Indian Economy Term Paper

Macroeconomic Policy, Inequality and Poverty Reduction

in India and China
Name: Swarnali Dutta
C.U. Registration Number:
146-1211-0649-21
C.U. Roll Number: 213146-11-0063
Paper: CC-12
Topic: Macroeconomic Policy,
Inequality and Poverty Reduction in
India and China (Written by C.P.
Chandrasekhar and Jayati Ghosh)
 INDEX
TOPIC Page No.
1. Introduction 4
2. Economic Growth, Poverty and 5-6
Macroeconomic Policies in
China
3. The Effects of Reform 7-8
4. Macroeconomic Trends since 8-9
the Reform
10-11
5. Implications for Poverty
Reduction
6. Conclusion 11-12
 INTRODUCTION
4

In this article -Macroeconomic Policy, Inequality and Poverty Reduction in

India and China, C.P. Chandrasekhar and Jayati Ghosh analysed the the two
major success stories of Globalization i.e India and China. India and China,
the two major countries of BRICS, emerged as one of the fastest growing
economies after the World War. The motive of this paper is to study the
macroeconomic policies behind the growth performance of these two
countries and analyse its effect on poverty and income inequality.
China’s steep growth during the 21st century, making them emerge as one of
the giant economies, had shocked the world. The high and sustained rates of
growth of aggregate and per capita national income; the absence of major
financial crises that have characterised a number of other emerging markets;
and substantial reduction in income poverty are one of the major indications
of this success. This paper attempts to unravel the extensive programme of
global economic integration and domestic deregulation, as well as sound
macroeconomic management, that was carried out to attain this economic
growth.
During globalisation, China and India- which together account for one-third
of the world’s population had a substantial increase in per capita GDP,
however a closer look gives us a different picture, because hidden behind the
per capita GDP figures we see that there has been an increase in economic
differentiation including rural urban inequalities.
Thus, this paper gives a detailed overview of the duality of China’s growth
performance, with respect to the macroeconomic trends before and after the
economic reform.
 5

Economic Growth, Poverty and

Macroeconomic Policies in China
China is a centrally planned economy, which in ideal form are supply
constrained systems, sui generis, contrary to the market economies i.e the
demand -constrained systems, around which most conventional
macroeconomic discussions revolve. Hence, the macroeconomic
mechanisms prior and after the launch of economic reforms in 1978,
substantially differ from macroeconomic mechanisms in market economies.
Since in centrally planned systems there is lack of monetary and fiscal levers
that, only economic reforms results in the generation of features
characteristic of market driven economies in centrally planned systems and
we witness a transition resulting in a gradual process of convergence in the
nature of the policies and outcomes.

Financial System of China (1951-1984)

● People’s Bank of China (PBC) implemented the cash and credit plans
formulated by the central authorities, which supported the physical plan
for mobilisation, allocation and utilisation of real resources.
● All public sector transactions, including those between various levels
of government and the state enterprises, were through transfers on their
accounts with the People’s Bank. (accounting for a share of up to 95 per
cent of all transaction)
● Cash was printed and issued by the PBC on demand by the central
government and allocated according to instructions issued.
● The banking system was not responsible for provision of resources for 6
fixed asset investments by the state-owned enterprises.
● The main elements of money in circulation were wage payments to
workers and staff, the purchase of agricultural products by the
government, other purchases of goods in the rural sector, and the
withdrawing of savings deposits by individuals

Monetary policy prior to reform

● Credit provision was centralised and strictly controlled.
● Enterprises and other economic entities received grants and loans
directly from the PBC.
● Lower level banking entities had to hand over deposits that exceeded
their credit provision targets to higher level units.
● Government restricted economic activity through administrative means
instead of monetary levers.
● The central authorities could adjust prices relative to money wages to
manage the supply of cash and its utilisation.

Fiscal policy prior to reform

● Using deficit financed expenditures to prime the economy, however it
does not appear to have been a major thrust of the government as the
deficits recorded rarely exceeded 1 per cent of GDP till the late 1980s
● As both prices and imports was controlled by the government, any
excess of demand over supply did not spill over in the form of inflation
or a current account deficit, but was dealt with through rationing. ( by
enforced realisation of a certain level of household financial savings)
● Excess of supply over demand in particular sectors resulted in the
accumulation of inventories the holding of which was financed by the
government and the banking system.
 The Effects of Reform 7

● Banks, financial institutions and enterprises at provincial and local

levels have more flexibility in providing and accessing loans, resulting
in reduced government control over investment and consumption.
● Government attempted to use countercyclical fiscal policy to correct for
recessionary or inflationary tendencies.
● Price Reform- Growing number of commodities have been removed
from the administered price category, so that excess demand can lead to
inflation.
● Trade Policy Reform- Excess demand can spill over onto the balance of
payments in the form of a reduced current account surplus or a current
account deficit.
● Financial Reform- To reduce the share of investment funds for
enterprises granted exclusively from the cost-free state budget and
replace budgetary grants with bank loans which were subject to interest
charges. Thus, the share of budgetary appropriations in financing capital
construction declined dramatically and that of loans and self-raised
funds increased quite significantly. A two-tiered banking system was
established in 1984 by converting the People’s Bank of China into the
country’s central bank and getting the specialized banks to undertake
the commercial banking business.. In 1986, reforms resulted in the
creation of a number of trust and investment companies, and financial
intermediaries such as leasing companies, pension funds and insurance
companies. Foreign banks got grant to start business in China.

