An Smu Economics Intelligence Club Production
An Smu Economics Intelligence Club Production
AN
SMU
ECONOMICS
INTELLIGENCE
CLUB
PRODUCTION
-
An
Evaluation
of
the
Chinese
Economy
-
Hong
Kongs
Poverty
Line
What
does
it
entail?
-
The
Economics
of
Crime:
Gangs
in
El
Salvador
The
Fortnight
In
Brief
(30th
September
to
13th
October)
US:
The
inexorable
march
to
default?
As
the
US
government
shutdown
looks
to
enter
its
third
week,
negotiations
to
reopen
government
have
been
m erged
with
plans
to
raise
the
debt
ceiling
which
is
expected
to
be
reached
on
Oct
17.
While
the
House
has
passed
numerous
spending
bills
to
restore
financing
for
specific
portions
of
the
federal
government,
President
Obama
and
the
Senate
has
stood
firm,
rejecting
all
piecemeal
bills
that
do
not
fully
restore
funding
with
a
clean
continuing
resolution.
Support
has
been
coalescing
behind
a
previously
rejected
bipartisan
plan,
led
by
Sen.
Collins,
that
would
fund
the
government
for
6
months
and
raise
the
debt
limit
through
Jan
31.
A
NBC/WSJ
poll
shows
Republican
approval
ratings
down
to
24%,
with
53%
placing
the
blame
squarely
on
Republicans,
and
31%
on
the
president.
Asia:
China
experiences
import
surge
and
export
wane
China
imported
25.68m
tonnes
of
crude
oil,
equivalent
to
6.47m
b arrels
a
day
in
September.
setting
a
record
and
overtaking
the
US
to
become
the
top
oil
importer.
China's
total
imports
increased
by
a
stronger
than
expected
7.4%
in
September,
while
exports
dipped
0.3%
compared
with
September
last
year.
The
increase
in
imports
underscores
China's
economic
growth
has
firmed
following
fears
of
a
hard
landing.
At
the
same
time,
analysts
worry
that
the
decrease
in
exports
is
a
sign
of
a
global
recovery
slowing.
EU:
Upbeat
data
reinforce
positive
sentiment
Eurozone
industrial
production
was
revised
to
a
1.0%
increase
in
the
month
of
August,
up
2.0%
from
July.
This
compares
favourably
with
a
2.1%
fall
in
the
same
month
last
year,
indicating
that
the
17
country
currency
bloc
is
reversing
its
18
month
long
economic
downturn.
Germany,
France
and
Italy
contribute
to
approximately
two
thirds
of
Eurozone
industrial
product.
Capital
goods
production
also
benefited
from
rising
consumer
sentiment,
rising
2.4%
in
August
after
a
1.8%
the
prior
m onth.
Despite
upbeat
economic
indicators
and
sentiment,
the
recovery
is
still
widely
considered
to
be
in
its
nascent
stages
as
countries
suffer
from
austerity
and
record
unemployment
rates.
IN COLLABORATION WITH
PROUDLY
SUPPORTED
BY
MSCI
AC
Asia
Ex.
Japan
S&P 500
560 550
540
530
From Figure 1, we can see M2 balance rapidly increased in 2008 while the GDP growth rate dropped around 7 percent per year. There are two key factors that fueled the divergence between M2 growth rate and GDP growth rate the stability of the real economic situation and maintenance of liquidity in financial markets. 2 Copyright 2013 SMU Economics Intelligence Club
The
Chinese
government
wants
the
GDP
growth
rate
to
be
slowed
down
in
long-run.
However,
the
rapid
slowdown
will
have
negative
impacts
on
the
economy.
Especially
after
financial
crisis,
a
slowdown
the
will
further
damage
local
demand.
Local
financial
markets
serve
as
a
liquidity
platform
for
the
corporate
system,
if
corporations
encounter
liquidity
problems,
the
financial
market
will
suffer
losses
due
to
credit
risk.
