China's Economic Transformation: From Stagnation to Global Dominance

Introduction:

According to CSR (Congressional Research Service) (2019), four decades ago i.e. before 1979, the Chinese government adopted inefficient economic policies which led its economy in a stagnant position resulting in increased poverty and leaving the country isolated from the rest of the global economy. But it was only after 1979 when the Chinese government revolutionised its economic policies which made it the fastest growing major economy in the world with its GDP averaging 9.5% per annum from 1979 to 2018 and also managed to lift 850 million people out of poverty. China is “the fastest sustained expansion by a major economy in history” (World Bank, 2019). As per CSR (2019), “China has become the world’s largest economy (on a purchasing power parity basis), manufacturer, merchandise trader, and holder of foreign exchange reserves”. According to U.S. trade data (2019), total trade between the US and China grew from $5 billion in 1980 to $660 billion in 2018, which is a result of rapidly growing Chinese economy and an increase in the bilateral commercial relations between the two countries. China is currently US’s largest merchandise trading partner, its third-largest export market and its largest source of imports (CSR, 2019). Looking for an economics dissertation help, to understand China's transformation in the economic area and its impact on global trade relations as it is said to be a valuable area of study.

The CCP (Chinese Communist Party) was formed nearly a century ago and is known as the original founding & ruling party of the modern-day China as we know. They have been the driving force behind the rapid economic growth of China in the last four decades. The CCP maintains the monopoly over the policy making in China where Xi Jinping is the current President. To counter western inspired ideas like “democracy, human rights, pro-market, civic participation, neoliberalism & media independence”; the CCP has embedded itself in various layers of the Chinese social and economic policy making (Albert & Xu, 2019). The Chinese communist government has been historically criticised for overuse of its power and influence onto its economic policies. Their influence can be witnessed in their dual trading regimes (Naughton, 1996). Firms which are export oriented can be seen functioning in an open policy environment known as ‘export promotion regime’, while the rest of the economy operates on something called as the ‘import substitution regime’ with substantial trade barriers.

US policymakers have blamed the Chinese currency to be undervalued against the dollar as it has been under increasing pressure to revalue or float. But Yang (2011) disagrees and has said that though it might look that way but there are many factors such as preferential treatment for foreign investments, control on capital outflows, etc. which explain why China’s international reserves are greater than international norms. But according to Pettinger (2009), the Chinese currency is undervalued by nearly 30% against the dollar which has been the source of conflict with the US. He further adds that the Chinese government intends to keep its currency undervalued against the dollar as it provides it a competitive edge in exports; which helps them in achieving higher economic growth. In August, 2019, the US angrily labelled China as a currency manipulator when for the time since 2008 Yuan fell below the historic level of 7 Yuan against a dollar, which can be seen in the figure 1 (BBC, 2019).

Literature Review:

According to Hirst (2015), China’s economic rise and growth over the last half century is one of the greatest examples of the benefits of opening an economy to the global markets. During this period, China transformed from a country that was agricultural to a modern day manufacturing powerhouse of the world. This helped China to improve wages, employment and standard of living of its people and lift 850 million out of extreme poverty. All this contributed to boost China to become the second largest economy in the world (2). World Bank (2019) has mentioned, “Today, China is an upper-middle-income country and the world’s second largest economy”. But on the other hand, around 373 million Chinese populations is still living below the upper-middle income poverty line, which is $5.50 per day. This shows that China’s per capita income is lower than countries of high income.

China has made significant progress in improving the problem of income inequality but due to high population and the weakness in the labor productivity, it is still struggling to eradicate it completely (4). According to World Bank (2019) “Reducing these imbalances requires shifts in the structure of the economy from low-end manufacturing to higher-end manufacturing and services and from investment to consumption” (5) (2019). Based on PPP (Purchasing Power Parity) as in below in Figure (1) China is now the world’s largest economy. As per Willige (2016) China’s economy and GDP are growing rapidly, “because your money stretches further in China than it would in the US, China’s GDP is adjusted upwards” (6).

