Currently many nations all over the globe are suffering from the so called “economic crisis”¯. When it started in the USA with the mortgage crisis in 2007, one could foresee that it would affect Europe and Asia. In Asia, though, the crisis is still at the beginning and we do not know how it will actually develop. In order to understand the triggering economic factors that influence the crises, the author tackles the up-to-date research question: “How will financial stimulus packages affect the Chinese recession in the long run?”¯
During an internship in China, when the author worked for a bank, he had his first experiences with the Asian crisis. Banks were forced to introduce new regulations to identify possible risks by a customer – credit crunches evolved and foreign direct investment decreased.
Because other countries became affected earlier in similar ways, it is possible to compare them and make an assumption on how the financial crisis will develop in China. The Chinese government has already reacted on the economic impacts of the crisis and initiated a stimulus package. To find out about the possible effects of this stimulus packages, the author will observe former financial stimuli as a political reaction on economic downturns.
Unfortunately, as it is all too often the case, we find ourselves playing an academic puzzle, trying, after the fact, to build up a framework for thinking about events that have already happened. For this specific topic, this is by no means a pointless exercise, because the crisis has not found its end yet. To evaluate the possible impacts of the crisis, the author will consider the “Global Economic Crisis Smash Effect Simulation”¯ as a framework.
Furthermore, the author wants to pay tribute to Dr. Carl Sagan’s famous quote: “To understand the present, we will have to understand the past”¯. Finding out about the governmental decisions made on the greater financial crises in the 20th century (the financial crisis in 1929 as well as the Asian financial crisis in 1997), the author will compare the recent crisis with the actual outcomes of the former. The point is that while any model we may make of the two crises, we will surely miss some crucial features of the recent crisis to come along as it has its very own characteristics – but it will still be helpful. Fortunately, a lot of academic research can be found on the internet. This recent research, mostly scientific journals, helped the author to find out about the ongoing crisis.
To make it easier for the reader to understand the topic, this paper will firstly explain the past and present development of the financial crisis and define it by its general characteristics, as well as its indicators (you will see, the indicators are really important to find a way to compare several crises with each other). Secondly the author will observe former crises and collect the similarities. Thirdly, with the similarities collected, he will wage an assumption, how the financial crisis in China may develop in the next years, based on the tool of the Global Economic Crisis Smash Effect Simulation developed by Ruiz Estrada.
2. Financial Crises
To start out, it is necessary to understand what happened in the last years and how those events could actually end up in the global economic crisis.
This Chapter will therefore explain the character of financial crises and it will deal with financial crises in the past to take a chance to explain the future effects of the crisis in China.
In general, a financial crisis can be defined as an abrupt, extensive decline of financial indicators and prices, which has macroeconomic effects (Aschinger 2001: 11). Also Kindleberger (1992: 46) defines a financial crisis “[”¦] as a sharp, brief, ultra-cyclical deterioration of all or most of a group of financial indicators [”¦]”¯.
In order to understand what both of them mean and how a crisis progresses, the indicators mentioned in the quote before have to be observed. According to Kindleberger (1996: 46-47) and the standards of the International Monetary Fund 2009, the important indicators are:
- Ā§ Increase in economic imbalances
- Ā§ Mistakes made in the adjustment of prices assets (asset pricing) and/ or exchange rates adjustments, mostly in the context of a biased financial sector (e.g. speculative bubbles)
- Ā§ Sudden loss of confidence for the banking – and currency system.
- Ā§ Intense decline in share prices and real property
- Ā§ Insolvency and bankruptcy of companies
- Ā§ Unemployment as a result of uncertainty
In the next sub-chapter, the author will observe some crises in the past under consideration of the indicators mentioned above. Those indicators shall lead to comparable factors and the similarities mentioned in the introduction, which will allow the author to take a chance and find an answer to the research question.
2.1 Great Depression
The earlier mentioned quote of Dr. Carl Sagan leads to important philosophical questions, whether historic events will reiterate and how new, not accommodated generations should cope with it. The author will not answer these questions, but stress on the assumption that similar circumstances will also lead to similar consequences.
Hence to find out about the future development of the Financial Crisis in Asia the author will come up with the big crisis started in 1929 in the USA. If similar circumstances can be found between the years 1929 and 2007, then the author can presume how the recent crisis will develop.
The crisis of 1929 also evolved from a speculative bubble, which was based on the unbroken optimism of the investors in the golden twenties. In 2007 the investors also had to feel real fear instead of optimism, when they noticed the stock crashes. The structures of American real estate financing were suddenly revealed and private investors as well as institutional investors faced the big bubble of insolvency and the big bank runs started (Galbraith 2009: 8).
