Introduction

China, the U.S. and Europe (European Union, EU) are the economic powerhouses of the world. Much is regularly written about the relations between the U.S. and China, focusing both on political and on economic ties between the two countries. Relations between EU and China are discussed less frequently in the daily and weekly media. 

There are several reasons for this emphasis on the relations between the U.S. and China. First, the U.S. and China are two powerful independent countries with their own decision-making.  Second, Congress appears to hold more openly discussed views on China than officials within EU. Third, U.S. officials have in the past years expressed their irritation about China’s undervaluation of the renminbi much more clearly and frequently than leading representatives of the EU have done. In particular the currency issue has frequently made headlines, partly because of China’s various strong reactions against foreign (American) verbal exchange rate interventions.  

On the other hand, the Chinese see the European Union – we discuss Europe in this context as the EU – as an economic organization rather than a political one.1  This is an important distinction to keep in mind. Furthermore, the EU is regarded as a very complex organization, quite hard to deal with. The Chinese hardly understand why national interests dominate EU meetings in these very difficult times. In Asia there is instead a desire for more harmony in the region when international problems are on the rise, but also more respect for the largest economy (i.e. China) – contrary to what Germany is currently experiencing.

Limited tensions between China and the EU are usually caused by (smaller) trade frictions, sometimes also by varying interpretations of free trade and environmental improvements. But more interesting issues regarding China and the EU show up currently and will continue to do so in the (forthcoming) aftermath of the global and European crisis. This may concern both microeconomic and macroeconomic developments.

China manifests itself as a country that increasingly has to be watched by means of interdisciplinary research. Politics, sociology, the environment and even psychology should be included in a future economic analysis. Pure macroeconomic analysis cannot capture China’s economic future.

This should be said despite the methodological difficulties that exist in interdisciplinary economic modeling. The current economic crises in some EU countries tell us, for example, that reasonable forecasts on European growth and financial markets for at least some years ahead cannot be made without including the political ability of reducing large fiscal deficits. And getting back to China: What will the new Chinese political leadership go for when it comes into power only a few years from now? China’s economy is – as we well know – very closely linked to the political leadership of the country.

I also look at future corporate relations between China and Europe. 

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Alan Blinder was a prominent professor at Princeton before he became the vice chairman of the Federal Reserve Board. After having left the Fed, he returned to academia and Princeton. Blinder is an influential monetary policy researcher. His work should be read by economists and others who want to discuss more than the next policy step by the central bank.

In his article “How Central Should the Central Bank Be?”, Blinder leans heavily on the economics of scope. He concludes that “the central bank should monitor and regulate systemic risk because preserving financial stability is (a) closely aligned with the standard objectives of monetary policy and (b) likely to require lender of last resort powers…” I think that Blinder is right about the first point, about monitoring systemic risk. Regulating systemic risks, however, should not necessarily belong to central bank commitments. There are both pros and cons.

Blinder pays special attention to the question whether “asset-price bubbles should be an integrated part of monetary policy. Or should the Fed eschew second-guessing market valuations content itself with “mopping up” after bubbles burst (what Blinder calls the Greenspan/Bernanke approach)? Blinder offers a reasonable distinction between credit-fueled bubbles and equity-type bubbles. He argues that the “mop approach” still should be applicable to equity bubbles not fueled by credits. However, the central bank should “try to limit credit-based bubbles”. I do share Blinders opinion on this issue by 100 percent. More central bankers begin to share this view as well.

I feel happy about these pragmatic changes in the real and academic world – an approach that I have been pleading for during a whole decade. Only a few years ago, the Swedish financial newspaper Dagens Industri interviewed a number of economists about their view on monetary policy and asset prices. If I remember correctly, I was the only one who supported this nexus.

Our modern global economy calls for a much broader and better macrofinancial analys and integration of central banks’ objectives and commitments. I am waiting for the next interesting publication of Alan Blinder.

Abstract
Transparency in Chinese financial markets is still poor. Lagging transparency has been cited as one of the main reasons for the current global financial and economic crisis. G20 countries – China included – have committed themselves in a communiqué from the London Summit of 2009 to work harder for increased transparency in financial markets.

