Sat, Nov 12, 2011 page8

• China will have to rethink economy

  • By Norman Yin 殷乃平
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  US economist Nouriel Roubini, known as “Dr Doom,” said at a recent seminar that for China’s economy to achieve a soft landing would be “mission impossible.” Roubini predicted that the Chinese economy might suffer a hard landing in either 2013 or 2014. The question of whether China will face a soft landing or a hard one has once more become a hot topic, as it looks as though the Chinese economy is going to come back down to earth before very long. If it does, when and how will it land and how will this affect us? This is quite a worrisome question.

  China’s economy has been growing rapidly for three decades following a process of reform and opening up and it has now become the world’s second-largest. However, hardly any of the basic economic factors or conditions that have attracted foreign investment over the years still exist.

  Following widespread wage hikes, China’s labor costs are now higher than those of neighboring developing countries. Since China can no longer offer cheap labor, labor-intensive industries are moving out one after another. Land used to be almost free in China, but now the cost of land in industrial zones is rising rapidly, driven by real-estate speculation. Water, electricity and energy prices that used to be held down by the government are moving toward free-market pricing adjustments. A credit crunch has also made it difficult for manufacturers to get hold of low-interest bank loans.

  As to the low exchange-rate policy formerly adopted to promote exports, the exchange rate for the yuan has been -continually raised under international pressure so that industries geared to earning foreign exchange are now having a hard time.

  Furthermore, commodity prices have been rising since the second quarter of this year, producing a clear imbalance in production and sales supply. As well as affecting people’s livelihood, this has put many industries under considerable pressure. As for China’s domestic market, fast-rising incomes have awakened consumer power. In the midst of the sluggish global economy, the rise of this new force has suddenly become the center of attention.

  Small and medium-sized enterprises in the prosperous industrial city of Wenzhou in Zhejiang Province are suffering financial difficulties because of credit tightening by the People’s Bank of China. They are being forced to turn to unofficial sources of financing and are being fleeced by high interest rates. This has caused a wave of businesses to fail, much to the consternation of China’s leaders.

  What is known as “gray finance,” “underground finance” or “shadow banking” actually makes up as much as 50 percent of business in the Chinese financial market. The more the central bank tightens bank loans, the more business there is for underground finance providers.

  Monetary policy is relatively ineffective in this gray zone as it lies outside the regular system. The capital used by underground financial outfits mostly comes from excess money supplied by the central bank and partially from “external circulation” of regular banks, which means that funds, having been recovered by a bank, remain available for outside use instead of being entered into their accounts.

  All these problems have made the central bank’s policies significantly less effective. Although the government has provided emergency funds, it has discovered that what has gotten companies into trouble are high wages and high exchange rates. As both production costs and product prices rise and overseas orders plummet, exporters can barely survive. It is the disappearance of the basic economic factors they have hitherto relied on that is dealing a deathblow to such companies. Emergency financing is merely a palliative, not a cure.

  China’s economic growth is slowing down. Although its growth rate for the third quarter of this year was 9.1 percent, it was markedly lower than the first quarter’s 9.7 percent and 9.5 percent in the second quarter. China’s export volume growth slowed and its trade surplus fell in September. In addition, commodity prices keep climbing, there is an economic bubble, credit is out of balance and critical structural problems are being covered up. The government is now employing administrative guidance in place of market mechanisms, but this cannot effectively resolve the country’s current problems. There are many warning signs, and they are not to be taken lightly.

  International developments give no cause for optimism either. The US economy is suffering a downturn. Europe’s debt crisis is weighing heavily on the continent’s economy, which is likely to remain depressed for the next two to three years. China’s policy of stimulating domestic demand may be unable to offset the influence of a deteriorating external economic environment. The pressure for economic reform will grow stronger in the wake of adjustments in China’s internal economic structure.

  Will the eventual result be a soft or hard landing? To answer this question, we will have to judge the situation according to subjective and objective changes as they happen. However, what is certain is that it will be hard for China to maintain the high economic growth it has known in recent years. In other words, judging by the changes in several economic variables, earning foreign currency from cheap exports will no longer be the mainstay of China’s economy. Reconstruction will be called for. For example, the structure of the manufacturing industry needs to be thoroughly adjusted and rebuilt. Financial markets will need to be reformed and opened up, and underground finance will have to be brought above ground.

  The line between public and private economies will have to be redrawn, but how? There are so many things that need to be done. China will soon have a change of leadership and it remains to be seen how the country’s new leaders will plan for the future.

  Norman Yin is a professor of financial studies at National Chengchi University.

  Translated by Eddy Chang
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