China and Global Macroeconomic Interdependence

• Author: Rod Tyers
• Published date: 01 November 2016
• Date: 01 November 2016
• DOI: http://doi.org/10.1111/twec.12435

China and Global Macroeconomic

Interdependence

Rod Tyers

1,2

1

Business School, University of Western Australia, Perth, WA, Australia and

2

Research School of

Economics, Australian National University, Acton, ACT, Australia

1. INTRODUCTION

CENTRAL to understanding the behaviour of the global economy is the interaction

between the macroeconomic policy regimes of the major economic regions, the United

States, the Western Europe and Japan, recently joined by China. These regions are all ‘large’

in that the policies of each affect the others as a group as well as the world’s many smaller

economies. Their behaviour is therefore highly interactive and strategic. The rise of China

and other Asian, heretofore developing, economies since the 1980s has not only underwritte n

global economic performance, but high East Asian saving rates have contributed to what

became known as the Asian ‘savings glut’ (See Bernanke (2005), Chinn and Ito (2007), Choi

et al. (2008), Ito (2009) and Tyers (2015b). Global real interest rates peaked in the mid-1980s

and have fallen since, in part because of this relative increase in global savings supply,

although more recently because of unconventional monetary policy (UMP), principally in the

United States and Japan (He and McCauley, 2013; Arora et al., 2015).

This pattern of interaction with Asia began to change, first with the slowdown in Japan in

the 1990s but more recently with the poor performance of the other large regions. It has

become clear that the export-led growth model is unsustainable for China, for three main rea-

sons. First, its light manufacturing exports now loom large in global trade and there is insuffi-

cient market growth for their expansion to continue. Second, a demographic contraction is

imminent that will eventually reduce the availability of surplus agricultural workers, raising

labour costs and slowing productivity growth. And third, reforms that will help continue Chi-

na’s high growth rate must now venture into the heavy manufacturing and services sectors,

which are oligopolistic, and therefore not the vanguard of future growth (Aghion et al., 2013),

and which have, in any case, not been export oriented. A ‘turn inward’ is required that is

therefore politically difficult. For these reasons, slower growth is likely, not only in China but

also in those Asian economies that depend on its market for manufacturing components.

1

Moreover, Asia’s contribution to global saving will also decline as reforms ensure that Chi-

nese households are offered the choice to consume from more of their corporate income and

as populations age, particularly in China and Japan.

2

Funding for the research described in this paper is from Australian Research Council Discovery Grant

No. DP0557885. Useful discussions on the topic with Dong He, Bert Hoffman, Song Ligang, Paul Luk,

Dai Mi, Peter Robertson, Wenlang Zhang and Peter Warr are acknowledged, along with comments

received at seminars at the China Center for Economic Research, Peking University, the Hong Kong

Institute of Monetary Research and the Australian National University. Thanks for assistance with data

gathering for this research are due to Ying Zhang Tsun Se Cheong and Kazuki Tomioka.

1

For details on the extent of production fragmentation and networking in Asia, see Athukorala (2011).

2

For a comprehensive analysis of Asian household saving, see Horioka and Terada-Hagiwara (2012),

and for discussion of China’s high corporate saving, see Kuijs (2006) and Tyers (2014).

©2016 John Wiley & Sons Ltd

1674

The World Economy (2016)

doi: 10.1111/twec.12435

The World Economy

This change presents both opportunities and dangers in the advanced economies. On

the one hand, rising Chinese consumption could be one of the Keynesian stimuli required

to raise demand and reduce unemployment queues in the advanced economies. On the

other, it will place upward pressure on global interest rates. Private portfolios that have

tended to hoard money during deflationary times will eventually rebalance and cent ral

banks will need to soak up liquidity, including by shedding the non-traditional assets

acquired via UMP. This will raise interest rates in both long and short maturity bond mar-

kets. Because the long instruments are extensively traded internationally and held by Asian

savers whose excess demand for them will decline, the rise in financing costs could be

very sharp.

This comes at a time when a recovery in the US economy has led to the declared abandon-

ment of US UMP and when an expected (and actual) appreciation of the US$ raises invest-

ment demand there. Meanwhile, Japan and Europe are maintaining, and Europe will bolster,

the global liquidity flood (Schweinberger, 2013). Low interest rates in Europe and Japan,

combined with the US appreciation, would suggest still lower rates in the United States, mili-

tating against a US tightening. In this context, it is possible that the change in China’s growth

regime, which is unleashing its consumption, could yield the offsetting financial tightening

force required. Clearly, these many shocks point in different directions, clouding vision of the

eventual trends in economic performance and financial behaviour.

To explore the interaction of shocks emerging in the major economic regions, a parsimo-

nious global macroeconomic model is introduced that incorporates bilateral linkages across

six regions via both trade and financial flows. It includes a number of innovative elements.

First, although it is deterministic, by allowing for asset differentiation, it incorporates optimis-

ing financial portfolio management in each region that serves to direct saving from each into

investments across all regions. Second, the degree of asset differentiation is quantified to

reflect financial integration that differs by region. Third, long maturity assets are focal and

UMP places direct demands on the global markets for these assets that are endogenous to

chosen targets. This tends to enhance the spillover effects of monetary policy (Chen et al.,

2014), which proves important because China’s growth surge was deflationary abroad, neces-

sitating monetary expansion despite slow growth, while its transition shock is, by contrast,

inflationary abroad.

Simulation results are found to be sensitive to the contributions of productivity and capi-

tal accumulation to China’s growth in ways that end up consistent with old assertions about

the sources of Chinese growth (Krugman, 1994) and about the effects of it on US employ-

ment (Krugman, 2010; Rodrik, 2010). When productivity and capital growth are offered in

realistic combination, the collective shocks are deflationary in the United States and China,

implying that contractionary US monetary policy is not imminent. Monetary responses in

the United States and China then combine with price targeting regimes in the EU and Japan

to expand liquidity globally, amplifying impacts on financial markets and the global distri-

bution of real investment. In the end, however, current year real effects of the change to

China’s growth regime prove to be modest. In the section to follow, a review is offered of

changes in China’s relative size and the associated domestic transitions that presage its

reduced excess saving. Section 3 then briefly discusses recent macroeconomic developments

in the advanced economies. The model used for quantitative analysis is then presented in

Section 4, and simulation results are described in Section 5. Conclusions are offered in Sec-

tion 6.

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