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China wants to force inflation down. Can it?

(2008-01-10 19:20:43)
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杂谈

 

Just as we start hearing serious rumors about government plans to streamline the government bureaucracy, merge various ministries and departments to create fewer “super-ministries”, and increase economic flexibility by reducing red-tape and government interference, the State Council announced “temporary price intervention measure” which will allow the authorities to prevent large scale producers from raising prices on what are called “daily necessities” (I have seen no definition of what this means, but assume it refers primarily to food and energy).  In a related announcement, following a cabinet meeting yesterday, Premier Wen Jiaobao announced a freeze on prices of natural gas, electricity, water, transportation, education and health care prices.

 

The urge to reduce the complexity of government is not new.  China is awash in red tape, and so many competing ministries and departments regulate different aspects of the economy that it is hard to get any coordination.  According to an article today by Andrew Batson and Rick Carew of the Wall Street Journal, the government has already tried reducing complexity – the number of ministries declined from 45 in 1983, to 41 in 1988, to 29 in 1998 to 28 currently.  The target is to get down to around 20 or fewer.  Although this top-down approach to reform may seem aesthetically pleasing to the bureaucratic mind, I am not sure that reducing the number of ministries and increasing their power will make the economy or the bureaucracy more flexible if there isn’t a significant change in the incentive structure for powerful bureaucrats – which to me means real accountability and a well-functioning mechanism to enforce bureaucratic response to the needs of the sectors being managed.  Increasing the power of these super-ministries may simply increase political infighting and factional struggles.  We’ll see.

 

Meanwhile the announcement that the State Council can “‘temporarily” intervene in price hikes and is freezing certain utilities suggests that inflation is worrying them enough to force them to reverse direction in freeing up the economy.  No one is certain how serious they are about these new measures – this might just be an attempt to show the people that they are truly concerned about inflation, which a recent survey has identified as the number one worry among the population at large, or it may be a very temporary measure to ensure a happy Spring Festival (this year it is on February 8, I think).  By the way in its announcement the cabinet also said some firms were hoarding goods, unreasonably jacking up prices or spreading rumors about price rises.  They assured us that they would crack down on such antisocial acts.  That makes me think these announcements are at least as much about public perception than about real measures.  Everything is so much better if we can identify the hooligans who have caused our troubles.  But even if they are serious about implementing these new measures I am still very pessimistic about the chances of their working.

 

The success of government measures to restrain prices depends very much, as I have argued several times, on which model you use to explain inflation.  If you believe that inflation is a temporary food-price phenomenon, one which will work itself out later this year as food production gets back on track, the greatest danger is the development of inflationary expectations which cause price rises to spread to other parts of the economy.  In that case the various measures the government has taken – steps to cool the economy, to sell food reserves, and now to freeze prices – might actually work, although even that is open to argument.  

 

If the problem is monetary, as I believe it is, then these measures are likely only to make things worse.  Price freezes will translate, as they already did in the energy sector, into reduced production, consumer shortages and long lines – which may be even worse for the population at large because there will almost certainly be unequal treatment, and people find it much harder to bear difficulties if there is a perception that these difficulties are not evenly shared.  Already the government is taking big losses on its fuel price subsidy and there are persistent rumors about fuel hoarding in expectations that prices will be forced up again in the near future.  Needless to say this makes matters worse, not better.

 

Selling off grain reserves to depress prices is not likely to be much of a help either because it means, effectively, backdating inflation – lower prices today will be met by an increase in inflationary pressure as grain stocks are replenished in the future, and if in the meantime lower prices today reduce incentives to increase production, the net effect will be an overall increase in prices.  Finally, restraining consumption simply means increasing the trade surplus and so increasing monetary expansion.

 

However you interpret these measures, the government is clearly very worried about inflation.  December CPI numbers haven’t come out yet, but I expect we will get them in the next week or so.  I would be very surprised if they are not high, but I think even then that December and January CPI numbers will understate the problem because of the immediate impact of measures aimed at keeping prices down for the Spring Festival, such as selling off grain reserves.  Most CPI inflation estimates I hear are in the low 6% range, down from November’s 6.9% but still far outside the government’s comfort range.  By the way the rumors are that producer prices will show in December continued rising from November’s already high 4.6%.

 

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