Up to now, China's modernization has been impressive. Its ranking as a trading economy was 32nd in 1978 and has improved to 8th place. Unfortunately, there are numerous challenges that threaten to undermine China's future economic health. Avoiding the worst of these potentially calamitous effects requires adoption of radical and expansive reforms.
The most crucial initiative that Beijing should take is to unleash private initiatives to deepen the development of the domestic sector of its economy. This is because the international sector is unable to continue to serve as the motor for China's impressive growth. Although nearly 36 percent of GDP comes from total foreign trade, this contribution to overall growth is on shaky ground since its wobbly Asian neighbors have purchased as much as 55 percent of China's exports.
Reviving and expanding China's domestic sector will not be easy. On the one hand, China does not have a well-integrated national economy due the poor transportation and communication systems between commercial centers. Consequently, products from China's coastal provinces are more likely to be found in a remote village at Europe's center rather than in its own hinterlands. Despite China's huge potential market, inefficient distribution systems put severe restrains on both domestic and foreign producers.
However, China remains in the grip of a destructive deflationary cycle. Current conditions contrast sharply with the perpetual shortages and excess demand under central planning. Now the same country where Mao Zedong's () mismanagement led to the starvation of 30-50 million peasants is able to produce grain reserves to fill its needs for almost three years.
Not so long ago, price ceilings were applied to ward off inflation. Now price floors are imposed to keep prices up and offset deflationary pressures. The introduction of personal incentives to China's "market socialism" has transformed shortages into surpluses in many sectors. Manufacturing capacity currently exceeds buyers so that many industries must reduce production to avoid large inventories. Consumer durables are especially affected. For example, the motorbike industry is operating at about 55 percent capacity, the car industry at 44 percent, washing-machine factories at 33 percent and air-conditioning plants at 33 percent.
This glut in inventories is driving prices down and putting a brake on new investment. Much of the "fixed asset" investment is being undertaken through Beijing's visible hand instead of being guided by the invisible hand of the market. Continuing declines in such investments will reduce long-term growth potential.
Beijing hopes to revive the economy by cutting interest rates and increasing central government deficits. China's 1999 budget included a public sector budget deficit that was 57 percent higher than the previous year, financed through the sale of long-term bonds worth over 150 billion renminbi (US$18 billion).
Unhappily, deficit spending and public-sector borrowing will not resolve China's problem. By contrast, modern economies that have banks that ration credit according to risk and returns can move to cut interest rates to boost private sector spending. In China, political and social interests guide investment funding even when the outcome of the decisions will retard long-term growth. In all events, deficit spending is a remedy that is appropriate for short-term economic dislocations associated with business cycles. China's ongoing deflation is rooted in structural contradictions and distortions that are leftover from the days of central planning. Beijing's options are becoming increasingly bleak. State-owned enterprises continue to divert too much capital and too many other precious resources from the private and non-state sectors of the economy. Without massive layoffs, the bank system is at risk of collapse under the growing burden of non-performing loans (NPLs) that some analysts guess to be 50 percent of GDP. Either course of action will almost certainly cause widespread social unrest.
RSS