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Dissecting the China Puzzle: Asymmetric Liberalization and Cost Distortion

  • Yiping HUANG

In this paper we attempt to explain the China Puzzle : coexistence of accelerating economic growth and worsening growth outlook. The root cause lies in Chinas unique liberalization approach, i.e., the combination of complete liberalization of product markets and continued distortions in factor markets. Repressed costs of labor, capital, land and resources artificially raise profits of production, increase returns to investment and improve international competitiveness of Chinese products. This is why economic growth is strong, but investment and exports are even stronger. These distortions also contribute to the global imbalances by boosting Chinas current account surpluses and capital outflows in forms of foreign exchange reserves. We estimate factor cost distortions for 20002009 to gauge the likely magnitudes and crossyear patterns. They provide a reasonable explanation of the movement in economic imbalances. These findings have important policy implications. The governments efforts to rebalance the economy after 2003 failed because it did not attack the root cause, i.e, the incentive structure. Popular calls for renminbi appreciation might work ineffectively as currency undervaluation is only part of the distortion. The best policy for achieving sustainable growth would be a comprehensive package focusing on liberalization of the factor markets and elimination of cost distortions.

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Article provided by Japan Center for Economic Research in its journal Asian Economic Policy Review.

Volume (Year): 5 (2010)
Issue (Month): 2 (December)
Pages: 281-295

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Handle: RePEc:bla:asiapr:v:5:y:2010:i:2:p:281-295
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  1. Jeffrey D. Sachs & Wing Thye Woo, 1997. "Understanding China's Economic Performance," Harvard Institute of Economic Research Working Papers 1793, Harvard - Institute of Economic Research.
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