Initiative In Crisis


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SmithStreetSolutions has broken down the US and China stimulus packages into ten spending categories in order to compare and analyze their effects. Our research shows that both packages will help bring global recovery by promoting trade. Additionally, China has seized the opportunity to use its package to advance two key long-term development goals, upgrading manufacturing and opening up its rural and western markets, that are critical milestones in the transition from ‘Made in China’ to ‘Created in China’.

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Initiative In Crisis

  1. 1. Copyright 2009 SmithStreetSolutions. All rights reserved.
  2. 2. Chapter 1 Introduction When the New Century Financial Corporation was Organization projects the global unemployment rate delisted from the New York Stock Exchange on March to be between 6.5% and 7.4% by the end of 2009, 13, 2007 and entered bankruptcy less than three compared with 6.0% in 2008 and 5.7% in 2007.3 A weeks later, few thought this event was the harbinger report by the World Bank on June 22, 2009 estimated of a global economic crisis. However, what began as a that the global economy would contract by 2.9% in problem caused by bad subprime mortgages spread 2009 compared to growth of 3.8% in 2007 and 1.9% like a virus throughout the American financial system. in 2008. While perhaps the largest impact of the crisis As the housing market plummeted, financial has been on the developed economies most institutions watched the veil of security fall away connected to the US financial system, the developing from years of irresponsible lending based upon the world has also been adversely affected. Developing expectation of its continuous growth. In 2008, the US economies watched their growth rates shrink from investment banking industry was decimated by the 8.1% in 2007 to 5.9% in 2008 and to a projected 1.2% collapse of two of the largest investment banks, Bear in 2009.4 Stearns and Lehman Brothers, the acquisition of Of particular interest is the effect of the financial Merrill Lynch by Bank of America, and the transition crisis on China, whose economy has become of Goldman Sachs and Morgan Stanley from increasingly intertwined with that of the United investment banks into bank holding companies. As States. The links between the world’s largest the American financial system was thrown into economy and the largest developing economy, which turmoil, lending came to a halt and the effects of this also represent the largest import and 2nd largest financial crisis were felt throughout the global export markets respectively, are profound and economy and financial system. The impact has been complex. With China-U.S. bilateral trade valued at profound, and the US is still experiencing its effects. $409 billion in 2008, the US is China’s largest trade The economy went into recession and unemployment partner, meaning that changes to demand in the US rates skyrocketed, reaching 9.8% in September 2009.1 have massi v e effe c ts on Chi na’s exports. 5 Consumer spending, a key engine of the United States’ Furthermore, China’s substantial holdings of US economic growth, decreased significantly in the wake dollars (representing an estimated 70% of China’s of the crisis; auto sales hit a 27 year low in January $2.27 trillion foreign exchange reserve) and Treasury 2009, and the consumer confidence index fell from bills ($800 billion) tie China’s economic fortunes to over 70 in September 2008 to only 55.3 in November the stability of the dollar.6 The closeness of this of that year.2 The American economy had not faced economic relationship has become increasingly such a crisis since the Great Depression in the 1930s. evident as China has felt the repercussions of the The decline of the US financial system and economy crisis. Growth rates have decreased remarkably, from was not isolated, and has had massive effects on a healthy 13.0% in 2007, before the crisis, to a today’s integrated global economy. Unemployment projected 8.5% in 2009.7 More noticeably, urban rates increased throughout the world, as a result of unemployment stood at 4.3% for the first two layoffs and hiring freezes. The International Labor quarters of 2009, and has disproportionally affected 1U.S. Bureau of Labor Statistics 2University of Michigan 3 International Labor Organization 4Global Development Finance 2009, World Bank 6 State Administration of Foreign Exchange of China; U.S. Department of the Treasury 7World Economic Outlook, International Monetary Foundation, October, 2009 -1-
  3. 3. graduating college students, among whom the and a stalled economy due to curtailed consumer unemployment rate is 32% as of July 1, 2009.8 The spending, targeted its stimulus at promoting consumer confidence index published by the National domestic consumption. China, a developing country Bureau of Statistics is down as well, reaching the and largely insulated from the global financial crisis, comparably low level of 88.0 in August 2009, utilized the slowdown as an opportunity to accelerate compared to 93.7 one year ago.9 While China’s its long term development goals to promote lagging economy still continues to grow, its leadership is rural and western development and upgrade understandably worried about the country’s ability to industrial infrastructure. The slowdown created by maintain the robust economic growth that the the crisis created a significant opportunity to advance Chinese people have come to expect. these goals, as the necessary investments and government expenditure had been withheld due to In the wake of the financial crisis, governments overheating concerns over the past few years. At this around the world have taken steps towards both point, it is still too early too judge the efficacy of each economic rescue and recovery. Countries have stimulus package in promoting recovery, as most understandingly looked to their own domestic needs, funds have yet to be disbursed. However, we expect through disbursing funds to address vulnerable both packages to have a positive contribution aspects of their economies and to protect those towards global economic recovery by promoting industries bearing the brunt of the downturn. One of international trade. Boosts in domestic consumption, the primary lessons of the crisis has been the reality especially in the US, and China’s need for imported of globalization: changes to a nation’s economy have machinery and technology should drive international the potential to reverberate throughout the entire trade that will promote the recoveries of the global system. Given the importance of the United countries involved. States and China in the world economy, their responses to the financial crisis have the potential to have global effects and alter the post-crisis economic landscape. The 5th Annual China Institute Executive Summit was held in Beijing from April 26-28, 2009. This forum brought together corporate leaders, entrepreneurs, and government officials from both the US and China to discuss the possible effects of the crisis on bilateral economic ties, and to explore avenues for the two countries to work together towards economic recovery. Following up on the summit, SmithStreetSolutions conducted a study examining the effects of the US and China economic stimulus packages on promoting global recovery and shaping the post-recovery world. To this end, we engaged in an independent analysis in order to gauge the potential short and long term effects of each stimulus package. Additionally, we conducted in-depth interviews with a number of key summit attendees regarding the potential of the stimulus packages to promote economic recovery. Our research provided us with a series of conclusions. Given the vast differences between the US and Chinese economies, and how they were effected by the financial crisis, their two packages are not directly comparable in their mechanisms or domestic effects. The US, a consumer driven nation facing a recession 8 National Bureau of Statistics of China; Ministry of Human Resource and Social Security of China 9NationalBureau of Statistics of China -2-
