Article :: Key for a prosperous economy

Economic downturns and crisis are mainly a result of a lack of long-term strategies, and mismanagement of the countries’ economies in Latin America and Asia. In an attempt to develop the Mexican economy, the increasing and unsustainable social polarization triggered Luis Colosio’s assassination, which in turn, caused negative expectations that led to a deep depreciation of the Mexican peso, and to a strong economic recession in 1994. Similarly, an inflexible Convertibility Plan that made Argentina’s competitiveness suffer when the U.S. dollar strengthened relative to most other currencies, several resignations due to corruption scandals, high taxes, contradictory IMF policy requirements, and strong capital outflow restrictions led to an economic deep crisis in 2001. The strong economic dependency on international interest rates, the unregulated banking sector, and the Asian crisis in 1997, contributed to the crisis in Chile, who relied on Asia for one-third of its exports. Yet, it was only Chile who successfully fine-tuned the variables of its economy, and regardless of the situations, managed to avoid a deep economic crash.  It is not the government tendency – left, center or right – but the mismanagement of the economic variables that lead to economic disasters.

One of the most important lessons of these crises is that countries cannot have the luxury of relying on one particular foreign economy, such as that of the United States, nor on a particular market, as Asia was for Chile. For a developing nation it is extremely important to diversify its exporting market to avoid sudden downturns, as well as to manage all the variables that determine the health of the economy. It is interesting to see that Mexico and Argentina made several changes in their policies in an attempt to adjust to the current economic situations, but unfortunately, lacked a clear development strategy for the long term. Nationalizing and then privatizing companies and banks, increasing and then decreasing trade barriers, regulating and then de-regulating banking sectors, raising and then falling domestic interest rates, imposing and then relaxing conditions for capital inflows and outflows, etc, were some of the mismanaged variables. Therefore, it is clear to see that there is no one particular recipe for economic success, but a series of variables that need to be managed or fine-tuned on a regular basis, and on the appropriate time in order to successfully adapt to the changing conditions of today’s globalized markets. However, not only adjusting variables is necessary, but also having a clear development strategy is essential.

In 1976, Deng Xiaoping took control of the Communist Party in China, and introduced a socialist market economy based on a strategy of several reforms in the agricultural sector, state-owned enterprises, the banking sector, international trade, and foreign investment. Such reforms continued after Deng’s death in 1997, and are still in place, led by Hu Jintao, and constitute China’s development policy, which has led the country to be considered the second-largest economy. China is, therefore, a good example of a country with a clear and strong strategy that has allowed it to successfully face market challenges and maintain economic growth. However, under the current global situation, China faces further challenges that will have an effect not only on the U.S. economy, but also on the world’s economy.

China’s move of its exports up in the value-added chain has created tensions with its trade partners, especially the U.S.A. Some argue that China’s maintenance of an undervalued fixed exchange rate against the U.S. dollar has allowed Chinese goods an unfair advantage in the U.S. market, hurting U.S. employment. Nonetheless, many U.S. observers disagree with such conclusion, arguing that if the Yuan were to rise, U.S. imports from China would fall as China loses competitive position to other low-wage economies, and such reduction of imports would not necessarily increase output in American factories because China’s exports to the U.S. would be replaced by another low-wage country. In addition, growing capital inflows into China through FDI put further pressure on the exchange rate, so in order to keep the value of the Yuan from rising, China’s central bank purchases dollar assets, such as U.S. Treasuries. As a result, an increasing foreign exchange reserve has built up, but such money has not been invested to develop the Chinese domestic economy. Thus, huge income inequalities have grown, along with massive rural unemployment, which in a period of political instability may scare investors out of the country, and cause an economic crash.

China’s decisions and actions will, therefore, have an impact on the value of the U.S. dollar, and as a result, affect hundreds of individual investors and firms whose capital has been invested in the American economy, as well as in the Chinese economy. In other words, if China appreciates its currency it will not only lose competitive position, but also decrease the value of the U.S. dollar, which may lead to an economic disaster. But if it keeps the Yuan at its current value by investing in dollar assets, the Chinese economy may collapse due to the growing inequalities, which in a period of political instability may scare investors out of the country. Of these two possible scenarios, the latter is more likely to occur, because keeping the Yuan at a low value guarantees the regular functioning of the Chinese economy, and maintains investors’ confidence in a strong U.S. dollar at the same time. In the meantime, China may look for ways to invest in programs targeted to reduce its social inequalities, making sure to keep under control the events that may scare investors out of the country. Thus, the potential for a global financial crisis decreases significantly.

However, some may still argue that China’s maintenance of an undervalued fixed exchange rate against the U.S. dollar still hurts U.S. employment. Nevertheless, if the most recent announcements of President Obama in Congress about investing in infrastructure to create jobs, creating and developing alternative sources of energy, and improving the education levels of the American society are successfully put into practice, the result of such investments may bring the American labor back into a level where it will be able to compete with those of other nations. As Thomas Friedman explains in his book “The World is Flat”: In a flat world, low wages will not be the only variable that will grant competitive advantage to a country, but also knowledge will play an increasing role for developing and competing economies.

All in all, having both a clear and long-term development strategy, and appropriately managing economic variables is key for maintaining a prosperous economy. China is a good example of a country with a clear and strong strategy that has allowed it to successfully face market challenges and maintain growth. In addition, China’s decisions and actions will have an impact on the global economy, hence keeping the Yuan at a low value guarantees the regular functioning of the Chinese economy, and maintains investors’ confidence in a strong U.S. dollar at the same time. Thus, the potential for a global financial crisis decreases significantly. Furthermore, current U.S. government development policies may bring the American labor into a level where it will be able to compete with those of other nations around the world, regardless of which nation pays the lowest wages.