TFP

China: Deleveraging is Hard to Do

For the first time in nearly three decades, Moody’s recently downgraded the long-term sovereign debt of China, lowering its rating from Aa3 to A1. As is frequently true in such cases, the adjustment was overdue. Since China’s massive fiscal stimulus in 2008, the government has experienced a surge in contingent liabilities, as its (implicit and explicit) guarantees fueled an extraordinary credit boom that continues today.

While the need to foster financial discipline is obvious, the process will be precarious. Ning Zhu, the author of China’s Guaranteed Bubble, has compared the scaling back of state guarantees to defusing a bomb. China’s guarantees have distorted incentives and risk taking for so many years that stepping back and allowing market forces to operate will inevitably impose large, unanticipated losses on many people and businesses. Financial history is replete with failed policy efforts to address credit-fueled asset price booms, such as the current one in China’s real estate. There is no safe mechanism for economy-wide deleveraging.

China’s policymakers are clearly aware of the dangers they face and are making serious efforts to address them. This year, authorities have initiated a new crackdown aimed at reducing the systemic risks that have been stoked by the credit boom. This post focuses on that policy effort, including the background causes and what will be needed (aside from good fortune) to make it work....

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Understanding Business Dynamism

For at least the past 30 years, the rate of U.S. business formation has been falling and the average age of existing firms has been rising. Since 2000, two other things have happened: productivity growth has slowed, while many skilled jobs have disappeared. Startups are thought be a key source of innovation in the economy and of net job creation. At the same time, as Schumpeter’s notion of creative destruction suggests, the death of old firms is a critical part of the renewal process. So, the declining trend of entry and exit has people worried that U.S. business dynamism is ebbing (see our earlier post).

How concerned should we be? To be completely honest, we don’t really know; at least, not yet. But the answer is important, because it can help orient the U.S. economic policy framework to support the creation of successful businesses that generate high-quality jobs. In this post, we summarize some new research aimed at helping us understand what the decline in business formation really means. Does it signal a fall in the number of successful firms that contribute substantially to business value added, productivity, and employment? Or, is it a decline in the formation of firms that never exceed a tiny scale and have little impact on the broader economy?

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