  4. 4. Chapter 2 Packaging Recovery In the wake of the financial crisis, both the US and purchase asset-backed securities collateralized by China undertook measures to promote their own student, auto, credit card, or small business loans. independent recoveries. In the United States, the Initially budgeted at $200 billion, the program has initial actions taken in response to the crisis were expanded to over $1 trillion in lending from the economic rescue measures to stabilize the economy. Federal Reserve Bank of New York. While both TARP The immediate problem at hand was the US financial and TALF represent significant measures to counter system, whose dramatically scaled back lending was the financial crisis, their focus was on stabilizing the harming the economy and causing the usual Federal US financial system. Reserve economic controls to be ineffective. On On February 17, 2009, US President Barack Obama October 3, 2008, Congress passed the Emergency signed the American Recovery and Reinvestment Act Economic Stabilization Act of 2008 (EESA), with the (ARRA), commonly known as the US economic goal of restoring liquidity and stability to the financial stimulus package. The bill included a total of $787.2 system of the United States. billion (5.5% of the 2008 US GDP) in government The fundamental component of this act was the allocations, the vast majority of which is to be used to Troubled Asset Relief Program (TARP), which broadly save US jobs and jumpstart the economy.10 authorized the Secretary of the Treasury to buy Proponents of the bill claim it will save 3 to 4 million troubled assets. Initially budgeted at $350 billion, the American jobs and the strict accountability measures TARP program was expanded by Congress to $700 built into the bill will ensure responsible distribution billion in January 2009. A number of programs and use of funds. As of October 13, 2009, $288 billion targeting different areas of the US financial system of these funds had been made available to Federal were created under TARP, including aid to agencies and $116 billion (15% of the total allocation) homeowners, financing for US auto manufacturers, had been spent.11 and government investment into financial institutions Social welfare provisions provided the lion’s share of to help promote lending. This third program, the the stimulus, with individual tax relief and state and Capital Purchase Program, allowed the government local fiscal relief forming over half of the total to purchase senior preferred shares in financial package. Other significant allocations went towards institutions and was budgeted for $250 billion. Nearly infrastructure, scientific R&D, and the US healthcare a year into the program, the emergency ‘bailout’ and education systems. Also included in the package nature of the Capital Purchase Program is becoming were a number of non-recovery related items that apparent, as many banks are choosing to exit the were part of long term plans or were otherwise program as soon as it is economically sound to do so. desired by Congress. In order to pay for the bill, US Also tied to the EESA was the Termed Asset-backed government spending is expected to surge, increasing Loan Facility, or TALF, to promote consumer and the US federal deficit, trade deficit, and the global business loans and restore liquidity to the financial supply of US dollars. system. Under this program, the Federal Reserve provides loans to financial institutions in order to 10; CIA World Factbook -3-
  5. 5. Breakdown of the US Economic Stimulus Package12 Breakdown of the China Economic Stimulus Package14 $ Bn $ Bn Healthcare, Other Social Education, Other Social 7 Programs, 7 Programs, 8 Sustainable 7 Development, Science, 31 63 Tax Relief, Rural Infrastructure, 213 Development, 63 54 Energy, Technology 65 Infrastructure, Advancement, 220 54 Healthcare, Protecting the 107 Protecting the Vulnerable, Vulnerable, 59 Education & 142 Post-Quake Training, Reconstruction, 126 147 Total = $787 billion Total = $586 billion Source: Source: The US stimulus package was fairly divisive among our significant funds also going towards rural respondents, with 54% believing that it was not development, technological advancement, appropriate given the global context of the financial sustainable development, and other forms of social crisis, and could be improved. Many voiced similar welfare. In March 2009, the package allocations were objections to those of the bill’s opponents in amended by the National People’s Congress. This did Congress, namely that the bill represented excessive not alter the total size of the package, but funds were government intervention that will harm the free rechanneled towards expediting crucial social welfare, market economy in the long run. However, the rural development projects, and public works. majority of our survey participants felt that the US Shortly after announcing the package, the national stimulus package addressed the key US needs to government revealed that it would only be supplying boost consumer confidence and domestic $173 billion (RMB 1.18 trillion) of the stimulus funds, consumption, crucial ingredients for the recovery of with the remainder expected from local governments the US economy. and the private sector. To help local governments Compared to the US, the effects of the financial crisis finance their share, the central government is issuing on China have been less severe. While the growth bonds for the local governments, and the debt of rate of the economy slowed, China never entered these bonds will be transferred to their deficits. The recession. On November 5, 2008, Premier Wen Jiabao reliance upon local governments and private called a meeting of the State Council Standing businesses raised some doubts about the efficacy of Committee to create a plan to boost domestic the plan, as some consider these sources of funding demand and maintain the momentum of the rapidly to be unreliable, due to the poor cash situation of growing Chinese economy. By November 9, the many local governments and doubts about the stimulus initiatives and the total size of the package willingness of private participation. Most of the were announced, and the specific allocations were purely public projects will be completely funded by released by the National Development and Reform the central government, and the government will Commission on November 27. The Chinese stimulus partner with the private sector for semi-public package includes $586 billion (RMB 4 trillion, 13.3% of projects. Importantly, many of these latter the country’s 2008 GDP) in allocations aimed towards infrastructure projects are expected to be profitable, a wide variety of projects.13 Infrastructure projects increasing the likelihood that private businesses will and reconstruction from the 2008 Sichuan be willing participants. By the end of October 2009, earthquake represented the largest allocations, with $80.46 billion (RMB 550 billion, 13.8% of the total 12Based on two assumptions: 1. Education programs, healthcare programs, and tax relief in State and Local Fiscal Relief share the same amount of allocation out of the total $144 billion. 