Comparative analysis of the economic performance of china & portugal

   Comparative Analysis of the Economic Performance of China & Portugal    Macroeconomics (ECO 583) Dr Karuna Gomanee 19th April 2013 Word Count: 3496 Lars Friedel Sumeet Khushalani Carlos Possenti Ziv Reichert  

Table of Contents I.   Introduction  ......................................................................................................................................  2  

II.   Economic  Growth  ............................................................................................................................  2  

A.   China  ............................................................................................................................................  2  

B.   Portugal  .......................................................................................................................................  3  

III.   Unemployment  ...............................................................................................................................  4  

A.   Portugal  .......................................................................................................................................  4  

B.   China  ............................................................................................................................................  6  

IV.   Inflation  ...........................................................................................................................................  7  

A.   Portugal:  ......................................................................................................................................  8  

B.   China:  ...........................................................................................................................................  9  

V.   Balance  of  Payments  .....................................................................................................................  10  

A.  China  .............................................................................................................................................  10  

B.  Portugal  .........................................................................................................................................  12  

VI.   Conclusion  .....................................................................................................................................  13  

VII.   Bibliography  :  ................................................................................................................................  14  

VIII.   Appendices  ....................................................................................................................................  17  

I. Introduction    The aim of this report is to compare the macroeconomic performance of China and Portugal over the last three years. For this purpose, we conducted analysis on the performance of each country based on the four main objectives: economic growth, unemployment, inflation and the balance of payments. In the last couple of years, China and Portugal experienced inversed economic cycles. China’s rapid economic growth has made it the second largest economy in the world, while the EU crisis has led Portugal to a recession. This report is based on secondary research; for a full list of sources please refer to the bibliography.

II. Economic  Growth    In order to measure the economic growth of a country, GDP is used to make precise comparisons between countries. The growth rate in Gross Domestic Product (GDP) measures the increase in value of the goods and services produced by an economy over a defined period of time (Trading Economics).

In the last decades China is moving more and more from a centrally planned system to a more market-oriented global player and is since 2010 the world’s largest exporter. (CIA, 2013) The strong economic performance and the important role in the global market can be easily proved by indicators, which are measuring important aspects of a country’s economy. As you can see in Appendix 1, China has had a sustainable and strong economic growth in the last 10 years measuring between 6 and 13 percent on yearly average. At the moment China is the 2nd largest economy in the world with a purchasing power parity (GDP) of 12.38 trillion US Dollar but has a GDP per capita with only 9.100 US Dollar (worldwide rank: 118) due to their very high population (CIA, 2013).

Portugal is an increasingly service-based economy, which has joined circulating the Euro on 1 January 2002. (CIA, 2013) As pictured in Appendix 2, Portugal is struggling in their economic growth over the last decade and could not manage a continuous and stable economic growth. With purchasing power parity (GDP) of $245 billion Portugal is the 52nd largest economy in the world but has with $23.000 a higher GDP per capita than China (CIA, 2013).

A. China    

2010:

After more than one year of rebound in the economic growth, the growth rate contracted because the Chinese government wanted to stop overheating the economy and property prices were out of control (Inman, 2010). The fear that the economy of China could be overheating was supported by the fact that the inflation was higher than expected with 4,6% (Branigan, 2011). In order to work against this process the government tried to curb growth by raising

banks' required reserves seven times in the last year and has raised interest rates twice ( Branigan, 2011). This led to a decrease in the consumption and also in the GDP but the average was still at 9,5%.

2011:

The decline in the economic growth continued through 2011 as the Europe’s debt crisis and the high US unemployment had a negative influence on the economic performance in China (McDonald, 2011). The second-largest economy in the World had undergone a decline in the GDP from 9.5% to 9,1% which was the lowest level since two years (McDonald, 2011). Furthermore, the government still tried to cool the inflation, which had a 37-month high in July with 6,5%, by increasing interest rates and putting curbs on construction and other investment (McDonald, 2011).

2012:

In the third quarter in 2012, the economic growth slowed down to 7,4% which was the weakest since early 2009 (Yao, 2012). This slowdown was a result of the weak global demand as Europe is struggling with their debt crisis and the economic adjustments of the Beijing government in order to guarantee a more sustainable growth without acceleration in inflation (Yao, 2012). But nevertheless the Beijing government wanted also to support the economic growth by cutting benchmark interest rates twice this year and lowering bank reserve ratios three times since late 2011. Furthermore, they injected large amounts of money into the market in order to encourage consumption (Yao, 2012).

