Topics: Macroeconomics, Inflation, Monetary policy Pages: 7 (1972 words) Published: June 29, 2014
The article discusses China's growth in these recent years. It forecasts that China's growth is not sustainable; thus growth rate will cease next year because the country is operating at full potential, facing the risk of overcapacity. In addition, China now has to face the severest national debt in its history, which puts its economy in extremely vulnerable state. The author also argues that China should stop relying on strong fiscal policy, but to initiate an economic reform if it wants to keep its dazzling growth record. Let us analyze whether China's situation is as problematic as the author perceives. Economic growth indicates an increase in national output as well as national income. There are two types of economic growth, long-run and short-run. In the short term, economic growth is influenced by aggregate demand (AD). If there is spare capacity in the economy, an increase in any components of AD - includes consumption (C), investment (I), government expenditure (G) and net export (X-M) - will give rise to a higher level of real GDP. Long-run growth, on the other hand, depends on the economy's aggregate supply, which is also known as productive capacity. The article predicts China's growth is a short-run growth because the main drive for it is the pro-active expansionary fiscal policy that China has been adopted since 2008, the year of global financial crisis. Two main tools that the Chinese government put in place to combat this great recession are a stimulus package and comprehensive tax reform. As mentioned above, government expenditure is a component of AD, so when the government expenditure changes, AD changes and thus real GDP changes subsequently. This induces a change in consumption expenditure, which bring in the process of government expenditure multiplier. In the case of China, the stimulus package includes 4 trillion yuan to spend on boosting China's domestic demand1. AD changes from AD0 to AD1 (Figure 1), causes real GDP to rise from Y0 to Y1. This increase in government expenditure initially increases the income of rural citizens, since low-income housing projects will get 400 billion yuan, and 370 billion yuan will be used to improve rural people's well-being. Better-off rural citizens now have higher purchasing power, thus would be able and willing to purchase more, which boosts consumption expenditures. With rising revenue, China’s businesses in all parts of the nation boom and expand their payroll. A second round of increased consumption expenditure increases income further. AD1 rises to AD2, and Y1 increases to Y2. As such, the expansionary fiscal policy is effective in driving up economic growth as they gear the economy on track of recovery for its target of eight percent during global financial crisis up to date2. Price level LRAS0 LRAS1
Real GDP Figure 1
Another tool that was used to boost China's AD is tax reform. Chinese government cut the value-added tax (VAT) by excluding investment from the tax base, starting from January 2009. The measure aims at reducing business tax burden and increasing investment. No VAT means higher profit margin for foreign investors as the cost of production is reduced significantly. China becomes more attractive to foreign direct investment (FDI). Meanwhile, the government increases tax rebates for some export goods. For example, on November 11, 2008, the government increases tax rebates for textile, clothing, toys, and other goods. The rebate rates for textile and clothing increases from 14% to 15% on February 1, 2009, and to 16% on April 1, 20093. Since investment and net export is another component of AD, an...
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