Growing Like China

Wei Chen

PROBLEMS

Return to Capital Remain High.

Saving Rate Remain High.

Foreign Surplus growth fast.

Contradict

How to Solve This Puzzle ?

ANSWERS

Return on

capital

• Reallocation of resources

Saving

• Transfer from external financial firm to entrepreneurial firms

Surplus

• Domestic Saving invests in foreign assets

HISTORY BACKGROUND

Video: History background1

1. Cameron D’AngeloChina’s, Economic Growth, <http://www.youtube.com/watch?v=7TT8uHVZWBY>

REALLOCATION

DPE: Domestic Private EnterprisesSOE: State-owned EnterprisesFE: Foreign Enterprises

DIFFERNECE BETWEEN DPE & SOEProductivi

tyAccess to Financial

Markets

DPE High Hard

SOE Low Easy

• China Scores poorly in terms of creditor rights, investor protection, accounting standards, nonperforming loans, and corruption

Reason

• Chinese firms must rely heavily on retained earnings to finance investments and operational costs.

Consequence

DIFFERNECE BETWEEN DPE & SOE

SOE finance more than 30 percent of their investments through bank loans compared to less than 10 percent for DPE

INCOME INEQUALITY

Fact: The Gini coefficient in China grew from 0.36 in 1992 to 0.474 in 2012 (0.61 in Southwestern University of Finance and Economics’ report )

Reason: This development may be due in part to the slow growth of wages relative to entrepreneurial income.

A. Preference, Technology, and Market 1

1. Two Periods Model: the first period and live off savings in the second period.

2. Utility Function:

3. Workers: N t+1 = (1 + ν) N t .

A. Preference, Technology, and Market 24. Firm types: Entrepreneurial firms (E) & Financially Integrated (F)

the manager makes decisions

based on superior information (χ > 1 extra efficiency)

the manager can divert a positive

share of the firm’s output for his own

use. (ψ < 1)

F firms are weak at corporate

governance and cannot effectively

monitor their managers

F firms will always choose a

centralized organization,

while E firms opt for delegation

A. Preference, Technology, and Market 3

5. Technology:

6. Budget:

7. Saving:

Conclusion: wages equal the marginal product of labor

A. Preference, Technology, and Market 4

E Value:

Interpreted: Value = Max {Total Output –money stolen – wages}

Conclusion:

A. Preference, Technology, and Market 5Capital = saving + Loan:

Firms need enough money to pay back loan

Conclusion:

Optimal Saving Rate:

B. Discussion of Assumptions

SOE

Weak Corporate Government

Less Productive

Easy Borrow Money

DPE

Manager related

High productive

Hard Borrow Money

Result :Hard for money to flow to high productive DPE firms

C. Equilibrium During Transition 1 Prove: Due to the disadvantage in raising funds,

E firms choose in equilibrium a lower capital-output ratio than do F firms.

1. Capital per labor:

2. Define lending rate R l pins down the marginal product of capital of F firms

3. κF is constant. in standard neoclassical open-economy:

4. Conclusion

C. Equilibrium During Transition 2

The growth rate of ρE is hump-shaped in ψ.

Recall: ρE is return on capital from E firm; ψ is the stolen rate

Assumption: 1.Ke and A are state variable. 2. capital per labor is constant. 3. entrepreneur savings is linear in Ke

Conclusion:

D. Foreign Surplus, Savings, and Investment

1. Bank Balance:

Interpreted: Loan to Firms F + Loan to Firm E + Foreign Bond = Saving

2. Foreign Surplus:

Condition: The intuition for the growing foreign surplus is that as employment is reallocated towards the more productive E firms.

3. All E Firms:

4. Conclusion: Due to the financial frictions, the growth rate ofthe foreign surplus can exceed that of GDP, resulting in a growing B t / Y t ratio

E. Discussion of Results Firstin spite of the high investment and growth of industrial production, the rate of return of firms does not fall.

SecondA lower capital intensity in E firms than in F firms. Moreover, the rate of return to capital is higher in E firms than in F firms

Third

the reallocation from SOE to DPE in the data

Forthsuch reallocation leads to an external imbalance— as in the data, the economy runs a sustained foreign surplus.

Fifthpredicts a growing inequality between workers’ wages and entrepreneurial earnings

QUANTITATIVE ANALYSIS1. In Theory, we used two period model. Now, we extend our theory to an Auerbach-Kotlikoff OLG model in which agents live T periods.

2. Young entrepreneurs （富二代） work as managers for T/2 periods and as entrepreneurs for the remaining T/2 periods

3. The parameters set exogenously. One period is one year. Agents enter the economy at age 28 and live until 78 (T = 50). The average retirement age in China is 58, so workers retire after J = 30 years of work.

RESULT

MY OPINION

• Developing market (Magic Happens1) • Increasing in investment caused increasing in demand at

beginning . The market in China is empty in 1978. When there was investment, there would be demand for the products.

• Recent complete market caused foreigner surplus increase. After market is complete, government and E companies realized less of future grow opportunity. They looked for foreigner investment opportunities.

• Better political status. At very beginning, if a company wanted to do business in China, there would millions of front cost caused by political agreements. While less political agreements would be for the recent 10 years.

• Begin from 2008, F firms grew fast with a high rate of return than E firms.

CHINA

• Developed market (Under Expectation)

USA

1. Yuan Da Corporation, Time Lapse Video Of China Completing 15 Story Hotel In 6 Days, <http://www.youtube.com/watch?v=VgXi2iKpX_0>

Thanks for listening!