Microsoft Word EcRefChina Oct06. doc

stability
of factor income is vital from a social 
point of view. This holds, in particular, for the poorest sections of the population, since 
their margins in terms of misery are especially narrow. Policies that smooth 
macroeconomic fluctuations may therefore be regarded as a first line of defense against 
income instability.
112
So far, however, it would seem that the Chinese government has not 
been very active in the field of short-term macroeconomic stabilization policy. In so far as 
such policies have been pursued at all during the last decades, they mainly seem to have 
taken the form of direct quantitative regulations of investment and credit flows rather than 
monetary and fiscal incentives, presumably because public-sector firms have been 
regarded as quite insensitive to economic incentives. However, as the economic system 
gradually becomes more incentive-oriented, stabilization policy can rely increasingly on 
such incentives. 
110
According to OECD (2005b), total agricultural support in China today amounts to 6-8 percent of gross farm 
receipts. 
111
For instance, the Tax-for-Fee reform a few years ago (which shifted tax revenues from local governments to 
the central government) seems to have had this purpose; see, for instance, Luo et al. (2006). 
112
On the basis of a dynamic simulation model of the Chinese macroeconomy, Zhang (2001) reports 
that temporary external shocks tend to reduce the growth path of the economy for a considerable period 
of time (several years). Of course, this is not unique for China. 

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57
A successful stabilization policy is important not only because it contributes to income 
stability. Experiences from various countries also suggest that GDP growth may be 
harmed for a prolonged period of time as a result of temporary macroeconomic shocks. 
This experience underlines the importance, even in a long-term perspective, of a 
reasonably successful macroeconomic stabilization policy.
Moreover, the financial crisis in Asia in the late 1990s vividly illustrates the risk of 
instability of factor income as a result of instability of foreign capital movements. More 
specifically, this experience confirms the advantage of exercising prudence when 
accumulating large stocks of short-term loans in foreign currency, in particular without 
hedging against exchange-rate fluctuations. While the domestic financial situation in 
China has obvious weaknesses (exemplified by the large volumes of soft loans), the 
country has been more prudent regarding international financial exposure.
113
One 
example is that China has recently run a non-trivial current account surplus in its balance 
of payments, another that the authorities seem determined to delay full currency 
convertibility on the capital account until a well-developed financial infrastructure and 
appropriate monetary and financial policies are in place.
114
Special types of policy measures to stabilize factor income in agriculture are also 
potentially important from a social point of view since about half the population is still in 
the agricultural sector. One possibility is to opt for policy measures that encourage 
counter-cyclical inventory holdings of agricultural products (buffer stocks) for the 
purpose of stabilizing the prices of such products, and hence revenues for farmers (since 
the price elasticity of demand for farm products is low). However, the more the markets 
for Chinese agricultural products become integrated with world markets, the less useful 
will such programs become. Moreover, as emphasized by Blanchard and Giavazzi (2005), 
there may be a conflict between ambitions to boost incomes for the rural population and 
to allow better market-adjusted exchange rates. The reason is that an appreciation of the 
113
In recent years, however, China’s 
short-term
foreign debt has increased to 46 percent of the total 
foreign debt of 233 billion dollars by mid-2005 (
China Daily
, June 9, 2005). 
114
It is somewhat doubtful, however, whether capital controls are particularly effective today for the purpose of 
stabilizing foreign capital flows. Prasad et al. (2005) have instead proposed that convertibility of the yuan 
should be delayed until a flexible (basically floating) exchange-rate regime has been created.

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58
yuan 
would tend to redistribute income to the disadvantage of agriculture (because China 
is increasingly a price taker on markets for agricultural products).