CHINA US Focus » China’s Economy

China’s Last Soft Landing?

Wed, 30 Jan 2013 07:31:17 +0000

Once again, China has defied the naysayers. Economic growth picked up in the final quarter of 2012 to 7.9% – half a percentage point faster than the 7.4% increase in GDP in the third quarter. This was a meaningful increase after ten consecutive quarters of deceleration, and it marks the Chinese economy’s second soft landing in slightly less than four years.

Stephen Roach

Despite all the talk about the coming shift to internal demand, China remains heavily dependent on exports and external demand as major drivers of economic growth. It is not a coincidence that its last two slowdowns followed closely on the heels of growth slumps in its two largest foreign markets, Europe and the United States. Just as the soft landing in early 2009 occurred in the aftermath of a horrific American-made crisis, this latest one followed the European sovereign-debt crisis.

China has several sources of strength that have enabled it to withstand the tough external shocks of the last four years. Large buffers of saving (53% of GDP) and foreign-exchange reserves ($3.3 trillion) are at the top of the list. Moreover, unlike the West, which has used up most of its traditional countercyclical policy ammunition, China has maintained ample scope for fiscal and monetary-policy adjustments as circumstances dictate. Likewise, a powerful urbanization dynamic continues to deliver solid support for China’s high-investment economy, while enabling relatively poor rural workers to raise their incomes by finding higher-paying jobs in the cities.

Nonetheless, this may be the last time that China can escape an external shock with its growth intact. Premier Wen Jiabao addressed this possibility nearly six years ago, arguing in March 2007 that the seemingly spectacular Chinese economy had become “unstable, unbalanced, uncoordinated, and ultimately unsustainable.”

Since then, many of China’s inherent strengths have been sapped by all-too-frequent external shocks. The banking sector is still digging out from the bad loans extended in the aftermath of the global meltdown in 2008. Finding affordable housing has become an increasingly serious problem for those relocating to cities for the first time. And corruption scandals and the related risks of political turmoil were unsettling, to say the least, in the months prior to last year’s Communist Party leadership transition.

In other words, the vulnerability implied by Wen’s “Four Uns” has increased significantly. China’s economy has certainly become more unstable, with major slowdowns in real GDP growth in 2009 and again in 2012. Its imbalances have gotten worse as well, with the investment share of GDP approaching 50% and private consumption falling below 35% of GDP.

Similarly, China has become more uncoordinated, or fragmented, as its income disparities have continued to widen. And sustainability is being jeopardized by environmental degradation and pollution, which pose a growing threat to the country’s atmosphere and water supply.

In short, China’s growth model has been stretched as never before. And, like a piece of fabric, the longer it remains stretched, the longer it will take to return to its former resilient state – and the greater the possibility that it will not spring back the next time something goes wrong.

The message to China’s new leadership is unmistakable: There has never been a more urgent time to get on with the heavy lifting of rebalancing and reform. Now is the time to implement the measures that will accelerate the transition to a more consumer-led economy.

The agenda is long, but it is hardly a secret. It includes developing the services sector, funding the social safety net, liberalizing an antiquated residential-permit system (hukou), reforming state-owned enterprises, and ending financial repression on households by lifting artificially low interest rates on savings.

Failure to act quickly on this program would leave China far too vulnerable to the inevitable next shock in a crisis-battered world. In the absence of rebalancing, any one of several potential tipping points could seriously compromise the economy’s ability to pull off another soft landing: deteriorating credit quality in the banking system; weakening export competitiveness as wages rise; key environmental, governance, and social problems (namely, pollution, corruption, and inequality); and, of course, foreign-policy missteps, as suggested by escalating problems with Japan.

The Chinese economy has come through two major global crises in the past four years. On the surface, its resilience has been impressive – the first to recover, as Chinese leaders always want to remind the rest of the world. But, beneath the surface, an unbalanced, unstable, uncoordinated, and unsustainable economy risks losing its capacity for resilience. Without rebalancing and reforms, the days of the automatic Chinese soft landing may be over.

