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Can there be a China model?

Comments on Yu Keping "Search for balance in China: a quest for dynamic stability", 23/09/2013, http://www.eastasiaforum.org/2013/09/22/a-quest-for-dynamic-stability/

Given the current contradictory between what the CCP official line says and the difficulties to reconcile that with the affluent societies in the West democracy, it will be very difficult to advance the Chinese fairs without creative and innovative thinking, reforms and great leadership.

While it may seem an almost impossible task, somehow the CCP needs to find a way that guarantee its ruling party status and the long term and continued acceptance by the vast majority of the Chinese people.

That would require a new social contract to be written between the CCP and the Chinese people.

That contract must ensure that the CCP is a collective force and the best one for raising the living standards of the Chinese people and the CCP is not corrupt, democratically governed for all Chinese
people, respects the law and creates the condition in which everyone
who makes effort can succeed.

Is that a difficult task? Surely it is.

Is that an impossible task? It depends, but only time will tell.
What it implies is that the CCP should learn from its history including its past before the PRC and the reform era and the history of the world and to form a new framework and a strategy.

NBN should not be a monopoly

Comments on Alan Kohler "The NBN board has run away. Why?", 23/09/2013, http://www.businessspectator.com.au/article/2013/9/23/information-technology/nbn-board-has-run-away-why

Alan, while your analysis has obvious merits, there are ways both to allow competition and to make the NBN profitable you have not considered.
Competition is to create a level playing field for all participants and not to create entry barriers. As long as NBN is not allowed to be a monopoly and treat it and other competitors equally, competition can be achieved.
While NBN profitability is dependent on the level of cross subsidies from urban to rural areas, this could arguably be achieved through, say, a national charge to all suppliers to urban areas including both the NBN and non-NBN ones. The income from this can be used to subsidise rural users or suppliers to rural areas.
The upshot that is most important is to allow competition for innovation and efficiency. Other policy objectives can be achieved through other means.

Under this framework the Coalition's NBN policy may not necessarily create a board problem for any NBN Co. Further, the Coalition government is unlikely to ask any board to do the impossible.

There are two dimesions in fiscal policy

Comments on Stephen Koukoulas "Sense should squib a surplus promise", 23/09/2013, http://www.businessspectator.com.au/article/2013/9/23/economy/sense-should-squib-surplus-promise

The talks of whether the budget is in crisis or not come down to different perspectives and what you compare with. If one compares ours with those in deeper trouble as Stephen did, ours is in a much better shape and not in crisis. On the other hand, if one compares with prudent practices as the Coalition implies, ours was not good and the speed of the debt growth may be described as crisis.
Both have a point of their own logic and reasoning.
However, the right thing to do is to choose the better elements of each side and do a better job in both managing the budget (better than in the past years to avoid wastes and reduce unnecessary spendings and achieving surplus as early as possible) and keeps the economy growing (the traditional fiscal policy management for the economy).
To achieve that, the government needs structural reforms to government expenditures to achieve the same outcomes with less spending or achieve better outcomes with the same spending.
So, it is important to bear in mind that fiscal policy has two dimensions of both a aggregate size and its structural content and work on both aspects to achieve the most optimal outcomes.

A good economist pays attention to both dimensions when considering fiscal policy.


Change the GST or not?

Comments on LAUREN WILSON "Tony Abbott dismisses fresh push to re-examine the GST", 20/09/2013, http://www.theaustralian.com.au/national-affairs/tony-abbott-dismisses-fresh-push-to-re-examine-the-gst/story-fn59niix-1226723309057

The current government prior to the federal election said GST will be included in its planned tax review and also said earlier GST won't change in this term of government and any change will need to get a mandate from the next election, although latter on it was changed to GST will not change.

My reading of the government's approach is that it will continue to say GST won't change until the review report is publically available  with recommendations that the GST should be changed. There appears a case that the GST should be changed to either replace some of the inefficient state taxes, such as stamp duty on conveyances, or to reduce personal income taxes.