Increasing
M2
supply
can
mitigate
this
situation
in
short
run
and
allow
the
domestic
economy
to
avoid
a
hard
landing.
Since
2010,
the
gap
between
M2
growth
and
GDP
growth
has
started
to
decrease.
Why
M2?
M2
equals
to
M1
plus
saving
accounts
and
money
market
accounts.
90%
of
Chinas
M2
come
from
banks
saving
account.
The
money
in
the
saving
accounts
can
be
transformed
into
liquid
money,
which
is
lent
to
non-financial
institutions,
governments
and
individuals.
Hence,
the
M2
balance
can
be
used
to
indirectly
measure
the
extent
of
leverage
in
an
economy.
Developed
countries
are
able
to
pay
debts
relatively
better
than
developing
countries
as
they
have
a
mature
financial
system
with
enough
capital
stock.
Developed
countries
which
have
a
high
M2/GDP
ratio
can
still
handle
their
financial
situations
better
compared
to
an
emerging
country
having
the
same
level
of
M2/GDP
ratio.
Total
Social
Financing
Another
measurement
for
total
credit
size
is
called
total
social
financing.
Total
social
financing
consists
of
foreign
investment,
trade
account,
corporate
bonds,
structured
products
and
trust
financing
etc.
The
credit
products
it
includes
are
more
than
that
of
M2.
In
addition,
statistics
show
that
the
growth
of
TSF
(around
30%)
is
much
faster
than
printing
speed
(around
5%).
However,
M2
is
measured
as
a
stock
value,
but
TSF
is
measured
as
a
flow
value.
The
total
amount
of
TSF
has
been
increasing
continuously
from
2002,
but
appears
to
be
slowing
down
in
2013.
See
Figure
2.
Figure
2:
Total
Social
Financing
30000
25000
20000
15000
10000
5000
1/1/2002
8/1/2002
3/1/2003
5/1/2004
7/1/2005
4/1/2007
1/1/2009
8/1/2009
3/1/2010
5/1/2011
7/1/2012
10/1/2003
12/1/2004
11/1/2007
10/1/2010
-5000
12/1/2011
2/1/2006
9/1/2006
6/1/2008
2/1/2013
0
Shadow Banking Starting to Shrink? According to S&P, shadow banking accounts for RMB22.9 trillion of credit in China. It represents 44% of Chinas GDP in 2012. Shadow banking has grown at a compounded annual 3 Copyright 2012 SMU Economics Intelligence Club
growth
rate
of
34%
since
the
end
of
2010.
The
reason
for
Chinese
banks
participating
in
shadow
banking
activities
is
regulatory
arbitrage,
which
indicates
that
market
competition
has
encouraged
banks
to
seek
loopholes
in
regulations
by
making
loans
and
attracting
deposits
via
wealth
management
products
and
other
unconventional
channels.
However,
from
2013,
the
shadow
banking
system
started
to
shrink.
See
Figure
3.
The
main
reason
for
the
decrease
is
because
of
a
decrease
in
both
traditional
bank
loans
and
nontraditional
lending
as
regulators
tightened
lending
rules
and
clamped
down
on
wealth- management
products
that
channel
funds
to
trusts.
Figure
3:
Total
Social
Financing
(in
2013)
30000
25000
20000
15000
10000
5000
0
Admittedly, the shadow banking problem cannot be solved unless Chinese government can develop a healthy way to increase domestic demand. But it is safe to say that the shadow banking system has not destabilized Chinas financial system. There are three factors that fuel the expansion: (1) The size of shadow banking is still modest relative to the regular banking system; (2) There are many risk characteristics of various shadow banking products; (3) The structure of loss for banks position. In general, the major Chinese banks capitalization, earning, and liquidity profiles provide a comfortable buffer to absorb any possible hit from shadow banking and credit risk to the wider Chinese economy. Implication on Real Estate Market and Fixed asset investments The increase of STF has pushed up the fixed asset investments. Most funds are in short term but they invested in long-term assets such as real estate. This duration mismatching has caused a short-term liquidity problem. As in the past, problems in the real estate market has always impacted the real economy. The surge in demand drove housing prices in 70 major cities up in the first half of the year. Limiting purchase orders did not have that much of an effect. More importantly, personal debt financing increased about 20% compared to last year. The increase of STF pushes up house price and also increased the investment in infrastructure. Land prices have surged due to the real estate bubble. Governments also use their land as collateral via shadow banking to do the off-balance sheet financing. The high lands price incentivize infrastructure investing. 4 Copyright 2013 SMU Economics Intelligence Club
Exchange
Rate
Risks
Exchange
Rate
Appreciation
The
short-term
capital
inflow
has
increased
the
exchange
rate
(see
Figure
4)
of
Chinese
Yuan
relative
to
US
dollar.