Thus, Chinese has an important global commitment: the improvement of transparency in its financial markets. This issue will become increasingly important if the Chinese economic powerhouse continues to gradually open its capital account, pursue its long‐term work for a
convertible currency and develop a global financial center in Shanghai.
Markedly increased financial transparency should not only give major microeconomic benefits to domestic and foreign shareholders, but also macroeconomic gains to China itself, to Europe and the whole global economy – even if modeling based on these correlations still appears to be impossible. Joining the process of more transparency will make the need for specific financial reforms more visible ‐ and more intensively discussed! This could accelerate the necessary structural changes in Chinese monetary policy and on financial markets.
Growing risks may be observed earlier than in the current opaque system. Avoiding bursting bubbles and bank crises may mean a very positive contribution to GDP growth – though in an inverted way.

China is already the number one exporter in the world. Soon it will become the second largest economy in the world in traditional GDP terms. These developments clearly call for a major upgrading and modernization of China’s financial markets – not least because of the
fact that many developments in China will have an increasing impact on global financial markets, European markets included. How should such a development be achieved without acceptable or good financial transparency?

There should not be an alternative to good transparency in Chinese financial markets – for both domestic and global reasons. Such a change would be positive for Europe as well.

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1. From a general point of view we should all be happy that another Nordic country wants to join the European Union, hopefully as an active and positive member. Whether Sweden always has been a strong EU supporter can be questioned. Recently, former Finnish prime minister Paavo Lipponen even accused Sweden of not always having taken its EU mandate seriously enough.

2.  There are different reasons for a country’s application for EU membership, including                         -  peace and sympathy for a co-operating Europe – also in order to tackle tough global competition                                                                                                                      -  the dominating role of the EU as a trading partner and the possibility of joining the euro later on                          -  a domestic economic emergency situation (like in Sweden in the early 1990s)                                         -  a combination of different motives.

3.  Former Polish president Aleksander Kwasniewski told me once that the first argument of peace between EU countries has been particularly important to him and most of his countrymen, since Poland in the past centuries has been a free country only for a few decades. The historical peace dimension has never been discussed very much in Sweden which is not quite justified – but understandable. In the case of distant Iceland, this possible neglect of European continental history certainly must be even more understandable.

4.  In the case of Iceland, the application for EU membership happened to a great extent due to economic crisis reasons. This is not a bad reason per se. In emergency situations, it is usually easier to secure relatively high political and public support for such a big step. But things may happen quite rapidly. This calls for good transparency and information to the voters – but also to the more domestically oriented politicians.

5.  Thus the issue of transparency should not be underestimated and should include information on the EU itself and both the advantages and the challenges for Iceland. There will be changes in legislation, institutions, the corporate sector, the banks, the labor markets, etc. Icelanders should be aware of these changes before joining the EU. However, Iceland’s previous EEA joining will make things easier in a number of areas.

 6. Another big issue will be the (probable) future Icelandic position with regards to the EMU. Current difficulties for the euro should not deter them. Currencies go up and down, particularly reserve currencies. Sure, the European Union has to work out some major structural problems in a number of member countries. But even the US and the UK – the main current speculation centers against the euro – have their homemade problems which at some point will send currencies in another direction again, this time favoring the euro.   

7.  However, the current euro crisis again stresses a fact that is sometimes neglected: Economic stability begins at home. As the examples from the Baltic countries and Greece show, strong links to the euro and EMU membership cannot serve as a rescue anchor if a country suffers from major domestic economic imbalances.

8.  In my opinion the analysis of the economic balance of a country applying for EU membership should not be limited to what is still called convergence criteria, i.e. total public debt, annual fiscal performance, inflation, the exchange rate before joining and long-term rates – but also the structural situation and the fundamental prospects of the current account. This is an issue that Iceland should think about in order to avoid joining the euro prematurely – even if many observers think that Iceland applied for EMU membership mainly with the objective to introduce the euro in the foreseeable future. Thus, preparing Iceland for the euro should include a long-term strategy for structurally improved exports and – if possible – also for some long-term reduction of imports.   

9.  This strategy has to include a number of important contributions from growth policy to the current account balance – or call it from the supply side if you want. Some of these factors that contribute to the creation of even more entrepreneurship and product development are a favorable general economic climate, improvements in education, innovation, well-functioning financial markets, good institutions, labor market immigration, etc. R&D as a share of GDP, for example, is just around 3 percent which certainly must be considered as moderate. And it should not be overlooked:  According to article 109 j 1 of the Maastricht treaty, the current account balance matters when a county wants to join the EMU. Unfortunately, nobody ever cared about this detail, probably because there are no numerical targets for an acceptable current account deficit. However, this – academically understandable – lack does not make the issue of a sustained acceptable deficit in the current account less important.  

