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It Is High Time for Structural Adjustment

Nov 10 , 2011

China does not need to worry about a hard landing of its economy. Having operated at an unhealthily high speed for years, however, the Chinese economy has arrived at a crucial stage of all-round structural adjustment. In the coming two or three years, the Chinese economy will see a slowdown of its growth rate and a moderate inflation rate of between 3-5 per cent, developments that will put quite some pressure on the operation of enterprises. To secure the smooth adjustment of the economy during this period of time, it is necessary, of course, to implement a stringent instead of lenient monetary policy. What is of fundamental importance, however, is to press ahead with reforms, including adjustment of the central and local tax structure, implementation of structural tax reduction, advancement of the reform of state-owned enterprises, and increase of the ratio of direct financing.

Why is it that China does not need to worry about a hard landing of its economy? First of all, the answer comes from the growth speed of its economy. China remains a country of relative poverty. Since it is still at a comparatively low level in terms of average per-capita development, with its average per-capita GDP merely standing around $5,000, it has lots of needs to be satisfied and much room for the natural expansion of a market economy.

Secondly, China remains an economic entity needing to catch up with and overpass developed economies. It still needs to borrow and copy lots of advanced technologies and business models from developed economies, and to overpass them in these fields as well, so as to substantially improve its production efficiency.

In the third place, China is a big economic power with an extremely big inland market. Its relatively poor and underdeveloped west, for instance, can both take over the production capacities from the east, but also digest lots of the excessive production capacities haunting the national economy as a whole. 

Based on these three factors, the Chinese economy will continue to enjoy a relatively high growth speed for a quite long period of time to come, at a rate of nearly 9 per cent, for instance. To be more specific, three major developments in China in the future will provide a solid foundation for its economic growth: urbanization; massive land development which is closely related to urbanization, such as construction of water conservancy and anti-seismic facilities and projects for prevention and control of other natural disasters; and the expectable continuation of consumption expansion for quite a long time to come. 

In one word, it is impossible for the Chinese economy to see its grow rate fall below 8 per cent in the future. Given this assumption, will China suffer any vicious inflation in the coming two or three years and come to be haunted by stagflation as a result? There will be little chance for such a situation to develop.

Fundamentally speaking, the Chinese economy has come out of the situation seen between the mid 1980s and the early 1980s when its aggregate effective demand kept growing rapidly. A basic feature of the present-day Chinese economy is the relative excess of production capacities, especially that in the manufacturing sector, and the inadequacy of effective demand. Under such circumstances, Chinese manufacturers will find ways to digest the pressure of rising costs even if raw material prices rocket at the international market. Chances are scarce for them to totally pass the pressure on to consumers.

As for agriculture, China has seen constant improvement of the basic conditions for agricultural production. As its output of basic farm produce keeps growing, it will not suffer from high-speed growth of farm produce prices for long.

In one word, the Chinese economy has shrugged off the pressure of vicious inflation. The vicious double-digit inflation it saw between the mid 1980s and the early 1990s will never come again.

Although the Chinese economy will not experience any hard landing, it is now the crucial time for it to undergo some structural adjustment. In the coming two or three years, its growth will inevitably slow down somewhat. The pressure of moderate inflation will still be there. More importantly, these years will be the crucial period for the all-round adjustment and transformation of the structure of the Chinese economy and of its growth model.

The basic reasoning supporting my view presented above is the fact that during the past decade, especially after China’s adoption of a stimulus package to combat the financial crisis, some fundamental issues besetting its economic development have become all the more eye-catching. They call for thorough solution. At the same time, the Chinese economy has maintained its high-speed growth. What is most noteworthy is the fact that for 17 years, China has basically kept its financial system unchanged. As a result, local governments have come to live on a land-based finance that is both unsustainable and pregnant of crisis for the local financial system.

The first symptom entailing adjustment during this crucial period of time is the slowdown of economic growth. A major factor leading to the slowdown is the sagging of the investment impulse, a situation directly blamable to changes in the investment sources accessible by local governments and the subsequent decrease in the sum of their investment.

Another major factor leading to the slowdown of China’s economic growth is the growing cost pressures piling over enterprises. On the one hand, pays to blue-collar workers have kept soaring, and on the other hand, the prices of raw materials at the international market have been going up day after day, encroaching on the low-cost advantage acquired by Chinese enterprises over the past decade.

In one word, China is gradually losing its advantage of big fixed assets investment and low-cost manpower, which will in turn slow down its economic growth speed in the coming two to three years. It is predictable that the Chinese economy will see a growth rate of 8-9 per cent in the coming two to three years, a marked fall from the 9.7-10.3 per cent growth it recorded during the financial crisis.

Another feature marking the Chinese economy is the stubborn stay of pressures from a moderate climb of prices. Two factors are to blame for the moderate inflation. The first is the inflow of hot money. Seeing that Western countries can hardly get out of their debt crises in a short period of time, major issuers of international currencies will continue their expansive monetary policies, driving up raw material prices at the international market and setting China’s price control efforts against long-lasting external pressures. The second factor is the inevitable adjustment of domestic prices including energy and resource prices. More often than not, such adjustment will drive up the general price level.

Due to the stubborn stay of a moderate 3-5 per cent inflation, China will hardly be able to keep its inflation rate below 2 per cent, as it did before the financial crisis. The slowdown of economic growth and the increase of inflation pressures are both the forces spurring China’s economic restructuring and the outcome resulting from such restructuring efforts. The relatively low speed of economic growth plus a moderate inflation will bring a considerable number of enterprises to feel the aggravating load in business operation. Export-oriented enterprises, in particular, will continue to groan under growing pressures in business operations. Some enterprises will go bankrupt during this process, and send their employees on the run for new jobs. Some export-oriented enterprises may withdraw their business antenna and direct it at domestic consumers. This will be the dominant pattern characterizing China’s overall economic restructuring in the coming two to three years.

During this rough course of policy adjustment, government policies will undoubtedly play the vital role. Its fiscal policies and financial systems, for instance, should be kept relatively lenient in the coming two to three years, while its monetary policies should be comparatively tighter and more stringent. All-round reform will continue to get the spotlight, of course, at the crucial stage of economic restructuring.

In short, mediation of the fundamental contradictions inflicting the Chinese economy is now out of the question, and the crucial time has come for all-round economic restructuring. The coming two to three years will be a period of enormous challenges and vital importance to China’s efforts in maintaining economic growth for a longer period of time. If our government, enterprises and other parties concerned can timely seize this opportunity, our economy will secure a solid foundation for lasting healthy development in the future.

Li Daokui is chair professor and Ph.D tutor of economics with the Business Management School of Tsinghua University, and distinguished professor with the Changjiang Scholars Program.

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