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What are China’s long-term economic challenges?
What are China’s long-term economic challenges?
ChinaFotoPress/Getty Image
ChinaFotoPress/Getty Image
Pupils wave Chinese Communist Party flags at Yuanqian Primary School on June 30, 2011 in Lianyungang, Jiangsu Province of China. This year's celebrations will mark the 90th anniversary of the founding of the Communist Party of China.
Chen Zhao Jun 30, 2011 – 2:13 PM ET | Last Updated: Jun 30, 2011 6:03 PM ET
There has been great debate over China’s economic problems and challenges. Some say the country faces a gigantic real estate bubble, and that its bursting could jeopardize the Chinese banking system, destabilize the economy and create a huge negative shock to the rest of the world. Others believe that the Chinese economy is on the verge of a major outbreak of inflation.
Although these issues represent serious challenges to China’s economic growth, they are only symptoms of a much deeper problem: the waning momentum of China’s long-term economic reforms and broader restructuring.
The “China miracle” is deeply rooted in the supply side reforms initiated by former leader Deng Xiao-Ping more than 30 years ago. It was Deng who dismantled the collective farm system, redistributed land and introduced the “household responsibility system” which allowed farmers to keep their surplus harvest after paying the state dues.
These simple but brave reforms sprouted farmers’ enthusiasm, producing a huge jump in agricultural outputs and quickly turning scarcity of agricultural supply into relative abundance in the early 1980s.
In the mid-1980s, Deng began transplanting the successful experiences of agricultural reform to the industrial sector. The Chinese government began liberalizing rigid price controls, making workers’ compensation more directly linked to performance and encouraging companies to focus on profits and efficiency.
These efforts produced mixed results: they sparked fast economic growth but also brought about spiraling inflation, as all state-owned companies went on a wage-maximization binge.
By 1992-1993, Chinese inflation was running at a 25% annual rate. In the 1990s, the “third generation” of Chinese leaders, headed By Jiang Zemin as party boss and Zhu Rongji as premier, made many gutsy moves to push forward additional reforms. These included the privatization of state-owned enterprises, the reduction of state interference in the economy, allowing greater freedom of labour mobility, the privatization of housing, the elimination of the dual foreign exchange system and the encouragement of private sector investment in areas that were previously open only to state-owned companies.
These supply side measures resulted in an explosion of productivity, as evidenced by the rapid and sustained surge in economic growth and steady fall in inflation. Since the 2000s, China’s real GDP growth has averaged 9.5%, but the average inflation rate has been 1.3%. The Chinese economy can be truly characterized as in a “deflationary boom.”
Unfortunately, the government’s policy orientation made a dramatic U-turn seven years ago when the current leadership, headed by Party boss Hu Jin-tao and Premier Wen Jia-bao, took office. The great hallmark of the current government has been its emphasis on “social justice,” income equality and building the so-called “harmonious society.”
The current government has taken strides to implement minimum wages, encourage collective bargaining, set up a social security system and enable pension funds, and is now beginning to roll out a social medical program that covers every individual.
Addressing issues of income inequality and social justice is absolutely necessary and should be regarded as an essential step in moving the Chinese economy from raw capitalism to a more civilized society. Nevertheless, the rapid implementation of these very costly programs when China’s per-capita GDP is only $4,400 could add an unbearable financial burden to future generations.
Most importantly, there have been no new reforms proposed or initiated to enhance the long-term growth of the economy. There is much to be done to restructure the economy. China’s rigid financial market structure has become a key obstacle to steady economic growth.
The foreign exchange market is overly regulated, with foreign exchange rates hardly reflective of market forces. Authorities are much more prone to relying on the old ways of administrative controls rather than using market tools to deal with delicate economic issues such as real estate speculation and excess liquidity inflows.
With the Chinese currency being suppressed at undervalued levels, both CPI and asset price inflation will inevitably rise. There are numerous other reforms that have yet to be even touched. The property right of farmland is still ill-defined and obscure, which discourages farmers from making long-term investment to boost outputs and raise productivity.
Private businesses are discriminated by state banks and having a hard time obtaining loans, even though they are the locomotives for economic growth and job creation. Interest rates are tightly controlled by the state and hardly reflective of true capital cost.
Credit quota control was widely used in the 1980s when the Chinese economy was still a centrally planned system and it is still being used today, even though the economy is already vastly different from what it was 30 years ago. The list can be extended easily but the key point is that without additional reforms to fuel productivity and properly allocate financial resources, inflation will inevitably rise and the boom-bust cycle will return.
The bad news is that the current government is running out of time and is unlikely to change its focus anytime soon. The good news is that the incumbent will be replaced by a new generation of leaders next year. Hopefully, the “fourth generation” of leaders will carry forward many of the reforms that began more than 30 years ago.
Chen Zhao is chief global strategist at Bank Credit Analyst Research Group in Montreal
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Originally Posted by Eldritch
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