Understanding Chinas Growth Miracle and Effects of Monetary Policy - Essay Example

Understanding China’s Growth Miracle & Effects of Monetary Policy Name: Course: Instructor: Institution: Date of Submission: CHINA’S GROWTH MIRACLE The Solow model is a neoclassical economic model developed by Robert Solow. It explains economic growth and analyses Gross domestic product from labour, capital formation, and progression in technology. This theory applies expansively as a theoretical frame of reference for insight on cross-country growth patterns. The model predicts that economic growth rate is determined exogenously by rate of progress in technology (Garnaut, 2011). Moreover, endogenous changes in accumulation of production factors bring about balanced steady-state growth. The production function in this case takes the form Y=F(K,L,T). Here, K is capital units, Y is output, L is labour inputs, and T is time. With the assumption of a constant return, this model displays the reward of technological change. China’s rapid and remarkable economic growth since the early 1980’s has spurred a lot of interest in the recent past. The augmented Solow model forecasts China’s economic growth rate with confounding accuracy. Economic reforms carried out between the 1980s and 1990s accelerated economic growth. The reforms were implemented in two stages. The first stage involved expanding the country to trade in foreign markets, legal rights to entrepreneurs to start business and improved productivity in agriculture. Consequently, these factors brought about better institutions and ultimately a lot of migration to the cities where the subsistence farmers now found jobs as urban workers. The second stage involved the reformation of the urban economy. Specifically, the state owned enterprises slowly attained greater managerial autonomy. The privatisation of theses SOEs allowed increase in competition from the local and later foreign enterprises. In addition to these, regulatory and administrative reforms in the tax and banking systems, foreign investments and trade as well as rural-urban migration alleviated barriers to economic growth. Indeed, economists have attributed most of China’s economic growth to large-scale capital investment and rapid growth in productivity. Historically, China has consistently upheld a high rate of savings. At the time of introduction of economic reforms, domestic savings constituted 32% of the GDP. However, these savings by then were generated from returns on the state owned enterprises. Therefore, upon when economic production was decentralized, a significant growth in corporate and household savings took place (Lin, 2003). As a result, China’s proportion of household savings relative to GDP is the highest among the leading economies. Consequently, this has fostered domestic investment. One of the chief objectives of the Chinese government was to make China’s economy considerably self-reliant. Due to this, the Chinese government actively embarked on rechanneling resources to uses that are more constructive. This had more emphasis in the sectors that were previously under the central government such as trade, agriculture, and services. Undoubtedly, trade has enormously contributed to the gains in efficiency and economic growth. Chinese exports have also exponentially risen over the years from $17 billion to 970 billion between the years 1980 to 2006 (Tang, 2012). In addition to that, foreign direct investments increased significantly between 1995- 2005 to more than double. Economists have also been keen to note that the yield on private investment assets were considerably higher compared to those of SOEs (15.1 % and 10.5 respectively) Chance of China’s economic growth According to the Solow model, it is quite evident that nations with high investment and saving rates are able to obtain high growth rates in the short run (Lin, 2003). This is the case with China. Moreover, growth theory maintains that increase in investment and savings levels subsequently increases economic growth. Therefore, in the course of time, increasing capital per labourer brings about a diminishing rate of return. This diminishing rate of return and slow productivity gains will in the end slow down economic growth. Inevitably, China’s economic progression will shrink to the level of Japan and United States. However, considering that China still has a significantly low per capita compared to the Unites States, it still has the privilege of hitting very high froth rates in the near future. The political and environment has in the recent years threatened prospects of China’s future progress. For instance, protests by millions of citizens and concerns by the public about widening gaps in income disparities have stirred resentment against the governments. Isolated cases of government’s seizures of land and instantaneous layoff of workers in SOEs have also caused public disturbances (Lin, 2003). Moreover, with stringent rules from world economic forum and UNEP programme, issues such as pollution have to be looked into as it is to the best interest of its citizen. Other factors such as corruption are most certainly to stifle economic growth if they are not checked. Another factor likely to slow down economic growth is the rising disparity between the East and West china. West China has developed slowly. A revised wage structure that favours the engineering, managerial, and other skills in short supply is bound to increase government’s recurrent expenditure. Moreover, SOEs have been a major impediment to future prospects of sustainable economic growth. This is because SOEs, which are approximately 33% of China’s production, are unprofitable (Tang, 2012). Therefore, they require government support in terms of loans and subsidies. This type of diversion of government’s funds to support these unprofitable SOEs is a major setback in the end. Other predictions deduce that china will enjoy this rapid growth but in the end, the rate will slow down. However, proper government procedures, reduced corruption, and political stability will most certainly ensure rapid growth for a longer period in comparison to the real economic super power that is United States. Replicating Chinas growth to Other Countries China’s economic policy and structure is very stable. However, its economic structure is unique to that of other economies. Replicating china’s economic model to other developing nations is quite a daunting task. There are structural challenges in China’s economy that cause unbalanced, uncoordinated, and unsteady environment. The impact of replicating this type of unbalanced development is that it ultimately creates uneven allocation of resources and slows down economic advancement in rural areas. References Chow, G. C. (1994). Understanding China's economy. Singapore [u.a.: World Scientific. Garnaut, R., & Huang, Y. (2001). Growth without miracles: Readings on the Chinese economy in the era of reform. New York: Oxford University Press. Lin, J. Y., Cai, F., & Li, Z. (2003). The China miracle: Development strategy and economic reform. Hong Kong: Chinese Univ. Press. So, A. Y. (2003). China's development miracle: Origins, transformations and challenges. Armonk, NY: