Friday, May 22, 2009

Can China Save the World?

The currently fashionable view of China, because of its "surplus" money, is that the country is an essential partner for solving the current crisis. This is a view that I have debunked earlier by pointing that even 3 trillion dollars amount to less than $2000 per Chinese – hardly enough for China to cope with its own problems let alone the world's.

I am therefore interested to see a paper just published by Christer Ljungwall, on behalf of the Swedish Institute of International Affairs, which points out that despite sweeping reforms of China’s state-owned dominated financial system significant policy distortions and constraints remain, which "may affect the country’s maneuverability to withstand and recover from external and internal shocks".

He describes the financial system as being in a "weak condition" and says that it has distorted domestic demand; the prevailing pattern of investment financing could lead to a surge in new non-performing loans. Excess capacity in certain sectors could also create "deflationary risk in the medium-term".

In Ljungwall's view, China's government will continue to dominate the country's banking and financial systems, and this basic weakness will limit economic growth through its adverse effect on the supply of savings and efficiency of resource allocation: The magnitude and implications of potential risks suggest that further financial market reform and development is a key priority for China.

"The current situation is grim", writes Ljungwall, "and the outcome over the next three years is difficult to predict". However, he argues, this situation also presents China with an opportunity to "analyze its problems, reflect on its weaknesses, and identify areas they should concentrate their efforts". Building a broader-based, well functioning financial market would also help to rebalance China’s economy by shifting domestic demand away from heavy reliance on investment toward consumption.

That matter is of course tied to the question of further opening the Chinese system and therefore relaxing the control of the Party. That is why, the question of whether China will make use of that opportunity remains, at present, an open question.

The paper, from the Swedish Institute of International Affairs, titled "Perspectives on Economic Growth and Stability in China", is available at: Sphere: Related Content

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