How Strong is China’s Economy?

By Sushil Seth

There is a growing fear that the world might be heading toward an economic Armageddon, with the Euro zone crisis looking intractable by the day. The US economy too is in a holding pattern with not much bright light ahead. In these times China appears healthy, though its rate of growth is slowing. This is not to say that China is trouble free.

China’s economy has some deep-rooted problems that do not augur well for its future. Indeed, this is the assessment of China’s Premier Wen Jiaobao who said some time ago that, “ We must…address the long standing problems in China’s economy of a lack of balance, poor co-ordination and unsustainability…”

If anybody else had said this, he/she would have been laughed out of town when China’s even slower growth rate of around 9 per cent is something another country will die for.

China’s growth strategy has been underpinned by three important factors. First: it has been export driven with seemingly unlimited demand for Chinese goods in the United States, Europe and even among third world countries.

Second: production costs in China are low because of low wages with long working hours which gives China an important and decisive competitive advantage with other countries.

Third: an undervalued currency further enhances China’s competitive advantage.

Not surprisingly, Chinese goods have flooded international markets to undercut local production with job losses.

Until the global financial crisis hit the world in 2008, the availability of cheap and easy credit didn’t create too much resentment in the US and the west against Chinese exports. For instance, with China buying US treasury notes and bonds with recurring and expanding trade surpluses, and its cheap goods helping to keep inflation under control, it didn’t seem a huge problem.

But all this is changing for a number of reasons. First: China’s export markets in Europe and the US are shrinking because of severe economic problems in these countries. They simply can’t afford to keep buying Chinese goods like before.

Second: these countries, especially the US, have been pressuring China to revalue its currency to create a level playing field for their exports to China. Because of China’s resistance to freely float its currency, protectionism is rising in the United States.

At the same time, the wages in China have been under upward pressure because of labor unrest. Therefore, the competitive advantage from lower wages in China might diminish.

With the rise of protectionism and rising labor costs, the export-driven growth strategy might not be as attractive as in the last thirty years.

China will, therefore, need to reorient its economy to produce goods and services for internal consumption. Because: any slow or sluggish growth will worsen unemployment leading to social unrest.

The problem, though, is that it is not like switching gears to change the direction of an export driven economy to focus more on creating and meeting internal demand. The state has to have a road map for this and a strategy to execute it. As far as is known, there is no such thing.

When the global recession hit in 2008 affecting Chinese jobs and exports, China sought to meet the situation with a hefty stimulation package of about $600 billion. Which has created the property bubble and stock market gyrations.

But the government has once again eased up on liquidity fearing contraction of the economy. This kind of go-stop economic approach is too arbitrary for a country of 1.3 billion people who need more jobs with a strong component of social welfare for difficult times. As it is China’s estimated 300 floating rural migrants working in urban economy are not entitled to the benefits accruing to their urban cousins.

Many poor and low income Chinese have difficulty accessing education and health facilities for their children because of prohibitive costs.

After all, China calls itself a socialist country, presumably to promote economic and social equity.

Tsinghua University’s Social Progress Report for 2011 has reportedly warned that China has fallen into a “transition trap” and faces a series of systemic “abnormalities” like, for instance, lopsided growth which has privileged the state and its monopoly industries.

It is a top-heavy system with entrenched corruption. It needs overhauling. But with a small elite at local, regional and central levels controlling the levers of power, it is easier said than done. They have parceled out businesses among their children and a select group of favorites.

In this situation any systemic transformation will seriously hit China’s relatively small political and economic elite feeding on the system.

This is why despite all the noise about corruption and the need to eradicate it, nothing much can be done because of the nature of the system.

Liu Xiaobo, China’s Nobel Laureate currently serving an 11-year prison sentence, has described it like this in one of his essays: “In China the underworld and officialdom have interpenetrated and have become one. Criminal elements have become officialized as officials have become criminalized…”

Apart from entrenched corruption, there are rank inefficiencies, colossal waste, structural imbalances, over production, with social justice and welfare a serious casualty.

To overcome the recessionary impact of the global crisis, Chinese banks lent liberally. Which has resulted in huge internal debt incurred by local and regional instrumentalities, creating inflationary pressures and bubbles in property and stock markets; not unlike what happened in Japan and recently in the United States.

Since the system lacks transparency and accountability in the absence of a participatory and responsive political system, China’s economy will continue to sputter with no medium or long-term solution.

To sustain growth, China needs political reform as even Premier Wen Jiabao admits. He said last year in Beijing: “ Without political restructuring, economic restructuring will not succeed and the achievements we have made in economic restructuring may be lost.”

He added, “If we are to address the people’s grievances we must allow the people to supervise and criticize the government.”

No chance of this happening any time soon, if at all.