment by Japanese companies declined by 15 percent in 1998, while their total investment declined by 27 percent. There may be no escape from continued declines in economic growth. Declining exports and incoming foreign investment combined with collapsing domestic consump tion is a recipe for a deep downturn. While public-sector budget deficits may delay the process, history proves that governments can not buy their way out of recession. In the end, China's economy will face the sharp corrections experienced by other com munist countries in transition. Communist economies cannot be reformed without first undergoing a substantial collapse in industrial production. The breakdown may be more or less severe, as can be seen in the different experiences of former Soviet bloc countries. Nonetheless, China's coming collapse is unavoidable owing to imbedded distortions imposed by nearly 50 years of mostly irra tional economic policies and political inter ference. As the internal contradictions of China's "market socialism" unfold, the econ omy will continue to unravel.

Central planning combined with state own ership of property and the means of produc tion are the principal sources of China's dis tortions. The worst consequences were tem porarily delayed by the impressive growth spurt when some of the worst policies were put aside and personal incentives were per mitted to operate. To a considerable degree, China's experi ence mirrored the East Asian "miracle" economies in its rapid trajectory. As else where, this high growth phase will wither. Consider the experience of its regional neigh bors. As in China, rising costs due to corrup tion and overspeculation sapped the competi tive edge, with domestic economic problems worsened by an overvalued exchange rate. Speculative bubbles led to property develop ments that far exceed demand, while financial mismanagement contributed to a banking cri sis, and so on. The State Should Retreat Unfortunately, changing these conditions will not be easy-not least because the eco nomic problems facing Beijing's policymak ers are to a considerable degree the outcome of political arrangements. A massive retreat of the state from the Chinese economy is required. Cadres and bureaucrats must have less power.

China's long march to modernizing its key sectors involves many challenges. Trans forming a centrally planned economy to a market-based economy is perhaps the most daunting task. This is because the rapid adjustments demanded by, and vigorous com petition arising from, globalized markets require supporting institutions that are gener ally absent in China. Among these are: the rule of law (including independent judges and reliable enforcement mechanisms), modern accounting and financial procedures, public accountability of corporate and politi cal officials, sound money, and a well integrated national market along with an openness to domestic and international competition. Leaving earned income in the hands of consumers and investors is a crucial step toward establishing a -sustainable basis for economic growth. The key to future growth in the modern global economy is to open up domestic economies to competition while unleashing creative young entrepreneurs who can produce wealth and jobs by starting small and medium-sized enterprises. Printing more money or throwing public funds and credit at the economy will not be able to accomplish this. D Economic Notions 'Economics Politics and Foreign Trade by Dwight R. Lee T he case for free trade is overwhelming, both theoretically and empirically. My last two columns developed the theoretical case, which is based on the concepts of oppor tunity costs and comparative advantage. Even if the people of a country have an absolute advantage in producing everything, they still gain from foreign trade because they cannot have a comparative advantage in producing everything.