Monday, January 24, 2011

China's Economy: Expanding and Overheating?

Last Wednesday's New York Times featured an article about Chinese economic expansion that is illustrative of a misconception all too common in economic journalism. The story is ostensibly about the apparent white hot Chinese economy that officials tell us "grew 10.3 percent in 2010." The annualized rate of Chinese economic expansion in the fourth quarter was 9.8%. "Both the quarterly and annual figures were significantly above what analysts had expected."

Now, given that economic expansion occurs as an economy produces more goods that people can use to achieve their various ends, one would think, assuming the numbers paint an accurate picture, that rapid economic progress would be greeted unequivocally as good news. However, the very next paragraph includes a definite caveat.
Taken together, the data and a number of other statistics in recent days supported the view of many economists who believe that the government will have to further tighten monetary policy, which could eventually lead the Chinese currency to appreciate against the dollar.

Now, if the Chinese economy was actually expanding, it must be that the Chinese have become more productive and that output has increased. If this is so, the supply of goods must have increased. Therefore, the prices of goods should be decreasing, not increasing. Economic progress results in overall prices that are lower than they otherwise would be, not higher than they otherwise would be.  If that is the case, there would be no necessary reason for the Chinese government to tighten monetary policy.

The idea that fast growth puts an economy in danger of price inflation due to "overheating" is a product of the Keynesian framework that views economic growth as synonymous with increases in national income made possible by increases in aggregate demand. If demand increases faster than supply, prices will increase, however, such a phenomena is not economic growth. It is merely an increase in spending. The caption under the accompanying photo reveals much: "Demand for consumer goods continued to fuel growth in China."

Consumption demand does not generate economic growth. We must produce in order to consume not consume in order to produce. Consumption does not fuel growth at all. If we directed all of our efforts toward consumption, we would very quickly consume all of the goods that exist and be left with nothing for future consumption. We only have goods to consume after they have been produced, which implies that it is saving and investment in production that fuel real economic expansion.

True economic progress should not generate fears of inflation. Unsustainable economic activity funded by monetary inflation should. If increased price inflation in China is a real threat, this indicates that recent increases in official Chinese income statistics are indicative of growth that is more apparent than real.

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