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Risks within China Lecturer: Zhigang Li Motivation Common Risks: Economic growth is not a smooth process. The uncertainty of economic growth could affect long-term growth rates. What have been underlying the uncertainty of China’s growth? How will they change in the future?

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risks within china

Risks within China

Lecturer: Zhigang Li

motivation
Motivation
  • Common Risks: Economic growth is not a smooth process. The uncertainty of economic growth could affect long-term growth rates.
    • What have been underlying the uncertainty of China’s growth?
    • How will they change in the future?
  • Idiosyncratic risks: Even if the economy is stable, risks may exist in many dimensions that may affect the investment and consumption activities of individuals or firms.
    • Health risk
    • Default risks
  • What could be done to reduce the risks?
outline
Outline
  • Common risks and growth
    • Theory
    • Evidence from the world
    • Evidence for China
  • Idiosyncratic risks within China
    • Evidence for China
risks
Risks

Total risks

=

common risks

+

idiosyncratic risks

how could risk be measured
How could risk be measured?
  • A typical proxy of risk is the realized volatility (or variance) of economic time series
  • More sophisticated measurement of risk can be inferred using GARCH models and Stochastic Volatility models.
theory how could risks affect economic growth
Theory: How could risks affect economic growth?
  • Neoclassical growth model (Solow, 1956)
    • Volatility plays no role for growth
  • Real business cycle (RBC) models (e.g. Kydland and Prescott, 1982)
    • The volatility of shocks to the economy may affect the level of growth (but not the growth rates of technology)
theory how could risk affect economic growth
Theory: How could risk affect economic growth?
  • Francois and Lloyd-Ellis (2003): Growth and business cycles can be positively linked via creative destruction.
  • Wen and wang (2006): Because of imperfect competition, firms charge higher prices during periods of larger volatility. Higher markup leads to lower capacity utilization and lower rate of return to capital.
  • Exchange rate risks could decrease investment and growth (e.g. Aghion et al.).
  • Inflation uncertainty could also affect growth.
  • Irriversibility of investments: When investments are irreversible, idiosyncratic investment risks could reduce firms’ investments (Jamet, 2004).
evidence how could risks affect economic growth
Evidence: How could risks affect economic growth?
  • Lucas (1987)
    • Welfare gains of eliminating fluctuations are trivial compared to that of stimulating long-run growth
  • Ramey and Ramey (1995)
    • Countries with higher output volatility tend to have lower output growth.
  • Wang and Wen (2006)
    • Further stabilizing the U.S. economy can increase welfare by 25% of annual consumption. stabilizing output growth (or capacity utilization) around a potential target.
exchange rate uncertainty
Exchange Rate Uncertainty
  • Aghion, Bacchetta, Ranciere and Rogoff
    • For countries with relatively low levels of financial development, exchange rate volatility generally reduces growth, whereas for financially advanced countries, there is no significant effect.
    • A 50 percent increase in volatility uncertainty leads to a 0.33 percent reduction in exchange rate volatility.
common risks of china
Common risks of China
  • Fluctuation due to policy changes
  • Exchange rate risks
  • Inflation risks
  • Efficiency of (physical) capital market (reducing the irreversibility of investments)
  • Risks of external markets
sources of idiosyncratic risks within china
Sources of idiosyncratic risks within China
  • Political connection
    • Political connection disrupts price information in the market
    • The market for political power is inefficient itself
    • Presentation by Chunyuan Shi
  • Contract risk (property rights)
    • Presentation by Yitian Li
  • Structural change of economic environment
    • Presentation by Xiaomeng Li
  • Health
    • Poor coverage of commercial health insurance and low quality of health service in rural China
how could risk be reduced
How could risk be reduced?
  • Economic development itself could actually reduce the effect of political connections
    • Reduced effect of political forces
    • Market integration (presentation by Fan Meng)
  • Government should be an important force
    • Help reduce exchange rate volatility
    • Public social insurance (presentation by Hao Liang)
    • Monitoring the financial sector (presentation by Yuanyuan Cao)
how are the different risks expected to change in the future
How are the different risks expected to change in the future?
  • Institutional environment
    • Policy making process
    • Contract enforcement
    • Property rights
  • Exchange rate scheme
  • Inflation uncertainty
    • Globalization
  • The development of financial market
  • Social security net
frankel 2008
Frankel (2008)
  • What has the de facto exchange rate regime of China been since 2005?
    • By mid-2007, the RMB basket had switched a substantial part of the dollar's weight onto the euro.

Frankel, Jeffrey A. New Estimation of China's Exchange Rate Regime. 2009, National Bureau of Economic Research, Inc, NBER Working Papers: 14700.

thesmar and thoenig 2004
Thesmar and Thoenig, 2004
  • Capital market development, by improving risk sharing between listed firms, increases the willingness of these firms to take risky bets. This in turn increases firm level uncertainty.
  • This effect could further diffuse to non-listed firms.
  • The spillover effect is larger when competition increases, and when labor market institutions are flexible.
    • Financial Market Development and the Rise in Firm Level UncertaintyPreview Thesmar, David; Thoenig, Mathias; 2004, C.E.P.R. Discussion Papers, CEPR Discussion Papers: 4761