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Special report: China's economy
Pedalling prosperity
China’s economy is not as precarious as it looks, says Simon Cox. But it still needs
to change
http://www.economist.com/node/21555762
May 26th 2012 | from the print edition
IN 1886 THOMAS STEVENS, a British adventurer (pictured), set off on an unusual bicycle trip. He
pedalled from the flower boats of Guangzhou in China’s south to the pagodas of Jiujiang about 1,000km
(620 miles) to the north. He was disarmed by the scenery (the countryside outside Guangzhou was a
“marvellous field-garden”) and disgusted by the squalor (the inhabitants of one town were “scrofulous,
sore-eyed, and mangy”). His passage aroused equally strong reactions from the locals: fascination, fear and
occasional fury. In one spot a “soul-harrowing” mob pelted him with stones, bruising his body and
breaking a couple of his bicycle’s spokes.
A century later the bike was no longer alien to China; it had become symbolic of it. The “bicycle kingdom”
had more two-wheelers than any other country on Earth. Many of those bikes have since been replaced by
cars—one obvious sign of China’s rapid development. But even today the bicycle looms large in the battle
for China’s soul.
For China’s fast-diminishing population of poor people, bikes remain an important beast of burden, piled
high with recycled junk. For China’s fast-expanding population of city slickers, the bicycle represents
everything they want to leave behind. “I’d rather cry in the back of your BMW than laugh on the back of
your bicycle,” as China’s material girls say. Some dreamers in government see a return to the bike as an
answer to China’s growing problems of prosperity—pollution, traffic and flab. The country’s National
Development and Reform Commission wants government officials to cycle to work one day a week,
though only if the distance is less than 3km.
Even if it is a fading symbol of Chinese society, the bicycle remains a tempting metaphor for its economy.
Bikes—especially when heavily laden—are stable only as long as they keep moving. The same is
sometimes said about China’s economy. If it loses momentum, it will crash. And since growth is the only
source of legitimacy for the ruling party, the economy would not be the only thing to wobble. From 1990 to
2008 China’s workforce swelled by about 145m people, many of them making the long journey from its
rural backwaters to its coastal workshops. Over the same period the productivity of the workforce increased
by over 9% a year, according to the Asian Productivity Organisation (APO). Output that used to take 100
people in 1990 required fewer than 20 in 2008. All this meant that growth of 8-10% a year was not a luxury
but a necessity.
But the pressure is easing. Last year the ranks of working-age Chinese fell as a percentage of the
population. Soon their number will begin to shrink. The minority who remain in China’s villages are older
and less mobile. Because of this loss of demographic momentum, China no longer needs to grow quite so
quickly to keep up. Even the government no longer sees 8% annual growth as an imperative. In March it set
a target of 7.5% for this year, consistent with an average of 7% over the course of the five-year plan that
ends in 2015. China has been in the habit of surpassing these “targets”, which represent a floor not a ceiling
to its aspirations. Nonetheless the lower figure was a sign that the central leadership now sees heedless
double-digit growth as a threat to stability, not a guarantee of it.
The penny-farthing theory
Stevens’s 1886 journey across south-east China was remarkable not only for the route he took but also for
the bike he rode: a “high-wheeler” or “penny-farthing”, with an oversized wheel at the front and a
diminutive one at the rear. The contraption is not widely known in China. That is a pity, because it provides
the most apt metaphor for China’s high-wheeling economy.
The large circumference of the penny-farthing’s front wheel carried it farther and faster than anything that
preceded it, much as China’s economy has grown faster for longer than its predecessors. Asked to name the
big wheel that keeps China’s economy moving, many foreign commentators would say exports. Outside
China, people see only the Chinese goods that appear on their shelves and the factory jobs that disappear
from their shores; they do not see the cities China builds or the shopping aisles it fills at home. But the
contribution of foreign demand to China’s growth has always been exaggerated, and it is now shrinking.
It is investment, not exports, that leads China’s economy. Spending on plant, machinery, buildings and
infrastructure accounted for about 48% of China’s GDP in 2011. Household consumption, supposedly the
sole end and purpose of economic activity, accounts for only about a third of GDP (see chart 1). It is like
the small farthing wheel bringing up the rear.
A disproportionate share of China’s investment is made by state-owned enterprises and, in recent years, by
infrastructure ventures under the control of provincial or municipal authorities but not on their balance
sheets. This investment has often been clumsy. In the 1880s, according to Stevens, China showed a
“scrupulous respect for individual rights and the economy of the soil”. The road he pedalled took many
wearisome twists and turns to avoid impinging on any private property or fertile plot. These days China’s
roads run straight. Between 2006 and 2010 local authorities opened up 22,000 sq km of rural land, an area
the size of New Jersey, to new development. China’s cities have grown faster in area than in population.
This rapid urbanisation is a big part of the country’s economic success. But it has come at a heavy price in
depleted natural resources, a damaged environment and scrupulously disrespected property rights.
The imbalance between investment and consumption makes China’s economy look precarious. A cartoon
from the 1880s unearthed by Amir Moghaddass Esfehani, a Sinologist, shows a Chinese rider losing
control of a penny-farthing and falling flat on his face. A vocal minority of commentators believe that
China’s economy is heading for a crash. In April industrial output grew at its slowest pace since 2009.
Homebuilding was only 4% up on a year earlier. Things are looking wobbly.
But China’s economy will not crash. Like the high-wheeled penny-farthing, which rolled serenely over
bumps in the road, it is good at absorbing the jolts in the path of any developing country. The state’s
influence over the allocation of capital is the source of much waste, but it helps keep investment up when
private confidence is down. And although China’s repressed banking system is inefficient, it is also
resilient because most of its vast pool of depositors have nowhere else to go.
Not so fast
The penny-farthing eventually became obsolete, superseded by the more familiar kind of bicycle. The leap
was made possible by the invention of the chain-drive, which generated more oomph for every pedal push.
China’s high-wheeling growth model will also become obsolete in due course. As the country’s workforce
shrinks and capital accumulates, its saving rate will fall and new investment opportunities will become
more elusive. China will have to get more oomph out of its inputs, raising the productivity of capital in
particular. That will require a more sophisticated financial system, based on a more complex set of links
between savers and investors.
Other innovations will also be needed. China’s state-owned enterprises emerged stronger—too strong—
from the downsizing of the 1990s, but the country’s social safety net never recovered. Thus even as the
state invests less in industrial capacity, it will need to spend more on social security, including health care,
pensions, housing and poverty relief. That will help boost consumer spending by offering rainy-day
protection.
Keep those wheels turning
The chain-drive was not the only invention required to move beyond the penny-farthing. The new smaller
wheels also needed pneumatic tyres to give cyclists a smoother ride. In the absence of strong investment to
keep employment up and social unrest down, China’s state will also need a new way to protect its citizens
from bumps in the road ahead.
The retreat of the monster surplus
China’s current-account surplus is on the verge of extinction
May 26th 2012 | from the print edition
THREE DINOSAURS LURK in a former factory district of Beijing. Bright red, with “Made in China”
embossed on their bellies, they look like the cheap plastic toys China exports to the rest of the world. But
these model dinosaurs are life-sized, towering over passers-by. And they look hungry.
The three beasts are one of the imposing installations at the 798 Art District in Beijing. Sculpted by Sui
Jianguo, a former factory worker, they are imprisoned in three cages, stacked on top of each other, like the
20-foot containers that carry the country’s manufactures to the world. In resin, bronze and steel, the
sculpture embodies the widespread fear that China’s exporters will gobble up foreign markets and
manufacturers. When it was made in 1999, the country’s exports were less than a third of America’s. Ten
years later China was the world’s largest exporter. Of the toys shipped to America and the European Union,
85-90% were made in China.
The country’s roaring exports contributed to a growing current-account surplus, which exceeded 10% of its
GDP in 2007 (see chart 3). China’s surpluses—its failure to import as much as it exported, spend as much
as it earned, or invest as much as it saved—became an economic cause célèbre, generating an equally
impressive surplus of commentary and explanation.
Ben Bernanke, now chairman of America’s Federal Reserve, argued that China’s surplus was adding to a
“global savings glut”. It was the subject of much debate and diplomacy at G20 summits, and the object of
much blame and many bills in America’s Congress. The latest of those, which passed the Senate in
October, calls for retaliation against any country that engineers an oversized surplus with an undervalued
currency. Mitt Romney, the presumptive Republican nominee for president, has threatened to brand China
as a currency manipulator on his first day in the White House.
China’s trade surplus with America remains large and controversial, but its current-account surplus with the
rest of the world is dying out. Last year it narrowed to $201 billion, less than 2.8% of the country’s GDP,
the smallest percentage since 2002. In money terms it was smaller than Germany’s.
Is that small enough? The Senate bill relies on IMF methods to calculate a current-account “norm” for a
country like China. Such calculations are more art than science: one exercise by the European Central Bank
estimated China’s norm 16,384 different ways. But an unofficial study using the IMF’s methods calculated
a benchmark of about 2.9% of GDP over the medium term, which suggests China’s surplus is about where
it should be. Whether it remains there depends partly on why it narrowed in the first place. In its latest
World Economic Outlook, the IMF identifies four reasons: China’s exchange rate, its terms of trade, global
spending and China’s own investment expenditure.
China’s exchange rate has risen, if not as far or as fast as many Americans had hoped. This appreciation
can be measured in various ways. The measure most economists watch is the real effective exchange rate
(REER) adjusted for consumer-price inflation and weighted by trade. This has gone up by 27% since July
2005. An alternative gauge is the internal real exchange rate (IRER), which measures the price of Chinese
goods that cannot be traded across borders relative to the price of things that can. According to a study by
the Hong Kong Institute for Monetary Research, China’s internal real exchange rate rose by over 35%
between July 2005 and December 2011 (see chart 2). This appreciation encourages the Chinese to make
more non-tradable goods and to buy more tradable ones. Both help narrow its surplus.
The size of China’s surplus also depends on some volatile prices, such as the cost of crude oil and other
commodities that China imports. The price of China’s imports has risen relative to the price of its exports in
recent years. According to the IMF, this deterioration in China’s terms of trade could explain up to half the
drop in its surplus between 2007 and 2011. Those terms are unlikely to improve. As long as China remains
the dominant force in the market for its main imports and exports, it will continue to influence the price of
both.
This pincer movement shows up in surprising ways. One British scholar argues that cheap Chinese exports
have deterred burglaries in his country because a £19.99 DVD player is hardly worth stealing. But others
say that China’s imports of copper have contributed to a rise in metal theft because China’s appetite for
such commodities has made them a more tempting target.
Domestic demand in China’s big trading partners has been slow to recover from the crisis. China’s own
spending, on the other hand, has surpassed all expectations. Investment as a share of GDP rose by over six
points between 2007 and 2010 as banks lent liberally to help stimulate the economy. The IMF reckons that
this rise in investment in itself accounted for between a quarter and a third of the narrowing of China’s
surplus. But it may also have been a contributory cause of some of the other factors, such as the rise in
commodity prices and the increase in Chinese wages and prices.
Will it return?
