IB Economic IA

Economic – Commentary 2
Section of syllabus: Macroeconomic

Title of the article: China’s economy is struggling but fears of sustained deflation are
premature
Link to the Article: https://www.theguardian.com/world/2023/aug/09/china-
economy-is-struggling-but-fears-of-sustained-deflation-are-premature
Source of the article: The Guardian
Economic key-concept: government intervention
Date of commentary: 27 June 2024

Date of publishing article: 9 Aug 2023
China’s economy is struggling
but fears of sustained deflation
are premature
Trade with rest of world is shrinking and youth unemployment is at 20%
but state interventions are expected
ountry Garden, one of China’s leading private sector developers, missed

two bond payments earlier this week. Photograph: Aly Song/Reuters
China’s economy is struggling. The recovery after the lifting of Covid-19

restrictions is faltering. Its trade with the rest of the world is shrinking. A
decade-long boom in house prices has come to an end.
The most obvious manifestation of the troubles besetting the world’s
second biggest economy is that China is now officially in deflation. In
the US, the UK and the eurozone, prices are rising – albeit not quite as
fast as they were a few months ago – but in China they are actually
falling.
News of the 0.3% year-on-year fall in prices inevitably prompted
speculation that China was about to be permanently gripped by deflation,
as was the case for neighbouring Japan after its asset-price bubble burst
at the end of the 1980s.
Such fears are premature, at least for now. There were one-off factors
involving the price of food that explained last month’s fall. Core inflation
– which excludes volatile items such as energy and food – not only
remained positive, but actually rose from 0.4% to 0.8%.
That said, China’s communist leaders are clearly worried about the state
of the economy, and they are right to be concerned. Attempts to
rebalance the economy away from investment and exports towards
consumer spending are still in their early stages. Factories are seeing
demand fall because of the slowdown in global demand.
It is not just consumer prices that are falling. The prices of goods leaving
China’s factories have fallen by more than 4% over the past year, which
will eventually feed through into cheaper imports for the rest of the
world. Any downward pressure on inflation will be welcomed by
developed country central banks.
There’s more bad news. In an echo of the events that prompted the global
financial crisis of 2008, house prices are falling and property prices are
feeling the pinch. Country Garden, one of China’s leading private sector
developers, missed two bond payments earlier this week.
Perhaps most worryingly for the authorities in Beijing, youth

unemployment is already running at 20% and could rise further as newly
qualified graduates look for work in an economy where growth is slowing.
Ever since the Tiananmen Square massacre of 1989, the Communist
party has been anxious to avoid having large numbers of angry,
unemployed young people protesting on the streets.
In the longer term, the president, Xi Jinping, has no real alternative but to
stick to his rebalancing strategy. The reason the economy grew strongly
in the years leading up to the pandemic was that Beijing kept the money
taps full on. The state invested heavily in new manufacturing capacity,
and property companies expanded on the back of plentiful supplies of
cheap finance. As a result, China now has a vast amount of underutilised
factories and homes that nobody wants to buy.
Does this mean Beijing will adopt a hands-off approach to the economy?
Almost certainly not. Deflation – even if temporary – will prompt the
authorities to stimulate demand through lower interest rates and higher
government spending.
In all likelihood, though, the interventions will be smaller and more

targeted than in the past. The China expert George Magnus says China’s
long-term sustainable growth rate is now 2%-3%, a far cry from the 10%
seen in the immediate aftermath of the global financial crisis. The road to
that lower, better-balanced growth is bumpy and strewn with obstacles.
Commentary
Consequently, China is struggling from recovery after Covid-19 which is experiencing
deflation in a rate of falling 0.3% year-on-year. The article examines the intervention
of China government by using expansionary fiscal policy would theoretically
stimulate aggregate demand to address the issue of deflation. The key concept of
government intervention signifies the involvement of the government in the market
to influence demand and supply.
Figure 1: China’s economy