However, the PBC could control the terms of its lending by charging lower
rates of interest for loans within the credit plan and penalise unauthorised
borrowing. Thus the ability of the PBC to realise its credit plan was
strengthened by the reform
Negative effects of the reform 8
Provincial and local governments could easily obtain finance for special
projects adding another element to the investment hunger determined by soft
budget constraints in the SOE sector. As a result, the capacity of the central
bank to use monetary levers to control investment expenditures has
weakened.

Macroeconomic Trends since the

Reform
This paper discusses China's economic growth, focusing on factors such as
high investment rates, domestic saving, and the role of government policies.
Here is a summary:

● Economic Growth: China has achieved remarkable economic growth,

with an annual GDP growth rate of 9.8% over 25 years until 2003. This
growth is attributed to consistently high investment rates, ranging from
32% to 44% of GDP.
● Volatility and Investment: Despite fluctuations, the overall trend shows
an increase in the investment rate from 34.5% of GDP in the early
1980s to over 40% in recent years, supported by domestic saving.
● Domestic Saving: China's domestic saving rates are exceptionally high,
contributing significantly to investment. Foreign savings play a minimal
role, with foreign capital inflows accounting for around 5% of GDP.
● Sectoral Changes: While there have been fluctuations in the growth
rates of primary and tertiary sectors, industrial production, especially in
the secondary sector, has been crucial for sustained high growth.
 9

● Macroeconomic Policy: The Chinese government has adjusted domestic

investment and consumption in response to inflation rates. "Stop-go
cycles" in investment are influenced by broader macroeconomic
policies.
● Monetary and Fiscal Policy: The effectiveness of monetary policy faced
challenges, leading to a shift towards an expansionary monetary
environment. Fiscal policy became more active from the mid-1990s
onwards, especially during economic downturns.
● Real Estate Development: Real estate development, including both
private and government projects, plays a significant role in fixed assets
formation, contributing to economic growth but introducing volatility.
● Administrative Measures: The government uses administrative
measures to control inflation and manage economic cycles, including
restrictions on land disposition and commands to regulate investment.
● Challenges and Deflation: The Chinese government faced challenges in
controlling inflation, and bouts of deflation are possible. Administrative
measures remain crucial in a centrally controlled system.
● Impact on Poverty: Despite economic oscillations, China's
unconventional demand management policies have sustained high
growth, preventing prolonged contractions and facilitating poverty
reduction.

In summary, China's economic success is characterized by high investment

rates, substantial domestic saving, and a mix of monetary, fiscal, and
administrative measures to manage economic cycles.
 10

Implications for Poverty Reduction

The evolving macroeconomic scenario in China has seen a rise in regional

inequality, particularly in urban-rural income disparity, with an increase in

the income ratio of urban residents to rural ones. Despite China's

consistently high economic growth, inequality worsened, hindering poverty

reduction efforts. The focus on coastal development, incentivized by the

government, led to slow development in central and western regions where

much of China's poverty is concentrated. The relationship between poverty

reduction and growth varied over time, being strong initially but weaker in

the late 1990s as growth shifted from agriculture to coastal cities.

Two distinct periods saw significant rural poverty reduction: the first five

years of reform (1979-1984) and the middle three years of the 1990s.

Reforms in agriculture and the implementation of the Poverty Reduction

Plan contributed to these reductions. However, the pace of poverty reduction

slowed, attributed to deteriorating growth quality and increased inequality.

Urban poverty rose due to market-oriented reforms restructuring state-owned

enterprises, causing unemployment.

 11
Financial constraints at the local government level limited poverty reduction

programs, impacting both rural and urban areas. Unemployment became a

significant economic challenge despite high growth rates.

A comprehensive survey by the Chinese Academy of Social Sciences in

2002 revealed a decline in income inequality between 1995 and 2002,

attributed to rural-urban migration and policy changes. However, the

rural-urban income gap widened. The study suggests that poverty reduction

in China is more closely tied to declines in inequality than to GDP growth

alone, emphasizing the importance of policies aimed at reducing inequality

for sustained poverty reduction.

CONCLUSION
The article discusses the macroeconomic experiences of China and India
over the past two decades and draws implications from the evidence
presented. It concludes by emphasizing the role of the Chinese revolution in
ensuring egalitarianism and state control, allowing global economic
integration under different premises than in India. The text highlights how
China's controlled opening-up, infrastructure development, and gradual trade
liberalization contributed to export-oriented employment generation and
economic growth.
 12
However, it acknowledges that the transition to a market-driven system in
China led to increasing inequality, which was later partially mitigated by
state measures.

The overarching conclusion is that a pro-poor macroeconomic framework

should incorporate state policies and regulation, as demonstrated by China,
challenging the either-or dichotomies often posed in macroeconomic
discussions. The paper argues that country-specific policy choices, drawing
from global macroeconomic experiences, are essential for achieving
sustained investment, growth, and positive outcomes in employment and
poverty reduction.