Any changes to the GST whether it is to broaden the base, or to increase the rate should be traded with a reduction in some taxes so to keep the level of overall taxation roughly unchanged. The aim is to increase the efficiency of taxation rather than to increase the level of taxation.

There are two other important issues related to potential changes in the GST. One is there should be a compensation to low income earners through tax reduction to minimise its impact on them and at the same time to increase the incentives to work.

Another is that if the GST is to be changed, it would present an opportunity to change the GST distribution system. Fundamentally, the federal government should consider to distribute the GST on population shares and should move the fiscal equlisation role through another general grants in a trade off with the states to support GST changes.

Since the introduction of the GST, fiscal equalisation is done through GST distribution. Given that GST is fully provided to the states and the federal government does not have any direct benefit from GST one way or another, it lacks interest in how it is distributed.

By moving fiscal equalisation into using another general grants from the federal general revenue pool, it would have an interest in the size of the redistribution, and hence how it is done. More importantly, it would provide a circuit breaker for the disagreement between the states on how GST should be distributed.

I see this as a practical way to move forward on the GST issue. And it is likely that a change to the GST will on the card in the next election.

PC inquiry on Australia's car industry

Comments on Sid Maher and John Ferguson "Coalition calls for 'urgent' report on car industry", 20/09/2013, http://www.theaustralian.com.au/national-affairs/coalition-calls-for-urgent-report-on-car-industry/story-fn59niix-1226723160050

The new government should let the PC conduct its inquiry into the car industry without any preconditions and should not preempty the PC inquiry and report on the future of the car industry in Australia, although politically it may continue the line that its supports the car industry until the report comes out.

More importantly, the government should fully respect the verdict from the independent economic body and accept rational and economically sensible recommendations on the future of the car industry without yielding to special interest groups.

It is too important for all Australians to be emotional rather than rationally making  difficult choice between the car industry and possibly better national wealth and welfare, particularly when the output of Australia's car industry has been declining and will decline more when Ford closes its production here. As a result, the costs of continuing government subsidies are likely to increase as car production falls.

My instinct feel is that it is very difficult for car manufacturing to survive in Australia for long. However, we should wait for the PC to report on this.

RBA, monetary policy and $A

Comments on Stephen Koukoulas "The sum of all our dollar fears...", 20/09/2013, http://www.businessspectator.com.au/article/2013/9/20/currency/sum-all-our-dollar-fears

The RBA and many economists and commentators have really adopted a very funny approach, namely when the dollar was really very high at about 1.05 they argued that the RBA is powerless in influencing the currency while now when the dollar is at 0.95 or even lower, they are saying the RBA could do something to make it lower.

Of course, the RBA now has probably understood it can play a role of influencing expectations, although the fall of the dollar in the past had little to do with the RBA policy on interest rates. Rather, it was because the global factor of the Fed on future QEs. But that has not limited the RBA from joining the force in making the noise that it thinks the dollar should be lower even when it was at 0.90 or lower.
The RBA should have known that it might have an influence on expectations when the dollar was really high and should have done better to play that role at those times!

Having argued that I fully understand that the RBA has its difficulties in targeting multi goals with only one policy tool that is interest rate.


Why are house prices in Australia so high?

Comments on Alan Kohler "A housing bubble? You bewdy!" 18/09/2013, http://www.businessspectator.com.au/article/2013/9/18/economy/housing-bubble-you-bewdy

Alan, you listed two reasons, "a lack of spending on infrastructure by state governments and planning restrictions by local councils", for "why is there a persistent shortage of housing in Australia when it’s the 3rd least densely populated nation on earth. (Mongolia and Western Sahara are less dense)."

While they are correct, there may be other more important reasons. For example, the relative price of building a house in Australia may be much higher, due to high labour and building materials costs here. This reflects a general pattern that non-traded goods and services have a much higher price relative to trade goods and services in Australia.