2.2 Asian Crisis 1997
During the period from 1990 to 1997, the Asian region received about two-thirds of the world’s new investments and gave about a half of global GDP growth. It has become increasingly important as an economic stimulator for the U.S. and Europe. In late 1996, three countries in the region were among the largest recipients of foreign private investments.
The Asian financial crisis is the economic crisis in the South and East Asia, which erupted in July 1997 and became the most serious shock for he world economy in the 90’s. The background of the crisis was an extremely rapid growth of the economies of the Asian tigers, which contributed to a massive inflow of capital into these countries, the growth of state and corporate debt, overheating of the economy and booming of real estate market. However, in 1997 there was a leakage of 105 billion dollars, which was equivalent to 10% of GDP of the affected countries.
Long-term cumulative losses were even greater. The Asian crisis was more profound and more violent than financial crisis usually is. According to preliminary estimates in 1998-2000 Asian crisis and its global effects decreased world production by 2 trillion dollars, which was about 6% of world GDP. It was also estimated that the Asian crisis, according to official figures left 10 million people unemployed. Moreover, approximately 50 million people in Asia alone were below the poverty line (Patomaki 2001: 31).
2.3 Financial Crisis in China 2009
Providing the essentials for the research question it is important to focus on China’s development during the last decades.
China’s economy during the last quarter century has changed from a centrally planned system that was largely closed to international trade to a more market-oriented economy that has a rapidly growing private sector and is a major player in the global economy (Naugthon 2007: 85-91).
The actual development of China began with the first plan of the central government in 1978. After Mao Zedong died, the country was desolated economically and morally. His follower Deng Xiao Ping then faced the need of encouraged reforms (Naugthon 2007: 85-87) His first ideas aimed at the stabilization of the country and the primary the health care. Else wise a replicated buildup would not have been feasible (Naugthon 2007: 88-90).
After the basic elements were given, Ping allowed the farmers to act liberally. They could produce what they wanted and keep the margins. So the first successful sector, the agriculture, could spread its success to the country.
At the same time the government established special economic areas near to the sea. Foreign companies came to these special economic areas and began to invest and to produce. By law, the investors were forced to involve Chinese companies. Hence the Chinese obtained great knowledge and techniques. They used the given circumstances to gain advantages (Naugthon 2007: 95-98). This is one of the causes why China was so successful in adjusting to western development. Today the economy is still booming. With an accelerated growth of over 9% in the last decades China is getting a developed market (Naugthon 2007: 100-110).
Anyhow, since autumn 2008, China became affected by the global financial crisis. The consequences become obvious in decreasing employment as well as a slow down in overall economic growth. Actual growth rates went down from 10.6% in the 1st quarter to 10.1% in the 2nd quarter and to 9% in the 3rd quarter of 2008 (SchĆ¼ller 2009: 3).
Economists might have thought that the domestic economy will be affected more heavily, but a drastic decline in employment was of sudden nature. Many workers had to move back to their hometowns, due to numerous lay-offs in the Southern part of China, were many companies are resident. Moreover, even professionals are wondering, after the Chinese GDP only reached 9% at the end of 2008, which is the lowest growth rate for years (in 2007 it yielded 13% and in 2006 11,6%).
For the running year 2009, Wen Jiabao the Chinese premier, announced a growth rate of 8%. The World Bank announced that a rather moderate growth rate of 6-7% would be more realistic. Although this figure is still very good, the Chinese government expressed concerns about decreasing growth rates, because it would be impossible to create new jobs amounting 24 million to meet the demand for stable employment (Saich 2001: 4).
In the last year, unemployment increased from 4% up to 4,2%, which is not a dramatic change, but nonetheless the first increase for five years. Saich (2001: 4) claims that realistic unemployment rates could have reached 12%. Even more alarming are employment rates of graduate students, about 25% of which cannot find a job. This is a further indicator for the dramatic changes in economic environments caused by an economic crisis – considering the Kindleberger’s indicators (1996: 46-47) in the 2nd section of this paper.
The Chinese government has already reacted to the upcoming alterations: the General Secretary Hu Jintao and the Chinese Premier Wen Jiabao announced that they would start thinking about the quality of the overall growth rate and GDP, instead of an uncontrollable growth, sustainable outlook of which remains unclear (Saich 2001: 4).
This marks a shift from the development model made by Xiaoping’s government in the 90s that focused on high growth rates and development of the special economic zones as well as exporting companies (Naughton 2007: 85-110). As a consequence to the global recession, the Chinese government enforced a stimulus package amounting.
3. Stimulus Packages Effects for China
The global economic slowdown, as well as attempts to reversing these trends could make China even more powerful economic competitor compared with pre-crisis period. China, rating 3rd in the world’s largest economy after USA and Japan, today uses its unusual status of a country with huge reserves of cash and a strong banking system for getting natural resources and finding new friends.