M.E. Sharpe. Tang, S., Selvanathan, E. A., & Selvanathan, S. (2012). China's economic miracle: Does FDI matter?. Cheltenham: Edward Elgar Pub. EFFECTS OF MONETARY POLICY Monetary policy bases fundamentally on the relationship that exists between the interest rates in an economy. Monetary policy deals with the fiscal tools that a government engages in to curb inflation, control exchange rates, and monitor economic growth (Gup, 2005). Therefore, monetary policies are dependent on a regulator whereby the Reserve Bank of Australia is the chief monetary authority. Where a monetary policy raises interest rates considerably, one saysthat it is contractionary. Moreover, an expansionary monetary policy is one that lowers interest rates. In addition to these, monetary policy is defined as tight, neutral, or accommodative. The major monetary policy tool is known as open markets operations. This involves monitoring and putting checks on the money in circulation through selling and buying of financial instruments rate (Reilley, 2012) .These include foreign currencies, bonds, as well as treasury bills. Subsequently, these tools have a direct on impact on foreign exchange rates. Selling and buying government securities have a far-reaching effect on increasing government’s deposits through commercial banks. Commercial banks add cash reserves thus enabling banks to raise their lending capacity. As a result, demand for government bonds results to high price hence reducing their interest rates. Therefore, selling of government bonds reduces the money supply leading to an increase in interest rate (Reilley, 2012). As the interest rates drop, there is a decline in capital and domestic assets and their values reduce. Consequently, this reduces their rates of return. Foreign investors reduce their investments in domestic government bonds, stock, real estate among other assets. This has the implication of deteriorating the Reserve bank’s balance on capital account. This is due to low holdings of domestic assets by foreigners. Moreover, increased interest rates by commercial banks reduces lending therefore money supply in the economy is reduced. This has the effect of lowering the number of domestic investors who invest in the stock market (Gup, 2005). Hence, value of stocks in the securities exchange market flops. Regulation of interest rates is a responsibility of the Central Bank whereby they give commercial banks a minimum rate for lending loans to the public. This is the floor rate. According to the minutes, a reduction of this rate by the Reserve Bank of Australia will see a definite boost in the money supply. In effect, this will encourage local and international investors to borrow money and a definite rise in stock market investment. However, it is the primary role of the Reserve Bank to ensure that there is sufficient money in their treasury. According to the minutes, the government through the Reserve bank issues bonds to the public with a coupon rate and a redemption after the end of the term period. In some circumstances, these bonds come with a zero coupon rate. However, some have index linked coupon rates. This is where the interest rates link to certain assets (Moutot, 2009). A monetary policy that causes a rise in the value of these assets has a direct eventuality of increasing the coupon rates of these bonds. An example of this is a reduction in interest rates to borrowers. In addition to this, the price of stock market and bond markets are a factor of the liquidity ratio demanded by the central bank. Here, if the central bank issues a regulation on the least reserve that commercial banks should hold. While this ratio primarily seeks to determine if a bank can pay its creditors who are short term, it also affects borrowing. Mathematically, we obtain by dividing the total cash in a bank with the short-term borrowings. If this value is greater than one, a company is secured and can continue lending. This will allow more investments in the stock and bond markets by investors. However, if the liquidity ratio is less than one, this definitely means that a bank is not in a position to pay its short term lending. Now, one way of reducing lending is increasing interest rates. Through the Reserve bank, banks get directives to increase interest rates. Consequently, this reduces money supply and thus reduces investments in stock markets by investors. Bond markets are inherently dependent on inflation. Inflation refers to a general increase in prices of commodities and services (Moutot, 2009). Despite the stringent monetary policies, inflation in any economy is bound to occur albeit at low levels. Economic recessions brought about by high inflation directly affect the economy. This happens due to several reasons. One, there is an uncertainty on future prospects of stock and bond markets. Another reason is that with inflation comes a high living standard and this reduces the disposable income thus domestic and foreign investment also significantly reduces. According to the minutes, projections on Australia’s expected performance in the bond market indicate a positive trend. The Reserve bank’s adoption of the expansionary monetary policy has boosted exports, domestic business and this has a direct impact on stock markets, as many investors will pool their capital in investing in these bond and stock markets. Moreover, with the current proposal by the Reserve bank to keep the present monetary policy unchanged, it is a strong indicator that the market is already attaining the effects initially intended. Following the current indicators, there are further hint that compared to the year 2013, activity growth in 2014 had increased rate. However, inflationary indices did not give a very indicative projection of what is to be expected. As mentioned in the minutes, there is an anticipated increase in inflation for some time and this could indicate an expected fall in stock market and domestic markets. That aside, we infer from the minutes that there is a general optimism in the future prospects in the bond and stock markets considering the relative stability in the economy over the past two years . According to the minutes, if the Reserve Bank maintains the interest rates, then it is highly likely that with this monetary policy, the Australian stock and bond market will in the present and near future enjoy a period of relative stability in the stock and bond markets. Regular reviews of these monetary policies, as well as prudence to respond cautiously and appropriately when changing interest rates will ensure continued interest by foreign and domestic investors to invest in the bond and stock markets. References Arner, D., Lejot, P., & Rhee, S. G. (2005). Impediments to cross-border investments in Asian bonds. Singapore: ISEAS. Frankel, J. A. (1995). Financial markets and monetary policy. Cambridge, Mass. [u.a.: MIT Press. Gup, B. E. (2005). Capital Markets, Globalization, and Economic Development. Boston, MA: Springer Science+Business Media, Inc. Moutot, P., & Vitale, G. (2009). Monetary policy strategy in a global environment. Frankfurt, M: Europ. Central Bank. Reilly, F. K., & Brown, K. C. (2012). Investment analysis and portfolio management. Mason, Ohio: South-Western Cengage Learning. Read More