Although, its economy is in decline for the last couple of years, China is still growing almost 3 times the economy of the USA. Willige (2016) further mentions that, “The two nations are on an even keel when it comes to exports. However, the US has a trade deficit – it imports more than it exports – while China imports significantly less than it exports, resulting in a trade surplus”. However, China is still far behind from US when it comes to the export of high-tech products, since the majority of the exports from China are of low-end products (8). It is due to the immunological strength of China towards global financial contagion and its currency reformation under strictly managed exchange regime; many researchers have become interested in learning more about the monetary and exchange rate policies used by China (Qin et.al, 2015). There are arguments on both sides where some blame China for manipulating its currency value and then there are others who feel that this is not the case (Chen et.al, 2011).

America often blames China for manipulating its currency and devaluing it intentionally to make its product cheaper than that of the US. The Chinese government is also accused of having a policy to intervene in currency markets to the appreciation of Chinese Yuan RMB (Renminbi) against US dollar and other currencies (9). As per Morrison & Labonte (2013), “China’s currency policy is intended to make its exports significantly less expensive and its imports more expensive”. This has led U.S to a trade deficit with China impacting its manufacturing and other jobs. Between the years from 1994 till 2005, China fixed its currency value at 8.28 yuan per dollar, only to let it appreciate after 2005 under a lot of pressure from other trading partners. But again, China fixed the value of RMB against the dollar in July 2008 with an excuse to protect its exporters from global economic crisis only to resume RMB appreciation in June 2010 (Morrison & Labonte, 2013). Moreover, the value of RMB had appreciated by 34% nominally and 42% on real basis (inflation-adjusted) against the dollar in June 2013, which shows that the Chinese government have constantly made their best effort to keep its currency undervalued by not letting it appreciate (fxcm.com, 2019).

According to FXCM (2019), Chinese government also keeps purchasing large amounts of foreign currencies such as dollar for their foreign reserves to keep their currency undervalued and is the biggest holder of U.S treasury bonds worth $1.25 trillion. Some economists have claimed that “China deliberately ‘manipulates’ its currency in order to gain unfair trade advantages over its trading partners” (Morrison & Labonte, 2013). (14). China is largest trading partner of the US which grew from being $5 billion annually in 1980 to $660 billion in 2018 (Congressional Research Service, 2019) (15). Many also blame China for influencing derivative contracts by using central bank to bring sophistication to manage its currency rates and foreign reserves, which permits the Chinese government to not sell dollars immediately and maintain the position of its currency in the future markets (16).

On the other FXCM believes that even after all the currency and exchange rate manipulations, the Yuan may still be overvalued by nearly 10% making the markets to bid lower on it (18). After the initial liberalization in 2005 the Chinese Central Bank maintained high interest rates but began easing it in 2014 to counter slowing economy. It is this part of the Chinese monetary policy which also boosts the undervaluing of the Yuan as it discourages the inflow of foreign currency resulting in the weakening of Yuan. As part of its monetary policy in 2005, the rule of fixed exchange rate of Yuan against Dollar was replaced for the flexible exchange rate, allowing the value of the currency to fluctuate. (19).

According to Chang and Li (1993), PPP (Purchasing Power Parity) is important to analyze the movement of exchange rates in the long run because “different national price levels should be equal when expressed in common currency”. They further explain that NER (Nominal Exchange Rate) and RCP (Relative Consumer Price) are helpful in evaluating the equilibrium value of a currency in the long run, offering the measure the effectiveness of the foreign exchange markets. Yi (2013) explains that highg exchange rate fluctuations of Yuan can drastically influence the producer’s and consumer’s price via imports which can negatively impact the growth of an economy. These high currency fluctuations can have some serious consequences during the times of economic crisis (Su et.al, 2016). According Qin et al., (2015), NER can impact RCP during many short periods positively as well as negatively, while the PPP doesn’t hold against internal or external shocks. Hence, it is essential for policymakers to consider other factors in order to make monetary policy in a moderate fashion which decrease any negative impact from NER on Chinese economy.