Worth
of
notice
is
that
in
2008,
China
was
forced
to
appreciate
their
currency
to
support
the
world
economy.
This
time
round,
we
should
be
worried
about
the
profit
earned
by
foreign
investments
because
with
the
high
nominal
interest
and
high
foreign
exchange
rate
expectation,
the
purchasing
power
parity
and
interest
rate
parity
no
longer
holds,
creating
an
arbitrage
opportunity.
Figure
4:
Exchange
Rate
(CNY/USD)
7.4
7.2
7
6.8
6.6
6.4
6.2
6
5.8
5.6
Q1 2009
Q2 2009
Q3 2009
Q4 2009
Q1 2010
Q2 2010
Q3 2010
Q4 2010
Q1 2011
Q2 2011
Q3 2011
Q4 2011
Q1 2012
Q2 2012
Q3 2012
Q4 2012
Q1 2013
Q2 2013
Q1 2008
Q2 2008
Q3 2008
Q4 2008
Q3 2013 7/1/2013
Drawback
1:
Local
product
sales
hurt
The
PPI
provides
insight
why
the
CNY
is
appreciating
too
fast
(Figure
5).
The
reason
that
we
use
PPI
to
observe
the
side-effect
of
CNY
appreciation
is
that
appreciation
hurts
the
sale
of
local
product,
resulting
in
negative
impacts
on
the
job
market
and
other
economic
areas.
The
producer
price
index
measures
the
selling
price
received
by
the
local
producer.
The
index
is
constructed
on
a
basket
of
all
tradable
goods.
If
CNY
appreciate
too
much
in
the
short-run,
the
PPI
will
decrease
correspondingly.
Figure
5:
Producer
Price
Index
4.75
4.7
4.65
4.6
4.55
4.5
4.45
4.4
1/1/2009
4/1/2009
7/1/2009
1/1/2010
4/1/2010
7/1/2010
1/1/2011
4/1/2011
7/1/2011
1/1/2012
4/1/2012
7/1/2012
1/1/2013
10/1/2009
10/1/2010
10/1/2011
10/1/2008
10/1/2012
1/1/2008
4/1/2008
7/1/2008
4/1/2013
Drawback
2:
Decreased
Exports
The
appreciation
of
CNY
will
not
only
hurt
the
domestic
economy
in
the
short-run,
but
also
put
stress
on
exports.
The
export
price
index
decreased
when
the
CNY
appreciated.
