According to the China Banking Regulatory Commission, shadow banking (all credit not regulated by the same standards as conventional bank loans) increased from ¥800 billion ($130 billion) in 2008 to ¥7.6 trillion in 2012 (roughly 14.6% of GDP). Total off-balance-sheet banking activity in China – composed of credits to property developers (30-40%), local-government entities (20-30%), and small and medium-size enterprises (SMEs), individuals, and bridge-loan borrowers – was estimated to be as high as ¥17 trillion in 2012, roughly one-third of GDP.

The term “shadow banking” gained prominence during the subprime mortgage crisis in the United States to account for non-bank assets in the capital market, such as money-market funds, asset-backed securities, and leveraged derivative products, usually funded by investment banks and large institutional investors. In 2007, the volume of shadow-banking transactions in the US exceeded that of conventional banking assets.

The Financial Stability Board has estimated that total global shadow-banking assets in 2011 amounted to $67 trillion, with the US accounting for $23 trillion, the eurozone for $22 trillion, and the United Kingdom for $9 trillion. Chinese shadow banking totals only about $2.2 trillion.

Shadow banking in China is dominated by lending to higher-risk borrowers, such as local governments, property developers, and SMEs. It is ultimately funded through retail bank deposits, banks’ wealth-management products, and private equity. Thus, the real issue in China is not the volume of shadow credit, but its quality, and the banking system’s capacity to absorb potential losses.

Market forces and policy conflicts triggered shadow banking’s emergence in China. With the People’s Bank of China (PBOC) keeping interest rates artificially low, retail depositors began taking advantage of higher rates of return offered by local governments, property developers, and SMEs, which needed funding to maintain investment and adjust to a new market environment.

Since 2008, shadow banking has exploded, owing to price and regulatory factors. In an environment dominated by direct quantitative controls, such as increasingly stringent lending quotas, shadow banking is meeting genuine market demand, with the interest rates that borrowers are willing to pay providing a useful price-discovery mechanism. China simply needs a better system for evaluating the quality of such credits (and for providing depositors with returns that can offset inflation).

Chinese policymakers should view the shadow-banking scare as a market-driven opportunity to transform the banking system into an efficient, balanced, inclusive, and productive engine of growth. They should begin by reforming the property-rights regime to enable market forces to balance the supply and demand of savings and investments in a manner that maintains credit discipline and transparency.

This requires, first and foremost, determining who – the investor or the bank – bears the underlying default risk of high-yield wealth-management products. Given that this is a legal question of contract definition and enforcement, it should be answered in the courts or arbitration tribunals, not by regulators. Clarifying ultimate responsibility for credit quality and risk would also reduce intermediation costs by eliminating the need to resort to informal channels, such as credit-guarantee and trust companies.

Furthermore, reducing local-government financing vehicles’ exposures is essential. China needs to build its municipal bond market to generate more sustainable funding for infrastructure projects. Local governments could then privatize the massive assets that they have accumulated during years of rapid growth, using the proceeds to pay down their debt.

Reform efforts should be supported by measures – such as strict enforcement of balance-sheet transparency requirements – to improve risk management. In fact, the existing shadow-banking risks are manageable, given relatively robust GDP growth and strong macroeconomic fundamentals. At the end of 2012, China’s commercial banks held ¥6.4 trillion in core capital and ¥1.5 trillion in non-performing-loan provisions, for a risk cushion of roughly ¥8 trillion.

Low-risk central-government bonds and central-bank reserve requirements – most of which are backed by substantial foreign-exchange reserves – account for ¥31 trillion of the ¥95 trillion in total commercial-bank assets. Another ¥8 trillion are housing mortgages, which also carry little risk, given low loan-to-value ratios. Exposure to domestic sovereign obligations – by state-owned enterprises and local governments – accounts for about ¥32 trillion, and obligations by private firms amount to roughly ¥24 trillion.

This breakdown suggests that the ¥8 trillion cushion would be sufficient to offset potential losses arising from higher-risk credit in China’s commercial banking sector. The high interest-rate margins set by the PBOC provide additional support.

But, if more risk builds up through continued expansion of shadow credit, this risk buffer may become inadequate. Thus, Chinese policymakers must focus on curbing the shadow-banking sector’s growth, while ensuring that all current and future risks stemming from the system are laid bare. The introduction of measures to cool the property market, and new direct regulatory controls over shadow-banking credit, represent a step in the right direction.

Perhaps the biggest challenges facing China are raising real returns on financial liabilities (deposits and wealth-management products) and promoting more balanced lending. Increased costs for investment in real assets would help to rein in property prices and reduce over-capacity in infrastructure and manufacturing.

Ultimately, addressing shadow banking in China will require mechanisms that clearly define, allocate, and adjudicate financial risks among the key players. This includes ensuring that borrowers are accountable and that their liabilities are transparent; deleveraging municipal debt through asset sales and more transparent financing; and shifting the burden of resolving property-rights disputes from regulators to arbitrators and, eventually, to the judiciary. Such institutional reforms would go a long way toward eliminating default (or bailout) risk and creating a market-oriented financial system of balanced incentives that supports growth and innovation.

Andrew Sheng, President of the Fung Global Institute, is a former chairman of the Hong Kong Securities and Futures Commission, and is currently an adjunct professor at Tsinghua University in Beijing. Xiao Geng is Director of Research at the Fung Global Institute.

© Project Syndicate 1995–2013

Zhang Monan

Some new changes will also alter the important strategic opportunities in the coming ten years. 