According to analysts, China turns the economic crisis into its own competitive advantage. The country uses $600 billion from stimulus package to enhance the competitiveness of its companies both at local and foreign markets. The money is also spent on training of migrant workers and expanding of research and development work (Liu 2009: 1-23).
While the U.S. leadership with great effort is trying to revive the credit system, China’s banks over the past three months have issued more credits than in the last year.
Former head of the Chinese branch of the International Monetary Fund, Eswar S. Prasad said that the recent amendments to the stimulus package prove that today even more attention is paid to the long-term competitiveness of Chinese industry. Increased spending on education, research and development will lead to greater economic productivity.
The global economic recession is also helping to achieve what Chinese authorities have not been able to do for four years – inflation slowdown, decrease continuously of dependence on exports, as well as the elimination of the bubble in the housing market.
Recession in most countries with large economies naturally harms China. The volume of Chinese exports has extremely declined, and therefore 20 million migrant workers have been out of work. This increased the possibility of social tension and unrest.
But the President of China Hu Jintao stated that challenges and opportunities are always closely linked, and under certain conditions, first can be turned into second. To achieve this, Chinese companies are buying up foreign companies. Business leaders are interested in different industries: the automotive, textile and food industries, energy, engineering, electronics and environmental protection, etc.
Government initiatives are fully consistent with the benefits that the economic downturn gives China. For example, due to reduction in demand, value of air and maritime transport has declined by two-thirds. For many blue-collars salary has plummeted, which has increased the competitive advantages of China in terms of labor costs. Unemployment has led to reduced rates of piece-rate pay, according to which plants pay for each item produced. Overtime jobs have practically disappeared.
While a year ago the country had an acute shortage of educated specialists and skilled middle managers, today there are too many of them because of mass layoffs. For unskilled workers it is harder to find a job, but the provincial administrations, receiving subsidies from Beijing, have launched large-scale training programs, like those widely discussed but not applied in the USA. Extensive training programs conducted in China, also help to maintain stability in society, keeping unemployed people from mass protests.
Transnational corporations in turn reduce their production in China less than anywhere else; and some of them are even expanding it, as for instance, Intel, the British industrial company IMI Plc., the Taiwanese company Hon Hai, etc.
However, the Chinese economy has its weaknesses. Very little is being done to reduce the dependence on investment in the production means and to increase consumption. The structure of social protection in the form of pensions, health care and education is practically absent, and the Chinese families are forced to save a lot for future.
Strict state policy in spheres of labor and environment protection, introduced a year ago, forces low-tech industries to move their factories to other countries with less strict laws (Liu 2009: 1-23).
4. Global Economic Crisis Smash Effect Simulation
The Global Economic Crisis Smash Effect Simulation (GECSE-simulation) is a theoretical framework designed by Ruiz Estrada to estimate the impact of the global financial crisis on the world economy. Basing on the estimation of the world unemployment and poverty distribution rates, GECSE-simulation helps to foresee possible effects and levels of damage the global financial crisis can do to the world economy. For the construction of the framework economic waves modeling was applied consisting of multi-dimensional economic modeling and economic modeling in real time.
Economy in analyzed by five indicators: GDP of the USA, US imports from this economy, Foreign Direct Investment from this country to US and vice verse, the Stock Market integration between US and this economy, the unemployment rate from this economy. The level of damage of the global financial crisis is graded by ten levels from weak impact (level 1) to strong impact (level 10). According to the research, China economy would show better recovery rates from the most serious global financial crisis comparing to other analyzed countries in certain indicators. Thus, the unemployment and poverty rates would show less extension, when the American economy would get better performance of its GDP (Estrada 2009).
Fiscal stimuli play a crucial role in stabilizing the world economy, especially as classical monetary policy appears to have reached its limit in many countries.
By and large, the governments in G-20 economies have acted on their leaders’ joint declaration at the end of 2008 to use fiscal stimulus in a concerted and coordinated manner to boost economic activity. It should be clear by now, that some countries like China and the U.S. have responded effectually, with impressive stimuli. The execution, anyhow, both in terms of size and speed leads to questioning the assumptions.
These are legitimate questions about the effectiveness of fiscal stimulus, especially in economies where the financial system has broken down and where monetary policy can no longer play much of a supporting role. Moreover, excessive government lending to finance the huge budget gaps could itself generate instability.
So far, the economists state that the economy of China demonstrates the evidence of recovery from the decline. The government of the country many times claimed that the taken anti-crisis measures were well-timed and effective, and that the policy of stimulus package has brought China’s economy to significant results. However, to maintain the stable economic growth in future, it is necessary to adjust the existing structure and expand the space for economic development.
Given the dire and fast-deteriorating economic situation and the lack of other tools, however, the world may have little choice but to engage in massive frontloaded fiscal expansion. The consequences of tentativeness, as history teaches us, could be even worse.