As per Xu et al., (2015), though there are criticisms about the Chinese government’s monetary policies in relation to its currency exchange, the Chinese currency included SDR (Special Drawing Rights) by IMF, which reflects the regimes effort in internationalizing and liberalizing its currency. Currently the Chinese government is concerned about its PPP, which if stays the same could increase the rate of inflation, decreasing the value of its currency further (Su et.al, 2016). However, Engel and Rogers (2004) argue that volatile movements in the NER due capital flow in short run can lead to misalignments making it difficult to achieve PPP equilibrium due to flexible exchange rate regime. But Ma et.al (2017) suggests that the argument for PPP cannot find support in the cases of other countries like Japan and South Korea including China using traditional unit root test. Bahmani-Oskooee et.al (2015) counters this by saying that PPP holds valid for most Asian countries including Japan and South Korea.

Ma et.al (2017), suggests that we should not jump to concluding that China manipulated its currency exchange rates, since we often forget that it went through economic structural changes between the period of 2005 to 2016 which lead to deep reaching ripple effects in its economy. Zhoa et.al (2013), supports this too since he acknowledges that China experienced “a paradoxical combination of rapidly rising inflation and spreading bankruptcies” after the global financial crisis in 2008. Ho (2014), blames the US for ignoring the fact that the global financial crisis for 2008 originated from US because of which China had to take preventive measures to self-guard its economy, but in response the US implemented quantitative easing in 2008, 2010 and 2012 without considering its effects on the global economy. But even after this most of the economists agree that China is surely manipulating its currency creating imbalances in the global economy (Su et.al, 2016).

Methodology:

In the current study the researcher has collected secondary data. By utilising this source the researcher was able to assess and understand the overall valuation of the Chinese Yuan. This source further has been used to evaluate China’s exchange rate policy. Several studies have already been carried out on the research topic. This was also one of the key reasons for selecting this source. There is an abundance of information and past studies on this research topic. By utilising this source, the researcher was able to get a better and effective understanding about the subject matter, and thus was able to understand exchange rate policy adopted by China.

Consumer Price Index (CPI) is defined as the measure which analyses weighted average of prices of different consumer goods and services. It focuses on areas such as medical care, transportation and food. It is calculated by assessing the price changes for each of the items that are included in the ‘pre-determined basket of goods’ and then averages them. By evaluating changes in the CPI, statistics regarding periods of inflation or deflation. Thus, CPI takes into consideration the average changes in prices that occur over a specific period that the consumers pay for different goods and services.

While nominal GDP can be termed as the GDP which is evaluated at the current market prices. It consists of all changes that happen in the market prices due to either inflation or deflation. It is different from the real GDP in terms that it takes into consideration the changes in prices due to different market factors and forces. It also focuses on rate of increase in prices in an economy. Thus, nominal GDP is the assessment of economic production in an economy but focuses on the current prices.

GDP PPP is the total of gross value which is added according to all the resident producers within the economy along with product taxes while excluding all and any subsidies that are included in value of the products. GDP PPP is further defined as the GDP which is converted to international values by suing the rates of purchasing power parity. The PPPs are known as the currency conversion rates which does not take into consideration the distinctions of price levels between different countries.

To analyse this data, the researcher used different statistical and quantitative methods. Herein, descriptive statistics, regression and independent t-test of the data was also carried out by using SPSS. Independent t-test was used to analyse and compare the exchange rates between USA and China. While on the other hand, regression model was used to evaluate the impact of independent variables on the dependent variable of exchange rate. Following equations have been tested in the present work:

Exchange Rate= B0+ B1*Nominal GDP+ 2*CPI

Exchange Rate= B0+ B1* GDP by PPP

Findings and Analysis:

For the purpose of the analysis data was collected from the Bloomberg platform for China and for the USA. The data was collected on an annual basis between the periods of 1990 to 2017. For China the data was collected for its currency’s exchange rate against dollar, CPI (Consumer Price Index), GDP growth, nominal GDP and GDP by PPP. Similarly for USA the data was collected only for CPI (Consumer Price Index), GDP growth, nominal GDP and GDP by PPP. The purpose of collecting the data was to compare them with each other and at the same time run regressions to test the research hypothesis. SPSS statistical software was used for the purpose of performing the analysis.