Firstly, China is gravitating to the center of the international economic system. Thirty years ago, China was still a low-income country. In 1980, its GDP accounted for merely 1.9% of the world’s total, ranking seventh in the world, but China’s current GDP has increased to account for 10.5% of the global total, becoming the second-largest economy in the world. From the perspective of global development, the rise of emerging economies, the eastward shifting of the center of global economic growth, and the lasting stagnation of the Western developed countries, it is possible for China to maintain and enjoy its strategic opportunities. When some western developed countries are still suffering from their sovereign debt crisis and the prospect for their economic recovery is not encouraging, China is still the most important growth engine for the global economy, in spite of the fact that it also faces some internal structural problems and a slowdown in economic growth. 

Secondly, China is in the transition from seizing and using the strategic opportunities to creating such opportunities. In the past 30 years China, with its reform and opening-up policies, benefited the most from economic globalization in the late years of and after the end of the Cold War, by incorporating into and adapting to the global economic system. China is now the second-largest economy in the world and is no longer an exogenous variable, which had to passively adapt itself to the international economic environment, but rather an important endogenous variable that bears an influence on the global economy. This means that China has the  qualifications to create strategic opportunities, and should be more active in doing so. 

Thirdly, developed nations have changed their position from paying attention to “China’s rise” to a policy of “containing China.” Now that the time is different from past strategic opportunities, China will have to face up to more complicated challenges and risks in the coming ten years when China’s status improves remarkably and its role changes from a “follower” to a “ front-runner”. The developed countries tend to resort to measures such as trade protectionism and technology control to contain and check China, and some developing countries will also join to exert pressure on China. In particular, when the world economy gets on the road to recovery and new growth, the United States, the European Union and some developing countries who share similar foreign trade structure with China, will definitely resort to various measures to vie with China for markets and resources, inevitably resulting in the rise of more economic and trade conflicts. 

Amid these domestic and international changes, China must work hard to avoid any weakening of its development, seize new opportunities and create new advantages. 

First, China needs to create new advantages from its enormous market. The report of the 18^th Party Congress proclaimed that the income of Chinese residents will double by 2020, the country’s purchasing power will have reached 64 trillion yuan. The huge domestic demand will become a new driving force for maintaining sustainable economic growth in China and the world as a whole. Ongoing urbanization will unleash a huge domestic market, and will promote and lead to the upgrading of China’s consumption structure, and ultimately promote industrial upgrading. 

Second, China needs to cultivate new advantages in innovation. Multinational corporations (MNCs) in China have developed to a new stage. In the early years after they entered China, they considered China as the center of their market, and in the second stage they considered China as a research and development center. China, with adequate technology, market and human capital, is now one of the MNCs strategic centers and decision-making centers, and a focus of their industrial chains. These changes would mean unprecedented opportunities for China to create new advantages as a hub of global technology transfers and an “innovation magnet.” 

Last, China needs to create new advantages from globalization by making use of global resources. Since the onset of the global financial crisis in 2008, there has been a growing tendency towards “anti-globalization”. China must learn and know how to deal with globalization, resort to the “going global” strategy to utilize global resources, and speed up its access to the global value chain through the means of international strategic alliances. As a “ front-runner,” China must play a role in and make the most of the globalization. 

The world will become more open. For developed countries such as the United States and indeed the whole world, China’s strategic opportunities will also be theirs. On the one hand, the growing Chinese market will translate into growing trade. In 2010, China’s import value ranked the second in the world, and the country’s trade surplus has shrunk for three consecutive years. Estimates show that the growth rate of China’s imports will be as high as 27% from 2011 to 2015, about five percentage points higher than export growth. In the coming five years, China’s commodities import will exceed $10 trillion, and this will generate more investment opportunities for many countries in the world. On the other hand, China is pursuing innovation-driven development, seeking to make better use of global technology and innovation resources, and carrying out win-win technology cooperation with other countries. In short, there will be great potential for China to open up its economy for the world. 

Zhang Monan is Associate Research Fellow at the State Information Center. This article was translated by Gao Jinan.

Stephen S. Roach

There were no surprises in the basic thrust of the strategy – a structural shift in China’s investment- and export-led growth model toward a more balanced consumer-based and services-led economy. The transformation reflects both necessity and design.

It is necessary because persistently weak global growth is unlikely to provide the solid external demand for Chinese exports that it once did. But it is also essential, because China’s new leadership seems determined to come to grips with a vast array of internal imbalances that threaten the environment, promote destabilizing income inequality, and exacerbate regional disparities.

The strategic shift is also a deliberate effort by Chinese policymakers to avoid the dreaded “middle-income trap” – a mid-stage slowdown that has ensnared most emerging economies when per capita income nears the $17,000 threshold (in constant international prices). Developing economies that maintain their old growth models for too long fall into it, and China probably will hit the threshold in 3-5 years.

Three insights from this year’s China Development Forum deepened my confidence that a major structural transformation is now at hand that will enable China to avoid the middle-income trap. First, a well-articulated urbanization strategy has emerged as a key pillar of consumer-led rebalancing. This was emphasized by China’s new senior leaders – Executive Vice Premier Zhang Gaoli and Premier Li Keqiang – in the Forum’s opening and closing remarks, and considerable detail was provided in many of the working sessions.

Urbanization is a building block for consumption, because it provides powerful leverage to Chinese households’ purchasing power. Urban workers’ per capita income is more than three times higher than that of their counterparts in the countryside.

