Chinese Inflation: Causes And Impacts

Introduction

Since the official accession to the WTO (World Trade Organization) in December 2001, China has become one of the fast-growing economies in the world. It is now the largest manufacturing economy and exporter; due to the high aggregate demand, it is also the second-largest importer in worldwide. Chinese economic development therefore has a great global impact.

Inflation however, seems to be an unpreventable problem that come up with the economic development in China. Inflation is a quantitative measure of the rate at which the average price level of a basket of selected goods and services in an economy increases over a period of time, It is the constant rise in the general level of prices where a unit of currency buys less than it did in prior periods (Chen, 2019).

Normally, inflation is caused by the excess supply of money in the domestic market. Such an excess supply would cause a country’s currency loses its real value and therefore, for a same product, larger amount of money should be used to indicates its value, price increased. Since there would not be a fixed supply of money, the price level will always fluctuate, this is the “quantity theory of money (Mankiw, 2015)”. Also, there are always confusions between the concept of inflation and depreciation. Inflation is when money loses its real value within its economy; whereas depreciation is the decrease in a currency’s exchange rate. Normally inflation would cause a depreciation as the demand for such a currency in the international market would fall, but these two terms belong to different concept.

There are various methods to calculate the inflation rate in an economy, CPI (consumer price index) and RPI (retail price index) are two most frequently used methods. CPI measures the average change in the price of a representative basket of products purchased by households in an economy; whereas RPI is an index that shows the changes in the cost of a fixed baskets of goods over time. The inflation rate measured will usually be different using different method, the difference is known as “formulae effect”. There is no perfect method for measuring inflation. However, comparing to RPI, CPI is more widely used by countries to calculate their inflation rate since it is less costly and the population considered is relatively larger than the population considered by RPI. Chinese inflation rate is also normally calculated by CPI.

China has been experiencing inflation for over 10 years. Especially in 2019, this year, the price of pork has increased sharply — from 10 RMB per kilogram to an average at 40 RMB per kilogram, and sent Chinese consumer inflation to a high level. The reason for this surge in price is that the rapid decrease of supply of pork due to swine fever. The purpose of this research is to find out the reasons of Chinese inflation during 2008 to 2018, and the impact of it.

Causes

The Consumer Price Index for China is calculated using a product basket that contains a predefined range of products and services on which the average consumer spends money throughout the year. Included are expenses for groceries, clothes, rent, power, telecommunications, recreational activities and raw materials (e.g. gas, oil), as well as federal fees and taxes (Han, 2019). The bar chart below shows the Chinese CPI from 2007 to 2018 and the predicted value from 2019 to 2024. (Han, 2019)

By looking at consumer price index, it shows the average Chinese inflation rate during 2008 to 2018 is at about 2.5 persent. Adjacently, it has a general decreasing trend which indicates that the government has controlled the inflation rate well over these 10 years. 2009, however, was a special year as there was a particular deflation at a rate of -0.68%.

To discover the reasons that causes such an inflation, it is important to know several main causes of inflation. First and foremost, demand-pull inflation is an inflation that is caused by an excess increase in aggregate demand not matched by equivalent (Pettinger, 2019)

increase in aggregate supply. Illustrated by the graph below, supply will become rather inelastic in a long term due to several

reasons (including increased cost of production or exhaustion of resources). Therefore, increased demand from AD1 to AD2 will shift the market equilibrium point from A to B and causing the average price level in the country increase from P1 to P2; meanwhile, the real GDP in the country will also increase from Y1 to Y2 as the consumption rises. (Pettinger, 2019)

Another main cause of inflation is called cost-push inflation. This occurs when the cost of production increases. The diagram above shows such a situation. Due to possible reason, the cost of production increases, causing the short run aggregate supply shift from SRAS1 to SRAS2. As a result, the equilibrium price level increases from p1 to p2.

Causes of Chinese inflation from 2008 to 2018 can be classified into different points.

Data in the secondary research shows that in China, a major part of inflation problem is the price of food, which means grocery contributed a major part to consumer price index shown by the diagram on the 3rd page. It has increased more rapidly as compare to other prices of goods. While some of this increase has to do with changes in international food prices, much of China’s problem is a function of increased agricultural wages (McDowell, 2010). Such a rise in agricultural wage can lead to a cost-push inflation, as the farmer’s wage is counted as one of the costs of the agricultural production. Also, natural disasters can be a contribution to such an increase in price, since the land are destroyed so the production in China decreases as well.

Secondly, with the industrialization of China, more labour tended to seek a job in secondary sector instead of primary sector. Such a situation not only increased the cost of production of agricultural products, but also pushed up the price level of rent in urban areas. Especially for real estate in China, the demand increased too rapidly but those manufacturers could not build more buildings in a short run. Such a demand – pull inflation has pushed high the price level very quickly. Over those 10 years (2008 – 2018), there was a significant rise in price for rent and real estate in almost every city. Especially in Shenzhen, the price difference for rent and real estate between these 10 years was 361% (楼市前沿, 2018). Such a boom in Chinese real estate has boost the economic development and pushes up the living cost and general price level in the economy, which apparently, has worsen the inflation.

