Beneath the surface of China’s ‘warming’ economy are structural impediments to long-term growth that demand attention -- now.
By Hu Shuli 28 April 2009
We’ve noticed a bit of swooning over the latest quarterly financial figures. Some folks are talking about “warming trends.” Others speak with fervour about “China leading the recovery” – an idea spreading in political, business and academic circles among those who suggest China has headed off the global crisis. From the Boao Forum of Asia in summer-like Hainan to the offices of government policymakers in Beijing, which is enjoying a balmy spring, affirmations of warmth are prevailing over cool scepticism.
We find it hard to identify with this kind of optimism. The “warming” is more show than substance. Although worth watching, it should not be overstated. Confidence notwithstanding, we believe more than ever that China needs to brace for adversity and adopt policies for a stable, sustainable economy.
True, the surface is warming with current improvements in economic conditions. But deep down, the temperatures are uneven.
A positive macroeconomic indicator is the latest Purchasing Managers Index, which has been rising in reaction to the government’s economic stimulus package. Auto and property markets are turning around, and foreign trade figures, after falling for three months, have stabilized. These are signs of an upturn.
But a lot of other data is worrying. Some indexes have flip-flopped, while others are continuing to deteriorate. For example, year-on-year power consumption growth turned negative in mid-March. Steel prices declined after a short spike. The business merchandise price index, compiled by the central bank, sank to record lows, suggesting lingering deflationary pressure. Moreover, the private sector lacks the will to invest, which might indicate that the market is unable to digest the huge stimulus package.
But recent investigations by Caijing reporters found that Chinese cities relying heavily on foreign trade and private enterprise have benefited little from the stimulus. Many small- to medium-size enterprises still face deep distress, reflecting the unevenness of the talked-about recovery. Considering macroeconomic trends, we see the present period fraught with uncertainty. We’re still far from ready to heave a sigh of relief.
A better course is to pay attention to reasonable folks in the market who harbour concerns about the effects of the economic stimulus.
The market has built-in expectations. It follows not only the immediate effects of government policies such as the stimulus, but also the consequences and impact over time. We should join the market in recognizing that effective growth of non-governmental investment is the key to stable and sustainable growth in the future.
First, the stimulus model’s influence on credit expansion is not sustainable. In the few months since the stimulus plan was implemented, lenders have opened the floodgates. The amount of new lending reached 4.58 trillion yuan in the first quarter alone, coming close to already reaching the official target of more than 5 trillion yuan set for this year. Obviously, lending growth during the next three quarters cannot match the first-quarter level. Nor can next year’s credit level match this year’s, which means efforts to stimulate the economy through credit expansion are likely to slacken.
Without visible improvements in the external environment, economic growth in coming quarters will depend entirely on the effects of investments already made. It will be difficult to generate a favourable multiplier effect and maintain a warming trend in the economy because credit for the latest investments will hardly pull in private investment or create new jobs.
A second problem is overcapacity. A popular view is that new demand is created without adding new capacity as long as investments are made in infrastructure. But infrastructure can create new supply. Without adequate utilization, investments in super highways, railroads and airports will not generate returns to repay banks. Without corresponding demand, excessive investment leads to overcapacity. There is rarely an exception to this rule.
A third issue is inflation. If the economy really is warming up, inflation will soon rear its head. Easy credit in the first quarter was expected to rapidly push up key indicators such as the Consumer Price Index, forcing monetary authorities to take action. But the government has few options for controlling inflation and curbing liquidity risks. And these options risk choking ongoing projects and creating more non-performing loans. Ill-timed policy adjustments can trigger stagflation as well.
Other worries should not be simply brushed off as silly cries of “the sky is falling.” Even if the warming effect can be fully attributed to the stimulus plan, we must admit that it’s only a way to reduce the short-term risk of economic downturn. It cannot ensure extended stability, nor sustain the warming trend.
Nevertheless, addressing symptoms buys time to cure the disease. Since we know that credit expansion is not the best economic healer, we should spend the coming days thinking about long-term approaches that will help China survive the crisis and pursue lasting development.
China is being forced to rebalance. It’s clear that, regardless of the angle from which we examine the situation, our economy is being squeezed by internal and external crises. Excessive consumption in the United States is a root cause of the global financial crisis. Instead of complaining about this fact, or even quietly congratulating ourselves, China must consider what to do if the United States learns its lesson and, for example, gradually raises its household savings rate. If external demand for Chinese goods is declining, how can internal demand rise?
At this juncture, structural adjustment should not be empty talk. It must involve a series of basic policies that deepen the nation’s economic reform. Structural adjustments can only follow the market’s lead and, for the most part, involve breaking up monopolies, opening the market wider, relaxing controls, and getting the pricing mechanisms right. Reform measures already written should be implemented; languishing reform proposals should be rolled out speedily. In terms of government macroeconomic policy, tax cuts are far better than new lending. The value-added tax for enterprises and income tax for individuals are higher than international levels. There is room for tax cuts that can boost private investment and consumption on a sustained basis.
International precedents indicate that China will enter a new phase of industrial upgrading and structural economic transformation now that the nation’s per capita GDP has topped US$ 3,000, which happened for the first time last year. The nation’s high per capita savings and investment rates, as well as advanced technology and manpower levels, offer additional positive conditions. At the same time, the scale of China’s economic expansion reminds us that resource and environmental constraints can create a bottleneck for development. Thus, new energy sources and high-tech industries must be the driving forces for long-term development.
History shows that a crisis of epoch proportions typically ends with the rise of new industry, new technology or a new state economy to trigger a new round of growth. Which choices will China make? We are not satisfied with a temporary “warm-up” encouraged by the traditional model. Instead, we see a strategic opportunity for structural adjustment.