The urban share of the Chinese population reached 52.6% in 2012 – up nearly three-fold from 18% in 1980, and is expected to rise toward 70% by 2030. If ongoing urbanization can be coupled with job creation – a distinct possibility in light of China’s emphasis on developing its embryonic labor-intensive services sector – the outlook for household-income growth is quite encouraging.

The pace of urbanization should dispel Western doubts stemming from concerns over so-called ghost cities and chronic over-investment. According to research by McKinsey & Company, with the annual influx of new urban residents totaling 15-20 million, China will need more than 220 large cities (at least one million people) by 2030, up from 125 in 2010. Moreover, because urbanization is a capital-intensive endeavor and China’s capital stock per worker – a key driver of productivity growth – is still only 13% of the levels in the United States and Japan, China has good reason to remain a high-investment economy for years to come.

What is new today is the focus on urbanization’s negative externalities – especially the thorny issues of land confiscation and environmental degradation. A well-developed “eco-city” framework was presented at this year’s Forum to counter both concerns, and features incentives promoting a new urbanization model that stresses compact land usage, mixed modes of local transportation, lighter building materials, and non-carbon energy sources.

The second insight from the 2013 China Development Forum is the new government’s focus on strengthening the social safety net as a pillar of a modern consumer society. In particular, owing to the hukou (China’s antiquated household registration system), access to public services and benefits is not portable. As a result, migrant workers – an underclass numbering roughly 160 million – remain shut out of government-supported health care, education, and social security.

Holes in the social safety net have led to high and rising levels of precautionary saving – driving a wedge between increases in labor income and any impetus to discretionary purchasing power. Significantly, there were strong hints from senior Chinese leaders at the Forum that hukou reform is now under active consideration.

While that would be welcome, such efforts need to be accompanied by an expansion of benefits. China’s retirement system has only about $430 billion of assets under management (national and local government social security and private-sector pensions). I pressed newly appointed Finance Minister Lou Jiwei on this point, suggesting that China deploy some of its excess foreign-exchange reserves to fund such an effort – the same tactic used to provide a $200 billion start-up injection for the China Investment Corporation, the sovereign wealth fund that he ran for the previous five and a half years. Unfortunately, he did not favor this suggestion.

The final – and possibly most important – insight that I took away from the Forum concerned the quality of China’s new leaders. From President Xi Jinping and Premier Li Keqiang on down, China’s new leadership team is quite sophisticated in terms of analytics, risk assessment, scenario modeling, and devising innovative solutions to tough problems. Moreover, under the organizational umbrella of the National Development and Reform Commission (NDRC) – the latter-day version of the old central planning apparatus – China has marshaled considerable resources into the formulation of a comprehensive and well-thought-out economic strategy.

But, in the end, it takes more than strong policy and analytical skills to deal with tough economic challenges. We have seen unfortunate examples of that repeatedly in the West in recent years, and there are no guarantees that China’s newly installed leaders will avoid comparable pitfalls.

Vision and strategy are vital for realizing the “China Dream,” as the country’s new leaders are now calling it. But it will take courage and sheer determination to tackle what is perhaps the biggest obstacle of all – resistance from deeply entrenched local and provincial power blocs. On this critical front, strong words must be accompanied by bold action. 

Stephen S. Roach was Chairman of Morgan Stanley Asia and the firm’s Chief Economist, and currently is a senior fellow at Yale University’s Jackson Institute of Global Affairs and a senior lecturer at Yale’s School of Management. His most recent book is The Next Asia.

© Project Syndicate 1995–2013

“After the Cultural Revolution, a lot of people felt the need to make up for lost time, so we worked extremely hard,” said Mr. Wang, 56, who studies at the China Europe International Business School, or Ceibs.

Mr. Wang was sent to a poor mountainous region during the Cultural Revolution, at a time when higher education was viewed with suspicion and those who were considered privileged were “sent down” to work with peasants. He ended up as the general manager of a chemical company, before making his fortune in a series of other ventures.

“I’ve been very successful,” he said. “However, I used to believe that because I was successful I must be right, but I’ve learned that what is successful in the past might be a burden for me in the future.”

Chinese executives are going back to school partly because, unlike their Western counterparts, many did not have the chance to study properly earlier in life.

“The average age of our executive M.B.A. student is 41 or 42, with almost 20 years of work experience — they are much older than their counterparts in Europe or the U.S.,” said Qian Yingyi, the dean of the School of Economics and Management at Tsinghua University in Beijing. They “simply didn’t have a chance to study business in their 20s.”

Some never finished high school. They grew up during the chaos of the Cultural Revolution and then built their careers through the state-owned enterprise system in the 1980s and ’90s.

Deans of business schools say that Chinese executives are often looking for more than just another qualification or practical managerial advice.

“China’s economy has really been booming in the last 20 years,” said Charles Chen, the associate dean at Ceibs. “There is now a tremendous need to summarize past experiences in order to move forward. To understand how, as well as why.”

“Chinese executives are great with intuition and experience, but what is missing is broader perspectives,” said Mr. Qian of Tsinghua University.

Long told that “to get rich is glorious” — a quote often attributed to the former Chinese leader Deng Xiaoping — some entrepreneurs are questioning the greater meaning of their success.

“Business schools in China are having some responsibility toward solving social problems in country,” said Xiang Bing, the founding dean at the Cheung Kong Graduate School of Business, which the Hong Kong tycoon Li Ka-shing established in Beijing in 2002 as the first private business school in mainland China.

“We have to look at the whole equation of wealth — why you do business, how you do business, and what to do with the money you have,” Mr. Xiang said.