 10.  Once Iceland has formally joined the E(M)U, North America has taken this big step as well (if we neglect the French Islands of St. Pierre and Miquelon off the coast of Canada which already have the euro). Surprised? Of course, this comment is related to Iceland, since the big island of Iceland geographically is located in both Europe and America.

In February, some of my concerns were expressed the following way:

-About inflation:  “There is an obvious risk that Chinese inflation later this year can go through the unofficial comfort ceiling of 4 percent…”

-About monetary/credit policy and the bubble risk:  “The risk is obvious that the government’s far too loose monetary policy has contributed to the dumping of money in risky and unprofitable projects” and that “recent tightening still means expansionary money/credit policy…Assuming the continuation of an only slightly more restrictive policy by the central bank, there will be at least twice the amount of new loans as in the years before 2009…Some more efficient fight against credit exuberance and inflation should come in the forthcoming quarters…”

-About exchange rate policy:  “I expect a return to the previous cautious Chinese appreciation policy in the latter part of 2010 or the first half of 2011 – but not before a more stable and export performance has been visible for at least a couple of months…”

Recent statistics shows some real Chinese hard facts. First, inflation in April got back to the uncomfortable trend from the beginning of this year (CPI: 2.8 %). Second, new bank loans soared in April to 774 billion renminbi or roughly 113 billion USD – an increase that cannot be regarded as soft as the dampening officials would like to see. Consequently, gradually increasing cash requirements by the banks are not enough. China also needs higher interest rates. With new information about inflationary pressure and ongoing strongly increasing credit activities, there is no reason to revise my forecast from February: “The most likely scenario is therefore that China this year will go for at least two interest rate hikes with 0.27 percentage points each time (2+7=9=good number). Another one or two hikes within the forthcoming year (comment: until the end of February 2011) would certainly not be a surprise if GDP growth has been established on a relatively steady course…” This latter assumption seems to become verified in the forthcoming quarters.

It can be added that I now tend to revise my forecast on Chinese GDP growth in 2010 from 9-9 ½% to 10-10 ½%. In other words: In my eyes, Chinese interest hikes are on their way even more likely. So is probably the renewed switch of Chinese exchange rate policy later this year from strictly pegging the USD to a slight appreciation process vis-à-vis the USD. Strategic exchange rate decisions, however, are an issue for the highest Chinese leaders. For this reason, currency forecasts for the RMB should be handled with necessary cautiousness – despite the strictly border control of financial cross-border transactions.

Summary: Unfortunately, my recent warnings on the Chinese economy seem to be on track.

Vissa (relativt) nya EU-länder ser ånyo ett EMU-medlemskap inom några få år som en gångbar försäkring mot framtid finansiella spekulationer. Om vi emellertid har lärt oss något av Grekland-krisen, måste det rimligen vara ett en valutaunion inte kan skydda mot hemmagjorda strukturella obalanser – inte ens mindre, av finansmarknaderna vanligen försummade länder. Därför kan inte tillräckligt varnas för en alltför tidig EMU-anslutning av exempelvis de baltiska länderna, vilka alltjämt har en längre tid med tuffa strukturella anpassningar framför sig.

1. In recent months, some new EU-member states (NMS) against raise the issue of an early joining of the EMU/euro, like, for example, Estonia already next year and the two other Baltic countries only a few years later. I have been warning for a premature EMU joining by NMS since 2002 – and I still have the same concerns: Countries should only join the EMU when they are structurally well-trimmed. Greece was not, and that’s why they are in deep troubles now.

2.  It’s the wrong believe that EMU membership shelters against existing economic imbalances and speculations of financial markets. Stability begins at home. No artificial measure whatsoever can break this fundamental rule.

3.  Improving structural problems or maintaining existing good structures urge for continuous structural efforts by the government and the corporate sector. Hard structural work happens usually effectively in emergency situations like the Greek, Latvian or Icelandic – or the Swedish in the 1990s. The new market economies in Central and Eastern Europe had their big ambitions in the 1990s after the fall of the Berlin wall and the iron curtain. Most of them succeeded indeed very well – better than anyone could expect in 1989.

4.  However, since the early years of this century we also could recognize another phenomenon, i.e. that most NMS became reluctant in implementing further reforms. Reforms had become a word that many times was equalized with sacrifices by ordinary people. This declining willingness of more ambitious reform activities did not come unexpectedly because

-   the implementation of further reforms became politically tougher;
-   opponents to changes became better organized;
-   social challenges increased;
-   income distribution worsened, also regionally;
-   Buchanan’s public choice theory about re-election started to penetrate economic policy, leading to more tactical economic policy.