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Lasting Economic Growth Beats a Warm-up
Beneath the surface of China’s ‘warming’ economy are structural impediments to long-term growth that demand attention -- now.
By Hu Shuli
28 April 2009
We’ve noticed a bit of swooning over the latest quarterly financial figures. Some folks are talking about “warming trends.” Others speak with fervour about “China leading the recovery” – an idea spreading in political, business and academic circles among those who suggest China has headed off the global crisis. From the Boao Forum of Asia in summer-like Hainan to the offices of government policymakers in Beijing, which is enjoying a balmy spring, affirmations of warmth are prevailing over cool scepticism.
We find it hard to identify with this kind of optimism. The “warming” is more show than substance. Although worth watching, it should not be overstated. Confidence notwithstanding, we believe more than ever that China needs to brace for adversity and adopt policies for a stable, sustainable economy.
True, the surface is warming with current improvements in economic conditions. But deep down, the temperatures are uneven.
A positive macroeconomic indicator is the latest Purchasing Managers Index, which has been rising in reaction to the government’s economic stimulus package. Auto and property markets are turning around, and foreign trade figures, after falling for three months, have stabilized. These are signs of an upturn.
But a lot of other data is worrying. Some indexes have flip-flopped, while others are continuing to deteriorate. For example, year-on-year power consumption growth turned negative in mid-March. Steel prices declined after a short spike. The business merchandise price index, compiled by the central bank, sank to record lows, suggesting lingering deflationary pressure. Moreover, the private sector lacks the will to invest, which might indicate that the market is unable to digest the huge stimulus package.
But recent investigations by Caijing reporters found that Chinese cities relying heavily on foreign trade and private enterprise have benefited little from the stimulus. Many small- to medium-size enterprises still face deep distress, reflecting the unevenness of the talked-about recovery. Considering macroeconomic trends, we see the present period fraught with uncertainty. We’re still far from ready to heave a sigh of relief.
A better course is to pay attention to reasonable folks in the market who harbour concerns about the effects of the economic stimulus.
The market has built-in expectations. It follows not only the immediate effects of government policies such as the stimulus, but also the consequences and impact over time. We should join the market in recognizing that effective growth of non-governmental investment is the key to stable and sustainable growth in the future.
First, the stimulus model’s influence on credit expansion is not sustainable. In the few months since the stimulus plan was implemented, lenders have opened the floodgates. The amount of new lending reached 4.58 trillion yuan in the first quarter alone, coming close to already reaching the official target of more than 5 trillion yuan set for this year. Obviously, lending growth during the next three quarters cannot match the first-quarter level. Nor can next year’s credit level match this year’s, which means efforts to stimulate the economy through credit expansion are likely to slacken.
Without visible improvements in the external environment, economic growth in coming quarters will depend entirely on the effects of investments already made. It will be difficult to generate a favourable multiplier effect and maintain a warming trend in the economy because credit for the latest investments will hardly pull in private investment or create new jobs.
A second problem is overcapacity. A popular view is that new demand is created without adding new capacity as long as investments are made in infrastructure. But infrastructure can create new supply. Without adequate utilization, investments in super highways, railroads and airports will not generate returns to repay banks. Without corresponding demand, excessive investment leads to overcapacity. There is rarely an exception to this rule.
A third issue is inflation. If the economy really is warming up, inflation will soon rear its head. Easy credit in the first quarter was expected to rapidly push up key indicators such as the Consumer Price Index, forcing monetary authorities to take action. But the government has few options for controlling inflation and curbing liquidity risks. And these options risk choking ongoing projects and creating more non-performing loans. Ill-timed policy adjustments can trigger stagflation as well.
Other worries should not be simply brushed off as silly cries of “the sky is falling.” Even if the warming effect can be fully attributed to the stimulus plan, we must admit that it’s only a way to reduce the short-term risk of economic downturn. It cannot ensure extended stability, nor sustain the warming trend.
Nevertheless, addressing symptoms buys time to cure the disease. Since we know that credit expansion is not the best economic healer, we should spend the coming days thinking about long-term approaches that will help China survive the crisis and pursue lasting development.
China is being forced to rebalance. It’s clear that, regardless of the angle from which we examine the situation, our economy is being squeezed by internal and external crises. Excessive consumption in the United States is a root cause of the global financial crisis. Instead of complaining about this fact, or even quietly congratulating ourselves, China must consider what to do if the United States learns its lesson and, for example, gradually raises its household savings rate. If external demand for Chinese goods is declining, how can internal demand rise?
At this juncture, structural adjustment should not be empty talk. It must involve a series of basic policies that deepen the nation’s economic reform. Structural adjustments can only follow the market’s lead and, for the most part, involve breaking up monopolies, opening the market wider, relaxing controls, and getting the pricing mechanisms right. Reform measures already written should be implemented; languishing reform proposals should be rolled out speedily. In terms of government macroeconomic policy, tax cuts are far better than new lending. The value-added tax for enterprises and income tax for individuals are higher than international levels. There is room for tax cuts that can boost private investment and consumption on a sustained basis.
International precedents indicate that China will enter a new phase of industrial upgrading and structural economic transformation now that the nation’s per capita GDP has topped US$ 3,000, which happened for the first time last year. The nation’s high per capita savings and investment rates, as well as advanced technology and manpower levels, offer additional positive conditions. At the same time, the scale of China’s economic expansion reminds us that resource and environmental constraints can create a bottleneck for development. Thus, new energy sources and high-tech industries must be the driving forces for long-term development.
History shows that a crisis of epoch proportions typically ends with the rise of new industry, new technology or a new state economy to trigger a new round of growth. Which choices will China make? We are not satisfied with a temporary “warm-up” encouraged by the traditional model. Instead, we see a strategic opportunity for structural adjustment.
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