China, whose economy heavily relies on exports, has been experiencing a decline in exports for six months now as of April. The value of China’s exports in April fell 22.6% in comparison to last year, a faster decline than in March’s exports (also in comparison to March of last year) during which China experienced a 17.1% drop.
Exports and imports are a factor of aggregate demand, and in our current situation of an economic crisis, people’s confidences along with many other factors contribute to an overall decrease in aggregate demand. However a senior retired government official points out that unlike the economic crisis in the 1930s, “the global economy is going to rebound quickly, at which point China will take a greater role in the world.” They rely heavily on government spending (another determinant of aggregate demand) on exporting industries in the form of favorable policies and tax rebates (which decrease the firm’s costs).
On the other hand, fixed asset investment (a long term asset that is not expected to be converted easily into cash) is doing comparably well as urban property prices begin to rise 0.4% in April compared to 0.2% in March. Fixed asset investment is another contributor to China’s growing economy because it is used to house the multitudes of Chinese civilians, as well as to provide factories for the production of cheap goods to be exported.
However a fall on both these major contributors of the Chinese economy lead to a decrease in the nation’s GDP growth from 13% in 2007 to 6.1% during this year, a clear characteristic of a recession. The decrease of net exports leads to a leftward shift of the aggregate demand curve below. This leads to not only a decrease in GDP, but also a decrease in price level, which in the long run may possibly lead to deflation.
Deflation for any economy is bad news as it can further lead to unemployment which in the graph above is characterized by the difference between full employment (Yfe) and the current point of output (Ye1). That is why the Chinese government steps in to attempt and make up for the lack of economic activity through spending, which brings me to the multiplier effect.
The spending multiplier is any increase in spending in the economy which gets increased by a multiple through further rounds of new spending, resulting in a higher GDP than the initial government spending. However this depends on the people’s tendency to consume with any change in income, also known as the marginal propensity to consume (calculated by: change in consumption/change in income). If the Chinese have considerable confidence in the economy and a high marginal propensity, then the multiplier effect will be all the more effective. On the graph below, the multiplier effect is more than double the initial government spending (GS), so final aggregate demand (AD1) is successfully increased.
As we are dealing with exports, the government cannot directly control other country’s consumption of Chinese products, what they can do is increase investment to stimulate firm activity by decreasing business taxes, so that the firm’s expected return on capital is greater. And finally, by passing monetary policies the Chinese government can decrease interest rates, and the expected rate of return will increase and encourage investment.
February 8th, 2010 at 2:14 pm
im sorry but where is the article for this commentary?
thank u!
March 16th, 2010 at 3:57 pm
I think that the lower prices being changed by decreased demand will eventually attract importers back to buying from China and eventually reverse these effects as the world comes out of its current recession. Also, as China becomes more weatlthy from these past and future exports, their exchange rate will rise, allowing the Chinese to import more. This will eventually lead to a trade deficit for China and an overall higher GDP. I think we are going to see China grow into a major economic player in the world, with its possible new higher GDP and importing power.