2. Infrastructure and science share the same amount of allocation in the fund allocated for the two categories totaling $126 billion. (Apart from the $111billion originally put aside for Infrastructure and Science, the largest category of the ARRA, Tax Relief, includes $15 billion for Infrastructure and Science.) 13 National Development and Reform Commission of China; CIA World Factbook 14Based on the assumption that education, healthcare, and other social programs share the same amount of allocation out of the smallest broad area of the package totaling $22 billion. -4-
  6. 6. Comparison of the US and China Economic Stimulus Packages The US Package The China Package Amount % of Amount No. Category Where the Money Is Going % of Total Where the Money Is Going ($ Bn) Total ($ Bn) Funds for social safety net programs, Social welfare plans, including Protecting the such as welfare, food stamps, child low-cost housing, rehabilitation 1 142 18.0% 59 10.0% Vulnerable support, and other forms of of slums, and other social safety assistance net projects Improving the quality of American Education & 2 126 16.0% education and making it more 7 1.3% Educational Programs Training accessible to the underprivileged Offsetting rising medical expenses 3 Healthcare 107 13.6% and rescuing the ailing Medicare 7 1.3% Healthcare Programs system Energy Promoting sustainable development, Promoting energy saving, cutting 4 (Sustainable 65 8.3% largely through developing new 31 5.3% emissions, and environmental Development) energy engineering projects A wide variety of transportation and Construction of infrastructure, 5 Infrastructure 63 8.0% 220 37.5% federal infrastructure projects mainly in transportation Science Reinforcing the United States’ Transforming manufacturing 6 (Technology 63 8.0% leading position as a technological 54 9.3% towards high-end production Advancement) innovator Other Social 7 8 1.0% - 7 1.3% - Programs Tax Relief and Recovery tax cuts for various 8 213 27.1% - 0.0% - Other purposes Post-Quake Reconstruction projects for the 9 - 0.0% - 147 25.0% Reconstruction May 2008 Sichuan earthquake Building public amenities, Rural 10 - 0.0% - 54 9.3% providing safe drinking water, Development etc. Total 787 100.0% - 586 100.0% - Note: The comparison of the two packages is based on the following assumptions: 1. Regarding the US package, education programs, healthcare programs, and tax relief in State and Local Fiscal Relief share the same amount of allocation out of the total $144 billion. 2. Regarding the US package, infrastructure and science share the same amount of allocation in the fund allocated for the two categories totaling $126 billion. 3. Regarding the China package, education, healthcare, and other social programs share the same amount of allocation out of the smallest broad area of the package totaling $22 billion. Source:; National Development and Reform Commission of China allocation) has been paid out by the central developed areas in the west and countryside. Given government, the majority of which is going towards the large disparities in income and industrial rural development, public infrastructure, and social development between the eastern seaboard and the welfare projects.15 interior, efforts to improve this infrastructure in particular will be a key to China’s long term economic When asked about the efficacy of the China economic success. stimulus package, a slight majority of our respondents believed the allocations were appropriate. One When comparing the two stimulus packages, it common criticism was that the package did not place becomes clear that similarities between the two enough emphasis upon promoting consumption in packages regarding areas of fund allocations exist order to boost domestic demand. However, many of only on the surface. Both the US and Chinese the experts applauded the focus on infrastructure economies are fundamentally different, have been development, which increases government spending effected by the financial crisis in differing ways, and while promoting the long term growth of China’s less require stimulus packages catering to their individual 15National Development and Reform Commission of China -5-
  7. 7. needs. The US stimulus reflects the fact that the US economy is consumer driven. In 2008, private consumption constituted 70.2% of the $14.26 trillion US GDP, with investment, government purchases, and net exports representing 14.6%, 19.8%, and -4.5% respectively.16 While the US stimulus package promotes recovery through some direct infrastructure spending, the key focus of the package is to boost lagging domestic consumption by keeping people employed in the public sector and placing money back into consumers’ pockets through tax relief, government welfare programs, and other forms of aid. Compared to the US, China’s economy is very different. Private consumption plays a much smaller role in China’s economy, accounting for 35.3% of China’s 2008 GDP of $4.402 trillion, and growth is driven by investment, net exports, and government purchases, representing 43.5%, 7.9%, and 13.3% of the country’s GDP respectively.17 Additionally, China’s development has been unequal between regions and its industrial and transportation infrastructure is still incomplete. The Chinese package places its focus on investing in infrastructure; even allocations such as rural development and protecting the vulnerable, have significant infrastructure characteristics. As such, the Chinese package creates jobs and pumps money into the economy in the short run, with the ultimate goal of building the infrastructure necessary for sustained growth. 16 Economist Intelligence Unit 17EmergingEast Asia - A Regional Economic Update, Asia Regional Integration Center, July, 2009 -6-
