Fan Gang

Getting economic recipe right

By Fan Gang (China Daily)
Updated: 2010-07-02 07:50

The relatively high inflation of the early 1990s was a warning to central government policymakers about the macroeconomic risks posed by fast growth. The bubble bursts in Japan's economy in the early 1990s, and the Southeast Asian economies later in the decade, provided a neighborly lesson to stop believing that bubbles never burst.

Since then, the central government's policy stance has been to put brakes on the economy whenever there is a tendency toward overheating. Stringent measures were implemented in the early 1990s to reduce the money supply and stop over-investment, thereby heading off hyperinflation.

In the recent cycle, the authorities began cooling down the economy as early as 2004, when China had just emerged from the downturn caused by the SARS scare in 2003. In late 2007, when GDP growth hit 13 percent, the government adopted more restrictive anti-bubble policies in industries (steel, for example) and asset markets (real estate), which set the stage for an early correction.

Economic theory holds that all crises are caused by bubbles or over-heating, so if you can manage to prevent bubbles, you can prevent crises. The most important thing for "ironing out cycles" is not the stimulus policy implemented after a crash has already occurred, but to be proactive in boom times and stop bubbles in their early stages.

I am not quite sure whether all Chinese policymakers are good students of modern economics. But it seems that what they have been doing in practice happened to be better than what their counterparts in some other countries were doing - a lot on "de-regulation," but too little on cooling things down when the economy was booming and bubbles were forming.

The problem for the world economy is that everybody remembered Keynes's lesson about the need for counter cyclical policies only when the crisis erupted, after demanding to be left alone - with no symmetric policy intervention - during the preceding boom. But managing the boom is more important, because it addresses what causes crises in the first place.

In a sense, what China has been doing seems to me to be the creation of a true "Keynesian world" - more private business and freer price competition at the micro level, and active counter cyclical policy intervention at the macro level.

There may be other factors that could slow down or interrupt China's growth. I only hope that policymakers' vigilance will prevail (and be improved upon), enabling China's high-growth story to continue for another 10, 20, or 30 years.

Fan Gang is professor of economics at Peking University and the Chinese Academy of Social Sciences.

Project Syndicate

(China Daily 07/02/2010 page8)