1. Descriptive analysis:

Table 1 above shows the outcome for the results of the descriptive analysis. The descriptive analysis is for all the described variables between the years 1990 and 2017. From the analysis we can see that the average exchange rate for Chinese Yuan against dollar has been 7.2041 with a standard deviation of 1.0726. The mean CPI for China is 459.3393 while its 190.0895 for the USA. This means that China has to spend more dollars to maintain the same lifestyle as that in the USA. The mean GDP growth for China was 9.5348% compared to 2.4515 of the USA, which means that China’s GDP grew faster than that of the USA on an average. The average nominal GDP for China was $3,911.1032 while that of the USA was $12,310.8089 and according to the USA GDP is nearly 3 times that of China. However, the average GDP by PPP for China was $8,207.1416 compared to $12,113.6357 which shows that USA’s GDP by PPP is nearly 50% greater than that of China. But we can also see that the average GDP by PPP for the USA is a bit lower than its average nominal GDP, while on the other hand the average GDP by PPP for China is nearly double than its average nominal GDP. This tells us that there is definitely a considerable difference between the two countries GDP by PPP compared to their nominal GDP.

2. Independent sample t-test:

Further an independent sample t-test was conducted to compare the means of CPI, GDP growth, Nominal GDP and GDP by PPP for China against USA. The purpose of the independent sample t-test is to compare the averages of two variables independent of each other and to analyse if there is significant difference between their averages. The table 2 below shows the mean of each China and USA along with the standard deviation.

The table 3 below show the outcome of the t-test analysis for variables for China and the USA. The results for Levene’s test were observed to see if the results were significant us to assume equal variances or not, hence if the p-value > 0.05 equal variances were assumed while if p-value ≤ 0.05 equal variances were not assumed and the results of the t-test were reported accordingly.

From the results for the independent sample t-test in the table 3 we can see that difference in the means of CPI (p-value = 0.000), GDP growth (p-value = 0.000), Nominal GDP (p-value = 0.013) and GDP by PPP between China and USA were found to be significant. China’s average CPI and GDP growth are significantly higher than that of the USA by $269.2498 and 7.0883% respectively, while its average nominal GDP and GDP by PPP are significantly less than that of the USA by $8,399.7057 and $3,906.4941 respectively.

3. Regression:

A regression analysis is helpful in explaining the causation effect where the dependent variable changes due to the activity of the independent variable. A series of multiple regressions were run where Chinese Yuan exchange rate against US dollar was the dependent variable while the remaining variables for china such as China’s GDP growth, nominal GDP and GDP by PPP was the independent variables. As seen in the table 4 below, it was found that the CPI (p = .000) and nominal GDP of China (p = .000) were significant for the changes in the Chinese Yuan exchange rate against the US dollar. This was an expected result based on similar researches in the past. Further, the Adj. R-square = .770 which means that the model was able to explain 77% of the changes happening to Yuan’s exchange rate while the remaining 23% can be explained by other factors.

But what was interesting is that China’s GDP by PPP was not found to be significant in the multiple regressions. However, based on the previous researches it has been found that a country’s currency exchange rate depends on the GDP by PPP. Hence, to explore this further a linear regression was run where the Chinese Yuan exchange rate against US dollar was the dependent variable while China’s GDP by PPP was the independent variable and results were still insignificant (p = .059, Adj. R-square = .097) as in the table 5 below. Hence, this tells us that the model was unable to explain why exchange rate of Yuan is dependent not on the GDP by PPP.

Discussion:

The main reason for conducting this study was to assess exchange rate policy adopted by China. Herein the researcher determines whether the Chinese Yuan is undervalued in comparison to the American dollar as claimed by the Americans. During the study it was observed that since mean CPI for China was higher than the US, it had to spend more to maintain living standard and lifestyle of the Chinese people as their counterparts. Further the independent t-tests revealed that the means of CPI, GDP growth and nominal GDP and GDP by PPP were significantly different between USA and China. Herein it was further noted that CPI and nominal GDP of China had a statistically significant impact on Chinese Yuan. This means that these two variables have an influence on exchange rate of currency of the country.