The executive M.B.A. curriculum at Cheung Kong includes classes on philosophy, Eastern and Western religion, global history and literature.

“We hope our executive students can strive for enlightened lives — it may not be attainable, but it should be strived for,” Mr. Xiang said.

Leading Chinese executives or their companies pay upwards of 600,000 renminbi, or about $96,000, for a part-time, two- to three-year course. Many fly across the country to attend four-day blocks of classes once a month.

In a light, spacious lounge at the Ceibs campus in Beijing, Wei Qiuli, a senior vice president at Gome Electrical Appliances, explained why so many Chinese entrepreneurs like her were enrolling in these programs.

“The environment here instills a sense of calm so we can systematically think about what we’ve been going through in our jobs,” Ms. Wei, 46, said.

Nearby, dozens of high-level Chinese business leaders — her fellow students — were tapping out messages on their iPhones and preparing for their class on Disruptive Marketing.

Ceibs, which has campuses in Beijing and Shanghai, plus a smaller presence in Shenzhen, has about 770 executive M.B.A. students.

After three decades of the kind of rapid economic growth that does not allow much time for contemplation, business leaders in China are turning to executive M.B.A.’s for a greater understanding of the global business world, how to be better corporate leaders and, increasingly, what to do after they have succeeded.

Twenty years ago, management education in China barely existed. While the first M.B.A. in the world was offered by Harvard University in 1908, it was not until 1991 that China introduced its own M.B.A. programs at a handful of schools. It took several more years for the first executive M.B.A. programs to open.

Today, China has 62 business schools offering executive M.B.A.’s to more than 8,000 students a year.

“At present, China’s executive M.B.A. education can hardly meet the huge demands of senior management talents due to China’s fast economic growth,” said Lu Xiongwen, the dean of the School of Management at Fudan University in Shanghai.

Four of the top 10 executive M.B.A. programs listed in the 2012 Financial Times ranking are taught in greater China, though most of them are partnerships with Western institutions. In first place is a collaboration between the Kellogg School of Management at Northwestern University in Illinois and the Hong Kong University of Science and Technology. Ceibs, established under an agreement with the European Commission, is in the top 10. There is also a linkup between Insead in France and Tsinghua, and another between the Olin Business School at Washington University in St. Louis, Missouri, and Fudan.

“Last year, 68 percent of our executive M.B.A. students were from the top levels of corporations — president, general managers, chairman of the boards,” said Mr. Chen of Ceibs, adding that almost half came from private Chinese companies, with the rest divided between state-owned enterprises and joint ventures.

Schools are not predicting a slowdown in the growth of M.B.A. programs in the near future. “The economy of mainland China is very likely to catch up with that of the U.S. in 10 years,” Mr. Lu of Fudan University said. “China has 50,000 M.B.A. and executive M.B.A. graduates each year, which is far from enough to support China’s economic growth and companies’ demands in order to survive against global competition.”

“The demand for business education is so huge in China right now,” said Mr. Xiang of Cheung Kong. “And if we need, we can eventually just start opening up our executive programs to more vice presidents, division heads and less senior management.”

Kit Gillet is a freelance journalist currently based in Beijing. His work appears regularly in the international press, for publications including The New York Times, Los Angeles Times, The Economist, The Wall Street Journal, The Guardian, Foreign Policy and CNN.

© 2013 The International Herald Tribune

Yi Xianrong

The GDP growth target is within the target range identified in the Report to the 18^th National Party Congress for the coming decade, with a gradual slowing down of the too fast growth of previous years and a focus on the quality and efficiency of economic growth. The basic idea will not change in the coming years. Can the target be achieved this year? The current economic situation is better than 2012. With hot sales on the real estate market, GDP may exceed 8% for the first few quarters. The probability of a GDP growth higher than 8% for the whole year is rather high. With the start of a new political cycle in particular, we may witness a new wave of investment by local governments, increasing the probability of growth above 8 percent.

Upon taking office, the new government will need to maintain the speed of economic growth and at the same time address some major problems, such as real estate bubbles, shadow banking risks and investment fervor at the start of the political cycle. How these two can be balanced will be a key point of consideration for the new government. With America recovering, the deepening of the European sovereign debt crisis and the depreciation of the Japanese Yen, there is still turbulence in the international market, adding uncertainties to Chinese economic development. The new government will need to reflect over and make renewed judgment of the domestic and international economic situations so as to identify the path to a balanced growth and define more appropriate policies accordingly.

The CPI target of 3.5% is largely related to the relatively low actual CPI growth in 2012. It may be fairly easy to achieve since the overall price level is fairly low against slow global recovery and some countries need to address deflation rather than inflation.

The M2 growth target for this year is 13%, one percentage point lower than last year’s money supply. The market may be concerned thinking that the Central Bank will tighten monetary policy. However, this is not correct. The Central Bank wants to have more appropriate levels of money and credit growth and may have proposed the target out of three considerations. First, the reverse of the domestic real estate market in 2012 was largely due to monetary policy change. Second, shadow banking risks in China are increasing and may well be enlarged if there is too much liquidity. Third, with financial innovations mushrooming, the domestic financial market has in the past few years evolved into a diversified financing system, in which the proportion of bank credit in overall financing has decreased, leading to reduced significance of monetary policy targets.

