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Cover Stories Series 2012> A Roadmap for Change> Archive
UPDATED: October 15, 2012 NO. 42 OCTOBER 18, 2012
A New Crossroad

Two solutions are needed to fundamentally solve the crisis. First, problematic countries must strengthen structural reforms in the labor market to enhance their competitiveness. Second, the euro zone must accelerate its integration process and establish a more uniform European fiscal union.

Although structural changes may take time, the market cannot wait. The huge pressure of the sovereign debt market and the continual decrease of bank deposits in periphery countries indicate that the euro zone cannot wait until reforms are complete. In creating policies to cope with the crisis, euro zone governments have been unable to catch up with market developments, creating more pressure on the ECB.

Another difficulty facing Europe is how to manage the economic and social consequences of austerity. The core of structural reforms is to improve the flexibility of the labor market, cut redundant staff and reduce salaries, welfare and public spending. Austerity will then bring in lower revenue and slow the pace of reducing fiscal deficits.

To break the vicious circle, the euro zone needs to not only relax its monetary policy, but also increase investment and maintain economic growth. Therefore it is of vital importance to attract investment from the private sector. In this respect, we have seen some signs of improvement.

Changes to come?

The slowdown of economic growth in China casts a shadow over the future of the global economy. Although it is believed to be cyclical rather than structural factors that have caused the current economic downturn, the Chinese economy is sure to face significant challenges in the next three to five years.

Structural challenges come from both supply and demand. In terms of demand, the 2008 financial crisis and the following stimulus package caused a shift from external demand to domestic demand, and China's trade surplus dropped from 9 percent to 2 percent of the GDP in 2011. Rapid growth in domestic demand over the last few years was mainly driven by massive investments in infrastructure and real estate projects, which is hard to sustain in the long term.

In order to maintain solid growth in the next 10-15 years, an increase in domestic consumption brought on by mass urbanization is needed.

In terms of supply, growing labor costs could hamper competitiveness. Rising incomes could help fuel domestic spending, but increasing labor costs could curb further economic growth.

Labor cost increases could ultimately change the face of the Chinese industry. The government—through education, training and investment—must find ways to improve productivity in the face of growing labor costs while maintaining flexibility to changes in the labor market.

The U.S. economy has its own challenges.

Since the outbreak of the sub-prime crisis in 2007, the U.S. economy has changed significantly. After years of de-leveraging, the proportion of individual debt to disposable incomes has declined to the 2004 level. Benefiting from the ultra-low interest rate policy set by the Federal Reserve, the proportion of debt payment to income is also reaching a historic low. In the past year, individual loans have recovered remarkably, indicating that individual debt is no longer a major obstacle blocking economic growth. Also, for the real estate and banking sectors, which were heavily pummeled by the crisis, the worst seems to be over.

Despite the above structural improvements, fiscal problems will still likely restrict U.S. economic growth.

U.S. public debt has surpassed $16 trillion. At this point it is premature for the country to tighten its fiscal policy. But in the next three to five years, once the economy sees steady recovery, improving its fiscal health should be of the highest importance.

Because of the U.S. dollar's status as an international reserve currency and minimal risk taking due to the European debt crisis and worldwide low interest rates, the U.S. Government can now finance at extremely low costs. Therefore when the global economy picks up, the most strenuous period for the U.S. economy may follow.

Email us at: yushujun@bjreview.com

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