I have been an optimist about China for 15 years. I still am. But the clock is ticking. Wen Jiabao’s critique six years ago was a powerful diagnosis of the Old China’s flaws that pointed to the Next China’s hopes and dreams. It remains a blueprint that China’s new leadership cannot ignore. Time is no longer on China’s side. It must act now.

Stephen S. Roach, a faculty member at Yale University and former Chairman of Morgan Stanley Asia, is the author of The Next Asia.

China Looks for Policy Discipline and Structural Advances at G20’s Los Cabos Summit

Xue Lei — Wed, 20 Jun 2012 03:23:18 +0000

The G20 Leaders’ Summit in Los Cabos, Mexico is meeting at a time of extreme complexity in the world economy. This premium forum for international economic affairs is encountering re-emerging signs of financial crisis and economic recession in euro zone economies. But adding to the complexity is that the US government and Congress still cannot forge a clear long-term fiscal consolidation plan. And the growth of emerging economies is starting to slow down. All these elements have thrust the G20 into another challenging and crucial period.

The Los Cabos Summit, on June 18-19, is expected to consider three major issues at the top of the agenda. First is the euro zone economic situation. The biggest worry is the rising policy uncertainty surrounding Greece’s future role in the euro zone. This is coupled with endless and fruitless policy debates among governments, at both a national and EU level, which may invoke the double jeopardy of a sovereign debt crisis and a bank liquidity crisis. The second issue is the disorderly international capital flow as a result of the spillover effect of continuous bailout monetary policies maintained by the central banks of advanced economies. The third is the fluctuation of commodity prices which may damage both consumer and supplier countries.

As the second largest economy in the world, China attaches great importance to the G20’s role. It views the G20 as a more balanced forum which includes on an equal footing both developed and emerging economies. Also, China has been striving to advance the G20’s role from not just a crisis management committee but to being the steering committee for global economic governance. Chinese leaders have been looking forward to the G20 Los Cabos Summit to reconvene the consensus of major economies and showcase again the spirit of we’re all “in the same boat”. Only through this collaborative approach can countries find solutions to the world’s current turbulent economic situation.

The following five issues are causes for great concern to China.

1.Euro zone economic situation

With the systemic importance of the euro zone economy to the world economy, China is watching closely the changing situation in Europe. Just like other countries outside Europe, China wants to see a stable and orderly crisis management process in euro zone countries. But some major points may need to be addressed. First, to reassure market investors, the euro zone countries must maintain a clear and stable macroeconomic policy. They should continue to intensively coordinate their policies and actions to prevent possible major market fluctuations as a response to policy uncertainty. Second, based on the economic scale of the potential countries in need of bailout such as Spain and Italy, the current euro zone firewall plan seems still not enough to address future crises and consolidate market confidence. Euro zone countries may need to raise the cap on available resources and accelerate the pace of funds contributed to the European Stability Mechanism. Third, euro zone countries should weigh carefully the balance between economic growth and fiscal austerity. Any measure they take must not erode the effectiveness of fiscal consolidation policies. Fourth, considering the limited space of maneuverability in monetary and fiscal policy, euro zone countries may need to dig deeper into other policy areas, such as wage reform, increased labor market flexibility and trans-border labors flows, and certain measures to attract and facilitate foreign and domestic investment.

2.Reform of international financial institutions’ governance structures

The 2010 IMF Quota and Voice Reform Package is scheduled to come into effect before the IMF’s annual meeting in November this year. However based on the slow rate of progress in approvals by IMF member countries, the required amendments to the IMF Articles of Agreement are far from completion. And the United States, with the biggest quota and voice in the IMF, still lags behind in presenting the reform package for approval to its Senate. Therefore, China and other major emerging countries need to take a united and stronger stance to push for the reform to come into effect according to the agreed schedule. What must be borne in mind is that IMF governance reform is a necessary precondition for an increase of no less than US$430 billion in resources to the fund. If the IMF really needs the deeper involvement of emerging market economies, it must adapt itself to the changed pattern of global economic power.