The surplus could widen again, for one of two reasons. First, China’s high investment could set the stage
for a renewed export boom. Second, China’s investment rate could falter without consumption rising to
make up for it, forcing China to rely on foreign demand to keep the economy moving.
The future of China’s export monster depends on whether China’s high investment rate is sustainable.
Many think it is not
To imagine the first scenario, you only have to examine the recent past. Pieter Bottelier of the Conference
Board, a think-tank, argues that China’s big surpluses before 2008 owed something to an investment boom
around the time China joined the World Trade Organisation in 2001. This investment created excess
capacity in industries such as cars, construction materials and especially steel. At first these new factories
displaced imports; then, when the domestic market proved too small, they flogged their surplus wares on
foreign markets instead. China went from being a net importer of steel in 2004 to being the world’s largest
net exporter, note Brett Berger and Robert Martin of the Federal Reserve.
But a repeat is unlikely. It would require China’s low consumption rate to move still lower to make room
for so much investing and exporting. It would also require China to make further rapid gains in global
market share.
The post-crisis investment boom was also different from the post-WTO one. It was weighted towards
inland provinces, far from the seaports that ship China’s goods to the rest of the world. Inland China’s
share of fixed-asset investment matched that of the coastal provinces for the first time in 2009, then
exceeded it in 2010. The investment boom in 2009-10 was also concentrated in infrastructure and property.
Neither can be traded across borders.
But some economists believe that the latest investment boom will prove unsustainable. If construction
collapses, some of the industries that fed China’s building rush will turn their attentions overseas, as they
did in 2006.
The future of China’s export monster thus depends on whether China’s high investment rate is sustainable.
Many think it is not. Economists like Paul Krugman, a professor at Princeton University and a
commentator for the New York Times, have gone from bashing China for its underpriced currency to
fretting about its overpriced property. Its spectacular building boom has diverted China’s energies inwards,
sucking in imports and displacing exports. It has thus eased the world’s fear of China. But it has raised
fears for China.
Investment
Prudence without a purpose
Misinvestment is a bigger problem than overinvestment
May 26th 2012 | from the print edition
GENGHIS KHAN SQUARE in Kangbashi, a new city in the northern province of Inner Mongolia, is as big
as Tiananmen Square in Beijing. But unlike Tiananmen Square, it has only one woman to sweep it. It takes
her six hours, she says, though longer after the sandstorms that sweep in from the Gobi desert. Kangbashi,
or “new Ordos”, as it is known, is easy to clean because it is all but empty. China’s most famous “ghost
city”, it has attracted a lot of journalists eager to illustrate China’s overinvestment, but not many residents.
Ordos was one of the prime exhibits in an infamous presentation by Jim Chanos, a well-known short-seller,
at the London School of Economics in January 2010. Mr Chanos argued that China’s growth was
predicated on an unsustainable mobilisation of capital—investment that provides only for further
investment. China, he quipped, was “Dubai times 1,000”.
His tongue-in-cheek reference to the bling-swept, debt-drenched emirate caused a stir. But not everywhere
in China shrinks from the comparison. One property development that actively courts it is Phoenix Island,
off the coast of tropical Sanya, China’s southernmost city. It is a largely man-made islet, much like Dubai’s
Palm Jumeirah. Its centrepiece will be a curvaceous seven-star hotel, rather like Dubai’s Burj Al Arab, only
shaped like a wishbone not a sail. The five pod-like buildings already up resemble the unopened buds of
some strange flower. Coated in light-emitting diodes, they erupt into a lightshow at night, featuring adverts
for Chanel and Louis Vuitton.
After a visit to Ordos or Sanya, it is tempting to agree with Mr Chanos that China has overinvested from its
northern steppe to its southern shores. But what exactly does it mean for a country to “overinvest”? One
clear sign would be investment that was running well ahead of saving, requiring heavy foreign borrowing
and buying. The result could be a currency crisis, like the Asian financial crisis of 1997-98. Some veterans
of that episode worry about China’s reckless investment in tasteless property. But although China invests
more of its GDP than those crisis-struck economies ever did, it also saves far more. It is a net exporter of
capital, as its controversial current-account surplus attests. Indeed, for every critic bashing China for
reckless investment spending there is another accusing it of depressing world demand through excessive
thrift. China is in the odd position of being cast as both miser and wanton.
Even an extravagance like Kangbashi is best understood as an attempt to soak up saving. The Ordos
prefecture, to which it belongs, is home to a sixth of China’s coal reserves and a third of its natural gas (not
to mention its rare earths and soft goat’s wool). According to Ting Lu of Bank of America Merrill Lynch,
Kangbashi is an attempt to prevent Ordos’s commodity earnings from disappearing to other parts of the
country.
China as a whole saved an extraordinary 51% of its GDP last year. Until China’s investment rate exceeds
that share, there is no cause for concern, says Qu Hongbin of HSBC. Anything China fails to invest at
home must be invested overseas. “The most wasteful investment China now has is US Treasuries,” he adds.
When talking about thrift, economists sometimes draw on a parable of prudence written three centuries ago
by Daniel Defoe. In that novel the resourceful Robinson Crusoe, shipwrecked on a remote island, saves and
replants four quarts of barley. The reward for his thrift is a harvest of 80 quarts, a return of 1,900%.
Castaway capital
Investment is made out of saving, which requires consumption to be deferred. The returns to investment
must be set against the disadvantage of having to wait. In Robinson Crusoe, the saving and the investing
are both done by the same Englishman, alone on his island. In a more complicated economy, households
must save so that entrepreneurs can invest. In most economies their saving is voluntary, but China has
found ways of imposing the patience its high investment rate requires.
Michael Pettis of Guanghua School of Management at Peking University argues that the Chinese
government suppresses consumption in favour of producers, many of them state-owned. It keeps the
currency undervalued, which makes imports expensive and exports cheap, thereby discouraging the
consumption of foreign goods and encouraging production for foreign customers. It caps interest rates on
bank deposits, depriving households of interest income and transferring it to corporate borrowers. And
because some of China’s markets remain largely sheltered from competition, a few incumbent firms can
extract high prices and reinvest the profits. The government has, in effect, confiscated quarts of barley from
the people who might want to eat them, making them available as seedcorn instead.
What has China got in return? Investment, unlike consumption, is cumulative; it leaves behind a stock of
machinery, buildings and infrastructure. If China’s capital stock were already too big for its needs, further
thrift would indeed be pointless. In fact, though, the country’s overall capital stock is still small relative to
its population and medium-sized relative to its economy. In 2010, its capital stock per person was only 7%
of America’s (converted at market exchange rates), according to Andrew Batson and Janet Zhang of GK
Dragonomics, a consultancy in Beijing. Even measured at purchasing-power parity, China has only about a
fifth of America’s capital stock per person, depending on how its PPP rate is calculated.
China needs to “produce lots more of almost everything”, argues Scott Sumner of Bentley University, even
if it does not produce “everything in the right order”. Its furious homebuilding, for example, has unnerved
the government and cast a shadow over its banks, which worry about defaults on property loans. But it still
needs more places for people to live. In 2010 it had 140m-150m urban homes, according to Rosealea Yao
of GK Dragonomics, 85m short of the number of urban households. About three-quarters of China’s
migrant workers are squeezed into rented housing or dormitories provided by their employer.
Nor is China’s capital stock conspicuously large relative to the size of its economy. It amounted to about
2.5 times China’s GDP in 2008, according to the APO. That was the same as America’s figure and much
lower than Japan’s. Thanks to China’s stimulus-driven investment spree, the ratio increased to 2.9 in 2010,
but that still does not look wildly out of line.
Malinvestors of great wealth
In Defoe’s tale, Robinson Crusoe spends five months making a canoe for himself, felling a cedar-tree,
paring away its branches and chiselling out its innards. Only after this “inexpressible labour” does he find
that the canoe is too heavy to be pushed the 100 yards to the shore. That is not an example of
overinvestment (Crusoe did need a canoe), but “malinvestment”. Crusoe devoted his energy to the wrong
enterprise in the wrong place.
It is surprisingly hard to show that China has overinvested, but easier to show that it has invested unwisely.
Of China’s misguided canoe-builders, two are worth singling out: its local governments (see article) and its
state-owned enterprises (SOEs).
China’s SOEs endured a dramatic downsizing and restructuring in the 1990s. Thousands of them were
allowed to go bankrupt, yet those that survived this cull remain a prominent feature of Chinese capitalism.
Even in the retail, wholesale and restaurant businesses there are over 20,000 of them, according to Zhang
Wenkui of China’s Development Research Centre.
SOEs are responsible for about 35% of the fixed-asset investments made by Chinese firms. They can invest
so much because they have become immensely profitable. The 120 or so big enterprises owned by the
central government last year earned net profits of 917 billion yuan ($142 billion), according to their
supervisor, the State-owned Assets Supervision and Administration Commission (SASAC). It cites their
profitability as evidence of their efficiency. But even now, returns on equity among SOEs are substantially
lower than among private firms. Nor do SOEs really “earn” their returns. The markets they occupy tend to
be uncompetitive, as the OECD has shown, and their inputs of land, energy and credit are artificially cheap.
Researchers at Unirule, a Beijing think-tank, have shown that the SOEs’ profits from 2001 to 2008 would
have turned into big losses had they paid the market rate for their loans and land.
Even if the SOEs deserved their large profits, they would not be able to reinvest them if they paid proper
dividends to their shareholders, principally the state. Since a 2007 reform, dividends have increased to 515% of profits, depending on the industry. But in other countries state enterprises typically pay out half,
according to the World Bank. Moreover, SOE dividends are not handed over to the finance ministry to
spend as it sees fit but paid into a special budget reserved for financing state enterprises. SOE dividends, in
other words, are divided among SOEs.
The wrong sort of investment
Loren Brandt and Zhu Xiaodong of the University of Toronto argue that China’s worst imbalance is not
between investment and consumption but between SOE investment and private investment. According to
their calculations, if state capitalists had not enjoyed privileged access to capital, China could have
achieved the same growth between 1978 and 2007 with an investment rate of only 21% of GDP, about half
its actual rate. A similar conclusion was reached by David Dollar, now at America’s Treasury, and ShangJin Wei of Columbia Business School. They reckon that two-thirds of the capital employed by the SOEs
should have been invested by private firms instead. Karl Marx made his case for collective ownership of
the means of production in “Das Kapital”. Messrs Dollar and Wei called their riposte “Das (Wasted)
Kapital”.
Perhaps the best that can be said of China’s SOEs is that they give the country’s ruling party a direct stake
in the economy’s prosperity. Li-Wen Lin and Curtis Milhaupt of Columbia University argue that the
networks linking the party to the SOEs, and the SOEs to each other, help to forge an “encompassing”
coalition, a concept they draw from Mancur Olson, a political scientist. The members of such a coalition
“own so much of the society that they have an important incentive to be actively concerned about how
productive it is”. China’s rulers not only own large swathes of industry, they have also installed their sons
and daughters in senior positions at the big firms.
