Beijing’s Olympian task is to curb inflation

By Stephen Roach

Too much is being made of the economic impact of the Beijing Olympics on China and the rest of Asia. China was slowing before the onset of the XXIX Olympiad and is likely to continue to slow in the year ahead. Elsewhere in Asia, a similar outcome appears to be in the offing.

Significantly, most of the Olympics-related construction activity in Beijing – some $42bn (€29bn, £23.6bn), according to the official Chinese tally – was completed more than a year ago. That means any post-Olympics construction payback should have occurred quite some time ago rather than in the aftermath of the summer games. Yes, there were plant closings in Beijing and the neighbouring city of Tianjin for a few weeks before and during the Olympics. But these two metropolitan areas collect­ively account for less than 6 per cent of total Chinese output – hardly enough to make much of a dent in the Chinese production juggernaut.

At work, instead, are powerful repercussions of an external shock that has nothing to do with the Olympics: post-bubble adjustments bearing down on the US consumer, along with collateral damage now starting to show up in Europe and Japan. Developing Asia is the most export-intensive region of the world, with a record of more than 45 per cent of its pan-regional output now going to foreign markets. China’s export share is close to 40 per cent. As the industrial world slows, China and the rest of export-dependent developing Asia will feel the effects of a shortfall in external demand with a lag. Any gyrations traceable to the Olympics are likely to be overwhelmed by these much broader, more powerful macro forces bearing down on the region.

Policymakers in China are very much aware of the mounting downside risks to economic growth. Bank lending quotas, which have been the centrepiece of recent tightening initiatives, have now been relaxed. The pace of currency appreciation has also slowed – a sharp departure from the accelerated rate of revaluation that had been evident in late 2007 and early 2008. And policy interest rates have been left unchanged in a rising inflationary climate – keeping real short-term interest rates close to zero, a highly stimulative position for any country’s monetary policy. In short, China’s pro-growth policy bias is once again coming though loud and clear, reflecting a shift in its policy stance that seems traceable to events far bigger than the ­Olympics.

In this context, inflation remains the biggest riddle for China. The recent pro-growth policy initiatives suggest that Chinese authorities are attempting to put a floor on the gross domestic product growth shortfall of somewhere in the 8 to 9 per cent range. Perhaps the biggest macro question for China over the next year is whether such a slowing – from the torrid growth pace of nearly 12 per cent in 2006-07 – is sufficient to stem the recent build-up of inflationary pressures.

There is good reason to believe that inflation risks will remain China’s most daunting macro challenge over the next few years. Particularly worrying is a growing inclination of Chinese officialdom to dismiss the build-up of inflationary pressures as “structural” – traceable to special forces that are argued to be beyond the control of domestic monetary policy. Three such developments are cited most frequently: recent labour reforms that have boosted minimum wages, an outbreak of “imported” commodity inflation, and international price equalisation that is presumed to bring the quotes of Chinese products up to world standards.

This structural excuse for China’s inflation problem is painfully reminiscent of an equally erroneous dismissal of US inflation risks in the 1970s. Back then, three structural forces were also cited as being beyond the purview of the US Federal Reserve, namely wage indexation to CPI shocks that created a wage-price spiral, imported inflation due to the worldwide commodity boom of the early 1970s, and mandated increases in production expenses traceable to regulatory initiatives in pollution abatement and worker safety.

The most important lesson of the 1970s is that the Fed proved to be dead wrong in dismissing inflation risks as structural. While inflation eased off in the middle of the decade as the US went through a deep recession, it roared back with a vengeance as the economy recovered in the latter half of the 1970s, hitting a high of 13 per cent by the end of 1979. It took a new, courageous Fed chairman, Paul Volcker, to put the structuralist inflation argument to rest by driving up the federal funds rate to extraordinary levels and putting the economy through a wrenching hard landing.

That is an outcome that China – and an increasingly China-centric developing Asia, long fixated on social stability and poverty reduction – simply cannot risk. A hard landing could prove devastating to regional development imperatives. Yet to the extent that China and other Asian countries dismiss mounting inflation risks as structural and fail to heed the most salient lesson of the 1970s, the risk of an eventual hard landing will only grow.

That poses a serious question for the rest of Asia as well as for the broader global economy: can a build-up of inflationary pressures be contained to China? In the near term the downside of the global business cycle may limit the spread of inflation. But over the medium term that could change. The cross-border linkages of globalisation may make containment of Chinese inflation exceedingly difficult.