  8. 8. Chapter 3 Consumer Nation One of the major effects of the financial crisis has been the dramatic decrease in US domestic consumption, due to an increase in unemployment, lowered wealth, and decreases in consumer confidence. Since private domestic consumption comprised 70.2% of the 2008 US GDP, this drop in consumer spending is adversely affecting the revenues of US companies and is exacerbating the negative economic affects of the crisis.18 As such, the US package places a large emphasis on boosting domestic consumption in order to jumpstart the engine of recovery. The US package dedicates $81 billion towards funding social welfare programs that are crucial in supporting America’s lower income brackets, such as unemployment funding, food stamps, child support, The US package places a large and other forms of economic assistance initiatives. emphasis on domestic consumption The US has allocated $61 billion in tax relief specifically for low income households. The bulk of in order to jumpstart the engine of the additional $213 billion tax relief goes towards recovery individuals and businesses with the overall goal of promoting employment and productivity. Taken together, these measures represent 45% of the US package and will put $355 billion back into the pockets of American citizens.19 This will be accomplished through direct tax relief, social welfare programs, and increased employment, which will increase the buying power of US consumers and promote domestic consumption. In the US package, the combined healthcare and education allocation is $233 billion, representing roughly 30% of the total package. Of this, $107 billion or 13.6% of the total, is being invested in healthcare, with the goal of offsetting rising medical expenses and rescuing the ailing Medicare system. While the US healthcare system has a wealth of technological 18 Economist Intelligence Unit 19Based on the assumption that education programs, healthcare programs, and tax relief in State and Local Fiscal Relief share the same amount of allocation out of the total $144 billion. -7-
  9. 9. resources and expertise, it is plagued by a poor distribution system that leaves 33.1% of the population under the age of 65 without medical insurance coverage.20 The stimulus funds represent a one time injection of funds amounting to 4.28% of the United States’ 2009 estimated health spending of $2.5 trillion, and will be going towards supporting medical services for those least able to afford them.21 By decreasing the medical expenses of America’s underprivileged, this portion of the stimulus will increase their disposable income. Regarding education, the US has allocated $126 billion, or 16% of its package, towards improving the quality of US education and making it more accessible to the underprivileged.22 Higher education is costly in the US, making it difficult for low-income students to finish their education. This has only worsened during the crisis. Due to the economic slump, shrinking university endowments, and a decrease in education investment, tuition standards have been steadily rising over the past few years. Many of the US funds are destined to flow to the college students directly through federal education grants. Other large funding Increases to domestic consumption outlays go towards local school districts, in order to allow them to avoid cutbacks in services and teaching are expected to drive demand for staff, and allow them to offer modern classrooms to imports, which make up 44% of all their students. While all of these have the primary goal of providing a quality education system, they will consumer goods sold in the US have effects on consumption as well. By subsidizing college students and funding of local education programs, more money is injected into local economies, and teachers and other education staff remain employed. As a result of all of these measures, nearly $600 billion of funds will provide tax relief, improve social welfare services, and improve public sector employment, creating a positive affect on disposable income and consumer confidence in the US. The expected increases in domestic consumption, as a result of this massive capital influx, are expected to drive demand for imports, which currently comprise 44% of all consumer goods sold in the United States.23 Not only will this benefit US consumers, it will also greatly benefit the exporting economies that cater to US demand. This is especially true for lower cost exporters, such as China, that are able to compete with the price of US domestic goods. Overall, this increase in consumption-driven imports will have a positive influence on the global economic recovery. 20Families USA 21U.S. National Coalition on Health Care 22 Based on the assumption that education programs, healthcare programs, and tax relief in State and Local Fiscal Relief share the same amount of allocation out of the total $144 billion. 23U.S. Consumer Product Safety Commission -8-
  10. 10. Chapter 4 Government-Led Construction In contrast, the Chinese stimulus package is in line with China’s long term development goals outlined in the 11th Five Year Plan. Nearly all of the allocations provided by China’s stimulus are consistent with the plan’s major goals of promoting concordant development of regions, upgrading industrial structures, and building a conservation-minded and environmentally friendly society.24 “Promoting the concordant development of regions” refers to the coastal-inland and urban-rural imbalances that exist in the Chinese economy. During China’s 10th Five Year Plan, it became apparent that China’s rapid development was unequal between regions, and that the economic gaps between urban and rural areas and between regions were increasing.25 Unlike the United States’ developed Building up infrastructure in domestic consumption market, China’s rural and underserved areas will be the key to western consumer markets are a long way from reaching their potential. The development of these their economic development and in regions lags far behind China’s coastal areas and unlocking their untapped consumer urban centers, and poor transportation connections markets to the coast and the rest of the world form a barrier to international trade and investment. Promoting their economic development, as well as their logistic ties to the rest of the country, will be an integral factor towards increasing the productivity and buying power of a relatively untapped market. In recent years, the gap in personal consumption expenditure between urban and rural areas has been expanding. The ratio of per capita personal consumption expenditure in urban areas compared with that of rural areas was 3.1:1 in 2007. 26 Building up infrastructure in underserved areas will be the key to their economic development and in unlocking their untapped consumer markets. Despite the importance of building infrastructure to redress this economic imbalance, concerns about overheating have caused 24National Development and Reform Commission of China 25 Report on the Work of the Government delivered by Premier Wen Jiabao at the Fourth Session of the Tenth National People's Congress, March 5, 2006 26National Bureau of Statistics of China -9-
