Twofish's Blog

January 28, 2008

China macroeconomy policy – The Mirror World

Filed under: china, finance — twofish @ 7:02 am

The important thing about the dividends is that this is the first time that the PRC government has asked for dividends from the state owned enterprises. This is in part because this is the first time that SOE’s are making profits.

I think that in the PRC dividends are likely to be anti-cyclic. When the economy is booming, corporate profits are high, and having the state take dividends from the SOE’s and do something like buy back borrowing creates a Keynesian cooling of the economy. When the economy is in a down cycle, dividends are smaller which leaves more money for the SOE’s to invest.

Dividends are likely to play a different role in the PRC economy than in other economies for two reasons. Dividends in the PRC are going to mostly to the state, which means that they are basically a form of taxation. The second unique feature of the PRC economy is that most investment spending doesn’t go through the banks, but rather through invested reserves from the state owned enterprises. Hence, dividend policy is likely to be more effective than interest rate changes.

In fact, one possibility is that interest rates in China might work the reverse than they do in the West. Most companies in the West are consumers of capital. When interest rates increase companies borrow less and so the economy slows. In China, enterprises have large cash reserves so when interest rates increase, this provides more return to the companies which allows them to spend more.

For households, the possibility exists that interest rates are a Giffen good. When interest rates decrease, households save *more* in order so that they can spend more on funding social welfare and pension needs. So when interest rates increase, households save *less* so sense they have more money available.

This would nicely explain why interest rates increases in China don’t cool the economy and why other tools like dividends, reserve rates, and forced sterilization are necessary.

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