JC Economics Essay Series #96 – China’s Decoupling & Macro Policies

JC Economics Essay China’s Decoupling & Macro Policies Model Answers 

Over 2-3 decades, China’s role in global trade has increased significantly. With several economic reforms starting in the early 80s, trade relationships between the euro area and China have grown rapidly. When China joins World Trade Organisation (WTO) in 2001, huge trade and investment links take place with the Chinese economy., and many other economies, including the Euro Zone.

China accounts for a relatively limited share of euro area exports, although this share has risen over time. Exports to China have rapidly increased across all euro area economies over the past 15 years, specifically, Germany, France and Finland who account for the largest shares of exports to China. Similarly, China’s share of extra-euro area exports expands at the same time, forging a healthy trade relationship.

At time of writing, China has begun to decouple form USA, and aims to rely more domestic market to drive economic growth.
(Note: Decoupling from USA mean a smaller U.S. share in China’s growing market, perhaps due to diversification by China, or attempt to rely less on exports , and more on domestic sector, for economic growth.)


The Euro zone is a key market for Chinese exports and the economies wes on the fore and has resulted in the slowing of Chinese exports to the region. This has led to conces nout f slowing down in China’s economic growth.

Assess the range of policies that might be appropriate for China to focus more on domestic sources to drive its growth. [25]


JC Economics Essay – Free Trade Agreements of Singapore

Part (a)
Explain that for China to “focus more on domestic sources” to drive economic growth means. a shift away from an over-reliance on external sources of growth (I.e X, inward FDI). Clarify the meaning of “domestic sources” of growth: Economic growth that results from a rise in Internal demand: Increase in C, domestic I and G.

State that China can consider the following range of economic policies: Demand-Mgmt Policies: MP, FP, Exchange Rate Policy, Supply Side Policy, Trade Policies

Explain how domestic sources allow China to achieve sustained economic growth: Increase AD via Increase in C, domestic I and G to achieve actual growth. Briefly explain the k effect and Illustrate with AD-AS diagram

Increase SRAS to achieve actual growth, increase LRAS (via domestic I, G) to achieve potential growth. Explain how the range of policies would allow China to influence the domestic sources of growth to achieve sustained economic growth.


1) Demand Management Policies
Expansionary MP: reduce r, increase Money Supply

China’s Central Bank can attempt to reduce interest rates to stimulate domestic C and investment With a cut in interest rates, this causes a fall in borrowing costs, raising domestic C espacially on big dicket hems for reduces opportunity cost of C). Alternatively, a lower Interest rata also discourages savings, which encourages C. Similarly a cut in interest rates also lowers the borrowing cost for domestic firms in financing investment projects. With a higher expected rate of return from investment, more investment projects become profitable and hence raless the incentive for domestic investment (sketch MEI diagram, not necessary for 9757 syllabus.)


In addition, the Chinese government can also make efforts to ensure better access to such loanable funds for non-state owned enterprises or non-SOEs. ence expansionary MP have the effect of raising AD and achieving actual growth.

Expansionary FP: Increase G, reduce (direct) Taxes: Increase in G can be centered on improving welfare assistance especially for the lower Income group (higher MPC to Induce a larger k effect). Reduction in direct taxes in the form of both personal Income and corporate taxes to stimulate domestic C and I.

With a lowering of personal Y taxes, this increases household’s disposable Income Increase in autonomous C. By Improving efforts to redistribute Income, China can alm to narrow to Income gap and raise the social mobility of the sizable middle-class to effectively raise C. With the increase in G, I, C, expansionary FP have the effect of raising AD and achieving actual growth.


Limitations of demand-management policies:
Ability to stimulate C and I depends on having both favourable consumer and business sentiment. In the situation of poor animal spirits, lower Interest rates/direct taxes will do little in raising C and I due to households being cautious about spending and firms expecting a weak profit outlook tend to withhold spending on Investment projects.

Ricardian equivalence effect of lowering household taxes may actually encourage savings; Opposing Income and substitution effects of tax cuts may discourage work effort; DD-pull Inflation, conflicts with price-stability objective.


2) Exchange Rate Policy
China can allow a further revaluation of the Yuan to reduce excessive export-led growth and give incentive for domestic producers to switch to producing more for more the domestic market. This would in turn raise domestic C and hence raising AD and achieving actual growth. Additionally, with a stronger Yuan, this raises the price of Chinese exports in foreign currency terms, lowers the price of M In domestic currency terms. Assuming MLC is satisfied, this leads to a worsening of BOT, reduction in net X.


Limitations of Exchange Rate Policy:
Marshall-Lerner Condition (MLC) may not be satisfied in the SR due to issue of fulfillment of trade-related contracts etc, so the observed worsening of BOT may not take place Immediately. Further, not all domestic producers may be able to simply and easily switch from producing for the foreign market to cater to the domestic market due to the nature of the goods produced, Any revaluation of the Yuan should be calibrated in a gradual and modest manner so as give sufficient time for domestic producers to make the necessary structural adjustments.


3) Supply-Side Policy
China can pursue a mix of both market-oriented and interventionist supply side policies, in terms of market-oriented policies, this can be in the form of deregulation and privatisation of previously government-owned industries. By doing so, firms within such Industries when subjected to market forces have the Incentive to raise their cost-efficiencies and compete better against their foreign counterparts. (With lowering of COP, raise SRAS to achieve actual growth).

Overtime, If successful, they will be able to build up sufficient capabilities to gain market share and undertake higher levels of private sector investment (contributing to actual and potential growth via accumulation of capital goods through greater domestic I). In terms of Interventionist policies, subsidies and tax breaks or concessions can be given to aid private domestic firms to lower their cost of production and/or raise their profit potential. This also. encourages higher levels of private sector investment (contributing to actual and potential growth)


Limitations of Supply-Side Policy
Not all Industries can be deregulated or privatised due to strategic reasons. Vested-interest by certain power Interest groups may lobby against the break-up of SOES, thus hindering the deregulation/privatization process.

Some firms may lack sufficient Internal economies of scale or access to sufficient financial resources to compete against the stronger foreign competitors Being-profit driven, firms may have incentive to monopolise market and raise prices reduce consumer surplus and welfare; Subsidies, tax concessions once given may be subjected to lobbying in the future and difficult to withdraw.

4) Trade Policies
This can take the form of protectionist measures to shelter domestic Industries from foreign competition and act as a form of expenditure-switching policy.


Limitations of Trade Policies:
Such expenditure switching policies assume that domestically produced goods are goods substitutes for foreign imported goods which may not be the case due to difforchgo fres product quality and variety. M tariffs protects cost-inefficient domestic producers, It goes against the Principle of Comparative Advantage, allocatively inefficient as resources are not directed to where they are most highly valued, likely to invite retaliation.

(Note: it is too early to say if China has decoupled from USA. In fact, China may be decoupling from the rest of the world.)

China may require a policy mix in order for her to successfully to switch from a growth that is more externally-driven to one that relies more on domestic sources. Highlight possible short term measures as opposed to long term measures in order to rebalance her economy.