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China's rebalancing imperative
Thursday, 08 December 2011 05:42

If there was one big lesson for China from the 2008/2008 global financial crisis, it was the urgent need to rebalance its economy.  Like most East Asian economies, it received a sudden and sharp jolt from the reduction in demand for their exports to Western markets.

In response to the crisis-induced sudden drop in exports, China stoked up its economy with fiscal and monetary expansion.  While this inflated growth, it did little to rebalance its growth -- with the result that China's economy looks decidedly more unbalanced than before the global financial crisis. 

In what way is China's growth unbalanced?

First, the main drivers of China's growth have been exports and investment, with domestic consumption playing a much lesser role.  China's exports are an expensive proposition for the country because they are subsidized in many ways -- cheap land, energy, finance, tax breaks, low wages -- and they are also subsidized by China's exchange rate which is kept artificially low.

These subsized exports have been beneficial to China in terms of providing export revenues and helping China lift its production standards and absorb foreign technology.  But the subsidies are costly in that they sidetrack China's production into less competitive activities, and reduce competitive pressures for further industrial upgrading, a key element for developmental progress.   

Further, since the lion's share of China's exports target European and US markets, these subsidized exports have exposed the Chinese economy to the volatilities caused by their financial crises.

Why doesn't China reduce these subsidies and let the exchange rate rise in value?  It is worried about short term adverse effects on jobs.  Also, it is under pressure from corporate interest groups to keep things as they are.

The second way in which China's growth is unbalanced is partly related to the first.  Workers receive a low and declining share of the national pie, with the result that private consumption is very low.  If workers were given a fairer share of income, this would boost domestic demand, reduce the need to rely on export demand, and also make the socially discontented Chinese workers more happy. 

Getting a fairer share of the national pie could take the form of more social welfare benefits like unemployment insurance, education, health and so on -- of which they receive very few and which encourages them to keep high savings, rather than spending money in the domestic economy.  A fairer share could also take the form of higher wages as demanded by Chinese workers.  But tight-fisted enterprises resist increasing wages resulting in the increasing number of industrial disputes in China.

Third, China's economy is unbalanced in that the nation's four large banks provide privileged access to finance for the China's large state-owned enterprises.  This is costly in many ways.  It is a form of subsidy because interest rates are kept down.  Some of the investments are very inefficient.  It contributes to corruption.  And it indirectly forces private sector enterprises to finance their investments through accumulating and reinvesting profits.  In other words, while China has a very high rate of investment, but much of it is inefficient.

The fourth major imbalance in the Chinese economy is that while growth has been very strong, it has come at a high cost to the environment.  When polluters do not pay for their pollution, they are being effectively subsized again, at the cost of the nation's environment.  This is also another form of corruption in the sense that some pollution results from the deliberate non-enforcement of environment laws and regulations.

When the global financial crisis struck in late 2008, the government launched a massive fiscal and monetary stimulus.  This was effective in terms of reviving economic growth and employment.  But a large measure of the fiscal stimulus was in infrastructure, much of which is in roads, bridge and airports which are barely used (the "Japan Syndrome").  Such infrastructure spending also fuels corruption.  The stimulus also provoked a real estate bubble.  It has left many provincial governments and the big banks which large debts.

Recognizing the overheating and inflation, the government tightened policy to slow down the economy in 2011.  But then the European sovereign debt crisis started to bite China's exports (Europe is China's biggest export market).  So the Chinese government has switched back again to stimulating the economy.

While the Chinese government's principal objective remains the survival of the Communist Party, it will do anything to keep economic growth and employment high.  But as it does that it puts off the necessity to correct the many imbalances in its economy.

As money continues to be wasted on inefficent investment, the Chinese economy will ultimately hit the wall and face a period of slower economic development.




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