The economic importance of China in the world economy is difficult to overstate. Simply by virtue of China's 1.3 billion people it’s economy is large in an absolute terms and is poised to overtake Japan as the world's second largest. Its sustained growth in real per capita GDP, at an average of 8.6 percent from 1978-2007, is high by any standard. While there has been a good deal of economic research done on China, most of it has been on microeconomic issues. Given the pace of globalization and China's role in international economics, surprisingly little research on China has been done on the macroeconomic side by academic economists.
There may be several reasons for this, but two possibilities jump to mind. The first concerns doubts about data quality. In one example of potential measurement error, in revising PPP exchange rates used to deflate nominal GDP, the World Bank revised the real GDP data for China downwards by about 40 percent. On the other hand, following the 2004 Chinese Economic Census, the National Bureau of Statistics (NBS) revised GDP from 1993-2004 upward so that by 2004, nominal and real GDP were modified to be 16 and 6 percent higher, respectively. Whether one believes in the accuracy of these revisions or not, the magnitude of the revisions serve to underscore some of the uncertainty surrounding the data. A second possibility stems from China's ongoing transition from a centrally planned to a market based economy but with continued heavy involvement of the government. Researchers may be skeptical as to whether a transitional economy such as China’s is appropriate for analysis by the current generation of business cycle models. These models are typically solved as approximations around the steady state but one can question whether China has converged to the steady state growth path. In this sense, China may be `too different’ from the typical country that macroeconomists study with the standard toolkit of business cycle models.
In this chapter, we examine the extent to which China's macroeconomy is suitable for business cycle modeling. Using the available data, we address whether China is sufficiently similar or different, say in comparison to Canada and the U.S. Of course, if we find that China is too different for business cycle modeling, it is possible that the underlying cause is data quality. In any event, it is beyond our manpower resources and our expertise to do anything about data quality issues and understanding the macroeconomics of China is too important to wait until the `high-quality data' are available.
We focus on two issues. First, we investigate the extent to which the cyclical properties of the post-reform Chinese economy (1978 to 2007) can be understood with a very basic real business cycle model. The model we use is nearly identical to Mendoza (1991), who studied the Canadian economy from 1946-1985. The only part of the model that is specific to China are the parameters of the exogenous processes (government spending and productivity) which we estimate from the Chinese data. Otherwise, we employ the same parameter values as Mendoza to facilitate the comparison between Chinese and Canadian macroeconomic behavior.
The main finding from this analysis is that China is not so very different. The business cycle model works about as well for China as it does for Canada in terms of matching the volatility and persistence of the macroeconomic data. For China, the model’s primary shortcoming is in explaining consumption and saving behavior whereas for Canada it is in explaining the persistence of investment and the trade balance. The model predicts consumption to be too smooth and to be too large a fraction of GDP as compared to the data.
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Business Cycles, Consumption and Risk-Sharing: How Different Is China?
