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CONFIDENTIAL #3
14
efficiency of production and the development of a rational
market.
The fiscal burden on the state is, however, the
(15) China now spends.
same as with producer subsidies about 14% of its budget on price subsidies (paragraph 17) and any attempt to cut these would cause great public
resentment.
22.
One
Somewhat similar in effect to price subsidies and also being considered by some local authorities in China is wage indexation. By this means, the urban employees can be protected from price increases. major drawback of this approach is that there is a high risk of a wage/price spiral developing, similar to those At worst, experienced in some Latin American countries. an hyper-inflationary situation could develop with the economy deviating further and further from a non-inflationary equilibrium position.
Repercussions of inflation in China's economy
(a) Income re-distribution caused by inflation
23.
In a large and relatively closed economy like China, inflation should not be a major problem if everyone's income is increased by the same relative amount. In practically all cases, however, inflation,
(16) unless it is fully anticipated
involves a
redistribution of income.
1
(15) According to some news reports, part of these
consumer subsidies have to be borne by state enterprises and institutions, unlike producer subsidies which were wholly borne by government.
(16) If inflation is fully anticipated by the government
and people, producers and consumers, employers and employees, and lenders and borrowers, they will make the necessary adjustments so as to eliminate the income re-distributions caused by inflation.
CONFIDENTIAL #3