Recession in Europe. Governments refuse to help. Will demand come from China?

The current crisis is five years old, and counting. Over the last three years the governments of the countries most affected by the recession have refused, as they still do, to take the only action that would reverse this dramatic trend: that is, to stimulate aggregate demand.

But it was not always like that. There was a time, not long ago, when government stimuli were not a sin.

Many will remember that in November 2008 the Chinese government was the first to adopt deficit spending, expansionary fiscal measure to the tune of Bln 576 US$ for an astonishing 16% ratio of deficit to GDP. And the world was grateful. Then it was the US Congress that, in February 2009, approved a deficit for the fiscal year 2009 for an amount of Bln 787 US$, due in part to lower revenues and in part to greater expenditures – a hefty 5.6% of GDP.

But then, in October 2009, Fitch shocked the world by downgrading Greek Government’s debt. For three years now the recession in Europe is getting worse, unemployment keeps rising, and none of the four engines of growth is working: household are facing shrinking disposable incomes, firms do not spend on investment goods given the negative outlook on the economy, exports grow at a sluggish pace and certainly not as fast as imports, and the governments like it this way and do nothing but push for further recession – which they call ‘austerity’.

The question is: where will demand come from? Are emerging economies going to help moderate the recession and, in time, turn the situation around? If they are to do so, the most efficient way would be to stimulate aggregate demand at home, re-direct domestic production from foreign markets to domestic ones, increase the pace at which they import from Europe as well as from the rest of the currently high-per-capita-income countries.

Let us look at China to assess whether there is any sign that something of the sort just described is happening. There are three levels on which we have to look for evidence: the policy debate, the balance of trade, the Renminbi exchange rate.

1. The policy debate

In China, economic policy guidelines are presented in the Five-year Plan. As reported in the main objectives and tasks section in the twelfth five-year plan of 2011-2015, the State Council approved Mr Wen Jiabao’s proposal according to which the government will work hard on social undertakings, continue to prioritize education and steadily raise the educational level of the people. Moreover, it will commit itself to improve the basic medical and health care system, so as to improve people’s standard of living and social welfare system especially by strengthening the public welfare facilities for aged care as well as encouraging the social capital to develop the nursing organization for elderly.

In this five-year-plan, it was proposed that China should adapt to a more balanced growth model, by putting equal stress on imports as it does on exports, attracting foreign capital and promoting outbound investments. China should also abandon its current dependence on exports and foreign capital, focusing its economic growth more on internal demand.

Considering the impact of the currency exchange rates fluctuation, it was stated that the government should manage the floating exchange rate regime based on the demand and supply in the market, in order to expand the scope of cross-border Yuan trade and push forward RMB capital account convertibility.

How much of all this are we already seeing in the international trade data and on the Renminbi/US$ exchange rate dynamics?

2. From policy statements to hard evidence: the balance of trade

Recessione in Europa. I governi si rifiutano di intervenire. La domanda verrà dalla Cina_Figura1

Figure 1 reports monthly data for current-Dollar values of Chinese exports and imports. We observe that exports used to outstrip imports for most of the pre-2012 period, and that such behavior has accelerated since. Thus, preliminary empirical evidence suggests an imperfect adherence to the twelfth five-year plan so far, at least as far as aggregate international trade figures are concerned.

Nor data reported in Figure 2 seem to predict an imminent inversion of China’s export orientation. Here we have computed year-over-year change rates (that is, the percentage change between any monthly value and the 12-month-earlier value) for both exports and imports. If an acceleration of imports relative to exports were to be observed, then we would tentatively conclude that China is really beginning to be more an importer than an exporter. That is not so. If anything, over the last quarter exports appear to have been increasing faster than imports.

Recessione in Europa. I governi si rifiutano di intervenire. La domanda verrà dalla Cina_Figura2

In order to assess whether any sudden acceleration in imports has been taking place  along with a parallel deceleration in exports, in Figure 3 we have computed the rate of change of trade flows over the previous month. One can see that since early Summer there is no appreciable difference between the two rates.

Recessione in Europa. I governi si rifiutano di intervenire. La domanda verrà dalla Cina_Figura3

Finally, Figure 4 summarizes all the information collected above by showing the way China’s trade balance has been moving over time. Again, there is no evidence of the emergence of a declining trade surplus vis-à-vis the rest of the world in the aggregate.

Recessione in Europa. I governi si rifiutano di intervenire. La domanda verrà dalla Cina_Figura4

3. From policy statements to hard evidence: the Renminbi exchange rate

The dynamics of the nominal exchange rate may be a good indicator of a country’s trade policy. Figure 5 shows that the Renminbi has been let appreciate beginning the early Summer of 2010 from a 6,8 RMB / US$ to slightly more than 6,3 RMB per US$. If, as the conventional story goes, an appreciating currency ought to have generated a shrinking trade balance, than in this instance the conventional story seems to be wrong. Unless. Unless the apparent uncorrelatedness of exchange rate and trade balance could not be explained by a gain in Chinese productivity that has compensated exactly for the RMB appreciation. But this is just a hypothesis requiring further investigation.

Recessione in Europa. I governi si rifiutano di intervenire. La domanda verrà dalla Cina_Figura5

4. In  the way of a conclusion

Facing the global financial crisis, China has announced a shift on emphasis from an export-led model to a domestic demand-driven model. At the same time, it has let the Renminbi appreciate. Official documents state that expanding domestic consumption is one of the key priorities for the coming years. Social welfare and sustaining environmentally friendly development have been put at the center stage as well, along with cutting of taxes and expenditure increases.

From the high per-capita income countries point of view, all this translates in one simple question: can they expect import demand by China to actually increase to an extent sufficient to offset, at least in part, the effects of contractionary policies at home? Preliminary evidence presented here seems to support the view that such virtuous effects are not yet taking hold. Or, to put it less mildly: you wanted a recession, you got. China cannot be the world’s savior.

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