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Seeking Equilibrium: Rebalancing China's Economy

News, Page 2, Issue 439, Oct 12, 2009
Translated by Tang Xiangyang
Original article: [Chinese

Jeffrey Sachs is deeply interested in China. The American economist, best known for his role in prescribing economic shock therapy to the newly independent countries of Eastern Europe in the early nineties, is currently in the process of setting up a special project called China 2049.

The ambitious goal of  the project is to inform the world of what China will be like in forty years time.

Obviously this is a huge and complicated task, but it's also very intriguing - who doesn't want to know what the future will hold.

Like Sachs, Cao Honghui, the director of the Financial Market Research Office at China's Academy of Social Science, has many question about China's economic future:

"Will our current model of our economic growth be able survive over the coming five to ten years?"

"Will we continue to enjoy such good times as we do now?"

"Will the next generation be able to enjoy good times like these?"

At this turning point in China's history, the Economic Observer attempts to understand what China's economic situation will be like in 10, 20, 40 even 60 years.


The majority of the economic experts that we interviewed for this article agreed that adjustments to the country's economic structure and economic growth model will be the major deciding factors in determining China's economic future.

Problems with the fundamental economic structure of the country have also been at the heart of difficulties with China's economic development over the past sixty years.

We asked Cao Yuanzheng, chief economist at Bank of China (BOC) International Holdings and a senior expert on Chinese economic restructuring who has worked on economic restructuring for the central government, to give the EO an overview of the major developments that have occurred in terms of Chinese economic growth since the founding of the People's Republic of China.

Large-scale economic construction only really began in 1953, when, under the auspices of the first Five-Year Plan and with assistance from the former Soviet Union, China adopted a growth model that prioritised the development of heavy industry.

However, due to imbalances in the development that followed, structural problems emerged with the over-development of heavy industry, light industry was also under developed and the agricultural sector was defunct.

In many respects, the reforms of 1978 were motivated by a desire to address these structural imbalances.

It was during this round of structural adjustment in the late seventies that township and village enterprises found the room they needed to develop, so from 1978 to 1990 the proportion of heavy industry declined while the proportion of light industry witnessed sustained growth.

Then, beginning around 1993 and 1994, China began to experience two major transitions, a shift in the nature of the economic system and a restructuring of the country's economic development model.

Looking back over these past developments, Cao reached two conclusions, "first, economic restructuring is necessary; secondly, it's not particularly laudable that structural adjustment relies almost entirely on government action."

After China joined the WTO in 2002, problems with over-capacity which had long existed in the Chinese economic system disappeared over night.

Wang Jian, former deputy director of the Economic Research Institute of the State Planning Commission (forebear to today's National Development Reform and Commission) and currently Executive Secretary-general of the China Society of Macroeconomics, recalled that: "Up until the late 90s, there had already been two eras of globalization, but the first two did not witness the transfer of manufacturing industry to developing countries, while during the third era of globalization, manufacturing began the shift towards China, India and other developing countries."

The pace of this transfer resulted in the rapid development of China's export-oriented economy. As Cao Yuanzheng put it: "there's never been anything like this before, we blew everyone else out of the water and established a unique 'Chinese economic growth model.'"

Yet, even at the time that this model was emerging, experts like Yu Yongding of China's Academy of Social Science's Global Economics and Politics Research Center were already warning that this kind of growth model was not sustainable.

Soon enough, this economic growth model had led to an imbalance in global financial payments, with China enjoying increasingly favorable international trade and capital positions.

Then, starting from 2005, China began to adopt a series of policy measures that helped to recalibrate China's economic growth model. Export tax rebate rates were lowered, labor costs were allowed to rise and the price of land usage increased. In 2006, the State Council also decided to tackle the problem of over-capacity that had emerged in various sectors including the steel, aluminum, coal and automobile industries.

More Problems Emerge

The global economic downturn turn has put all recent moves to adjust China's economic growth model and alter the country's industrial structure on hold.

In addition, the stimulus package introduced to help the country deal with the effects of the global downturn have exacerbated existing problems with overcapacity in certain areas of production.

Because of this, some experts are worried that China might squander the opportunity it has of restructuring the economy and instead return to the old path of relying on investment and foreign trade to fuel growth.

Wendy M. Liu (Liu Mingdi), head of China research at RBS, has observed that although Chinese policy-makers have realised the importance of restructuring, given its actions, the government still seems to be more focused on marinating GDP growth.

The numbers appear to support her argument. From January to August, fixed-asset investment increased by 33% compared with the same period last year, with its contribution to economic growth exceeding 80%.

Of this number, investment in real estate development was up 11.6% in the January to July period but this shot up to 14.7% in the January to August period.

As an indicator of investment in the steel sector, fixed-asset investment in the smelting and pressing of ferrous metals increased by 3.3% from January to July, but the figure for January to August. was up 11% on the previous year.

When we look at the direction of new loans, in the first half year, only 7% of new loans found their way in to real estate, but this percentage had risen to 54% by July. This kind of investment is bound to create problems of overcapacity.

The Ministry of Industry and Information Technology (MIIT) published an announcement in August drawing attention to the growing problem.

