Mon, Dec 05, 2011 - Page 8 News List

Putting China’s risks in perspective

By Gerard Lyons

One of the key questions being asked about the world economy is whether China will have a hard or a soft landing.

Although no part of the world is totally immune to what happens in Europe, events in China are more important for many. Given its increasing demand for goods and commodities and the impact it has on investor sentiment toward emerging markets, what happens in China is of growing global significance.

One challenge when analyzing China is that it is easy to compile a long list of negatives, but also to make an even longer list of positives. The negatives should be taken seriously. However, those who look solely at the negatives in China are like stopped clocks: They will be right at some time, but they are of little use.

The key message is that China is on an upward trend, but there will be setbacks along the way.

China’s policymakers clearly take the risks seriously. A number of years ago, the leadership identified five major issues: coastal versus inland disparity, urban versus rural disparity, social problems, environmental concerns and foreign relations. Since then, the focus has been on achieving more sustainable growth.

The most important thing to appreciate about China is the scale and the pace of change. It is breathtaking. China is experiencing an industrial revolution. Despite this, there is still considerable potential for catch-up. China is the world’s second--largest economy, but its income-per-head is ranked 94th, on par with Albania.

To complicate matters further, China is made up of a multitude of different economies. Coastal areas, such as the Pearl and Yangtse River deltas, have developed considerably in recent decades, while western and central China is still heavily agricultural and poor.

Rapid wage growth, encouraged by policymakers, is not only seen as an alternative to currency appreciation, but also as an incentive for businesses in the coastal areas to move up the value curve by switching to higher-quality exports, as well as moving their lower-cost production inland, where land and labor costs are lower and jobs are needed.

All of these factors suggest that we need to be looking at China’s upside, as do certain recent policy initiatives. China’s rapid pace of change was demonstrated by its 12th Five-Year Plan, unveiled earlier this year. Its aim was to shift the economy toward domestic demand and away from low-cost exports. Boosting social welfare, consumer spending, the “green economy” and seven high-value industries all figured prominently. This plan is likely to significantly boost in spending in these areas in the coming years.

While these are big positives, it is the negatives that have grabbed market attention lately. There is no doubt that even inside China, sentiment has cooled.

Recently, Beijing has managed its risks well. Yet China is now a US$7 trillion economy and as it grows, it becomes harder to control the economy. The private sector has grown, free-market pricing is more entrenched and thus central control from Beijing is more difficult to administer.

Given its scale and complexity, China now requires powerful and independent policy institutions and regulators. The trouble is, it takes time to achieve this. In parallel, China’s financial sector needs to develop, and interest rates need to be liberalized to allow resources to be allocated more efficiently. Again, this takes time.

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