The SOEs provide some reassurance that the government will remain committed to economic growth,
according to Mr Milhaupt and another co-author, Ronald Gilson. The party officials embedded in them are
like “hostages” to economic fortune, “the children of the monarch placed in the hands of those who need to
rely upon the monarch”. That gives private entrepreneurs confidence, because the growth thus guaranteed
will eventually benefit them as well—although they will have to work harder for their rewards.
What are the implications of China’s malinvestment for its economic progress? At its worst, China’s
growth model adds insult to injury. It suppresses consumption and forces saving, then misinvests the
proceeds in speculative assets or excess capacity. It is as if Crusoe were forced to scatter more than half his
barley on the soil, then leave part of the harvest to rot.
The rot may not become apparent at once. Goods for which there is no demand at home can be sold abroad.
And surplus plant and machinery can be kept busy making capital goods for another round of investment
that will only add to the problem. But when the building dust settles, a number of consequences become
clear. First, consumption is lower than it could be, because of the extra saving. GDP, properly measured, is
also lower than it appears, because so much of it is investment, and some of that investment is ultimately
valueless. It follows that the capital stock, properly measured, is also smaller than it seems, because a lot of
it is rotten. That would make for a very different kind of island parable, a tale of needless austerity and
squandered effort.
Fortunately there is another side to China’s story. It has not only accumulated physical capital but also
acquired more know-how, better technology and cleverer techniques. That is why foreign multinationals in
the country rely on local suppliers—and also why they fear local rivals. A Chinese motorbike-maker
studied by John Strauss of the University of Southern California and his co-authors started out producing
the metal casings for exhaust pipes. Then it learnt how to make the whole pipe. Next it mastered the
pistons. Eventually it made the entire bike.
China “bears” like Mr Chanos sometimes neglect this side of the country’s progress. In his 2010
presentation he compared China to the Soviet Union, another empire in the east that enjoyed a stretch of
beguiling economic growth. Like the Soviet command economy, China is good at marshalling inputs of
capital and labour, he pointed out, but China has failed to generate growth in output per input, just as the
Soviet Union failed before it. Yet this analogy with the Soviet Union is preposterous.
Economists refer to a rise in output per input of capital and labour as a gain in “total factor productivity”.
Such gains have many sources. One textile boss got 20% more out of his seamstresses by playing
background music in his factory, recalls Arnold Harberger of the University of California at Los Angeles.
The striking thing about the growth in China’s total factor productivity is not its absence but its speed: the
fastest in the world over the past decade. Between 2000 and 2008 it contributed 43% of the country’s
economic growth, according to the APO. That is just as big a contribution as the brute accumulation of
capital, which accounted for 44% (excluding information technology). Thus even if some of China’s recent
investment has in fact been wasted, China’s progress cannot be written off.
And even if some of China’s past investment has been futile, adding nothing worthwhile to the capital
stock, there is a consolation: it will leave more scope to invest later, suggesting that the country’s potential
for growth is even larger than the optimists think. The right kind of investment can still generate high
returns. But what if the mistaken investments of the past disrupt the financial system, preventing resources
from being deployed more effectively in the future?
The ballad of Mr Guo
What makes local-government officials tick
May 26th 2012 | from the print edition
SINGING KARAOKE WITH Taiwanese investors, smearing birthday cake on the cheeks of an American
factory owner, knocking back baijiu, a Chinese spirit, with property developers: Guo Yongchang would do
anything to attract investment to Gushi, a county of 1.6m people in Henan province, where he served as
party secretary. His antics are recorded in “The Transition Period”, a remarkable fly-on-the-wall
documentary about his last months in office, filmed by Zhou Hao.
Mr Guo persuades one developer to raise the price of his flats because Gushi people are interested only in
the priciest properties. After a boozy dinner he drapes himself over the developer’s shoulder and extracts a
promise from him to add more storeys to his tower to outdo the one in the neighbouring city.
The one-upmanship exemplified by Mr Guo has generated great economic dynamism, but also great
inefficiency. When the central government tries to stop economic overheating, local governments resist.
Conversely, when the government urged the banks to support its 2008 stimulus effort, local governments
scrambled to claim an outsized share of the lending. The result is a local-government debt burden worth
over a fifth of China’s 2011 GDP.
The worst abuses, however, involve land. Local officials can convert collectively owned rural plots into
land for private development. Since farmers cannot sell their land directly to developers, they have to
accept what the government is willing to pay. Often that is not very much.
Such perverse incentives have caused China’s towns and cities to grow faster in area than they have grown
in population. Their outward ripple has engulfed some rural communities without quite erasing them. The
perimeter of Wenzhou city in Zhejiang province, to take one example, now encompasses clutches of
farmhouses, complete with vegetable plots, quacking ducks and free-range children. This results in some
incongruous sights. Parked outside one farmhouse are an Audi, a Mercedes and a Porsche. Alas, they do
not belong to the locals but to city slickers who want their hub caps repainted.
Oddly, where electoral reforms have given Chinese villagers a bigger say in local government, growth
tends to slow, according to Monica Martinez-Bravo of Johns Hopkins University and her colleagues. This
is partly because elected local officials shift their efforts from expanding the economy to providing public
goods, such as safe water. But it is also because a scattered electorate cannot monitor them as closely as
their party superiors can.
Fear of their bosses and hunger for revenues keep local officials on their toes. Mr Guo, star of “The
Transition Period”, was eventually convicted of bribery. He was not entirely honest in the performance of
his duties, and not always sober either. But with all the parties, banquets and karaoke, no one could accuse
him of being lazy.
Finance
Bending not breaking
China’s financial system looks quake-proof, but for how long?
May 26th 2012 | from the print edition
VISITORS TO SICHUAN’S atmospheric mountains, home to both Tibetan and Qiang minorities, used to
skip Yingxiu village on their way to more scenic spots higher up. But the devastating earthquake that struck
the area in May 2008 has turned the village into an unlikely tourist attraction. The earthquake killed 6,566
people in the village, over 40% of its population. Its five-storey middle school collapsed, killing 55 people.
Nineteen students and two teachers remain buried in the rubble.
Four years on, the crumpled school remains. It has been preserved as a memorial to the disaster, but almost
every other sign of the quake has been erased. The village is full of new homes with friezes painted in
strong Tibetan colours. Other buildings are topped with flat roof terraces, a white concrete triangle in each
corner, echoing the white stones that adorn traditional Qiang architecture. The new homes look a little like
Qiang stone houses on the outside, one villager concedes. “But inside they are all Han.”
Yingxiu is an example of “outstanding reconstruction”, according to a billboard en route. Outside this
showcase village, people have rebuilt their lives with less government help. But there is no denying that
China set about reconstructing the earthquake zone with a speed and determination few other countries
would be able to match. A propaganda poster shows Hu Jintao, China’s president, bullhorn in hand,
declaring that “Nothing Can Stop the Chinese”.
The earthquake did great damage to the region’s property and infrastructure. But although it left the local
economy worse off, the pace of economic activity picked up in the wake of the disaster. There was much to
do precisely because so much had been lost. Even today the mountain road is lined with lorries.
Some economists worry that China may soon suffer a different kind of economic disaster: a financial
tremor of unknown magnitude. Pivot Capital Management, a hedge fund in Monaco, argues that China’s
recent investment spree was driven by a “credit frenzy” which will turn into a painful “credit bust”.
Lending jumped from 122% of GDP in 2008 to 171% just two years later, according to Charlene Chu of
Fitch, a ratings agency, who counts some items (such as credit from lightly regulated “trust” companies)
that do not show up in the official figures. This surge in credit is reminiscent of the run-up to America’s
financial crisis in 2008, Japan’s in 1991 and South Korea’s a few years later (see chart 5), Ms Chu argues.
When Fitch plugged China’s figures into its disaster warning system (the “macroprudential risk indicator”),
the model suggested a 60% chance of a banking crisis by the middle of next year.
China’s frenzied loan-making has traditionally been matched by equally impressive deposit-taking. Even
now, most households have few alternative havens for their money. This captive source of cheap deposits
leaves China’s banks largely shock-proof. They make a lot of mistakes, but they also have a big margin for
error. That will help them withstand any impending tremors.
But this traditional source of strength will not last for ever. China’s richest depositors are becoming
restless, demanding better returns and seeking ways around China’s regulated interest rates. The
government will eventually have to liberalise rates. That will make China’s banks more efficient but also
less resilient.
There remains great uncertainty about China’s financial exposure. Not all of the country’s “malinvestment”
will result in bad loans. Some of its outlandish property developments, including the empty flats of Ordos,
were bought by debt-free investors with money to burn. By the same token, not all of China’s “bad” loans
represent malinvestment. Rural infrastructure projects, to take one example, are often “unbankable”, failing
to generate enough income from fees, charges and tolls to service their financial obligations. But the
infrastructure may still contribute more to the wider economy than it cost to provide. That is especially
likely for stimulus projects, which employed labour and materials that would otherwise have gone to waste.
But suppose a financial quake does strike China: how will its economy respond? Financial disasters, like
natural ones, destroy wealth, sometimes on a colossal scale. But as China’s earthquake showed, a one-off
loss of wealth need not necessarily cause prolonged disruption to economic activity as measured by GDP.
Yingxiu suffered a calamitous loss of people and property, but this was followed by a conspicuous upswing
in output (especially construction) and employment.
If this seems counterintuitive, that is because GDP is easily misunderstood. It is not a measure of wealth or
well-being, both of which are directly damaged by disasters. Rather, it measures the pace of economic
activity, which in turn determines employment and income. Financial distress will damage China’s wealth
and welfare, almost by definition. The interesting question is whether it will also lead to a pronounced
slowdown in activity and employment—the much-predicted “hard landing”. To put it in Mr Hu’s terms,
can a financial quake stop the Chinese?
If the banking system as a whole had to write off more than 16% of its loans, its equity would be wiped out.
But the state would intervene long before that happened. Despite the excesses of China’s local authorities,
its central government still has the fiscal firepower to prevent loans going bad, or to recapitalise the banks
if they do. Its official debt is about 26% of GDP (including bonds issued by the Ministry of Railways and
other bits and pieces). If it took on all local-government liabilities, that ratio would remain below 60%.
Alternatively, it could recapitalise a wiped-out banking system at a cost of less than 20% of GDP.
Even if many loans do eventually sour, banks do not have to recognise these losses all at once. No loan is
bad until someone demands repayment, as the saying goes. In March the government released details of a
long-rumoured plan to roll over loans to local governments. Many of these loans were due to mature before
the project they financed was meant to be completed. If the project is worth finishing, this kind of
evergreening is an efficient use of resources. And some projects, once under way, are worth finishing even
if they were not worth starting.
Loan rollovers give banks time to earn their way out of trouble, setting aside profits from good loans before
they recognise losses on bad ones. This task is easier in China than in other countries because its financial
system remains “repressed”. Banks can force their depositors to bear some of their losses by paying them
less than the market rate of interest. Indeed, deposit rates are often below the rate of inflation, making them
negative in real terms. A bank’s depositors, in effect, pay the bank to borrow their money from them.