Let me now turn to the 2.0% fiscal deficit target. The fiscal deficit target set by the government for 2012 was 800 billion yuan or 1.5% of GDP, while the actual deficit stood at 850 billion or 1.6% of GDP. This year’s deficit target is bigger than last year, meaning a more “proactive” fiscal policy. The purpose may be two-folded. The first is to increase expenditures for better livelihood such as investing in social securities, health care and indemnificatory housing; the other purpose is to create conditions to tackle local government debts. Current risks of local government financing vehicles (LGFV) mainly occur in relatively underdeveloped places. The central government will use the greater deficit to move some fiscal expenditure responsibilities from local government to the central. Such a transfer will not only help mitigate LGFV risks but also benefit local economic growth for the backward regions to catch up. In this connection, the more proactive fiscal policy of the central government will be a driving factor for growth.

The various economic targets for 2013 suggest that the government intends to steer the Chinese economic development into a new direction without introducing excessively radical policy changes or reforms. By doing so huge social impact of new economic reforms can be reduced, thereby laying down a foundation for continued steady growth in the future. Basically, 2013 will be a period of stable transition. There will not be too many fluctuations. The overall trend is good and there is no need to worry about lack of momentum in economic growth.

Yi Xianrong is a Researcher with the Institute of Finance and Banking at the Chinese Academy of Social Sciences.

Qi Jingmei

The demand for investment will continue to rise and fall. Over a certain period of time, the fixed-asset investment will maintain a growth faster than 20 percent and investment will remain the important force driving economic growth. In the first half of this year, China will continue to boost economic recovery with investment in large-scale infrastructure projects.

There are three reasons for this. First, the demand for infrastructure is robust. Second, 2013 is an important interim evaluation year for the 12th Five-Year Plan (2011-2015) and local governments will have new heads elected. Third, the loose financing environment will provide fund guarantees for investment in infrastructure construction projects.

Affected by the upgrading of the industrial structure, energy saving efforts and the macro-control polices issued by the State Council to curb rising house prices, the investment in manufacturing industries will drop slightly and investment growth in the real estate sector will slow down.

The primary driving force for the growth of consumption demand is constantly growing. Income is the most important factor deciding consumption growth. The fast growth of incomes will support a steady growth in consumption.

There are some factors driving consumption growth: First, the good incomes and employment situation of urban and suburban residents will support the steady growth of consumption. The employed population increased by 11.88 million in 2012 and resident’s real incomes in urban and rural areas grew by 9.6 percent and 10.7 percent respectively, higher than the GDP growth in China for the first time. It is expected that the central government will push forward comprehensive income distribution reform from many aspects, such as the primary distribution, redistribution, the growth of farmers’ incomes and distribution order. As this crucial reform is gradually carried out, China’s domestic consumption will gain more forward momentum.

The fast development of online consumption, community consumption and some other new consumption models will provide new powers driving China’s consumption. As China’s per capita GDP exceeded $6,000, China’s consumption structure entered an important period of upgrading and the consumption in cities is striding into the stage of “enjoying life” and rural consumption is entering the stage that features higher demand for living and traveling. The core drivers of consumption growth are the steadily growing demand for cars, medium and high-level household appliances and better services.

The gloomy prospects for exports, which are the result of the many global uncertainties and the slow recovery of the global economy, will be both favorable and adverse for the China’s foreign trade. The growth in China’s exports and imports in the first quarter of 2013 are expected to hit 8 percent and 6 percent.

The favorable factors include, first the strengthening signs that the global economic recovery is conducive to the steady operation of China’s export trade.  The Purchasing Managers’ Index, a global measure of manufacturing, rose from 49.6 percent to 50.2 percent in Dec 2012, passing the “vicissitude line”. The real estate market of the United States just saw its largest restorative growth since 2006 and the unemployment rate in the US declined to 7.8 percent. The deficits of some European counties are becoming smaller. And the economies in Greece and Spain are recovering slightly. The MIST countries (Mexico, Indonesia, South Korea and Turkey) and some small emerging economies’ growths are accelerating. The warming of the world economy will improve the foreign demands for China’s export in the first quarter. Second, the optimization of trade structures will continue. China’s export growth will be higher than the world’s average, China’s share in the world market enjoys great potential for expansion as China is trying to upgrade the production structure of its exports .

The adverse factors are as follows: First the pressure of exchange rate appreciation is big. The developed countries apply quantitative easing monetary policies forcing the yen and US dollar to depreciate fast. The renminbi’s appreciation against the yen lowered the real growth of China’s exports by about 2 percentage points. The US economy is recovering and its imports are rapidly growing and so its trade deficit is increasing. The US dollar will depreciate. The real effective exchange rate of the renminbi will appreciate, which will weaken the price competitiveness of China’s exported products and add pressure to the growth of China’s exports. Second, China will come across some obstacles on its way to joining the world multilateral trade system. After the financial crisis, all countries paid more attention to grabbing international market share. The US and European countries all made policies supporting exports and to contain the exports of China and the other emerging economies by introducing protectionist measures and building up trade alliances, which goes against the growth in demand for China’s exports.

Last but not least, the price level growth trend is for a mild rise. China’s domestic economy is warming up. The pressure of cost-pushed inflation is building up. The liquidity of the international currency market is becoming looser and the prices of staple commodities are recovering. Under such circumstances, the price of consumer goods will show a rising trend. The Consumer Price Index is expected to rise about 3 percent in the first quarter of this year, higher than the fourth quarter of last year, but lower than the same period of time last year.

Qi Jingmei is a researcher with the State Information Center.