B. Portugal    

2010:

Although Portugal had one of the best recovery rates in terms of economic growth in the European Union in the first quarter of 2010, the markets plummeted because they feared that Portugal could be the next Greece (Donadio, 2010). The loss in confidence in Portugal was due to its high deficit with 9,3% of gross domestic product in 2009. Another Problem which Portugal hit hard was the eastward expansion to Asia and the loosening of its trade barriers. As Portugal based his economy on labor costs they were dependent on foreign investment (Donadio, 2010). Furthermore, there debt was 76,6% of gross domestic product in 2009 because of rising in unemployment and government spending (Donadio, 2010).

2011:

As the problems continued and the government of prime minster Socrates collapsed, Portugal was forced, after Greece and Ireland, to seek a bailout. The Government cut public spending and raised taxes to meet terms of a 78-billion Euro aid plan from the EU and IMF (Bloomberg, 2012). This bailout was necessary because the country’s borrowing costs increased extremely and they were not able anymore to borrow from the markets (Bloomberg, 2012). But as we can see in Appendix 2, the economic growth contracted in 2011 and

Portugal was facing a deep recession. As a result of the tax increases the consumption declined and unemployment went up.

2012:

These problems continued in 2012 and the budget deficit grew continuously as a result of a decline in domestic consumption and the increase of unemployment benefits (Indexmundi, 2013). The economy shrank for the 8th quarter in a row and was experiencing a deep recession as the fiscal consolidation of the country had negative impacts of the economic growth (Lima and Almeida, 2012). Furthermore, Portugal struggles to comply with the conditions of the EU-IMF to reduce their deficit till 2013 below 3% (Lima and Almeida, 2012).

III. Unemployment  One of the key economic factors to measure the performance of a countries economy is the unemployment rate. (Investopedia, 2012).

It is a closely guarded statistic because a rising rate is seen as a sign of a weakening economy that may call for cut in interest rate. (Business Dictionary 2013)

Unemployment occurs when a person is actively searching for employment is not receiving wages.

Therefore the unemployment rate is archived by calculating the number of unemployed in the workforce, which includes people who are able to work. This includes people who are in the appropriate working age minus children, students, people who are incapable of work and also people who do not aspire a job (Bls, 2009).

There is a linked relationship between economic growth and unemployment known as the Okun’s Law, the previous statement can be seen when comparing the Chinese and Portuguese growth rate and looking at their respective unemployment rates afterwards. (Investopedia 2012)

A. Portugal    

Portugal is in deep economic recession. When analyzing its employment rate since the European crisis, there is no doubt that Portugal its in a social and economical turmoil. Lima J, and Reis A 2013)

Portugal’s economy is mainly service based (76% of GDP) unlike China, this sector was largely affected after the 78 Billion in bailouts issued by the IMF and European Central Bank.

The current Unemployment rate is 16.9% and has been increasing since the 2008 global crisis. (Index Mundi, 2013)

Austerity measures led to a steady increase in unemployment, which became one of the highest in Europe. (Pattinger, 2012)

In just one quarter after the Bailout in 2011, the unemployment rate rose 4% points.

Despite the current cost of austerity for the unemployment rate in Portugal, it is predicted in the 2013 budget to propose more austerity measures including enormous tax increases. (Pattinger, 2012)

Youth unemployment is so high, currently at 8.6% that even the prime minister has encouraged its youth to show more efforts leaving the country and finding new jobs in Portuguese speaking markets abroad like Angola and Brazil who are currently experiencing extensive economic growth. (Pattinger, 2012), (CIA 2013)

B. China    

Since the late 1970’s China has moved from a closed, centrally planned system to a more market oriented economy. (CIA 2013)

The Chinese labor market has been transitioning from a previously high Agricultural setting to a more Industrial. (Cai F, Park A 2012)

In 2010, China became the world’s largest exporter. (CIA 2013)

Today, in the Chinese economy, the labour force engaged in agriculture is still high at 49%, but quickly decreasing and moving to services currently at 29%. (Cai F, Park A 2012)

Unlike Portugal, China is experiencing very high economic growth rates.

The current unemployment rate in China is 4.1%, according to the data graph below it shows it has been consistent for many years with no significant drops of rises. (Trading Economics 2013)

However many economists around the world are criticizing this unemployment rate offered by the official Chinese government labour institution as it only calculates urban unemployment. (Cai F, Park A 2012)

Estimated Real Unemployment rate calculated by some institutions, which includes private enterprises and migrants range around 6.5%. (CIA, 2013)

It is predicted that China will have to deal in the future with the increasingly problem of sustaining adequate job growth for tens of millions of migrants and new entrants to the work force, who are transitioning from the previously based primary sector economy. (Cai F, Park A 2012)

IV. Inflation    Inflation is defined as an increase in prices and goods in an economy over a period of time (Investopedia). There is a clear relationship between economic growth and inflation. This means if the economic growth of country A rises, most probably there will be a decrease in the inflation rate.

