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The Risks of China’s Rebalancing

Sep 16 , 2013

Somewhere in the autumn of this year, China’s Central Committee will gather for a session that will shape the outlook of the global economy. As the world relies increasingly on the China for growth, everyone hopes the meeting to announce a major overhaul that balances its huge investments out by more consumption. This would create huge export opportunities for other markets and prevent China from squandering more money on congested factories. But guess what? A serious rebalancing strategy is not even on the table. 

The reason is that Beijing does not find the large share of investment in its GDP all that exceptional. Recent analyses produced by bodies like the State Council, the National Development and Reform Commission, or the Ministry of Industry and Information Technology all recognize that the current growth pattern is unsustainable and that rebalancing is key. But they also reckon that it is natural for an industrializing country to have a high investment rate and that this will last longer in case of a large country like China. In the same way, it is also considered inevitable that China will continue to have to rely on exports to keep its infant industries upright. 

Rebalancing from investment to consumption is an endeavour for the long run, after the process of industrialization is accomplished. Usually, Chinese officials speak of a decade, or so. Within that decade, the rebalancing that is considered, takes place from resource-intensive industries to labour- and capital-intensive industries. Indeed, despite rising wages, labour-intensive industries remain a priority, especially to create jobs in the hinterland. Meanwhile, the main aspiration is to upgrade the industrial sector, which means to reorient investments to high-end industries. Those have to permit China to vie for the lucrative slices of the market, to reduce its dependence on foreign competitors, and to close some of its more polluting factories. 

Experts in government departments argue that only a sustained investment in advanced industry permits China to make the efficiency gains that will get it over the middle-income trap. Policy papers and studies of the last half-year give us a clue how China will work towards this so-called upgrading of the industrial base. First of all, it will make an effort to diversify the financing of the manufacturing sector. Second, it will accelerate the creation of strategic emerging industries, important national players that can go global. This involves more mergers, better management, higher standards, and so forth. Third, China will invest heavily in strengthening its technological knowhow. Fourth, overcapacity in so-called backward industries will be cut. 

But by refocusing its industrial policy, China of course also risks to relocate its overcapacity problem just to more advanced sectors. The Ministry of Industry already warned that about a quarter of China’s manufacturing capacity is idle. For that too, the decision makers in Beijing have found as solution: more exports of manufactured goods. The Ministry and Commerce and other departments came up with new policies of so-called trade development. This entails a major push for free trade agreements, an effort to position Chinese companies favourably along the international supply chains, better branding, and to assist small and medium large companies to join the scramble for new markets. These documents also stress the need to shift trade away to the developing countries and to balance these growing export flows out by increasing imports of raw materials and tourism services. 

Furthermore, China is set to provide more export credit. These credits are already an important tool to win over costumers abroad. Last year, about 8 percent of Chinese exports were covered by some sort of credit, good for a total of US$ 153 billion. In response to growing criticism from the United States and the European Union, Beijing promised limit this form of trade support, but no policy documents confirm this. The contrary is true. Plans are made to provide more export credit in support of smaller exporters. China is also more frequently using Western banks to provide the credit with Chinese sovereign guarantees. Other countries do that as well, but the sheer scale of China’s lending remains exceptional. 

We should thus expect more of the same. But the Chinese government will probably not get another decade to push its industrial policy to the limits. Households are less and less willing to fetch the bill. This is not surprising: China’s economic system has transferred about US$ 4 trillion of their savings to the corporate and government sector, for which they fetch hardly more than 2.5 percent in interests – just enough to compensate for inflation. Moreover, the government spends already almost as much on export rebates as on social security. The renewed push for industry also brings new risks of bubbles. 

Most of all, such strategy is poised to draw China into fierce economic competition with other countries. While industrialized markets are becoming increasingly concerned about unfair Chinese competition, developing countries grumble that they are pushed in deeper in a commodity trap and that exports to China should be diversified. If China indeed thinks that it needs another ten years to become a fully-fledged industrial power, putting at risk both the savings of its households and the future of manufacturers in other countries, it might be heading for an unbearable decade.  

Jonathan Holslag is a Professor of International Politics at the Vrije Universiteit Brussel and a fellow at the Brussels Institute of Contemporary China Studies. This note is based on a lengthier paper that is available here.

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