Business Cycle Accounting: China vs. India

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Business Cycle Accounting China vs. India

• Christer Ljungwall and Gao Xu

China Center for Economic Research, CCER, and
the Stockholm School of Economics. World Bank
Office, Beijing, China (EASPR). The findings,
interpretations, and conclusions expressed in
this paper are entirely those of the authors.
They do not necessarily represent the view of the
World Bank, its Executive Directors, or the
countries they represent.
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Outline

• Motivation
• Literature Review
• Quantitative Method (Business Cycle Accounting)
• Benchmark Model
• Accounting Procedures
• Empirical Findings
• Comparison of Business Cycle Facts
• Comparison of Business Cycle Accounting Results
• Conclusions

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Motivation

• The rise of China and India is one of the most
  significant economic developments in nowadays
• Great achievement of human development better
  life for 1/3 of world population
• Major representatives of emerging markets BRIC
• Big players in the global market made-in-China,
  service outsourcing into India
• Similar development path of China and India
• Start point planned economy of China and rigid
  state control in India
• Market oriented reform and integration into the
  world economy

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Motivation

• Differences between China and India
• Average growth 9.8 of China vs. 3.4 of India
• Investment-led growth pattern of China vs.
  consumption-led growth in India
• Strong competitiveness of Chinas manufacturing
  sector vs. advantages of service outsourcing in
  India
• It is of both theoretic and practical interest to
  compare China and India within a rigorous
  quantitative framework

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Literature Review

• Business Cycle Accounting (BCA)
• Proposed by Mulligan(2002) and Chari, Kehoe and
  McGratten (2007)
• A DSGE model with time varying wedges
• Measure the wedges so the model replicates data
  exactly.
• Inspect measured wedges to analysis shocks.
• Application Chakraborty (2004), Kobayashi and
  Inaba (2006) to investigate Japans recession.
  Lama (2005) used it to identify business cycle
  sources for Argentina, Brazil and Mexico.
  Cavalcanti (2004)

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Literature Review

• Business cycle research on Chinese economy
• Descriptive study and summary statistic
  calculations Qian (2004), Lu and Qi (2006), Liu
  (2006)
• SVAR Zhang and Wan (2005), Xu (2007)
• Little quantitative research on Indian business
  cycle fluctuation

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Benchmark Model

• Model setup
• Household
• Firm
• Resource constraint

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Benchmark Model

• Four wedges (shocks)
• Efficiency wedge
• frictions which cause inputs to be used
  inefficiently
• investment wedge
• financial frictions, etc.
• labor wedge
• sticky wage, powerful labor union, etc.
• government (exogenous demand) wedge
• government consumption, net exports

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Benchmark Model

• Equilibrium conditions
• Optimal condition for consumption-leisure choice
• Euler equation
• Production technology
• Resource constraint

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Accounting Procedures

• Shocks
• Estimation of wedges
• Log-linearize equilibrium conditions
• Solve linearized system with Blanchard-Kahn
  (1980) method
• Use Kalman filter to write likelihood function
• Estimate parameters with MLE combined with prior
  from long-run relationships (Bayesian approach)
• Estimate wedges with Kalman smoothing algorithm

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Accounting Procedures

• Counterfactual experiments
• Marginal effect of each wedge let one wedge
  fluctuate and keep the rest fixed, and simulate.
• Effect of a combination of wedges let a subset
  of wedges fluctuate and keep the rest fixed, and
  simulate.
• Data
• Annual GDP by expenditure data, deflate nominal
  variables with GDP deflator to construct real
  series.
• 4 observation series (to avoid singularity
  problem) GDP, private consumption, investment,
  government consumption plus net exports (all are
  log deviations from their HP trends).

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Comparison of Business cycle Facts

• Growth rate
• China high and persistent
• India relatively low

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Comparison of Business cycle Facts

• Expenditure structure
• China significant role of investment
• India predominant role of private consumption
• Similarity Shrinking relative size of private
  consumption

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Comparison of Business cycle Facts

• Business cycle fluctuation
• China big output fluctuation, even bigger
  consumption volatility, high output persistence,
  investment lag output
• India small output fluctuation, smaller
  consumption volatility, less output persistence,
  investment co-moves with output

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Comparison of BCA Results
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Comparison of BCA Results
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Comparison of BCA Results

• Main driving force in both countries efficiency
  wedge (Solow residual)
• Important role played by technology advances and
  infrastructure change
• Missing factors of RBC model
• Bigger damping effect of labor wedge points to
  more labor market rigidities in India
• Ignorable roles played by financial frictions and
  government consumption in both countries

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Conclusions

• Both of China and Indias business cycle
  fluctuations are mainly driven by efficiency
  wedge (including technology advance and
  institutional change)
• More rigid labor market (sticky wage and powerful
  labor union) is spotted in India
• Minor roles played by financial frictions and
  government consumption in both countries

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• Thanks!
• comments welcome