Inflation and its impact on the Chinese economy

By Hazrat Hassan

In a different place in the world, China’s government continues to walk a very thin line. China’s GDP is largely created by funneling easy credit (total credit is now at 200% of GDP) into infrastructure projects (a record 49% of China’s GDP is in investment)… the cost of this money pumping and incessant investment is higher inflation. [1]

However, the reality of higher inflation won’t show up in China’s inflation data (which clocks in at an absurdly low 3%). However, you can see clear signs of this in China’s civil unrest: you don’t get wage and labor strikes for nothing. Workers protest for higher wages because they cannot afford increased costs of living. [2]

And the situation may be rather worse than this. Two weeks ago a pundit at the Chinese Academy of Social Sciences, one of the government’s top think tanks, said that by its own calculations the country’s consumer price index had been understated by more than 7% over the past five years. And last week the original ‘Dr Doom’, Marc Faber, said he reckons the ‘real’ Chinese inflation rate is nearer 10% a year. [3]

Whatever the exact figures, there’s no doubt inflation is rising far too fast for comfort for the authorities. The Chinese central bank has been trying to cool things down gently. Five times this year its raised bank holds prerequisites, which diminishes the sum that moneylenders can loan. Yet “the credit brakes are being tapped not slammed”, says the FT. “The government could be more aggressive.” In other words, so far the tightening hasn’t had much of an impact. [4]

The workforce is getting far strop pier than it once was. Between 2007 and 2008 – the latest available data – labor disputes more than doubled. Food prices are already rising at 10% year-on-year. The Xinhua news agency reported last week that a basket of 18 staple vegetables cost 62% more during the first ten days of November than in the same period last year. [5]

This article is talking about the inflation occurring in china and the costs that it has brought to china. This inflation has caused severe consequences to china and we will be discussing the possible solutions inflation is a rise in the general level of prices of goods and services in Ana economy over a period of time. When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects erosion in then purchasing power of money – a loss of real value in the internal medium of exchange and unit of account in the economy. A chief measure of price inflation is the inflation rate, the annualized percentage change in a general price index over time. [6]

Costs of inflation in China

When inflation rates are high, groups such as pensioners, households, dependent on social security benefits, stand lose to a great deal since they are often on fixed incomes. These Chinese will now be able to purchase less than before (less purchasing power), and will start to demand for higher wages. Only those with strong bargaining positions will be able to bid up for higher wages. In addition, people will be able to buy less food items than before which is a major issue because food is one of the basic necessities in human life, as in the article it has shown the prices of food increase 10% year-to-year. [7]

Inflation causes an increase in interest rates and will therefore have a negative effect on investment and output, both of which will adversely affect employment, as in the article we can see that labor disputes have been doubled. Higher inflation means that the businesses in china will have to change their prices to keep up to date on the price level. [8]

Inflation affects the foreign trade and the exchange rate. Experiencing high rates of inflation, china’s domestic products will be less competitive internationally. As the domestic products’ prices increase the demand for these products will fall and therefore the demand for china’s currency will also fall, thus affecting the exchange rate. [9]

The cause of inflation in China:

The cause of inflation in China’s economy was expansionary monetary policies and rising wages. The inflation in china was caused by “cost-push inflation. It means that the cost of firms increase, in this case it is higher wages, and the firms are forced to raise prices in order to cover the costs. [10]

Cost-push inflation:

If the economy demands higher wages, the higher costs of labor will shift the SRAS curve to the left from SRAS1 to SRAS2. The price level rises from P1 to P2. A higher wage increase consumption and therefore increases aggregate demand from AD0 to AD1. The increased spending (and possible expansionary policies) moves the economy towards equilibrium at Yfe but at a higher price level. We have now a round of cost-push inflation. [11]

Solution:

In the article, it has shown that china’s government is trying its best to avoid this issue but it has been said that it hasn’t had much of an impact.

One of the possible ways of reducing inflation is by subsidizing businesses. The government can give out subsidies to business so that the businesses can reduce their costs of production. This will then encourage the businesses to lower their prices and thus avoiding inflation. The problem here is that the government will suffer a huge loss if there are many businesses to subsidize.[12]

Another possible solution is by appreciating its currency. This is because if it appreciates its currency then firms will be able to buy cheaper raw materials and therefore will have lower costs of production. Thus reducing prices of goods. It can appreciate its currency by using its foreign currency reserves to buy its own currency and this will increase the demand for its currency. Even though this method will help businesses to reduce their prices, there are also negative consequences. [13]

References

1. BRADSHER, KEITH. “Rising Chinese Inflation to Show Up in U.S. Imports.” The NewYork Time, 2011.
2. Capital, Phoenix. “The China Inflation Problem and Its Impact For Markets.” Zero Hedge, 2013.
3. “China’s Inflation is the World’s Inflation.” Phil for Humanity, 2007.
4. “Chinese inflation is rising too fast.” UKEssays , 23 March 2015.
5. “Inflation and its Impact on china Economy .” Nyshka Chandran , 2016.
6. “Inflation China – 2016.” Inflation World wide inflation data, 2016.
7. “Inflation China – consumer price index (CPI).” Global Rates, 2016.
8. “Inflation in China 2015.” Inflation World wide Inflation data, 2015.
9. “Inflation rate in China from August 2015 to August 2016.” Statista , 2016.
10. Kostohryz, James. “Five Ways Inflation in China Can Affect the US.” Minyanville, 2015.
11. McDowel, Daniel. “The Causes and Consequences of Chinese Inflation.” WPR ( World Politics Review , 2010.
12. Tong, Christoper S.P. “Impact of inflation on Chinese economy: Growth, investment, and regional development.” Journal of Contemporary China , 2016.
13. Willard, Tarhan Feyzioglu & Luke. “Does Inflation in China Affect the USA and Japan .” Asian & Pacific Developement , 2006.