Chinese banks can get away with this because deposit rates are capped by the government, preventing rival
banks from offering higher rates. China’s capital controls also make it hard for depositors to escape this
implicit tax by taking their money abroad. As a consequence, Chinese banks luxuriate in a vast pool of
cheap deposits, worth 42% more than their loans at the end of 2011.
This cash float gives Chinese banks a lot of room for error. In 2011 new deposits amounted to 9.3 trillion
yuan, according to official figures, more than enough to cover fresh loans of 7.3 trillion yuan. Although
deposit growth is slowing, these inflows give banks a cash buffer, allowing them to keep lending, even if
their maturing loans are not always repaid in full and on time.
A chronic complaint
So China’s financial strains will not result in the sort of acute disaster suffered so recently by the West.
Instead, they will remain a chronic affliction which the state and its banks will try to ameliorate over time
with a combination of government-orchestrated rollovers, repression and repayment.
Such a combination is unfair to taxpayers and depositors, but it is also stable. According to Guonan Ma of
the Bank for International Settlements, bank depositors and borrowers ended up paying roughly 270 billion
yuan ($33 billion) towards the cost of China’s most recent round of bank restructuring, which stretched
over a decade from 1998. However, some commentators think that China will find it harder to repeat the
trick in the future. Depositors are not as docile as they were. In fits and starts, resistance to China’s
financial repression seems to be growing.
“Let’s be frank. Our banks earn profits too easily,” Wen Jiabao, China’s prime minister, admitted on
national radio in April. He is right. The ceiling on deposit rates and the floor under lending rates guarantee
banks a fat margin, preventing competition for deposits and allowing big banks to maintain vast pools of
money cheaply.
If the deposit ceiling were lifted, small banks would offer juicier rates to take market share from
incumbents. Conversely, the big banks would trim their deposit bases as they became more expensive.
Households would be better rewarded for their saving, and China’s banking “monopoly” would be broken,
as Mr Wen professes to want. In fact, though, the government is still dragging its feet on rate liberalisation.
Its hesitancy may reflect the political clout of the state-owned banks. It may also reflect the government’s
own fears.
Most developing countries (and some developed ones too) that freed up their financial systems suffered
some kind of crisis afterwards. Upstart firms can poach the incumbents’ best customers, threatening their
viability but at the same time overextending themselves. Even in America, rate liberalisation in the early
1980s allowed hundreds of Savings and Loan Associations to throw their balance sheets out of joint,
offering higher returns to depositors even though their assets were producing low fixed returns. In a 2009
paper, Tarhan Feyzioglu of the IMF and his colleagues strongly endorsed Chinese rate liberalisation. But
they also acknowledged that it can be mishandled, citing America’s S&L crisis as well as even worse
debacles in South Korea, Turkey, Finland, Norway and Sweden. The most famous study of these risks was
written more than 25 years ago. Its sobering title was “Goodbye Financial Repression, Hello Financial
Crash”.
The risks of repression
These are good reasons for caution, but not for procrastination. Repressed rates have their own dangers. To
avoid them, savers have overpaid for alternative assets such as property, contributing to China’s worrying
speculative bubble. In places like Wenzhou, a city in Zhejiang province, rate ceilings have encouraged
firms and rich individuals to make informal loans to each other, bypassing the regulated banking system in
favour of unsafe, unprotected intermediation in the shadows (see article). The patience of the public at large
is also wearing thin. At a central-bank press conference in April, a journalist (from Xinhua, the official
mouthpiece, no less) refused to let go of the microphone until her complaint about negative deposit rates
was heard.
A growing number of depositors are looking for ways to circumvent the ceiling. Those with lots of money
to park are driving the demand for “wealth-management products”, short-term savings instruments backed
by a mix of assets that offer better returns than deposit accounts.
By the end of the first quarter of 2012 these products amounted to 10.4 trillion yuan, according to Ms Chu
of Fitch. That is equivalent to over 12% of deposits. Most had short maturities, leaving buyers free to shop
around from month to month. Banks accustomed to sitting on docile deposits may struggle to match the
timing of cash pay-outs and inflows, Ms Chu frets. The banking regulator may also be worried. It has now
banned maturities of less than a month.
To avoid repressed interest rates, savers have overpaid for alternative assets such
as property, contributing to China’s worrying speculative bubble
The recent proliferation of wealth-management products amounts to a de-facto liberalisation of interest
rates, Ms Chu argues. The growing competition for deposits is showing up in other ways too. When the
finance ministry auctions its own six-month deposits, banks are now willing to offer rates as high as 6.8%,
more than twice the maximum they are able to offer to ordinary depositors.
The government may seek to formalise this de facto liberalisation, gradually allowing banks more freedom
to set rates on large long-term deposits—the kind that will otherwise disappear from banks’ books. Net
corporate deposits, for example, did not grow at all in 2011. Higher rates would help attract them back.
That would also raise banks’ costs of funding, forcing China to become more efficient in its allocation of
capital. At the moment the system is segregated between big enterprises, which enjoy relatively low
borrowing costs, and credit-starved private firms that could potentially earn much higher returns on
investment. In a freer financial system, competition would begin to close this gap. If interest rates went up
to match the return on capital, Chinese investment would fall by 3% of GDP, according to a study by Nan
Geng and Papa N’Diaye of the IMF.
More flexible interest rates would also raise Chinese consumption, says Nick Lardy of the Peterson
Institute for International Economics. He calculates that if banks paid something resembling a market
interest rate on their vast deposits, household income would increase by 2% of GDP. Higher incomes, he
argues, would cause their spending to rise and their saving rate to fall. The idea that higher rates will make
people save less is unorthodox, but Mr Lardy argues that the higher income from saving will have a bigger
effect than the higher reward offered for it. Chinese households save towards a goal, he suggests, such as
the down-payment on a house or the cost of a potential medical emergency. Lower the return to saving, and
they will just save even harder to achieve their goal.
Research by Malhar Nabar of the IMF suggests that higher interest rates would indeed bring down saving
rates, but the effects would be modest. If the real rate on one-year deposits rose from roughly 0% today to a
more reasonable 3%, it would lower household saving by only about 0.5% of GDP, he calculates. But if
higher interest rates alone will not liberate Chinese consumption, what will?
Homeric wisdom
Easier cross-border capital flows may help liberalise interest rates
May 26th 2012 | from the print edition
SPEECHMAKERS LIKE TO claim that the Chinese word for crisis (weiji) contains the characters for both
danger and opportunity. Most linguists dispute this. Either way, China’s economic policymakers don’t
seem to believe it. For them, a crisis is a reason to batten down the hatches.
In 1996 China’s government told the IMF that it intended to remove its controls on international capital
flows within five to ten years. But when the Asian financial crisis struck a year later, China’s government
retreated into its shell.
Sixteen years later the timing looks better. Fear of capital outflows has been assuaged by China’s vast
foreign-exchange reserves. The opposite danger—excessive capital inflows—has also eased. Indeed, the
yuan has come under downward pressure at several points in the past year.
Reformers in the government are testing the waters. In April regulators raised the amount that “qualified”
foreign investors can venture in the country’s securities markets to $80 billion, and eased the limit that
similarly qualified Chinese investors can whisk out of the country. The central bank also loosened its grip
on the currency a little, widening the yuan’s daily band from 0.5% either way to 1%.
China has no obvious need for foreign capital: its own saving is more than enough to meet its investment
needs. So liberalisers may have ulterior motives in mind, calculating that external liberalisation will force
the pace of domestic financial reform. If capital could move more freely across borders, the authorities
would struggle to keep interest rates artificially low—unless they were prepared to let capital flee and the
currency fall.
By opening the capital account soon, China could claim several prizes, reformers argue. Its investors could
acquire foreign firms at low prices, thanks to European turmoil and American caution. The country could
also take advantage of the world’s disillusion with the dollar to promote the yuan as an international store
of value and medium of exchange.
Eswar Prasad of the Brookings Institution calls this a “Trojan horse” strategy, after the gift horse described
by Homer that tricked the Trojans into opening their gates. The reformers’ ploy poses some risks. If China
opens the capital account before it reforms its SOEs, foreign lending may help feed their investment
hunger. An open border would also make it harder to contain a domestic banking crisis. A different Homer
put it best. Told that Chinese uses the same word for crisis and opportunity, Homer Simpson exclaimed:
“Yes! Crisa-tunity!” A premature opening of the capital account would be just that.
Shades of grey
Wenzhou’s shadow banking system has taken a knock
May 26th 2012 | from the print edition
THE SMALL-BUSINESS association of Wenzhou, a city in Zhejiang province renowned for its scrappy
entrepreneurialism, used to inhabit spartan premises in the city centre, but in March it graduated to plusher
offices 15 floors up on the fringes of the city. It is a sign that Wenzhou’s brand of wheeler-dealer
capitalism is being spruced up.
The desk of Zhou Dewen, the association’s head, must be ten feet long. But he still does most of his talking
on the couch or in a nearby restaurant where he entertains visiting businessmen. In his office, Mr Zhou
hears a pitch from Mao Shuhui, who runs the province’s first and only etiquette company. Her clients
include the local tax office and a number of mostly state-owned banks. Their staff sometimes need a few
pointers, she says. Their hair can be messy and their gestures impolite. Placing a finger on each corner of
her mouth, she teaches them how to smile as though they mean it.
However wide their grins, China’s banks have not been much help to most Wenzhou entrepreneurs. Longestablished firms like Ritai, the shoe-manufacturing outfit run by Mr Zhou’s deputy, Jin Zhexin, can get a
loan if it is guaranteed by a more creditworthy enterprise. But most Wenzhou entrepreneurs have turned
elsewhere. Businessmen with money to spare lend it directly to firms in need, without a bank as
middleman. Wenzhou’s shadow financial system amounted to 110 billion yuan in 2010, according to one
estimate, equivalent to 38% of the city’s GDP.
In escaping China’s financial repression, however, the city’s informal lending system also ducked out of its
financial safety system, including its prudential safeguards and its lender of last resort. As the central bank
tightened credit in 2010 and 2011, desperate borrowers drew too heavily on grey finance, taking loans they
could not repay. Some simply fled. Unnerved, informal lenders began calling in their loans and refusing
new ones. The crisis fed on itself. Eventually the government cracked down on borrowers and lenders alike,
so the money dried up completely.
In Wenzhou’s Fortune Centre, where the most successful lenders once congregated, all that is left of one
shadow financier are the indentations on a plaque where its name used to be. In another office, an erstwhile
private lender has gone for a completely different sort of business, investing 10m yuan in a TV spy caper
set during the Japanese occupation. He wears a Dennis Hopper T-shirt and keeps cans of Budweiser in the
office fridge. In the past he could arrange a loan with a single telephone call. Now “the trust is destroyed.”
In the absence of trust, lenders demand more tangible collateral. The manager of Dongkai Pawnshop says
his business has benefited from the crisis. People who could previously borrow on the strength of their
relationships must now offer something solid, like the 100g gold bar commemorating the Beijing Olympics
that is for sale in the lobby.