Figure
6:
Export
Price
Index
4.75
4.7
4.65
4.6
4.55
4.5
4.45
4.4
1/1/2009
7/1/2009
1/1/2010
7/1/2010
1/1/2011
7/1/2011
1/1/2012
7/1/2012
1/1/2013
4/1/2009
4/1/2010
4/1/2011
4/1/2012
10/1/2009
10/1/2010
10/1/2011
10/1/2008
10/1/2012
1/1/2008
4/1/2008
7/1/2008
4/1/2013
7/1/2013
Drawback 3: High Interest Rates Even though the Chinese government can control foreign capital flows, it is only an effective instrument in the short-run. The foreign fund flow will still enter into the country in the long term due to the high domestic interest rates. Hence, in long run, both the banking system and corporate system suffers due to high interest rates. According to the interest rate parity, it is necessary for China to decrease their local interest rate if exchange does not appreciate. The Banking System The high interest rate is likely to become an obstacle for liquidity in banking system. Unlike in the past, the Chinese government wants the interest rate to be determined by the market demand and supply. Admittedly, interest rate liberalization can enhance market efficiency, however, it is hard to say whether medium size banks and financial institutions can handle this market determined rate in the event of a liquidity shortage. History is proof - in mid-June, the liquidity problem of Chinese banking system drove the interbank over-night borrowing rate to 30%, a level unheard of in the past. Such high rates is not something that many medium sized institutions can handle on their own. While interest rate liberalization is needed, perhaps now is not the right time. Conclusion There is no concrete solution for many of these issues. Chinas real estate market has faced big problems, and its potential impact on the real economy makes this a precarious situation. While people may not be worried now, no one really knows where the next crisis lurks. Moreover, with its more opened economy, China is even more vulnerable to external shocks to its economic stability. Thus, we should not assume that all is well and good.
They translates to 19.6% of the population falling beneath the poverty threshold2, indicating the high level of economic inequality and widening income gap within Asias financial hub. With such startling statistics, the Hong Kong government can no longer afford to ignore the plight of its poor, residents of shanty towns obscured by the faade of success portrayed bythe glistening skyscrapers of its financial district. 7 Copyright 2012 SMU Economics Intelligence Club
Government
action
We
have
discussed
amply
about
the
pressing
concern
of
closing
the
income
gap
and
bringing
the
poverty
level
down.
Governments
have
to
ensure
economic
growth
is
inclusive
and
avoids
creating
a
large
disparity
in
standards
of
living.
This
applies
not
just
in
in
Hong
Kong
but
Honduras,
Haiti
or
any
other
country.
Achieving
this,
however,
is
the
primary
bane
of
the
modern-day
capitalist
system.
Economists
and
governments
have
been
racking
their
heads
to
solve
the
problem
and
the
poverty
line
is
an
intelligent
yet
simple
diagnostic.
In
Hong
Kongs
case,
the
government
has
declared,
along
with
the
revealing
of
these
figures,
the
following
action
plans:
Providing
financial
help
via
the
Comprehensive
Social
Security
Assistance
(CSSA),
a
system
of
income
supplements
and
grants
for
the
less
advantaged,
to
help
those
still
in
need.
This
will
lift
294,000
people
(4.4%)
in
111,000
households
out
of
poverty.
Further
policy
intervention
costing
$14.8
billion
(an
average
of
$3,100
per
household)
might
be
used
to
alleviate
poverty
for
the
remaining
1,018,000
people.
Added
focus
on
employment:
providing
work
incentives,
rechanneling
of
resources,
and
educational
support
for
juveniles
in
these
households.
Most
importantly,
recognise
that
the
poverty
line
has
its
limitations
and
devise
sound
policies
to
attain
its
economic
goals.
The
final
point
is
of
considerable
importance.
While
the
poverty
line
may
be
a
concise
measure
of
inequality,
an
over
emphasis
on
it
may
lead
to
policy
hazards
or,
in
some
cases,
sending
the
wrong
political
messages
(which
is
of
course
not
deliberate
but
inherently
committed
by
data).
Figure
2:
Hong
Kong
government
expenditure
and
Inflation
Rate,
2005
to
2012
25 Govt expenditure ($ bn) 20 15 10 5 0 2005 2006 2007 2008 2009 2010 2011 2012 6% 5% 4% 3% 2% 1% 0% Inflation rate (%)
Government expenditure
Inflation rate
Ideally, we want to move away from these expensive mitigation methods to developing sustainable solutions to the problem in the long run. The fiscal approach easy, concise, and immediate will allow poverty to be eradicated in a rather hassle free manner (at least for the current year). However, spending some $15 billion per year would mean eroding about 2% of Hong Kongs current reserves, and should not be used as a long term policy to address the 8 Copyright 2013 SMU Economics Intelligence Club
issue.