Zhang Monan

Although this model is unsustainable, China’s over-reliance on investment is showing no signs of waning. In fact, as China undergoes a process of capital deepening (increasing capital per worker), even more investment is needed to contribute to higher output and technological advancement in various sectors.

In 1995-2010, when China’s average annual GDP growth rate was 9.9%, fixed-asset investment (investment in infrastructure and real-estate projects) increased by a factor of 11.2, rising at an average annual rate of 20%. Total fixed-asset investment amounted to 41.6% of GDP, on average, peaking at 67% of GDP in 2009, a level that would be unthinkable in most developed countries.

Also driving China’s high investment rate is the declining efficiency of investment capital, reflected in China’s high incremental capital-output ratio (annual investment divided by annual output growth). In 1978-2008 – the age of economic reform and opening – China’s average ICOR was a relatively low 2.6, reaching its peak between the mid-1980’s and the early 1990’s. Since then, China’s ICOR has more than doubled, demonstrating the need for significantly more investment to generate an additional unit of output.

As the accumulation and deepening of capital accelerate growth, they perpetuate the low-efficiency investment pattern and stimulate overproduction. When production exceeds domestic demand, producers are compelled to expand exports, creating an export-oriented, capital-intensive industrial structure that supports rapid economic growth. But if external demand lags, products accumulate, prices decline, and profits fall. While credit expansion can offset this to some degree, increased production based on credit expansion inevitably leads to large-scale financial risk.

Thus, a combination of investment, debt, and credit is forming a self-reinforcing risky cycle that encourages overproduction. In the wake of the global financial crisis, Chinese banks were instructed to extend credit and invest in large-scale infrastructure projects as part of the country’s massive monetary and fiscal stimulus. As a result, China’s credit/GDP ratio rose by 40 percentage points in 2008-2011, with most of the lending directed toward large-scale investment by state-owned enterprises (SOEs). In the last two years, bank credit has become the main source of capital in China – a risky situation, given the low quality and inadequacy of bank capital.

Meanwhile, strong currency demand has led China’s M2 (broad money supply) to increase to 180% of GDP – the highest level in the world. The massive wall of liquidity that has resulted has triggered inflation, sent real-estate prices soaring, and fueled a sharp rise in debt.

Given that it is in local governments’ interest to maintain high economic-growth rates, many are borrowing to fund large-scale investment in real estate and infrastructure projects. The active fiscal policy adopted during the financial crisis enabled the rapid expansion of local official financing platforms (state-backed investment companies through which local governments raise money for fixed-asset investment), from 2,000 in 2008 to more than 10,000 in 2012. But, as local-government debt grows, Chinese banks have begun to regard real estate and local financing platforms as a major credit risk.

Likewise, with key industries facing overproduction and slowing profit growth, firms’ deficits are growing – and their debts are becoming increasingly risky. Indeed, the proportion of deficit spending among enterprises is on the rise, and the accounts-receivable turnover rate is falling. By the third quarter of 2012, industrial enterprises’ receivables totaled 8.2 trillion renminbi ($1.3 trillion), up 16.5% year on year, forcing many to borrow even more to fill the gap, which has driven up debt further.

According to GK Dragonomics, corporate debt amounted to 108% of GDP in 2011, and reached a 15-year high of 122% of GDP in 2012. Many heavily indebted companies are SOEs, and most of the new projects that they initiate are “super-projects,” with the return on investment taking longer than creditor banks expect. Indeed, some highly indebted firms’ capital chains may well rupture in the next two years, when they reach their peak period for debt repayment.

As a result, China’s financial system is becoming increasingly fragile. The expansion of infrastructure investment – which, according to some reports, exceeds 50 trillion renminbi, including highway and high-speed railway construction – will lead to the expansion of banks’ balance sheets. The investment loans and massive debts among local financing platforms, together with the off-record credit channeled through the “shadow” banking system, are increasing the risk that non-performing loans will soon shake the banking sector.

To reach the next stage of economic development, China needs a new growth model. Reliance on investment will not enable China to achieve stable, long-term growth and prosperity; on the contrary it may well inflict serious long-term damage on economic performance.

Zhang Monan is a fellow of the China Information Center and of the China Foundation for International Studies, and a researcher at the China Macroeconomic Research Platform.

© Project Syndicate

In the late 19th and 20th centuries, internal chaos gave the rest of the world and the emerging United States a running start as China was challenged by warlords fighting, Japanese invasions, Western manipulation and occupation, internal civil disturbances, Mao’s disastrous Great Leap Forward and the Cultural Revolution.

That global slumber continued until Deng Xiaoping threw off the ideological yoke of the past and opened China to the world in the 1980’s.

Today, what happens in China does NOT stay in China.  The greater fear is of a stumbling Chinese economy – a fiscal nightmare for the rest of the world.

According to Ross Terrill, a research associate at Harvard’s Fairbank Center for Chinese Studies, China’s success or failure over the next two to three decades rests in four key areas:

1) Drive to achieve an ever-higher standard of living for a populace of still mostly poor people; (114th among nations in gross national income per capita according to the World Bank)

2) The preservation and unity of the enormous, multi-national territory, The People’s Republic of China;

3) The ability of China’s Communist Party to maintain its monopoly on political power;

4) China’s efforts to eclipse the United States in Asia and beyond.

Terrill believes that “In the first two areas, success is quite likely; in the last two, less likely.”

Many ordinary Chinese I have met in travels seem content with the current Communist Party’s one-party rule. Over the last three decades, their lives have grown remarkably better as the standard of living rose. Today, more than 400 million people have risen out of abject poverty into China’s middle class.