In March the central government unveiled a number of sensible reforms to tame the Wenzhou system
without crushing it. Informal lenders will henceforth need to be registered, more private capital will be
encouraged and the issuance of high-yield bonds approved. Yet the government still resists the more
elegant solution to the problem proposed by Mr Zhou: allowing borrowers and lenders the freedom to set
whatever interest rate they like.
Consumers
Dipping into the kitty
Chinese consumption is about much more than shopping
May 26th 2012 | from the print edition
An important source of demand
ZHANG GUIDONG GREW up on a farm in Anhui, a poor inland province, where China’s economic
reforms made a humble beginning. He left home for Beijing in 1995 with only a few years’ schooling. First
he sold belts and lighters in Tiananmen Square. When that was banned, he joined some friends from back
home in Beijing’s Silk Market, where he sold vegetables and silk items to the staff of the embassies nearby.
The Silk Market is famous for selling brand-name goods at suspiciously low prices, often to tourists who
seem to enjoy the combination of rip-offs and knock-offs. Fined many times for selling fakes, Mr Zhang
eventually decided to change his strategy. He sought a licence to sell genuine goods under the brand “Hello
Kitty”. A white bobtailed cat that first appeared on a purse in the 1970s, Kitty now counts as Asia’s answer
to Mickey Mouse.
The brand’s guardians were initially worried by all the fakes on sale in the market, but in the end they were
persuaded that the place was trying to clean itself up. Mr Zhang’s business is now doing well. In March he
was set to move from his old ten-square-metre stall on the ground floor to a 15-square-metre spot on the
third floor, where the market is grouping its more reputable outlets. Most of the other stallholders are also
from the countryside, Mr Zhang notes. “I never dreamt that I could one day have a life like this.”
Most people think of China as an industrial powerhouse, not a consumer’s paradise. Household
consumption as a percentage of GDP fell for ten years in a row from 2001. By the end of that decade it
amounted to only 34% of GDP, about 19 points below Japan’s lowest post-war ratio and 15 points below
South Korea’s. America’s consumption did not dip far below 50% of GDP even during the second world
war, as Mr Lardy of the Peterson Institute for International Economics points out in his book, “Sustaining
China’s Economic Growth”. But this declining ratio is deceptive. Consumption in China has actually been
growing faster than in any other big country. It is just that China’s GDP has been growing even more
rapidly.
Consumption always lags income, both on the way up and on the way down, argue Carl Bonham of the
University of Hawaii at Manoa and Calla Wiemer of the University of Southern California. This is partly
because people choose to “smooth” their consumption over time, but also because people generally hesitate
to abandon a lifestyle to which they have grown accustomed. Although China’s output and income surged
after 2000, its consumption habits have yet to catch up.
Bootstrap businessmen from the boondocks do not always know what to do with their newfound wealth,
according to research by Jacqueline Elfick, a cultural anthropologist. One couple, newly arrived in
Shenzhen, lined their entire flat with bathroom tiles. Another complained that their bathroom windows
lacked the blue translucent glass found in rural toilet blocks. A homebuyer who had never previously lived
in anything bigger than a two-room flat took a residence with six rooms, filling four of them with dining
suites.
But consumer habits are evolving. In Shenzhen, notes Ms Elfick, the constant churn of the population and
relative absence of established hierarchies means “you are what you buy.” The new rich announce
themselves by spending profusely. They favour “heavy ornate furniture in faux Baroque”. In Sanya, an
advert for one luxury residence shows a painting of Napoleon crossing the Alps hanging on the wall as a
woman in a low-backed evening dress lingers by the window.
But there is also a growing class of discerning customers who look down on ostentation. They pride
themselves on their appreciation of wine, tea and coffee. In Beijing the TV screens that now pop up in taxis
teach passengers how to judge a wine’s intensity and why they should not overfill their glass. “Knowledge
of how to consume has in itself become a commodity,” Ms Elfick writes.
Just as consumption failed to grow as quickly as incomes over the past decade, it will fail to slow as
quickly over the decade to come. As China’s growth eases from 10% a year to something closer to 7%
during this decade, consumption will rise naturally as a share of GDP.
Some economists think it has already begun to do so. Yiping Huang of Barclays Capital says the official
statistics fail to reflect a surge in consumer spending since 2008. They are particularly bad at capturing
extra spending on accommodation, such as rent payments by tenants or the benefits enjoyed by owneroccupiers.
One proxy for consumer spending is retail sales, which have grown much faster than GDP in recent years.
Unfortunately, these statistics are no better at capturing expenditure on accommodation. And in China they
include many things other than household consumption, such as government purchases and trade in
industrial products like basic chemicals. But even when those items are stripped out, Mr Huang shows,
sales are rising fast.
He thinks that the level of expenditure as well as its growth may be understated. Despite the conspicuous
consumption, a lot of income and spending is hidden from the prying eyes of taxmen and statisticians. The
best effort to throw light on this shadow income is a study by Wang Xialou of the National Economic
Research Institute at the China Reform Foundation. His team asked about 4,000 of their friends how much
they earned and spent. The answers they got were more candid, though also less representative, than
official surveys. After doing some statistical tricks to eliminate the bias, Mr Wang calculated that the
disposable income of China’s households was 9.3 trillion yuan ($1.4 trillion) higher than the official 2008
figure of 14 trillion yuan. Drawing on this work, Mr Huang thinks that private consumption may have
accounted for 41% of GDP in 2010, about seven points higher than the official figure (see chart 6).
Mr Huang’s calculations do not convince everybody, and even if they are right, they have disturbing
implications. Hidden income disproportionately benefits the better-off: the richest 10% of urban households
take home over 60% of it. That might help explain why China is now the world’s largest market for luxury
goods, according to one estimate. If that hidden income is counted, the top tenth of urban families are about
26 times better off than the bottom tenth, not just nine times, as the official figures suggest. These figures
make China’s economic imbalances look better but its social inequities far worse.
However, there is another important source of final demand that is often neglected: the government. Its
consumption spending (on health care, education, subsidised rent and so on) as a share of GDP has been
growing since 2009, but it remains inadequate and uneven.
The patchwork state
China has greatly broadened its rural pension scheme, which collected contributions from 140m people in
2011, compared with under 80m a year before. But even now it reaches only about 30% of the eligible
population. The government has also expanded the coverage of health insurance, bringing 95% of the
population into the net, according to the OECD. Patients now pay directly for only 35% of China’s total
health spending, compared with well over 60% ten years ago. But progress has not been uniform. China has
one scheme for urban workers, another for non-workers and a third for rural folk, each administered by
separate city or county governments. The contributions required and benefits provided differ a lot between
the three schemes. According to the OECD, the rural scheme pays out an average of only $16 per person
per year and covers only 41% of the cost of in-patient care.
In social as in economic policy, the government prefers local experimentation and piecemeal expansion.
That works well for economic reforms, but in social policy it fails to pool risk efficiently. And the safety
net is thin as well as patchy. This keeps down its cost to the exchequer but leaves the population exposed to
dangers such as debilitating illness or job loss. Health benefits, for example, are capped, leaving patients
uncovered for the worst crises. And China’s hospital-centric health-care system provides only one general
practitioner for every 22,000 people.
Older Chinese grew up in a society where many of their consumption choices were dictated by the state or
by their workplace. They ate in state canteens and slept in state-provided dormitories or flats. It was a
grinding, tedious existence. But in discarding the “iron rice bowl”, the Chinese state failed to provide
alternatives, including health care and minimum pensions. According to the World Bank, China spends
only 5.7% of its GDP on these items and other forms of social protection, such as payments to support the
very poor. Other countries in the same income category as China spend more than twice as much, an
average of 12.3%.
More social spending of the right kind would not crowd out private consumption. On the contrary, it would
encourage it. The patchiness of China’s safety net is one reason why households save so much of their
incomes. According to Emanuele Baldacci and other economists at the IMF, a sustained rise in public
spending by 1% of GDP, spread evenly across health, education and pensions, would increase the ratio of
household consumption to GDP by 1.25 percentage points. The IMF’s Steven Barnett and Ray Brooks
calculate that in urban areas every extra yuan the government spends on health prompts an extra two yuan
of consumer spending.
Can China afford to spend so freely? In one sense, it cannot afford not to. If investment were to falter and
private consumption failed to compensate, China would be left with a big hole in demand, jeopardising
employment and growth. If the investment rate were to drop back to its 2007 level, for example, the
demand shortfall would run to over 6% of GDP. To make up for that, the government would have to spend
about 3.4 trillion yuan this year, or face widespread joblessness. That is a substantial amount. With only a
sixth of that sum, the government could raise the incomes of all of China’s poor to the equivalent of $2 a
day, according to calculations by Dwight Perkins of Harvard. The point of such a thought experiment is to
demonstrate that China has enormous productive powers to mobilise, and has to spend a lot to mobilise
them fully.
There is another obvious measure, peculiar to China, that would lift consumer spending. That is the earliest
possible repeal of the country’s household registration system, or hukou, which limits the access of rural
migrants to public services in the cities where they work and live. This keeps migrants unsettled and
therefore unwilling to spend. Migrants without an urban hukou spend 30% less than otherwise similar
urban residents, according to research by Binkai Chen of the Central University of Finance and Economics,
Ming Lu of Fudan University and Ninghua Zhong of Hong Kong University of Science and Technology.
Mr Zhang, the Silk Market trader, is a good example of the system’s iniquity. He arrived in Beijing 17
years ago. He has a house, a son, a business and even a licence from Hello Kitty. But he still does not have
a Beijing hukou.
Beyond growth
China will have to learn to use its resources more judiciously
May 26th 2012 | from the print edition
Still plenty of room to grow
THE POLICYMAKERS WHO will determine China’s future are trained at the Central Party School, a
spacious oasis of scholarly tranquillity in north-west Beijing. The campus looks like an Ivy League school
with Chinese characteristics. The grounds are dotted with stiff bamboo as well as pendulous willows,
pagodas as well as ducks. The school remains largely closed to outsiders. In the past it did not even appear
on maps. But it is opening up. The campus signpost, for example, is sponsored by Peugeot Citroën.
The school has over 1,500 students and almost as many professors, many of whom are much younger than
their students. It teaches economics, public finance and human-resource management as well as communist
doctrine, such as Marx’s labour theory of value. It takes only three or four classes to teach Deng Xiaoping
Theory, the party dogma that legitimised China’s economic reforms and still guides its Politburo. But if
even that is too much, three famous clauses may suffice: “Our country must develop. If we do not develop
then we will be bullied. Development is the only hard truth.”
Deng said these words 20 years ago, not at a portentous party conference in Beijing but on his “southern
tour” of the workshops of the Pearl River Delta. He was inspired by practice, not theory, having just visited
a refrigerator factory in the delta that had expanded 16-fold in seven years. Even the word he used for truth
(daoli, which is often translated as reason or rule) is more colloquial than the loftier term, zhenli, reserved
for high truths like Marxism-Leninism.