Adjacently, China was influenced by the globalization. With the development of Chinese economy, people have great confidence in spending, this provided incentive for many foreign corporations in developed economies entering into Chinese market. Since a large amount of foreign currency entered into China, RMB, which is Chinese currency, faced a situation of appreciation in terms of its exchange rate. As the world largest exporter, appreciation would result in decrease export and might cause a balance of payment deficit. Therefore, in order to prevent this from happening, Chinese central government had to increase the supply of Chinese currency. Such an increase in supply in RMB caused its real value decreases in domestic market, therefore, the general price level within the economy has increased. Consequently, inflation occurred.

Impact

The impacts caused by such an inflation can be classified into two different points of view.

From negative side, the inflation increases the difference in wealth of different class of people. This doesn’t necessarily mean that the general purchasing power of working class or low paid class decreases, in fact, their purchasing power increase overtime. Take year 2008 as an example, in 2008, Chinese average lowest national disposable income was 4753.6 RMB, compare to 2007 (lowest disposable income was 4210.1RMB), it increases 11.43%; meanwhile, in 2008 the increase in CPI compare to last year was only 5.9% (Data source: (Unknown, 2007-2008)). Although purchasing power of citizens from these 2 classes increased, but compare to that of those who are in upper class, there was an increasing gap of purchasing power. This is because that during the inflation, those who owns properties like land or real estate, their wealth increases as these properties has more value. At the same time, many of these people rented their land or real estate out with a high price, so their income rose as well.

Secondly, unpredictable inflation created and sent wrong signal for investors. In a normal market, the price is the signal for both consumer and producer to react. The rise in general price caused by inflation might be misunderstood by investors as they might think this is a result of increase in demand. Lack of market information would result in many impulse investments and result in many misallocations of resources. For example, as the preceding text has mentioned that the price of Chinese real estate has increase rapidly during the inflation. This boom has attracted many entrepreneurs or unwealthy managers in their original market entered the market and causing the misallocation of managerial talent. (A misallocation of managerial talent would occur, as long as the unwealthy and thus constrained managers do not have the comparative advantage in their current sector (Shi, 2018).)

Thirdly, inflation can be harmful to residents in terms of their bank deposits. Take the same year 2008 as an example, its inflation rate compared to 2007 was 5.9%, but its annual interest rate of fixed deposit was only 2.25% (Bank of China, 2008), comparing to 2007 (its interest rate of annual fixed deposit was 4.41%), it even halved. Therefore, Chinese residents actually got a negative interest rate. As long as they preserved their properties in terms of money in the bank, their actual wealth would decrease. Consequently, the general purchasing power decreased.

From a positive side, the Chinese inflation during those 10 years was basically conform to Philips Curve (The Phillips curve is an economic concept developed by A. W. Phillips stating that inflation and unemployment have a stable and inverse relationship (CHAPPELOW, 2019).). Which suggests that even though the inflation rate in China was high, the unemployment rate was low. Therefore, the government spending for unemployment assistance can be reduced.

Also, as the income increased with the raise of inflation rate, Chinese government increased the tax rate to raise their tax revenue. For example, in 2009 there was a deflation at a rate of -0.68%, the national tax revenue at that year was 5952.159 billion yuan (Chinese currency). In the following year 2010 (inflation rate was 3.3%), the national tax revenue was 7321.079 billion yuan. There was an obvious increase in government tax revenue with the increase of inflation rate.

Last but not least, Chinese inflation has boosted the area development. Take Daqing city of Heilongjiang province as an example, from my own primary research (by distributing 40 surveys at Business Centers including Shiao), 92.5% of my target group (37 out of 40) agreed that their purchasing power has increased, while others think that their purchasing power had no obvious change. Among these 37 people, 51.35% (19) are come from manufacturing(secondary) sector, they also admitted that even though their production cost has increased (at an average of 15%), but their profit also had an obvious increased from 2008 to 2018. Also, if we look into national data, the overall GDP in China in 2008 was 31924.46 billion yuan; in 2018, the GDP in China has increased to 90030.95 billion. Such a data report has supported that there were developments in many areas in China that has contributed to the increase in GDP.

Conclusion

Altogether, Chinese inflation rate was both beneficial and harmful. However, inflation is always an imperfection that occurs with the development in an economy.

To comment on the inflation in China, I would say that the implementation of several government policies has effectively controlled the inflation rate and prevented the possible depression. The most effective policy would be sound monetary policy, it is a way to adjust domestic money supply and interest rates based on the current economic situation (Lee, 2018). Government has announced that in the following years, the monetary policy id going to remain stable, but they are going to emphasize more on flexibility, moderation and reducing social financing (经济参考报, 2019). Therefore, to ensure that the inflation is controlled effectively and prevent the economic downturn.

Chinese overall macroeconomic adjustments should consider both the benefits and costs of any implementation of government policies. Due to the redistribution effect of inflation, low-income class will be negatively affected the most, therefore the government should adhere to the goal of anti-inflation. Only if government takes full account of the effect that many caused by inflation, and working towards the goal, the inflation can be further controlled.

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