China Continues to Fall Short of Market Economy
American leaders like Senators Chuck Schumer and Lindsay Graham have long argued that China has an unfair trade advantage based on the historically undervalued Renminbi. While they were right to a small degree, these policymakers long failed to identify a much more problematic issue. Chinese manufacturers have had an edge over their counterparts in America and Europe based on a double-whammy policy that is a throwback to the command economy days: subsidies and price-ceilings for gasoline.
Yesterday’s announcement that China had increased gasoline and natural gas prices about 15% only emphasizes the fact that manufacturers here have long held a real advantage over their foreign competitors and continue to do so. Even worse than that, subsidized oil is a disaster in terms of global economic and environmental impact. It distorts market demand for gasoline in China because the normal check on overly robust demand (price) is no longer a factor for consumers. As a result, Chinese drivers buy up gasoline at the artificially low prices, pushing up demand in China and price globally.
You might be wondering how it’s possible that Chinese consumers can continue to have access to cheap gasoline without someone picking up the bill. Two main players pay for this foolish policy: the Chinese government and Chinese oil companies. The New York Times makes the magnitude of this policy blunder clear:
…controls have also squeezed Sinopec and PetroChina, China’s top oil refiner and producer, respectively. They still had to pay near-record oil prices on world markets even if they were not allowed to charge market prices to consumers. The companies lost money on every gallon of gas they sold in China.
That explains the price ceiling side of the equation. These two companies quite logically respond by reducing output, to avoid losing money on volume (which further drives up world price). But there is another side of this equation, and that is government expenditure. How much do subsidies cost the government, and indirectly the tax-payer?
As a matter of policy, the Chinese government sets gasoline and diesel prices well below international market prices in order to encourage economic growth. In 2007, China’s subsidy of gasoline alone was $22 billion, close to 1 percent of its gross national product.
So basically the Chinese government is paying 1% of GNP (not tax revenue) with a result of to costing the country’s biggest two companies billions of dollars, distorting markets, creating oil shortages in the country and encouraging drivers to ruin the environment. This is a seriously disturbing policy. But why do they do it?
Recent economic policy has been built around the “development at any cost” philosophy. If the government can make it affordable for developers to build, they will do so, side-effects be damned. The brilliance of the gasoline subsidy/price ceiling policy from the government perspective is that all of these horrible effects are spread out around the economy, making it more difficult to pinpoint any single problematic effect. However, if China wants to avoid a tidal wave wiping out its recent progress, it will need to begin looking at real market solutions very soon.
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jen responds:
Posted: June 21st, 2008 at 10:11 am →
How many other countries subsidize oil? I’m pretty sure Iran does and I know Malaysia does (they also recently reduced subsidies).
Bobby responds:
Posted: June 21st, 2008 at 10:17 am →
@Jen
Iran produces oil, so not quite the same. Plus, are you saying what Chinese does is smart, or that the other countries are foolish too?
Oli responds:
Posted: June 21st, 2008 at 10:36 am →
Get you facts right before whining:
- China only imports 1/3 of its oil consumption - the rest is locally produced; the impacts of the price-hikes on world-wide demand is thus going to be very small;
- Oil demand in China is relatively inelastic: not many people own cars (contrary to what the streets of Beijing may suggest) and most of the demand is industrial. A hike in prices is not going to affect that significantly - it will rather drive up end-user prices of manufactured goods.
- Subsidies of one form or another are common in all countries, even in (shock, horror!) the US. The US government subsidies its defence industry with large “research” efforts, its oil industry with low taxes, etc, etc… The Chinese government has done it via the oil price, which may not be the best way in terms of environmental impact, but is certainly no reason for one of the usual “unfair competition” whines! The same subsidies apply across many Asian countries, as well as Russia.
I suggest you stop using words like “policy blunder” before you know what you are talking about.
Josh responds:
Posted: June 21st, 2008 at 2:25 pm →
So basically you’re saying that it’s not a problem because the US and EU have idiotic price subsidies that have disastrous effects on Africa and cause food shortages. I’d classify those as policy blunders as well.
allroads responds:
Posted: June 21st, 2008 at 11:49 pm →
Josh,
nice post. I just put one together myself on the issue, and where I would disagree to some extent is that 1% of GDP is simply a cost of doing business, a cost of stability if you will…. however, those in power are realizing that the Chinese economy needs to wean of sibsidizies and begin standing on its own.
I call the paying the China price: the real China price.
Taking a look at other policy changes recently, you have seen Beijing walk away from VAT rebates, you have seen the removal of corporate tax subsidies, you have seen the implementation of a labor law (reduction of labor subsidy), you have the recent energy subsidy removal, but more important than all these you are seeing that Beijing is not longer willing to subsidize the economy through pollution and environmental degradation… this is the one that will be the most costly for all involved.
At the end of the day, the removal of all these subsidies is simply making industry pay all the costs of doing business, something every developing economy must do to continue developing.
Have a good weekend
R
nanheyangrouchuan responds:
Posted: June 23rd, 2008 at 2:05 am →
The promise of China is nothing but a lie.