Giants playing catch-up
Thanks to a sevenfold rise in its output since then, China is well past the point of being bullied. Its dollar
GDP, measured at purchasing-power parity, may have already overtaken America’s, according to
economists such as Hu Angang of Tsinghua University or Arvind Subramanian of the Peterson Institute for
International Economics. Converted at market exchange rates, it is still much smaller than America’s. But
even by that measure, China may catch up sooner than many people currently expect. To draw level with
America by 2020, China’s dollar GDP would have to grow at only about three-quarters of the average rate
it recorded over the past decade.
Now that China has become too important to be bullied, development may be less of an imperative. Indeed,
in some quarters of society there is an increasing distaste for the unwelcome side-effects of China’s growth
model, which depletes the country’s natural assets at the same time as it expands its physical ones, and
which builds lots of property but often bulldozes property rights.
Some party elites and vested interests may also have grown complacent, worrying more about how to
divide the economic spoils than how to enlarge them. But at least in their rhetoric, leaders do not appear to
be resting on their laurels. Asked about China’s prospects of becoming the world’s number one economy,
Li Wei, head of the Development Research Centre, which advises China’s cabinet, saw no reason to
celebrate. The country’s income per person still ranks around number 90 in the world. And even if its GDP
overtakes America’s by the end of the decade, China will remain as poor as Brazil or Poland are today, by
one estimate.
Hubris may be less of a danger than its opposite, a kind of economic diffidence. If China is still poor in the
minds of policymakers, they may conclude that the economy is not yet ready for reforms that are in fact
overdue. They may feel that a poor developing country does not need a more sophisticated financial
system, cannot cope with a more flexible exchange rate and cannot afford to let its rural masses settle in the
cities with their families.
As long as the demand for investment remains strong and the supply of saving captive, China’s
policymakers can feel confident that their country’s economy will continue to enjoy rapid growth and
stability. But the faster that China expands, the sooner it will outgrow the development model that has
served it so well for so long. Japan began to change its growth model back in the mid-1970s. By some
measures China has already reached a similar stage of development, and yet its reforms remain tardy and
timid.
School rules
There are at least three schools of thought on China’s economic prospects over the next few years. The first
sees few dangers ahead. China has expanded quickly, always beating forecasts, and will continue to do so
for the time being. It is a huge, fast-developing country with plenty of room yet to grow. It invests a lot—
and so it should. These investments might not always generate good returns for the bankers that lent the
money. But they will contribute more to the economy than they cost.
The second school of thought argues that China’s imbalances could overwhelm it. It cannot sustain its
current high rate of investment, but there is nothing else to replace this as a source of demand. Much of the
credit extended by banks and shadow banks to keep growth going will sour. A government that owes its
legitimacy entirely to growth will find it hard to contain the disappointment that a slowdown will entail.
This special report subscribes to a third school of thought. It argues that China does face significant
problems, but nothing it cannot handle. It has not obviously overinvested, but it has often invested
unwisely. That is imposing real losses on Chinese developers, depositors and taxpayers. However, China’s
financial system is better equipped than many others to ride out these losses. It may be inefficient in its
allocation of capital, but it is quite stable. Indeed, it is resilient for some of the same reasons that it is
inefficient.
“Our country must develop. If we do not develop then we will be bullied.
Development is the only hard truth”
Until recently most economists believed that China was heavily dependent on exports. But it has carried on
growing even as its current-account surplus has shrunk, and trade has subtracted from growth, not added to
it. The country is undoubtedly investment-dependent, but its biggest problem is malinvestment not
overinvestment. Most people believe that its past malinvestment will impede future growth. This special
report has raised doubts about that. Clearly China would be better off had it not wasted so much capital.
But if the capital stock is not as good as it should be, that gives the country all the more room for
improvement.
If the investment rate does fall, China will need another source of demand. The obvious place to look is
household consumption, but consumers may not rise to the challenge. This special report has argued that a
much higher rate of government consumption would be equally desirable—and perhaps more feasible.
As China’s capital accumulates, its population ages and its villages empty, saving will grow less abundant
and good investment opportunities will become scarcer. China will then need to use its resources more
judiciously. That will require it to free up its financial system, introducing more efficiency even at some
cost to stability.
China is a vastly more prosperous and expansive country than it was 20 years ago. It has broader horizons
and can afford a wider range of concerns. Development is no longer China’s only truth. But it is still hard.
The Economist
Going to town
Jan 18th 2012, 15:09 by The Economist online
Over half of China's people now live in urban areas
FOR a nation whose culture and society have been shaped over millennia by its rice-farming traditions, and
whose ruling party rose to power in 1949 by mobilising its put-upon peasantry, China has just passed a
remarkable milestone: its city-dwellers now outnumber its rural residents. New data from the National
Bureau of Statistics show that of China’s 1.35 billion people, 51.3% lived in urban areas at the end of 2011.
In 1980 less than a fifth of China’s population lived in cities, a smaller proportion than in India. Over the
next ten years the government remained wary of free movement, even as it made its peace with free
enterprise. Touting a policy of “leaving the land but not the villages, entering the factories but not cities”, it
sought industrialisation without urbanisation, only to discover it could not have one without the other. Even
now, its ratio of city-dwellers is, if anything, low for an economy at its stage of development. America
reached the 50% mark before 1920. Britain passed it in the 19th century. Go further back, however, and
China’s cities dazzled the world. It is likely that one thousand years ago, the Song Dynasty capital of
Kaifeng was the world’s most populous city. Marco Polo, who visited China in the 13th century, claimed
that Hangzhou was “the most splendid city in the world” with 13,000 bridges—although later estimates
suggest the true number was 347.
The Economist
China’s economy
Fears of a hard landing
China ran a massive trade deficit in
February. What does it say about the
economy?
Mar 17th 2012 | BEIJING | from the print edition
http://www.economist.com/node/21550300
CHINA is routinely accused of exporting too much. Its foreign sales far exceed its foreign purchases, often
by a wide margin. This chronic surplus angers many. This week President Barack Obama signed a bill that
restores his administration’s power to impose tariffs on countries like China and Vietnam, when their goods
are reckoned to be subsidised or dumped on American markets. The bill passed swiftly through both
chambers of Congress. When it comes to rebuffing China’s exports, America’s fractious legislature is as
harmonious as the Chinese one.
But this month brought two intriguing breaks to the routine. On March 13th three of China’s biggest
trading partners—Japan, the European Union and America—complained that China was exporting too
little, not too much. They brought a case at the World Trade Organisation alleging that China was unfairly
restricting its exports of tungsten, molybdenum and 17 “rare earths”, obscure elements such as terbium and
europium, used in the manufacture of many high-tech goods including fluorescent lights. China’s reaction
was incandescent; it dismissed the case as “groundless”.
The other novelty arrived a few days earlier when China’s customs bureau reported something rarer than
europium: a Chinese trade deficit. At $31.5 billion in February, the imbalance was bigger than any deficit
on record—it was bigger even than many of China’s monthly surpluses.
China’s trade balance often dips around Chinese New Year, as export factories close for the festival. The
holiday also arrived earlier this year than last, distorting the data. But even if the figures for January and
February are added together, China ran a deficit of over $4 billion. Exports and imports typically rebound
in sync as China gets back to work. This year, imports rebounded alone (see chart 1).
The deficit has fuelled one fear and one hope. The fear is that China’s economy will slow sharply, hobbled
by declining exports to crisis-racked Europe and a rising bill for commodities like oil. The hope is that
China is rebalancing, moving away from an economic model reliant on foreign demand. Neither the hope
nor the fear is wholly justified by this month’s figures.
It is true that China’s weak exports are contributing to a slowdown in the broader economy. China’s
industrial production grew by 11.4% in January and February, compared with the same two months in
2010, much slower than its normal pace of about 15%. But the prospects for global growth are brightening,
suggesting that China’s exports have bottomed out. And the slowdown in China’s economy has been
matched by a helpful fall in inflation. That gives China’s government some scope to stimulate demand.
What about rebalancing? February’s trade deficit may be an anomaly but it highlights a broader trend: the
swift decline in China’s external imbalance. China’s current-account surplus, a broad measure of the
country’s external payments and receipts for goods and services, fell to 2.8% of GDP last year from a peak
of over 10% of GDP before the financial crisis (see chart 2). In Hong Kong’s currency-derivatives market
people no longer bet that the yuan will only strengthen. That suggests the yuan is close to its “equilibrium”
level, said Wen Jiabao, China’s prime minister.
Unfortunately, China has rebalanced externally without rebalancing internally. Its current-account surplus
has narrowed largely because of an increase in domestic investment, not consumption. Some economists
therefore worry that China’s trade surpluses will soon reappear. An investment boom from 2001-04, for
example, paved the way for the ballooning surplus of 2004-07, according to Jonathan Anderson, formerly
of UBS. That investment poured into heavy industries, such as aluminium, machine tools, cement,
chemicals and steel. This domestic supply displaced imports of the same products. And when a slowdown
in China’s construction industry subsequently depressed domestic demand for these items, China sold
abroad what it could no longer sell at home. Big surpluses were the result.
In the past three years, China has also enjoyed a terrific investment boom. And with the property market
weakening, the construction industry is also liable to slow again. Is the stage therefore set for a repeat of the
surpluses of 2004-07?
The difference now is the nature of China’s investment boom, which has concentrated on roads, railways
and houses, not factories. In 2009, for example, loans for fixed investment increased dramatically. But only
10% were made to manufacturers, says Nicholas Lardy of the Peterson Institute. About 50% went to
infrastructure projects. In his annual review of the government’s work this month, Mr Wen noted that
China had shut down outdated factories capable of making as much as 150m tonnes of cement and 31.2m
tonnes of iron.
Efforts to rationalise heavy industries and remove excess capacity should help prevent a repeat of the big
external surpluses of yesteryear. That should, in turn, placate China’s irritable trading partners. But things
might not be so simple. Take one particularly fragmented and dirty industry. At the government’s urging,
one of its bigger firms has bought over a dozen others, eight of which were later shut down. That has
reduced the industry’s capacity to flood the world with its products. The problem? These products are rare
earths.
The world economy
Powering down
More months of uncertainty about the
euro area will weigh on the global
economy
Jul 7th 2012 | from the print edition
EUROPEAN leaders delivered rather more progress in tackling their interminable debt crisis than had been
expected when they met in Brussels on June 28th and 29th. They decided, among other things, to allow the
new permanent bail-out fund to recapitalise banks in ailing economies directly rather than via their
governments. They also enabled rescue funds to buy the government bonds of struggling countries without
imposing such strict conditions as before.
The euro promptly rose; stockmarkets regained some vim; the oil price spiked (see article). Governmentbond yields fell in Spain and Italy; they also tumbled in Ireland on expectations that it will gain some
retrospective relief from the heavy costs of its banking clear-up. In response, the Irish government decided
to raise money by issuing short-term bills on July 5th, its first such auction since 2010.
But the June summit also delivered rather less than the market rally suggested. In theory, the agreement
promises to break the self-reinforcing link between weak governments and weak banks. In practice, that
will not happen until the European Central Bank (ECB) is put in charge of euro-area banking supervision,
which may take a lot longer than the planned six months. Before then a deal stitched together in the bleary
hours could well snag on legal difficulties about redefining the permanent fund’s remit without changing
the treaty that set it up, or on political objections in smaller northern economies—Finland, for example,
doesn’t like the idea of using the rescue funds to buy government bonds in secondary markets. Meanwhile,
Greece has lost none of its capacity to cause trouble, as a new, weak government tries to extract
concessions from creditor nations.
