ACJC Macro Policies Case Study Suggested Answers

Suggested Answers: SECTION B: CASE STUDIES Case Study Question 1: Imbalances in the United Kingdom and China economies Table 2: Government debt (percentage of GDP) Year China UK 2010 33.7 76 2011 33.6 81.6 2012 34.3 85.1 2013 37 86.2 2014 39.9 88.1 2015 42.6 89 Source: IMF Table 3: GDP Composition breakdown by percentage in 2015 China UK Consumption Expenditure 37% 65% Government Expenditure 14% 19% Gross Capital Formation 45% 17% Export Revenue 22% 28% Import Expenditure 18% 29% Source: World Bank Extract 5: Is the game up for China’s much emulated growth model? From the early 1990s, China adopted an export -led strategy that delivered continuously increasing shares of the world market, fed by relatively low wages and very high rates of investment, enabling massive increases in infrastructure. It led to big increases in inequality and even bigger environmental problems, but the strategy seemed to work – until 2008-09, when exports were hit by the global financial crisis. Yet even then, China, India and other large emerging markets continued to grow. The talk at the time was that they were already dissociated from the west. In reality, China (and much of developing Asia) had simply shifted to a different engine of growth without abandoning the focus on exports. The Chinese authorities could have generated more domestic demand by stimulating

consumption through rising wage shares of national income, but this would have threatened their export-driven model. Instead they put their faith in investments to keep growth rates buoyant. So the “recovery package” in China essentially encouraged more investment, which was already nearly half of GDP. Provincial governments and public sector enterprises were encouraged to borrow heavily and invest in infrastructure, construction and more production capacity. To utilise the excess capacity, a real estate and construction boom was instigated, fed by lending from public sector banks. Total debt in China increased fourfold between 2007 and 2014, and the private debt-GDP ratio nearly doubled to over 280%. All this comes in the midst of an overall slowdown in China’s economy. Exports fell by around 8% in 2014. Stimulus measures such as interest rate cuts do not seem to be working. As such, the recent devaluation of the yuan is clearly intended to help revive the economy. However, it will not really help. Demand from the advanced countries – still the driver of Chinese exports and indirectly of exports of other developing countries – will stay sluggish. Meanwhile, China’s slowdown infects other emerging markets across the world as its imports fall even faster than its exports. A weaker yuan is bad news for export -oriented economies like Singapore, Hong Kong, South Korea and Taiwan as their exports will be more expensive to Chinese buyers. Their exports to other countries will also have to compete against Chinese rivals who have the advan