China and Singapore — Balance of Trade, Living Standards and Policy Options

Case

Table 2: China’s composition of aggregate demand (USD, billions)

	2014	2015	2016	2017	2018
GDP at current market prices	10475.7	11061.5	11233.2	12310.4	13889.5
Private consumption expenditure	5502.3	5972.2	6182.7	6754.4	7650.2
Government consumption expenditure	1656.9	1793.9	1838.2	2009.7	2297.6
Gross fixed capital formation	4594.2	4656.3	4667.7	5153.3	5952.9
Exports of goods and services	2462.8	2362.1	2199.9	2424.2	2655.6
Imports of goods and services	2241.3	2003.2	1944.5	2208.5	2564.1

Table 3: Singapore’s composition of aggregate demand (USD, billions)

	2014	2015	2016	2017	2018
GDP at current market prices	314.9	308.0	318.8	343.4	376.0
Private consumption expenditure	148.7	145.8	149.1	155.8	167.4
Government consumption expenditure	30.3	31.4	32.8	34.9	37.6
Gross fixed capital formation	88.6	83.8	83.0	86.8	85.1
Exports of goods and services	604.4	549.4	525.2	587.4	665.7
Imports of goods and services	530.6	465.3	441.7	496.6	557.5

Extract 5: China’s economy to face key challenges

The Chinese economy continues to slow down as it faces multiple pressures in 2019, but it is also showing resilience with the support of a complex set of stabilizing policies. While 2020 will be a crucial year for China to secure a decisive victory in building a moderately prosperous society in all respects, the country will face greater challenges.

External challenges will be more demanding. The global economic downturn and US–China friction have entered new phases, bringing about unprecedented uncertainty to global economic policies. This will not only directly impact China through trade, but it will also negatively influence its economy by undermining market confidence. As external demand has weakened from 2018, the global manufacturing industry is set to slump. Also, domestic demand is expected to remain weak and has experienced a significant decline, which may accelerate the economic slowdown.

The economy is therefore more vulnerable, particularly when enterprises do not expand their investment in production and residents do not increase their consumption of durable goods, hence China must implement more targeted measures to boost domestic demand.

Source: Adapted from Global Times, 11 December 2019

Questions

(a)(i) Compare China’s balance of trade (BOT) with that of Singapore from 2014 to 2018. [2] (command: compare)

(a)(ii) With reference to Extract 5, explain one reason why the trend of China’s BOT is likely to continue in 2019. [2] (command: explain)

(b) With reference to Tables 2 and 3, what additional information is required to compare material living standards between China and Singapore? [4] (command: explain)

(c) Extract 5 mentioned two economic challenges faced by the Chinese economy. Evaluate two policy options the Chinese government may consider in overcoming any one of the above challenges. [8] (command: evaluate)

Answers

(a)(i) Compare China’s BOT with Singapore’s, 2014–2018 [2] — compare

The balance of trade is exports of goods and services minus imports. Computing exports − imports for each economy from Tables 2 and 3 gives a positive figure throughout, so:

• Similarity: both China and Singapore ran a BOT surplus in every year 2014–2018.

• Differences: China’s surplus generally fell over the period (from about 221.5 to 91.5 USD billion) while Singapore’s surplus generally rose (from about 73.8 to 108.2 USD billion); and China’s surplus was generally larger than Singapore’s in every year except 2018, when Singapore’s overtook it.

(a)(ii) One reason the trend of China’s BOT is likely to continue in 2019 [2] — explain

Extract 5 states that “external demand has weakened from 2018” amid a “global economic downturn”. A fall in income among China’s trading partners reduces foreign demand for Chinese exports, so China’s export revenue (X) falls. With imports unchanged, net exports (X − M) decline, which is consistent with the continuing fall in China’s BOT surplus observed over 2014–2018.

(b) Additional information needed to compare material living standards [4] — explain

Material standard of living refers to the quantity and quality of goods and services available to residents for consumption, for which GDP is the headline proxy. Tables 2 and 3 alone are insufficient for a cross-country comparison for two reasons — both standard limitations of national-income comparison:

• Exchange-rate distortion. The GDP figures are expressed at market exchange rates, which do not capture differences in the purchasing power of each currency arising from cost-of-living differences. A given USD figure buys a different basket in China than in Singapore, so the values may over- or under-state true material living standards. Data on purchasing power parity (PPP) rates would correct for this.

• No adjustment for population. China and Singapore have vastly different populations, so aggregate GDP says nothing about the output available to the average resident. Per capita data (GDP divided by population) is required before the two can be meaningfully compared.

(c) Evaluate two policy options to overcome one of China’s challenges [8] — evaluate

The two challenges Extract 5 identifies are a decline in external demand (“external demand has weakened from 2018”, reducing X and hence AD) and a decline in domestic demand (“domestic demand is expected to remain weak”, reducing C and hence AD). This answer addresses the decline in domestic demand; either challenge is acceptable, and the policies must be ones China can actually employ. China operates both an exchange-rate lever and an interest-rate lever, so both an exchange-rate and a demand-management policy are available.

Policy 1 — Depreciation of the exchange rate. A managed depreciation of the renminbi raises domestic export competitiveness: export prices fall in foreign-currency terms while import prices rise in domestic-currency terms, so export revenue (X) rises and import expenditure (M) falls. Provided the Marshall–Lerner condition holds, net exports rise, lifting aggregate demand and, via the multiplier, real national income. This raises external rather than domestic demand, however, so against the domestic-demand challenge it is an indirect remedy — and a weaker renminbi raises the cost of imported inputs, risking imported cost-push inflation.

Policy 2 — Expansionary fiscal policy. Expansionary fiscal policy — higher government expenditure (G) and lower taxes — raises households’ disposable income, lifting induced consumption (C), and raises firms’ post-tax profits, lifting investment (I). Because the challenge is specifically weak domestic demand (weak C and I), this policy targets the root cause directly: C, I and G all rise, shifting AD right and raising real national income through the multiplier.

Evaluation. For the domestic-demand challenge, expansionary fiscal policy is the more effective of the two: it acts on the weak components (C and I) directly, whereas depreciation works through external demand and so addresses the symptom only obliquely. Fiscal policy is also better suited to a confidence-driven slump, since direct government spending is not contingent on firms and households choosing to respond. Its limitations are real — fiscal expansion worsens the government’s budget position and is subject to time lags in implementation, and its potency depends on the size of the multiplier (a high marginal propensity to import or save dampens it). On balance, where the binding constraint is weak domestic demand, expansionary fiscal policy should be the lead instrument, with exchange-rate management reserved for the external-demand challenge.