  11. 11. the central government to place more stringent advanced components still need to be imported. For controls on infrastructure spending and investment in example, XCMG, the leading construction machinery recent years.27 With the slowing down of China’s manufacturer in China, made $156 million from economy during the financial crisis, this overheating exports in 2008, but spent $34 million importing concern has been removed and both long planned foreign parts.29 China’s focus on infrastructure will and new infrastructure projects are being funded. form a boon to foreign companies that provide these items, which will positively affect the economies of China has allocated 37.5% of its package, or about the developed nations where they are based. $ 2 2 0 bil li on, towards th e cons truc ti on of infrastructure, focused mainly in transportation. In addition, most of China’s other stimulus allocations are also geared towards improving the country’s infrastructure, albeit targeting more specific types of projects. For example, the allocation of funds for post-quake reconstruction represents $146.5 billion dollars, 25% of the total stimulus, which will go towards the reconstruction of infrastructure damaged in the 2008 Sichuan earthquake. The allocation for protecting the vulnerable involves building community infrastructure for low-income citizens. This will include physical infrastructure, such as building low-cost housing and rehabilitating slums, and represents $58.6 billion, or 10% of the total package. Promoting rural development, $54 billion and 9% of the package, is mainly achieved through rural engineering projects; these help to support agricultural projects and public works, such as improving access to safe drinking water and social programs for resettling nomads. Even China’s relatively insignificant allocations towards improving healthcare and education, each representing $7.3 billion and 1.3% of the package, are likely to spur construction of new schools and hospitals in underserved areas.28 While a lack of transparency in the Chinese package makes tracing the specific allocations difficult, it is clear that a massive percentage of the China stimulus, perhaps as much as 8 0%, i s goi ng towards i mprovi ng nati onal infrastructure. These infrastructure and engineering projects are long-term endeavors, and it could take years before they are completed and contributing to rural and western economic development. In the short term, however, these projects will promote employment in rural and western regions, improve standards of living, and increase buying power by disbursing funds into local economies. This nation-wide infrastructure push will create a demand for engineering equipment and technologies from other countries. Though China has become one of the world’s major exporters of engineering equipment, many technologically 27China’s Economy in 2007/8: Coping with the Problems of Secular High Growth, John Wong, EIA Background Brief No. 364 28 Based on the assumption that education, healthcare, and other social programs share the same amount of allocation out of the smallest broad area of the package totaling $22 billion. 292008Annual Report, XCMG - 10 -
  12. 12. Chapter 5 Domestic Recovery With the majority of the stimulus packages yet to be 69.4 in October, an improvement from a low of 55.3 spent, it is difficult to isolate the impacts of each in November of 2008.31 package on domestic recovery. In the US, there are The unemployment rate, while still high at 9.8% in some encouraging trends that suggest that the September, has seen its growth rate flatten over the economy is beginning to emerge from the crisis. In past several months. How much of this improvement July, the IMF improved its forecast for the US can be attributed to the stimulus is still an open economy from their April estimate of a 2.8% question. With both the US economy and stimulus contraction to a projected 2.6% contraction, a package focused on US consumer spending, the modest gain but a promising trend. But later in stimulus’ effect on boosting consumption has been October, the IMF lowered its forecast for the US dampened by a sharp increase in the US personal economy’s 2009 performance to a bigger contraction savings rate. of 2.7%.30 Consumer confidence has increased to Monthly Change Rate of the Michigan Consumer Sentiment and the US Unemployment Rate 80 10% 70 Unemployment Rate Consumer Sentiment 60 50 40 30 20 10 0 5% July Sep Nov Jan Mar May July Sep 2008 2008 2008 2009 2009 2009 2009 2009 Michigan Consumer Sentiment Index Unemployment Rate Source: University of Michigan; US Personal Saving as a Percentage of Disposable Personal Income 7% 6% 5% 4% 3% 2% 1% 0% Jan July Jan July Jan July Jan July 2006 2006 2007 2007 2008 2008 2009 2009 Source: 30 World Economic Outlook, International Monetary Foundation, October, 2009 31University of Michigan - 11 -
  13. 13. The situation for China appears brighter. According to To fund all these projects, the central government the National Bureau of Statistics in China, in the first mandated a more open approach to lending by half of 2009 China’s total investment in fixed assets institutions from the People's Bank of China down to increased 33.5% year-over-year and GDP increased the thousands of local commercial bank branches, 7.1% year-over-year. The IMF also revised its growth which led to a substantial expansion of credit projection for China, from its April projection of 6.5% throughout the country. Not surprisingly, the June to 7.5% in July. More recently in October, the IMF credit outlay by Chinese banks brought total lending further improved its projection for the China for the first half of the year to a record $1.08 trillion economy’s growth rate in 2009 to a more (RMB 7.37 trillion), 3 times the amount of loans encouraging 8.5%.32 Partially thanks to the issued during the same period last year. implementation of the country’s $586 billion stimulus package, the Chinese economy did reasonably well in the first 6 months of 2009.33 Total Monthly Investment in Fixed Assets in China 2,500 40% 2,000 30% 1,500 20% 1,000 10% 500 0 0% July Aug Sep Oct Nov Dec Jan&Feb Mar Apr May June July Aug 2008 2008 2008 2008 2008 2008 2009 2009 2009 2009 2009 2009 2009 Total Monthly Investment in Fixed Assets (RMB billion) Fixed Assets Investment Y-O-Y Change Source: Monthly Credit Outlay of China 2,000 1,500 1,000 500 0 July Jan July Jan July 2007 2008 2008 2009 2009 Total Monthly Credit Outlay of China (RMB billion) Source: People’s Bank of China 32 World Economic Outlook, International Monetary Foundation, October, 2009 33National Development and Reform Commission of China - 12 -
  14. 14. Chapter 6 Protectionism in the Packages In times of crisis, nations historically seek ways to “Government investment projects should buy protect the most vulnerable parts of their economies. domestically made products unless products or The large amounts of direct government spending in services cannot be obtained in reasonable commercial the US and China stimulus packages create an conditions in China.” However, our respondents were environment conducive to protectionism, where in agreement that the ‘Buy Chinese’ provision is a policies are enacted that benefit one country (or an paper tiger, and does not represent a trend towards interest group in that country) at the expense of protectionist sentiment. The low costs of domestic others. Despite promises to the contrary, 17 of the labor and materials mean foreign suppliers are often G20 countries have adopted measures that can be not competitive, largely eliminating the influence of viewed as protectionist, and the US and China are not protectionist measures on the bidding process. Most exceptions, both having added ‘buy local’ provisions respondents went a step further, stating that it is for their stimulus infrastructure projects.34 absolutely not in China’s interest to institute protectionist policies. As a country dependent on The US package allocates $63 billion towards exports, China has everything to gain by promoting a infrastructure through direct government spending, free economy, and much to lose by adopting spread across a wide variety of transportation protectionist measures that could slow global infrastructure projects, including modernizing federal economic integration. It appears