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New Book by Nicholas Lardy Argues China Must Adopt New Growth Model

February 1, 2012

WASHINGTON—China has emerged successfully from the global financial and economic crisis but must nonetheless undertake fundamental reforms to sustain its economic growth and help the rest of the world recover, a new book by Nicholas Lardy of the Peterson Institute for International Economics concludes. The book, Sustaining China's Economic Growth after the Global Financial Crisis, argues that China must move away from its heavy reliance on exports and investment toward "a new growth model in which domestic consumption demand becomes an increasingly important source of economic growth." Lardy further recommends a reform of fiscal, financial, exchange rate, and pricing policies to achieve the goal of reducing its economic imbalances.

In the face of a global financial crisis and slowdown in 2008–09, China acted aggressively and its economic expansion slowed only to an enviable 9.2 percent in 2009 while the rest of the world suffered its sharpest decline in 60 years. Its success stemmed from the 2009–10 fiscal and monetary stimulus program, but Lardy notes that the stimulus was not intended to address the longer-term structural problems that led China's premier, Wen Jiabao, to characterize China's growth as early as 2007 as "unsteady, imbalanced, uncoordinated, and unsustainable." The issue of how China intends to proceed is certain to be at the center of the meeting between China's Vice President and likely future president, Xi Jinping, with President Obama later this month.

Lardy argues China's large trade and current account surpluses, which are smaller than they were a few years ago but which could grow in size if China does not adjust its growth strategy are at the root of China's tensions with the rest of the world. He explains that China's imbalances encompass such factors as a low share of private consumption and a super elevated share of investment in GDP; an outsized manufacturing sector and small services sector; accumulation of unprecedentedly large official holdings of foreign exchange; and an increasingly high and probably unsustainable rate of investment in residential property. Among the essential reforms China must take, Lardy says, are market-oriented interest rate liberalization, eliminating underpricing of energy and other inputs used predominantly in manufacturing, greater exchange rate flexibility, and a more rapid expansion of social safety nets.

One of the key factors behind China's distorted economic model, Lardy says, is financial repression, particularly the negative average real return on one-year bank deposits since 2003. This negative rate contrasts sharply with the years 1997–2003, when the average real rate of return was 3 percent. Financial repression limits spending on consumption for several reasons. It has depressed the growth of household income, increased the share of Chinese after tax income that goes to saving, and compelled households put their savings into housing and other alternatives. As a result, residential housing has become the single most important driver of China's economic growth, though that trend is not likely to continue. However, unless offset by increased private consumption expenditure, any slowdown in the pace of property investment would limit China's economic growth. The beneficiaries of existing policies—including export industries, coastal provinces, the real estate and construction industries, and China's banks—have disproportionate influence over economic policy and to date have been able to block most needed policy reforms. But Lardy argues that China's unbalanced growth model is not sustainable and, if left uncorrected, could undercut the country's future growth prospects.

Sustaining Economic Growth in China after the Global Financial Crisis has already won widespread praise. Eswar S. Prasad, professor of trade policy at Cornell University and senior fellow at the Brookings Institution, has called it, "a masterful account of the policy reforms that China needs to put in place to rebalance its economy and sustain high growth. The book is rich in data and thoughtful analysis, making it essential reading for anyone interested in understanding China's growth prospects."

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Sustaining China's Economic Growth After the Global Financial Crisis
Nicholas R. Lardy
ISBN paper 978-0-88132-626-0
January 2012 | 182 pp. | $21.95

About the Author

Nicholas R. Lardy is the Anthony M. Solomon Senior Fellow at the Peterson Institute for International Economics. He joined the Institute in March 2003 from the Brookings Institution, where he was a senior fellow in the Foreign Policy Studies Program from 1995 until 2003 and served as interim director of Foreign Policy Studies in 2001. Before Brookings, he served at the University of Washington, where he was the director of the Henry M. Jackson School of International Studies from 1991 to 1995. From 1997 through the spring of 2000, he was also the Frederick Frank Adjunct Professor of International Trade and Finance at the Yale University School of Management. He is an expert on Asia, especially the Chinese economy.

About the Peterson Institute

The Peter G. Peterson Institute for International Economics is a private, nonprofit, nonpartisan research institution devoted to the study of international economic policy. Since 1981 the Institute has provided timely and objective analysis of, and concrete solutions to, a wide range of international economic problems. It is one of the very few economics think tanks that are widely regarded as "nonpartisan" by the press and "neutral" by the US Congress, its research staff is cited by the quality media more than that of any other such institution. Support is provided by a wide range of charitable foundations, private corporations and individual donors, and from earnings on the Institute's publications and capital fund. It moved into its award-winning new building in 2001, and celebrated its 25th anniversary in 2006 and adopted its new name at that time, having previously been the Institute for International Economics.