Are there shortcomings and problems? As with any rapidly changing country – absolutely!

The seeds of discontent simmer just beneath the surface and might erupt if:  the social contract for a better life stalls, the gulf between the haves and the have-nots widens, environmental problems are not addressed or people feel oppressed.

The unspoken trade-off between the rulers and the ruled seems to be– If our (Chinese) lives improve, then you (the Communist Party) can remain in power. 

The Chinese leaders appear more worried about internal threats than external ones as the second decade of the 21st century unfolds. 

It is reported that China’s 12th Five-year Plan produced by the Fifth Plenary Session of the 17th Central Committee of the Communist Party (2011-2015) will focus on reducing the nation’s income disparity to a greater degree than the continued hot pursuit of national wealth.

 Many China watchers believe that the Communist Party has concluded that their greatest threat to continued one-party rule may be a rise in social instability as outgoing President Hu Jintao called for the rise of a “harmonious” society. Some question whether the new social policy being fashioned may merely be a slogan designed to keep the peace. 

For a more harmonious society, Chinese leaders must balance profit margins and economic growth against destroying their environment and improving the quality of life for ordinary people and minority populations. 

China’s new Communist Party Secretary General Xi Jinping appears to understand that leadership and accountability must begin at the top to ensure a peaceful rise. 

Prior to his pending elevation to the top Communist post in October, Xi warned that corruption has the potential not only to bring about the demise of the Party but to also bring about the downfall of the country. In a closed door meeting with members of the new Politburo of the Communist Party of China (CPC), it was reported that Xi spoke powerfully about the need to reverse out-of-control corruption from other nations that was directly responsible for political unrest and the ultimate collapse of those governments. 

Not naming names, Xi was clearly referring to Egypt, Libya, and other totalitarian, corrupt governments, which have been tossed about in the wake of the Arab Spring revolutions. 

Deng Xiaoping explained why the Chinese Communist Party was powerful in the past this way: “In the war years, we often said that if the Party member made up 30 percent of an army company, that company must be very good and have a strong fighting capacity. Why? Because Party members were invariably the first to charge and the last to withdraw on the battlefield, the first to bear hardship and the last to enjoy comforts in daily life … now some Party member are different. They join the Party in order to be first to enjoy comforts and last to bear hardships. 

The fear is real that internal corruption, environmental degradation, lack of Party discipline, and oppression might bring down the Chinese Communist Party.

The U.S. can and will benefit from a stable and prosperous China. The Economist wrote: “A 20-percent rise in Chinese consumption might well lead to an extra $25 billion of American exports. That could create 200,000 American jobs.” 

For the sake of the Chinese people and all humanity, let’s hope for China’s continuous, peaceful rise one that lifts all boats, lest the world will be caught in its undertow. 

Tom Watkins serves on the University of Michigan Confucius Institute Board of Advisors and the Michigan Economic Development Corporation international advisory board.  He is the former Michigan State Superintendent of Schools, and former President and CEO of The Economic Council of Palm Beach County, FL. He is currently a U.S./China business and educational consultant.

The Global Trends series strives to provide a framework for stimulating strategic thinking about the most important critical trends and potential discontinuities that could shape alternate future worlds. One clear “megatrend” driving the world’s evolution is the growing importance of China’s economy. Not only is the China projected to have the largest national economy in a decade or so, but the NIC expects China to continue to deepen its integration into the world economy in coming years through more outward and inward foreign direct investment and Beijing’s assuming a leadership role in more international economic institutions. By their calculations, despite a probable decrease in China’s growth rates from the spectacularly high figures seen during most of the 1980-2010 period, China “will contribute about one-third of global growth by 2025, far more than any other economy.” 

In its previous Global Trends 2025, the NIC depicted the most likely outcome as the continued growth of China’s economic and military strength, but the report also discussed the possibility that a lengthy economic slowdown could lead to “virulent and xenophobic forms of Chinese nationalism” if the Chinese government attempts to blame foreigners for China’s difficulties. Global Trends 2030 also warns that “a serious or prolonged Chinese economic slump could … reinforce latent fears about the potential regional implications of internal unrest there.” 

The NIC also questions whether the past success of China’s “state capitalist” development model—in which the government largely directs national economic activity typically left to private sector market forces in traditional liberal democratic states—will continue to yield superior performance. For the past decade, Chinese leaders have acknowledged that their economic model—based on high rate of growth driven by top-down, state-directed domestic infrastructure investment driven by loans from state-owned banks—needs major reforms. 

One imperative for change is that China could easily fall in the “middle-income trap” that has ensnarled so many other developing states whose growth plateaus after they can no longer achieve easy gains from adding low cost labor inputs to production. The PRC’s annual growth has fallen to below double-digit levels in recent years, with growing inflation and unemployment. In addition, the country suffers from extraordinarily high rates of wealth and income inequality, both between and within its regions. The financial system also remains vulnerable to collapse due to the large number of non-performing loans issued by state-owned banks to unprofitable state-run enterprises. 

The NIC accordingly argues that Chinese leaders need “to manage the challenging transition to an innovation-and-consumer-based economy.” Toward this end, PRC leaders have declared  their goal to rebalance China’s economy into one less dependent on exports and public spending and aimed more at meeting the need of China’s consumers and private enterprises. But the Chinese government has hesitated to make some major reforms such as closing unprofitable state-owned enterprises by depriving them of capital, since the resulting massive unemployment could antagonize the Party’s working-class supporters. 