In China, during the pandemic “government invested heavily in new manufacturing
capacity”. As a result, it has caused a vast number of underutilized factories meaning
the economy is below the full employment level of output which some labor, capital,
or other resources are unemployed, the short-run aggregate supply curve shift
inwards from SRAS to SRAS1. Simultaneously, the demand of factories falls because of
the slowdown in global demand which the number of employees is likely to reduce,
causing the unemployment rate of China rise. This lower consumer and firms’
confidence causing a reduce in the consumption and investment. Since both of them
are the component of aggregate demand AD, AD curve would also shift inward from
AD to AD1.
Furthermore, this rises a downward pressure on the average price level from P1 to P2 by 0.3%
every year and have reduced to GDP from the full employment level of output YFELO to Y1,
hence creating a deflationary gap.
To address the negative effect of deflation, which “prompt the authorities to stimulate
demand through higher government spending.” The China government proposed the
method of government intervention by imposing an expansionary fiscal policy. The impact
of proposing expansionary fiscal policy is illustrated in figure 2.
Figure 2: impact of expansionary fiscal policy to China’s economy

The implementation of government intervention should bring the economy into a
recovery stage, which theoretically would stimulate economic activity and increase
aggregate demand as AD = C+I+G+(X-M), increase in government spending would
cause the AD curve to shift outward from AD1 to AD2. Simultaneously, the multiplier
effect (an initial increase in spending, cycles repeatedly through the economy and
has a larger impact than the initial dollar amount spent) also creates an extensive
effect to aggregate demand. Consumers and firms receiving higher disposable
income, this causes increase their purchasing power and contribute to a higher
consumption and investment. Since consumption and investment are two main
components of aggregate demand, as a result the aggregate demand curve shifts
further outward to AD. Additionally, the government intervention could focus on
addressing the long-term structural issues in China’s economy after pandemic such as
overcapacity in manufacturing and the cooling property market. As a result,
investments in restructuring these sectors could enhance productivity causing a shift
outward of the SRAS curve (SRAS1 to SRAS).
Consequently, a new equilibrium point is formed at E1 which reached the full
employment level of output. The use of government intervention likely to close the
deflationary gap and place upward pressure on the average price level from P1 to P2.
The increase in economic growth would help to reduce unemployment as businesses
need to ramp up production to meet the demand. Therefore, firms are hiring more
workers to produce more output.
However, this government intervention may not be effective as predicted as
consumers may choose to primarily save rather than spend their increased income.
During China’s economy recessions after pandemic, it may reduce consumer
confidence and consumers may fear of another downturn. As a result, consumers
may remain cautious which they tend to save more and consume less. This means
that the initial outward shift in AD is reduced due to lower additional spending and
the subsequent multiplier effect.
Furthermore, the intervention of China government in underutilized factories may
not be able to resolve all the bottlenecks that are occurring. The overcapacity
problem resulted from previous state-led investments that were not aligned with
actual market demand. Further government spending could risk repeating these
mistakes if the funds are not carefully targeted. Additionally, inefficient allocation of
resources can lead to "white elephant" projects (an investment or project that has
required a high expenditure but fails to deliver returns or serves no useful purpose)
that do not contribute meaningfully to economic productivity. These projects tend to
reduce both the short-term and long-term productive capacity of the economy, as a
result the overall supply side impact should be reduced.
Despite this, in the long term, when China’s economy reached the full capacity, the
continuously government intervention without corresponding increases in
productive capacity may cause inflationary pressure but little or no increase in real
GDP. The initial stimulus benefits are eroded as inflation expectations become
entrenched, wages and prices continually rise, and the economy faces the risk of
overheating.
In conclusion, the Chinese government's intervention may not be as successful in
the short term as anticipated owing to the previously mentioned issue, even though
it is necessary required given the country's slowing economic growth. Additionally,
Long-term effects could also include unexpected outcomes like inflation.

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Economic – Commentary 2

Section of syllabus: Macroeconomic

Date of commentary: 27 June 2024

ountry Garden, one of China’s leading private sector developers, missed

China’s economy is struggling. The recovery after the lifting of Covid-19

Perhaps most worryingly for the authorities in Beijing, youth

In all likelihood, though, the interventions will be smaller and more

Figure 1: China’s economy

Figure 2: impact of expansionary fiscal policy to China’s economy

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