How to fix China's economy?

By S.P.SETH

In the midst of global economic doom and gloom, China has attracted much attention and admiration for its impressive growth. Not long ago, China’s annual GDP was growing by over 10 per cent. Things are now slowing down but the pace is still healthy. In his speech at the recent National People’s Congress in Beijing, Premier Wen Jiabao revised down the GDP growth rate to 7.5 per cent, the lowest for a long time. In his address to China’s 3000 delegates, he detailed the problems facing the economy. He said: “Domestically, it has become more urgent but also more difficult to solve institutional and structural problems and alleviate the problem of unbalanced, uncoordinated, and unsustainable development.”

And: “Internationally the road to global economic recovery will be tortuous, the global financial crisis is still evolving, and some countries will find it hard to ease the sovereign debt crisis any time soon.”

The main reason for China’s relatively slower growth rate is a contraction of its major export markets in Europe and the United States. The US and Europe are trying to deal with their debt and deficit problems. They were, the US in particular, running large trade deficits with China. A good chunk of China’s trade surplus with the US was invested in US bonds and treasury notes. It seemed a convenient exercise for both countries with China continuing to expand its exports, while the US had access to easy credit. In the process, with cheap Chinese goods flooding into US and Europe, the inflation remained under control. An important contribution of China’s export economy was to keep inflation under wraps in the West.

With inflation under control and easy credit available domestically and internationally through all sorts of complex and phony credit instruments, the Western economies went on a spending spree like there was no tomorrow. But the time and their profligacy eventually caught up, leading to the global financial crisis of 2008 that is still working its way. Not surprisingly, China too got caught up in all this, with a sudden drop in its exports and rising unemployment. This was potentially dangerous for China’s social stability, when millions of unemployed migrant workers from rural areas returned to their villages with not much employment prospects back home.

The Chinese government sought to deal with this situation with a massive economic stimulation package of about $600 billion. This did salvage the situation temporarily with banks (under state direction and funding) making credit available to fund all sorts of construction projects at local, regional and central levels. While this massive expenditure did halt the slow down and improved employment, it has also created a housing bubble, inflationary pressures and a huge internal debt from easy credit availability. For instance, there are vast empty housing estates built in the last few years without people to live in them, as most people can’t afford to buy these places.

In some ways it is like the Japanese bubble of the nineties that is still plaguing the Japanese economy. In other words, the Chinese economy, with its inbuilt imbalances of rural and urban development and growing income disparities all around has become even more distorted. And this sort of “unbalanced, uncoordinated, and unsustainable development” cannot continue, as Premier Wen Jiabao told the assembled 3,000 delegates of the National People’s Congress.

The breakneck speed of China’s economic development has not only created structural imbalances but also social dislocation. From a predominantly agricultural economy, China is now 50 per cent urbanized. Nearly 300 million rural people (and rising) constitute its floating migrant population working on urban industrial and construction sites. And they are not entitled to urban residency entitlements because of their rural residency registration. A whole way of life, going back thousands of years, is in search of a new sense of belonging that eludes them.

No wonder, China is in the midst of widespread social unrest. According to the last official estimate, China experienced in one-year 90,000 cases of social unrest, big and small. The government has stopped compiling and issuing statistics on this. Corruption is now endemic and getting institutionalized, affecting even the higher level of bureaucracy and government. The Bloomberg columnist William Pesek has quoted a report to the effect that: “The wealthiest 70 members of China’s legislature added almost $90 billion to their bank accounts last year....”

The big question is: how do you restructure an economy geared to high rates of growth fuelled by ever increasing exports? China is planning to address this question by expanding domestic consumption to increase its internal market. For this to happen people’s incomes would need to rise alongside increased employment. As regards the first, there has lately been some increase in wages due to workers’ protests, especially in the coastal industrial zones. Another way is to give people greater return on their savings with the government banks, which currently have very low interests. People have no options but to accept what is offered. Being essentially government institutions, people also feel safe about their money.

China has a very high rate of savings, mostly at the government’s disposal with very little cost involved. If people were to save less and get more return on what they save, their disposable income will rise thus enabling them to spend more and stimulate demand. Of course, China’s industrial enterprises will need to invest more in producing consumer goods for domestic economy, thus diverting funds from fixed investment in construction projects that is creating a bit of a bubble economy. But to transform the country’s economy in such a radical way is a tall order, especially because the existing system has spawned vested interests and in the midst of entrenched corruption.

Another way to diversify China’s economy is to spend more on education, health, and social welfare sectors. China’s preoccupation with statistical growth has seriously neglected these sectors, even though it is now the second biggest economy. Besides, there is also need to invest more in the rural sector that has seen relative neglect in the last two decades from the nineties. That explains the increasing migration of rural people to cities in search of jobs. China could also do with developing ancillary small and medium scale rural industries to provide employment for people closer to farming communities. This is important not only to stem the outflow of rural population to cities but also to foster social harmony by keeping people within their familiar social and cultural environment. But unfortunately the government instrumentalities at the local and regional level, in particular, have been busy acquiring rural land for urban development and industrial construction without much consultation and compensation. Which is an important reason for rural unrest.

The overhaul of the economy will be a slow and a long process, requiring public accounting and transparency. In other words, it is time for China to link up economic transformation with political reform. As Premier Wen Jiabao said at his press conference, “ … Without successful political structural reform it is impossible for us to institute economic structural reform and the gains we have made in this area may be lost.” He has said before that, “… if we are to address the people’s grievances we must allow the people to supervise and criticize the government.

China will soon undergo a change of top leadership, with a new President and Prime Minister. That might lead to a concerted effort to transit China into a more sustainable development path, though it is not going to be easy and painless.