How Did China Maintain Macroeconomic Stability During 1978–2018?

• Published date: 01 May 2021
• Author: Ming Feng,David Daokui Li,Shuyu Wu
• Date: 01 May 2021
• DOI: http://doi.org/10.1111/cwe.12376

©2021 Institute of World Economics and Politics, Chinese Academy of Social Sciences

China & World Economy / 55–82, Vol. 29, No. 3, 2021 55

*Ming Feng, Senior Researcher, National Academy of Economic Strategy, Chinese Academy of Social

Sciences, China. Email: fengmingthu@126.com; David Daokui Li, Professor, Academic Center for Chinese

Economic Practice and Thinking (ACCEPT), Tsinghua University, China. Email: daviddaokuili@126.com;

Shuyu Wu (corresponding author), Lecturer, Emerging Markets Institute, School of Economics and Resource

Management, Beijing Normal University, China. Email: wushuyu@bnu.edu.cn.

How Did China Maintain Macroeconomic Stability

During 1978–2018?

Ming Feng, David Daokui Li, Shuyu Wu*

Abstract

In this paper, we analyze the role of macroeconomic management in developing

countries’ economic take-off and structural transformation. We argue that developing

countries face three leading challenges: market immaturity, lack of a developed fi nancial

system, and severe information asymmetry between international investors and domestic

players. If not properly dealt with, these challenges can lead to macroeconomic volatility

and fragility in economic development. Therefore, the government must intervene

appropriately to address these challenges. By analyzing China’s experiences in the era of

reform and opening up (1978–2018), we fi nd three important lessons: (i) It is important

for the government to facilitate the entry and exit of enterprises in macroeconomic

cycles, relying not only on market signals but also on administrative orders and

measures of institutional reform; (ii) Financial reforms should be implemented in order

to promote financial deepening and channel savings into investment; and (iii) The

government should carefully manage capital account liberalization in order to preserve

fi nancial stability while promoting foreign investment, international trade, and industrial

upgrading.

Key words: capital account liberalization, China’s macroeconomic management, fi nancial

deepening, macroeconomic stability

JEL codes: E61, E65, P20

I. Introduction

Economists have long explored how to help underdeveloped countries achieve economic

take-off and structural transformation while preserving their macroeconomic

stability. Regrettably, neither the existing literature in development economics nor in

Ming Feng et al. / 55–82, Vol. 29, No. 3, 2021

©2021 Institute of World Economics and Politics, Chinese Academy of Social Sciences

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macroeconomics provides satisfactory answers to this problem. Most existing theories

on macroeconomic management are extracted from the experiences of developed

countries in Europe and North America, ignoring the dramatic heterogeneity among

economies in different stages of development, and thus usually failing to appropriately

guide macroeconomic management practices in developing countries.

In this article, we take the Chinese economy during the last four decades as a

case study to analyze the role of macroeconomic management policies in developing

countries’ economic structural transformation. We point out that the economic structural

transformation of developing countries is rather complicated for three reasons. Firstly,

the immaturity of the market impedes market clearance. Therefore, developing countries

typically experience more intense hot and cold economic fl uctuations than developed

countries, which makes the transformation process rather fragile and full of uncertainty.

In this regard, laissez-faire marketization leads to inefficient economic activities.

Secondly, due to the lack of a developed fi nancial system, domestic savings cannot be

channeled effectively into investments. In addition, the immature fi nancial market can

easily lead to fi nancial volatilities or even crises. Thirdly, the information asymmetry

between international investors and local players distorts global investors’ perceptions

of emerging market economies (Wang and Yang, 2012).

Essentially, all these three issues are related to market immaturity, which is a

prominent feature of most developing countries. Due to these challenges,1 developing

countries are more prone to economic fluctuations compared to advanced countries.

Myint ( 1965) pointed out that due to the market imperfections of the less-developed

countries such as the immobility, indivisibility of resources and the imperfect

knowledge, the free market allocation of the developing countries deviates from

the optimum results as estimated from the macro-growth models. According to a

comparative study on the major developing economies, Ogaki et al. (1996) found

that for countries with relatively low income levels, the rising real interest rates that

typically accompanies financial liberalization not necessarily lead to higher private

savings and economic growth. Hence policy tools are needed to promote financial

1In addition to these three reasons, we acknowledge that there are some other factors that might lead to or

exacerbate macroeconomic fluctuations in developing countries. For example, the elasticity of supply in

developing countries is, in general, smaller than in developed countries due to the defects of the supply

system. Therefore, a trivial exogenous shock for developed countries may trigger severe macroeconomic

fl uctuations in developing countries. As for China, the defects of the supply system were also one of the major

challenges before the mid-1990s. During this time, a small positive demand shock could lead to high infl ation

and severe macroeconomic fl uctuations. After the mid-1990s, this problem was alleviated in China due to the

improvement of the supply system and the expansion of production capacity. In this article, we focus on the

three challenges as stated above and leave other factors for future research.