that the ‘Buy Chinese’ infrastructure, constructing highways and bridges, provision is a form of political protest, retaliation and improving mass transit and railway networks.35 against the United States and other importing In a free market, this kind of expenditure represents countries who have adopted protectionist policies of an opportunity for global suppliers. However, the their own. desire to keep manufacturing and jobs in the United States led to the passing of a ‘Buy American’ provision While technically protectionism does exist in both to the ARRA on February 17, 2009. This provision packages, it’s not meaningful in the economic sense, requires the use of domestic suppliers for all stimulus as the magnitude of this effect should be negligible in engineering projects. The only exceptions allowed are light of the total effects of the stimulus packages. if insufficient quality goods are available domestically, Despite all the fuss over ‘Buy American,’ at stake is domestic prices are 25% higher than foreign bids, or only a small portion of the US package, and the ‘Buy the use of domestic goods is not in the national Chinese’ provisions are largely empty. The negative interest. Due to this requirement, foreign firms are effects of these measures are far outweighed by the effectively shut out from the bidding process, positive trade effects of raising demand and domestic directing the bulk of the US infrastructure stimulus consumption in the US and China. towards domestic firms. On the surface, China’s June 4, 2009 decision to add a ‘Buy Chinese’ provision to its stimulus package appears to be a large step in the direction towards a protectionist world. According to the provision, 34 Trade Protection: Incipient but Worrisome Trends, World Bank, March, 2009 35Basedon the assumption that infrastructure and science share the same amount of allocation in the fund allocated for the two categories totaling $126 billion. - 13 -
  15. 15. Chapter 7 Matters of Great Import The magnitude of these positive effects on global recovery can be estimated by looking at each country’s marginal propensity to import, or MPI, which represents the percentage of GDP growth that is spent on imported goods. Based on regression analysis of imports and GDP between 1985 and 2008, we calculated China’s historical MPI to be 0.3149, meaning that for every dollar of GDP growth, $0.3149 will be spent on imports. Researchers at Xi’an Jiaotong University analyzed the effect of China’s stimulus package on China’s GDP, and calculated that the stimulus would increase China’s GDP by $944.6 billion.36 Together, the US and China stimulus Based upon historical MPI data, we expect this GDP increase to translate into a $298.0 billion increase in packages are expected to drive imports. Likewise, our analysis of historical (from $572.9 billion in imports 1985 to 2008) GDP and import data in the US resulted in a calculated MPI of 0.2029. Based upon the Congressional Budget Office’s estimate that the US stimulus, in a best scenario, will lead to a 9.5% total increase to GDP, resulting in a net increase of $1.35 trillion, the stimulus is expected to drive $274.9 billion of imports.37 Together, the US and China stimulus packages are expected to drive $572.9 billion in imports. Should the stimulus packages perform as projected, they will have a very large positive effect on promoting international trade and will assist the economic recovery of exporting nations. 36 Calculation of the Pulling Effect of the RMB Four-Trillion Plan on the Chinese Economy, Guo Ju’e, Guo Guangtao, Meng Lei, Xue Yong, December, 2008 37Year-by-yearEstimate of the Economic Effects of the American Recovery and Reinvestment Act of 2009, U.S. Congressional Budget Office, March, 2009 - 14 -
  16. 16. Chapter 8 Technology and Sustainable Development Technology has long been a key driver of economic to maintain the US leading edge in science and growth, allowing countries to create and realize technology, representing 8% of the US package.40 value-added products and services. Recognizing this This money will be spent on putting scientists to work economic importance, both China and the US made looking for the next great discovery, creating jobs in significant allocations towards promoting technology cutting-edge industries, and making smart sectors, representing 14.5% and 16.3% of their investments, such as broadband infrastructure, that respective packages.38 For both countries, this will help American businesses succeed in the global allocation is split between promoting technological economy. advancement and sustainable development. In terms of allocations towards scientific advancement, the One area which also might contribute to the global packages of each country are representative of their recovery is sustainable development and new energy. current needs. The Chinese package is mainly geared China has devoted 5.3% of its package, or $30.8 billion, at upgrading Chinese manufacturing infrastructure, towards promoting energy saving techniques, cutting following the 11th Five Year Plan goal of upgrading emissions, and environmental engineering projects. China’s industrial structures. Much of the Environmental sustainability has been a long-time manufacturing technology introduced to China from concern of China due to the increasing environmental abroad twenty to thirty years ago is now at the end of impact of its development, and promoting an its lifecycle and needs to be replaced and upgraded. environmentally friendly society is another key aspect Following goals outlined through the Chinese of the 11th Five Year Plan. While there is some government’s latest development blueprint, China concern that other stimulus money could go to has allocated 9% of its package, $54 billion, in order environmentally harmful industries, the situation for to shift manufacturing away from export-oriented sustainable development in China looks hopeful. The and labor-intensive growth models and towards high- stimulus allocations for green technology reaffirm end production. Much of the technology required for China’s commitment to the environment and its this transition is expected to be imported from recognition of the importance of sustainable abroad; indeed, advanced electronics and machinery development to its economic future. This focus should already represent 20% of China’s total import value.39 drive imports of clean technology from advanced Imports of manufacturing equipment and technology economies such as the European Union and the transfer are expected to have a positive effect on United States, who are the main creators and global recovery, by supporting job growth in innovators in this field. countries that are key suppliers of advanced Similarly, the United States is also promoting technology, such as the European Union, Japan, and sustainable development and has devoted $65 billion, the United States. 8.3% of its package, towards this goal. Most of the US Indeed, the US stimulus allocations towards science sustainable energy allocations are for promoting and technology are designed to reinforce the United renewable energy, in which the United States has two States’ leading position as a technological innovator. main objectives. While environmental protection is a Approximately $63 billion is being invested key driver, weaning the US from its reliance on foreign 38Basedon the assumption that infrastructure and science share the same amount of allocation in the fund allocated for the two categories totaling $126 billion. 39 Ministry of Commerce of China 40Basedon the assumption that infrastructure and science share the same amount of allocation in the fund allocated for the two categories totaling $126 billion. - 15 -