All of which means yet more uncertainty and yet more harm to the global economy. Within the euro area
itself, the unemployment rate reached 11.1% in May, a record high on data going back to 1995 for the 17
countries now in the monetary union. The composite purchasing-managers’ index (PMI), which covers
services as well as manufacturing, inched up in June but at 46.4 remained well below the 50 level that
separates expansion from contraction. Even the redoubtable German economy now seems to be buckling.
Its PMI composite index points to a small decline in national output in the second quarter, according to
Markit, which assembles the indices. There is particular weakness in German manufacturing, which was
contracting in June at its fastest rate in three years.
That industrial fragility has now spread around the world. In America the Institute for Supply
Management’s manufacturing index fell in June to below 50, for the first time in almost three years (see
chart). New orders plummeted, which suggests that the weakness will persist. One of the main reasons was
a sharp decline in new export orders, with manufacturers blaming slacker demand in Europe and China. In
its annual health-check of the American economy, the IMF this week said that recovery remained “tepid”
and fretted about the fallout from an intensifying euro crisis.
In Asia, too, an industrial slowdown is under way. Japan’s PMI slipped below 50 in June for the first time
since November. After falling in recent months, China’s official PMI is now only just above that
threshold—although for China that probably means industrial production growing at an annualised pace of
around 10% rather than its usual rate of 15%. Any slowdown still hurts economies, like Brazil, that have
thrived by selling commodities to China. Brazil’s manufacturing sector contracted for the third successive
month in June.
If markets remained relatively buoyant early this week, that was doubtless because they were waiting for
central banks to step into the breach yet again. On July 5th, after The Economist had gone to press, both the
ECB and the Bank of England were expected to ease monetary policy. Britain’s central bank had already
signposted another dose of quantitative easing. For its part the ECB seemed likely to lower its main policy
rate below 1% for the first time, probably to 0.75%. Passing that milestone would show how much more
needs to be done to end the crisis.
NYT
Chinese Leader Calls for Strong Moves to Offset Slowdown
By KEITH BRADSHER
Published: July 8, 2012
HONG KONG — Premier Wen Jiabao of China warned on Sunday of “huge downward pressure” on the
Chinese economy, in the clearest expression yet of concern at the top of the country’s leadership about a
sharp slowdown in recent months.
During a weekend inspection tour of east-central China, Mr. Wen called for the government to “preset and
fine-tune its policies in a more aggressive manner,” using fiscal and monetary tools to offset the economic
slowdown as much as possible. But he also tried to reassure the public, saying the economy was “running
at a generally stable pace,” said Xinhua, the official Chinese news agency.
Mr. Wen largely attributed the slowdown to weak demand from overseas, particularly Europe with its
faltering economies. But in separate remarks on Saturday, he reaffirmed a government policy of making
real estate prices more affordable by banning real estate speculation.
That policy has played a central role in China’s economic slowdown, as housing construction has slowed to
a crawl except for subsidized housing for lower-income families. Developers across the country have laid
off huge numbers of workers.
Construction sites from the steamy factory cities of Guangdong in the southeast to manufacturing and
logistics hubs like Xi’an in the northwest have cut back this year from three shifts working around the
clock, seven days a week, to one day shift on weekdays.
Scant accurate data is available on the extent of the decline in real estate prices. Brokers say prices have
fallen 20 percent or more in the last year. A monthly government survey of older neighborhoods where few
transactions take place shows a much smaller decline, however, while a separate survey of real estate
developers shows that few acknowledge the steep discounting described by brokers.
The Chinese central bank announced on Thursday that it was cutting the country’s regulated bank lending
and deposit rates for the second time in four weeks, an uncharacteristically brisk pace. The cuts have started
to rekindle the Chinese public’s enthusiasm for real estate investments, with the number of transactions
starting to quicken in recent weeks.
But the central bank warned banks on Thursday to keep a tight rein on mortgage lending, and Mr. Wen said
on Saturday that the government’s policy of improving the affordability of real estate had not wavered. “To
further implement the regulation,” Xinhua said, “Wen urged unswerving efforts to ensure prices return to
reasonable levels, and block a price rebound that would undermine the effects of previous efforts.”
Informal tallies suggest that about a third of China’s 100 largest cities have loosened the ban on real estate
speculation in recent weeks to revive local markets. Mr. Wen warned that these loosening moves must be
halted and reversed, and even threatened punishment for officials who tried to “cheat” on the restrictions.
Sales of land leases are a critical source of revenue for local governments, so the downturn in real estate
markets has hurt their finances. Many of these governments are deeply in debt after spending lavishly in
2009 and 2010 on infrastructure projects like airports, highways and high-speed rail to offset the effects of
the global economic slowdown.
The Chinese government has already adopted policies to support the rest of the economy. In addition to the
interest rate cuts, the government has freed banks to lend a larger share of their deposits, subsidized the sale
of energy-saving home appliances and accelerated the approval of large construction projects.
During his inspection tour over the weekend, Mr. Wen hinted at further measures, including tax credits for
companies that invest in research and development. He urged Chinese businesses to pursue export
opportunities in Southeast Asia, Central Asia and South Asia as alternatives to industrialized countries
where protectionist pressures might build.
Despite these efforts in recent weeks, economic data for June and for the second quarter, scheduled to be
released this week, is expected to show further weakness. April and May data showed unusually slow
growth in retail sales, investment, electricity consumption and other barometers of economic growth.
As electricity demand has slowed, so much unneeded coal has accumulated that storage areas at major
Chinese ports are at record levels and arriving ships full of coal must wait many days to unload. Piles of
mined coal fill empty lots and line roadsides in some mining areas in northern China, as mine owners
maintain production while hoping prices will recover.
WP
With slower growth numbers, China can’t prop up world economy
By Chico Harlan, Updated: Friday, July 13, 8:49 AM
BEIJING — China’s economy is expanding at the slowest rate in three years, government data released
Friday showed, reinforcing concerns that Beijing will not be able to prop up a global economy being
dragged down by sluggishness in the United States and Europe.
Chinese gross domestic product grew by 7.6 percent in the second quarter, year over year, down from 8.1
percent at the start of the year. That growth rate is the weakest since 2009 during the depths of the financial
crisis, and far removed from the double-digit growth rates of 2010.
The fresh numbers were in line with market expectations, and Asian stocks rose slightly on the news. But
the figures also marked the sixth consecutive quarter of deceleration for the world’s second-largest
economy, according to data from the state-run Xinhua news agency. And they come at a time when
officials here are pressing for ways to drive consumption and make up for slumping demand for China’s
exports.
Recently, that has meant a series of interest rate cuts and stimulus measures — short-term tools that have
led many economists to predict an uptick for the Chinese economy later this year.
China, preparing for a once-a-decade leadership handover later this year, still seems in line to easily meet
the 7.5 percent GDP growth rate that Premier Wen Jiabao set as the target in March — important for a
Communist Party that has long pointed to GDP as an emblem of economic strength.
But some economists say that China is in a battle over how to maintain the turbo-charged growth of the last
three decades. For years, China did this with government investment in production, tamped-down
consumer demand and plenty of exporting. After the 2008 global economic shock, China responded with an
enormous stimulus — one that produced fresh investment in infrastructure, a lending boom and severe
inflation.
Almost half of China’s GDP growth last year came from investment, but that boom is faltering, economists
say, because a lot of the money was misspent.
Additionally, China has moved in the last year to curb inflation by reining in lending, another factor that
leads to slower growth.
“So what we’re seeing now, essentially, is that the investment boom that has driven China for the last three
years is now falling apart under its own weight,” said Patrick Chovanec, an assistant professor at Tsinghua
University in Beijing.
Some Chinese authorities would like to boost relatively meager consumer spending, but doing so would
require a meaningful shift from a planned economy to a market economy. It would also upend the status
quo, driving growth in new industries and hurting traditional ones.
At a briefing Friday, Chinese government spokesman Sheng Laiyun acknowledged that China, “after 30
years of vigorous growth ... has entered a transition.” But he said that growth between 7 and 8 percent is
“good,” particularly considering the tepid global economy and slumping performance in emerging
economies such as India and Brazil.
Economists predict better numbers here for the third quarter after China’s central bank cut interest rates
twice since June.
That triggered a notable jump in bank loans — from 793 billion yuan ($124 billion) in May to 920 billion
yuan ($144 billion) in June — and a slight rebound in property sales, which analysts describe as signs of a
short-term rebound.
The current government policy moves are part of a calculated effort to “make the economy look good” as a
younger generation of leaders rises to power, said Liang Xiaomin, an economics professor at the Business
School of Beijing Technology and Business University.
“The economic stimulus will have functions in the short term,” Liang said, “but in the long term the
government cannot stop the economy sliding to the bottom.... Definitely 7.6 percent [GDP growth] won’t
be the bottom of China’s economy in the foreseeable future.”
Analysis: China consumers counter economy gloom with travel boom
Reuters – 7 hours ago
8/13/12
By Nick Edwards
BEIJING (Reuters) - Soaring numbers of Chinese tourists packed onto flights out of the country is a sure
sign that a fast-growing consumer class of around 130 million is not worried that the likely slowest year of
economic growth since 1999 will sap their spending power.
Nearly 39 million mainlanders left China on overseas trips in the first half of 2012, roughly double on five
years ago and evidence that a powerful consumer force - envisaged by the top leadership as the engine of
economic expansion in a generation to come - may be bulking up faster than thought.
The question for investors is if a burgeoning bourgeoisie is now big enough to fully offset the economic
impact of faltering foreign demand evident in data last week, when undershoots in July new bank lending,
export, import and industrial output growth prompted analysts to start slicing into GDP forecasts.
Paul French, Shanghai-based chief China strategist at market intelligence consultancy Mintel, says the
purest view of the domestic economy's health always comes from the consumer.
"If consumers feel good about things they'll spend. If they don't feel good they'll stop," he told Reuters.
"Travel is a good indicator because people are travelling more and they are consuming a lot when they
travel abroad."
Investors, facing world growth slowing to levels economists define as marking a global recession, are
anxious for any sign that critical consumer mass may have already arrived in China.
Consumer spending in China has comfortably enjoyed double-digit growth for a decade, while exports have
slowed to become a net drag on the economy in 2011 and in the first half of 2012.
Retail sales rose 13.1 percent year on year in July. Adjust for inflation and it was the second best month of
the year.
But that's not been enough to arrest six straight quarters of slowdown, with the latest Reuters poll
forecasting economic growth to slide to 8 percent in 2012 from 9.2 percent in 2011.
While well below the 10 percent average of the last 30 years and a level that has previously prompted
urgent action to create jobs, 8 percent remains above Beijing's 7.5 percent target.
Meanwhile the labor market appears tight, with data showing the ratio of vacancies to workers near its
highest in 10 years.