There are two causes of inflation. A country has cost-push inflation or demand-pull inflation (Bized, 2001).

Cost-push inflation is caused when there is an increase in costs of production and an increase in the prices of raw materials (Bized, 2001).

This diagram clearly shows that there is a upward shift in the aggregate supply which demonstrates and increase in prices, which therefore is causing and increase inflation (Bized, 2001).

Demand pull inflation is caused when there is strong consumer demand. This is when individuals want to buy the same good (Bized, 2001). Nevertheless, the price of the product automatically rise (Investopedia).

This diagram shows that there is a right shift in the aggregate demand curve (Bized, 2001). Therefore as I said before, and increase in aggregate demand will increase the prices (Bized, 2001).

A. Portugal:  

The Euro crisis has been one of the reasons why Portugal has not had a proper economic growth, which has lead to a low inflation (The economist, 2013). Portugal`s inflation rate fell in 2009 to negative value while the unemployment rate was rising. This has been there lowest inflation rate in the Eurozone. While relating it with the economic growth further up, the growth has also fallen. From this we can say that there is a linear relationship between inflation and economic growth. Furthermore. We can see that by looking at the last two years there has been fluctuations and inflation rates have therefore not been constant.

It is clear from the graph that Portugal has gone through several changes as soon as the Eurozone crisis started in 2008. This is shown as reaching to a negative value in 2009, it has jumped into 4.2 percent in the end of 2011 (Bloomberg, 2011).

Looking the actual inflation rate in March 2013 was 0.5% (Trading Economics).

B. China:  

China has been conquering the market from the last decade. There is no doubt about this. However since 2010 there economy has started to “overheat¨ which means that there are higher taxes and unemployment rates are being completely sustainable (Priyanka, 2010). It is said that in 2010 they should had a inflation rate between 1-3% however it has reached to 4% (Priyanka, 2010). This means that there is a rapid increase in the inflation rate. So everyone ask there selves if China should turn into monetary policies which would increase the interest rates and would help to decrease inflation or should the use fiscal policy which relates in increasing taxes which will probably decrease the consumer disposable income (Priyanka, 2010).

China has used the monetary policies. This could be raising interest rates and also increasing the value of their currency, Yuan (Priyanka, 2010).

Analyzing the graph we can also see that there is a pattern between Portugal and China graph in where deflation has occurred (Phil for Humanity, 2011). One of the problems of China is that inflation not only affects them but globally. There has been a cost-push inflation, which has affected labour and factories to outsource their factories (Phil for Humanity, 2011). This means that expenses have increased for the manufactured goods and so has the inflation (Phil for Humanity, 2011). Therefore there has been a link between the global and china´s inflation rate.

V. Balance  of  Payments    The balance of payments is a key indicator towards determining a country’s economic performance, as it measures all of a country’s inflows and outflows, showing whether a country is undergoing a deficit (more outflows than inflows) in their total economic transactions or whether it is experiencing a surplus (more inflows than outflows). The balance of payments consists of three fundamental figures: current account, capital account and the financial account (note: capital account and financial account are usually merged). While the current account measures net exports of goods, services and transfer payments, the capital and financial account measure the net flows of financial securities and the ownership of assets.

 A.  China     Ever since new economic reforms were established in the late 1970’s, the Chinese economy has been growing at unbelievable rates. The country’s immense population of over 1.3 billion people - and thus its reputably large labour force, has allowed it to produce with incredibly low costs and thus has led the country to become the largest exporter in the world (CIA, 2012) and has pushed it to become the second largest economy in the world with over $7.2 trillion in nominal GDP as of 2012 (CIA, 2012). Though due to recent circumstances and the continuous growth in economic volatility, the upward trend-line that China has possessed for

so long is no longer as apparent

as it once was. By looking at China’s Balance of Payments, we can see that in 2008 its current account was in a surplus of $421 billion, an all-time high for the country’s economy and an impressive figure by all means. China’s exports prior to the 2008 financial crisis accounted for roughly 34% of its economy, though quickly dropped to under 29% only two years later in 2010, representing a decline of roughly $375 billion. The increased volatility in the global financial markets and the apparent bearish outlook, have led to a substantial decrease in the country’s exports – leading to a steady decline in its current account surplus from $421 billion in 2008 to $214 billion in 2012, nearly halving in only five years time. In addition to the global recession, a large contributing factor to the decline in China’s current account surplus was the devaluation of the currencies of many of its largest importers (e.g. India, Russia and the United States of America). The United States has long been in conflict with China, criticizing the country for purposely devaluing the Yuan through its intensive buying of foreign currencies (particularly the USD) and treasury bills. In response, the United States has applied quantitative easing throughout the last three years, a monetary policy used to increase money supply and depreciate the value of the currency. By looking in the appendices, in figure ‘appendix 3’, the affect of the United States quantitative easing policy is shown, through the stark decline in the balance of trade in 2012. Even though a tremendous decline the current account surplus has occurred the country still has a healthy exporting sector, particularly growing in its service sector, representing around 35.7% of the country’s economy as of 2011 (CIA, 2011). In addition, increased emigration has led to 50 million Chinese living outside of the country and thus increased the amount of remittances and therefore inflows into the economy.