  17. 17. oil has been influential in shaping the policy. However, clean energy technologies such as solar photovoltaics, light-emitting diode lighting, and wind turbines all rely on strategic metals that are primarily imported from Africa, China, and Russia. Solar photovoltaic technology, for example, requires cadmium, tellurium, indium, gallium, germanium, and silicon; the US is completely dependent on foreign gallium and indium, and is 80% dependent on imported germanium. While the US may seek to decrease its reliance on the Middle East, its economy will become increasingly integrated with these suppliers of strategic metals and minerals. The trade that this will drive will make positive contributions to global economic recovery. Both the US and China are stressing the importance of sustainable development, and allocating funds in this regard through their packages. Chinese imports of green technology, and US imports of strategic metals necessary for the development of clean energy, should drive integration between the two economies. This economic interdependence, as well as aligned policy objectives, could form the foundation for enhanced cooperation and coordination between the United States and China in the environmental field. - 16 -
  18. 18. Chapter 9 Initiative in Crisis Examining both the US and Chinese packages, it Looking to the post-recovery world, the influences of becomes clear that their responses to the crisis the two packages are likely to have marked address the specific needs of each economy. The differences. These are mainly due to the unique United States, facing a meltdown in its financial dynamics of the US and Chinese economies, and the system and being a consumer-driven economy, took mechanisms needed to address their individual emergency measures to shore up its financial system recoveries. The United States is a developed economy, and focused its stimulus package on promoting driven by consumption and already possessing basic domestic consumption. China, a developing nation infrastructure. Its stimulus package reflects those whose financial system escaped the crisis intact, conditions, and seeks to boost domestic consumption focused its stimulus on providing infrastructure in line over a two year period in order to provide a jumpstart with the 11th Five Year Plan that will aid the country’s to the economy. While some investment is being long term growth. As the needs and responses of the made into funding infrastructure and technological two countries are fundamentally different, it is innovation, the bulk of the US package is geared difficult to directly compare their efficacies in bringing towards the short term and its potential dividends are about domestic recovery. However, we were able to largely limited to setting the US economy on its pre- analyze the two packages potential effects on crisis track. Post recovery, the US economy will still promoting recovery through international trade, and embody the same basic dynamics as it did pre-crisis, their influence in shaping the post crisis world. albeit with a hopefully better regulated financial sector. Aspects of both packages should have the effect of promoting international trade, which is expected to The situation is very different in China, whose contribute to global economic recovery. Despite economic growth is export and investment driven, some protectionist sentiment, its influence is and whose national economic infrastructure is not yet expected to be limited and should not form a lasting mature. It becomes apparent that the financial crisis trend. We expect this short term, negative influence has provided unexpected opportunities for China’s on international trade to be outweighed by the trade development and emergence on the international that is promoted by various aspects of the two stage. China’s stimulus allocations have not been packages, such as imports driven by American reac ti onary, i nst ead bei ng consi s ten t with consumers who are provided with more money in development goals laid out by the 11th Five Year Plan. their pockets as a result of boosts to domestic The vast majority of stimulus funds have gone consumption. Additionally, China’s massive towards projects designed to bring about “concordant infrastructure push is expected to drive demand for development among regions,” “upgrade industrial imported engineering and manufacturing equipment structures” and build a “conservation minded and and technology, providing a boost for economies that environmentally friendly society.” While these have all export these goods. Finally, the focus on sustainable been policy goals for the past several years, they have development by both packages creates further received relatively small amounts of direct funding opportunities for trade in strategic metals and green from the central government. In 2008, for example, technology. rural construction received 2.4% of the central - 17 -
  19. 19. government’s budget allocations, transportation 7.8% criticisms of the dollar’s paramount status. (not limited to infrastructure), and post-quake In the wake of the crisis, China has taken numerous reconstruction only 0.5%.41 Indeed, overheating steps towards promoting internationalization of the concerns over the past several years have caused the Yuan: negotiating currency swap agreements with government to restrict public and private investment central banks in various countries worth a total of in these key areas. The slowing down of the Chinese RMB 650 billion, boosting its gold reserves, and using economy and diminished overheating concerns due the Chinese Yuan as a clearance currency for to the financial crisis has provided an opportunity for international trade.42 Additionally, the issuance of China to fund these long term growth programs. The RMB 6 billion ($878.5 million) in bonds in Hong Kong infrastructure-related spending of the package, in September was a major step towards promoting approximately RMB 3.26 trillion, is over 20 times the Yuan as an international currency.43 It seems that larger than the yearly infrastructure-related spending China may be serious in moving towards making the in China’s 2009 central government budget. Using the Yuan freely-convertible, a necessary step if it seeks to massive amount of money injected by the stimulus, transform it into an international reserve currency China is able to dramatically accelerate these and Shanghai into an international financial center. development goals and lay the foundation for upgrading its economy. For the United States and most of the world, the financial crisis dealt a severe blow to economic Promoting western and rural development and development and required governments to take allowing China’s underserved consumer markets to emergency action in order to prevent economic reach their potential is only one part of the equation. collapse. For China, however, the crisis has been The stimulus