3.Impact of disorderly capital flow

The spillover of the bailout monetary policy adopted by advanced economies works mainly through capital flow channels. So we should beware of the potential balance of payment crisis that could result from a sudden stop of capital inflow in emerging and developing economies. China therefore needs to urge the IMF to strengthen its monitoring and assessment of the spillover effect of monetary policies on advanced economies, with provision for timely warning messages to their governments. In responding to such exogenous impacts, emerging and developing economies have the right to take measures such as capital account controls to offset the effect of a global surplus of liquidity. On the other hand, in terms of balance of payment crises suffered by the emerging and developing economies, the IMF needs to increase its resources to address such issues with relatively loose conditions required.

4.Stabilization of commodity prices

Volatile commodity prices have not only put great pressure on the world economy’s recovery, but also led to security-related problems. Generally speaking, the goals of addressing such issues are twofold: to ensure sustainable supply, and to achieve relatively stable prices. Chinese Premier Wen Jiabao presented at the start of 2012 the idea of addressing global energy governance through one organisation, incorporating the supplier, consumer, and intermediate countries into an integrated mechanism to coordinate the interests of different parties. This concept could also be expanded to cover all the different commodities. The major role of such an organization would be to implement a compensation mechanism for environmental damage, a protocol for the sharing and transfer of technology, and a method to stabilize market prices.

5.Multilateral trade talks

As an important member of both the G20 and the WTO, China has a large stake in the conclusion of the Doha Round of trade talks. Its position on the talks is guided by two basic principles. First, is to stick to the nature of them as a development round, giving special and preferential treatment to the poorest developing countries, such as “quota free, duty free” provisions. Second, the Doha Round should adhere to the WTO’s major principle, which is the vivid manifestation of multilateral reciprocity. Therefore, some members should not use certain industries to forge a separate deal.

Xue Lei is research fellow at Shanghai institutes for International Studies.

The Slower Road in China

Brian P. Klein — Tue, 05 Jun 2012 02:06:39 +0000

There’s an unusually cool breeze blowing from across the Pacific as spring gives way to an uneasy summer. China’s stringent government efforts to reign in a clearly overheating economy initially marked a welcome pause in the hottest growth story of the century. The depths of the slowdown, however point to a less manageable set of problems after years of state-led economic development.

Based on recent accounts of U.S. firms including GM, Starbucks and Apple, which are experiencing stellar growth in China, domestic consumers appear to be driving growth. Actually they have taken a back seat in a fast car for much of China’s rise. Their share of gross domestic product has fallen from about 50% in 1980 to under 40% three decades later (consumers account for roughly 70% of the U.S. economy.)

Certainly the average household has more purchasing power today than they did before Deng’s momentous reforms. Salaries are outpacing inflation and mandated minimum wages are on the rise. Beneath the glassy exteriors of newly minted malls and dark tinted sedans in major urban centers lies a harder truth. The much anticipated transition to a consumer-driven economy may be harder to accomplish than most expect.

By the numbers the slowdown appears widespread and deep. April imports dropped dramatically to a mere 0.3% from an expected 11%. Purchasing by the 100 million or so presumed middle class consumers certainly hasn’t kept pace with the largely “on sale” products of an outside world still struggling with recovery.

Exports have been faltering as well and mid-term prospects look bleak. The EU, China's largest export market, confronts the specter of a wider economic crisis spreading from Greece and Italy to Spain, Portugal and perhaps even France. The U.S. faces an extended period of anemic growth with new employment numbers slipping and a housing market still under the cloud of foreclosures and falling prices. HSBC’s Purchasing Manager’s Index has been at contractionary levels for the past seven months. Electricity and rail cargo shipments appear weak as well.