According to Li et. al. (2015), the valuation of a currency is dependent on a wide variety of factors and forces. The author stated that GDP is one of the key factors that also has a significant impact on the way a currency is valued. If the GDP is high, then it would indicate a strong position of the currency and therefore will enable the country to attract a considerable amount of investments from foreign countries. Eichengreen and Tong (2015) analysed GDP rates of developed countries and compared them. They found that valuation of a currency is directly affected by the GDP rate. It is an indicator of overall growth in the country. If the nation is able to achieve higher GDP, then its probability of getting currency rates will also be higher.

During the current study it was also noted that Purchasing Power Parity (PPP) also has a significant impact on valuation of the currency. Herein Ryan (2015) states that even though there are certain criticisms about policies adopted by the Chinese government, however they have been very effective in improving economic condition of the country as well as its ability to fulfil demands and requirements of the citizens. Currently the Chinese government is concerned about its PPP, which if stays the same could increase the rate of inflation, decreasing the value of its currency further. According to Sun et. al. (2016), if there is any kind of disparity in PPP, then there are chances that it would have significant negative impact on economic performance of the country, as well as on the way its currency is valued.

Differences in the interest rates is also a key factor that has an influence on valuation of a currency. Similar to the current results, Milbury et. al. (2017) stated that interest rates tend to define the extent to which a currency is valued. This means in order to gain the highest valuation; the interest rates should be maintained optimally. As per the author, getting to such a situation is not an easy task. There are a number of factors and aspects which will have to kept in mind by the authorities. Any mistake will have detrimental impact on the economy as well as valuation of the currency. During the current it was observed that interest rate within the country has a significant influence on valuation of the currency, as well as the way an economy works and achieves its goals and objectives.

From the data analysed in the study, it can be observed that there is a statistically significant impact of CPI and nominal GDP on the Chinese economy, as well as valuation of the Chinese Yuan. Cheong et. al. (2017) also obtained similar results. As per the author, both these variables tend to provide a thorough understanding about functioning of an economy and the way its currency is valued in the international arena. Based on the results obtained by Geng et. al. (2017), it can be said that assessing the CPI and GDP helps in understanding the economy as well as the various aspects of its functioning and performance.

While conducting the current study it was also observed that when there is a significant change in the independent variables, then it would have a proportionate influence on the economy and the economic performance as well. In such cases it becomes extremely crucial for the authorities that they get a better and thorough understanding about the factors that influence economic performance. Such knowledge can be crucial for the authorities and can help them in comprehending as well as managing economic functioning of the country in an efficient and effective manner. Results obtained during the current study are very similar to the results obtained by Black (2018) and Chen and Pan (2019), as their findings also highlight different aspect of China’s economic policy and also compared Chinese Yuan with the American dollar. Based on the results of Black (2018), it can be said that using factors such as CPI and GDP have a significant value on Chinese Yuan, The current study also showed similar results, as it was determined that the value of the Chinese currency is dependent on these factors.

CONCLUSION:

From the above study it can be concluded that exchange rate policy adopted by China has had a significant impact on overall functioning of the economy, as well as the extent to which the country is able to gain growth and development. While conducting this current study, it was determined that CPI and GDP have a major impact on overall growth and development of the economy. Herein it may be said policies adopted by the Chinese government have helped in improving valuation of the Chinese Yuan and its strength in the international arena. During the study, it was noted that one of the key reasons for explosive growth achieved by the country is due to the fact that its government has adopted a communist outlook which has helped it to attract a significant amount of interest from the international arena. In addition, its policies have also proved to be very helpful in enabling the country to attain a significant amount of growth and development.

The study also revealed that even though the US policy makers have blamed the Chinese currency to be undervalued against the American dollar. One of the key reasons for this has been the increasing pressure to revaluing value of the currency and its overall functioning as well. China’s economic rise and growth over the last half century is one of the greatest examples of the benefits of opening an economy to the global markets. During this period, China transformed from a country that was agricultural to a modern-day manufacturing powerhouse of the world. This helped China to improve wages, employment and standard of living of its people and lift 850 million out of extreme poverty. All this contributed to boost China to become the second largest economy in the world.

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