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Shi Zhengfu:Changing Reality and Theoretical Innovation



Shi Zhengfu is the director of Center for New Political Economy of Fudan University. He is the author of several publications, including Structure and Management of Modern Enterprise, Socialist Macroeconomic Analysis (co-author), and a dozen of papers. The following is the transcript of Professor Shi Zhengfu’s speech.

 

Theories take reality as the study object. An unchanged theory will never match with the changing reality. Major theoretical reforms certainly follow major reality reforms. Generally, economics theories today is about economics of industrial capitalism, which features a study object of the real economy. The biggest change in the past three decades is that industrial capitalism is turning into global financial capitalism. The reason I use the term “capitalism” instead of “market economy” is that the former is commonly adopted in English. There are three major reality reforms last month that economists do not attach importance to; therefore, I think it will result in failures of seven to eight main existing economic theories.

 

The first reality reform is that currency is no longer currency. Although we still say that traditional currency possesses intrinsic value and it is a special commodity, currency is a piece of paper today. The U.S. dollar is no longer associated with gold, but it is true that this piece of paper has been universal for decades.

 

The circulation of paper money is determined by the political decision-making of a country. Issuance of U.S. paper currency leads to a result that the total amount of paper currency is far beyond the amount required by traditional production and operation of GDB. It brings about the second phenomenon that I call “the internalization of the financial industry”. In the past, the financial industry is an intermediary industry of service institutes that connecting depositors and investors. Now, it is known that the major part of the financial system is no longer intermediary services; instead, it is a self-service, self-circulated distribution system creating profits and loss in transactions with financial derivatives. So the second financial industry is “self-circulated finance” which ranks higher and has larger scale compared with the intermediary finance. Before the 2007 subprime mortgage crisis, the transaction amount of financial derivatives registered 600 trillion U.S. dollars, which declined to 30 trillion U.S. dollars after outbreak of the crisis. 600 trillion U.S. dollars was several times more than the global GDP, but the amount shrunk to 30 trillion U.S. dollars in a short period, so we can understand that the financial industry is no longer the same industry it used to be. The fundamental contribution to the large-scale financial industry today is the development of financial derivatives, and the financial derivative is to convert most major production factors to financial investment goods. Although it can be dated back to 19th century, the financial derivative only achieved the large-scale development in the past three to four decades. From petroleum to cotton and to corns, soybeans and metal, exchanges convert a wide range of production factors to investment goods.

 

I talk about this because of the greatest difference between investment goods and general goods. General goods are for personal use. We can buy less when they are expensive and more when they are cheap. But investment goods are different. We may buy more when it is expensive because we expect the price will continue to increase. There are investment goods experiencing long-time price rise, because higher prices lead to more demands, which drive prices continue to go upward. It is called positive feedback, which is the opposite of the negative feedback required by the general economy.

 

It brings about a big problem: production factors in the market and other financial derivatives form new prices in the financial market, which challenges the first economic theory, general equilibrium theory. The pricing of assets in the modern financial market is no longer consistent with the equilibrium pricing, and there is phenomenon of going with the tide in bulk investments, which is a premise in behavioral finance. Investors even large investors appear, and new profit-making approaches are created. It is known that the root cause of the success of Adam Smith’s “invisible hand” is what he emphasized: all for one and one for all. That is I provide supply to the society. The current financial asset pricing should be called as “constructing the price”. It is reasonably constructed by spontaneous interaction of the national policy, the mainstream capital market and the market. The process can be illustrated with a model.

 

The second theory is marketing theory. Whether the general goods market of a liberal economy is effective and whether it has international competitiveness is determined by the fundamental factor market. It means whether a strong factor supply environment of a country can take shape in the fundamental factor market with investment behaviors. The factor supply environment is formed by the interaction among the national capital and spontaneous market forces. It can explain the 500-year western development and the tragedy of the developing countries.

 

The third theoretical impact is on monetary theory. The quantity of money needs to be expanded. Originally, MA equals PQ. The price in the quantity of money is the price of logistics and services rather than that of financial goods. Now the price of assets needs to be added, which means material price and asset price constitute the new price index. Inflation in macroeconomics usually refers to the material price. Secondly, in addition to the real economy, a large part of money demand flows into the virtual economy. Thus, the measurement of the amount of money and the concept of appropriate amount of money are all changed.

 

The fourth is that the transmission mechanism of monetary policy begins to fail. We’ve mentioned money, interest and investment. Now, the relation between money and interests is not always effective. Money doesn’t always influence interests, and interests don’t always determine investments. I find it is the liability of monetary market instead of the interest investment that influences the economic growth. The economic growth mainly relates to whether liabilities are on the productive capital or the virtual economy.

 

The last is the central bank. The theory and the nature of the central bank are different. It is believed that fiscal monetary policy supports the economic growth. The central bank has become a purchaser of micro assets and engaged in market transactions directly. Purchasing “toxic assets” is the most obvious behavior, as well as purchasing shares of large companies. There is more (due to limited time, I only mention it). In conclusion, new economic doctrines generate ongoing intrinsic reform requirements. It is critical that economists can face the reality and conduct independent research based on major reality problems. We hope academic progress in economics can be achieved by combining the research with practices in China.

 

(Organized based on the record)

 



◆please indicate the source if authorized: National Economics Foundation

◆photo:National Economics Foundation