Investors have become increasingly wary. While the Dow Jones Industrial Average has bounced back to near pre-crisis highs, off 11% since 2007, the Shanghai composite index has lost 60% of its value. Foreign direct investment has dropped for the past six months running. Recent turmoil in Europe contributes to this slump, but government policies curtailing foreign control of their own firms may be having a substantial chilling effect as well. The Ministry of Finance’s decision to severely restrict ownership and management of foreign accounting firm’s local subsidiaries will only increase investor concerns. This comes after several corporate scandals have damaged investments in Chinese companies.

Financial concerns continue to gather momentum. In a curious move several banks are going back to the markets to raise fresh capital even after reporting substantial profits and a drop in lending. With so much cash supposedly on hand it is a curious case to make for selling more shares. The banks true debt loads remain obscured by risky side transactions made to avoid government restrictions. These risks are hard to quantify, much as the private U.S. collateralized debt and derivatives markets were (and still are considering JPMorgan Chase's recent $2 billion trading loss). Risks of moral hazard can’t be easily dismissed.

Part of the slowdown was expected after implementing prudent policy to cool the housing market and get inflation under control. Prices continue declining in major markets and inflation has dropped below 4.5%, the latest government target (up substantially from the original 3%, but still well below historical highs.) Now talk has turned back to stimulus. With the beginning of quantitative easing state-controlled banks can now lower their reserve ratios and free up more money for lending. The key question remains, what type of lending?

Some of the previous state-led development has certainly been useful and will likely lead to growth in the future. New low cost housing projects benefiting the poor keeps construction workers employed. Connecting large coastal cities to the interior via new roads provides an important route for manufacturers seeking to lower wages. Garment factories have already begun shifting operations to places like Vietnam and Bangladesh.

Many projects won't give the economy the longer-term boost it needs. While the high speed rail line from Shanghai to Beijing remains a popular route, many of the other lines are priced out of reach for the average traveler. The Ministry of Railways recently announced a plan to attract private investment after posting a $1 billion loss for the first quarter of 2012 after amassing $384 billion in debt.

In tough economic times such as these the private sector takes the hardest hit. They have far less access to capital compared to state-owned enterprises. If debt servicing becomes a problem banks are far less likely to roll over their loans or adjust terms as they do under government supervision. Absent reform China risks hollowing out its dynamic private sector just as the domestic economy begins adjusting to slower days ahead.

The next few months will reveal whether the central government can really turn the growth taps on and off at will. Quality now matters far more than quantity alone. Following through on much needed and talked about reforms to spur domestic consumption will create a more stable environment. Maintaining the status quo will not. Either way, China's economy is changing and so is the world outside.

Brian P. Klein is global macroeconomic and geopolitical strategist. He can be reached at www.brianpklein.com.

Why Is It Difficult for Jobs to Grow in China?

Wu Xiaobo — Fri, 04 Nov 2011 05:47:24 +0000

Following the passing of Steve Jobs, the Chinese media has frequently raised one question: When will China have its own Steve Jobs? Even the Reference News, a daily newspaper known for its seriousness, had a headline on its front page, reading ‘China Calls for Innovative Talents Like Jobs.’

In China there are four traditional barriers to the growth of private businesses.

The first barrier is the division between state capital and private capital, with the former monopolizing the upstream resource and energy industries and the latter controlling the consumption sector at the middle and lower reaches. This has created an unprecedented disconnect between various sectors of the economy.

Fernand Braudel, a French historian of the Annales School, was an expert on capitalism. He has classified markets into two categories, the low-end market consisting of bazaars, stores and pedlars, and the high-end market made up of the resource industry, exchanges and trade fairs. Based on a study of economic growth of various countries, he came to the conclusion that ‘China boasts the most perfect economic entities at the lower end of the market ladder, where it is almost possible for one to figure out the volume of a market simply by referring to its geographic location.’ At the high-end of the market, however, China has always exercised strict government control, totally banning free trade. ‘In China, businesses and bankers are allowed to invest in the public utilities sector under legal protection and with government encouragement. Political rating is given overwhelming priority. Whenever capitalism gets a chance and develop to some extent, totalitarianism will come up and force its retreat to the starting point,’ as Braudel has believed.