From
a
Keynesian
viewpoint,
supply
side
policy
(productivity
and
capacity
improvement
teaching
a
man
how
to
fish)
must
not
be
ignored,
it
should
be
pursued
alongside
the
governments
fiscal
redistributive
mechanism.
It
is
hence
comforting
to
read
that
the
government
has
placed
an
emphasis
on
the
employability
of
the
working
poor.
While
we
cannot
expect
Nordic
style
income
equality
(average
Gini
index
of
0.254),
Hong
Kongs
Asian
neighbours
can
provide
useful
case-studies.
Learning
from
the
successes
and
policy
missteps
in
its
peers
such
as
Singapore
and
China
(provincial
level)
is
pivotal
to
ensuring
Hong
Kongs
effort
at
equality
goes
well.
The
antidote
for
the
Hong
Kong
Government
may
be
found
in
promoting
economic
knowledge
and
looking
at
the
policies
of
other
economies,
and
eventually
combining
them
in
a
manner
applicable
to
the
local
context.
For
instance
the
Hukou
system
on
the
mainland
provides
a
solution
for
distribution,
though
it
may
be
a
tad
too
regimental
for
Hong
Kong.
While
Singapore
academic
Lim
Chong
Yah
prescribes
a
wage
shock3
policy
his
country,
Hong
Kong
may
be
able
to
practice
discriminatory
price
shocks
in
response
to
its
high
costs
of
living
(especially
home
loans)
such
as
distributing
food
coupons
as
with
the
American
system.
1
Gini
coefficient
An index commonly used to depict quantitatively the distribution of income in an economy. It is mathematically derived by the Lorenz curve (developed by Max Lorenz in 1905), and obtaining a value of 0 we have perfect income distribution (all people have the same amount of wealth); while a value of 1 implies that all the money is held by just one individual. While common in usage, there are intrinsic limitations to using it, both qualitatively and mathematically. 2 Poverty threshold A certain income level determined by the government, and citizens, falling below which, are considered statutorily to be in poverty. It may be defined as per-person or per- household. Just like the Gini coefficient, there are inherent limitations to this analysis tool as well. 3 Wage shock An uncommon policy used to enhance income equality in modern day capitalistic economic systems. This generally involves imposing a minimum wage, freezing the pay at the top percentiles (usually by setting a cap or proportional deduction), or a mixture of both. A highly left-wing policy, it is seldom used, largely for political reasons. Sources: 1. World Bank Database online. Retrieved October 10, 2013. URL: http://data.worldbank.org 2. Yun, M., September 28, 2013. Hong Kongs First Poverty Line Puts One-Fifth of People in Need (Bloomberg News online). Retrieved October 9, 2013. Source URL: http://www.bloomberg.com/news/2013-09-28/hong-kong-s-first-poverty-line-puts-one- fifth-of-people-in-need.html
3. News.gov.hk, September 28, 2013. Poverty line set for HK (Hong Kong government website) Retrieved October 9, 2013. Source URL: http://www.news.gov.hk/en/categories/health/html/2013/09/20130927_191059.shtml 4. To be eligible for the CSSA, residents must pass financial tests set by the Social Welfare Department. Payments are categorised into Standard, Supplements and Grants. Further information: http://www.swd.gov.hk/en/index/site_pubsvc/page_socsecu/sub_comprehens/ 5. Hong Kongs reserves stand at $722 billion as at 30 June 2013. Source: info.gov.hk. URL: http://www.info.gov.hk/gia/general/201307/31/P201307310417.htm 6. The number is the mean of the Gini coefficients of Sweden, Denmark, Norway, and Finland. Data extracted from World Bank Database. URL: http://data.worldbank.org 7. Tan, A., October 25, 2012. Lim Chong Yah unveils Shock Therapy II (The Business Times). Retrieved October 11, 2013. Source URL: http://www3.ntu.edu.sg/CorpComms2/Documents/2012/10_Oct/BTonline_121025_Lim %20Chong%20Yah%20unveils%20_Shock%20Therapy%20II.pdf 8. The Hukou system mandates that every household is on the government register, and subsequently stratifies them by socio-economic status. In our context, the register may be used to identify those who need further help, apart from CSSA eligibility and the poverty line already in place.