5.  There is an obvious risk that NMS countries with current tough fiscal restrictions and , for instance, the strongly hit Ukraine cannot quite consequently  stick to their needs austerity needs in the forthcoming years simply for social and political reasons. Structural reform policy may weaken again in line with the previously summarized explanations.

6.  But it is important to remind the readers of this blog that the former planned economies in Northern, Central and Eastern Europe are no homogeneous region anymore – but countries with quite different own conditions. Estonia, for example, will certainly achieve a faster and more sustained adaptation process than the Ukraine. The latter country, of course, is no EMU candidate – but a transition and reforming country that has been very negatively affected by the global crisis and that has been facing a lot of troubles because of domestic policy mistakes (such as the previous link of their currency, the hryvnia, to the US dollar and big amounts of foreign credits in USD for domestic Ukrainian purposes).

7.  One of the most demanding challenges for NMS will be to manage innovation, technological progress and the commercialization of new products ready for exports at a higher value-added level. Such a positive development is extremely necessary in order to avoid a renewed structural deterioration of the vulnerable current account balances in several NMS. But where should such progress come from, particularly when public spending is so restrained?

8.  This takes us to a main conclusion:  The current good shape of the current account balances in a number of NMS (Baltic states) will not go on once reasonable GDP growth has come back. Imports will grow again, that’s for sure. But will exports simultaneously grow enough to avoid a sizable, new weakening of the current account? Of course, we all hope so. Unfortunately, the contrary seems to be more probable in a number of NMS. And then (still) having a fixed currency – and  getting new pain?

9.  According to the Maastricht Treaty (article 109 j 1), the current account balance matters when entering EMU. But nobody within EU cared about this important stability indicator in the past decade. Politicians know about the risks of high inflation and budget deficits – but they usually do not understand the complexity of problems that are related to a structurally weak current account balance. This is a main reason why the advantage of a solid – not necessarily positive – balance of current account did not directly become part of the so-called convergence criteria. This should be the case in the forthcoming, reformed EU framework for macroeconomic supervision.

10. Nowadays, there are only four NMS with floating exchange rates: Poland, Hungary, Czech Republic and Romania. All the other NMS have a formal link to the euro or are – like Slovenia and Slovakia – already members of the EMU. Sure, countries with floating rates can sometimes come under appreciation pressure, like in the past quarters. Is that really bad?

11. There are also two advantages in healthy, appreciating countries. Inflation can be combated, and there is – ceteris paribus – some negative impact on competitiveness if the appreciation process is more sustained. However, hardening competition can exactly give the structural progress in products and production that is needed to perform better on exports markets in the longer run. Productivity has to be improved. New attractive and competitive products have to be developed. Germany benefited highly from this kind of exogenous pressure until the introduction of the euro.

12. It is understandable that the decision of staying outside the may give mixed feelings to many people in the new EU-member countries. But there is no doubt that joining EMU should happen from a position of structural strength – and not as a rescue anchor for future emergencies! And there will be more NMS that will join the euro. But this should not happen any time soon. Before joining the euro, a structurally healthier current account balance has to be achieved. Getting there, takes time.

Brad deLong – välkänd professor i ekonomisk historia vid Berkeley-universitet i San Francisco – analyserar i denna nyutkomna bok tillsammans med kollegan Stephen Cohen USA:s framtida roll i världsekonomin.  Kinas tilltagande globala inflytande diskuteras – vilket kommer att ske på bekostnad av USA:s. DeLong/Cohen förutser en växande statskapitalism och en tillbakagång av nyliberalismen.

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Many articles have been written in the past two years about the declining economic power of the American economy in the aftermath of the global financial and economic crisis. Of course, nobody can give an exact answer to this topic at this stage. But one should listen when experts like Cohen and – particularly -  DeLong raise their voices. This is why I read their book “The End of Influence” with great interest.

DeLong/Cohen use the uncomfortable American indebtedness and China’s enormous accumulation of currency reserves as the starting point for their analysis. “When you have the money – and you are a big, economically and culturally vital nation – you get more than just a higher standard of living for your citizens. You get power and influence…” On the other hand: “When the money drains out, you can maintain the edge of living standards of your citizens for a considerable time (as long as others are willing to hold your growing debt and pile interest payments on top). But you lose power…”

The two authors of the book forecast the revival of state capitalism and a declining influence of neoliberalism, particularly in the U.S. In the future, governments will intervene much actively to affect markets, according to the two professors.