The business world that Steve Jobs knew is of stark contrast to the Chinese market.

The second barrier is the absence of a contractual link between the government and the private sector, which has denied a guarantee to the accumulation of private capital.

Individually speaking, all Chinese business people strive for larger profits through a variety of investments. They are also as hardworking and frugal as advocated by Max Weber in his Protestant Ethic, and take wealth accumulation as their goal in life. In this sense, they are no less outstanding than Jobs. When it comes to the relationship between the market and the power over its rule, however, the underlying difficulty for the market economy to develop in China prominently reveals itself. The right over properties and their inviolability, as prescribed in law, is a code governing the relationship between the ordinary people only. It never has anything to do with the relationship between the citizens and its ruler who enjoys limitless power and influence over the former’s personal and property rights.

The third barrier is the tyranny of crony capital, the prevalence of rent seeking, and the feverish aggregation of wealth around power, resource and land. Instead of accumulating and multiplying in the production sector, social capital has come to been distributed and redistributed at the circulation link, totally eroding the soil for the growth of technical revolution.

Upon introduction of the state monopoly system, the Chinese government had to install a system for state-owned enterprises. Due to factors such as ambiguity of property rights and fuzziness of authorization, however, a crony economy has developed. Those in positions of power are acquiring resources in the name of the state, dividing up wealth in the name of market operation, and vying with each other to seek personal gains.

At the same time, private businessmen have managed, through rent seeking, to earn incredible profits, giving rise to a possible clash between the government and the private sector. Ever since the Song Dynasty, the mostwealthy businessmen in China have always been the so-called ‘red-tops.’ All of them have earned their fortunes through government authorized monopolies. This is a deeply rooted business model and the chances of a change are slim. These businessmen are anything but enthusiasts for technical advancement or R&D investment.

Policy-backed rent-seeking is extremely disgraceful and hardly possible in Western business culture. Here in China, however, it has been the prevailing practice.

The last barrier is the anxiety constantly haunting private business businesses struggling under the dual pressure of state-owned and crony capital. The greatest fears of these businesses stem from the flow of industrial capital from production to consumption, and the loss of the innovative engine driving economic growth.

Long long ago in 200 B.C., Si Maqian, a great Chinese historian, developed a theory on wealth accumulation in the industrial and business sectors. First, industrialists earn more than farmers but less than businessmen; and second, the best way to secure wealth is to turn earnings into real estate investments. It is true that over the 2,000 years since then, Chinese businessmen have accumulated astonishing amounts of wealth through development of family-based businesses or promotion of business alliance. Nevertheless, they haven’t enjoyed independence in terms of economic interests or political status. Neither have they got any legal protection of their property rights from infringement by the ruling class. When people say it is impossible for a Chinese family to remain rich for more than three generations, they do not merely mean that Chinese businessmen are not intelligent enough to keep accumulating wealth for any longer than three generations. They imply that wealth accumulation depends on the relations between its owners and those in power, which are inevitably fragile and asymmetrical. As a result, the sustainable accumulation of wealth and its safety is not under the total control of the wealth owners. When it comes to wealth inheritance, the ability to maintain the government-business relationship will be far more important than the ability to expand businesses or to aggregate capital.

These four traditional barriers to private-sector growth are the basic features of China’s present-day business world. They also may lend an answer as to why a Chinese Steve Jobs has yet to emerge. Unless thebusiness environment is changed, it will be useless for us to search for talents like Steve Jobs in China, regardless of how loud or hysterical our voice may be.

Wu Xiaobo is a columnist long dedicated to the research of Chinese companies.