Capital costs are generally higher in Australia as, much higher than in the US. This is because it is an small, growing and capital importing country. For example, it is probably common for the official interest rates in Australia to be more than 2 percentage point higher than in the US.

Further, state and local governments rely on either land tax or rates as a source of revenue, so if land value is lower, their revenue may be lower too. From that point of view, they have incentives to keep land value high, contributing to higher housing prices. This is particularly true for local governments given that rates are one of the main sources of revenue for them.

On the demand side, Australia's geographical location close to Asia where there are billions of people with much higher population densities and relatively scarce land in conjunction with Australia's fairly open policy on foreign buyers of real estate properties, mean external demand can be a significant factor in driving the house price higher than it would otherwise be.

In fact, I would argue that this is a very important fact behind Australia's much higher ratio of house price to income and has been overlooked by many economists and analysts when they say that Australia's housing price is too high and there is a significant bubble in the housing market in Australia.

If using housing price to income ratio as a definition for house market bubble, then it is true that there is a housing market bubble in Australia and indeed a quite big one. However, it can be argued that such  bubble may not be as easily to burst as in other industrialised countries because of the external demand factor.

This is likely to be a unique feature of the Australia housing market.

Complexity demands more monetary policy tools

Comments on Stephen Koukoulas "House price bull heaven", 18/09/2013, http://www.businessspectator.com.au/article/2013/9/18/property/house-price-bull-heaven

Leaving how the housing market price in Australia will develop and how the RBA will deal with that aside, it should be acknowledged that the current monetary policy tool is not enough to deal with both the broad economy and the asset markets prices with only uniform official interest rates applied to all.

The RBNZ policy development regarding housing lending as Koukoulas mentioned (New Zealand’s bold move against the housing bubble)  partly mirrored China's approach and has some merits, though the approach of restricting the LVR is not an efficient economic policy because it lacks clear price signals for both lenders and borrowers. In another word, it is not really a market approach but a administrative approach.
A better policy approach is a market based on price, that is, by introducing and applying differential 'official' rates that could be applied when dealing with different situations such as the broad economy and the housing market.
That itself may raise some costs, but that may be a price that needs to be paid in dealing with complex situations. Otherwise, you may continue to have the sort of risks of the GFC to reoccur. Further, it is not too dissimilar to fiscal policies that have its own structural content.


China and central Asia

Comments on Laurie Pearcey "Xi Jinping’s New Silk Road: Chinese foreign policy, energy security and ideology", 17/09/2013, https://theconversation.com/xi-jinpings-new-silk-road-chinese-foreign-policy-energy-security-and-ideology-17994

Given the size and continued rapid growth of China's economy and the current and expected energy mix in the world economy, China will have stronger interests in the middle east for its energy security. This implies that it will not only increase its investment in many ways in the region, but also extend its strategic consideration for diversification of its energy sources, such as from Russia and possibly from some central Asian countries, as well as build alternative oil transport such as pipelines running through Pakistan and Burma.
As China increase its navy power, the importance of middle east oil to its energy and security means it will probably increase its military presence along its ocean oil transport including up to the middle east.
Central Asia plays an important economic as well as security role in China's new silk road strategy. As China expand its navy power to protect its ocean transports, it is essential to have a secure backyard in the west inland borders, particularly along its restive Xijiang region.

Reforming China's monetary system

Comments on Sara Hsu and Andrew Collier "China’s shadow banking tug of war", 17/09/2013, http://www.eastasiaforum.org/2013/09/16/chinas-shadow-banking-tug-of-war/

Shadow banking as well as the prevalence of ‘illegal fundraising’ in China reflects the severe deficiency of its monetary policy and management system. Given the role of money and credits in the economy, reforming the banking and finance system and its monetary management system in China should be a top priority.
From monetary policy point of view, a number of areas should be reformed. Firstly, monetary authority should not control both deposit and lending rates and should adopt the general practice of most central banks in the industralised countries.
Secondly, neither the government nor the central bank should force any banks to lend state owned entities at lower than the market rates to distort the banking system and monetary policy. This not will create a fair competition between the SOEs and other entities in the market place but also reduce the risks for banks.
Thirdly, China needs to transform the shadow banking into the formal banking and finance system and allow more entries of the private sector into the banking and finance system if they can meet regulation requirement.
Once the previous step is taken, it should strengthen its management of the banking and finance sector.