The NIC is uncertain whether and when China could make the transition to a stable liberal democracy–one of their low-likelihood but high-impact “Black Swans.” In general, countries with higher per capita incomes and without large youth bulges are more likely to liberalize their political systems. In many other societies, rising national prosperity has led people to demand political rights to correspond with their new economic power. Indeed, they seek political influence precisely to defend their growing economic interests. 

But the transition process is typically messy, with countries zig-zagging between autocracy and democracy over time. If historical patterns hold, China, with its maturing population and growing middle class, should follow the path of Taiwan, Singapore, South Korea and other Asian countries and become more democratic over time. The NIC believes China’s democratization could trigger a massive democratic “wave” in other countries, such as occurred with the Soviet bloc’s collapse. 

As part of their effort, the NIC consults various foreign and domestic experts, including by attending meetings in some 20 countries. The NIC analysts found that “China was a key theme in all the discussions.” Some Chinese interlocutors praised recent reforms but lamented persistent corruption  within their society. Indian analysts described China primarily as a rival, but Africans saw China generally as a useful partner. Although nobody expected China to surpass the United States as the leading world military power in the next two decades, and there was a consensus outside China that the United States had to pursue a vital role in Asia to prevent  a security vacuum from arising, everyone agreed that the world’s future critically depended on both countries. 

In fact, the NIC’s “most plausible best case” future world (“Fusion”) is one in which China and the United States find an increasingly number of global challenges to cooperate in solving directly and in partnership with other states and multinational institutions. Perhaps for this reason, a supplementary report by the Atlantic Council on what U.S. strategy would best manage the Global Trends 2030 landscape urges the Obama administration to “deepen cooperation with China as the most crucial single factor that will shape the international system in 2030.” 

Richard Weitz is a Senior Fellow and Director of the Center for Political-Military Analysis at the Hudson Institute. His current research includes regional security developments relating to Europe, Eurasia, and East Asia as well as U.S. foreign, defense, homeland security, and WMD nonproliferation policies.

Zhang Yansheng

Namely, the nation must (1) speed up its economic restructuring; (2) change the pattern of economic development to ensure that the sustained development of the economy is based on expanding domestic demand; (3) continue working effectively and tirelessly on matters concerning agriculture, rural areas and farmers, as well as advancing urban-rural integration; (4) persist in implementing the strategy of invigorating China through science and education, and increase economic and social development; (5) maintain the interest of the people above everything else and further secure and improve work concerning people’s well-being to make development results benefit the whole nation more widely and fairly; (6) deepen reform in an all-round way and clear away all obstacles in the system that hinders development, and be more proactive and aggressive in implementing the opening strategy, creating a competitive edge and raising the openness of the economy. The key to fulfilling the “six musts” lies in handling the relations between steady growth in the short term, economic restructuring in the intermediate term and systematic transformation in the long run.

This said, the prospect of global economic growth remains troubling in 2013.

First, the global economy will continue to grow slowly in 2013. It’s been five years since the financial crisis of 2008, but the global economy has barely risen from its bottom. For example, the International Monetary Fund (IMF) predicted that the global economic growth rate in 2012 would be 3.3 percent (the lowest since 2009), and marked down China’s and India’s rates to 7.8 percent and 4.9 percent respectively. Purchasing manager indexes around the world, and in European and American economies in particular, are mostly below 50 percent, which is also the lowest since June 2009. This raises the question: will the predicted 3.3 percent global economic growth rate and China’s 7.8 percent become constant in 2013? How long will they last if this happens? Suppose the world economy and China does slow down this year, it’s only more reason for China to focus on improving the quality and results of its economic development by handling the relations between stable growth in the short term, and restructuring in the intermediate-to- long term. Fundamental to all of this is the deepening of reform.

Second, the prevailing macro-economic policies in major developed countries around the world in 2013 will be increasing jobs by creating inflation. The United States has already activated QE4. The Federal Reserve Board will keep the basic interest rate at or close to zero, while linking the country’s inflation and unemployment rates, so that the policy will remain as long as inflation does not rise above 2.5 percent and unemployment does not fall below 6.5 percent. This will hold the global economy hostage until the US unemployment rate reaches its desired level by creating worldwide inflation and asset bubbles to achieve its own economic recovery. The European Union is now doing the same, while Japan plans to follow suit very soon. Faced with an expected influx of excessive liquidity from the Western world, China must step up its financial assistance for efforts to expand domestic demand and develop the real economy, as well as deepening reform to soften the impact of foreign capital invasion.

Third, in 2013 major developed economies around the world will resort to trade and investment protectionism more than ever to break free from the limbo of industrial hollow-rization. This means that China will see trade disputes extending from tactical to strategic dimensions and spreading from the economy to political, social, cultural and military affairs.

China’s economy will enter an important period of transition in 2013.

This year China’s GDP growth potential will be adjusted downward to between 7 and 8 percent, and its foreign trade is expected to slow down as well. Economic growth in the more developed regions along the East coast will remain relatively slow while the central regions will grow slightly faster, and western regions quicker still.  The country’s heavy chemical, construction and real estate industries, including their related equipment manufacturing output, will enter a long period of adjustment, while the increase of electricity, steel, a range of industrial materials and car output will also slow down. At the same time the cost of industrial essentials such as labor, land, water, power and gas as well as the yuan exchange rate, interest rate and consumer price index will continue to rise. All these developments make it even more important to improve the quality and result of growth in 2013.

The author is secretary-general of the Academic Committee of the National Development and Reform Commission.