allocations towards upgrading China’s more akin to an opportunity. Like the United States, industrial structure and implementing sustainable China has taken steps to promote a slowing economy development will also aid China’s transition to higher through stimulus measures; while both packages are value goods and services. By importing foreign targeted at domestic recovery, aspects of both industrial machinery to upgrade its aging industrial packages are also expected drive international trade infrastructure, and stressing technology transfer in which can help bring about global recovery. However, manufacturing and sustainable development, Chinese with its financial system intact and its economy still industry can shift gears from basic production growing, China has been able to focus on promoting towards higher-value added production and long term growth rather than on reactionary rescue innovation. Doing so will allow Chinese industry to and recovery programs. The economic slowdown begin focusing on value propositions other than cost. made it possible to fund a slew of infrastructure As companies begin to offer higher quality goods, projects that will accelerate the upgrading of China’s they can start differentiating themselves and economy. This transition to ‘Created in China’ is developing the innovative products required for a complimented by what is shaping up to be an mature brand to capture more of the value chain, and accelerated emergence of China in the world financial transition from ‘Made in China’ to ‘Created in China’. system. Through taking advantage of the The opportunity for China to upgrade its economy opportunities provided by the financial crisis, we could not be coming at a better time. Not only has expect China to take on an expedited new role in the the financial crisis offered China opportunities to global economy in the years to come. hasten its own domestic development plans, it has also launched it into a position of greater prominence in the global financial system. The near collapse of the US financial system has raised doubts about the wisdom of using the US dollar as the main reserve currency, and the high deficit spending of the US on its recovery packages has raised fears of inflation. China has been especially concerned about US dollar stability as it is the world’s largest holder of dollar- denominated monetary instruments, as evidenced by Premier Wenjiabao and People’s Bank of China Central Governor Zhou Xiaocun March 2009 41Ministryof Finance of China 42 Wall Street Journal 43XinhuaNews Agency - 18 -
  20. 20. Appendix I General Methodology We analyzed both the broad implications of the two packages, as well as the specific trade effects of particular allocations. To help our analysis of the US and Chinese packages, we re-categorized the stimulus allocations into 10 comparable sectors. Our analysis is largely based upon secondary research based on facts collected from related official websites and data sources. Our data sources have been cited throughout the paper using footnotes. Our qualitative analysis is also based on a survey of China Institute Executive Summit attendees to provide expert insight about the financial crisis and where the financial crisis will lead us. The survey was conducted using various methodologies, including face-to-face interviews, telephone interviews, and an online questionnaire. We’ve successfully collected insights into six open questions regarding specific topics, such as Sino-US cooperation, sustainable development, etc. For breakdowns of relevant survey responses, please see Appendix II. Apart from qualitative analysis, we also conducted quantitative analysis, studying the marginal propensity to import of the US and China economies, in an effort to gauge the amount of increase in imports as a result of the stimulus packages. For a detailed explanation of our qualitative analysis, please see Appendix III. - 19 -
  21. 21. Appendix II Survey Results How Appropriate are the Fund Allocations for the US How Appropriate are the Fund Allocations for the Package? China Package? No Comment, No Comment, 8% 15% Appropriate, 31% Not Appropriate, Appropriate, 54% 38% Not Appropriate, 54% Effects of the US Stimulus on Sustainable Effects of China’s Stimulus on Sustainable Development Development Inhibition, Inhibition, 42% 27% Stimulation, Stimulation, 58% 73% - 20 -
  22. 22. Appendix III Calculations for Estimating the US and China Packages’ Effects on Imports Marginal Propensity to Import (MPI) refers to the Similarly, linear regression analysis based on import change in import expenditure that occurs with a and GDP value of the United States from 1985 to change in GDP. 2008 gives MPI = 0.2029 (go to Table of Linear Regression). In regard to the pulling effect of US’s MPI = dI / dY stimulus package on US economy, the Congressional Budget Office of the US released its estimate of the According to the increment in dY (i.e. change in GDP) economic effects of the American Recovery and and MPI , we can calculate the change in import. Reinvestment Act of 2009 (ARRA, Public Law 111-5) on March 2, 2009. According to their estimates, Take China for example. Linear regression based on totally 9.5% increase of GDP will be brought about by import and GDP data from 1985 to 2008 gives (go to the US package. Based on this as well as the US GDP Table of Linear Regression) in 2008 (that is $14.26 trillion), we can calculate the overall increase of GDP caused by stimulus packages I = 0.3149 * GDP – 82.1112 is $1.3547 Trillion. Where the constant coefficient is: MPI According to MPI formula, we get MPI = 0.3149 dI = 0.2029 * 1354.7 = 274.87 Billion According to the estimates of researchers Guo Ju‘e, The ration of increase in import to the size of the US Guo Guangtao, Meng Lei, Xue Yong, at Xi’an Jiaotong package is University, China’s $587 billion (RMB 4 trillion) stimulus package will push up China’s GDP by $946.2 g = dI / SP = 274.87 / 787 = 34.93% billion (RMB 6.4478 trillion). According to MPI formula, we get dI = 0.3149 * 946.2 = 297.96 Billion The ration of increase in import to the size of the China package is g = dI / SP = 297.96 / 587 = 50.76% - 21 -
  23. 23. Source Data for the Linear Regression $, billion USA China Import GDP Import GDP 1985 411.0 4,187.5 38.2 304.9 1986 448.6 4,427.7 34.9 295.7 1987 500.6 4,702.1 36.4 268.2 1988 545.7 5,063.9 46.4 307.2 1989 580.1 5,441.7 48.8 342.3 1990 616.1 5,757.2 42.4 354.6 1991 609.5 5,946.9 50.2 376.6 1992 656.1 6,286.8 64.4 418.2 1993 713.2 6,604.3 86.3 440.5 1994 801.7 7,017.5 95.3 559.2 1995 890.8 7,342.3 110.1 728.0 1996 955.7 7,762.3 131.5 856.1 1997 1,042.7 8,250.9 164.4 952.7 1998 1,099.3 8,694.6 163.6 1,019.5 1999 1,231.0 9,216.2 190.3 1,083.3 2000 1,450.4 9,764.8 250.7 1,198.5 2001 1,370.4 10,075.9 271.3 1,324.8 2002 1,399.1 10,417.6 328.0 1,453.8 2003 1,515.2 10,918.5 448.9 1,641.0 2004 1,769.2 11,679.2 606.5 1,931.7 2005 1,996.7 12,416.5 712.1 2,243.9 2006 2,212.0 13,201.8 852.8 2,668.1 2007 2,344.6 13,807.5 1,034.7 3,430.1 2008 2,522.5 14,264.6 1,232.8 4,421.6 Note: “Import” includes both products and services Source: State Administration of Foreign Exchange of China; National Bureau of Statistics of China; U.S. Census Bureau Regression Result: China: Imports = 0.3149*GDP - 82.1112, MPI=0.3149 USA: Imports = 0.2029*GDP - 565.0564, MPI=0.2029 - 22 -