Read the following article. Based on what you have learned in Chapter 2 about the different kinds of economies and the effect that they have on people and firms, post your thoughts on the situation that China is in.
http://money.aol.com/news/articles/_a/china-turns-to-economic-controls/n20080210173109990007
China Turns to Economic Controls
By JOE McDONALD,
AP
Posted: 2008-02-10 17:31:20
BEIJING (AP) - Fighting stubbornly high inflation, China’s leaders dusted off a blunt
tool from its pre-market reform era and commanded utility companies to freeze electricity prices. Households got temporary relief after that September order, but the capitalist-style economy produced unwanted consequences. Coal shortages cropped up as power companies cut back on buying and
mines reduced production. Freak snowstorms over the past month caught power plants with dangerously low stocks, resulting in blackouts and factory shutdowns. While the easy ability to rule by fiat often makes the communist government appear nimbly responsive to crises, economists warn that the approach does not always work in an economy as headily capitalist as China’s. “Using a prescription from the planned economy to cure the market is absurd,” the Economic Observer, a prominent business newspaper, said in a recent editorial. Beijing’s resort to command economy decrees has not been confined to electricity alone. Beset by inflation galloping at a decade high of more than 6 percent, the government has steadily widened price controls, finally freezing all food prices last month as well as clamping limits on fertilizer prices and raising price supports for rice and wheat. The controls are meant to shield China’s poor and working classes, who spend up to half their incomes on food. But the inflation spike is blamed on shortages of pork and grain, and economists warn that putting a lid on prices just shifts the hardship to farmers, discouraging them from raising output, which would bring down high prices. “It’s a balancing act - whether the government wants to control inflation or whether it’s going to make sure there is abundant supply for these very basic, important goods,” said Jing Ulrich, chairwoman of China equities at JP Morgan. Stabilizing food costs will require Beijing to ease market controls and increase grain imports, Ulrich said. “It’s a long-term issue, but it’s becoming very critical right now at this juncture,” she said. Beijing’s anti-inflation tactics highlight its continued reliance on the tools of communist central planning in an economy that depends on private business for its dynamism. Normally, prices for meat, vegetables, clothing and consumer goods are set by the thriving free market. But the government dictates those for one-third of goods, including gasoline, fertilizer and other basics. The Communist Party’s willingness to reduce its economic role since 1979 has let business flourish, igniting a boom that saw gross domestic product growth soar last year to 11.2 percent.
Still, when it comes, intervention is often more dramatic and sweeping than other major countries would dare to try. And the costs often are high. Take Beijing’s efforts to shield people from rising oil prices, for example. Over the past two years, state-set retail prices for gasoline and diesel have been kept low. But the low
prices drove up fuel consumption by more than 20 percent a year. That boosted demand for expensive oil imports and hurt conservation efforts. Oil companies were squeezed by rising crude costs, so they skimped on expanding refining capacity. That set off a diesel shortage in October that left truckers lined up at filling stations and threatened to disrupt key export industries. Prices were raised by almost 10 percent in November to curb demand but are still among the world’s lowest. Food costs - which rose 18.2 percent in November - especially alarm communist leaders. Though the government first tried to encourage farmers by offering free vaccinations for pigs and higher grain subsidies, the measures had little effect. So it then took a more drastic step in January and barred food producers from raising prices without permission.
Similar tactics worked in 1993-94 to crush 20 percent-plus inflation. Companies complained bitterly but price hikes eventually abated and China began a long expansion. More than a decade later, the economy is bigger, more complex, more dependent on private business and less obedient. “Fighting inflation naturally becomes the primary official goal,” said the Economic Observer. “But this goal should not be achieved by price controls or by transferring costs to companies.” The newspaper said instead authorities should be cracking down on price-fixing. The government has given no indication of who will pick up the tab this time. The oil suppliers want compensation, especially after they were ordered to import millions of barrels of diesel to ease the October crunch. To ease the electricity shortages, thousands of trainloads of coal were rushed to power stations and hundreds of mines were kept running through the Lunar New Year holiday. And with the price of coal forecast to climb by up to 100 percent this year, Beijing has yet to say how power companies will cope. In all, the power shortages and disruptions in the delivery of goods brought on by energy price caps could instead wind up fueling inflation, according to Goldman Sachs economist Hong Liang. “These latest developments will likely push up near-term inflation to levels that will be very uncomfortable for either the policymakers or China’s investors,” Liang wrote in a report to clients.
02/10/08 17:30 EST