DeLong and Cohen do not see a primary risk in foreign (Chinese) buying of American companies per se – but in the challenge “where the spillovers of the innovations go”. DeLong/Cohen fear that the spillovers – which historically stayed in the U.S. and which strongly contributed to regional growth – will go outside the U.S, thanks to foreign money.

The book does not predict the fall of the U.S. We are, however, told that others have the money. Consequently, the U.S. will lose power and influence – but it will remain a world power. 

 “The End of Influence” is a most interesting reading. However, it is based on the assumptions of sustained major fiscal problems in the U.S. and continuous economic stability in China. These assumptions are probably right for the forthcoming years. But what will happen 10-15 years from now? China has its (still hidden) structural imbalances as well – and the U.S. may at some point turn their own problems in the right direction again.

DeLong’s and Cohen’s book is not written very academically, which is good for trying to get a broader public to understand this ongoing, very severe problem in the world economy. They point to possible developments that really look uncomfortable. Not each and every one of their conclusions will come true.  But the warning signals should not be ignored.

I like the recently published book because it may lead to a new, important approach in interdisciplinary research – an approach that I have been supporting for quite some years, particularly when it comes to psychology and sociology. Historically – as A/K point out – Adam Smith showed considerable interest in social issues and the creation of a good society. Since the end of the eighteenth century, however, economic research has become more and more model-oriented, using that incredible person called homo oeconomicus who is supposed to know everything, receive all necessary information and always comes along with perfect individual decisions.

We know, however, that such an ideal world does not exist in reality. As Gary Becker realized more than 40 years ago – entirely correctly – social issues matter in economic developments. In 2002 economic psychology received a great deal appreciation when the Nobel Prize was awarded to Daniel Kahneman and Vernon Smith.

A/K seem to be ready to give economics a new social dimension by modeling and analyzing how “our identities shape our work, wages, well-being”, etc. They put together identity, norms, and social categories into economics. A/K conclude that “people’s identity defines who they are”: Their social categories and their identities determine their economic decisions.  This is the case because “different norms for behavior are associated with different social categories”. We have to understand these two factors in order to capture what IE is all about. Choosing identity may be the most important economic decision a person can ever make, according to Akerlof and Kranton. People’s choice of identity reveals their conception of who they want to be and/or who they are.

Gender and race issues fit particularly well into the IE approach, many times related to education and work – factors that in the long run also have an impact on economic growth. Thus, IE has a macroeconomic dimension as well. Other applied examples are why certain incentives work or don’t work and why certain schools or cities succeed or don’t succeed.

A/K nicely blend their research approach with examples from real life. This really fascinating book has a non-mathematical content which should give it quite a large readership. But it should be added that A/K also deal with the necessary technical modeling. More about this can be read in various economic reviews and papers.

Read the whole text of the China Survey

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There is no doubt that China has achieved great economic progress since the start of the opening-up policy in 1978, particularly in the past 15 years. The fact that the country is currently ranked number 1 exporter in the world and soon to be number 1 importer, already number 1 car market by registrations, soon to be number 2 in total production (GDP), etc., clearly underlines the success of the Chinese policy. It is no exaggeration to say that China has emerged as the main benefiter of the current rapid phase of globalization.

However, obvious economic progress had – and still has – a major flip side. Many imbalances and problems are discussed in this paper. But many challenges are still neglected in the general discussion – even by Westerners. Furthermore, a great number of problems are hidden and not very transparent. Insufficient transparency – especially in the financial sector – must be interpreted as directly contradictory to the spirit of globalization. Despite these shortcomings, economic discussions are nowadays much more open-minded in China than they were ten or fifteen years ago – many times more open than Western business people and analysts discuss the Chinese economy. Some examples will be given in the paper.

Major improvements in the large number of structural problems would mean a very positive impact on China’s potential growth rate. Thus, China should have more to give in growth and import terms (under the assumption of political stability).

One of the most urgent and neglected areas that needs major improvement is transparency, both when it comes to economic policy, the financial sector and corporate China as a whole. Both China and rest the whole global would benefit from such a development.

This analysis is structured as follows:

1. Achievements
2. Short-term challenges
3. Long-term challenges
4. Own view of current discussions
5. Examples of frequent and open discussions in China  �
6. Outlook

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