The Financial and Economic Affairs Committee (FEAC) of the National People's Congress (NPC) also flagged the problem, drawing attention to nineteen industries that were plagued by problems of overcapacity.

Most of the industries mentioned had already been targets of the 2006 push to address overcapacity.

But according to Mao Zhenhua, Co-Director of the Institute of Economic Research of Renmin University, the problem is: "in the past, China depended on investment and exports as the two drivers that worked to maintain high rates of growth. If we do away with both of these before we've settled on a new driver of economic growth, we'll be the cause of our own demise."

Difficulties that can't be Ignored

Pan Xiangdong, chief economist at Everbright Securities, has a distinctively pessimistic view of what China's economic situation will be like in 20 years time: "Now we have the comparative advantage of cheap labor,but in the future economic development will depend on technology, will China still have a comparative advantage then?"

More and more people are starting to realise that China will not be able to maintain an economic growth model that relies on investment and exports, as Wang Jian explained  "it's simple, before there was demand and we could export, now demand has dropped, and it's natural that we'll have to alter our economic growth model." As Cao Yuanzheng put it, it's not a case of China choosing to transform its economic structure, it's has no choice but to change. 

At the Third WEF Annual Meeting of the New Champions (the Annual Meeting of the Summer Davos 2009) held in Dalian, Chinese Premier Wen Jiabao stated clearly: "We should focus on restructuring the economy, and make greater effort to enhance the role of domestic demand, especially final consumption in spurring growth."

But the question of how will China develop domestic demand and restructure its economy remains a controversial one.

"Most discussion concentrate on two aspects, firstly, are the policies introduced to counter the effects of the crisis compatible with restructuring efforts or will restructuring require exiting the stimulus measures. This is a question that economic planners all around the world are dealing with, and the answer is still not clear" observed Cao Yuanzheng.

The other aspect relates to industrial policy, and comes down to whether overcapacity really is a problem for China.

"Some continue to hold on to the mistaken belief that China will once again be as lucky as it has been in the past, and that future economic developments will solve the current problems with industrial overcapacity". Cao Honghui thinks that if China was to miss this chance to restructure, than it would have missed it's best opportunity to adjust, "Because the world economy is in trouble, it's easier for China to reform it's economic structure now, if other countries recover, it will be extremely difficult for China to once again consider adjusting its economic structure.

Another controversial issue that splits commentators is the nature of short- and long-term restructuring policies.

Cao Honghui argues that the current economic adjustments should not only be structural, but also comprehensive.

Wang Jian thinks adjusting the structure of the economy requires more than simply worrying about production and that you have to take demand into account, he argues that urbanization will expand domestic demand and was necessary for economic restructuring.

Pan Xiangdong agreed but added that in addition to urbanization, China also needs to carry out an upgrade of its industrial capacity.

Possible Solutions

From the Chinese government's perspective, it has to achieve a balance that allows it to avoid an economic recession but at the same time continue on with its restructuring of the economy, it also has to weigh short-term adjustments against a long-term transformation of the country's economic growth model.

In terms of short-term policies, we've already  seen that the Chinese government is doing its best to reduce the side-effects brought about by the introduction of stimulus measures. For example, the Ministry of Industry and Information Technology is starting to be more vigilant in relation to overcapacity in clean energy, wind power and solar power sectors and it's also taken measures to address overcapacity in those industries that have had problems before - including the steel, cement and glass industries.

However, Liu Yuanchun, assistant dean at Renmin University's School of Economics, was pessimistic about the ongoing economic restructuring. "The decentralized system is an obstacle to restructuring the structure of the economy.

Due to local interests, current attempts to adjust will not be able to improve the structure.

For example, "For the benefit of industrial restructuring many mergers are being carried out. But most of these are government-mandated, and are far from being the independent actions of enterprises, on the face of it it appears that things are going well, but problems of over capacity won't be solved in this way."

Cao Yuanzheng however sees a few reasons for optimism in the current adjustments, "this round of changes is different from those took place in 1980s and 1990s, firstly, this time we're mainly reliant on a market economy system and relying on the reform of the pricing mechanism to promote structural simplification and economic progress.

At the same time, the government is outlining even stricter standards - such as environmental standards and energy standards to spur structural transformation.

According to Cao Yuanzheg, the financial crisis has given birth to something new. "The financial crisis has awakened us to the realization that we can't rely on an export-driven economy forever. In addition, at the heart of expanding domestic demand is income. So, policies introduced to deal with the crisis also contained measures aimed at maintaining growth, the goal of which was to maintain the livelihood of the people and also employment.

A further cause for optimism is that the restructuring of the economy will also open up some new opportunities, the adjustment of the industrial structure and the proportion of the economy made up of various kinds of industry is bound to change, amongst these changes, the most important is likely to be the development of the service industry and increasing its contribution as a percentage of total industrial output.

However, Cao admitted, this round of restructuring was still plagued by government interference, a remnant of the days of a planned economy.

As experience has shown that this is no good - we need to proceed with reforms, must make advances in introducing reforms to the pricing system, reform the system of income distribution and more.

Cao Yuanzheng warned that "economic restructuring is a gradual process, we can't expect It to be solved in a day."

Liu Yuanchun concurred, observing that although the transformation of China's economic growth model is going smoothly, the process will be much slower than people expect.

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