STRONGER, FASTER
Evidence that consumers are rapidly getting stronger comes from the Geneva-based Digital Luxury Group,
which reckons China's travel market is already worth some $232 billion.
Its new World Luxury Index China Hotels report says Chinese travelers made 70 million overseas trips in
2011 to be pampered at spa resorts in Bali, to shop in Dubai, Paris and London, and to spend in Singapore
and Hong Kong.
International Air Travel Association chief executive, Tony Tyler, says airlines will see an extra one billion
travelers in a decade if average annual incomes in China hit $15,000.
Part of the proof is in the building going on. China, IATA says, plans to build 56 new airports nationwide
before the end of 2016, with a further 16 relocated and 91 being expanded.
Chinese carriers made about half of all the $7.9 billion in profits earned by the global airline industry in
2011, according to IATA, which expects international traffic growth of 8-9 percent from China in the five
years to 2015.
A Beijing-backed World Bank report envisages per capita income rising to $16,000 by 2030 from about
$5,000 now, with two thirds of economic activity forecast to come from domestic consumption against less
than 50 percent now.
CONSUMER CUSHION
A shift to the domestic market, leveraging China's 1.3 billion-strong population, would cushion the
economy from huge falls in foreign demand that Europe's debt crisis is causing, barely three years on from
the trade shock it suffered in the 2008-09 global financial turmoil.
An emerging urban middle class has made grocery shopping the engine of domestic retail sales growth,
taking in 41 percent of all retail spending in China which analysts at Citi reckon will be up 55 percent up
over five years to $600 billion in 2012.
Annual double digit wage rises over the last decade - the government has decreed minimum wages rise at
least 13 percent in the five years to 2015 - have helped China create what brokerage CLSA says is "the
world's best consumption story".
But while workers in the world's second largest economy are earning more, they lag well behind those of
the United States.
Average annual wages in the state-owned firms which dominate economic output were 42,452 yuan
($6,700) in 2011 and just 24,556 yuan in the private sector which creates some 75 percent of the country's
jobs. The U.S. average wage was $39,959 in 2010, according to the latest data available.
China's wealthy elite, however, have generated a whole new market for the world's luxury personal goods
makers, estimated to be worth $25 billion a year now and likely to leapfrog Japan and the United States to
the $28 billion top spot by 2015.
It indicates a consumer market presently polarized between the super rich and a middle-class with modest
discretionary spending strength, but growing rapidly in size and affluence.
It is one reason why Yolanda Fernandez Lommen, head of the economics unit at the Asian Development
Bank's China mission, says a self-sustaining consumer class is some way off.
"We consider that 10-15 percent of the population shows a consumption pattern that is consistent with the
type that would be regarded as a solid domestic driver of growth," she said.
"In general, economies where consumption plays a meaningful role as a driver of growth entail a wide
middle class that on average comprises about 70-80 percent of the population."
AFFLUENCE ARRIVING
China officially classed 51 percent of its citizens as urban dwellers in 2011, but that includes some 230
million rural migrant workers who generally do poorly paid jobs in cities, lack residency rights in them and
have very little to spend.
Only deep structural reforms will turn those migrant workers into fully-fledged urban consumers,
Fernandez Lommen said.
Analysts at consultancy, McKinsey, say affluence is arriving faster than many economists anticipate,
forecasting a giant leap by 2020 based on annual surveys it has carried out since 2005.
By then China will have 167 million "mainstream" consumer households - those with annual disposable
income of between $16,000 and $34,000 - more than 10 times the 14 million, or 6 percent, who currently fit
that definition.
There will also be 120 million households with $6,000-$15,999 of spending power, according to
McKinsey.
Analysts at Nomura point out that domestic consumption contributed 4.5 percentage points of the 7.8
percent growth in China in the first half of 2012.
All of which implies consumer strength underpinning activity - and the confidence Mintel's French says his
clients have in the spending power of China's shoppers at home and overseas.
"The only thing we're seeing slowdown in is some softening in the higher end numbers for luxury goods.
But the reason for that is because we have got unparalleled amounts of arbitrage going on from the Chinese
going abroad and shopping," he said.
Construction and Real Estate Hinder China’s Growth
By KEITH BRADSHER
Published: September 9, 2012
http://www.nytimes.com/2012/09/10/business/global/10ihtyuan10.html?pagewanted=2
CHENGDU, China — With more than 100 tall cranes on the skyline, this metropolis in western China
looks vibrant at first glance despite the country’s sharp economic slowdown.
A high-speed rail bridge under construction on the outskirts of Chengdu. The government is pushing ahead
with big public works projects even as residential construction has slowed.
The New York Times
But only a few cranes — those building national government projects like a high-speed rail line — are
floodlit and busy far into the night. The more numerous cranes looming above the skeletons of future highrises move much less often, even by day, and are dark and deserted by night.
The pattern among Chengdu’s construction cranes is evident across the country. As summer fades into
autumn, Beijing is stepping up investment in a bid to rescue the economy, but consumers, businesses and
debt-burdened local governments in China are showing little interest in spending money again.
Economic data released on Sunday by the National Bureau of Statistics showed the extent of the problems.
Investment in new buildings and other fixed assets is in the doldrums. Manufacturers are retreating from
ambitious production goals as they struggle with bloated inventories of unsold goods. Even the service
sector, still underdeveloped and widely seen by economists as full of potential, is showing signs of distress.
“Business is slow these days — just look around this shopping center, there are so few people walking
around,” said Zhong Yongping, a beautician in downtown Chengdu, as she woke on Thursday from an
afternoon nap while she waited for a customer to show up.
Industrial production grew only 8.9 percent in August from a year ago. That was even slower than
economists had expected, and the weakest pace since May 2009, when the global economic downturn was
still in full swing.
But the real problem, as signaled by the slow-moving cranes at high-rises in Chengdu, lies in fixed-asset
investment, previously the mainstay of the Chinese economy.
“Construction is slowing down,” said Zhao Chenzhen, a young electrical worker, as he and other workers
in red hard hats left a darkened high-rise construction site in Chengdu early Friday evening.
President Hu Jintao said in a speech on Saturday at the Apec summit meeting in Vladivostok, Russia, that
China’s economy suffered from a “lack of balance, coordination and sustainability.” He strongly hinted at
further economic stimulus, saying that, “We will boost domestic demand and maintain steady and robust
growth as well as basic price stability.”
Bankers and executives say that across China, developers have slowed construction to the most cashconserving pace possible without activating default clauses on their loans by stopping work entirely and
sending away the cranes.
That slow pace, done on single shifts instead of three shifts around the clock as in the past, also showed up
in national data on Sunday.
Fixed-asset investment grew 20.2 percent in the first eight months of this year compared with the same
period last year. It was the second-lowest pace since December 2002; only May of this year was marginally
lower.
While even 20.2 percent might sound high by international standards, it overstates actual growth by
including the replacement of existing factory equipment and buildings that may have worn out, in addition
to new investment.
The monthly data also includes extensive double-counting, which Chinese statisticians only eliminate in
more comprehensive annual data.
The August figure for investment growth was weaker than expected even though central government
agencies in Beijing have started spending more money again. Their investment spending rose last month
from year-ago levels for the first time in 15 months, the details of Sunday’s official data showed, as Beijing
started trying to revive the economy.
Central government investment spending fell late last year and early this year as the economic stimulus put
in place in 2009 wound down.
It was the rest of investment spending that has been weak this summer and remained so in August. Local
government investment spending, for example, grew last month at the slowest pace since December 2001
— and local government investment spending in China is 18 times as large as central government
investment spending.
Cities across China borrowed and spent huge sums over the last several years and now find themselves
financially stretched. To make matters worse for them, the real estate slowdown has hurt their crucial
revenues from sales of government-owned land, as falling prices have made developers reluctant to buy
more land and build more buildings.
Construction in Chengdu last week. Investment in fixed assets was once a mainstay of the Chinese
economy.
He Yong, a saleswoman at a luxurious apartment complex slowly being built here in Chengdu, sat alone
this week in a spacious sales office empty of customers. The apartments sell for $120 to $165 a square foot,
Ms. He said, but she quickly volunteered that “we are now offering a 10 percent discount, and if you would
like further special discounts, you can contact our sales manager.”
Li Hongzhi, a Chengdu real estate broker, said that prices had dropped 5 percent from a year ago. But the
number of apartments changing hands has fallen much more steeply, often a sign that sellers are wary of
accepting even lower offers from buyers.
Mr. Li said that his company’s number of completed transactions in the city for already completed
apartments had slumped 30 percent in July compared with the previous month, after the national and local
government tightened restrictions on real estate speculation in a bid to improve the affordability of housing.
Anecdotal evidence from brokers is often the best guide to real estate prices in China, where government
indexes of transactions are flawed.
The national government’s own index of real estate prices attracts skepticism from analysts. Beijing
statisticians allow local governments to measure prices based on a few old neighborhoods in each city
where few transactions take place, so the national index shows fairly stable prices year after year in a
wildly gyrating market.
Private surveys of real estate developers tend to reflect price increases accurately during good times, but
few developers have been willing to admit their heavy discounting in the past year.
Other economic statistics released on Sunday also did not paint a cheerful picture. Retail sales were up 13.2
percent in August from a year ago, maintaining the slower pace they have shown through the summer —
although part of the slowness reflects lower inflation.
Producer prices plunged 3.5 percent in August from a year ago, an even faster decline than expected, as
companies accepted ever-lower prices for their goods in the hope of clearing overstuffed warehouses.
Yet for consumers, inflation actually picked up slightly in August, creeping up to 2 percent, from 1.8
percent in July, as food prices kept rising. Inflation makes it harder for the government to stimulate the
economy now without risking a further increase in prices.
Even before the release of Sunday’s data, some economists were already marking down their forecasts for
China’s growth this year and next year. Tao Wang, the China economist at UBS, did so on Friday, lowering
her forecasts for the third quarter of this year to 7.3 percent and for the fourth quarter to 7 percent — both
figures below the government’s target for this year of 7.5 percent.
Ms. Wang also cut her forecast for next year to 7.8 percent, from 8.3 percent.
In addition to weak domestic demand for new apartments and big-ticket purchases like cars, the Chinese
economy has suffered from slumping overseas demand, particularly from Europe. That has contributed to a
large buildup in inventories of unsold goods, particularly at manufacturers.
Beijing officials are starting to send signals that they plan to help exporters unload their inventories
overseas. They have allowed the renminbi to edge down 1 percent since the end of April against the dollar,
the main currency in which China conducts its trade, although the renminbi has appreciated 3.5 percent
against the euro since then.
Premier Wen Jiabao said after a tour of export zones in southern China last month that measures should be
taken by the end of September to help exports. Citing unidentified sources at the Commerce Ministry, the
semiofficial China Daily newspaper reported over the weekend a package of initiatives would be started in
mid-September, including tax rebates, insurance, loans and other measures.
For now, demand is weak across the Chinese economy.
“I would say my business is down 15 percent this year,” said Ms. Zhong, the beautician. “Customers are
tightening their belts and spending less; they are choosing fewer and cheaper treatments than before.”