Sun, Feb 03, 2002 page8

• China's economy faces severe pain

  • By Christopher Lingle
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  Investors seeking portfolio plays or considering whether to create a physical presence in China have been buoyed by Beijing's accession to the WTO. Most of the analysis has depicted China's entry as a "win-win" arrangement.

  Assessment of improved relations with China has always been premised on the allure of trading with a country of 1.3 billion inhabitants and an untapped economic potential. China's annual GDP ranks seventh in the world, and it is the 10th largest trading economy.

  Whatever the presumed benefits to foreign investors, some observers have asserted that there will be heavy costs to China from participating in the global trading body. By allowing Chinese consumers to choose from a wider range of foreign-made products, it is likely that many inefficient and uncompetitive local enterprises will go under.

  China's agriculture and manufacturing sectors are especially vulnerable to foreign competition and these provide employment for almost 80 percent of the workforce. It is inevitable that more layoffs will add to the ranks of the 45 million to 60 million laborers who have been made redundant in recent years.

  There is no denying that China's economy faces serious trouble in the near future. But it is important to understand the real causes. Rather than fault WTO entry or Beijing's partial flirtation with capitalism, China's future job losses are fundamentally caused by the irrationalities introduced by central planning.

  In attempting to experiment by creating a "market socialist" economy, China's leaders allowed too much "socialism" to overwhelm too little "market."

  This faux capitalism maintains the ingrained inefficiencies of communism while depriving market participants of protections from the rule of law or the advantages of competition.

  As it is, a vast chunk of enterprises are owned or controlled by various arms of government. They consume more resources, including the squandering of around 40 percent of all bank deposits over the past 20 years, and employ many more people than the private sector.

  And they are inefficient. State-owned enterprises (SOEs) required government subsidies of 150 billion yuan (US$18 billion) to generate profits of 49 billion yuan in 2000. Since SOEs currently account for 80 percent of all outstanding loans, their problems create a high risk of a full-scale banking crisis as well as growing problems with unemployment.

  It is true that the number of SOEs engaged in industrial activities fell to 60,000 from nearly 100,000 from 1995 to 1999. They continue, however, to employ about 55 percent of urban workers. Of these workers, more than 10 percent are probably unnecessary and will eventually be laid off.

  Besides the unemployment effects, downsizing or bankruptcy of SOEs will impose a large burden on the public treasury. Since most social spending has historically been channeled through the SOEs, the central government will have to provide social spending that could rise by as much as US$600 billion, accounting for about 60 percent of GDP.

  China has to have rapid growth so that its economy can produce between 10 million and 14 million new jobs a year, or unemployment will continue to rise. One of the primary lessons of recent decades is that private entrepreneurs and not governments are the source of sustained economic growth. It turns out that "market socialism" does not provide sufficient opportunities or protections for private initiatives.

  Beijing's meddling has created a dysfunctional economy that will interfere with one of the principle advantages of WTO membership. By allowing imports of more and cheaper products, China's citizens will enjoy a higher standard of living. Such a rise in living standards comes because more can be consumed even if nominal incomes do not increase.

  In a functioning market economy, this would translate into an explosion of new economic activity that would create new jobs and growth through the expansion of the private sector. The underdeveloped nature of the domestic capital market, however, combined with the fact that SOEs take most of the funds lent by state-owned banks places non-government enterprises at a disadvantage. Since there are few private banks, and regulations ensure that private listings on the local bourses are very limited, it is difficult for entrepreneurs to gain access to funds.

  Another limit on the emergence of private enterprises is the arbitrary enforcement of a confusing array of laws and rules. Of particular concern are the actions of corrupt Communist Party cadres who manipulate these laws to confiscate property and income.

  China's future suffering will not be caused by too much capitalism or too much competition. Indeed, there are too few market activities that are openly contested and too few of the means of production are owned privately.

  China's communist legacy continues to be an enormous drag on the economy that aggressive privatization and membership in the WTO can help to resolve. Unfortunately, these painful transition costs are unavoidable, but they were put onto the books from the day that Mao Zedong (毛澤東) instituted communism in China.

  Whatever happens, China will have to hive off as much of its inefficient productive capacity as the former Soviet Union did and for the same reasons. Beijing must then allow the private sector to provide the basis for growth to keep the economy on a high growth trajectory. Further delays in both these transitions will only exacerbate the unavoidable economic pain that will promote avoidable political turmoil in the future.

  Christopher Lingle is global strategist for eConoLytics.com and author of The Rise and Decline of the Asian Century.
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