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Whither China's economy?
Sunday, 01 April 2012 07:57

Is the Chinese economy heading for a crash?  Or will the government be able to engineer a continuation of growth?  Or will it surprise us all again by booming along?  No-one can really be sure now, or even in a year's time, given the unreliability of Chinese statistics.

One thing for sure is that China's longtime unbalanced economy, which desperately needs rebalancing, is looking decidedly more unbalanced than ever.

The China bears argue that the 2008-2009 stimulus in response to the global financial crisis provoked a property bubble and inflation, created loads of debt (especially for local governments) and that the government won't be able to pump the economy up again in response to the weakening of European export markets.

Then there are the bulls who argue that the Chinese government still has plenty of fire-power to keep the economy bubbling along, and that the highly competent government most certainly knows what it is doing.  Then there are others who argue that we always underestimate the inherent momentum of the Chinese economy.

But too many of these observers and analysts skate over the deep and growing imbalances of the Chinese economy, which represent a grave danger for the medium term.  The government, currently paralyzed by a leadership transition and other scandals, seems unable to tackle these problems, thus storing up problems for the future.

In what way is China's growth unbalanced?

First, China's growth has been over-reliant on exports and investment, with domestic consumption playing a relatively minor role.  But 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 these subsidies are now becoming costly as they sidetrack China's production into less competitive activities, and reduce competitive pressures for further industrial upgrading, a key element for developmental progress.

The government has also biased development in favor of the manufacturing sector, leaving the agricultural sector backward in many areas and the services sector stunted in its development.  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 financial crises.

Why doesn't the government start reforming these policies, as it has promised to do so many times?  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 have been receiving 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 little 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.  Many of the investments by these state-owned enterprises are very inefficient, and are resulting growing non-performing loans for the banks.  It also contributes to corruption.  And it indirectly forces private sector enterprises, especially SMEs, to finance their investments through accumulating and reinvesting profits.  Thus, 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 much pollution results from the deliberate non-enforcement of environment laws and regulations.

When the global financial crisis struck in late 2008, the Chinese 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 investment in housing, roads, bridge and airports, a good part of which is under-utilized.  Such infrastructure spending also fuels corruption as officials pocket a slice of the price.  The stimulus also provoked a real estate bubble, and 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 merely throws money at the economy's short-term problems and puts off the necessary correction of the above imbalances in its economy.

And as these imbalances accumulate, the Chinese economy will ultimately hit the wall and face a period of slower economic development, long before it reaches the level of an advanced country.  How the country's politics will cope with this, we can never predict.

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