Your World Today: Chinese subsidies affect global economic stability
by Timothy J.A. Passmore
Jun 28, 2013 | 342 views | 0 0 comments | 61 61 recommendations | email to a friend | print
If the 2008 global financial crisis taught us anything, it is that free economic activity comes at a price. A system of “laissez-faire” capitalism had for years been heralded, particularly in the United States, as the most efficient and prosperity-inducing way of doing things. Yet, as under-regulated behavior paved the way for financial disaster, the idyllic image of the free market system fell from grace.

In the immediate aftermath, governments scrambled to rescue ailing industries and stimulate growth through investments and various incentives. The U.S. government effectively became the largest shareholder in the American auto industry, as well as a large proportion of Wall Street. Other countries similarly took a more hands-on approach to particular industries in order to keep the national economy afloat.

The heavy reintroduction of the state into business has challenged years of assumptions that the government has no place in the private sector. Furthermore, it has to a degree vindicated countries like China, which for years have followed an aggressive strategy of government-infused growth.

Now, the economics textbooks may have to be rewritten to account for the major success of the Asian model that has appeared in the last several decades. This model involves governments identifying specific industries and fostering their growth to increase export competitiveness and dominate global markets.

China has done this largely through subsidies to various industries. We tend to think of “subsidies” as a bad word, and not without good reason. When governments give money to companies for production, they can then produce more goods than they otherwise would in an efficient market. So if a car company has depleted sales, government financial injections allow them to continue manufacturing, while selling their vehicles at a price lower than the equilibrium price set by supply and demand.

In theory, countries should allow successful companies to continue being successful, while inefficient and struggling companies should be allowed to change their ways or bow out. While this seems harsh, it is the best way to maintain efficiency and produce national economic success.

The U.S. government provides heavy subsidization to the agricultural sector simply to allow it to compete with cheaper goods from other countries. It is not efficient — the U.S. should focus on what it does best if it wants to strengthen its economy — but no politician will commit career suicide by suggesting we allow American farmers to go out of business.

China’s role in providing subsidies to industries has been aimed primarily at increasing export competitiveness. This goes a long way in explaining why Chinese goods flood the American market: they can be made and sold for much cheaper. Low labor wages explain this to a degree, but the heavy influence of government subsidies is the most significant factor.

Herein lies the problem. The distortion of natural economic processes caused by government subsidies affects not only China’s own economic stability, but also global markets. Selling items at augmented prices creates imbalances in efficient market behaviors and affects similar industries in other countries. The cheap price for Chinese-made televisions will choke competing companies that operate efficiently in America, yet cannot match the prices of the subsidized companies. When efficient companies are driven to failure, the country will pay a price.

This may all sound good for China, and certainly the country has seen exponential economic success since the state-driven economic policies were introduced in the 1970s. Yet the overcapacity and inefficiency of Chinese industry resulting from subsidies and government intervention will soon catch up with it, and unless there is a strong private sector developing in the wings, sustained growth will not take over when the government reaches its limits. This will most likely lead to a stagnation of Chinese growth.

On the other hand, increased private development will bring continued economic success to China, but would require the state to relinquish a great deal of its control over the economy, which it will be reluctant to do. Should it choose to do so, China will likely succeed economically while undergoing a radical political shift that will shake the longtime communist system to its core.

Whichever path China chooses, the future of that increasingly great country will be far from the status quo of recent years. And when the dust settles, economists may be lauding a system that has challenged conventional theory, or else reiterating what we in the West have believed to be true for years — that government intervention in industry should be avoided where possible.