incentivise the criminal (agent) to not engage in illicit activities. The government instead has accumulated huge costs in terms of maintaining overcrowded prisoners, increasing manpower and surveillance. Security in El Salvador is further fettered by institutional weaknesses including corruption and opaque legislative processes. Given that the truce terms of agreement are unclear, the lack of transparency does not formally hold any of these gang members accountable. Further, this nebulous truce highlights that these gangs have power even within the political arena. For instance, on the eve of the truce, gang leaders threatened to unleash their members to disrupt local elections. The government instead of using enforcement methods, balked and transferred them to the medium security prisons where contact with the outside is made more possible (Dudley, 2013). Using the economic theory of crime here, these gang members have little incentives to behave in the interest of the government. The crumbling of the truce indicates that current incentives are insufficient, underlining the inability of the government to deter crime. Costs are clearly outweighed by benefits for these criminals as through the truce, they have been able to gain more political muscle. Being thrown into jails too (Iron Fist Plan) will not deter clandestine activities from ensuing as though imprisoned, gangs are often consolidated and many of the street gangs now effectively command from inside prisons (Cawley, 2013). Hence, institutional weaknesses of the government play a role in exacerbating gang violence. Resolving the issue of gang violence in El Salvador requires more than just state policies. The government should invest more in youth development to reintegrate youths into the employment sector as well as create a safer milieu for citizens. By assuring citizens that they can place their trust in the police, community cooperation can help deter crime. A critical deterrent to crime is not an active police presence but instead the presence of knowledgeable civilians, prepared to report crimes and cooperate in police investigation (Akerlof & Yellen, 2013). Reforms at the institutional level should also be ensured. Punitive punishments should be imposed on officials who are corrupt and ensure these punishments are monitored and enforced. Admittedly, changes will occur at a glacial pace, but at least El Salvador will be on the right track. Conclusion The economic theory of crime is a useful economic model to be applied to non-market social structures. Where governments face a deadlock in alleviating social problems, such as gang violence in El Salvador, these models can be useful in understanding why these problems persist and what are the necessary incentives needed to bring change. Being one of the most murderous countries in the world, it is imperative that control of crime shifts from the gangs to the government. Sources: 1. Akerlof, G., & Yellen, J. L. (2013). Gang Behavior, Law Enforcement, and Community Values . Brookings Institution. 2. Bahrani, M. (2012). The economics of crime with Gary Becker. The Chicago Maroon. 3. Cawley, M. (2013). 'Iron Fist' Policies Feed Central America Gang Violence: Study. InsightCrime. 4. Cawley, M. (2013). Overcrowded CentAm Prisons Reflect Failed 'Iron Fist' Policies. InsightCrime. 12 Copyright 2013 SMU Economics Intelligence Club
5. Dudley,
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The S&P 500 is a free-float capitalization-weighted index published since 1957 of the prices of 500 large- cap common stocks actively traded in the United States. It has been widely regarded as a gauge for the large cap US equities market The MSCI Asia ex Japan Index is a free float-adjusted market capitalization index consisting of 10 developed and emerging market country indices: China, Hong Kong, India, Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan, and Thailand. The STOXX Europe 600 Index is regarded as a benchmark for European equity markets. It represents large, mid and small capitalization companies across 18 countries of the European region: Austria, Belgium, Denmark, Finland, France, Germany, Greece, Iceland, Ireland, Italy, Luxembourg, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland and the United Kingdom.
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Ng Jia Wei (Vice President, Operations) [email protected] Singapore Management University Singapore Yingyu Zeng (Liaison Officer) [email protected] Singapore Management University Singapore Darren Goh Xian Yong (Editor) [email protected] Singapore Management University Singapore Koh Kang Liang (Writer) Undergraduate School of Economics Singapore Management University [email protected]
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