Unlike China’s current account, its capital and financial account have shown a steady increase up until 2010, from roughly $40 billion in 2008 to $287 billion. Though due to economic turbulence, the capital and financial account have since plummeted from a surplus to a deficit of $117 billion. This is mainly due to the continuous fluctuations in the Yuan; a currency noted for its relatively stable performance had begun to experience volatility, pushing away investors from buying it, towards buying other similar substitutes. To combat the stark decline in its capital and financial account, in 2012, China bought up the least amount of currency reserves since 2003. The financial crisis and the fears of a real estate bubble (Forbes, 2013),

have led investors to stir away from investing in the country, while the Chinese private and public sector have continued investing outside the country. This has of course led to the current state, leading to a very large capital and financial account deficit. By looking in the appendices at figure ‘appendix 4’ you can see that Chinese investment outflows have increased, while foreign investor confidence in the country has substantially decreased, as represented by the capital and financial account deficit.

As of 2012, China is relatively balanced within its balance of payments, indicating that it has a rather healthy, yet volatile-prone economy.

B.  Portugal   Like most European countries, Portugal was heavily hit following the 2008 financial crisis and the Eurozone Crisis. With Portugal having experienced the largest dip in GDP growth in

the EU after Greece, it could be said that it was affected a lot more than other countries in the region. With a current account deficit of around EUR 2.1 billion in 2008, Portugal managed to reduce the figure to EUR 250 million by 2012. Though the country’s export sector only accounts for roughly 35% of its economy and thus is not completely detrimental to its full economic performance. Even though the country managed to decrease its current account deficit substantially, as of 2012, it was still undergoing a deficit. It’s possession of the Euro currency, means that it has little to no influence in intervening to the change currency’s value. The relatively high value of the Euro has of course led to a decrease Portugal’s exports, maintaining its apparent deficit. Ironically, the large decline in Portugal’s nominal GDP has led to a fall in wages and thus lower production costs in the country. This has of course helped reduce the deficit, but by no means managed to eliminate it. Another factor that helped improve the deficit has been the trade contracts that Portugal signed with China in 2010, increasing its exports by 8% by 2012 and reducing its imports by 3.3%. By looking at figure ‘appendix 5’ in the appendices, you can see that Portugal’s trade balance has steadily increased since 2010, following its contract establishment with China.

Furthermore, Portugal’s capital and financial account surplus has decreased from EUR 2.1 billion in 2008 to EUR 200 million in 2012. The Eurozone crisis and its $103 billion bailout has decreased investor confidence tremendously, while Portuguese outflows have increased following a strong decline in 2010, as seen in ‘appendix 6’ in the appendices. In addition, increased volatility and weak performance of global financial instruments have led to Portugal’s portfolio investments to fall from a surplus of EUR 1.5 billion in 2008 to a deficit of EUR 200 million in 2012. As portfolio investments represent an extremely large part of the

Portuguese capital and financial account, the large fall has had a great contribution to the large decline in country’s capital and financial account surplus.

As of 2012, Portugal is experiencing a deficit in its Balance of Payments estimated to be around EUR 473 million.

VI. Conclusion Portugal and China were affected by domestic and international factors, which influenced the performance of the country.

The financial crisis in 2008, the Europe’s debt crisis and the struggle of the USA led to a slowdown in economic growth in China. Furthermore, the Chinese government tried to work against overheating the economy by their fiscal and monetary policy in order to achieve a more sustainable growth. Yet, the Chinese economy is growing on a very high rate as they are still considered as a developing country.

In Contrast, Portugal is in a deep recession as their unemployment is increasing and they are struggling with their public deficit. This is also a result of EU and IMF bailout for which the Portugal government had to increase taxes and cut government spending in order to comply with the conditions. Furthermore, the Europe crisis with troubled countries had a negative impact on the performance of Portugal’s economy, as there is a loss in confidence that the economy will recover in the future.

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VIII. Appendices    

Appendix 1: China GDP Annual Growth Rate

Appendix 2: Portugal GDP Annual Growth Rate

Appendix 3: China Trade Balance

Appendix 4: China Investment Outflows

Appendix 5: Portugal Trade Balance

Appendix 6: Portugal Investment Outflows