Reforming its banking and finance system will also have the added benefits of reducing corruption and organised crimes such as money laundering.
A better functioning banking system in China will also reduce the need for the Chinese people to physically store and carry a lot of cash.
The most important benefit is to allow much more efficient allocation of economic resources.


Pettis is wrong about China's growth for the next decade

Comments on  Pettis "Why China faces four per cent growth: Pt. 2", 14/09/2013, http://www.businessspectator.com.au/article/2013/9/13/china/why-china-faces-four-cent-growth-pt-2
I made a comment on Friday and now Pettis' second half is out so I would make a little more.

Firstly, are the two examples of painful adjustment that Pettis used, namely the US in the 1930s and Japan in the 1990s applicable to China at all? The 1930s was or was in the wake of the great depression world wide but particularly in the US following the stock market crash in 1929 and the 1990s for Japan were the first of Japan's two lost decades following the burst of its financial bubbles. Further, both countries at the respective times were at world economic frontier with one of the highest income in the world. Is China in those situations? No, any person with a common sense would understand China isn't. China is only probably about 20% of the per capita income of that of either the US or Japan. China may have some bubbles, but definitely not as severe as to hurt its real economy. There is plenty room for positive growth and the degree of uncertainties on its growth is not as high as those in the economic frontier given the room to further catch up. By any measure, China would not allow bubbles to burst to such a damage degree.

Secondly, as long as China's saving rate is high to sustain its investment and net export, there is no need to artificially to adjust its domestic consumption at a damaging speed. Its financial market and hosing market are unlikely to depress its economy, given its huge foreign reserves and high savings.
Thirdly, Pettis has a automatic adjustment factor, that is, the net export and government consumption. Contrary to Pettis assumption, this factor can accommodate a higher savings/low consumption and high investment if and when needed.
So, Pettis is wrong in his conclusion that China is facing a decade of 3-4% growth.
Further, Pettis got the cause effect wrong. The painful adjustments in the US in the 1930s and in Japan in the 1990s were the results of low economic growth. During the relevant periods, their investments fell and their consumptions didn't grow. It's not the adjustments that caused low growths. Rather, it's the low growth that caused painful adjustments.
China won't have that painful adjustment and as a result there won't be automatic low growth flowing from that painful adjustment. And if there is no low growth, there won't be painful adjustment in consumption and investment.
China's new leadership government has already stated that it will sustain reasonable growth in the process of economic adjustment. It seems its limit of low growth is likely to 7.5% and it is unlikely to allow growth below that for any long period.

The argument of a decade low growth of 3-4% for China is fanciful and delusional to the extreme.

All the scenarios Pettis listed in the table is real growth rate and no inflation is included. In all likelihood, inflation in China is likely to be between 3-4% a year on average for the next decade or so, as indicated by the current 3.6% target for a real GDP growth target of 7.5% for this year.

If inflation is included I would assume that China can maintain 8-9% real GDP growth that means nominal growth will be around 12-13% or more higher. For a nominal growth of 12% a year, according to the Pettis table (by extension, roughly 2% higher for all variables), the investment growth can be as high as 9-10.5% a year and consumption growth 16-18%.

Would be that healthy economically? I don't see a problem with that. Of course, there is no need to adjust between investment and saving/consumption as rapidly as Pettis argues and a longer adjustment, possibly 20 years or more is more likely given that consumption growth is that high and people would still have enough incentives to maintain high savings. Most people would be happy with that outcome.