Temporary growth risks should not be the dominant concern in post-Olympics China. Stagflation may well be the greatest risk: an externally induced growth shortfall coupled with a significant deterioration of underlying inflation risks. Chinese officials are fixated on the growth side of the stagflationary equation, but they ignore the inflation piece of the outcome. That remains the greatest worry in the aftermath of an otherwise spectacular Olympics.

 

WSJ’s report on the meeting, with some great discussions

Bloomberg reports a debate over the conference was so heated that Stanley Fischer suggested to use fire distinguisher to cool it down.

What does this authoritarian moment mean for developing countries?

by Pranab Bardhan

As the petro-authoritarianism of Russia flexes its muscles and the economic prowess of China struts in Olympic glory, developing countries in the world might start rethinking about the lectures on democracy and development they have heard all these years from the West. This is at a time when advanced capitalist democracies are reeling under the shock of unregulated financial overreach and years of living beyond their means, a far cry from the end-of-history triumphalism of capitalist democracy of less than two decades back.

The Chinese case in particular is reviving a hoary myth of how particularly in the initial stages of economic development authoritarianism delivers much more than democracy. This is also backed by the memory of impressive economic performance of other East Asian authoritarian regimes (like those in South Korea and Taiwan in the recent past). The lingering hope of democrats had been that as the middle classes prosper in these regimes, they then demand, and in the latter two cases got, the movement toward political democracy.

But the relationship between authoritarianism or democracy and development is not so simple. Authoritarianism is neither necessary nor sufficient for economic development. That it is not necessary is illustrated not only by today’s industrial democracies, but by scattered cases of recent development success: Costa Rica, Botswana, and now India. That it is not sufficient is amply evident from disastrous authoritarian regimes in Africa and elsewhere.

 
Even if we were not to value democracy for its own sake (or regard it as an integral part of development by definition), and look at it in a purely instrumental way, it is worth reiterating the several advantages of democracy from the point of view of development. Democracies are better able to avoid catastrophic mistakes, (such as China’s Great Leap Forward and the ensuing great famine that killed nearly thirty million people, or a massive mayhem in the form of Cultural Revolution), and have greater healing powers after difficult times. Democracies also experience more intense pressure to share the benefits of development among the people, thus making it sustainable, and provide more scope for popular movements against industrial fallout such as environmental degradation. In addition, they are better able to mitigate social inequalities (especially acute in India) that act as barriers to social and economic mobility and to the full development of individual potential. Finally, democratic open societies provide a better environment for nurturing the development of information and related technologies, a matter of some importance in the current knowledge-driven global economy. Intensive cyber-censorship in China may seriously limit future innovations in this area.
 
All that said, India’s experience suggests that democracy can also hinder development in a number of ways. Competitive populism– short-run pandering and handouts to win elections– may hurt long-run investment, particularly in physical infrastructure, which is the key bottleneck for Indian development. Such political arrangements make it difficult, for example, to charge user fees for roads, electricity, and irrigation, discouraging investment in these areas, unlike in China where infrastructure companies charge full commercial rates. Competitive populism also makes it difficult to carry out policy experimentation of the kind the Chinese excelled in: for example, it is harder to cut losses and retreat from a failed project in India, which, with its inevitable job losses and bail-out pressures, has electoral consequences that discourage leaders from carrying out policy experimentation in the first place. Finally, democracy’s slow decision-making processes can be costly in a world of fast-changing markets and technology.
 
The hopes of democrats relying on the middle classes in authoritarian regimes have not always borne fruit. Latin American or South European history has been replete with many episodes of middle classes hailing a supreme caudillo. The police state in China shows no signs of loosening its grip soon, despite the spectacular progress in the opening of the economy. While there has been some relaxation in controls over individual expressions of thought, and some open middle class grumbling over pollution and forcible acquisition of property, the state never fails to clamp down on political activities that have even a remote chance of appearing to challenge the monopoly of power of the central authority.  Most people in the Chinese middle class are complicit in this in the name of preserving social stability, as long as opportunities for money-making and wallowing in nationalist pride keep on thriving.
 
So markets and capitalism will not do their political cleansing job automatically.  On the contrary, markets often sharpen inequality, and the resultant structures of political power, buttressed by corporate plutocrats and all-powerful lobbies, may even hijack or corrupt the democratic political process, a phenomenon not unknown in some industrial democracies. Thus both for democracy and development other social forces and movements for civil and economic rights for the common people have to be pro-active and eternally vigilant.

The author is a professor of economics at the University of California at Berkeley